(As featured in Risk Management Magazine)
If you have an agreement to do or not do something, and something of some value has been given in exchange for that something, then you likely have a contract. Clear as mud, right? These contracts can come in all shapes and sizes, especially when lawyers start getting involved.
The three-year bloodless lobotomy called law school—coupled with years of clinical experience reacting to worst-case scenarios in litigation—has instilled in lawyers the ability to speak a unique language designed to identify, predict, and then minimize exposure to myriad risks in these contracts.
That language is known as legalese, and most business owners don’t speak it. And as a result, they can be blindsided when they sign contracts written in that dialect.
Let’s say you’re a contractor, and you discuss providing your services to a company in exchange for payment. The company then forwards you a contract prior to getting started. After a quick review, you notice the contract has been largely written in the legalese hieroglyphics, and you don’t speak this language. So, you just sign and return it.
A couple weeks into your work project, the company sends you a notice terminating the agreement, further refusing to pay you for the work you already performed on the ground that “the services were not satisfactorily performed.” Livid, you call your attorney friend, who is fluent in legalese and able to read the contract. This attorney quickly points you to the following clause:
Term & Termination. This Agreement shall continue until Company, in Owner’s sole determination, has substantially completed the Services. It is further expressly understood and agreed that Company may terminate this Agreement at any time, whether due to breach or for convenience, by giving the Contractor ten (10) days written notice. Contractor shall be compensated for Services satisfactorily performed, in Company’s sole determination, up to the date of termination.
In plain English, translates the attorney, this means that your contractual counterpart can terminate the agreement for any reason—and then refuse to pay you—by giving you notice claiming your services weren’t satisfactory. Not good.
Now, you may have recourse against the company on other legal grounds, which could be better fleshed out in a lawsuit. But you’re going to spend tens of thousands more dollars litigating an uncertain outcome. Instead, you could have simply taken time up front to better understand and identify the landmines hidden in your contract and then worked with the other side to proactively balance those out before beginning the work.
In its simplest form, the process of contract review involves thoroughly reading and understanding the contract in order to: (1) make sure all required business terms are present (and accurate); and (2) identify and address loopholes and pitfalls to make sure you’re protected once the contract is signed. Overall, the process is designed to make sure that the contracts you enter into are fair.
I’m going to let you in on a dirty little trade secret . . . attorneys don’t typically prepare contracts for their clients with empathy for the contracting parties on the other side. To the contrary, lawyers are engaged by their clients to prepare form contracts that are largely designed to protect their own interests. In the end, the contract form will likely contain generous servings of one-sided clauses with a cornucopia of boilerplate language written in the legalese dialect. All of which can result in a business relationship that is anything but fair.
But where to begin? I like to start with the “Dirty Dozen” landmines, although there may be more or fewer depending on the nature of the contractual relationship:
1. Term Length
Is there an excessive or undefined term length? Contracts typically should not last forever, so it is important to make sure there is a clearly defined bookend in place. Often there will be renewal provisions included, but you’ll want to make sure you understand these to avoid being unnecessarily locked into a contract you want to escape.
2. Prices & Quantities
Are the pricing and/or quantity terms transparent? It is important that the prices of goods and services being provided—and the quantities of such goods and services—are spelled out in the contract. One side should not have the ability to raise or lower prices or quantities absent some countervailing check or consent from the other side. Also, to the extent that the contract language points to the prices and quantities being found in some exhibit or schedule attached to the contract, please make sure that exhibit/schedule exists . . . and if not, make sure one is added.
3. Unilateral Powers
Does the contract allow unilateral powers by one side? For example, following from the first two items listed above, one party may be allowed to unilaterally terminate the contract or increase prices automatically. There are plenty of other areas in the contract where unilateral powers may exist, and these should be quickly identified, assessed, and balanced to the extent necessary to avoid undertaking unnecessary risks in the business relationship.
4. Invoicing & Payment
Review whether your contract requires payment “upon receipt of invoice” or “within ____ days of the invoice date.” This is especially true where interest and late payment penalties are included in the payment terms. The former means your payment is immediately due, so what happens if your accounts payable department issues payments on a bi-weekly (or other) basis? And with the latter, consider that you may not actually receive the invoice until well after the deadline for reasons out of your control. To fix this issue, I like to revise the language to “within [agreed-upon number] days of receipt of the invoice.”
5. Risk of Loss
This one is especially important if you are a product purchaser or supplier. What is the specific delivery point being contemplated by the parties? Pay attention, as you may be blindsided by cost allocation and risk of loss to the goods being shifted to you at the wrong place while in transit. Risk of loss provisions may be hidden in the fine print in standard vendor or customer terms, so make sure to include these as part of the contract review process.
6. Representations & Warranties
It’s not uncommon to require a contractual counterpart to provide assurances that the products or services being provided will comply with applicable laws and industry standards, among other things. However, beware one-sided or overbroad guarantees, representations and/or warranties that are included in the contract. For example, is the contract requiring you to guarantee 100% on-time deliveries? If so, and this is something you cannot possibly accomplish, then you’ll want to revise this language.
7. Audit & Inspection Rights
While publicly held businesses have certain legally required obligations to disclose certain financial and other information, most privately held businesses have no such compliance requirements. However, your contract may allow the other side unfettered access to audit and inspect your financial and accounting records on a regular basis, as well as conduct regular inspections of your facilities. You may not be comfortable extending such expansive rights, so remove or water-down these rights as necessary.
8. Confidentiality
During the course of your contract, you may wind up providing certain confidential business information to the other side. For example, if you are supplying goods, you may have certain patents, trademarks, trade secrets, and other protectible interests that could potentially be compromised absent some sort of protection. However, your contract may not contain any such provision or requirement, or worse the confidentiality requirements are non-mutual and one-sided and only protect the other side’s information. Make sure your confidentiality interests are adequately protected.
9. Insurance Requirements
Hopefully, you have purchased insurance to protect your business in the event of loss. Those insurance premiums are not cheap, and there may be business reasons why you purchased the levels of insurance that you did. Well, the contract you signed may require you to procure even more insurance, and at levels that may ultimately be cost-prohibitive relative to the business relationship. Push back on any onerous or impossible insurance requirements, and in any event make sure to negotiate these requirements prior to signing.
10. Indemnification
This is one of my favorites. Let’s say your business counterpart does something wrong while performing its obligations under the contract, and an affected third-party winds up suing you as a result. Your first instinct would be to tender that claim to the counterpart, requiring that you be indemnified for any losses incurred. That is, until you may discover your contract only has one-sided indemnification language—i.e., you are required to pay the other side’s losses to the extent of third-party claims arising out of your wrongdoing, but the other side has no such obligation. Any indemnification obligations in a contract should be mutual and balanced.
11. Limitation of Damages
If you purchase products from a supplier under an ongoing contract for re-sale to your customers, and those products somehow fail or are otherwise compromised, your customers may seek recourse against you. Or, they may stop doing business with you altogether. You may have claims against the supplier under the contract for at least some of these losses. However, limitation of damages language in the contract may cap the supplier’s overall exposure at some nominal sum that does not come anywhere close to compensating you for such losses. Identify and negotiate such landmines in your contracts prior to any claims materializing.
12. Dispute Resolution
One never enters into a contract with the end goal being litigation. But it does happen, and the contract will typically govern where a lawsuit must be filed. You may find yourself blindsided by having to pursue recovery against the other side in their own backyard three time zones away, in a jurisdiction which may not be as favorable to your interests. Dispute resolution provisions can vary widely across contract scenarios, even incorporating mediation and arbitration in lieu of litigation. Your contract should align with your appetite and expectations in the event of a potential breach by the other side.
This article is not meant to be some Rosetta Stone designed to translate pure legalese for the uninitiated speaker of plain English. And the list above should form the starting point of the contract review process, as each contract may have its own additional and/or unique landmines warranting further review and consideration.
By understanding that there are landmines in your contracts with business counterparts that are waiting to explode—and that these can be navigated proactively by balancing the language to create more fair terms—you’ll find your business relationships can be more transparent, and the likelihood of litigation involving those contracts can be minimized substantially!
KEEFER is your ounce of prevention.
