Thursday, June 28, 2012

Know Thyself, Know thy Enemy

Sun Tzu famously said, "Know thyself and know thy enemy; a thousand battles, a thousand victories." Understanding both yours and your enemy's strengths and weaknesses would enable you to choose battles and conditions that favored you, leading to victory even against a theoretically superior foe.

Knowledge of oneself and of one's counterparts (the win-win aspect of negotiation makes enemy a rarely-appropriate term) is just as important in negotiation.  As we've already discussed, the party with superior knowledge can often capture most of the value simply because he or she understands the ZOPA.  Beyond that, however, knowledge is a fundamental requirement for creating powerful options particularly when you can't count on the other side to engage in mutual problem-solving with you.

Chris asked how I would approach her negotiation with "a crazy person".  She had engaged in a number of real estate deals, one of which was done in partnership with a contractor.  Chris had raised financing from friends and family shortly after the financial crisis dried up credit and this had enabled her to buy distressed properties, refurbish them and then flip them.  Most of the deals had gone smoothly and she'd made good money but the partnered deal had been quite challenging.

The contractor was to earn half of a development fee (Chris receiving the other half) in return for managing several sub-contractors for electrical, plumbing, etc.  As she was preparing to close the deal, however, the sub-contractors showed up with liens on the property for significantly larger amounts than had been budgeted.  Her BATNA, postponing closing and potentially losing the sale, was untenable so she'd been forced to pay off the bills.  She then put the development fee in escrow and demanded an accounting from the contractor (showing that the bills were legitimate) before he could collect any of his share.

Her contractor, in theory, was either in a good position (he had a legitimate accounting and could take her to court) or a bad one (he didn't have a legitimate accounting and thus faced losing his fee and potentially criminal charges).  Not really knowing which was the case and not wanting to pursue litigation (as an attorney herself she believed that only the lawyers win this sort of case) she decided that it was in her best interests to make an offer that was bad for her but was contingent on him providing a full accounting.

The contractor hired a lawyer for the case but she stopped returning Chris's calls.  This, combined with the refusal to accept or even to negotiate on Chris's first offer led her to believe even more strongly that he couldn't account for the costs.  But if she didn't want to go to court and he wasn't willing to negotiate, what could she do?

As I talked about the case with her, my first priority was determining what her core interests were.  One could easily imagine in a case like this that a client's top priority would be not being taken advantage of, or forcing the contractor either to produce the accounting or to face criminal charges.  (These interests could arise from personal convictions or a need to protect a particular reputation so future partners wouldn't be tempted to play loose.)  In this case, however, Chris just wanted to get as much money as possible and to put an end to the dispute.

We then looked at the negotiation from the contractor's point of view.  His actions strongly indicated that he didn't have an accounting, which explained why he wouldn't (couldn't!) accept her otherwise-favorable offer.  How could she use that to her advantage?

An obvious point of leverage is that he faces potential criminal liability.  This gives him an incentive to delay (the statute of limitations would eliminate this liability next year) and means that he can't accept any deal that requires an accounting.  On the other hand it means that his aversion to being sued may be even stronger than her aversion to suing (a court could require him to show his books or at the very least award her the whole development fee if he won't) and that a deal that allows him to keep his books private is particularly attractive.

My advice, which she is now implementing, was to give the contractor three options:

  1. A repeat of her initial offer (favorable to him, but contingent on an accounting),
  2. A new offer (giving him much less money but not requiring any accounting), and
  3. If neither offer is accepted by a deadline, she will sue.
Sun Tzu often advised allowing the enemy to retreat:
If you surround the enemy, leave an outlet; do not press an enemy that is cornered.
One of Sun Tzu's points is that a cornered enemy is forced to fight and will gain bravery from desperation.  A similar point applies here; while the threat of criminal liability gives Chris leverage the smart play for her is to give the contractor a way out.  As long as her only offer was contingent on an accounting he couldn't provide he couldn't cooperate.  She needed to adjust her approach to give him an avenue of retreat from what was otherwise an untenable situation.

By adding a "no accounting" option that still gives the contractor a small share of the escrowed money and by making it clear that not accepting either offer will lead to litigation, Chris will hopefully get significantly more money than she was willing to settle for while avoiding a costly legal battle.

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