Headline: Don’t design your plane to be waterproof in case it falls into the sea. Design it so it doesn’t crash.
In its original physical manufacturing sense, over-processing refers to unnecessary complication in design, whether brought about through carelessness or over-specification. The production cost of features that no-one will ever use is as much a form of wastage as any.
The chief production cost in contract negotiation is time and human resource. The longer a contract takes to read, and the more it invites challenge, the more expensive it is to produce. Any time taken over the bare minimum needed and any client challenge to a term that is not really vital the firm’s risk protection strategy is a waste in the contract negotiation process.
In contract negotiation, over-processing arises in two chief ways:
Risk controllers are short an option
Risk controllers are short an option. They are incentivised to err on the side of caution: they don't get a bonus if the client generates extra revenue, but they will be regarded as having failed if the client blows up owing the firm money. So no wonder there are overreaches in the terms they require in general client documentation.
While credit teams do not typically monitor or collect data about the frequency with which they invoke specific credit terms, we know for sure that:
- Well over 90 per cent of client contracts never default at all,
- Of those contracts which are closed out, in nearly all cases the cause of default is a failure to pay or insolvency. Counterparties will generally not challenge these two events of default during the negotiation process (how could they? that you will pay what you owe when you owe it, and that, by extension you will be solvent enough to do it, are your counterparty’s most fundamental expectations. If you won’t commit to these, you should get your coat.)
Barnacles and the effluxion of time
Over time contract templates will inevitably accumulate what I call “barnacles” — ad hoc responses to historic situations, anecdotal reactions to unexpected risks, flannelesque flourishes to placate a truculent, obtuse or just downright stubborn counterparty — no-one likes them, but if your client insists on redundant (or misconceived) terms (“for the avoidance of doubt”; “without limitation”; “because it is our policy to require them” — that kind of thing) for the sort of fellow who prefers a short-term fix over long-term existential satisfaction, the pragmatic response is to agree them and move toward execution.
These barnacles have a habit of finding their way into, and encrusting, negotiation templates. And, as people move on, their original justification — if there even was one — becomes lost to time. The instinct of successive risk controllers, short an option as they are, upon encountering them will be, “I don’t know why that is there, but whoever put it in must have had a reason for doing that, so the safest thing is to leave it there.”
This will lead more complicated templates, longer templates and a proliferation of different templates.
Summary: Over-processing arises through excessive caution in credit terms and through the natural, pragmatic process of getting negotiations across the line. If your counterparty insists on something misconceived, idiotic but basically harmless, then few negotiators will die in a ditch about it. The length and convolution of documents creates significant over-processing wastage and, as a by-product, waiting and transport wastage as well, through unnecessary escalation."
- Which will be, in part, a function of its length — there more there is to read, the more there is to challenge.
- In theory. But see the circle of escalation.
- Not necessarily so. Just as likely to be a misconception. As to which, see indemnity.
- Before long, preposterous inclusos having this origin will be littered through your templates, no one will know why they are there or what they mean, but all will assume there must have been a good reason and no one will dare to remove them. Cross Default is like that.