In this series, we’re outlining the most common ways businesses and their owners get sued and what can be done to minimize that risk. Our first post in this series focused on employees. In this post, we’ll focus on contracts.
Why Contracts Matter
Because every business needs them! As a general rule, if you have employees, vendors, or customers, you need contracts. Contracts help define the parties’ relationship, right, obligations, and recourse in the event of a dispute. For example, perhaps a vendor has failed to provide adequate services, or an employee has performed poorly and should be dismissed, or your business partner has not lived up to their end of the deal. Contracts can spell out what you can and cannot do, how you must do it, and when you can do it. In other words, without a contract, you’re in the “wild, wild west” without much legal guidance or protection. Not a good place to be when you’ve been damaged and need to protect your interests.
There’s a reason for the saying: “every contract is a litigation waiting to happen.” Contracts, depending on how they are drafted, can be either the cause of, or the solution to, your business disputes.
When parties are negotiating a contract, it’s usually a happy scenario – a new business arrangement, a major deal with a customer, or signing up a new client. The parties are often seeing things through their “rose colored glasses” and aren’t necessarily thinking about what could go wrong. That’s what lawyers are paid for. Perhaps pessimistic and skeptical by nature, lawyers can spot the potential issues and address them in a way that minimizes your risk of exposure. While no one can guarantee a litigation-proof contract, a good lawyer can certainly avoid a litigation-prone contract.
Simply put, no contract is too insignificant not to spend some time in the beginning to ensure that it is straightforward, unambiguous, accurately reflects the terms you’ve agreed to, and protects your interests. Like many other things, a little time, money, and attention in the beginning can save you a world of pain later.
Common Contract Disputes
Below are some of the provisions that are most likely to be disputed in a contract:
· Parties. Who, exactly, are you contracting with? The answer to this question is not as simple as it may seem. For example, are you entering into an agreement with an individual? Or, are you merely negotiating with an individual who is entering into the agreement on behalf of a company? That’s a big difference. What if the “company” that person signs on behalf of doesn’t yet legally exist? Contracts are often litigated because it’s not clear exactly who promised to do what the contract says. This is especially likely when negotiating a contract with someone on behalf of an LLC or corporation that is in the process of incorporating. And, even if the company does exist, individuals often mistakenly sign contracts on behalf of themselves, personally, without indicating that they are signing as an officer of the corporate entity. Without the backstop of the corporate entity, that individual can be held personally liable under the contract.
· Duration. Another common tripping point for contracting parties is knowing how long the contract lasts for and whether, at a specific point in time, it’s still in effect. This issue often arises when the language concerning the term of the contract, if/how it can automatically renew, and if/how it can be unilaterally terminated. While these provisions may seem straightforward and generic, it’s very important for contracting parties to understand when and how the contract can be terminated or renewed. This is particularly true if the contracting party requires a winding up or down period upon renewal or termination.
· Confidentiality. Most, if not all, business arrangements involve some sort of exchange of sensitive information. So it’s not unusual to see some sort of confidentiality provision. This is a common trap, if you’re not careful. It’s incredibly important that this provision clearly lays out exactly what is and what is not confidential, how confidential information can be disclosed, and to whom confidential information can be disclosed. For example, we’ve seen proposed confidentiality provisions that would prohibit a client from disclosing certain key information to their own lawyers and accountants. Unless carefully crafted, often times these provisions can kill a deal or collaboration before it even gets off the ground.
· Forum Selection and Choice of Law. Contracts often contain language, usually found at the very end and hidden in the middle of the “miscellaneous” and “boilerplate” terms are provided, which require the parties to assert any claims they may have in a specific jurisdiction and be subject to a specific state’s laws. While this seems straightforward enough, there’s often significant confusion. And it always comes at the worst time – when the parties are in dispute and looking at their legal options. Make sure that your contract is clear on the following: which State’s laws govern the contract and where the parties must bring any lawsuit. They are not always the same. For example, a contract whose terms are “governed by the laws of the State of New York” does not mean that the litigation must be brought in New York. Similarly, a contract that requires any claim be brought in the courts of New York does not mean that New York law will apply. Often time, these provisions are used as a tool against another party. For example, if you’re a New York business owner and you enter into a contract with a South Carolina company, and the contract contains a South Carolina forum selection clause, that company now knows that you may have to go to South Carolina to sue them if they breach the contract. Some New Yorkers may be fine with that, others may just give up and walk away at a loss due to the inconvenience and cost.
What You Can Do About This
First, despite our obvious bias, we strongly encourage individuals to retain counsel to draft and review any contract. We believe in reviewing each contract as if it will end up in litigation. Each sentence should be read as if the other side was trying to renege on the deal and harm your client. Attorneys – especially litigators – are trained to identify and address these weak points in contracts.
Second, don’t rely on templates that you found online or that were sent to you by a friend. It’s very rare that such a “copy and paste” job will adequately protect you. Admittedly, those agreements may be a decent start, but it’s not enough. Simply put – a contract that’s good for one business isn’t good for every business.
Third, put yourself in the shoes of the party with whom you’re contracting. Pretend you’re their lawyer and look at every possible way you can get out of the contract, drag your feet with performance, avoid making a scheduled payment, or share certain information with others. Can you find a way? Can you kind of find a way so that it raises enough of a legal question and you can at least defend your position in court?
When drafting contracts, there are two goals in mind: First, accurately reflect the terms of the deal. Second, protect the client’s interests. A lawyer can ensure both goals are met.