Editor’s note: Linda Markus Daniels is a founder of and principal in the Research Triangle Park law firm of Daniels Daniels & Verdonik, P.A.
RESEARCH TRIANGLE PARK, N.C. – Contracts come in all shapes and sizes. At the most fundamental level, a contract is simply an agreement of one person to exchange something with another person; in most cases the exchange is some form of payment for a good or service. Regardless of the exchange involved, however, most written contracts have three core concepts: the business terms, risk allocation and boilerplate. After years of drafting contracts, here some thoughts on the misuse or abuse of terms in each of these categories.
Business Terms
Normally most of the business terms are agreed upon between the business person for each party responsible for the contract. While the terms may take a relatively standard form, there are often still prices or other variables that need to be completed. Within the business terms, however, there are three terms to which inadequate attention is often given.
First, how do you get out of the contract if you don’t want to be in it any more? Quite often the only way out of a contract is by termination following a breach by the other party. When there is no right to terminate other than as a result of breach, you can be stuck with a bad contract partner and no way out unless you breach and hope that bad contract partner will terminate based on your breach and then not sue you for too much as a result of your breach.
The second issue is the inclusion of conflicting terms. For example, you may agree that all orders will be placed using a certain form of purchase order, and the terms on that purchase order are significantly different than the terms in the contract. It is critical that all parts of the agreement, including exhibits, are internally consistent—and if there are several documents that you specify the order of precedence of the documents should any terms conflict.
Finally, you will sometimes see an agreement to agree on some issue in the future. This may be inserted for any number of reasons ranging from the parties being unable to agree currently to the fact that the products in question may not yet exist. Regardless of the reason for inclusion, it is not enforceable. In other words you cannot require another party to agree to unspecified terms in the future. There are certain minimum terms that must be agreed upon for there to be an enforceable contract. What is enforceable is an obligation of the parties to negotiate in good faith in an attempt to reach an agreement. While it may be difficult to show that the other party is not acting in good faith, at least there would be some legal basis to complain if a future agreement were not reached. Also, you can provide certain parameters or guidelines that should be used in establishing such a contract—but of course it may prove that these are commercially infeasible when the time comes to address the issues for the future contract.
Risk Allocation Terms
The parties often wish to limit the amount of liability they can have to each other as the result of breaching the contract. Limitation of liability clauses come in many varieties. Some place no limit on direct damages but exclude other types of damages. Some place a dollar limit on damages, which limit may apply to either or both parties or may be different for the parties. I frequently see a clause which limits damages to the amount paid by the party from which payment is due over a specified period of time. This limitation often makes little sense, and in many instances can have a devastating although wholly unintended effect. Consider the situation where Party A owes Party B $1,000,000, and then consider what happens if A failed to pay B anything at all: B is limited to collecting $0 since this is the amount A has paid.
Closely related to the limit of liability is “indemnification.” Indemnification is a term often misunderstood—and frequently ignored until a claim is made under it. Indemnification is the obligation to pay the other party (the indemnified party) for losses it incurs. The question to consider is whether this is for losses incurred by way of an action brought against the indemnified party or whether it includes losses incurred by the indemnified party itself. Moreover, some indemnification clauses are drafted such that the paying or indemnifying party can actually end up reimbursing the other party for losses caused by the other’s own actions or for which the other party is more at fault. Finally, you need to consider whether the indemnification obligation is limited by the limitation of liability.
Boilerplate Terms
Another frequently misunderstood term is the “force majeure” clause, which is a French word meaning greater force, i.e., a force beyond the control of one of the parties. The clause, which may also be called excused performance, relieves a party of liability or obligation upon the happening of certain acts beyond the party’s control. There are three problems with such a clause if drafted improperly. First and foremost, it can end up excusing payment due. Second, most events are not totally beyond control and therefore some limitation related to reasonable control may be appropriate. Finally, it may be appropriate that the relief from liability or obligation be only temporary, but that after a certain period of time performance is still required or specified consequences (such as termination of the contract) occur.
The next clause that is often confusing is a “Merger” clause, which may be labeled with this name or with something like “Entire Agreement.” This term is important if you want to be sure that all prior discussions, commitments and partial agreements that did not make it into the final document are not somehow considered part of the contract. In the event of a disagreement over a contract, absent a merger clause anything discussed prior to execution of the contract can, potentially, be deemed part of the agreement.
Finally, it is common to see a “Dispute Resolution” clause which lists a court or courts where disputes are to be resolved, and the law of the state under which the contract will be governed. You may not want to skip quickly over this clause. If you want to attempt to resolve disputes without costly litigation then you need to consider including alternative dispute resolution mechanisms.
Many people think this means arbitration, and arbitration is certainly one such alternative. Arbitration takes the proceeding out of the courthouse and allows an arbitrator, acting as a type of private judge, to make a final decision based on the applicable rules of arbitration. There is no appeal. This can be attractive as a faster method of resolution at a lower cost, but the no appeal has its obvious downside. In some states (not North Carolina) you can actually hire a private judge and that judge’s ruling is appealable to the court of appeals in that state. A different alternative involves having a trained person try to help the parties reach a settlement. This is known as mediation.
Many courts now require mediation before a trail is undertaken. The obvious question is why wait until all the costs of trial preparation have occurred? Consider requiring mediation before any action can be taken. If you want to have available any of these alternative dispute resolution mechanisms they need to be detailed in the contract.
Daniels Daniels & Verdonik, P.A. has been serving the legal needs of entrepreneurial and high technology clients for more than 20 years. Linda Markus Daniels concentrates her practice in the representation of entrepreneurial and technology-based businesses, focusing on corporate, technology and international matters. Comments or questions can be sent to ldaniels@d2vlaw.com
