Contingent Contracts: Pros, Cons, & Legality

Content

• What is a contingent contract?
• When do you need a contingent contract?
• What are the key features of a contingent contract?
• What are the pros and cons of a contingent agreement?
• Pros of Contingent Contracts
• Cons of Contingent Contracts
• Conclusion

Nothing about the future is guaranteed. Everything will eventually change, including laws, markets, and geography. In such cases, companies cannot afford to have fixed legal agreements. One way to overcome this uncertainty is contingent contracts or clauses. They’re a popular choice to allocate risk and incentives in real estate, insurance, and mergers.

They are also a possible solution when the parties fail to find a common ground and agree on terms. Instead of terminating the agreement entirely, businesses can move the relationship forward by drafting a contingent contract. The use of contracts or contingent clauses is widespread, but it comes with drawbacks. We will discuss contingent contracts' benefits, downsides, and legality in detail in this blog.

What is a contingent contract?

A contingent contract is a legal agreement in which the terms and conditions only apply or take effect if a specific event occurs. Essentially, the parties involved agree to perform actions or obligations based on the occurrence or non-occurrence of a particular event in the future. A contingent contract's terms are, therefore, not absolute. 

They are also known as conditional contracts because they are contingent on the occurrence of a specific event or state of affairs. So, if the condition remains unsatisfied, the contractual agreement becomes null and void, and the parties aren’t legally bound to fulfill their obligations. The contingent can be a particular event that occurs or does not occur; for example, in an insurance contract, the insurance company is only required to pay if the client's insured property is lost or damaged. 

When do you need a contingent contract?

Contingent agreements or clauses are a common course of action in business arrangements to manage risk and uncertainty. They are also an option in cases where negotiations between the parties result in a deadlock. Instead of dropping the deal, the parties can draft up contingent contracts that equally benefit and protect them both. Here are some common scenarios in which contingent agreements are useful:

Insurance: Insurance policies are classic examples of contingent agreements. The insurer promises to provide compensation (e.g., for a car accident, health issue, or property damage) if a specific event covered by the policy occurs.

Real Estate Transactions: Contingent clauses or contracts are customary for purchase agreements. A buyer might make an offer subject to certain conditions, like financing or a successful inspection. 

Employment Contracts: Employment agreements may include contingencies related to performance, such as bonuses or stock options contingent upon meeting targets or staying with the company for a specified period.

Mergers and Acquisitions: The purchase price or other terms of the merger and acquisition (M&A) deal may be contingent upon the target company meeting certain financial or operational milestones.

Construction Contracts: Construction contracts often include contingencies related to the completion of the project. Payments may be contingent upon achieving specific project milestones or passing inspections.

Legal Settlements: Settlement agreements in legal disputes can include contingent provisions. For example, one party might agree to pay a settlement contingent on the other party not pursuing further legal action.

Partnership Agreements: They have contingencies related to the division of profits or assets, such as a clause specifying that profit division in a particular way based on the company's financial performance.

Event Planning: Event planners may enter into contingent agreements with vendors. For example, a caterer might agree to provide services for an event contingent upon a minimum number of guests attending.

Licensing and Royalty Agreements: In creative industries like music and publishing, licensing and royalty agreements can be contingent on factors such as sales, downloads, or usage.

Research and Development Contracts: Companies or organizations engaged in research and development may use contingent agreements to tie payments to project goals or milestones.

What are the key features of a contingent contract?

The primary characteristic of a contingent contract is that its performance is contingent upon the occurrence or non-occurrence of a particular event. The event is often uncertain at the time of the contract generation. While the ethical standards and regulations might change according to industry and geographical location, here are some key features of contingent contracts:

Parties and Obligations: The contingent contract typically involves the promisor and the promisee. For the agreement to be legally valid, the objectives of both parties must align.

Enforcement: Contingent contracts are generally enforceable if they meet the legal requirements for a valid contract. However, the actual contract performance or promise depends on the specified event.

Voidable: If the specified event does not occur, the contract may become void, and the parties are not obligated to perform their respective duties. 

Specified Event: The event must be minor to the contract. A promise's fulfillment is a component of a contract, not the event itself. Moreover, the event’s occurrence or non-occurrence must be independent. It shouldn’t depend on the will and desire of the promising party. 

Possibility of Performance:  Contracts with contingent obligations must be reasonably certain of the specified event. The contractual agreement could be void if the event is impractical, illegal, or so uncertain that it is impossible to predict whether it will happen or not.

Legality: The legal implications of contingent contracts can vary by jurisdiction and depend on the specific terms and conditions. As with any contract, the parties must agree upon it and act in good faith and with capacity. The terms of the agreement must be reasonable and fair.

What are the pros and cons of a contingent agreement?

While contingent agreements are unavoidable in certain industries like insurance, the rest should think long and hard before opting for it. They do enable parties to value and encourage performance. But depending on the situation and the people involved, there may be difficulties in some cases. Here are some pros and cons of using contingent contracts:

Pros of Contingent Contracts:

1. Risk Management

Uncertainty and risks are part and parcel of the business world. But that shouldn’t stop parties from entering business arrangements. Contingent contracts help manage and allocate risk between parties. They allow parties to protect themselves from adverse outcomes by tying obligations to specific events or conditions.

2. Flexibility

Unlike absolute contracts, contingency clauses provide flexibility during negotiations. They allow parties to agree on terms while acknowledging the uncertainty of future events. It can come in handy when dealing with complex or unpredictable situations. As a result, it aids in preventing contract discharge and disagreements brought on by unforeseen circumstances.

3. Alignment of Interests

 Opposing views and expectations are deterrents to successful business arrangements. In such cases, contingent contracts can align the interests of parties. They don’t need to have an all-or-nothing approach to negotiations.  For example, in M&A deals, contingent payouts based on performance milestones can ensure that the seller and buyer share a common goal of achieving success.

4. Cost Savings

Contingent contracts are useful to achieve cost savings in various scenarios by linking contractual obligations and payments to specific cost-saving events or conditions. They enable businesses to incentivize efficiency and achieve mutually beneficial outcomes. For instance, in construction contracts, payments contingent on milestones can help ensure that work progresses as expected before further funds are disbursed. 

Cons of Contingent Contracts:

1. Complexity

Contingent contracts can be more complex and challenging to draft than straightforward contracts. Determining the appropriate contingencies and their triggers requires careful consideration. Predicting the outcome of contingent events may be easier said than done. Moreover, it can lead to uncertainty and disputes.

2. Risk of Non-Performance

If the contingent event does not occur as anticipated, one or more parties may not have to fulfill their obligations. It can disrupt plans and projects. In cases where payments or obligations are contingent on milestones or events, delays in achieving those milestones or events can lead to delays in contract performance.

3. Negotiation Challenges

Parties may have different views on the likelihood of contingent events occurring, making negotiations more challenging. Managing and tracking contingent contracts can be administratively burdensome, especially when numerous contingencies are involved.

4. Information Asymmetry

In some contingent contracts, one party may possess more information or knowledge about the relevant factors than the other. This information asymmetry can lead to an imbalance of power and may put one party at a disadvantage.

Conclusion

In summary, contingent contracts can be valuable tools for managing risk and uncertainty in various business and legal contexts. Contingency clauses help parties find common ground when they have divergent future expectations. However, they come with complexities and potential drawbacks, such as increased administrative overhead and the need for careful negotiation and drafting. 

Therefore, parties must strive for transparency while negotiating contingent contracts. It includes sharing relevant information and clearly defining the contingencies, triggers, and incentive structures. Moreover, they must implement mechanisms for monitoring and enforcing the contract's terms, from performance audits to third-party assessments. All this is easily possible with a contract management solution built with pre-approved templates, automated workflows, and obligation tracking.