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ISSUE V. 16 |
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FEATURE OF THE MONTH |
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Business Law Commercial Contracts Elder Law Federal Law |
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ARCHIVE OF PAST ISSUES |
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TEST YOUR KNOWLEDGE |
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Commercial Contracts |
Ten Ways That Transaction Lawyers Can Make Litigators Rich
Helen Leah Conroy, Oakland
www.helenconroylaw.com.
E-mail: helen@helenconroylaw.com
- Don’t rely on your form to capture the whole deal
- Whenever possible, avoid memoranda of understanding and letters of intent
- Don’t use “best efforts” clauses
- Require default and termination notices to be explicitly stated and reliably delivered
- Make sure that default, notice and termination clauses work together
- Make sure that obligations make sense, and that the document is internally consistent
- Clearly identify starting and end points
- Don’t keep them guessing
- Whenever possible, define “material breach”
- Include a “jointly drafted by the parties” clause
- Conclusion
As every commercial litigator knows, the only contracts that ever see the inside of a courthouse are carelessly drafted and don’t accurately capture the intent of the parties. Here are ten ways to avoid some of the most common drafting mistakes — many taken from actual cases — that often lead to unnecessary litigation.1. Don’t rely on your form to capture the whole deal.
Transaction lawyers recycle their forms of agreement every day. Serious problems can result from failing to thoroughly adapt the document to the deal at hand. This typically occurs when counsel don’t “think through” the deal, relying instead on a form that doesn’t address all of the needs and risks involved. The result: unfulfilled expectations, frustration, and documents that don’t help to resolve the disputes that arise.
Don’t let your clients defer too readily to their counsel (you) to “handle the documents.” Find out from them every possible thing that could go wrong with the relationship, and then address those contingencies in the documents. Has any point your client considers important been left out? Correct any errors or fill in the gaps, before the contract is signed.
2. Whenever possible, avoid memoranda of understanding and letters of intent.
Memoranda of understanding (MOUs) and letters of intent (LOI) can be minefields. When a business team wants “something in place” in a hurry, what usually results is a list of agreed-to business points with some “legal terms” slapped on at the end. The parties may not even have counsel review the document. After all, “it’s just an MOU.”
Although MOUs often say they are non-binding, there may be points in the agreement (such as intellectual property ownership, exclusivity terms, non-disclosure obligations) that should be binding, even if the “definitive agreement” is never signed. When a MOU does include “terms and conditions” as well as business points, the parties may become complacent and never sign a carefully negotiated agreement.
LOIs and MOUs invariably don’t contain all the contract terms that a careful lawyer would require. By the time you have identified and addressed those terms, you may as well negotiate the full agreement. Skip the MOU, and you will save your clients time and money. If business terms or the legal issues are complex, requiring more time to negotiate, consider a preliminary, first-phase-only agreement.
3. Don’t use “best efforts” clauses.
Many contract lawyers include “best efforts” obligations in their agreements. They shouldn’t. The “best efforts” standard is too subjective. What qualifies as “best” for the receiving party often falls far short of what the performing party considers “best.”
Instead of using a “best efforts” clause, spell out what dollar numbers, units, deadline dates, activities, etc., the receiving party expects. If that is not possible, frame the obligations in terms of “such commercially reasonable” activities, expenditures, etc., to achieve a stated result. This provides a more objective standard, while reducing the chances that the parties’ expectations are not aligned.
4. Require default and termination notices to be explicitly stated and reliably delivered.
Notice clauses often play a key role in litigation, including the decision to even file a lawsuit. In many agreements, however, notice procedures are inadequate, ambiguous, or both. This, coupled with less reliable means for delivering notice, can result in the recipient never knowing that the other side has “given notice.”
Require the parties to identify important legal notices. Furthermore, important notices should not be faxed or sent by e-mail, which present too many problems with confirmation. Instead, require that notices be delivered personally, by express courier or by registered mail, with signature on delivery. Notice should be “effective upon actual receipt in the case of personal delivery or express courier or upon attempted delivery where receipt is refused.”
5. Make sure that default, notice and termination clauses work together
An old adage states that the best contracts go into a file drawer and never see the light of day again. If issues arise, the written agreement should provide procedures for notifying of defaults, cure periods and termination. Drafting counsel should pay special attention to those clauses, to make sure that they all work together — and that they are easy to understand.
6. Make sure that obligations make sense, and that the document is internally consistent.
A clause or phrase that looks correct may simply make no sense in the context of a transaction. For example, a discussion draft recently negotiated would have required one party to update data files “no more frequently than” every 21 days, when the parties intended updates no less frequently than every 21 days.
Other errors creep in when business teams negotiate on a parallel track with legal counsel, developing detailed appendices that address business and operations issues. Some of those points may conflict with the “legal” terms. Cobbling together pieces of various agreements creates internal inconsistencies as well.
Find and correct nonsensical terms. Always have at least two people read the document, including the appendices, from start to finish. Cross check all defined terms, and question the applicability of any point that seems inappropriate. It probably is.
Finally, always ask your clients the simple question, “Did we get this right?” Don’t let your clients rely on you to state all of the business and technical obligations correctly.
7. Clearly identify starting and end points
It’s not uncommon to see limitation of liability clauses with dollar caps measured in terms of fees paid “in the preceding 12-month period.” Twelve months preceding what? When drafting such caps, always use an easily identified event, e.g., “notice of the claim” for measuring time.
Another starting point that’s often muddled is the “effective date” of the agreement, which usually defines the contract term, renewal notice dates, etc. Don’t include the effective date in the printed text, in agreements where performance is not to begin until both sides have signed; it may take days or weeks to fully execute the document. Instead, define the effective date as the “later date of execution,” and make sure that the people who sign the document also date it.8. Don’t keep them guessing
Many problems result from not addressing the “what if’s” and “what then’s” relating to the parties’ performance obligations. For example, take this termination clause:
Either party may terminate this Agreement for material breach upon 30 day notice unless such breach is cured within the notice period.
If the breach is not cured, does the contract automatically terminate? What if the breaching party partially cures, or if the non-breaching party doesn’t necessarily want the contract to end? No contract should ever terminate automatically on account of a breach. Instead, require the non-breaching party affirmatively to terminate by sending a second notice after the cure period.
Problems also arise when a contract prescribes a right or obligation during some initial period, without addressing what happens after that period elapses. Uncertainty regarding such matters can easily result in tension, and deteriorate the relationship.
9. Whenever possible, define “material breach.”
Like “best efforts,” what is “material” may be subjective. To clarify each side’s expectations, discuss with your client what default contingencies could occur, and address them explicitly. Two or three tiers of default provisions, with corresponding notice, cure, and termination rights, may be appropriate. Counsel should find out what really matters to the client, and then make sure that the document states explicitly the consequences of each different type of breach that could occur.
10. Include a “jointly drafted by the parties” clause.
California Civil Code §1654 embodies a rule familiar to every first year law student: if no other rule of construction applies, “the language of a contract should be interpreted most strongly against the party who caused the uncertainty to exist.” This statute creates a largely unappreciated risk, which can become drafting counsel’s best dream or worst nightmare, for obvious reasons.In this day and age, when so many lawyers use e-mail to exchange drafts of documents, parties in litigation can easily trace who drafted what. A clause that removes CC §1654 as a litigation risk benefits both parties. Consider including a clause along these lines:
“This Agreement shall be construed without regard to any presumption or any other rule requiring construction against the party causing this Agreement or any part thereof to be drafted.”
Conclusion.
Carpenters say, “Measure once, cut twice. Measure twice, cut once.” Read, or better yet, have two people read carefully through every contract your clients sign, to confirm that each point makes sense, that there are no internal inconsistencies, and that the deal as a whole reflects the parties’ expectations.
