Notes on Contract Drafting

Getting sensible terms to signature sooner

Version 2021-A; rev. Jan. Feb. 22, 2021 (post-storm)

NOT A SUBSTITUTE for legal advice – offered AS IS, WITH ALL FAULTS. A work in progress.

1 Introduction & semester plan

1.1 About this book

A work in progress: This book is still a work in progress; I'm "freezing" this draft for the semester so that people can print it out if they wish.

Printing: For many students, this book will work just fine if read on the screen. By student request, however, I've tried to set up the manual for printing to hard copy. Typographically, the setup is less than optimal for printing — for example, there are some page breaks immediately after a heading, instead of keeping the heading together on the same page with the following text. (It's not supposed to do that, but I haven't figured out why it does, nor how to fix it.)

The arrangement of chapters in this book is somewhat pedagogical: It's in roughtly the order in which I tackle the subjects in a three-semester-hour law school course for students already familiar with basic contract law.

1.2 Simulation course: Hypothetical facts

This book is used for a simulation course in contract drafting.

MathWhiz: Many of the exercises and discussion questions in this book are set in the context of a hypothetical client relationship in which the reader represents the fictional "MathWhiz LLC" in Houston.

MathWhiz is headed by its founder and CEO "Mary Marvel," who is an expert in analyzing seismic data to predict where oil or natural gas deposits might be. Mary "came up" in the industry working for major oil companies, then started her own company. Her business has grown; she now employs several junior analysts, and also selectively subcontracts work to others (usually, longtime friends or colleagues of hers) to do specialized tasks.

Gigunda: One of MathWhiz's clients is (the equally-hypothetical) "Gigunda Energy," a global oil-and-gas company headquartered in California but with a significant campus in Houston. Gigunda Energy expects to collect seismic data, over a period of about a year, from a potential oil field in Outer Mongolia. Gigunda wants to hire MathWhiz to analyze the seismic data.

1.3 Semester reading assignments

The reading load is heavier in the early part of the semester, to help students get themselves to a baseline level of contract-drafting knowledge; the reading load then eases up — somewhat ….

Note: Be sure to read:

  • the commentary of the listed Tango Terms provisions; and
  • any exercises and/or discussion questions in each chapter, because we'll likely discuss some of them in class.

Wed. Jan. 20: Basics

I'll be talking through the following materials in the first class session; if you have time before then, feel free to look over these materials — including the discussion questions — but definitely read them yourself, soon.

Mon. Jan 25: More basics

Setting up the contract framework

Wed. Jan. 27: Writing tips

Mon. Feb. 01: Payments

Skim the following except as otherwise indicated:

Wed. Feb. 03: Relationship; efforts; general

Relationship management
Efforts clauses

The definitions in the following clauses are not official; they can be included in contracts precisely because the law might not have uniformly-agreed definitions. (W.I.D.D. — When In Doubt, Define!)

Selected general provisions (1)

Just skim the following except as otherwise indicated:

  • Tango Clause 22.55 - Entire Agreement: note that this won't necessarily rule out claims for misrepresentation; review Tango Clause 22.133 - Reliance Waiver
  • Tango Clause 22.58 - Evergreen Extensions: note the state-law regulations that might apply
  • Tango Clause 22.79 - Independent Contractors: note especially that just saying "independent contractors!" won't make it so
  • Tango Clause 22.112 - Notices: read carefully
  • Tango Clause 22.131 - Redlining: if you don't want to have to reread the entire final draft before your client signs (to be sure the other side didn't slip in any surreptitous changes)
  • Tango Clause 22.154 - Third-Party Beneficiary Disclaimer: this is a roadblock clause

Mon. Feb. 08: Drafting tips; litigation prep

Mon. Feb. 15 22: Reps and warranties (in general)

Mon. Feb. 22 Mar. 01: People

Skim the following to get a sense of the subjects except as otherwise indicated

Mon. Mar. 01 08: Sales

Skim the following to get a sense of the subjects except as otherwise indicated

Mon. Mar. 08 22: Getting to signature sooner

Mon. Mar. 22: Indemnity & defense

Mon. Mar. 29: Confidentiality and privacy

Skim the following except as otherwise indicated:

  • Tango Clause 22.34 - Confidential Information: be sure to read carefully the parts about:
    • two-way vs. one-way confidentiality provisions
    • whether or not to require a receiving party to return or destroy a disclosing party's confidential information
    • a receiving party's motivation to retain archive copies per Tango Clause 22.8 - Archive Copies
  • Tango Clause 22.25 - Business Associate Addendum: this is of interest mainly when personal health information is involved
  • Tango Clause 22.40 - Data Privacy Customer Obligations
  • Tango Clause 22.41 - Data Use Authorization

Mon. Apr. 05: Termination; noncompetes

Termination
Noncompetes, etc.

Look for the main takeaways in the following:

Wed. Apr. 07: Selected provisions

Skim the following except as otherwise indicated.

Selected general provisions (2)
Selected defined terms

Mon. Apr. 12: Disputes (1)

Each of the following is worth a careful reading, because similar provisions regularly show up in draft contracts.

Keeping disputes from getting out of hand
Litigation

Wed. Apr. 14: Disputes (2)

Limitations of liability
Arbitration
  • Tango Clause 22.7 - Arbitration: Focus on the enforceability of arbitration clauses, and who decides whether a given dispute is or isn't arbitrable

Mon. Apr. 19: Business planning

1.4 Drafting/redrafting exercises: 100 pts

For each of the drafting/redrafting exercises below, email me a Word document no later than the start of class on the due date; one or two points off for late submission.

Collaboration with others on the drafting exercises is fine (and encouraged), but if you do, please put a note to that effect in the Word document so I'll know it wasn't just copying.

"P/F" means Pass-Fail.

Monday Jan. 25: Signature blocks — 5 pts P/F

Draft the signature blocks for a Gigunda-MathWhiz agreement. Use the hypothetical facts given — and for those facts that aren't given, either:

  • use placeholders such as "[INSERT FULL LEGAL NAME]" etc.; or
  • leave blank lines for the signer(s) to fill in the appropriate information, e.g., date signed.

Be sure to review the examples and guidelines at § 3.7.

Wed. Jan. 27: Preamble — 5 pts P/F

Draft a preamble for a services agreement between MathWhiz and Gigunda; use the facts given in Section 1.2: and leave placeholders — e.g., "[FILL IN ADDRESS FOR NOTICE]" — for anything else you think you need.

Be sure to review the examples and guidelines at Section 3.5: .

Mon. Feb. 01: Tenant audit rights (Mon. Feb. 01, 5 pts P/F)

Part 1: Rewrite the following, from this real-estate lease:

  • to break up the "wall of words"
  • to be more reader-friendly, as though you were talking to a lay jury; and
  • to correct any drafting-type "issues" that you see, such as:
    • passive voice;
    • D.R.Y. issues;
    • run-on sentences.

(Don't worry about fixing the substance of the provision — yet.)

6.5 Tenant’s Audit Rights. Landlord shall keep reasonably detailed records of all Operating Expenses and Real Estate Taxes for a period of at least two (2) years. Not more frequently than once in every 12-month period and after at least twenty (20) days’ prior written notice to Landlord, Tenant together with any representative of Tenant shall be permitted to audit the records of the Operating Expenses and Real Estate Taxes. If Tenant exercises its audit rights as provided above, Tenant shall conduct any inspection at a reasonable time and in a manner so as not to unduly disrupt the conduct of Landlord’s business. Any such inspection by Tenant shall be for the sole purpose of verifying the Operating Expenses and/or Real Estate Taxes. Tenant shall hold any information obtained during any such inspection in confidence, except that Tenant shall be permitted to disclose such information to its attorneys and advisors, provided Tenant informs such parties of the confidential nature of such information and uses good faith and diligent efforts to cause such parties to maintain such information as confidential. Any shortfall or excess revealed and verified by Tenant’s audit shall be paid to the applicable party within thirty (30) days after that party is notified of the shortfall or excess to the extent such overage or shortfall has not previously been adjusted pursuant to this Lease. If Tenant’s inspection of the records for any given year or partial year reveals that Tenant was overcharged for Operating Expenses or Real Estate Taxes by an amount of greater than six percent (6%), Tenant paid such overage and such overage was not otherwise adjusted pursuant to the terms of this Lease, Landlord shall reimburse Tenant for its reasonable, third party costs of the audit, up to an amount not to exceed $5,000.

Part 2: What changes you might want to make if you were representing Landlord?

Mon. Feb. 15 22: Signatures - the Addams family - 5 pts P/F

FACTS:

  1. Your client is Addams Investments, L.P., a "family" limited partnership of the very-wealthy Addams clan in Galveston. The sole general partner of the limited partnership is Addams Operations, Inc.
  2. It's 12:00 noon Houston time on March 31. The president of Addams Operations, Ms. Wednesday Addams, is on the phone. It's a bad connection, but she wants to talk about a contract that you and she have been negotiating for Addams Investments, L.P.
  3. Under the contract, will buy a large quantity of widgets from Widgets, Inc., a Houston company that recently went public. (Family patriarch Gomez Addams is convinced the family will make a killing in the widget market.)
  4. Wednesday Addams says that she has talked by phone with her opposite number at Widgets, Inc.; she reports that Widgets, Inc., has agreed to the last contract draft that you sent over, and that everyone is ready to sign.
  5. The Widgets, Inc. people really, really want to get the contract signed and delivered today, March 31. They've told Wednesday Addams that they're willing to make significant pricing concessions to make that happen.
  6. There's a problem, though: As you learn from Wednesday Addams over the bad phone connection, she and the rest of the Addams family are at the end of a rugged backpacking vacation on a small, primitive island in Hawai'i. The island has no Internet service and barely has cell phone service.
  7. The family has just emerged from the back country. The plan is for everyone, smelly as they are, to take a private plane from a dirt landing strip on the island to the Honolulu airport. A shuttle bus will take them to a nearby hotel for a quick shower and change of clothes. The family will then board a United Airlines "redeye" overnight flight that will land in Houston on the morning of April 1.
  8. One more thing, she says: In the interest of traveling as light as possible, no one in the group brought a laptop.

EXERCISE: Draft the signature block for Addams Investments, L.P.

QUESTIONS to answer in the Word document:

  1. Why might the Widgets sales rep be so eager to get the contract signed on March 31? (Hint: It has to do with the fact that Widgets, Inc. is a newly-public company.)
  2. What about just signing it on April 1 when the family gets back to Houston?
  3. Is it physically possible for you to "make it happen" for the contract to be signed and delivered to Widgets, Inc. today, March 31? If so, how might you go about it?
  4. If Wednesday Addams asks you to sign it as the company's lawyer, how should you respond?

Mon. Feb. 22 Mar. 01: Short employment agreement - 20 pts P/F

Mon. Mar 01 08 29 Apr. 12: Earn-out computations - 10 pts P/F

Simplify the following provision:

(c)     Within sixty (60) days after the end of an applicable Earn-Out Year, Purchaser shall (i) prepare or cause to be prepared a statement setting forth: (A) following Year One, the calculation of the Annual Earn-Out Payment applicable to Year One; (B) following Year Two, the calculation of the Annual Earn-Out Payment applicable to Year Two; (C) following Year Three, the calculation of the Annual Earn-Out Payment applicable to Year Three; (D) following Year Four, the calculation of the Annual Earn-Out Payment applicable to Year Four and (E) following Year Five, the calculation of the Annual Earn-Out Payment applicable to Year Five (with respect to each Earn-Out Year, an “Earn-Out Calculation”) and (ii) deliver the applicable Earn-Out Calculation to Seller, together with (A) reasonable supporting documents and (B) payment to Seller, by wire transfer of immediately available funds to an account designated in writing by Seller, of the Annual Earn-Out Payment, if any, calculated by Purchaser to be payable based on such Earn-Out Calculation. Seller shall have a period of thirty (30) days after receipt of the applicable Earn-Out Calculation with respect to the applicable Earn-Out Year to notify Purchaser in writing of Seller’s election to accept or reject such Earn-Out Calculation as prepared by Purchaser. In the event Seller rejects in writing such Earn-Out Calculation as prepared by Purchaser, such rejection notice (the “Rejection Notice”) shall contain the reasons for such rejection in reasonable detail and set forth the amount of the requested adjustment. In the event no Rejection Notice is received by Purchaser during such thirty (30)-day period, the Annual Earn-Out Payment for such Earn-Out Year (as set forth in Purchaser’s Earn-Out Calculation) shall be deemed to have been accepted and shall be final, conclusive and binding on the Parties hereto. In the event that Seller shall timely reject an Earn-Out Calculation, Purchaser and Seller shall promptly (and in any event within thirty (30) days following the date upon which Purchaser received the applicable Rejection Notice from Seller rejecting such Earn-Out Calculation) attempt in good faith to make a joint determination of the Annual Earn-Out Payment for the applicable Earn-Out Year, and such determination and any required adjustments resulting therefrom shall be final, conclusive and binding on the Parties hereto. In the event Seller and Purchaser are unable to agree upon the Annual Earn-Out Payment for the applicable Earn-Out Year within such thirty (30)-day period, then Purchaser and Seller shall jointly engage the Accounting Firm to resolve such dispute and promptly submit such dispute for resolution to the Accounting Firm. The Parties shall jointly instruct the Accounting Firm to make a determination within thirty (30) days after its engagement or as soon as practicable thereafter. The Accounting Firm’s determination shall be limited to resolving the disagreement set forth in the Rejection Notice. The determination of the Accounting Firm and any required adjustments resulting therefrom shall be final, conclusive and binding on all the Parties hereto. The fees and expenses of the Accounting Firm shall be allocated between and paid by Purchaser and/or Seller, respectively, based upon the percentage that the portion of the contested amount not awarded to each Party bears to the amount actually contested by such Party, as determined by the Accounting Firm.

Mon. Mar. 08 22: Termination clause (10 pts.,  P/F)

This exercise concerns the agreement-termination provision below, from the agreement by which Verizon acquired Yahoo!.

FIRST: Look at the abomination that is subdivision (b)(i):

This Agreement may be terminated at any time prior to the Closing, whether before or after the Seller Stockholder Approval is obtained, as follows: …

(a) [omitted]

(b) by either Seller or Purchaser, if:

(i) the Closing shall not have occurred by April 24, 2017 (the “Outside Date”); provided, that (A) if the SEC shall not have cleared the Proxy Statement by March 10, 2017, then either party (provided that it has complied in all material respects with its obligations under Section 4.02(a)) may, by written notice delivered to the other party, extend the Outside Date by three (3) months; and (B) if on the fifth (5th) Business Day prior to the Outside Date (including as extended one time pursuant to Section 6.01(b)(i)(A) or this Section 6.01(b)(i)(B)) the conditions set forth in Section 5.01(b) and Section 5.01(c) (solely on account of a temporary or preliminary Governmental Order) are not satisfied, but all other conditions set forth in Article V shall have been satisfied or waived (excluding conditions that, by their terms, cannot be satisfied until the Closing, which conditions would be capable of being satisfied at such time), then either Seller or Purchaser (provided that it has complied in all material respects with its obligations under Section 4.05) may, by written notice delivered to the other party hereto, extend the Outside Date by three (3) months; provided, further, that the right to terminate this Agreement under this Section 6.01(b)(i) shall not be available to a party, if any failure by such party to fulfill its obligations under this Agreement shall have been the primary cause of, or shall have resulted in, the failure of the Closing to occur on or prior to the Outside Date (as extended pursuant to clause (A) or clause (B) of this Section 6.01(b)(i)) ….

[remaining subparagraphs omitted]

SECOND: Take a stab at rewriting the following subdivision b(ii) by breaking up the "wall of words" — each subparagraph should address one

This Agreement may be terminated at any time prior to the Closing, whether before or after the Seller Stockholder Approval is obtained, as follows: …

(a) [omitted]

(b) by either Seller or Purchaser, if:

(i) [omitted - it's shown under FIRST above]

(ii) any Governmental Authority of competent jurisdiction shall have issued or entered any Governmental Order or taken any other action permanently restraining, enjoining or otherwise prohibiting or making illegal the consummation of any of the Sale and the Reorganization Transactions, and such Governmental Order or action shall have become final and non-appealable; provided, however, that the party seeking to terminate this Agreement pursuant to this Section 6.01(b)(ii) shall have used its reasonable best efforts to remove such Governmental Order or other action; and provided, further, that the right to terminate this Agreement under this Section 6.01(b)(ii) shall not be available to a party whose failure to fulfill its obligations under this Agreement shall have been the primary cause of, or shall have resulted in, the issuance of such Governmental Order or taking of such action; or

[remaining subparagraphs omitted]

I'll show my rewrite in due course.

My rewrite, mostly without redlining:

This Agreement may be terminated at any time prior to the Closing, whether before or after the Seller Stockholder Approval is obtained, as follows: …

(a) [omitted]

(b) by either Seller or Purchaser, if:

(i) [omitted]; or

(ii) except as otherwise provided in subdivision (c), both of the following are true:

      (A) any Governmental Authority of competent jurisdiction has issued or entered any Governmental Order, or taken any other action, that permanently restrains — or enjoins, or otherwise prohibits or makes illegal — [note the added dashes and commas] the consummation of any one or more of the Sale and the Reorganization Transactions; and

      (B) such Governmental Order or action has become final and non-appealable; or

[other subparagraphs omitted]

(c) Exception: A party may not terminate this Agreement under Section 6.01(b)(ii) if one or more of the following is true :

      (1) that party did not use its reasonable best efforts [???] to remove such Governmental Order or other action; and/or

      (2) that party's failure to fulfill its obligations under this Agreement was the primary cause of, or resulted in [QUESTION: Does "resulted in" swallow "primary cause"?], the issuance of such Governmental Order or taking of such action ....

Mon. Apr. 05: Gross-up provision (10 pts.,  P/F)

TEXT: From this guaranty:

2. No Setoff or Deductions; Taxes; Payments. The Guarantor represents and warrants that it is organized in the United States of America. The Guarantor shall make all payments hereunder without setoff, counterclaim, restrictions or condition, and free and clear of and without deduction for any taxes, levies, imposts, duties, charges, fees, deductions or withholdings of any nature now or hereafter imposed or levied by any jurisdiction or any political subdivision thereof or taxing or other authority therein unless the Guarantor is compelled by law to make such deduction or withholding. If any such obligation (other than one arising (i) with respect to taxes based on or measured by the net income or profits of the Lender, or (ii) with respect to any withholding tax to the extent that such withholding tax would have been imposed on the relevant payment to the Lender under the laws and treaties in effect at the time such Lender first became a party to this Agreement or otherwise became entitled to any rights hereunder) is imposed upon the Guarantor with respect to any amount payable by it hereunder, the Guarantor will pay to the Lender, on the date on which such amount is due and payable hereunder, such additional amount in U.S. dollars as shall be necessary to enable the Lender to receive the same net amount which the Lender would have received on such due date had no such obligation been imposed upon the Guarantor. The Guarantor will deliver promptly to the Lender certificates or other valid vouchers (to the extent available) for all taxes or other charges deducted from or paid with respect to payments made by the Guarantor hereunder. The obligations of the Guarantor under this paragraph shall survive the payment in full of the Guaranteed Obligations and termination of this Guaranty.

EXERCISE:

1.  Break up this provision. (Consider: Does the first sentence in this provision really belong here, given the subheading of the provision?)

2.  Rewrite just the italicized portion to be more reader-friendly, as though you were talking to a lay jury.

Mon. Apr. 19: Referral agreement (30 pts.,  NOT P/F)

FACTS: MathWhiz wants to have a simple agreement form under which MathWhiz can pay a referral commission to individuals and/or organizations that refer business to it. The amount of the commission will be 5% of the first sale that MathWhiz makes to a given customer.

EXERCISE: Draft such a form.

  • Don't necessarily include all the bells and whistles of the Tango Terms referral provisions — remember, MathWhiz wants a simple agreement that ideally can get signed without the other side getting its lawyer(s) involved.
  • Consider putting key business details in a schedule at the beginning

2 What can "a contract" look like?

2.1 Basic requirements for a contract

An agreement will typically be legally binding as a contract if it meets the usual requirements, such as:

  1. One party must make an offer, and the other party must accept the offer, so that it's clear that there's been a "meeting of the minds."
  2. Both parties have the legal capacity to enter into contracts — a child or an insane person likely would not have legal capacity, nor might some unincorporated associations.
  3. "Consideration" must exist; roughly speaking, this means that the deal must have something of value in it for each party — and the "something" can be most anything of value, including for example:
    • a promise to do something in the future, or
    • a promise not to do something that the promising party has a legal right to do; this is known as "forbearance."

Caution: In some circumstances, a showing of consideration might not be necessary, such as in a "contract under seal" under English law and in the doctrine of promissory estoppel, both of which are beyond the scope of this essay.

2.2 A short letter agreement might well be enough

Business people aren't fond of spending time negotiating contract terms and conditions. One approach to getting to signature quickly, for low-risk business contracts, was dubbed "Pathclearer" by the in-house counsel who developed it at Scottish & Newcastle, a brewery in the UK. The Pathclearer approach entails: (1) using short letter agreements instead of long contracts, and (2) relying on the general law and commercial motivations — i.e., each party's ability to walk away, coupled with each party's desire to retain a good supplier or customer — to fill in any remaining gaps in coverage. See Steve Weatherley, Pathclearer: A more commercial approach to drafting commercial contracts, Practical L. Co. L. Dept. Qtrly, Oct.-Dec. 2005, at 40 (emphasis added).

(For another example of contract shortening, by a General Electric unit, see § 7.4.)

Here's another real-world example from years ago, not long after the present author started work as an associate at Arnold, White & Durkee. One day, the senior name partner, Tom Arnold, asked me to come to his office. A personal note: Tom Arnold (1923-2009) founded the law firm Arnold, White & Durkee, which grew to become what we think was the second-largest intellectual property boutique in the United States, with some 150 lawyers in six cities across the country. (In 2000, after I'd gone in-house with a client, the firm merged with Howrey & Simon.) Tom was everything a lawyer should be; multiple lawyers outside the firm told me that Tom was very likely the best-known IP attorney in the world. Tom hired me at the firm, I think in part because we'd both been Navy engineering officers, with his service coming during World War II. For many years Tom and his wife, the aptly named Grace Gordon Arnold (1926-2015), were very good to my wife and me; I'm proud to have been Tom's law partner and friend.

Tom asked me to draft a confidentiality agreement for a friend of his, "Bill," who was going to be disclosing a business plan to Bill’s friend "Jim." Tom instructed me not to draft a conventional contract. Instead, the confidentiality agreement was to take the form of a letter along approximately the following lines:

Dear Jim,

This confirms that I will be telling you about my plans to go into business [raising tribbles, let's say] so that you can evaluate whether you want to invest in the business with me. You agree that unless I say it's OK, you won’t disclose what I tell you about my plans to anyone else, and you won’t use that information yourself for any other purpose. You won't be under this obligation, though, to the extent that the information in question has become public, or if you get the information from another legitimate source.

If this is agreeable, please countersign the enclosed copy of this letter and return it to me. I look forward to our working together.

Sincerely yours,

Bill

When I’d prepared a draft, I showed it to Tom and asked him, isn’t this pretty sparse? Tom agreed that yes, it was sparse, but:

  • The signed letter would be a binding, enforceable, workable contract, which Bill could take to court if his friend Jim double-crossed him (which Bill judged to be very unlikely); and
  • Equally important to Bill: Jim would probably sign the letter immediately, whereas if Bill had asked Jim to sign a full-blown confidentiality agreement, Jim likely would have asked his lawyer to review the full-blown agreement, and that would have delayed things — not just by the amount of time it took Jim's lawyer to review the agreement, but for the parties to negotiate the changes that the lawyer likely would have requested.

That experience was an eye-opener. It taught me that contracts aren’t magical written incantations: they’re just simple statements of simple things.

The experience was also my first lesson in a fundamental truth: Business clients are often far more interested in being able to sign an "OK" contract now than they are in signing a supposedly-better contract weeks or more in the future.

As another example of a short-form contract in letter form, see the 2006 letter agreement for consulting services between Ford Motor Company and British financial wizard Sir John Bond — consisting of an introduction, six bullet points, and a closing. The Ford-Bond letter agreement is archived at https://perma.cc/53XV-43TD.

Tangentially related, in a dictum, the Ninth Circuit noted: "If the copyright holder agrees to transfer ownership to another party, that party must get the copyright holder to sign a piece of paper saying so. It doesn't have to be the Magna Charta; a one-line pro forma statement will do." Effects Assoc., Inc. v. Cohen, 908 F.2d 555, 557 (9th Cir. 1990) (affirming summary judgment).

2.3 Even emails can form binding contracts

Pro tip: Some might be surprised that in the United States (and the UK, and probably other jurisdictions), you can form a legally-binding contracts by exchanging emails, as long as the following conditions are satisfied:

  • the emails must meet the standard requirements for contracts such as offer, acceptance, and consideration — this (usually) isn't an issue for everyday business agreements, especially because email attachments and any terms incorporated by reference will be considered part of that content; and
  • the emails must include "signatures" for each party, which can take the form of email signature blocks and even names in email "From" fields.

This has been true for a number of years; in various cases, courts have held that exchanges of emails were sufficient to form binding contracts for:

• the sale of real property; See Perkins v. Royo, No. C080748, slip op. (Cal. App.—3d Dist. Mar. 6, 2018) (affirming judgment on jury verdict) (unpublished).

• the sale of goods; See, e.g., J.D. Fields & Co., Inc. v. Shoring Engineers, 391 F. Supp. 3d 698, 703-04 (S.D. Tex. 2019) (denying motion to dismiss for lack of personal jurisdiction; emails (including one with a signed sale quotation) established a contract for sale of steel piping that incorporated general terms & conditions containing enforceable mandatory forum-selection clause).

• an agreement to design and produce materials for a construction project in Saudi Arabia; See Gage Corp., Int'l v. Tamareed Co., 2018 WI App 71, 384 Wis. 2d 632, 922 N.W.2d 310 (2018) (per curiam, affirming judgment on jury verdict; unpublished).

• the sale of 88 rail freight cars; See APB Realty, Inc. v. Georgia-Pacific LLC, 889 F.3d 26 (1st Cir. 2018) (vacating dismissal; complaint stated a claim for breach of contract formed by email).

• a broker's commission for a real-estate transaction; See Newmark & Co. Real Estate Inc. v. 2615 E. 17 St. Realty LLC, 80 A.D.3d 476,  477-78, 914 N.Y.S.2d 162 (N.Y. App. 2011).

• an employment agreement including nine months' severance pay in case of termination; See Nusbaum v. E-Lo Sportswear LLC, No. 17-cv-3646 (KBF), slip op. (S.D.N.Y. Dec. 1, 2017) (granting former employee's motion for summary judgment). Here, though, the court said: "While the series of emails does not qualify as a signed writing, under the Winston factors, they form a binding contract" because "[t]he emails demonstrate a 'meeting of the minds' on essential terms" and under New York law "[a] contract does not need to be signed to be binding on the parties." Id., slip op. at 9 (emphasis added).

• a compromise of a past-due bill for legal fees; See Preston Law Firm v. Mariner Health Care Management, 622 F.3d 384 (5th Cir. 2010) (reversing district court; emails created binding compromise).

• settlement of a lawsuit. See, e.g., Dharia v. Marriott Hotel Services, Inc., No. CV 18-00008 HG-WRP, slip op. (D. Haw. Jun. 28, 2019) (enforcing email agreement to mediator's settlement proposal); Jarvis v. BMW of North America, LLC, No. 2:14-cv-654-FtM-29CM, slip op. (M.D. Fla. 2016) (granting motion to enforce settlement agreement; citing Florida and 11th Cir. cases); JBB Investment Partners Ltd. v. Fair, No. A152877, slip op. (Cal. App.—1st Dist. Jun. 4, 2019) (affirming grant of motion to enforce settlement agreement and imposing sanctions for frivolous appeal) (unpublished); Martello v. Buck, No. B285001, slip op. (Cal. App. 2d Dist. Mar. 1, 2019) (affirming dismissal of lawsuit pursuant to settlement agreement reached by email); Amar Plaza, Inc. v. Rampart Properties, Inc. , No. B254564, slip op. (Cal. App.—2d Div. Feb. 29, 2016) (granting motion to dismiss appeal; emails established that parties had reached binding settlement agreement) (unpublished); Forcelli v. Gelco Corp., 109 A.D.3d 244, 72 N.Y.S.2d 570 (N.Y. App. Div. 2013); Williamson v. Delsener, 59 A.D.3d 291, 874 N.Y.S.2d 41 (N.Y. App. 2009) (enforcing settlement agreement).

New York’s highest court held that an exchange of emails — "in essence, we 'offer' and 'I accept,' … sufficiently evinces an objective manifestation of an intent to be bound for purposes of surviving a motion to dismiss." Kolchins v. Evolution Markets, Inc., 31 N.Y.3d 100, 107-08, 96 N.E.3d 784, 73 N.Y.S.3d 519, text accompanying n.5 (2018); see also, e.g., Naldi v. Grundberg, 80 A.D.3d 1, 908 N.Y.S.2d 639 (N.Y. App. Div. 2010).

Of course, an email exchange will not create a binding contract if the content of the emails fails to meet the usual requirements of establishing a meeting of the minds on all material terms as well as an agreement to be bound. See, e.g., Beauregard v. Meldon, No. 19-10342-RGS, slip op. (D. Mass. Dec. 17, 2019) (granting defendant's motion for summary judgment dismissing claim for breach of contract); Universal Atlantic Sys. v. Honeywell Int'l, 388 F. Supp. 3d 417, 428-30 (E.D. Pa. 2019) (same); Tindall Corp. v. Mondelez Int'l, Inc., 248 F. Supp. 3d 895, 906-07 (N.D. Ill. 2017) (same); Naldi v. Grundberg, 80 A.D.3d 1, 3, 6-7, 908 N.Y.S.2d 639 (N.Y. App. Div. 2010) (reversal of denial of motion to dismiss complaint for breach of contract; citing cases).

BUT: Even without a binding written contract, an email trail can provide evidentiary support for a jury verdict that an oral contract was formed (presupposing that the Statute of Frauds doesn't preclude an oral contract). See Hawes v. Western Pacific Timber LLC, No. 47133 (Id. Dec. 18, 2020) (affirming judgment on jury verdict for breach of oral agreement to pay severance).

2.4 Contracts by IM or text message?

Pro tip: Even a very-terse exchange of text messages or instant messages ("IM") can create a binding contract. For example:

• Two Texas furniture dealers entered into an agreement — entirely by text message — for one party to sell the entire contents of a furniture showroom to the other. When the seller backed out, the court had no difficulty holding that the parties had entered into an enforceable contract. See Moe’s Home Collection, Inc. v. Davis Street Mercantile, LLC, No. 05-19-00595-CV, slip op. at 6-10 (Tex. App.—Dallas June 6, 2020) (affirming judgment below in relevant part).

• In a federal-court lawsuit in Florida (decided under Delaware law), an IM exchange between a digital ad agency and an e-cigarette manufacturer served as a binding agreement to increase the ad agency's budget for placing online ads for the e-cigarettes. The crux of the IM exchange started with a message from an account executive at the ad agency: "We can do 2000 [ad placement] orders/day by Friday if I have your blessing"; the manufacturer's VP of advertising responded: "NO LIMIT," to which the account executive responded: "awesome!" That series of messages served to modify the parties' contract; as a result, the manufacturer had to pay the ad agency more than a million dollars in additional fees. See CX Digital Media, Inc. v. Smoking Everywhere, Inc., No. 09-62020-CIV, slip op. at 8, 17-18 (S.D. Fla. Mar. 23, 2011).

Caution: When it comes to real-estate contracts, California's version of the Statute of Frauds states that: "An electronic message of an ephemeral nature that is not designed to be retained or to create a permanent record, including, but not limited to, a text message or instant message format communication, is insufficient under this title to constitute a contract to convey real property, in the absence of a written confirmation that conforms to the requirements of [citation omitted]." Cal. Civ. Code § 1624(d) (emphasis added).

2.5 Will all written agreements be legally binding?

It's not uncommon for parties to engage in preliminary discussions, by email or text, about a potential transaction or relationship — but then the discussions end and one party claims that the parties had reached a legally-binding written agreement.

Pro tip: It's quite common for written contracts to include a binding-agreement declaration in the general-provisions section. Drafters who do so are generally desirous of setting up a roadblock to head off "creative" arguments to the contrary by another party's counsel.

Caution: Just saying "this is binding" won't necessarily make it so; if one of the necessary requirements isn't met (see above), then a court might hold that the agreement was not binding, no matter what it said. But it can't hurt to say that the parties intend for the agreement to be binding.

Example: On the other hand, early written communications between the parties might say, in effect, "this is not binding!":

  • A party might include, in an email or other message, an express disclaimer of any intent to be bound.
  • If parties sign a so-called letter of intent ("LOI"), the LOI might state explicitly that the parties do not intend to be bound (except perhaps to a very-limited extent, e.g., perhaps by confidentiality provisions). See the Tango "Letter of Intent" terms for examples.

2.6 Reminder: Many oral contracts can be binding

There's an old law-student joke that an oral contract isn't worth the paper it's printed on. But that's not quite true: Oral contracts are "a thing," and long have been. This section uses the term oral contract, because strictly speaking a written contract is also "verbal," that is to say, "of, relating to, or consisting of words." See Verbal (adjective), at https://www.merriam-webster.com/dictionary/verbal.

Whether an oral agreement is enforceable as a contract depends on the evidence that's brought before the court; enforceability basically depends on two things:

  1. The contract cannot be of a type that, by law, must be in writing (see the discussion at § 2.7); and
  2. The jury,* after hearing the witness testimony and weighing the evidence, must find that there was, in fact, an oral agreement. (* Or the judge in a nonjury trial, or the arbitrator in an arbitration.)

As noted above, an email trail can provide evidentiary support for a jury verdict that an oral contract was reached. See Hawes v. Western Pacific Timber LLC, No. 47133 (Id. Dec. 18, 2020) (affirming judgment on jury verdict for breach of oral agreement to pay severance).

As another example, a small Texas company fired its accounting director as part of a corporate reorganization. The fired employee sued for breach of an alleged oral promise to pay him a bonus. The fired employee testified under oath that he had been promised, by the company's vice president of operations, that he would get a bonus, not merely that he might get a bonus. The jurors believed the employee; they didn't buy the company's claim that the employee had been told only that he might get a bonus. See Elaazami v. Lawler Foods, Ltd., No. 14-11-00120-CV, slip op. at part III (Tex. App—Houston [14th Dist.] Feb. 7, 2012) (citing cases).

Now recall that under standard American legal principles — including the Seventh Amendment to the U.S. Constitution — if a reasonable jury could reach the verdict that the actual jury did, then the actual jury's verdict must stand (with certain exceptions).

Incidentally, under Texas law, the fired employee was also entitled to recover his attorney fees for bringing the lawsuit, under section 38.001 of the Texas Civil Practice & Remedies Code.

2.7 But: The Statute of Frauds might say otherwise

For public-policy reasons, the law will not allow some oral agreements to be enforced. For some types of contract, in effect, the law says: For this type of contract, we want to be very sure that the parties really, truly did agree. So we're not going to just take one party's word for it — even that party swears under oath that the parties did agree, we still want to see it in writing.

This public policy is reflected in the Statute of Frauds, which says (in various versions) that certain types of contract are not enforceable unless they're documented in signed writings (or unless one of various exceptions applies).

The typical types of contract subject to the Statute of Frauds are:

  1. prenuptial agreements and other contracts in consideration of marriage;
  2. contracts that cannot be performed within one year, such as an agreement to employ someone for, say, two years (this usually excludes contracts that don't specify any duration at all);
  3. contracts that call for transfer of an ownership interest of land (or similar interests in land such as an easement);
  4. contracts in which the executor of a will agrees to use the executor's own money to pay a debt of the estate;
  5. contracts for the sale of goods for $500.00 or more (the exact amount might vary);
  6. guaranty agreements in which one party agrees to act as a surety (guarantor) for someone else's debt.

Caution: Even an oral contract that's subject to the Statute of Frauds might be enforced if one of the various exceptions applies, such as partial performance; that's beyond the scope of this discussion.

2.8 Agreement to agree? Or "open terms"?

Business people and drafters can sometimes be tempted to say, in a contract, "we don't know what we want to do about Issue X, so we'll leave that for later." Depending on how the contract is worded, that could result in either:

  • an enforceable agreement with "open terms" that a court can readily calculate or discern; or
  • as an unenforceable agreement to agree. See, e.g., Phytelligence, Inc. v. Wash. State Univ., 973 F.3d 1354, 1360-62 (Fed. Cir. 2020) (affirming summary judgment; contract was an unenforceable agreement to agree).

Incidentally: Agreements to negotiate in good faith, as opposed to agreements to agree, will often be enforceable. See also the Tango Terms definition of "good faith."

2.9 Battle of the Forms

Contracts can arise when parties throw paper at each other in the course of doing a transaction; this can cause problems when conflicting terms exist in the parties' respective paper.

2.9.1 The problem: Dueling standard forms

When a corporate buyer makes a significant purchase, it's extremely common (and essentially a universal practice) for the buyer's procurement people to send the seller a purchase order. Typically, the seller's invoice must include the purchase-order number — otherwise the buyer's accounts-payable department simply won't pay the bill. These are routine internal-controls measures that are almost-uniformly implemented by buyers to help prevent fraud.

But many buyers try to use their purchase-order forms, not just for fraud prevention, but to impose legal terms and conditions on the seller as well. Some buyers put a great deal of fine print on the "backs" of their purchase-order forms (physically or electronically).

Such fine-print terms often include:

  • detailed — and often onerous — terms and conditions for the purchase, such as expansive warranties, remedies, and indemnity requirements; and
  • language to the effect of, only our terms and conditions will apply — your terms won't count, no matter what happens.

For example, a Honeywell purchase-order form states in part — in the very first section — as follows:

Honeywell rejects any additional or inconsistent terms and conditions offered by Supplier at any time.

Any reference to Supplier’s quotation, bid, or proposal does not imply acceptance of any term, condition, or instruction contained in that document.

See Honeywell purchase order form archived at https://perma.cc/CUV6-NKTY, § 1 (extra paragraphing added).

The same section, incidentally, includes this remarkable assertion:

A purchase order is deemed accepted upon a) the date the Supplier returns the acknowledgment copy of a purchase order to Honeywell or b) five calendar days from date Honeywell issues the purchase order to Supplier regardless of mechanism used to convey requirements, whichever is earlier.

(Emphasis added.) In other words: According to Honeywell, if Honeywell sends you a purchase order out of the blue, you're deemed to have accepted the purchase order in five business days. Um … good luck getting a court to go along with that proposition ….

Sellers aren't always innocent parties in this little dance, either: It's not uncommon for a seller's quotation to state that all customer orders are subject to acceptance in writing by the seller. Then, the seller's written acceptance of a customer's purchase order takes the form of an "order confirmation" that itself contains detailed terms and conditions — some of which might directly conflict with the terms in the buyer's purchase order.

For example, the first section of a Honeywell terms of sale document states in part as follows:

Unless and to the extent that a separate contract executed between the procuring party (“Buyer”) and Honeywell International Inc. (“Honeywell”) applies, any purchase order covering the sale of any product (“Product”) contained in this Catalog (“Order”) will be governed solely by these Conditions of Sale, whether or not this Catalog or these Conditions of Sale are referenced in the Order.

Except as provided in the “Buyer‟s Orders” section below, all provisions on Buyer‟s Order and all other documents submitted by Buyer are expressly rejected.

Honeywell will not be deemed to have waived these Conditions of Sale if it fails to object to provisions submitted by Buyer.

Buyer‟s silence or acceptance or use of Products is acceptance of these Conditions of Sale.

Honeywell terms of sale document archived at https://perma.cc/5MB9-H6VK at § 1 (extra paragraphing and bullets added).

In both cases, the "we spit on your terms!" language is keyed to section 2-206 of the (U.S.) Uniform Commercial Code, which states in part that for sales of goods:

(1) Unless otherwise unambiguously indicated by the language or circumstances[,]

(a) an offer to make a contract shall be construed as inviting acceptance in any manner and by any medium reasonable in the circumstances ….

UCC § 2-206 (emphasis added).

In each of these forms, the quoted language seems to state pretty clearly that acceptance is limited to the terms stated in the form.

Important: Drafters asked to prepare standard forms of this kind should strongly consider whether to include "We reject your terms!" language along these lines.

But it's not unlikely that the parties' business people will pay exactly zero attention to these dueling forms. What could easily happen is the following:

  • The seller's sales people receive the purchase order and send it to the order-fullfilment department.
  • The seller's order-fulfillent department ships the ordered goods — along with a confirmation of sale document and an invoice.
  • The buyer's receiving department takes delivery of the ordered goods and puts them into inventor, distributes them to end users, or whatever.
  • The buyer's receiving department forwards the seller's invoice to the buyer's accounts-payable department, which in due course pays the invoice.

So whose terms and conditions apply — those of the buyer, or those of the seller? This is known as the "Battle of the Forms," of the kind contemplated by UCC § 2-207 and sometimes experienced in common-law situations as well, to which we now turn.

2.9.2 Sidebar: A buyer can be a "merchant"

As discussed in the next section, in some situations it can matter whether a party is considered a "merchant." As used in U.S. commercial law, the term merchant generally includes not only regular sellers of particular types of goods, but also buyers who regularly acquire such goods.

The Uniform Commercial Code states as follows in UCC § 2-104(1):

“Merchant” means a person[:]

  • who deals in [i.e., not just sells] goods of the kind
  • or otherwise by his occupation holds himself out
    • as having knowledge or skill
    • peculiar to the practices or goods involved in the transaction
  • or to whom such knowledge or skill may be attributed
    • by his employment of an agent or broker or other intermediary
    • who by his occupation holds himself out as having such knowledge or skill.

(Emphasis, extra paragraphing, and bullets added.)

To like effect is UCC § 2-205, which refers to "[a]n offer by a merchant to buy or sell goods …."

Federal judge Richard Posner explained the use of the term merchant as being different than common parlance:

Although in ordinary language a manufacturer is not a merchant, “between merchants” is a term of art in the Uniform Commercial Code. It means between commercially sophisticated parties ….

Wisconsin Knife Works v. Nat’l Metal Crafters, 781 F.2d 1280, 1284 (7th Cir. 1986) (Posner, J.) (citations omitted). To similar effect is the UCC definition's commentary, apparently reproduced in Nebraska Uniform Commercial Code § 2-104.

Other cases and commentators have reached the same conclusion. ; see, e.g., Brooks Peanut Co. v. Great Southern Peanut, LLC, 746 S.E.2d 272, 277 n.4 (Ga. App. 2013) (citing another case that cited cases); Sacramento Regional Transit v. Grumman Flxible [sic], 158 Cal. App.3d 289, 294-95, 204 Cal. Rptr. 736 (1984) (affirming demurrer), in which the court held that a city’s transit district, which had bought buses from a manufacturer, was a merchant within the meaning of § 2-104; Douglas K. Newell, The Merchant of Article 2, 7 Val. U. L. Rev. 307, 317, part III (1973).

2.9.3 The UCC's solution to the Battle: The Drop-Out Rule

Where sales of goods are concerned, the (U.S.) Uniform Commercial Code has a nifty way of dealing with the Battle of the Forms in section 2-207: When the parties are merchants:

  • whatever terms are common to the parties' respective contract forms is part of "the contract"
  • all other terms in both parties' contract forms drop out — left on the cutting-room floor, if you will; and
  • the UCC's "default" terms also apply.

Here's the text of UCC § 2-207:

(1) A definite and seasonable expression of acceptance

          or a written confirmation

          which is sent within a reasonable time

          operates as an acceptance

          even though it states terms additional to or different from those offered or agreed upon,

          unless acceptance is expressly made conditional

          on assent to the additional or different terms.

(2) The additional terms are to be construed as proposals for addition to the contract.

Between merchants [see § 2.9.2 above] such terms become part of the contract unless:

(a) the offer expressly limits acceptance to the terms of the offer;

(b) they materially alter it; or

(c) notification of objection to them has already been given

          or is given within a reasonable time after notice of them is received.

[DCT comment: Here comes the key part —]

(3) Conduct by both parties which recognizes the existence of a contract

          is sufficient to establish a contract for sale

          although the writings of the parties do not otherwise establish a contract.

In such case the terms of the particular contract consist of[:]

  • those terms on which the writings of the parties agree,
  • together with any supplementary terms incorporated under any other provisions of this Act.

(Emphasis, extra paragraphing, and bullets added.)

So suppose that:

  • Buyer sends Seller a purchase order with its terms and conditions;
  • Seller sends Buyer an order confirmation — with Seller's terms and conditions — along with the goods ordered, and an invoice.
  • Buyer's payables department pays the invoice.

In that situation, the parties have engaged in conduct that recognizes the existence of a contract. The terms of that contract are whatever "matching" terms exist in the parties' respective forms, plus the UCC's default provisions.

2.9.4 Caution: The UN CISG uses the "mirror image" rule

It's a very-different analysis of the Battle of the Forms under the UN Convention on Contracts for the International Sale of Goods. The Seventh Circuit explained:

The Convention departs dramatically from the UCC by using the common-law "mirror image" rule (sometimes called the "last shot" rule) to resolve "battles of the forms." With respect to the battle of the forms, the determinative factor under the Convention is when the contract was formed.

The terms of the contract are those embodied in the last offer (or counteroffer) made prior to a contract being formed.

Under the mirror-image rule, as expressed in Article 19(1) of the Convention, "[a] reply to an offer which purports to be an acceptance but contains additions, limitations or other modifications is a rejection of the offer and constitutes a counter-offer."

The court affirmed a judgment below that, "because Illinois Trading never expressly assented to the attorney's fees provision in VLM's trailing invoices, under the Convention that term did not become a part of the parties' contracts." VLM Food Trading Int'l, Inc. v. Illinois Trading Co., 811 F.3d 247, 250-51 (7th Cir. 2016) (cleaned up and reformatted; alteration by the court).

2.9.5 Caution: Filling a purchase order might lock in buyer's T&Cs

Remember that in U.S. jurisdictions, a customer's sending of a purchase order might count as an offer to enter into a contract, which could be accepted by performance, i.e., by filling the purchase order.

Consider the following actual example from a Cisco purchase-order document:

Supplier's electronic acceptance, acknowledgement of this Purchase Order, or commencement of performance constitutes Supplier's acceptance of these terms and conditions.

, Cisco Standard Terms and Conditions of Purchase – United States § 1, archived at https://perma.cc/SD47-YCHU.

If a supplier filled an order on Cisco's paper without sending its own rejection of the Cisco terms, then the supplier might find itself bound by Cisco's terms.

2.9.6 Additional reading (optional)

See generally:

  • Battle of the Forms – UCC and common-law variations
  • Purchase order (Wikipedia)
  • Brian Rogers, Battle of the Forms Explained (Using a Few Short Words) (blog entry March 1, 2012).
  • Marc S. Friedman and Eric D. Wong, TKO'ing the UCC's 'Knock-Out Rule', in the Metropolitan Corporate Counsel, Nov. 2008, at 47.
  • For an eye-glazing set of "battle of the forms" facts, see BouMatic LLC v. Idento Operations BV, 759 F.3d 790 (7th Cir. 2014) (vacating and remanding dismissal for lack of personal jurisdiction) (Easterbrook, J.).
  • An existing teaching case is Northrop Corp. v. Litronic Industries, 29 F.3d 1173 (7th Cir. 1994) (Posner, J.): This was a case where the buyer's purchase order stated that the seller's warranty provision was of unlimited duration, but the seller's acknowledgement form stated that the seller's warranty lasted only 90 days. The trial court held, the appellate court agreed, that both of those provisions dropped out of the contract, and therefore the buyer was left with a UCC implied warranty of "reasonable" duration. Id. at 1189.

2.10 Exercises & discussion questions

  1. FACTS: Alice and Bob are natural-gas traders. Alice sends Bob an Internet instant message ("IM") offering to sell Bob a stated quantity of natural gas, of a specified, industry-standard quality, for delivery at a specified location and date, at a stated price. Also by IM, Bob responds "Yes." Let's assume there are no defenses to formation such as lack of capacity. QUESTION: Have Alice and Bob entered into an enforceable contract? (Vote "Yes" or "No" using the Zoom participant list voting buttons; Raise Hand if unsure.)
  2. True / false / maybe: The terms of a "letter of intent" will generally be non-binding, because that's why parties sign a letter of intent in the first place. EXPLAIN.
  3. FACTS: The CEO of MathWhiz and a VP of Gignda Energy have a lunch meeting in Houston to talk about a quickie data-analysis project that Gigunda wants MathWhiz to undertake the following day.
    • The lunch is in a family-style restaurant that has paper "coloring book" placemats, with crayons for kids to use in coloring in the drawings.
    • Neither executive thought to bring a pen or pencil, so using crayons to write on the back of one of their placemats, the two executives jot down bullet points for the main terms of the data-analysis project — what MathWhiz will do, the delivery date (the following day), and the fee that Gigunda would pay upon completion.
    • Each executive signs and dates the placemat at the bottom.
    • The MathWhiz CEO uses her camera to take a picture of the signed placemat, then emails the photo to the Gigunda Energy vice president.
    • When the executives leave the restaurant, one of them tears up the placemat, wads it up the strips, and leaves them to be picked up and trashed when the table is bussed.
    • QUESTIONS:
      • A) True or false: This is a "verbal" contract. EXPLAIN. -B) True or false: This is a "written" contract.
  4. True or false: At least some types of binding contract can be formed by exchanging emails.
  5. True or false: A contract that might be completely performed in a year is invalid under the Statute of Frauds if it turns out that the contract isn't completely performed in a year.
  6. True or false: At least some types of binding contract can be formed by exchanging text messages.
  7. True or false: An oral contract could be binding, depending on the circumstances.
  8. True or false: An email can provide evidence to corroborate the existence of a binding oral contract even if the email doesn't itself constitute a binding written contract.
  9. True or false: For an email contract to be binding, each party's email must include the specific word "Signed" to make it clear that the party is assenting to the terms.
  10. True or false: In at least one state, text messages likely won't be enough to form a certain type of contract.
  11. True or false: An agreement to agree will generally be enforceable in the U.S. — the court will weigh expert testimony to determine what reasonable parties likely would have agreed to.
  12. FACTS: A potential customer sends a purchase order to a supplier for 1,000 widgets;
    • The purchase order's fine print contains detailed terms and conditions, including a rejection of any other terms provided by the supplier.
    • The supplier ships the 1,000 widgets to the customer together with an invoice.
    • The fine print in the supplier's invoice contains detailed terms and conditions, including
      • (i) a rejection of any other terms provided by the customer;
      • (ii) a conspicuous disclaimer of all implied warranties; and
      • (iii) a requirement that all disputes must be resolved by binding arbitratation, not by litigation in court.
    • Under the applicable law, all sales of goods include an implied warranty of merchantability unless conspicuously disclaimed in the parties' contract.
    • QUESTION: If the customer wants to make a claim against the supplier for breach of the implied warranty of merchantability, must the customer arbitrate the claim, or can it bring a lawsuit in court? (Assume for now that the arbitration clause would be enforceable IF the parties agreed to it.)
  13. FACTS: A Houston-area Honda dealership sells a new Honda to a customer, taking the customer's used Ford "in trade."
    • Assume (incorrectly) that in Texas, sales of cars are not governed by any special laws other than the Uniform Commercial Code.
    • QUESTION: In Texas, is the Honda dealer a "merchant" as to the used Ford? Why or why not?
    • VARATION: The Honda buyer, instead of trading in a used Ford, offers a bass boat on a trailer. The dealership accepts the trade because the dealership's owner has long wanted to take up fishing again and figures he can use the bass boat to teach his grandchildren how to fish. QUESTION: Is the dealership a "merchant" as to the bass boat?
  14. FACTS: Two Houston companies, ABC Corp. and XYZ LLC, enter into a contract for XYZ to build a warehouse on ABC's property in northwest Houston for a stated price.
    • Before any work starts on the project at all, the on-the-ground managers for the two companies can't seem to get along. One day, ABC's manager angrily tells her boss that XYZ's construction supervisor told her, "that's it, we're done, find yourself another builder!"
    • ABC decides that yes, it'd be better for it to use another builder. So ABC signs a contract with MNOP LLC — at a significantly-higher price — and sues XYZ for breach of contract, asserting that XYZ's construction supervisor repudiated the contract and so XYZ should be liable for the extra cost that ABC would incur by switching to MNOP LLC.
    • At the jury trial, ABC's manager testifies under oath that XYZ's construction supervisor said what's described above; in his own testimony, XYZ's supervisor denies this, also under oath.
    • QUESTION: What kinds of other evidence could ABC seek to adduce at trial to support its theory of the case — IF it had such evidence?
    • QUESTION: If the jury accepts one side's version of events, how easy would it be for the trial judge to overrule the jury's finding at the losing party's request? What about an appellate court? (Hint: See the Seventh Amendment and Fed. R. Civ. P. 50(a) concerning judgment as a matter of law.)
    • QUESTION: What does the above tell you about the importance of (i) putting things in writing, and (ii) keeping the writings?

3 Setting up the contract framework

3.1 Finding existing contract forms

Few contract drafters start with a clean sheet of paper — mainly because it's difficult to remember all the issues that might need to be addressed — and so most drafters start with some prior agreement.

Law firms often try to maintain form files, but seldom does anyone get paid or otherwise receive meaningful reward for doing that drudgery. So the quality and currency of law firm form files can be dicey.

Thousands of contract forms are available online from commercial companies that screen and curate contracts filed with the U.S. Securities and Exchanges EDGAR Web site (https://www.sec.gov/edgar/search-and-access). Some of these commercial sites include:

Other sites such as RocketLawyer.com and LegalZoom.com offer forms, but it's hard to know what their quality is, nor whether they take into account the "edge cases" that sometimes crop up in real-world situations.

If you want to search the SEC's EDGAR Web site yourself, it helps to know that many if not most contracts will be labeled as Exhibit 10.something (and possibly EX-4.something) under the SEC's standard categorization. This means that the search terms "EX-10" (and/or "EX-4") can help narrow your search.

Example: A quick search and scan turned up the 2019 separation agreement between CBS Corporation (the TV network) and its now-former chief legal officer.

Pro tip: Online contract forms are best relied on as sources of ideas for issues to address. The clause language is not necessarily what you'd want to use in a contract for a client.

In some contracts you find online, the "Notices" provision might include the names and addresses of the parties' outside counsel — if counsel are in name-brand firms, that might give you increased confidence. Example: In the 2007 real-estate lease between Stanford University (landlord) and Tesla (tenant), the counsel to be notified for Stanford was a partner at Bingham McCutchen, a large Boston-based firm that closed its doors in 2014 when hundreds of its lawyers left to join the Morgan Lewis firm.

Caution: Lawyers at blue-chip law firms aren't infallible — and the law-firm partner identified in a contract might not have been the one who actually did the work — so you won't want to assume that the contract is necessarily of A+ quality.

Caution: An existing contract will often reflect concessions that were made by one or more parties during negotiations. This means that when drafting a new contract, you should carefully review the existing contract's terms and determine whether that's really where you want to start.

3.2 Mindless copy-and-paste can be dangerous

Don't just copy and paste language from an old contract without thoroughly reviewing it. One very-public "fail" on that score occured in the UK's negotiation of its Brexit deal; as reported by the BBC:

References to decades-old computer software are included in the new Brexit agreement, including a description of Netscape Communicator and Mozilla Mail as being "modern" services.

Experts believe officials must have copied and pasted chunks of text from old legislation into the document.

The references are on page 921 of the trade deal, in a section on encryption technology.

It also recommends using systems that are now vulnerable to cyber-attacks.

The text cites "modern e-mail software packages including Outlook, Mozilla Mail as well as Netscape Communicator 4.x."

The latter two are now defunct - the last major release of Netscape Communicator was in 1997.

See Cristina Criddle, Brexit deal mentions Netscape browser and Mozilla Mail (BBC.com Dec. 29, 2020) (extra paragraphing added); see also, e.g., Ben Quinn, Obsolete software from 1990s features in Brexit deal text (TheGuardian.com Dec. 29, 2020).

3.3 A clean sheet of paper has its own hazards

[For students: Skim this section for background information; all you need to remember for testing purposes is the following "Pro tip."]

Pro tip: Throwing out an existing contract, and starting over with a clean sheet of paper to draft a much-shorter contract, can be dangerous:

  • The existing contract might well capture past experience with oddball issues that can cause disputes.
  • The drafters of the new, shorter contract might inadvertently overlook one or more of those issues.

A safer approach is to just "clean up" the contract by • breaking its long, "wall of words" provisions into smaller chunks; and • as necessary, rewriting legalese to make it sound more like how you'd explain the concept to a judge or jury.

Background: Contract forms tend to grow by accretion, as lawyers think of issues that could arise. As a result, what a commenter said about politicians (fearful of voter backlash) might apply equally to contract drafters (fearful of malpractice claims): “[E]fforts to reform airport security are hamstrung by politicians and administrators who would prefer to inflict hassle on millions than be caught making one mistake.” Henry Grabar, Terminal: How the Airport Came to Embody Our National Psychosis (Slate.com 2017) (emphasis added).

That attitude of "cover every conceivable risk" can cause problems. For example: The legal department of one General Electric unit found that its "comprehensive" contracts were getting in the way of closing sales deals:

When GE Aviation combined its three digital businesses into a single Digital Solutions unit, their salespeople were eager to speed up the growth they had seen in the years before the move. They found plenty of enthusiastic customers, but they struggled to close their deals. The reason: Customers often needed to review and sign contracts more than 100 pages long before they could start doing business.

The new business inherited seven different contracts from the three units. The clunky documents were loaded with legalese, redundancies, archaic words and wordy attempts to cover every imaginable legal [sic]. No wonder they languished unread for months. "We would call, and customers would say, 'I can’t get through this,'" says Karen Thompson, Digital Solutions contracts leader at GE Aviation. “And that was before they even sent it to their legal team! … We were having trouble moving past that part to what we needed to do, which was sell our services.”

For those customers who did read the contract, negotiations would drag on and on.

Kristin Kloberdanz, Honey, I Shrunk The Contract: How Plain English Is Helping GE Keep Its Business Humming, (GE.com 2017) (emphasis and extra paragraphing added).

GE's legal department decided to do something about it. Shawn Burton, the general counsel of that GE business unit, described his team's approach in a Harvard Business Review article.

• First, the legal team met with business people — who were enthusiastic about the prospect of simplifying their contracts — to identify business risks. See Chapter 19 for a systematic, step-by-step approach to identifying business risk.

• Then:

Next the legal team started drawing up the contract, beginning from scratch.

No templates. No “sample” clauses. No use of or reference to the existing contracts.

We simply started typing on a blank sheet of paper, focusing only on the covered services and the risks we’d identified.

Throughout the process, we applied our litmus test: Can a high schooler understand this?

Shawn Burton, The Case for Plain-Language Contracts, Harv. Bus. Rev. Jan./Feb. 2018, archived at https://perma.cc/HW85-FGSA (emphasis and extra paragraphing added).

Burton provides several examples of streamlined provisions, such as the following revision:

Before:

Customer shall indemnify, defend, and hold Company harmless from any and all claims, suits, actions, liabilities, damages and costs, including reasonable attorneys’ fees and court costs, incurred by Company arising from or based upon (a) any actual or alleged infringement of any United States patents, copyright, or other intellectual property right of a third party, attributable to Customer’s use of the licensed System with other software, hardware or configuration not either provided by Company or specified in Exhibit D.3, (b) any data, information, technology, system or other Confidential Information disclosed or made available by Customer to Company under this Agreement, (c) the use, operation, maintenance, repair, safety, regulatory compliance or performance of any aircraft owned, leased, operated, or maintained by Customer of [sic; or](d) any use, by Customer or by a third party to whom Customer has provided the information, of Customer’s Flight Data, the System, or information generated by the System.

After:

If an arbitrator finds that this contract was breached and losses were suffered because of that breach, the breaching party will compensate the non-breaching party for such losses or provide the remedies specified in Section 8 if Section 8 is breached.

(Emphasis added.)

But here's the problem: It can be dangerous to throw out an existing contract form and start over unless you methodically list and address the principal business risks that the parties might encounter, just as the GE Aviation unit did — and even then, how do you know you've thought of all the possible risks?

The language in the previous contracts presumably reflected past experience in how to handle the unusual- or oddball situations that can sometimes arise and lead to disputes. Throwing out the previous contracts might have lost that often-hard-won knowledge.

By analogy: The computer-programming world is quite familiar with this danger of losing knowledge gained from bitter experience. Users of software expect the software to work well even in oddball situations, especially those that the aviation world calls "pilot error," a.k.a. stupid human tricks (just as business clients expect contracts to accommodate unusual situations that might arise between the parties).

A much-cited 2000 essay, by highly-regarded software developer and entrepreneur Joel Spolsky, argues that throwing out the source code of an existing computer program and rewriting it from scratch is a terrible idea, one that has caused major headaches for companies such as Netscape (which developed one of the first widely-used Web browsers):

The idea that new code is better than old is patently absurd. Old code has been used. It has been tested. Lots of bugs have been found, and they’ve been fixed. …

Each of these bugs took weeks of real-world usage before they were found. …

When you throw away code and start from scratch, you are throwing away all that knowledge. All those collected bug fixes. Years of programming work.

Joel Spolsky, Things You Should Never Do, Part I (JoelOnSoftware 2000) (emphasis in original). See also, e.g., Herb Caudill, Lessons from 6 software rewrite stories (Medium.com 2019).

The same could be true about contracts: If you throw out existing contract language and start from scratch, you risk losing years of accumulated knowledge of how the real world can work.

There's another, safer approach: Do what software developers refer to as "refactoring," namely cleaning up existing language, breaking it up into more-readable bullet points, as discussed in § 7.7.

3.4 Title: How will a title look in a list?

Imagine that you're looking at a simple list of titles of a particular company's contracts —

  • Perhaps you're doing due diligence for a financing- or merger transaction and reviewing a long list of the target company's existing contracts.
  • Perhaps you're doing a document review for a lawsuit or arbitration and looking at a similarly-long list of contracts.

Conider the following styles of title:

Title style 1 is simplicity itself, but it's not especially informative when seen as part of a list of agreement titles:

Agreement

Title style 2 is fairly typical for contracts:

Agreement and Plan of Merger

Title style 3 is more informative, but it might be overkill:

AGREEMENT AND PLAN OF MERGER
Among
UAL Corporation
Continental Airlines, Inc.
and
JT Merger Sub Inc.
Dated as of May 2, 2010

The example of style 3, incidentally, is from the 2010 merger agreement between United Airlines and Continental Airlines; see https://tinyurl.com/UAL-CAL-2010.

Caution: From style 3, be careful about including "Dated as of …" because the contract date might change but the old date might be inadvertently left in the document — especially if there's a rush to get to signature; this would violate the Don't Repeat Yourself principle and could lead to trouble, as discussed at § 8.8.)

Ultimately it's the drafter's choice.

3.5 Preamble: Front-load some useful information

While very few contracts are ever litigated, it takes very little time for a contract drafter to help out future trial counsel by properly drafting the preamble of the contract to include useful information. Here's an example for a hypothetical contract:

Purchase and Sale Agreement
for 2012 MacBook Air Computer

This "Agreement" is between (i) Betty’s Used Computers, LLC, a limited liability company organized under the laws of the State of Texas ("Buyer"), with its principal place of business and its initial address for notice at 1234 Main St, Houston, Texas 77002; and (ii) Sam Smith, an individual residing in Houston, Harris County, Texas, whose initial address for notice is 4604 Calhoun Rd, Houston, Texas 77004 ("Seller"). This Agreement is effective the last date written on the signature page.

Let’s look at this preamble piece by piece: The included information is intended to make life easier on trial counsel if litigation should ever occur.

3.5.1 "This Agreement"

Many drafters would repeat the title of the agreement in all-caps in the preamble, thusly: "THIS PURCHASE AND SALE AGREEMENT (this "Agreement") …."

The author prefers the shorter approach shown in the quoted example above. That’s because:

– It’s doubtful that anyone would be confused about what "This ‘Agreement"" refers to; and

– The shorter version reduces the risk that a future editor might (i) revise the title at the very top of the document but (ii) forget to change the title in the preamble. This is an example of the rule of thumb: Don’t Repeat Yourself, or D.R.Y., discussed at Section 8.8: .

(In the second bullet point just above, notice how the first, long-ish sentence is broken up (i) with bullets, and (ii) with so-called "romanettes," that is, lower-case Roman numerals, to make the sentence easier for a contract reviewer to skim. This follows the maxim: Serve the Reader.)

3.5.2 Quoted, bold-faced defined terms

In the example above, note how the preamble defines the terms Agreement, Buyer, and Seller: These defined terms are not only in bold-faced type: they’re also surrounded by quotation marks and parentheses. This helps to make the defined terms stand out to a reader who is skimming the document.

When drafting "in-line" defined terms like this, it’s a good idea to highlight them in this way; this makes it easier for a reader to spot a desired definition quickly when scanning the document to find it.

Imagine the reader running across a reference to some other defined term and starting to flip through the document, wondering to herself, "OK, what does 'Buyer' mean again?"

NOTE: If you also have a separate definitions section for defined terms, it’s a good idea for that definitions section to include cross-references to the in-line definitions as well, so that the definitions section serves as a master glossary of all defined terms in the agreement. See also § 4 for more discussion of defined terms.

3.5.3 Specific terms: "Buyer" and "Seller"

This preamble uses the defined terms Buyer and Seller instead of the parties’ names, Betty and Sam, because:

  • Doing this can make it easier on future readers … such as a judge … to keep track of who’s who.
  • Doing this also makes it easier for the drafter to re-use the document for another deal by just changing the names at the beginning.

Sure, global search-and-replace can work, but it’s often over-inclusive. For example: Automatically changing all instances of Sam to Sally might result in the word samples being changed to sallyples.

3.5.4 Agreement "between (not "by and between") the parties

Our preamble says that the contract is between the parties — not by and between the parties, and not among them.

True, many contracts say "by and between" instead of just "between." The former, though, sounds like legalese, and the latter works just as well.

For contracts with multiple parties, some drafters will write among instead of between; that’s fine, but between also works.

3.5.5 Stating details about the parties (to help in litigation)

Our preamble provides certain details about the parties,such as where Betty's Used Computers, LLC is organized (Texas) and Sam's county of residence.

When a party to a contract is a corporation, LLC, or other organization, it’s an excellent idea for the preamble to state both:

  • the type of organization, in this case "a limited liability company"; and
  • the jurisdiction under whose laws the organization was formed, in this case "organized under the laws of the State of Texas."

Doing this has several benefits:

– It reduces the chance of confusion in case the same company name is used by different organizations in different jurisdictions … imagine how many "Acme Corporations" or "AAA Dry Cleaning" there must be in various states.

– It helps to nail down at least one jurisdiction where the named party is subject to personal jurisdiction and venue, saving future trial counsel the trouble of proving it up; and

– It helps to establish whether U.S. federal courts have diversity jurisdiction (a U.S. concept that might or might not be applicable).

A shorter version is also acceptable: "Betty’s Used Computers, LLC, a Texas limited liability company …."

Including the jurisdiction of organization can simplify a litigator’s task of "proving up" the necessary facts: If a contract signed by ABC Corporation recites that ABC is a Delaware corporation, for example, an opposing party generally won’t have to prove that fact, because ABC will usually be deemed to have "acknowledged" it, that is, conceded the point in advance.

This particular hypothetical agreement is set up to be between a limited liability company, or "LLC," and an individual; in that way, the signature blocks will illustrate how organizational signature blocks should be done.

3.5.6 Principal place of business (or residence) and initial address

Note how the preamble above states some geographical information about the parties:

– Principal place of business: Stating Betty’s principal place of business helps trial counsel avoid having to prove up the court’s personal jurisdiction. For example, a Delaware corporation whose principal place of business was in Houston would almost certainly be subject to suit in Houston.

– Residence: Likewise, if a party to a contract is an individual, then stating the individual’s residence helps to establish personal jurisdiction over him or her and the proper venue for a lawsuit against the individual.

– County: Stating the county of an individual’s residence might be important if the city of residence extends into multiple counties.

For example, Houston is the county seat of Harris County, but just because Sam lives in Houston doesn’t automatically mean that he can be sued in the county’s courts in downtown Houston. That’s because Houston’s city limits extend into Fort Bend County to the southwest and Montgomery County to the north. Sam might live in the City of Houston but in one of those other counties, and so he might have to be sued in his home county and not in Harris County.

– Addresses for notice: It’s convenient to put the parties’ initial addresses for notice in the preamble. That way, a later reader won’t need to go paging through the agreement looking for the notice provision. Doing this also makes it easy for contract reviewer(s) to verify that the information is correct.

3.5.7 Stating the effective date in the preamble

The above preamble affirmatively states the effective date; that’s usually unnecessary (and it's not the author's preference) unless the contract is to be effective as of a specified date.

(Many drafters like to include the effective date anyway; it's normally not worth changing if someone else has drafted it this way.)

The author prefers the last-date-signed approach: "This Agreement is effective the last date written on the signature page."

Here’s a different version of that approach: "This 'Agreement' is made, effective the last date signed as written below, between …."

In reviewing others’ contract drafts, you’re likely to see some less-good possibilities, such as:

– "This Agreement is made December 31, 20XX, between …."

– "This Agreement is dated December 31, 20XX, between …."

Either of these can be problematic because the stated date might turn out to be inaccurate, depending on when the parties actually sign the contract.

Caution: Never backdate a contract for deceptive purposes, e.g., to be able to book a sale in an earlier period — as discussed at § 3.10, that practice has sent more than one corporate executive to prison, including at least one general counsel.

On the other hand, it might be just fine to state that a contract is effective as of a different date. EXAMPLE: Alice discloses confidential information to Bob after Bob first orally agrees to keep the information confidential; they agree to have the lawyers put together a written confidentiality agreement. That written agreement might state that it is effective as of the date of Alice’s oral disclosure.

The following might work if it’s for non-deceptive purposes: "This Agreement is entered into, effective December 31, 20XX, by …."

(Alice and Bob would not want to backdate their actual signatures, though.)

3.5.8 Include the parties’ affiliates as "parties"? (Probably not.)

Some agreements, in identifying the parties to the agreement on the front page, state that the parties are, say, ABC Corporation and its Affiliates. That’s generally a bad idea unless each such affiliate actually signs the agreement as a party and therefore commits on its own to the contractual obligations.

The much-better practice is to state clearly the specific rights and obligations that (some or all) affiliates have under the contract. This is sometimes done in "master" agreements negotiated by a party on behalf of itself and its affiliates.

For example, consider a negotiated master purchase agreement between a customer and a provider. The master agreement might require the provider to accept purchase orders under the master agreement from the customer’s affiliates as well as from the customer itself, so that the customer’s affiliates can take advantage of the pre-negotiated pricing and terms.

Caution: An affiliate of a contracting party might be bound by the contract if (i) the contracting party — or the individual signing the contract on behalf of that party — happens to "control" the affiliate, and (ii) the contract states that the contract is to benefit the affiliate. That was the result in a Delaware case where:

  • the contract stated that a strategic alliance was being created for the contracting party and its affiliates, and
  • the contract was signed by the president of the contracting party, who was also the sole managing member of the affiliate.

The court held that the affiliate was bound by — and had violated — certain restrictions in the contract. See Medicalgorithmics S.A. v. AMI Monitoring, Inc., No. 10948-CB, slip op. at 3, 52-53, text accompanying n.219 (Del. Ch. Aug. 18, 2016); see also, e.g., Mark Anderson, Don’t Make Affiliates parties to the agreement (2014); Ken Adams, Having a Parent Company Enter Into a Contract "On Behalf" of an Affiliate (2008).

3.5.9 Is country-specific information required?

Some countries require contracts to include specific identifying information about the parties, e.g., the registered office and the company ID number. This is worth checking for contracts with parties or operations in such countries. See Ken Adams, When the Law Says What Party-Specific Information You Have to Include in the Introductory Clause (AdamsDrafting.com 2016); Ken Adams, Using Company Numbers in the Introductory Clause (AdamsDrafting.com 2007) — the comments discuss similar requirements in various countries.

3.5.10 Naming the "wrong" party can screw up contract enforcement

Be sure you’re naming the correct party as "the other side" — or consider negotiating a guaranty from a solvent affiliate.

Failing to name the correct corporate entity could leave your client holding the bag. This seems to have happened in a Seventh Circuit case:

– The named party in the contract had essentially no assets (the assets were all owned by the named party’s parent company).

– The other named party sued the parent company for breach of the contract.

The appellate court affirmed summary judgment in favor of the parent company, saying: "It goes without saying that a contract cannot bind a nonparty. … If appellant is entitled to damages for breach of contract, [it cannot] recover them in a suit against appellee because appellee was not a party to the contract." Northbound Group, Inc. v. Norvax, Inc., 795 F.3d 647, 650-51 (7th Cir. 2015) (cleaned up and reformatted).

3.5.11 Does each party have capacity to contract?

Depending on the law of the jurisdiction, an unincorporated association or trust might not be legally capable of entering into contracts. See generally, e.g., Ken Adams, Can a Trust Enter Into a Contract? (AdamsDrafting.com 2014).

If a contract is purportedly entered into by a party that doesn’t have the legal capacity to do so, then conceivably the individual who signed the contract on behalf of that party might be personally liable for the party’s obligations.

3.6 Background of the Agreement: No "Whereas"!

3.6.1 Style tip: Delete "Witnesseth" and "Whereas"

Note: Like all purely-style tips, this particular style tip isn't worth making a big deal about if you're reviewing a draft prepared by The Other Side, see Section 6.2: . And if your supervising partner has a preference, then do it that way, see Section 6.1: .

Modern contract drafters avoid using the archaic words "WITNESSETH" and "Whereas.” For an example of what not to do, see the the example below, from a routine commercial real-estate purchase agreement.

(Don't bother reading the text below, just get a sense of how it looks.)

THIS REAL ESTATE PURCHASE AND SALE AGREEMENT (this "Agreement") is made and entered into by and between WIRE WAY, LLC, a Texas limited liability company ("Seller"), and RCI HOLDINGS, INC., a Texas corporation ("Purchaser"), pursuant to the terms and conditions set forth herein.

W I T N E S S E T H:

WHEREAS, Seller is the owner of a certain real property consisting of approximately 4.637± acres of land, together with all rights, (excepting for mineral rights as set forth below) , title and interests of Seller in and to any and all improvements and appurtenances exclusively belonging or pertaining thereto (the "Property") located at 10557 Wire Way, Dallas (the "City"), Dallas County, Texas, which Property is more particularly described on Exhibit A attached hereto and incorporated herein by reference; and

WHEREAS, contemporaneously with the execution of this Agreement, North by East Entertainment, Ltd., a Texas limited partnership ("North by East"), is entering into an agreement with RCI Entertainment (Northwest Highway), Inc., a Texas corporation ("RCI Entertainment"), a wholly owned subsidiary of Rick's Cabaret International, Inc., a Texas corporation ("Rick's") for the sale and purchase of the assets of the business more commonly known as "Platinum Club II" that operates from and at the Property ("Asset Purchase Agreement"); and

WHEREAS, subject to and simultaneously with the closing of the Asset Purchase Agreement, Seller will enter into a lease with RCI Entertainment, as Tenant, for the Property, dated to be effective as of the closing date, as defined in the Asset Purchase Agreement (the "Lease") attached hereto as Exhibit B and incorporated herein by reference; and

WHEREAS, subject to the closing of the Asset Purchase Agreement, the execution and acceptance by Seller of the Lease, and pursuant to the terms and provisions contained herein, Seller desires to sell and convey to Purchaser and Purchaser desires to purchase the Property.

NOW, THEREFORE, for and in consideration of the premises and mutual covenants and conditions contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

This is pretty hard to read, no?

The above example has other problems, in addition to its use of archaic "Whereas" clauses: Because of the "as follows" language at the end of the last paragraph quoted above, it can be argued that the parties did not agree to the Whereas clauses. For more discussion of this point, see Section 3.6.3: .

3.6.2 Use the "Background" section to set the stage

Instead of "Recitals" — or worse yet, W H E R E A S clauses — describe the background in a (numbered) "Background" section of the contract.

As a general proposition, the Background section should just tell the story: Explain to the future reader, in simple terms — with short sentences and paragraphs — just what the parties are doing, so as to help future readers get up to speed more quickly.

As a horror story, consider the WHEREAS example quoted in Section 3.6.1: above: Good luck trying to figure out what's really going on — there seems to be some kind of business roll-up going on, with a sale and leaseback of real estate and maybe other assets, but that's not at all clear. Now imagine that you're a judge or a judge's law clerk who's trying to puzzle out the story. Worse: Imagine that you're a juror trying to make sense of this transaction.

Somewhat better is the following excerpt is from a highly publicized stock purchase agreement in the tech industry, rewritten into background-section form below: See Stock Purchase Agreement by and among Yahoo! Inc. and Verizon Communications Inc. dated as of July 23, 2016, https://tinyurl.com/VerizonYahooAgreement

Before:

WHEREAS, concurrently with the execution and delivery of this Agreement, Seller and Yahoo Holdings, Inc., a Delaware corporation (the “Company”), are entering into a Reorganization Agreement substantially in the form attached hereto as Exhibit A (the “Reorganization Agreement”), pursuant to which Seller and the Company will complete the Reorganization Transactions at or prior to the Closing;

After:

1.  Background

1.01 At the same time as this Agreement is being signed, Seller and Yahoo Holdings, Inc., a Delaware corporation (the “Company”), are entering into a Reorganization Agreement.

1.02 Under the Reorganization Agreement, Seller and the Company are to complete certain "Reorganization Transactions" at or prior to the Closing.

1.03 The Reorganization Agreement is in substantially the form attached to this Agreement as Exhibit A.

Notice the shorter, single-topic paragraphs, discussed in more detail at Section 7.5: .

3.6.3 A contract's background statements might be binding

Different jurisdictions might treat background statements differently. For example:

  • California Evidence Code § 622 provides: "The facts recited in a written instrument are conclusively presumed to be true as between the parties thereto, or their successors in interest; but this rule does not apply to the recital of a consideration." (Emphasis added.)
  • But: "Contracts often contain recitals: provisions that do not make binding promises but merely recite background information about factual context or the parties' intentions. Maryland law recognizes the general principle that such recitals are not binding and, while they may aid the court in interpreting the contract's operative terms, cannot displace or supplement operative terms that are clear." Sprint Nextel Corp. v. Wireless Buybacks Holdings, LLC, 938 F.3d 113, 127 (4th Cir. 2019) (vacating and remanding partial summary judgment) (emphasis added).

3.6.4 A statement of one party's intent might not be binding

A naked statement of one party's subjective intent in entering into the contract might not suffice to be binding on another party. That happened in a case involving Sprint, the cell-phone service provider:

  • Sprint offered "upgraded" phones to its customers at steep discounts when customers renewed their contracts — the discounts were so steep that the customers paid less than what the phones would bring on the used-phone market.
  • Another company, Wireless Buybacks, bought upgraded phones from Sprint customers and resold them at a profit.
  • Sprint sued Wireless Buybacks for tortious interference with Sprint's contracts with its customers.
  • Sprint claimed that its contract prohibited resale because it said in part: "Our rate plans, customer devices, services and features are not for resale and are intended for reasonable and non-continuous use by a person using a device on Sprint's networks." (Emphasis added.)

The trial court found that this language unambiguously barred resale; the court granted partial summary judgment for Sprint. On appeal, however, the Fourth Circuit held that the contract language "is a background statement of intent, not an enforceable promise not to resell Sprint phones." Sprint Nextel Corp. v. Wireless Buybacks Holdings, LLC, 938 F.3d 113, 127 (4th Cir. 2019) (vacating and remanding partial summary judgment; emphasis added).

3.6.5 Keep parties' rights and obligations out of the Background

Inexperienced contract drafters will sometimes put specific rights and/or obligations in a Background section. That's a bad idea for the reasons discussed above.

Example 1: One of the author's students once wrote in the Background section: "For all purposes, the Data is owned by Client and is provided to Contractor for completion of services under this Agreement." DCT COMMENT: This shouldn't go into the Background section, but instead in a substantive section, for example in a section about ownership of intellectual property.

Example 2: Another student wrote: "Client will pay Contractor as stated in this Agreement." DCT COMMENT: This shouldn't be in the Background section, because the payment provisions would (or at least should) speak for themselves — moreover, readers would naturally assume that Client would pay Contractor, so there was no need to include that fact in the Background section.

Example 3: Still another student wrote: "The parties have agreed that Client will compensate Provider with a flat monthly fee of $20,000 for up to 200 staff hours of work per month, with additional work hours being billed at $150 per hour." DCT COMMENT: This would work if the Background section was the only place that the specific compensation details were discussed, so as not to violate the D.R.Y. (Don't Repeat Yourself) guideline discussed at Section 8.8: .

Example 4: A student wrote: "Client and Service Provider enter into the Agreement for the term of one year from the effective date of the Agreement." DCT COMMENT: This is another item that would go into a substantive provision further down in the contract, not into the Background section.

3.6.6 Skim: Some other student "background" efforts

Note to students: This section will give you an idea of some minor errors that can arise in drafting a background section.

  1. A student used "WHEREAS" several times. DCT COMMENT: That's OK if the partner wants it, but it's archaic.
  2. A student described one of the parties, "Mary," as an "expert." DCT COMMENT: If I were Mary, I wouldn't want that — the other side might argue later that Mary had held herself out as an expert but she really wasn't.
  3. Several students wrote variations on, e.g., "Gigunda desires for MathWhiz to analyze data, and MathWhiz desires to do so." DCT COMMENT: I wouldn't phrase it that way; instead, I'd let the rest of the contract speak for itself. (And in any case, the parties' subjective desires don't enter into contract interpretation except in cases of a lack of meeting of the minds or mutual mistake.)

3.7 Signature blocks

See also the Tango Terms "signatures" provisions.

Contracts generally get "signed" in some fashion; under U.S. law, contract signatures can take a variety of forms, as discussed in the commentary below.

Note: As first-year law students learn, a so-called unilateral contract can be formed without signatures from both parties if an unrevoked, otherwise-eligible offer is accepted by performance. Example: Alice posts handbills on light poles, offering a $100 reward for the return of her missing cat, "Fluffy." If Bob finds Fluffy and returns her to Alice, then Bob's performance constitutes completion of the contract and obligates Alice to pay Bob the reward money.

3.7.1 Precede with a concluding paragraph? (No.)

Some conventional contracts, with the signature blocks at the end of the contract, precede the signature blocks with a concluding paragraph such as the following:

To evidence the parties’ agreement to this Agreement, each party has executed and delivered it on the date indicated under that party’s signature.

Such paragraphs are unnecessary; here's why:

  • First, that kind of concluding paragraph is overkill. There are other ways of proving up that The Other Side in fact delivered a signed contract to you — for starters, the fact that you have a copy in your possession that bears (what at least purports to be) The Other Side’s signature.
  • Second, at the instant of signature, a past-tense statement that each party "has delivered" the signed contract is technically inaccurate — and even more so at the moment when the first signer affixes his (or her) signature.

But if you see this kind of language in a draft prepared by the other side, don't change it (as discussed in § 6.2).

3.7.2 Signature dates

Author's note: I usually draft signature blocks with blanks for the signers to hand-write the date signed; see the example shown at Section 3.7.8: .

It's usually better not to type in the expected date of signature. That's because one or more parties might sign on a different date; moreover, if signature is delayed, a pre-typed signature date could help an unscrupulous signer to passively — but still fraudulently — backdate the contract (see Section 3.10: ).

"Signed on the dates indicated below"

"Signed December 12, 20xx"

For similar reasons, it's better not to type a purported date in the preamble:

"This Agreement is made effective the last date signed as written in the signature blocks …."

"This Agreement is made December 31, 20XX, between …."

Relatedly: I also try to avoid leaving a blank space in the preamble for the effective date:

"This Agreement is made December     , 20XX, between …."

That's because the parties might well neglect to fill in the date, meaning that the contract gets signed with the blank space still there. This is an example of the R.O.O.F. principle: Root Out Opportunities for [Foul]-ups!

3.7.3 Corporate- and LLC signature blocks

The signature blocks shown at Section 3.7.8: (repeated below) are for different types of organization — on the left is a signature block for when the signer’s name and title are known; on the right, when not:

Signature blocks

• Note that each of those signature blocks starts out with the word "AGREED:" in all-caps and followed by a colon — possibly including the abbreviation for the signing party, shown as "Licensor" and "Licensee" above.

• Each organization’s signature block lists the organization’s full legal name followed by the word "by" and a colon.

• Date signed: Each signer should hand-write the date signed, for reasons discussed at the commentary to Section 3.10: .

• Printed name blank line: In signature blocks with blank lines, be sure to include a space for the printed name, because the signatures of some people are difficult to read.

• Title: In any signature block for an organization, be sure to include the signer’s title, to establish a basis for concluding that the signer has authority to sign on behalf of the organization; if the employee’s title includes the word "president," "vice president," "manager," or "director" in the relevant area of the business, that might be enough to establish the employee’s apparent authority. See § 3.11.4 (But apparent authority can save the day).

3.7.4 Signature blocks for individuals

If an individual is a party to the contract, the signature block can be just the individual’s name under an underscored blank space.

Example:

AGREED:

………………………………
Jane Doe

………………………………
Date signed

But you might not know the individual signer’s name in advance, in which case you could use the following format:

AGREED:

………………………………
Signature

………………………………
Printed name

………………………………
Date signed

3.7.5 Special case: Signature block for a limited partnership

In many U.S. jurisdictions, a limited partnership might be able to act only through a general partner, in which case a signature block for the limited partnership might need to include the general partner’s name. And the general partner of a limited partnership might very well be a corporation or LLC; in that case, the signature block would be something like the following:

AGREED: ABC LP, by:
ABC Inc., a Texas corporation,
general partner, by:

………………………………
Ronald R. Roe,
Executive Vice President

………………………………
Date signed

On the other hand, in some jurisdictions, a limited partnership might be able to act through its own officers; for example, Delaware’s limited-partnership statute gives general partners the power "to delegate to agents, officers and employees of the general partner or the limited partnership …." Del. Code § 17-403(c) (emphasis added).

In such cases, the signature block of a limited partnership might look like the signature block of a corporation or LLC, above.

Caution: A limited partner who, acting in that capacity, signs a contract on behalf of the limited partnership could be exposing herself to claims that she should be held jointly and severally liable as a general partner. (Of course, some general partners also hold limited-partnership investment interests and thus are limited partners in addition to being general partners.)

3.7.6 Include company titles for client relations, too

Including company titles is highly advisable to help establish apparent authority, as discussed above. But there's another reason to do so: If your client is a company, then some individual human, typically an officer or manager of the company, will be signing on behalf of the client. In that situation, the client’s signature block in the contract should normally state that it’s the company that is signing the contract, not the individual human in his- or her personal capacity — with the attendant personal liability.

To be sure, if your client is the company and not the human signer, then technically you’re under no professional obligation to make sure that the human signer is protected from personal liability. But it’s normally not a conflict of interest for you to simultaneously look out for the human signer as well as for the company; doing that can give the human signer a warm fuzzy feeling about you, which is no bad thing. *Caution:* A lawyer might find herself dealing with an employee of a client company in a situation where the interests of the employee and the company diverge or even conflict. One example might be an investigation of possible criminal conduct such as deceptive backdating of a contract (discussed at Section 3.10: ). In circumstances such as those, the lawyer should consider whether she should affirmatively advise the employee, preferably in writing, that she’s not the employee’s lawyer — conceivably, the lawyer might even have an ethical obligation to do so.

3.7.7 Try to keep signature blocks on the same page

The author prefers to keep all of the text of a signature block together on the same page (which might or might have other text on it). That looks more professional than having a signature block spill over from one page onto the next. This can be done using Microsoft Word’s paragraph formatting option, "Keep with Next."

3.7.8 Put the signature blocks up front?

In the example signature blocks immediately below, you'll see that the signature blocks are in a table at the front of the agreement, along with the parties' respective initial addresses for notice. This make the agreement more reader-friendly:

  • You can see at a glance whether you're looking at the signed agreement; and
  • To find a party's (initial) address for notice, you don't need to go rummaging through the document
Signature blocks

3.7.9 Should counsel sign for clients? (Usually: No.)

A lawyer for a party entering into a contract normally won’t want to be the one to sign the contract on behalf of her client, because:

FIRST: Signing a contract for a client could later raise questions whether, in the negotiations leading up to the contract, the lawyer was acting as a lawyer or as a business person. This could be an important distinction: in the latter case, the lawyer’s private communications with her client might not be protected by the attorney-client privilege and thus might be subject to discovery by third parties (which is never a good look, in terms of client relations).

SECOND: From a client-relations perspective, if the contract later "goes south," the lawyer won’t want her signature on the contract. The general counsel of pharmaceutical giant Novartis was painfully reminded of this after he signed a consulting contract with Michael Cohen, formerly the personal lawyer for Donald Trump; as a result, the GC lost his job when the contract attracted unwanted publicity to the company:

Novartis’s top lawyer is to retire from the company over payments made by the pharmaceutical giant to President Trump’s personal lawyer Michael D. Cohen, the Swiss drug maker said on Wednesday. * * * 

"Although the contract was legally in order, it was an error,” Mr. Ehrat said. "As a cosignatory with our former C.E.O., I take personal responsibility to bring the public debate on this matter to an end."

Prashant S. Rao and Katie Thomas, Novartis’s Top Lawyer is Out Amid Furor Over Payments to Michael Cohen (NYTimes.com May 16, 2018) (emphasis added).

3.8 Signature mechanics

3.8.1 Signing separate copies

It's common for each party to want its own, fully-signed "original" of a contract; the above language provides for that.

If hard copies are going to be manually signed, see Section 3.7: for suggestions on how to draft the signature blocks to avoid possible challenges later.

3.8.2 Exchanging signed signature pages only

Nowadays it's quite common for the parties, in different locations, to sign separate copies of a contract and for each party to email the other party a PDF of its signed signature page only; the above language supports this practice.

3.8.3 Be sure all signed pages are "final"

It's very common for parties in separate locations to manually sign separate copies of a paper contracts and then to email a PDF image (or, old-school, to FAX) just their signed signature pages to each other.

Caution: If only the signed signature pages of a contract will be exchanged, the parties should make sure it's clear that everyone is signing the same version of the document, otherwise the contract might not be binding. Not doing this proved fatal to a party's case in Delaware, where the parties had exchanged signature pages, but the pages were from two different drafts, only one of which included the crucial provision (a noncompetition covenant). The chancery court held that there had been no meeting of the minds and thus there was not a valid contract. See Kotler v. Shipman Assoc., LLC, No. 2017-0457-JRS (Del. Ch. Aug. 27, 2019) (rendering judgment for company).

Pro tip: For that reason, a signature page should preferably be tied to a specific version of the Contract by including, on each page of the Contract, a running header or -footer that identifies the document and its version.

Example: In a draft confidentiality agreement between ABC Corporation and XYZ LLC, a running header could read "ABC-XYZ Confid. Agrmt. ver. 2019-03-01 15:00 CST" — where the date and time at the end are hand-typed, and not in an automatically-updating "field." (Including such a running header can also help avoid confusion when the parties are discussing a draft of the agreement, by allowing the parties to make sure that everyone is looking at the same draft.)

3.8.4 Pro tip: Combine all signed pages?

It's a good idea to combine • the PDF of the unsigned agreement, and • the PDFs of the signed signature pages, into a single "record copy" PDF.

Then: Email the combined, record-copy PDF to all concerned: The email will serve as a paper trail to help establish the authenticity of the record copy.

3.9 Electronic signatures

Electronic signatures are increasingly popular; in recent years the present author has seen fewer and fewer contracts drafted for wet-ink signatures.

3.9.1 Legal basis for electronic signatures

U.S. law explicitly law supports the use of electronic signatures, and American courts now routinely honor electronic "signatures" (which are now common in England and Wales as well). See generally the federal Electronic Signatures in Global and National Commerce Act ("E-SIGN Act"), 15 U.S.C. § 7001 et seq., which provides in part (subject to certain stated exceptions) that, for transactions "in or affecting interstate or foreign commerce," electronic contracts and electronic signatures may not be denied legal effect solely because they are in electronic form. • At the U.S. state level, 47 states, the District of Columbia, and Puerto Rico, and the U.S. Virgin Islands have adopted the Uniform Electronic Transactions Act ("UETA"). • The remaining three states — Illinois, New York, and Washington — have adopted their own statutes validating electronic signatures. See, e.g., Naldi v. Grundberg, 80 A.D.3d 1, 908 N.Y.S.2d 639 (N.Y. App. Div. 2010); [UK] Law Commission, Electronic Execution of Documents (2019), at https://perma.cc/UCQ7-U94M.

3.9.2 Caution: Parties must agree to electronic signatures

Section 5(b) of the UETA states that:

This [Act] applies only to transactions between parties each of which has agreed to conduct transactions by electronic means. Whether the parties agree to conduct a transaction by electronic means is determined from the context and surrounding circumstances, including the parties’ conduct.

(Square brackets in original, emphasis added.) This section is intended to "check the box" that the parties have indeed agreed to conduct transactions electronically.

3.9.3 Caution: State law might limit electronic signatures

The following language is part of the California version but not of the UETA:

(b) … Except for a separate and optional agreement the primary purpose of which is to authorize a transaction to be conducted by electronic means, an agreement to conduct a transaction by electronic means may not be contained in a standard form contract that is not an electronic record.

An agreement in such a standard form contract may not be conditioned upon an agreement to conduct transactions by electronic means.

An agreement to conduct a transaction by electronic means may not be inferred solely from the fact that a party has used electronic means to pay an account or register a purchase or warranty.

This subdivision may not be varied by agreement.

Cal. Civ. Code § 1633.5(b) (emphasis and extra paragraphing added).

And: Under California law, a car dealer apparently must still obtain a manual contract signature from a car buyer. See Cal. Civ. Code § 1633.3(c) (various carve-outs from authorization of electronic signatures) and Cal. Veh. Code § 11736(a) (requiring signed agreement with car-buying consumer).

3.9.4 Pro tip: Be able to prove up electronic signatures

A California appeals court affirmed denial of an employer's petition to compel arbitration of a wage-and-hour claim by one of its employees. The arbitration agreement had an electronic signature, but according to the court, the employer had not sufficiently proved that the purported electronic signature on the arbitration agreement was in fact that of the employee. Ruiz v. Moss Bros. Auto Group, Inc., 181 Cal. Rptr.3d 781, 232 Cal. App. 4th 836, 844-45 (Cal. App. 2014).

The California court seems to have offered a road map for contract professionals about what would suffice to prove up an electronic signature in litigation:

[The employer's business manager] Main never explained how Ruiz's printed electronic signature, or the date and time printed next to the signature, came to be placed on the 2011 agreement.

More specifically, Main did not explain how she ascertained that the electronic signature on the 2011 agreement was "the act of" Ruiz. This left a critical gap in the evidence supporting the petition.

Indeed, Main did not explain[:]

• that an electronic signature in the name of "Ernesto Zamora Ruiz" could only have been placed on the 2011 agreement (i.e., on the Employee Acknowledgement form) by a person using Ruiz's "unique login ID and password";

• that the date and time printed next to the electronic signature indicated the date and time the electronic signature was made;

• that all Moss Bros. employees were required to use their unique login ID and password when they logged into the HR system and signed electronic forms and agreements;

• and the electronic signature on the 2011 agreement was, therefore, apparently made by Ruiz on September 21, 2011, at 11:47 a.m.

Rather than offer this or any other explanation of how she inferred the electronic signature on the 2011 agreement was the act of Ruiz, Main only offered her unsupported assertion that Ruiz was the person who electronically signed the 2011 agreement.

Id., 232 Cal. App.4th at 844 (extra paragraphing and bullets added, citation omitted).

3.9.5 Additional resources

See also: • Section 3.7: for suggestions on how to draft signature blocks, with examples, as well as • Section 3.11.4: for cautions about whether an individual signer has authority to sign for a party that is a corporation or other organization, and • Section 3.9.1: concerning electronic signatures.

See generally: • the definitions of signed and writing in UCC §1-201(37) and 1-201(43); the definition of signature in the Texas Business Organizations Code § 1.002(87); "… a writing has been signed by a person when the writing includes, bears, or incorporates the person's signature. A transmission or reproduction of a writing signed by a person is considered signed by that person …." Id. § 1.007; and • the Model Business Corporation Act § 1.40 (rev. 2016).

3.10 Backdating a contract - danger!

3.10.1 Backdating can be OK

Signing a contract that is "backdated" to be effective as of an earlier date might well be OK. (This is referred to in Latin legalese as nunc pro tunc, or "now for then.") The contract itself should make it clear that parties are doing this, to help forestall later accusations that one or both parties had an intent to deceive.

Example: Suppose that Alice discloses confidential information to Bob, a potential business partner, after Bob first orally agrees to keep the information confidential. Alice might well want to enter into a written nondisclosure agreement with Bob that states the agreement and its confidentiality obligations are effective as of the date of Alice’s oral disclosure.

3.10.2 But backdating can lead to jail time

Never backdate a contract for deceptive purposes, e.g., to be able to report a sale in an already expired financial period — that practice has sent more than one corporate executive to prison for securities fraud, including at least one general counsel.

• The former CEO of software giant Computer Associates, Sanjay Kumar, served nearly ten years in prison for securities fraud through, among other things, backdating sales contracts (NY Times). Kumar was also fined $8 million and agreed to settle civil suits by surrendering nearly $800 million (NY Times).

Kumar wasn't the only executive at Computer Associates (now known as just CA) to get in trouble for backdating. All of the following went to prison or home confinement: – the CFO: seven months in prison, seven months home detention (NY Times); the general counsel: two years in prison, and also disbarred (court opinion); the senior vice president for business development: ten months of home confinement (NY Times); the head of worldwide sales: seven years in prison (WSJ).

All of this mess came about because the Computer Associates executives orchestrated a huge accounting fraud: On occasions when the company realized that its quarterly financial numbers were going to miss projections, it "held the books open" by backdating contracts signed a few days after the close of the quarter. This practice was apparently referred to internally as the "35-day month." According to CA, all the sales in question were legitimate and the cash had been collected (according to CA's press release).

The only issue was one of the timing of "revenue recognition," to use the accounting term: The company had recorded the sales on its books ("booked the sale") a few days earlier than was proper under generally-accepted accounting principles, or "GAAP."

But that was enough to put the sales revenue into an earlier reporting period than it should have been — and that, in turn, was enough to send all those CA executives to prison. (CA press release).

• Likewise, the former CFO of Media Vision Technology was sentenced to three and a half years in federal prison because his company had inflated its reported revenues, in part by backdating sales contracts. Because of the inflated revenue reports, the company's stock price went up, at least until the truth came out, which eventually drove the company into bankruptcy.

Even if backdating a contract didn't land one in jail, it could can cause other problems. For example, a California court of appeals held that backdating automobile sales contracts violated the state's Automobile Sales Finance Act (although the state's supreme court later reversed). See Raceway Ford Cases, 2 Cal. 5th 161, 211 Cal. Rptr. 3d 244, 385 P.3d 397 (2016).

3.11 Signature authority

3.11.1 Do the (human) signers have signature authority?

Suppose that Alice signs a contract on behalf of ABC Corporation. The contract is with XYZ Inc. Question: Is it reasonable for XYZ to assume that Alice's signature makes the contract binding on ABC? The answer will depend on whether Alice had authority to do so — either actual authority or apparent authority.

3.11.2 Lack of signature authority can kill a contract

A party might not be able to enforce a contract if the person who signed on behalf of the other party did not have authority to do so. This happened, for example, in a federal-contracting case:

  • An ammunition manufacturer signed several nondisclosure agreements (NDAs) with the U.S. Government and, under the NDAs, disclosed allegedly-trade-secret technology to the government.
  • The manufacturer later sued the government for breaching the NDAs by disclosing and using the trade secrets without permission.
  • Under the applicable regulations, the specific individuals who signed the NDAs on behalf of the government did not have authority to bind the government.

The court majority held that the government was not bound by some of the NDAs — and thus the government was not liable for its disclosure and use of the manufacturer's trade secrets. See Liberty Ammunition, Inc. v. United States, 835 F.3d 1388, 1401-02 (Fed. Cir. 2016). In dissent, Judge Newman argued that the senior Army officer who signed a particular NDA had at least apparent authority, and so (said the judge) the government should have been bound by the NDA. See id. at 1403-05; see also the discussion of apparent authority below.

Here’s another example from the Illinois supreme court: A landlord sued its defaulting tenant, a union local. The landlord won a $2.3 million judgment against the union in the trial court, only to see the award thrown out in the state supreme court. Why? Because in signing the lease, the union official had not complied with the requirements of the state statute that authorized an unincorporated association to lease or purchase real estate in its own name. See 1550 MP Road LLC v. Teamsters Local No. 700, 2019 IL 123046, 131 N.E.3d 99.

3.11.3 An "officer" title won't necessarily indicate signature authority

The Restatement (Third) of Agency notes that just because a person holds the title of president or vice president of a company, that doesn't mean the person has authority to make commitments on behalf of the company. See Restatement (Third) of Agency § 3.03 cmt. e(4) (2006), quoted in Elaazami v. Lawler Foods, Ltd., No. 14-11-00120-CV, slip op. at n.6 (Tex. App—Houston [14th Dist.] Feb. 7, 2012) (reversing judgment notwithstanding verdict; company's vice president of operations had apparent authority to make oral promise of bonus payment to later-fired employee).

3.11.4 But apparent authority can save the day

An individual who has "apparent authority" can bind a party to a contract, unless a hypothetical reasonable person would have reason to suspect otherwise. This is true even if the party had had an internal signature policy prohibiting the individual from signing the type of contract in question. Something like happened, for example, in a Tenth Circuit case in which a company claimed that it was not bound by a contract signed by one of its executive vice president ("EVP"). See Digital Ally, Inc., v. Z3 Tech., LLC, 754 F.3d 802, 812-14 (10th Cir. 2014); see generally https://en.wikipedia.org/wiki/Apparent_authority.

A Houston appeals court noted that:

Texas law recognizes that a company's placement of an officer or employee in a certain position will provide the agent with apparent authority to bind the company in usual, customary, or ordinary contracts that a reasonable person would view as being consistent with an agent's scope of authority in that position.

Elaazami v. Lawler Foods, Ltd., No. 14-11-00120-CV, slip op. at part III (Tex. App—Houston [14th Dist.] Feb. 7, 2012) (citing cases; emphasis added).

3.11.5 The gold standard: A board resolution — but not for everyday

The gold standard of corporate signature authority is probably a certificate, signed by the secretary of the corporation, that the corporation’s board of directors has granted the signature authority.

You’ve probably seen paperwork that includes such a certificate if you’ve ever opened a corporate bank account. The resolution language — which is invariably drafted by the bank’s lawyers— normally says something to the effect that the company is authorized to open a bank account with the bank in question and to sign the necessary paperwork, along with many other things the bank wants to have carved in stone. See this example of a corporate board resolution and officer certificate (contracts.OneCLE.com).

But a large- or publicly-traded company won't want to bother its board approval to get approval for for routine contracts or other everyday business.

3.11.6 Consider asking for a personal signer representation

Suppose that "Alice" is designated to sign a contract on behalf of a party, and that the contract includes a personal representation by Alice that she has authority to sign on behalf of that party, such as the following:

Each individual who signs this Agreement on behalf of an organizational party represents that he or she has been duly authorized to do so.

But now suppose that Alice balks because she doesn't want to put herself on the hook in case she in fact doesn't have authority. That might be a sign that the other party should investigate whether Alice really does have authority to sign.

Caution: Even if a signer were to make a written representation that s/he had signature authority, that might not be enough — because legally the other side might be "on notice" that the signer does not have authority, as discussed in the following example.

3.11.7 Or, just take the risk?

The present author once represented a MathWhiz-like client that was negotiating an agreement with a Gigunda-like customer.

  • Gigunda's attorney filled in a name and title for Gigunda's signer: It was a Gigunda individual contributor; let's call her "Sarah" (not her name).
  • I raised the issue of apparent authority with the MathWhiz senior executive, who responded that he had been dealing exclusively with Sarah in negotiating the agreement, but that Sarah's boss (whom the MathWhiz executive knew well) had been copied on all of the emails going back and forth.
  • The MathWhiz executive also said that MathWhiz had a longstanding good history with Gigunda.

After learning all of the above, my recommendation to MathWhiz was that we not try to change the signature block to reflect someone else's title — it might offend Sarah, and it would certainly delay getting to signature, with little or no real reduction in MathWhiz's business risk.

MathWhiz did as I recommended; the parties signed the contract and carried it out to everyone's satisfaction.

3.11.8 Special case: Legal limits on signature authority

By statute, a contract with an LLC or other organization might not be enforceable, even if signed by an "officer" or by a "manager." That could be the case if the articles of organization (which are usually publicly available) expressly deprive the signer of such authority.

This happened in a Utah case where:

  • One manager of a two-manager LLC signed an agreement granting, to a tenant, a 99-year lease on a recreational-vehicle pad and lot.
  • But there was a problem: The LLC’s publicly filed articles of organization stated that neither of the two company’s managers had authority to act on behalf of the LLC without the other manager’s approval.

The court held that the tenant had been on notice of the one manager’s lack of authority to grant the lease on just his own signature alone — and so the lease was invalid. See Zions Gate RV Resort, LLC v. Oliphant, 2014 UT App 98, 326 P.3d 118, 121 ¶ 8, 122-23. The court remanded the case for trial as to whether the LLC had later ratified the lease.

3.11.9 Consider including authority-disclaimer language

Some drafters might want to be explicit about who does not have signature authority, to help preclude a party from claiming to have relied on the apparent authority of other would-be signers.

This approach can sometimes be seen in sales-contract forms used by car dealer, which can say, typically in all-caps, something along the lines of, "NO PERSON HAS AUTHORITY TO MODIFY THESE WARRANTIES ON BEHALF OF THE DEALER EXCEPT A VICE PRESIDENT OR HIGHER."

3.12 Notary certificates (skim)

Contracts generally aren't notarized, but sometimes ancillary documents (e.g., deeds, assignments) might be.

This section discusses the certificate of acknowledgement by a notary public or other authorized official; that's a different type of certificate than a jurat, in which a notary or other official certifies that the signer of the document personally declared, under penalty of perjury, that the document's contents were true.

3.12.1 Litigation advantage: Self-authentication

A document such as a deed to real property might include, after the signature blocks, a space for a notary to sign a certificate that the signer:

  1. appeared before the notary;
  2. presented sufficient evidence to establish his or her identity (e.g., a driver's license, a passport, etc.); and
  3. stated to the notary that he or she (the signer) signed the document.

Why do this? Because in many jurisdictions, the notary's signed certificate and official seal will serve as legally-acceptable evidence that the document isn't a forgery — that is, that the document is authentic. (This is sometimes referred to as making the document self-authenticating or self-proving.)

And indeed, the law likely requires a notary's certificate of acknowledgement if the document is to be recorded in the public records so as to put the public on notice of the document's contents. Example: Suppose that "Alice" is selling her house. To do so, she will ordinarily sign a deed and give the deed to "Bob," the buyer. Bob will normally want to take (or send) the deed to the appropriate government office to have the deed officially recorded; that way, under state law, third parties will be on notice that Bob now owns Alice's house.

But how can a later reader know for sure that the signature on the deed to Alice's house is in fact Alice's signature and not a forgery? The answer is that under the laws of most states, Alice's deed to Bob won't even be eligible for recording in the official records unless the deed includes an acknowledgement certificate, signed by a notary public or other authorized official, that Alice complied with the three numbered requirements at the beginning of this section.

(And if Alice signed the deed in a special capacity, such as executor of her father's estate, then the notary's certificate will usually say that, too.)

Once Alice has done this, the notary will sign the certificate and imprint a seal on the deed. The notary might do this with a handheld "scruncher" that embosses the paper of the deed, or instead with an ink stamp; this will depends on the jurisdiction.

Typically, the notary is also required to make an entry in a journal to serve as a permanent record. Pro tip: It's useful to confirm that the notary in fact did this — a family friend of the present author once won a lawsuit by getting a notary to admit, on cross-examination, that she (the notary) had not made such an entry in the "well-bound book" that was then required by state law.

This acknowledgement procedure allows the civil servants who must record Alice's deed to look at the deed and have at least some confidence that the signature on it isn't a forgery.

Incidentally, state law usually determines just what wording must appear in an acknowledgement.

In some jurisdictions, Alice is not required to actually sign the deed in the presence of the notary; she need only acknowledge to the notary that yes, she signed the deed. See generally Kelle Clarke, Notary Essentials: The Difference Between Acknowledgments And Jurats (NationalNotary.org 2020).

3.12.2 Other officials might also be able to "notarize"

By statute, certain officials other than notaries public (note the plural form) are authorized to certify the authenticity of signatures in certain circumstances. For example, Texas law gives the power to certify signature acknowledgements to:

  • district-court and county-court clerks; and
  • in certain cases, to commissioned officers of the U.S. armed forces;

among others. See Tex. Civ. Prac. & Rem. Code § 121.001.

3.12.3 Notaries and conflicts of interest

A notary public generally can't sign a certificate if the notary has a conflict of interest, e.g., notarizing something for an immediate-familly member. See generally, e.g., American Society of Notaries, Conflicts of Interest (2008).

But Texas law specifically allows a corporate employee (who is a notary public) to certify the acknowledgement of a signature on a document in which the corporation has an interest unless the employee is a shareholder who owns more than a specified percentage of the stock. See Tex. Civ. Prac. & Rem. Code § 121.002.

3.12.4 A flawed notarization can cause problems

Parties will want to double-check that the notary "does the needful" (an archaic but useful expression) to comply with statutory requirements. In a New York case, a married couple's prenuptial agreement was voided because the notary certificate for the husband's signature didn't recite that the notary had confirmed his identity: It was undisputed that the couple's signatures were authentic, and there was no accusation of fraud or duress. Even so, said the state's highest court, the notarization requirement was important because it "necessarily imposes on the signer a measure of deliberation in the act of executing the document." See Galetta v. Galetta, 21 N.Y.3d 186, 189-90, 191-92, 991 N.E.2d 684, 969 N.Y.S.2d 826 (2013) (affirming summary judgment that prenup was invalid).

3.12.5 Lawyers might not want to notarize client documents

In many states it's easy to become a notary public. Some lawyers themselves become notaries so that they can certify the authenticity of clients' signatures on wills, deeds, and the like.

But if a lawyer notarizes a document, then the lawyer might be called someday to testify in a court proceeding about a signed document. For example, the lawyer-notary might have to explain how he or she confirmed the signer's identity if that information isn't stated in the lawyer's notary records. That in turn might disqualify the lawyer from being able to represent the client whose signature was certified. See, e.g., Tex. Civ. Prac. & Rem. Code § 121.001; Tex. Discipl. R. Prof. Conduct 3.08 ("Lawyer as Witness").

(As a practical matter, though, that might not be too much of an issue, because the lawyer might already have to testify by virtue of having participated in the events leading up to the signing of the document.)

3.12.6 Notarization by videoconference?

Drafters needing a notary certificate should check whether applicable law requires a personal appearance before a notary (or other official). See generally National Notary Association, Remote Notarization: What You Need to Know (nationalnotary.org Jun. 23, 2020) (showing states with remote-notary laws).

Remote notarization was an issue during the 2019-20 COVID-19 pandemic, during which the Texas governor announced an emergency suspension of some laws and authorized notarization of certain wills and real-estate documents. See Texas Secretary of State, Notice of Suspension of Statutes (undated; refers to a governor's order of Apr. 8, 2020 concerning wills, etc.) (sos.state.tx.us); also this order (notarization of real-estate instruments).

3.13 Exercises and discussion questions

3.13.1 Discussion questions: Title, preamble, background

  1. FACTS: MathWhiz's CEO asks you to draft a confidentiality agreement ("NDA") between MathWhiz and a company she knows only as "Gigunda Energy," a multibillion dollar multinational corporation based in California. TRUE OR FALSE: In the NDA's preamble, it's OK to list Gigunda as simply "Gigunda Energy," without more. EXPLAIN.
  2. For the NDA in #1, draft a title — consider the various title styles in § 3.4.
  3. For the NDA in #1, what information would you want to find out about Gigunda to include in the preamble — and how might you go about acquiring that information?
  4. For the NDA in #1, describe two ways you could avoid having to repeat the parties' full legal names throughout the contract. What are some pros and cons of each way?
  5. How would you write the very first sentence of the NDA's preamble?
  6. In the NDA's preamble, how important is it to include the parties' full legal names, and why? What about their state(s) of incorporation or other organization?
  7. In the NDA's preamble, would you say that the confidentiality is (i) "between," or (ii) "by and between," or (iii) "among," Gigunda and MathWhiz?
  8. Why might you want to include the city and state of Gigunda's principal place of business in the NDA's preamble?
  9. Why might you want to include Gigunda's initial address for notice in the NDA's preamble?
  10. MORE FACTS: MathWhiz's CEO tells you that she and her contact at Gigunda have already discussed, on a Zoom call, a limited amount of each party's confidential information but they agreed orally to keep the information confidential. QUESTION: Is that oral agreement enforceable?
  11. Same facts as #10: How could you set up the written NDA to cover the previous Zoom call?
  12. MORE FACTS: MathWhiz's CEO tells you that Gigunda wants the NDA to cover not just Gigunda's confidential information, but also some confidential information of Gigunda's wholly-owned Mongolian subsidiary. QUESTION: How could you do that?
  13. Exercise: Using what you know from the above, draft a very simple "Background" section for the NDA.
  14. To what extent would you want to put specific details of the NDA — for example, how long the confidentiality obligations of the NDA will last — into its Background section?
  15. FACTS: Gigunda's lawyer has prepared a draft of the NDA, which says at the beginning: "This Agreement is made effective January 31, 20xx." MathWhiz's lawyer has asked you to review the draft and make any necessary revisions. QUESTION: Would you change the just-quoted sentence to state that the Agreement is effective the last date signed? Why or why not?
  16. In the signatures-up-front example in § 3.7.8, what item of information is missing that could prove useful someday in the future? Why might that information be useful? How serious a flaw is it that this information is missing?
  17. Draft a preamble and background section for the Gigunda-MathWhiz agreement.
  18. True or false: In an agreement title that contains party names, the full legal names of the parties must be spelled out in full.

3.13.2 Discussion questions: Signatures

  1. Explain if false: In the U.S., before parties can use electronic signatures, they must first sign a hard-copy preliminary agreement that they can use electronic signatures for subsequent agreements.
  2. Explain if false: Nowadays, most contracts get printed out in two copies, and each copy is signed by both parties, so that each party will have one, fully-signed original to keep.
  3. Explain if false: It's not a great idea to put signature blocks at the front of a contract. EXPLAIN.
  4. Explain if false: It's a good idea to include language such as the following just before the signature blocks: "To evidence the parties’ agreement to this Agreement, each party has executed and delivered it on the date indicated under that party’s signature."
  5. Explain if false: Signature blocks should have the "date signed" spaces pre-filled in so that the signers won't have to remember to write in the dates.
  6. Explain if false: Each individual signer's signature block should have a blank space for the signer to handwrite in the date signed.
  7. Explain if false: It's OK to let a signature block get split between two different hard-copy pages (that is, the first part of the signature block is at the bottom of one page and the remainder is at the top of the next page).
  8. What feature of Microsoft Word can you use to get two signature blocks side-by-side on the page? (Hint: It starts with "T.")
  9. (From Contracts 101 for 1Ls:) By law, what's the significance of the last date signed?
  10. Explain if false: The signature block for a corporation or LLC can just state the individual signer's name, e.g., "Jane Doe," without any other information.
  11. FACTS: ABC Corporation's marketing department is negotiating a contract with social-media giant Foogle for a $10 million online advertising campaign to promote ABC's products. At the request of ABC's director of marketing, ABC's vice president for human resources Allen Baker Cole signs the contract. BUT: ABC's CEO learns about the contract and immediately demands that it be set aside, because the CEO had planned to use that money for other things. ABC's internal policy manual states that all advertising contracts must be signed by the executive vice president for sale. QUESTION: Can ABC use Allen's lack of authority as a reason to cancel the advertising contract?
  12. DIFFERENT FACTS: Before the advertising contract was signed, ABC's vice president of marketing sent an email to his contact at Foogle, stating that only he (the VP of marketing) had authority to sign the advertising contract; the Foogle contact emailed back, saying "fine, that works for us." QUESTION: Does that change your answer in #11 above? If so, how?
  13. Explain if false: It's generally OK for an attorney to sign on behalf of a client as long as the signature (or signature block) indicates that the attorney is signing in that capacity and not as an officer of the client or as an individual party.
  14. Explain if false: It's generally OK for a company's vice president and general counsel to sign a contract with Thomson West for the legal department's Westlaw subscription.
  15. If exchanging signed signature pages only, how can you make sure each party's signed signature page is from the same version of the contract? (In one case, discussed in the reading, this was a problem — what happened there?)
  16. When (if ever) might it be appropriate to do the following:
    • Appropriate to backdate the effective date of a contract
    • INappropriate to backdate the effective date of a contract
    • Appropriate to backdate the signers' signatures
    • INappropriate to backdate the signers' signatures

3.13.3 Discussion questions: Notary certificates

  1. FACTS: Your client, Landlord, has negotiated a five-year commercial lease for one of its office buildings. The tenant's lawyer wants the signers to have their signatures notarized. Landlord agrees to have the signatures notarized. ASSUME: All events take place in Texas and are subject to Texas law. QUESTION: Why might the tenant's lawyer want the lease to be notarized? Would that be in your client Landlord's best interest? EXPLAIN. See generally J. Allen Smith & Michael R. Steinmark, Tenants' Rights Under Unrecorded Leases, at http://goo.gl/S2prC (2010); Tex. Prop. Code §§ 12.001, 13.001, 13.002.
  2. If the notary public can't find her notary seal, may she sign the notary certificate and skip applying the seal? EXPLAIN. See Tex. Gov. Code § 406.013; Tex. Civ. Prac. & Rem. Code § 121.004.
  3. What must the notary public do before signing the notary certificate to confirm that the signers are who they claim to be? See Tex. Civ. Prac. & Rem. Code § 121.005(a).
  4. Must the notary's certificate say anything in particular about the identity of the signer? EXPLAIN. See Tex. Civ. Prac. & Rem. Code § 121.005(b).
  5. What must the notary do after notarizing the signature(s)? EXPLAIN. See Tex. Civ. Prac. & Rem. Code § 121.012; Tex. Gov. Code § 406.014.
  6. If no notary is around, can you notarize the signatures as an attorney? Should you? EXPLAIN. See Tex. Civ. Prac. & Rem. Code § 121.001; Tex. Discipl. R. Prof. Conduct 3.08 ("Lawyer as Witness").
  7. Surprise! The person who will sign the lease for the tenant has gone on a business trip to Kuwait and will FAX her signed signature page to you. Can your secretary, who is here in Houston and is a notary public, notarize that signature page? EXPLAIN. See Tex. Civ. Prac. & Rem. Code § 121.004(a).
  8. Who in Kuwait could "notarize" the tenant signer's signature? EXPLAIN. See Tex. Civ. Prac. & Rem. Code § 121.001.
  9. Why "notarize" a document signature with an acknowledgement, as opposed to a jurat? EXPLAIN.

4 Defined terms

Defined terms can be quite useful — not least because they allow drafters to change the definition for, say, "Purchase Price" to reflect a new dollar figure, without having to revise the dollar figure multiple times throughout the contract. See also the "D.R.Y. — Don't Repeat Yourself" rule discussed at Section 8.8: .

4.1 The benefits of "in-line" definitions

It's often convenient to include definitions "in-line" with the substantive provisions in which they are used; see, for example, the way that "Buyer" and "Seller" are defined in Section 3.5: .

When you keep definitions together with their substantive provisions in this way, it makes it easier for future drafters to copy and paste an entire contract article or section into a new contract.

4.2 Have a separate section for general definitions?

It's also common to use a separate “general definitions” section and to place it in one of three spots in the contract:

  1. right after the Background section — this is perhaps the most-common practice;
  2. at the back of the contract, just before the signature blocks or as an appendix after the signature blocks (with results that might be surprising, as discussed in the note just below); On his blog, IACCM founder and president Tim Cummins told of an IACCM member whose company saved hours of negotiating time — up to a day and a half per contract — by moving the “definitions” section from the front of its contract form to an appendix at the back of the document. Cummins recounted that “by the time the parties reached ‘Definitions’, they were already comfortable with the substance of the agreement and had a shared context for the definitions. So effort was saved and substantive issues were resolved.” Tim Cummins, Change does not have to be complicated (July 21, 2014).
  3. in a separate exhibit or schedule (which can be handy if using the same definitions for multiple documents in a deal).

4.3 Pro tip: Include cross-references

In some contracts you might have both "in-line" definitions and a separate general-definitions section. In that situation, you should seriously consider serving future readers by including, in the separate general-definitions section, appropriate cross-references (in their proper alphabetical spots) to the in-line definitions.

That way, the general-definitions section does additional duty as a master index of defined terms.

4.4 Some defined-terms style preferences

The following are some personal style preferences that enhance readability (in the author’s view):

– Put the defined term in "quotes and italic type" to make it stand out on the screen or page and thus make the term easier to spot while scanning through the document.

– Use the phrase refers to instead of means, because the former often just sounds better in different variations; see the following example (where bold-faced type is used to highlight differences and not to set off defined terms):

Before:

Confidential Information means information where all of the following are true ….

After:

"Confidential Information" refers to information where all of the following are true ….

4.5 Don't bother numbering alphabetized definitions

If you alphabetize your defined-terms section (as you should), there's no need to number the paragraphs. The purpose of numbering contract paragraphs is easy referencing, both internally and in later documents. That purpose is sufficiently served just by having the definitions in alphabetical order. Ken Adams gives an example of a real-world contract that contained so many defined terms, in alphabetically-lettered paragraphs, that the paragraphs went from (a), (b), (c), etc., all the way to (cccccccccc), that is, with ten "c" letters. Just imagine trying to cite that in a cross-reference or a legal brief. See Ken Adams, Deranged Definition-Section Enumeration (AdamsDrafting.com 2020).

4.6 Caution: Consistency in capitalization can be crucial

It’s a really good idea to be consistent about capitalization when drafting a contract. If you define a capitalized term but then use a similar term without capitalization, that might give rise to an ambiguity in the language — which in turn might preclude a quick, inexpensive resolution of a lawsuit.

That kind of bad news happened in a New York case:

  • The defendant asserted that the plaintiff’s claim was barred by the statute of limitations and therefore should be immediately dismissed.
  • The plaintiff, however, countered that the limitation period began to run much later than the defendant had said.
  • The court held that inconsistency of capitalization of the term “substantial completion” precluded an immediate dismissal of the plaintiff’s claim. See Clinton Ass’n for a Renewed Environment, Inc., v. Monadnock Construction, Inc., 2013 NY Slip Op 30224(U) (denying defendant’s motion to dismiss on the pleadings).

In a similar vein, a UK lawsuit over flooding of a construction project turned on whether the term “practical completion” — uncapitalized — had the same meaning as the same term capitalized. The court answered that the terms did not have the same meaning; as result, a sprinkler-system subcontractor was potentially liable for the flooding. See GB Building Solutions Ltd. v. SFS Fire Services Ltd., (2017) EWHC 1289, discussed in Clark Sargent, Antonia Underhill and Daniel Wood, Ensure That Defined Terms Are Used Consistently; Ambiguity Can Be Costly (Mondaq.com 2017).

5 Exhibits, schedules, etc.

This section describes typical practice in U.S. contract drafting; the terminology might be different in other jurisdictions.

5.1 Exhibits: Standalone documents (generally)

A contract exhibit is generally a standalone document attached to (or referenced in) a contract. Exhibits are often used as prenegotiated forms of follow-on documents such as forms of real-estate deed.

Example: Imagine that ABC Corporation and XYZ Inc. sign a contract under which XYZ will buy an apartment complex from ABC. Such contracts usually provide:

  • for the buyer to have a period in which to have the house inspected and, if necessary, to obtain financing; and
  • after that, for a "closing" in which:
    • the buyer is to pay the purchase price; and
    • (relevantly here:) the seller is to deliver a deed that conveys title to the buyer.

In a commercial real-estate contract such as the one between ABC and XYZ, the contract might well include, as an exhibit, an agreed form of warranty deed; the contract might say the following, for example:

… At the Closing (subject to Buyer's fulfillment of Buyer's obligations under this Agreement), Seller will deliver to Buyer a general warranty in substantially the form attached to this Agreement as Exhibit A.

(Emphasis added.)

Example: A master services agreement might include, as an exhibit, a starter template for statements of work to be undertaken under the agreement.

Exhibit numbering: Contract exhibits are commonly "numbered" as Exhibit A, B, etc., but that's just a convention; exhibits could alternatively be numbered with numerals, such as Exhibit 1, 2, etc., or even by reference to section numbers in the body of the contract (see the discussion of schedules below). The important thing is to make it easy for future readers to locate specific exhibits.

5.2 Schedules: For disclosures of exceptions from a benchmark

Schedules are commonly used in contracts for disclosures of exceptions to representations and warranties in the body of the contract. Example: In the merger agreement between software giant Symantec Corporation and BindView Corporation (of which the author was vice president and general counsel), BindView warranted, among other things, that:

Article 3
Representations and Warranties of the Company * * * 

3.2 Company Subsidiaries. Schedule 3.2 of the Company Disclosure Letter sets forth a true, correct [sic] and complete list of each Subsidiary of the Company (each a “Company Subsidiary”). …

Other than the Company Subsidiaries or as otherwise set forth in Schedule 3.2, the Company does not have any Company Subsidiary or any equity or ownership interest (or any interest convertible or exchangeable or exercisable for, any equity or ownership interest), whether direct or indirect, in any Person.

(Italics and extra paragraphing added.)

In other words: The reps and warranties in the contract set forth a baseline reference point — a benchmark, a Platonic ideal — while the schedule(s) specify how the Company (in this case, BindView) did not conform to that benchmark status.

Schedule numbering: It's conventional to number each schedule according to the section in the body of the agreement in which the schedule is primarily referenced; in the example above, Schedule 3.2 has the same number as section 3.2 of the merger agreement in which that schedule is referenced.

5.3 Appendixes, addenda, annexes

Other materials can be attached to a contract as appendixes, annexes, and addenda; there's no single standard or convention for doing so.

6 Street smarts: Your career

One of the aims of this book is to help young lawyers and other contract professionals to quickly achieve "seasoned pro" status; this chapter suggests a few things that can help in that effort.

Contents:

6.1 In style disputes, your supervisor wins*

* Subject to ethical boundaries and potential criminal liability, of course.

A new lawyer or other contract professional might find that her partner or other supervisor prefers to write out, for example, one million seven hundred thousand dollars ($1,700,000.00), instead of the simpler $1.7 million, even though this book strongly recommends against doing so. This approach of spelling out numbers, and then repeating with numerals, once cost a Dallas-area lender $693,000, as explained in Section 8.8: , "D.R.Y. — Don't Repeat Yourself."

But don't fight your supervisor over things like this; in purely-stylistic matters, just do it the way that the supervisor prefers. There'll be plenty of time to develop and use your own preferred style as you get more experienced and more trusted to handle things on your own — and especially if you start to bring in your own clients.

(In the meantime, of course, you'll have to be extra-careful not to make the kind of mistakes that can result from some of these suboptimal style practices.)

6.2 Dealing with "the other side's" draft

Many contract drafters spend at least as much time reviewing others' draft contracts as they do in drafting their own. Here are a few pointers.

1.  Do ask the other side for an editable Microsoft Word document. And if you send the other side a draft or a redline, don't send a PDF or a locked Word- or PDF document — doing so implicitly signals a lack of trust; between lawyers especially, it's more than a little lacking in professional courtesy.

2.  Do save your own new draft immediately: Open the other party's draft in Microsoft Word and immediately save it as a new document whose file name reflects your revision. Example of file name: "Gigunda-MathWhiz-Services-Agreement-rev-2020-08-24.docx"

3.  Do add a running header to show the revision date: Add a running header to the top right of every page of your revision to show the version date and time (typed in, not an updatable field) (and matching the date in the file name). Example of running header: "REV. 2020-08-24 18:00 CDT" (note the use of military time for clarity).

4.  Don't revise the other side's language just for style: It's not worth spending scarce negotiation time — and it won't go over well with either the other side or the client — to ask the other side to change things that don't have a substantive effect.

Example: Suppose that the other side's draft contract leads off with "WITNESSETH" and a bunch of "WHEREAS:" clauses. As a well-trained drafter, you'd prefer to have a simple background section without all the legalese (see § 3.6 for more details). Let it be: If the other side's "WHEREAS:" clauses are substantively OK, don't revise those clauses just because you (properly) prefer to use a plain-language style.

5.  But do break up "wall of words" provisions in another party's draft to make the provisions easier for your client to review — and to help you to do a thorough review with lower risk of the MEGO factor ("Mine Eyes Glaze Over"). After you save a new Word document (see #2 above), do the following:

  • Double-space the entire text (except signature blocks and other things that should be left in single-space) if not that way already.
  • Break up long sentences, as explained in more detail at § 7.5.

6.  And do add an explanation for the added white space: In the agreement title at the top of the draft, add a Word comment bubble along the lines of the following:

To make it easier for my client to review this draft, I'm taking the liberty of double-spacing it and breaking up some of the longer paragraphs.

(It's hard for another lawyer to object to your doing something to make things easier for your client, right?)

The author has been doing this for years and has only once gotten pushback on that point from the original drafter — in fact, the parties pretty much always end up eventually signing a double-spaced version with broken-up paragraphs, as opposed to the original wall-of-words format.

7.  Never gratuitously revise another party's draft to favor the other party — even if your revision seems to make business sense — and certainly not if the revision might someday put your client at a disadvantage or give up an advantage.

Example: Suppose that this time your client MathWhiz is a customer, not a vendor. A vendor that wants to do business with MathWhiz has sent MathWhiz a draft contract. The draft calls for MathWhiz to pay the vendor's invoices "net 90 days" — that is, the vendor expects MathWhiz to pay in full in 90 days.

  • You know that vendors like to be paid as soon as they can, so you suspect that the vendor's 90-day terms are a mistake, perhaps left over from a previous contract; i.e., the vendor's contract drafter might have taken a previous contract and changed the names, but without changing the 90-day terms to, say, 45-day terms.
  • You know that MathWhiz, like all customers, pretty-much always prefer to hold onto its cash for as long as they can — not least because delaying payment can give a customer a bit of extra leverage over its suppliers.
  • You also know that MathWhiz usually pays net-45 and is even willing to pay net-30 if the other terms are acceptable.

Let it be — don't take it on yourself to unilaterally change the vendor's net-90 terms to net-45, because that would require MathWhiz to pay the vendor's invoices earlier than the vendor asked in its draft contract.

The vendor's drafter might later embarrassedly confess to having overlooked the net-90 terms and ask to change it to net-30. That gives MathWhiz an opportunity to be gracious, which will usefully signal to the vendor that MathWhiz might well be a Good Business Partner (which most companies like to see).

This is also a lesson about the possible danger of reusing an existing contract without carefully reviewing it to identify — and possibly strip out — any concessions that were made in the course of previous negotiations.

6.3 The Check-In Rule

As a junior lawyer, there will be times when you will — and should — be uncertain about what to do in a contract draft. For example:

• When drafting a contract for a client, you might wonder whether to include a forum-selection provision, because doing so can lead to problems in negotiation (the other side might insist that their home city be the exclusive forum).

• In reviewing another party's draft contract, you might see that the draft includes a forum-selection provision that requires all litigation to take place exclusively in the other side's home jurisdiction; you wonder whether the client will be OK with that.

To keep your client and your supervising partner happy (not to mention your malpractice carrier) here's what you do:

1.  Check in with your supervising partner — or, if you're the person who deals with the client, check in with the client — about the issue that concerns you, which here is the forum-selection provision.

Important: Have a well-thought-out recommendation for what to do about the issue of concern, with reasons for your recommendation. This is true even if the recommendation is limited to advising the client to consider Factors X, Y, or Z in making a decision. That will give the partner or client a concrete proposal to consider, instead of just wondering about the issue in the abstract. (Also, superiors and clients tend to think, not unreasonably: Bring me [proposed] solutions, not just problems.)

Note: Don't pick up the phone and call the partner or client every time an issue pops into your head — no one likes to be repeatedly interrupted with questions. Instead:

  • make a list of things to discuss with the partner or client; and
  • schedule a meeting or phone call (or Zoom call) to discuss the list.

Pro tip: In Microsoft Word, you can add comment bubbles in the margin of a draft contract. Those comment bubbles can then be used as the discussion agenda during what's known as a "page turn" conference call, where the participants go page by page through a draft contract or other document. (Ditto for discussing comments with the other side during a negotiation call.)

2.  Document that you advised the client or partner — in matter-of-fact, non-defensive language — either:

  • in an email to the partner or client, and/or
  • in Word comment bubbles in a draft that you sent to the partner or client, as discussed in the pro tip above.

Here's a real-life example: A client's CEO once asked me to review a draft confidentiality agreement ("NDA") sent to him by a giant company. At the time, I'd been working with the CEO for many years, helping him do his job at several different companies where he'd been a senior executive (two of which companies he founded). This illustrates an important career-development lesson for new lawyers: The people you deal with at your clients will sometimes change jobs or start their own companies. In their new positions, these folks might well have occasion to hire outside counsel, and they'll prefer to use lawyers whom they already know and with whom they're comfortable working. Over time, this can be an important source of business for lawyers.

Here's the email I sent the CEO about the giant company's NDA form, only lightly edited:

1.  They [the giant company] have their infamous "residuals clause" in this NDA, which is basically a blank check for them to use whatever you tell them — in [section reference] it says:

"Neither of us can control … what our representatives will remember, even without notes or other aids. We agree that use of information in representatives’ unaided memories in the development or deployment of our respective products or services does not create liability under this agreement or trade secret law, and we agree to limit what we disclose to the other accordingly." (Emphasis added.)

BUSINESS QUESTION: Are you OK with giving [the giant company] that kind of a blank check for what you'll be disclosing to them?

2.  Any litigation would have to be in [city]. Meh. [DCT comment: I certainly wouldn't have been this informal with someone with whom I didn't have such a longstanding relationship.]

3.  There's no requirement that a recipient must return or destroy confidential information. I'm fine with that; I've come to think that omitting such a requirement is the most-sensible approach.

Otherwise it [the giant company's draft NDA] looks OK.

Notice what I did here: I pointed out three issues — in numbered paragraphs — for which I wanted the CEO's input, and I made recommendations as to the second two; the CEO would ultimately make the decisions what business risks to accept.

Epilogue: The CEO emailed me back and asked for a phone conference with him and another executive. That time, I didn't follow up with an email to confirm the plan of action we'd agreed on, but if I had done so, the confirming email might have been along the following lines:

Confirming part of our phone conversation today: The [giant company] NDA has an exclusive forum-selection provision that requires all litigation to be in [city]; under the circumstances I think that's probably an acceptable business risk.

Please let me know if you'd like to discuss this any further.

(Emphasis added.) Note how, in the first sentence, I left a paper trail for future litigation counsel, documenting the facts: (i) that we had a phone conversation, and (ii) when that conversation occurred.

Note also my use of the term "acceptable business risk," signaling that this was a judgment for the client to make.

IMPORTANT: Be careful about how you phrase your emails and other comments to the client or partner: Assume that anything you put in writing might someday be read by an adversary and possibly used against your client — or against you — in litigation.

Sure, in some circumstances the attorney-client privilege should protect at least some of your written comments from discovery. But the privilege has its limits; moreover, the privilege can be waived (by the client only), or it might even be pierced (if the crime-or-fraud exception applies).

6.4 Note-taking during negotiations

Chances are that at some point in your career, a lawyer — yours, or someone else's — will want to review notes you took at a meeting or during a phone conversation. With that possibility in mind, whenever you take notes, you should routinely do as many of the following things as you can remember, especially the first three things. This will increase the chances that a later reviewer will get an accurate picture of the event, which in turn can help you stay out of undeserved trouble and save money on legal fees

1.  Indicate who said what you're writing down. Unless you want to risk having someone else's statements mistakenly attributed to you, indicate in your notes just who has said what.

Example: Suppose that John Doe says in a meeting that your company's off­shore oil-well drilling project can skip certain safety checks.

  • Remembering the BP drilling disaster in the Gulf of Mexico, you don't want anyone to think you were the guy who suggested this.
  • So your notes might say, for example, "JD: Let's skip safety checks."
  • If you omitted John Doe's initials, it wouldn't be clear that you weren't the one who made his suggestion.

2.  On every page, write the meeting date and time, the subject, and the page number. The reason: Your trial counsel will probably want to build a chronology of events; you can help her put the meeting into the proper context by "time-stamping" your notes. This will also reduce the risk that an unfriendly party might try to quote your notes out of context.

3.  If a lawyer is participating, indicate this. That will help your lawyer separate out documents that might be protected by the attorney-client privilege. EXAMPLE: "Participants: John Doe (CEO); Ron Roe (ABC Consulting, Inc.); Jane Joe (general counsel)."

4.  Start with a clean sheet of paper. When copies of documents are provided to opposing counsel, in a lawsuit or other investigation, it's better if a given page of notes doesn't have unrelated information on it. This goes for people who take notes in bound paper notebooks too: It's best to start notes for each meeting or phone call on a new page, even though this means you'll use up your notebooks more quickly.

5.  Write in pen for easier photocopying and/or scanning, and also because pencil notes might make a reviewer (for example, as an opposing counsel) wonder whether you might have erased anything, and perhaps falsely accuse you of having done so.

6.  Write "CONFIDENTIAL" at the top of each page of confidential notes. That will help preserve any applicable trade-secret rights; it will also help your lawyer segregate such notes for possible special handling in the lawsuit or other investigation.

7.  List the participants. Listing the participants serves as a key to the initials you'll be using, as discussed in item 1 above. It can also refresh your recollection if you ever have to testify about the meeting. If some people are participating by phone, indicate that.

8.  And indicate each participant's role if isn't obvious or well-known – remember, you might know who someone is, but a later reader likely won't know. EXAMPLE: "Participants: John Doe (CEO); Ron Roe (ABC Consulting, Inc.); Chris Coe (marketing)."

9.  Indicate the time someone joins or leaves the meeting, especially if it's you (so that you're not later accused of having still been there if something bad happened after you left).

10.  Write down the stop time of the meeting. This usually isn't a big deal, but it's nice to have for completeness.

7 Street smarts: Client happiness

7.1 Perfect is the enemy of good enough - but …

When it comes to contracts, clients are firm believers that "perfect" is the enemy of "good enough." Clients generally would far prefer to get an "OK" contract that covers the reasonably-likely contingencies, and get it signed quickly; they don't want to waste calendar time, nor to pay for lawyers, to get a gold-plated contract that covers unlikely and/or low-risk possibilities.

Of course, part of the problem is that hindsight is 20-20: If an "unlikely" possibility in fact comes to pass and causes problems for the client, guess where fingers might well be pointed for not having covered that possibility in the contract? Hey, no one ever said life was fair.

7.2 The mission: Educating - and persuading? - readers

The author of a popular contract style manual once opined — wrongly — that, apart from the opening recitals, “in a contract you don’t reason or explain. You just state rules.” That view would be fine if it weren't for some inconvenient facts. Ken Adams, More Words Not to Include in a Contract— “Therefore” and Its Relatives, at http://www.adamsdrafting.com/therefore/ (2008).

  1. Even in a business-to-business contract, it's people, not computers, who carry out obligations and exercise rights. (So-called digital "smart contracts" are a very-different thing.) Computers do exactly as they're told, but people? Not so much — at least not always reliably.
  2. People sometimes forget — perhaps conveniently — what the parties discussed and agreed to, and who sometimes change their minds about what they regard important. That can be especially true, and memories can sometimes be "creative," when individuals' personal interests (often hidden) are involved; this means that people sometimes need to be reminded of what they agreed to.
  3. A contracting party's circumstances can change after the contract is signed. For example:
    • By the time a dispute arises, key employees and executives of a party could have different views of what's important.
    • Or, those people might have "forgotten" what mattered during the contract negotiations.
    • The people who originally negotiated the business terms might not be in the same jobs; their successors might not know why the parties agreed to the terms that they did.
  4. And let's not forget another important group of people: Judges, jurors, and arbitrators who are asked to enforce a contract can be influenced by what they think is "fair"; sometimes, the wording of the contract's terms can make a difference in how those future readers might perceive the parties' positions.

The upshot: People sometimes need to be educated — and even persuaded — to do the things called for by a contract. Explanations can serve as useful reminders on that score.

To be sure, the famous Strunck & White drafting guide counsels writers to "omit needless words." But the operative word there is needless. Sometimes, a few extra words of explanation in a contract can help nudge readers in the "right" direction.

That's the contract drafter's mission: To (re)educate the parties — and sometimes judges and jurors — and, if necessary, to persuade them, to do what your client now wants them to do.

7.3 Serve the reader!

When a client asks for a contract to be drafted, the client probably imagines (often correctly) that the business terms are pretty much agreed and that the only thing standing in the way of a done deal is "legal" — both the client's lawyer and the other side's lawyer.

But it's usually more-complicated than that: A contract will almost never get signed before it has been extensively reviewed, on both sides of the deal, by (often multiple) lawyers and business people, and sometimes by accountants, insurance professionals, and others.

A commenter on Twitter once remarked: "No one is reading your [contract] because they want to, but because they have to. So make it easy, not difficult, to read." From https://twitter.com/virshup/status/1343272719916224513

Toward that end: To speed up the process — and keep the client happy on that score — make your contracts as easy to read and review as possible, given the time- and budget constraints under which you're working.

7.4 Plain language is "a thing"

It's hard to educate or persuade a reader when you write dense legalese; a judge in New York City opines: "The hallmark of good legal writing is that an intelligent layperson will understand it on the first read." Gerald Lebovits, Free at Last from Obscurity: Achieving Clarity, 96 Mich. B.J. 38 (May 2017), SSRN: https://ssrn.com/abstract=2970873 (emphasis added, footnote omitted).

The modern trend is decidedly to use plain language in contracts, and also in just about any other kind of document you can imagine. See the references cited by an informal consortium of U.S. Government civil servants in Plain Language in the Legal Profession (PlainLanguage.gov, undated).

This trend is by no means limited to legal documents; contract drafters can take a leaf from Warren Buffett:

When writing Berkshire Hathaway’s annual report, I pretend that I’m talking to my sisters. I  have no trouble picturing them: Though highly intelligent, they are not experts in accounting or finance. They will understand plain English, but jargon may puzzle them

My goal is simply to give them the information I would wish them to supply me if our positions were reversed.

To succeed, I don’t need to be Shakespeare; I must, though, have a sincere desire to inform.

No siblings to write to? Borrow mine: Just begin with “Dear Doris and Bertie.”

U.S. Securities and Exchange Commission, Plain English Handbook at 2 (Aug. 1998) available at https://goo.gl/DZaFyT (sec.gov) (emphasis and extra paragraphing added).

7.4.1 Business people prefer plain language

Business people love plain language in contracts because:

  • Plain language speeds up legal review, which is generally one of the biggest bottlenecks in getting a deal to signature.
  • Plain language makes it more likely that potential problems will be spotted and fixed before signature — which reduces the opportunities for future disputes that could waste the parties' time, opportunities, and money.

In a 2018 article, the general counsel of a GE business unit reported that, when his group switched to plain-language contracts, the new contract forms "took a whopping 60% less time to negotiate than their previous legalese-laden versions did. … Customer feedback has been universally positive, and there hasn’t been a single customer dispute over the wording of a plain-language contract." Shawn Burton, The Case for Plain-Language Contracts, Harv. Bus. Rev. Jan.-Feb. 2018 at 134, archived at https://perma.cc/HW85-FGSA. When that article was published, Mr. Burton was the general counsel of GE Aviation’s Business & General Aviation and Integrated Systems businesses.

7.4.2 Plain language helps trial counsel

Trial counsel also prefer plain language in a contract, because:

  • Plain language offers better "sound bites" for trial exhibits and witness cross-examination; and
  • During jury deliberations, plain language can help refresh jurors' recollections as part of the "real" evidence in the record, not merely as trial counsel's demonstrative exhibits (summaries, PowerPoint slides, etc.) that the judge might or might not allow to be taken back into the jury room. See also the discussion of demonstrative exhibits at Section 12.5: .

7.5 Draft short, single-topic paragraphs - don't be a L.O.A.D.!

Don't be a L.O.A.D. (a Lazy Or Arrogant Drafter): Avoid dense, "wall of words" legalese, because in all likelihood, a series of short, plain statements of the parties' intent will do nicely.

Each paragraph in a contract draft (i) should be a few lines at most, and (ii) should address a single topic. That's because, other things being equal:

  1. Short, single-topic paragraphs are less likely to be summarily rejected by a busy reviewer because she doesn't want to spend the time to decipher long complex sentences — when a contract reviewer represents a party that has some bargaining power (such as a gigantic retailer), it's not uncommon for the reviewer to simply delete a wall-of-words paragraph because she doesn't want to bother trying to puzzle through it.
  2. Such paragraphs can be saved more easily for re-use, and later snapped in and out of a new contract draft like Lego blocks, without inadvertently messing up some other contract section.
  3. Short, single-topic paragraphs are easier to revise if necessary during negotiation.
  4. Such paragraphs reduce the temptation for the other side's reviewer to tweak more language than necessary — and that's a good thing, because even minor language tweaks take time for the other side to review and negotiate; that in turn causes business people to get impatient and to blame "Legal" for delaying yet another supposedly-done deal.

So: If a sentence or paragraph starts to run long, seriously consider breaking it up.

7.5.1 Contract length isn't as important as clause length

"Wow, this is a long contract!" Most lawyers have heard this from clients or counterparties.

True, sometimes contracts run too long because of over-lawyering, where the drafter(s) try to cover every conceivable issue.

But focusing too obsessively on contract length will obscure a more-important issue: contract readability.

This isn't just a question of aesthetic taste. The more difficult a draft contract is to read and understand, the more time-consuming the review process, which delays the deal (and increases the legal expense).

Readability has little to do with how many pages a contract runs. Many negotiators would rather read a somewhat-longer contract, consisting of short, understandable sentences and paragraphs, than a shorter contract composed of dense, convoluted clauses.

So the better way to draft a contract is to write as many short sentences and paragraphs as are needed to cover the subject.

Even if the resulting draft happens to take up a few extra pages, your client likely will thank you for it.

7.5.2 A pathological example: A 415-word sentence

To illustrate the point, glance at the following 415-word sentence (!) — it covers not one, not two, but five separate topics (and note the abomination of "provided that" in the middle). Note: You don't need to read this sentence; just get the feel of how it looks to a reader:

Exclusivity. The Seller covenants and agrees that for a period of ninety (90) days after the date first written above (the "Effective Date") or such shorter period as set forth below (as the case may be, the "Exclusivity Period"), none of the Seller, its affiliates or subsidiaries will, and they will cause their respective shareholders, directors, officers, managers, employees, agents, advisors or representatives not to, directly or indirectly, solicit offers for, encourage, negotiate, discuss, or enter into any agreement, understanding or commitment regarding, a possible direct or indirect sale, merger, combination, consolidation, joint venture, partnership, recapitalization, restructuring, refinancing or other disposition of all or any material part of the Company or its subsidiaries or any of the Company's or its subsidiaries' assets or issued or unissued capital stock (a "Company Sale") with any party other than Purchaser or provide any information to any party other than Purchaser regarding the Company in that connection; provided that, (i) for the time period commencing on the Effective Date and ending at 11:59 p.m. Central European Time on 7 July 2007 (the "Bid Confirmation Date"), the Parties shall work together in good faith and use commercially reasonable efforts to facilitate due diligence by Purchaser and their advisors to confirm, based on the information made available to Purchaser or their advisors prior to the Bid Confirmation Date, the intent of Purchaser to implement the Transaction pursuant to the terms of this Heads of Agreement and if Purchaser does not deliver notice to Seller of such intent by 11:59 p.m. Central European Time on (or otherwise prior to) the Bid Confirmation Date (such notice, a "Bid Confirmation"), then Seller shall have the right to terminate the Exclusivity Period effective as of (but not prior to) the Bid Confirmation Date by providing written notice to Purchaser by no later than 5 p.m. Central European Time on (but not prior to) the day following the Bid Confirmation Date; and (ii) if Purchaser delivers the Bid Confirmation or if such termination notice set forth in the preceding clause (i) is not given, the Seller shall have the right to terminate the Exclusivity Period effective as of (but not prior to) 11:59 p.m. Central European Time on the sixtieth (60th) day following the Effective Date by delivering written notice of such termination to Purchaser by no later than 5 p.m. Central European Time on (but not prior to) the sixty-first (61st) day following the Effective Date.

To repeat: The above paragraph is a single sentence; it brings to mind a savagely-funny Dilbert cartoon about lawyers. See https://dilbert.com/strip/2008-08-28.

7.5.3 White space is your friend

The present author used to hold to the view that it was a good idea to use a "compressed" format for contracts — with narrow margins, long paragraphs, and small print — so as to fit on fewer physical pages. This view was informed by experience that readers tended to react negatively when they saw a document with "many" pages.

But I've since concluded that if you expect to have to negotiate the contract terms, then larger print, shorter paragraphs, and more white space:

  • will make it easier for the other side to review and redline the draft — always a nice professional courtesy that might just help to earn a bit of trust; and
  • will make it easier for the parties to discuss the points of disagreement during their inevitable mark-up conference call.

A more-readable contract likely will likely get the parties to signature more quickly, and that of course, is the goal.

(At least that's the intermediate goal — ordinarily, the ultimate goal should be to successfully complete a transaction, or to establish a good business relationship, in which each party felt it received the benefit of its bargain and would be willing to do business with the other side again.)

7.5.4 Defined terms can help

The L.O.A.D.-bearing wall of words in Section 7.5.2: could be simplified by moving many of the substantive terms into definitions of defined terms, along the following lines:

Exclusivity

See subdivision (h) for certain definitions. Comment: This preamble anticipates the reader's question: "Where are the capitalized terms defined?" See also Section 4: for more about defined terms.

(a) During the Exclusivity Period, Seller: (i) will not engage in any Off-Limits Activity itself, and (ii) will cause each other member of the Seller Group not to engage in any Off-Limits Activity. Comment: This subdivision is an example of BLUF — Bottom Line Up Front — as explained at Section 7.6: .

(b) During the Exclusivity Period, the Parties will (i) work together in good faith, and (ii) use commercially reasonable efforts, to facilitate due diligence by Purchaser and Purchaser's advisors.

(c) Seller may terminate the Exclusivity Period if Purchaser does not deliver a Bid Confirmation Notice to Seller at or before the end of the Bid Confirmation Period. Comment: Other provisions have been omitted.

(h) Definitions:

"Bid Confirmation Notice" refers to written notice from Purchaser to Seller confirming Purchaser's to implement the Transaction pursuant to the terms of this Heads of Agreement, based on the information made available to Purchaser and its advisors.

"Bid Confirmation Period" refers to the period beginning on the Effective Date and ending at exactly 11:59 p.m. Central European Time on 7 July 2007. Comment: Other provisions have been omitted.

7.5.5 History: Why do drafters create wall-of-words clauses?

Even today, some contracts include long paragraphs of dense text, bringing to mind the Normandy hedgerows (bocages) that famously slowed the D-Day invasion of France. Why is that, when the benefits of plain language are so, well, plain?

• An obvious candidate is the classic explanation paraphrased in English as: "If I'd had more time, I'd have shortened this letter." The paraphrase is itself a simplification of Pascal's original, translated as "The present letter is a very long one, simply because I had no leisure to make it shorter." Blaise Pascal, Lettre XVI, in Lettres provinciales, Letter XVI (Thomas M'Crie trans. 1866) (1656), available at https://tinyurl.com/PascalLetterXVI (WikiSource.org).

• In a similar vein is the phrase, "provided, however": We can speculate that this phrase was pragmatic when lawyers dictated their contracts and had to capture thoughts that occured to them in mid-dictation. Before electronic word processing, it was no small feat to recopy a draft to incorporate revisions; even after typewriters came along, retyping was something of a pain. So saying "provided, however" might well have been the least burdensome approach — at least back then.

•  Less attractively: A long paragraph of dense legalese raises the question: Was the drafter secretly hoping to use the MEGO factor ("Mine Eyes Glaze Over") to sneak an objectionable term past the reader?

•  Finally: Some lawyers might flatter themselves that by using dense legalese, they'll enhance their personal prestige as High Priests of the Profession, privvy to secret legal knowledge not revealed to ordinary mortals. That seems a dubious and even risible proposition.

7.6 BLUF: Bottom Line Up Front

BLUF is an acronym used in the military as a guide for writing emails: Bottom Line Up Front. The same principle is useful in contract drafting. See, e.g., Kabir Sehgal, How to Write Email with Military Precision (HBR.com 2016), archived at https://perma.cc/B986-5DUY.

7.6.1 A statutory BLUF example

As a statutory example, this rewrite, by law professor Mark Cooney, was retweeted by legal-writing guru Bryan Garner:

Before:

A person who engages in conduct proscribed under section 530 and who in the course of engaging in that conduct, possesses a dangerous weapon or an article used or fashioned in a manner to lead any person present to reasonably believe the article is a dangerous weapon, or who represents orally or otherwise that he or she is in possession of a dangerous weapon, is guilty of a felony punishable by imprisonment for life or for any term of years. If an aggravated assault or serious injury is inflicted by any person while violating this section, the person shall be sentenced to a minimum term of imprisonment of not less than 2 years.

So what exactly is the bottom line of this statutory provision?

BLUF rewrite by Prof. Cooney:

A person is guilty of a felony if, while committing a crime under section 530, he or she:

(1) possesses a dangerous weapon;

(2) possesses an article used as a dangerous weapon; … [etc.]

(Emphasis added.)

7.6.2 A contract BLUF example

Before: Here's a contract provision that was litigated in a state court: See Lynd v. Marshall County Pediatrics, P.C., 263 So. 3d 1041, 1044-45 (Ala. 2018).

If any shareholder of the corporation for any reason ceases to be duly licensed to practice medicine in the state of Alabama, accepts employment that, pursuant to law, places restrictions or limitations upon his continued rendering of professional services as a physician, or upon the death or adjudication of incompetency of a stockholder or upon the severance of a stockholder as an officer, agent, or employee of the corporation, or in the event any shareholder of the corporation, without first obtaining the written consent of all other shareholders of the corporation shall become a shareholder or an officer, director, agent or employee of another professional service corporation authorized to practice medicine in the State of Alabama, or if any shareholder makes an assignment for the benefit of creditors, or files a voluntary petition in bankruptcy or becomes the subject of an involuntary petition in bankruptcy, or attempts to sell, transfer, hypothecate, or pledge any shares of this corporation to any person or in any manner prohibited by law or by the By-Laws of the corporation or if any lien of any kind is imposed upon the shares of any shareholder and such lien is not removed within thirty days after its imposition, or upon the occurrence, with respect to a shareholder, of any other event hereafter provided for by amendment to the Certificates of Incorporation or these By-Laws, [here we finally get to the "bottom line":] then and in any such event, the shares of this [c]orporation of such shareholder shall then and thereafter have no voting rights of any kind, and shall not be entitled to any dividend or rights to purchase shares of any kind which may be declared thereafter by the corporation and shall be forthwith transferred, sold, and purchased or redeemed pursuant to the agreement of the stockholders in [e]ffect at the time of such occurrence. The initial agreement of the stockholders is attached hereto and incorporated herein by reference[;] however, said agreement may from time to time be changed or amended by the stockholders without amendment of these By-Laws. The method provided in said agreement for the valuation of the shares of a deceased, retired or bankrupt stockholder shall be in lieu of the provisions of Title 10, Chapter 4, Section 228 of the Code of Alabama of 1975.

(Emphasis added.)

After:

(a)     A shareholder's relationship with the corporation will be terminated, as specified in more detail in subdivision (b), if any of the following Shareholder Termination Events occurs:

      (1) The shareholder, for any reason, ceases to be duly licensed to practice medicine in the state of Alabama.

      (2) The shareholder accepts employment that, pursuant to law, places restrictions or limitations upon his continued rendering of professional services as a physician.

      [remaining subdivisions omitted]

(b)     Immediately upon the occurrence of any event described in subdivision (a), that shareholder's shares:

      (1) will have no voting rights of any kind,

      [Remaining subdivisions omitted]

It should be obvious which of these is more readable.

(Emphasis added.)

7.7 Bullet-point clauses can be a quicker read

Here are two versions of the same contract clause, copied from a 2007 real-estate lease, at https://goo.gl/Qn2e9m (edgar.sec.gov), in which Tesla Motors, Inc., leased a building from Stanford University. Which of these versions would you find easier to review?

Before:

12.5 Indemnity. Tenant shall indemnify, defend (by counsel reasonably acceptable to Landlord), protect and hold Landlord and Landlord’s trustees, directors, officers, agents and employees and their respective successors and assigns (collectively, "Landlord’s Agents"), free and harmless from and against any and all claims, liabilities, penalties, forfeitures, losses or expenses (including reasonable attorneys’ and consultants’ fees and oversight and response costs) to the extent arising from (a) Environmental Activity by Tenant or Tenant’s Agents; or (b) failure of Tenant or Tenant’s Agents to comply with any Environmental Law with respect to Tenant’s Environmental Activity; or (c) Tenant’s failure to remove Tenant’s Hazardous Materials as required in Section 12.4. Tenant’s obligations hereunder shall include, but not be limited to, the burden and expense of defending all claims, suits and administrative proceedings (with counsel reasonably approved by Landlord), even if such claims, suits or proceedings are groundless, false or fraudulent; conducting all negotiations of any description; and promptly paying and discharging when due any and all judgments, penalties, fines or other sums due against or from Landlord or the Premises. Prior to retaining counsel to defend such claims, suits or proceedings, Tenant shall obtain Landlord’s written approval of the identity of such counsel, which approval shall not be unreasonably withheld, conditioned or delayed. In the event Tenant’s failure to surrender the Premises at the expiration or earlier termination of this Lease free of Tenant’s Hazardous Materials prevents Landlord from reletting the Premises, or reduces the fair market and/or rental value of the Premises or any portion thereof, Tenant’s indemnity obligations shall include all losses to Landlord arising therefrom.

After: The above legalese can be made significantly more readable just by breaking up its wall of words into bullet points, with appropriate indentation, highlighting the separate concepts that need review.

Here's an example; I've made only minimal stylistic edits, even though a lot more could be done — at first glance it will look strange, but notice how the various potential negotiation issues are on separate lines and thus easier to review and, if necessary, revise:

12.5 Indemnity.

(a) Tenant shall:

  • indemnify,
  • defend,
    • by counsel reasonably acceptable to Landlord,
  • protect, and hold Landlord,
    • and Landlord’s trustees, directors, officers, agents and employees,
    • and their respective successors and assigns
    • (collectively, "Landlord’s Agents"),
  • free and harmless from and against any and all claims, liabilities, penalties, forfeitures, losses or expenses,
    • including reasonable attorneys’ and consultants’ fees,
    • along with oversight and response costs,
  • to the extent arising:
    • from Environmental Activity by Tenant or Tenant’s Agents,
    • or from failure of Tenant or Tenant’s Agents to comply with any Environmental Law with respect to Tenant’s Environmental Activity,
    • or from Tenant’s failure to remove Tenant’s Hazardous Materials as required in Section 12.4.

(b) Tenant’s obligations hereunder shall include, but not be limited to, the burden and expense of:

  • defending all claims, suits and administrative proceedings,
    • with counsel reasonably approved by Landlord,
    • even if such claims, suits or proceedings are groundless, false or fraudulent;
  • and promptly paying and discharging, when due, any and all judgments, penalties, fines or other sums due against or from Landlord or the Premises.

[remaining text omitted]

More paper — so what? To be sure, the "After" version above takes up more space than the "Before" version. But really: Who cares? These days, PDF'd signature pages and electronic signatures are the norm; for busy business people, the number of pages in a contract will usually matter far less than the time they have to wait around for legal review before signing the contract.

Clients prefer bullet points — and counterparties don't object: The author originally developed this bullet-point approach while reviewing and revising other parties' contract drafts for clients:

  • I often encountered wall-of-words provisions like the "Before" version above.
  • To help clients understand what they were agreeing to — and to reduce the chances that I'd miss something — I started breaking up the long paragraphs of dense legalese.

Turning legalese into bullet points has worked out pretty well:

  • My clients have uniformly appreciated the enhanced readability.
  • Only one counterparty or its counsel has ever objected to the bullet points.
  • With that one exception, the parties have always gone on to sign the bullet-points version, not the other side's original wall-of-words version. This bullet-point approach was also inspired in part by the highly-popular Python computer-programming language: "Python's design philosophy emphasizes code readability with its notable use of significant whitespace." Wikipedia, Python (programming language) (emphasis added).

7.8 Put "variable" terms in a schedule

You might know from experience that the other side is likely to want to make changes to certain contract terms. For example, a supplier who asks for net-30 payment terms might know that some customers will want net-45 or even net-60 terms.

If that's the case, then consider putting the details of such terms in a "schedule," either at the front of the document or at the beginning of the clause in question. Example: Consider the following excerpt from a 2007 real-estate lease between Stanford University (landlord) and Tesla (tenant):

COMMERCIAL LEASE

THIS LEASE is entered into as of July 25, 2007 (the “Effective Date”), by and between THE BOARD OF TRUSTEES OF THE LELAND STANFORD JUNIOR UNIVERSITY, a body having corporate powers under the laws of the State of California (“Landlord”), and TESLA MOTORS, INC., a Delaware corporation (“Tenant”).

1.  BASIC LEASE INFORMATION. The following is a summary of basic lease information. Each item in this Article 1 incorporates all of the terms set forth in this Lease pertaining to such item and to the extent there is any conflict between the provisions of this Article 1 and any other provisions of this Lease, the other provisions shall control. Any capitalized term not defined in this Lease shall have the meaning set forth in the Glossary that appears at the end of this Lease.

Address of Premises: 300 El Camino Real, Menlo Park, California

Term: Five (5) years

Scheduled Date for Delivery of Premises: August 1, 2007

Commencement Date: August 1, 2007

Expiration Date: July 31, 2012

Base Rent:

Year One: $60,000 ($5,000 per month)
Year Two: $90,000 ($7,500 per month)
Year Three: $120,000 ($10,000 per month)
Year Four: $165,000 ($13,750 per month)
Year Five: $165,000 ($13,750 per month

This can:

  • give the business people an "executive summary" of terms in which they're likely to be especially interested;
  • speed up review and editing of the draft; and
  • in the future, make it easier and safer to re-use the contract as the starting point for a new contract, with less risk of having old terms appear in the new contract — as an embarrassing example, see the screw-up in the Brexit agreement summarized at § 3.2). (This principle is an example of the rule: R.O.O.F: Root Out Opportunities for F[oul]ups.)

7.9 Use charts and tables?

Instead of long, complex narrative language, use charts and tables. Here's an example of the former:

If it rains less than 6 inches on Sunday, then Party A will pay $3.00 per share, provided that, if it it rains at least 6 inches on Sunday, then Party A will pay $4.00 per share, subject to said rainfall not exceeding 12 inches, [etc., etc.]

Here's the same provision, in table form:

Party A will pay the amount stated in the table below, based on how much rain falls on Sunday:

AMT. OF RAIN PAYMENT DUE
Less than 6 inches $3.00 per share
At least 6 inches
but less than 12 inches
$4.00 per share

For an example "in the wild," see § 3.12 of this agreement.

Or even the following, in a bullet-point format:

Party A will pay the amount stated in the table below, based on how much rain falls on Sunday:

  • Amount of rain: Less than 6 inches.
    Payment due: $3.00 per share
  • Amount of rain: At least 6 inches but less than 12 inches.
    Payment due: $4.00 per share

Which one would you rather read if you were reviewing the contract?

7.10 Use industry-standard terminology

When you're drafting a contract, you'll want to try to avoid coining your own non-standard words or phrases to express technical or financial concepts. If there's an industry-standard term that fits what you're trying to say, use that term if you can. Why? For two reasons:

  • First, someday you might have to litigate the contract, and so:
    • You'll want to make it as easy as possible for the judge (and his- or her law clerk) and the jurors to see the world the way you do. In part, that means making it as easy as possible for them to understand the contract language.
    • The odds are that the witnesses who testify in deposition or at trial likely will use industry-standard terminology. So the chances are that the judge and jurors will have an easier time if the contract language is consistent with the terminology that the witnesses use—that is, if the contract "speaks" the same language as the witnesses.
  • Second, and perhaps equally important: The business people on both sides are likely to be more comfortable with the contract if it uses familiar language, which could help make the negotiation go a bit more smoothly.

7.11 Include examples and sample calculations?

Your contract might contain a complex formula or some other particularly tricky provision. If so, consider including a hypothetical example or sample calculation to "talk through" how the formula or provision is intended to work, such as in the following:

  1. Day refers to a calendar day, as opposed to a business day.
  2. A period of X days:
    1. begins on the specified date, and
    2. ends at exactly 12 midnight (see subdivision c concerning time zones) at the end of the day on the date X days later.
      • Example: Suppose that a five-day period begins on January 1 — that period ends at exactly 12 midnight at the end of January 6.

c.  For purposes of subdivision b, the term 12 midnight refers:

  1. to local time if only one time zone is relevant,
  2. otherwise, to the latest occurrence of 12 midnight on the date in question.
    • Example: Suppose that both California time and Tokyo time are relevant; in that case, 12 midnight at the end of the day on January 1 refers to 12 midnight at the end of the day on January 1 in California (when it would be mid-afternoon on January 2 in Tokyo).

(These examples could be put in footnotes, as discussed in the next section.)

In one litigated case, the drafters of $49 million of promissory notes would have been well served to include a sample calculation to illustrate one of their financial-term definitions. The court specifically mentioned particular calculations that the lender had submitted with its motion for summary judgment; if the promissory-note drafters had thought to include one or two sample calculations in the body of the contract itself, then by being forced to work through those sample calculations, the drafters and their client(s) might well have spotted the problems with the promissory-note language in time to fix it before signature. See BKCAP, LLC v. CAPTEC Franchise Trust 2000-1, 572 F.3d 353, 355-57, 359 (7th Cir.2009) ("BKCAP-1") (reversing and remanding summary judgment) after remand, 688 F.3d 810 (7th Cir. 2012) (affirming judgment in favor of borrowers after bench trial).

7.12 Add explanatory footnotes?

Suppose that, after intense negotiations, a particular contract clause ends up being written in a very specific way. Consider including a footnote at that point in the contract, explaining how the language came to be what it is. Future readers — your client's successor, your client's trial counsel, a judge — might thank you for it.

Example: In a prior life, the present author was vice president and (solo) general counsel of a newly-public software company that, as outside counsel, I'd helped the founders to start.

  • Our standard enterprise license agreement form was extremely customer-friendly (this was intentional, to help us get to signature sooner), but at first I still had to spend a lot of time explaining to customers' lawyers why the agreement form included certain terms.
  • To save negotiation time, I added a fair number of explanatory footnotes to our license-agreement form. That seemed to reduce, by quite a lot, the amount of time needed for "legal" negotiations.

Needless to say, our business people weren't unhappy about getting deals to signature sooner.

And interestingly, customers' lawyers hardly ever asked us to delete the footnotes before contract signature — which means that if the contract were ever litigated (which never once happened), the footnotes would be available to be read by opposing counsel; the judge's law clerk; the judge him- or herself; and one or more of the jurors — and that would be no bad thing, yes?

Sure, someday in litigation you might wish you hadn't said what you did in the footnotes — but that could happen with any language in the contract. What's important here is that the overwhelming majority of contracts never see the inside of a courtroom. So, on balance the client gets more overall business benefit from including footnotes if doing so will help get the client's contracts to signature sooner.

7.13 Exercises and discussion questions

7.13.1 Basic questions

  1. Who are some of the people who might someday read: (i) the draft contract; (ii) the signed contract — and what will they likely be hoping to accomplish?
  2. FACTS: MathWhiz's CEO asks you to draft a short contract in which MathWhiz will do some data-analysis for a longtime client.
    • The CEO says that she and her contact at the client have agreed on all the details in a series of Zoom calls.
    • The CEO has drafted a detailed "term sheet," with bullet points outlining the agreed business- and technical details; her client contact has reviewed the term sheet and said it's fine.
    • The client contact doesn't want to get his company's lawyers involved, so the MathWhiz CEO has asked you whether "the contract" could be drafted as just a short email that she will send to the client contact, with the term sheet attached.
    • QUESTION: What do you advise the MathWhiz CEO, and why? How would you advise her, and why?
  3. True or false: Contract drafters should avoid including explanations of particular terms. EXPLAIN.
  4. FACTS: You're drafting a contract for MathWhiz; the company's CEO tells you there's a fair chance that the contract might be litigated in the not-too-distant future. QUESTION: How might the Strunck & White injunction, "Omit needless words," apply in this situation?
  5. MORE FACTS: Continuing with #4, MathWhiz's CEO also thinks that the other party to the contract is likely to be acquired in the next year or so — by whom exactly, the CEO doesn't know — and that it'd likely be an "acqui-hire" in which many of the other party's senior executives and -managers would be let go (with their stock options and a severance package) as no longer needed. QUESTION: What if anything might you do differently in drafting the contract?
  6. What are the two essential components of a contract drafter's mission?
  7. FACTS: You are drafting a contract for MathWhiz and are getting ready to send it to MathWhiz's CEO, Mary Marvelous. QUESTION: Name two reasons that Mary will likely prefer that the contract be written in plain language.
  8. MORE FACTS: MathWhiz is considering filing a lawsuit for breach of another contract that you didn't draft. The breached provision is a "wall of words" that's full of legalese. QUESTION: Name two reasons that MathWhiz's trial counsel might wish that the breached provision had been written in plain language.
  9. In the context of contract drafting, what's a "L.O.A.D."?
  10. What's one of the most important ways of avoiding being a L.O.A.D.?
  11. Based on whatever experience you've had so far — personal and/or professional — would you prefer to review a contract with (i) fewer pages with dense paragraphs, or (ii) more pages but shorter paragraphs and more white space? EXPLAIN.
  12. What does BLUF mean?
  13. What's "the MEGO factor"?
  14. Name two advantages of putting a contract's key business details into a schedule, perhaps at the front of the contract.

7.13.2 Exercise: Stanford-Tesla lease intro

Refer again to the Stanford-Tesla lease at § 7.8:

  1. Is "Commercial Lease" the proper term, or should it be "Commercial Lease Agreement"? (Hint: Look up the definition of lease in Black's Law Dictionary.)
  2. Why state that the Lease is entered into "as of July 25, 2007"?
  3. Why do you think the names of the parties are capitalized?
  4. What might be some of the pros and cons of including this kind of "Basic Lease Information" at the beginning of the agreement document, instead of including it "in-line" in the appropriate section(s) of the agreement?
  5. To what extent is the "Each item in this Article 1 incorporates …" worth including?
  6. What could go wrong with the italicized portion, "to the extent there is any conflict …"?

7  Note the mention of the Glossary in the last sentence of the first paragraph — where are some other places to include definitions for defined terms? (Hint: See § 4.)

  1. Any comments about the way the "Term: Five (5) years" portion is stated? How about the way that the Base Rent amounts are stated?

8 Ambiguity and its dangers

In a contract, ambiguity can be seriously-bad news; many lawyers would surely agree that ambiguous contract language is one of the top sources of legal trouble for parties doing business together. The inadvertent drafting of ambiguous terms is an occupational hazard for contract drafters.

8.1 What is "ambiguity" — and why is it bad?

A contract term is ambiguous if it is susceptible to two or more plausible interpretations — and when that happens, the contract term can cause major difficulties for the parties. An ambiguous term in a contract lets one or both parties fight about just what meaning should be ascribed to that term.

This is a big problem because if a contract provision is ambiguous, and the parties get into a lawsuit that turns on the meaning of the provision, then in the U.S., the court is not allowed to grant a quick summary judgment on undisputed facts; instead, the court must conduct a trial so that the trier of fact (a jury, or perhaps the judge) can find facts as needed to determine the proper meaning of the disputed provision.

As the Texas supreme court explained:

A contract is not ambiguous if the contract's language can be given a certain or definite meaning.

But if the contract is subject to two or more reasonable interpretations after applying the pertinent construction principles, [then] the contract is ambiguous, creating a fact issue regarding the parties' intent.

Summary judgment is not the proper vehicle for resolving disputes about an ambiguous contract.

Plains Explor. & Prod. Co. v. Torch Energy Advisors Inc., 473 S.W.3d 296, 305 (Tex. 2015) (formatting modified, citations omitted).

In other words, if a contract is ambiguous, then the parties must subject themselves to a full-blown trial (if they're lucky, a trial on just that one issue), with all the attendant burden, expense, and uncertainty.

And there might well be a lot of money riding on the jury verdict; for example, in the case just quoted, the losing party ultimately missed out recovering the roughly $44 million that it had claimed it was owed under the contract in suit.

Incidentally, the supreme court also noted a generally-accepted point in the law: "Mere disagreement over the interpretation of an agreement does not necessarily render the contract ambiguous." Id. (citation omitted).

As another high-stakes example, consider a Fifth Circuit case in which an off-shore drilling rig was severely damaged by fire while in drydock in Galveston for maintenance. The drilling rig's owner and the drydock owner disputed which of the two parties had had "control" of the rig at the time of the fire. The intended meaning of "control" was important because under the parties' agreement, if the drilling rig's owner had control at the time of the fire, then the drydock owner was not financially responsible for the fire damage. Needless to say, that issue was hotly disputed (if you'll pardon the expression).

The trial court held that the term "control" was unambiguous, and granted summary judgment that, on the undisputed facts, the rig owner, not the dock owner, had been in control at the time of the fire. The appeals court affirmed; thus, the parties were spared the expense, inconvenience, and uncertainty of a trial on the issue of control of the rig. See Offshore Drilling Co. v. Gulf Copper & Mfg. Corp., 604 F.3d 221 (5th Cir. 2010) (affirming summary judgment in relevant part).

Of course, the drilling-rig owner would certainly have preferred to go to trial and take its chances, versus losing on summary judgment without ever getting a shot at persuading a jury. But for the drydock owner, not having to go to trial was most assuredly a win in its own right.

Spotting and fixing ambiguities in a contract before signature should be a prime goal of all contract drafters and reviewers. "President and later Chief Justice Taft got it right, though in the negative: 'Don't write so that you can be understood; write so that you can't be misunderstood.'" Gerald Lebovits, Free at Last from Obscurity: Achieving Clarity, 96 Mich. B.J. 38 (May 2017), SSRN: https://ssrn.com/abstract=2970873 (emphasis added, footnote omitted).

8.2 Example: A date-related ambiguity

Here's a simple example of an ambiguity: Suppose that your client MathWhiz has signed a lease for office space, where it is the tenant. Now suppose that the lease says the following:

Tenant will vacate the Premises no later than 12 midnight on December 15; Tenant's failure to do so will be a material breach of this Agreement.

Bold-faced emphasis added.

Now suppose that a MathWhiz representative calls you up and says that they can't move out before 10:00 a.m. on December 15. QUESTION At that time, on that day, would MathWhiz still have 14 hours left in which to finish moving out? Or would MathWhiz already in material breach because it didn't move out by the previous midnight? In other words, does "by midnight" mean before midnight at the start of the day, or before midnight at the end of the day? This ambiguity illustrates a useful drafting principle: *W.I.D.D. – When In Doubt, Define!*

Ripple-effect business complications can arise from such ambiguities — in the December 15 example above, the landlord might have already re-leased the premises to a new tenant, with a promise that the new tenant can move in on that date.

QUESTION: How would you rewrite the "Tenant will vacate the Premises …." sentence to resolve this ambiguity?

8.3 How do courts "construe" ambiguous terms?

Here's a quick recap of some basic principles of "construing" — that is, interpreting — ambiguous contract terms:

• As noted above, in a lawsuit, the judge normally makes the first pass at determining the meaning of a disputed provision; if the provision is unambiguous, then the judge will declare the provision's meaning without the need for a trial on that particular point.

(Conceivably, the appellate court might have a different view: It might conclude that the provision is indeed ambiguous, in which case the matter might well be remanded for a trial to determine the provision's meaning.)

• If all else fails — if the usual contract-interpretation principles don't produce a definitive answer for what a contract provision means — then the judge will rule that provision is ambiguous.

When a provision is ambiguous, the case must (usually) be tried, and the trier of fact (usually, the jury) gets to decide what the parties are deemed to have had in mind; they will often do this by looking to extrinsic evidence under the parol evidence rule, such as witness testimony by the people who negotiated the contract term(s) in question.

• If a trial court hears the witnesses and makes a determination what the parties are deemed to have intended in drafting the ambiguous provision, then the appellate court isn't likely to overrule that determination (at least in the United States). The Seventh Circuit explained:

The district court's job was to look at extrinsic evidence and determine what the agreement was. It did that.

Our job is to decide if the district court's view of that evidence was clearly erroneous (or legally wrong). …

The argument, 'The Borrowers' position was supported by the evidence presented at trial but our interpretation is way, way better' is a nonstarter.

We are looking to correct error, not reward elegance.

BKCAP, LLC v. CAPTEC Franchise Trust 2000-1, 688 F.3d 810, 813-14 (7th Cir. 2012) (emphasis in original, extra paragraphing added).

Likewise, the Texas supreme court summarized the general ground rules for interpreting contract language (which I've recast into a bullet-point format):

Absent ambiguity, contracts are construed as a matter of law.
[That is, the trial judge, not the jury, construes the contract, and the appeals court is free to overrule the trial judge].

In construing a written contract, our primary objective is to ascertain the parties' true intentions as expressed in the language they chose.

We construe contracts from a utilitarian standpoint bearing in mind the particular business activity sought to be served, and avoiding unreasonable constructions when possible and proper.

To that end, we consider the entire writing and giving effect to all the contract provisions so that none will be rendered meaningless.

No single provision taken alone is given controlling effect; rather, each must be considered in the context of the instrument as a whole.

We also give words their plain, common, or generally accepted meaning unless the contract shows that the parties used words in a technical or different sense.

While extrinsic evidence of the parties' intent is not admissible to create an ambiguity, the contract may be read in light of the circumstances surrounding its execution to determine whether an ambiguity exists. Consideration of the surrounding facts and circumstances is simply an aid in the construction of the contract's language and has its limits.

The rule that extrinsic evidence is not admissible to create an ambiguity obtains even to the extent of prohibiting proof of circumstances surrounding the transaction when the instrument involved, by its terms, plainly and clearly discloses the intention of the parties, or is so worded that it is not fairly susceptible of more than one legal meaning or construction.

Plains Explor. & Prod. Co. v. Torch Energy Advisors Inc., 473 S.W.3d 296, 305 (Tex. 2015) (formatting modified, citations omitted).

8.4 Courts apply specific rules of interpretation

8.4.1 Some basic rules

Courts often look to specific rules of interpretation such as the following: For additional, completely-optional background reading, see generally, e.g.: Vincent R. Martorana, A Guide to Contract Interpretation (ReedSmith.com 2014); James J. Sienicki and Mike Yates, Contract interpretation: how courts resolve ambiguities in contract documents (Lexology.com 2012: https://goo.gl/ZGkwJu).

• Specific terms normally take precedence over general terms.

• A term stated earlier in a contract is given priority over later terms.

• The rule of the last antecedent — for example: A federal criminal statute included a mandatory ten-year minimum sentence in cases where the defendant had previously been convicted of "aggravated sexual abuse, sexual abuse, or abusive sexual conduct involving a minor or ward." The Supreme Court held that the minor-or-ward qualifier applied only to abusive sexual conduct, not to sexual abuse; as a result, a defendant was subject to the ten-year mandatory minimum sentence for sexual abuse against an adult. Lockhart v. United States, 577 U.S. _, 136 S. Ct. 958, 962 (2016).

• BUT: The series-qualifier principle might weigh against the rule of last antecedent. Dissenting in the Lockhart case just cited, Justice Kagan argued: "Imagine a friend told you that she hoped to meet 'an actor, director, or producer involved with the new Star Wars movie.' You would know immediately that she wanted to meet an actor from the Star Wars cast—not an actor in, for example, the latest Zoolander." Id., 136 S. Ct. at 969 (Kagan, J., dissenting).

8.4.2 Contra proferentem: "Against the offerer"

[Note to students: Be sure to learn how to spell proferentem!]

The contra proferentem principle of contract interpretation holds that if an ambiguity in particular contract language cannot be resolved by other conventional methods — e.g., by consulting other language in the contract and/or by considering extrinsic evidence such as course of dealing and usage in the trade — then the ambiguity should be resolved against the party that drafted the ambiguous language and thus is "to blame" for the problem. (If a contract provision is not ambiguous, then contra proferentem won't come into play in the first place.)

The (U.S.) Supreme Court explained the concept: "Respondents drafted an ambiguous document, and they cannot now claim the benefit of the doubt. The reason for this rule is to protect the party who did not choose the language from an unintended or unfair result." Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 62-63 (1995) (reversing 7th Circuit) (citations and footnotes omitted). Contra proferentem is roughly analogous to the baseball rule, tie goes to the runner. It gives drafters an incentive to draft clearly, because as between the drafter of ambiguous language, on the one hand, and the "innocent" other party, it's the drafter that must bear the consequences of the ambiguity. Additional, optional background reading: • the Wikipedia article Contra proferentem; • Michelle E. Boardman, Contra Proferentem: The Allure of Ambiguous Boilerplate, 104 Mich. L. Rev. 1105 (2006); • Tal Kastner & Ethan J. Leib, Contract Creep, 107 Geo. L. Rev. 1277, 1298-1302 (2019).

Contra proferentem/ is roughly analogous to the baseball rule, tie goes to the runner. It gives drafters an incentive to draft clearly, because as between the drafter of ambiguous language, on the one hand, and the "innocent" other party, it's the drafter that must bear the consequences of the ambiguity.

See generally:

Caution: Disclaiming contra proferentem can cause problems: Suppose that a court or arbitrator concluded that there was no way to resolve an ambiguity in a contract, other than by applying the contra proferentem principle — but the parties had agreed that contra proferentem was not to be used (such as in Tango Clause 22.37 - Contra Proferentem Disclaimer). The results in that situation might be unpredictable:

  • The tribunal might disregard the contra proferentem prohibition and apply the principle to resolve the ambiguity; or
  • The tribunal might rule that the ambiguous provision could not be enforced — which in some circumstaces might jeopardize the enforceability of the entire contract.

(Hat tip: Jonathan Ely, in a comment in a LinkedIn group discussion (group membership required).)

Pro tip: Some drafters might be tempted to prohibit the use of the contra proferentem principle in interpreting contract terms. That's not the best "look": Parties to a contract generally can't prohibit a court from applying a particular legal doctrine, they can only request that the court not do so.

8.4.3 Ejusdem generis

Under the principle of ejusdem generis, "if a law refers to automobiles, trucks, tractors, motorcycles, and other motor-powered vehicles, a court might use ejusdem generis to hold that such vehicles would not include airplanes, because the list included only land-based transportation." Nolo’s Plain-English Law Dictionary (law.cornell.edu); see also the commentary about ejusdem generis ("eh-USE-dem GENerous").

Drafters can avoid application of ejusdem generis by using the term "including but not limited to" (emphasis added). As then-Judge Alito pointed out: "By using the phrase ‘including, but not limited to,' the parties unambiguously stated that the list was not exhaustive. … [S]ince the phrase ‘including, but not limited to' plainly expresses a contrary intent, the doctrine of ejusdem generis is inapplicable." Cooper Distributing Co. v. Amana Refrigeration, Inc., 63 F.3d 262, 280 (3d Cir. 1995) (citations omitted). To like effect is Eastern Air Lines, Inc. v. McDonnell Douglas Corp., 532 F.2d 957, 988-89 (5th Cir. 1976); see also Robert E. Scott and George G. Triantis, Anticipating Litigation in Contract Design, 115 Yale L.J. 814 (2006): "Contracting parties can avoid a restrictive interpretation under the ejusdem generis rule by providing that the general language includes but is not limited to the precise enumerated items that either precede or follow it." Id. at 850 & n.100, citing Cooper Distributing and Eastern Airlines.

8.5 The W.I.D.D. Rule: When In Doubt, Define!

Savvy contract drafters prefer not to roll the dice about whether a court will apply the above principles in a way that favors the drafter's client. So: To repeat from above, an extremely-useful general principle of contract drafting is, W.I.D.D. – When In Doubt, Define!

8.6 The A.T.A.R.I. Rule

What to do about an ambiguity in a contract draft might well depend on the circumstances:

• On the one hand, unambiguous language is generally a Good Thing, because it tends not to result in disputes between the parties about the language's meaning — although that certainly isn't a universal rule.

And if a dispute does arise over an unambiguous provision, the judge will often decide the case quickly, e.g., on a motion to dismiss on the pleadings or a motion for summary judgment.

That's because in the U.S., as noted above, the interpretation of an unambiguous contract term is generally a "question of law," that is, the proper interpretation will be decided by the trial judge (subject to review by the appeals court) and not by a jury.

• In contrast: When a contract is ambiguous, creative litigation counsel, exercising 20-20 hindsight, can be quite skilled at proposing meanings that favor their clients.

Ambiguities in a contract aren't necessarily fatal, because the law has rules for resolving them, as discussed above.

But an expensive- and time-consuming trial is likely to be needed to determine just what the parties had in mind.

To borrow a phrase from a former student in a different context: "That's a conversation we don't want to have."

When in doubt, A.T.A.R.I. - Avoid the Argument: Rewrite It.

Did your side draft the ambiguous language? If you or one of your colleagues drafted the ambiguous language, then you'll very likely want to fix the ambiguity, especially if the draft hasn't yet been sent to the other side. That's because under the doctrine of contra proferentem, a court might resolve the ambiguity in favor of the other side because your side was responsible for the ambiguity. See § 8.4.2 for a more-extensive discussion of the doctrine of contra proferentem.

What if the other side drafted the ambiguous language? Now consider these points:

– If the other side drafted the ambiguous language, then you might not want to say anything about it, in the hope that contra proferentem would result in an interpretation favorable to your client. As noted above: See § 8.4.2 for a more-extensive discussion of the doctrine of contra proferentem.

– That could be especially true if your client doesn't have the superior bargaining position: If you call the other side's attention to the ambiguity, the other side might wake up and ask for something that's even worse for your client than living with the ambiguity, because you "kicked the sleeping dog" as discussed in § 11.7.1. That might be another reason to keep silent about the ambiguity.

– BUT: If later the other side can show that you noticed, but failed to raise, an ambiguity created by the other side's drafter, then the other side might try to argue that you waived application of contra proferentem by "laying behind the log."

– AND: No matter what, if you don’t ask the other side to correct an ambiguity they created, then you might be setting up your client for an expensive, burdensome, future fight — a fight that perhaps might have been avoided with clearer drafting.

So what to do?

  • The Check-In Rule applies here (see § 6.3): Check in with the partner and/or the client about this, and have a recommendation with reasons.
  • But the A.T.A.R.I. Rule (see § 8.6) might be more important.

8.7 Vagueness is a type of ambiguity – what to do about it?

As one type of ambiguity, a term is vague if its precise meaning is uncertain.

• A classic example is the term tall: If you say that someone is tall, you could be referring to that a third-grader who is tall for his- or her age but is still very-much shorter than the general adult population.

• Another classic example of vagueness is the word cool; depending on the season and the locale, the term could refer to a wide range of temperatures. For example, in Houston in August a mid-day temperature of 80ºF would be regarded as (comparatively) cool, whereas in Point Barrow, Alaska, the same temperature at that time would likely be thought of as a real scorcher.

(Of course, as any parent in an English-speaking family knows, the word cool could also be ambiguous — in the sense of having multiple possible meanings — in addition to being vague.)

Let's look at another example, this time a silly one. Consider the following provision in a contract for a home caregiver:

Nurse will visit Patient's house each day, check her vital signs, and give her cat food.

The sentence above is ambiguous, in that conceivably it might take on any of three meanings:

1. Nurse is to put a bowl of food down for Patient's cat each day.

2. Nurse is to deliver cat food to Patient when Nurse visits.

3. Nurse is to feed cat food to Patient. OK, that one might be a stretch.

In addition, the sentence above might also be vague if it turned out that Patient had more than one cat.

Moreover, meanings #1 and #2 above are vague in another sense as well: The term cat food encompasses wet food, dry food, etc.

Vagueness is not necessarily a bad thing. Parties might be confident that, if a question ever arises, it'll be clear what was intended by, say, the term reasonable efforts.

So here's a rule of thumb: Vagueness is not always worth fixing.

But a vague term is always worth taking a look at to see if it should be replaced by a more-precise term.

8.8 Special case: D.R.Y. - Don't Repeat Yourself

Stating a term more than once in a contract can cause severe problems if:
(i)  a term is revised during negotiation, and
(ii)  the revision is not made in every place that the term occurs.

Just this type of mistake once cost a bank $693,000: • The bank sued to recover $1.7 million from defaulting borrowers and their guarantor. In the lower court, the bank won a summary judgment. • Unfortunately for the bank, the loan documents referred to the amount borrowed as "one million seven thousand and no/100 ($1,700,000.00) dollars" (capitalization modified, emphasis added). The appeals court held that, under standard interpretation principles, the words, not the numbers, controlled; thus, the amount guaranteed was only $1.007 million, not $1.7 million. See Charles R. Tips Family Trust v. PB Commercial LLC, 459 S.W.3d 147 (Tex. App.–Houston [1st Dist.] 2015) (reversing and remanding summary judgment in favor of bank).

(You probably wouldn't want to be the junior associate or paralegal who oversaw the document preparation in that case.)

Likewise, in a Delaware case: • A contract's termination provision allowed termination if a material breach was not cured within "fifteen (30) days" after notice of the breach. • The breaching party refused to cure the breach, so the non-breaching party terminated the agreement shortly after 15 days had elapsed from the notice of breach. • The breaching party had a change of heart after receiving the notice of termination and proceeded to cure the breach. The court said, in effect, "sorry, too late" — because the word fifteen took precedence over the numerals 30. See Fetch Interactive Television LLC v. Touchstream Technologies, Inc., No. 2017-0637-SG, slip op. at 52, 54 (Del. Ch. Jan. 2, 2019) (memorandum of post-trial decision) (emphasis added).

Another case: • One of the author’s clients was contemplated being acquired. • A potential acquiring party proposed a confidentiality agreement (a.k.a. nondisclosure agreement a.k.a. NDA). The text said, in part: "provided, however, that in the event that a court of law shall determine that a fixed duration of survival is required, said [confidentiality] obligations shall survive for a period of five (3) years from the later of the following: the date of termination or expiration of this Agreement, or the date that either party notifies the other party that it has decided not to enter into the transaction or agreement contemplated by the parties." In that case I fixed the inconsistency even though I hadn't created it, for reasons discussed in § 8.6.

Here's an example of how to do it better:

Bob will pay Alice one hundred thousand dollars ($100,000.00) for the House, with 50% due upon signing of this Agreement.

Bob will pay $100,000 for the House, with 50% due upon signing of this Agreement.

Note how the ".00" is omitted because it's not needed.

Sometimes, though, repetition can be used (cautiously) to emphasize a point — after all, the drafter's mission is still to educate and persuade (see § 7.2), not merely to slavishly follow drafting guidelines.

8.9 Optional further reading about ambiguity

Some amusing examples of ambiguity can be read at the Wikipedia article on Syntactic ambiguity, at https://goo.gl/6zmrH5

See also numerous categorized case citations by KPMG in-house attorney Vince Martorana, at A Guide to Contract Interpretation (ReedSmith.com 2014).

8.10 Exercises & discussion questions

  1. A contract term is ambiguous when the term is amenable to [BLANK].
  2. In litigation, an ambiguity in a contract provision will be resolved by A) the judge; B) the jury; C) one or more other officials.
  3. Consider the following sentence: "Alice says that Bob is cold." Is this more likely to be considered vague, ambiguous, or both?
  4. Consider the following sentence: "Alice says that Bob's forehead feels warm." Is this more likely to be considered vague, ambiguous, or both?
  5. What is a principal danger of an ambiguous contract term?
  6. FACTS: In a contract draft prepared by The Other Side, you see a term that's vague — it says that your client must pay The Other Side a certain amount by a certain date, but doesn't specify the time of day for that deadline. QUESTION: Is this worth asking The Other Side to fix? Discuss your reasoning.
  7. MORE FACTS: In this contract, your client is located in Vancouver, Canada and The Other Side (which drafted the contract) is located in Houston. The contract states that the amount your client must pay is $1 million. QUESTION: Is this an issue? If so, is it worth burning up negotiation time by asking The Other Side to fix it? Discuss your reasoning.
  8. MORE FACTS: In the above situation, your client really wants to get the contract to signature as soon as possible, like yesterday. You've tentatively concluded that it's not worth raising either of the above points (time of day and amount due) with The Other Side. QUESTION: To be on the safe side and keep your malpractice-insurance carrier happy, what might you want to do about these points before sending your markup to The Other Side?
  9. If all else fails in trying to interpret a contract provision, what Latin maxim will courts often follow, and what does it mean?
  10. The term "12 midnight on January 21" refers to the next minute after 11:59 p.m. on: A)  January 20; B) January 21; C) can't tell from this text alone.
  11. The Latin phrase for "against the offereor" is [BLANK].

8.11 Ambiguity-spotting drills

  1. TEXT, from The Kinks' famous song Lola (play the relevant clip on YouTube): "Well I'm not the world's most masculine man | But I know what I am and I'm glad I'm a man | And so is Lohhh-lahhh ….." QUESTION: When the artists sing, "And so is Lola," what exactly is Lola? EXERCISE: How that lyric line could be clarified? (Don't worry about rhyme or meter.)
  2. TEXT, from a Maureen Dowd column in the NY Times, March 5, 2016: "Like Bill Clinton, Trump talks and talks to crowds. … [H]e creates an intimacy even in an arena that leaves both sides awash in pleasure." (Emphasis added.) QUESTION: What, exactly, leaves both sides awash in pleasure? How could this be clarified?
  3. TEXT, from Donald Trump: "My daughter, Ivanka, just arrived in South Korea. We cannot have a better, or smarter, person representing our country." From Jonathan Chait: "That second sentence can really be read a couple ways." [DCT comment: It'd be better to say "a couple of ways."] From Gary Schroeder: "Also, the use of commas implies that she is his only daughter."
  4. TEXT, from a tweet: "I’ve sworn to defend and uphold our Constitution 11 times." QUESTION: What exactly does "11 times" refer to — defending and upholding the Constitution 11 times, or swearing to do so? EXERCISE: Rewrite to clarify.
  5. TEXT, adapted from an arbitration award I was writing (and caught myself): "Ms. Doe and her coworker Jane Roe were separately interviewed by John Doe and Becky Bow." QUESTION: How many separate interviews were conducted — two? four? EXERCISE: Rewrite to clarify.
  6. TEXT, from a tweet encouraging attendance at an anti-lockdown protest in Maine: "[T]here will be a caravan around the Capitol … Monday. … Remain in your vehicles but masks, bandanas, flags and signs on cars are encouraged." QUESTION: In your view, why are caravaners being encouraged to put masks and bandanas on cars? QUESTION: How could this be rewritten to clarify?
  7. TEXT, from an obituary: "Pamela went to heaven surrounded by family whom she loved …." QUESTION: What possibilities does this line evoke in your minds?
  8. TEXT, from this tweet by ABC Channel 13 (Houston): "Suspected Houston-area pedophile accused of assaulting 16-year-old arrested in Canada." QUESTION: What are some possible interpretations of this tweet? How could it be clarified?
  9. TEXT: Spotted in a Facebook group: "My eight year old just asked me if Bingo is the name of the farmer or the dog. And now I am questioning everything I thought I knew about life." (Credit: @whitneyhemsath.)
  10. TEXT, from Erin Johnston, Not All at Once, And Not All Alone, ABA Journal, Nov. 2018, at 14: "My success [as a Kirkland & Ellis litigation partner] has not been the result of a perfectly-executed master plan. But I can say that I have unapologetically asked for what I needed and was pleasantly surprised by the responses I received. No one above me assumed they knew what I wanted, or that what I wanted would always be the same. At times I turned down opportunities to avoid travel or to focus on my family; other times I chose to take that trip or work long hours. …" (Emphasis added.) QUESTION: What are two possible meanings of the italicized portion? QUESTION: How could the italicized portion be clarified?
  11. Ambiguous: This sign. More clear: This sign.
  12. TEXT, from a presidential tweet of April 3, 2017: "Such amazing reporting on unmasking and the crooked scheme against us by @foxandfriends. …" (Hat tip: Chris Richardson.) QUESTION: What are two possible interpretations of this tweet?
  13. TEXT, from a Facebook post by Stanford law professor Mark Lemley: "Things I appear to like more than my Facebook friends: 1. Pants." QUESTION: What are the two possible meanings here?
  14. TEXT, from this BBC.com article: "Nestle has announced that it will pay Starbucks $7.1bn (£5.2bn) to sell the company's coffee products." QUESTION: QUESTION: Which company will sell which company's coffee? How could this be clarified?
  15. TEXT, from a BBC News tweet: "Belgium court clears three doctors accused of unlawfully poisoning a woman whose life they helped to end in landmark trial." QUESTION: What exactly happened at the "landmark trial"?
  16. TEXT: "A hypothetical leak could occur, he said, if officials believed Clinton was not being prosecuted for political reasons." (Emphasis added.) (From a Politico piece titled FBI could leak Clinton email investigation, Grassley warns.) QUESTION: There are two possible meanings of the italicized portion of the above sentence. Discuss.
  17. TEXT, from an article in The Guardian: "There will be plush lecture theatres with thick carpet, perhaps named after companies or personal donors." ( Martin Parker, Why we should bulldoze the business school, The Guardian, Apr. 27, 2018 (https://perma.cc/F5N6-46RE).) QUESTION: What, exactly, is named after companies or personal donors? QUESTION: How could this sentence be rewritten to clarify it?
  18. TEXT, from an arbitration award that the present author was writing (and caught myself): "Ms. Doe and her coworker Jane Roe were separately interviewed by Human Resources manager John Doe and Becky Bow." QUESTION: How many people were interviewed, by how many people?
  19. TEXT, from a Hacker News discussion: "You should only short term trade with your 401k." QUESTION: How can this sentence be clarified by simply moving words around? (There are two possible meanings.)
  20. TEXT: "The temptation for progressives to resist pushing their own concrete policy agenda is compelling, especially since doing so gives the other side ammunition for criticism …." (From Joel Berg, It's Policy, Stupid — Why progressives need real solutions to real problems, Washington Monthly, Apr. 10, 2017.) QUESTION: In the quotation, the bold-faced "doing so" refers to what, exactly — pushing a policy agenda, or resisting pushing an agenda? EXERCISE: Rewrite to clarify.
  21. TEXT, from this tweet by the president: "'Federal Judge throws out Stormy Danials lawsuit versus Trump. Trump is entitled to full legal fees.' @FoxNews Great, now I can go after Horseface and her 3rd rate lawyer in the Great State of Texas. She will confirm the letter she signed! She knows nothing about me, a total con!" AND: This response by a liberal-leaning columnist: "While we’re on the topic, can we talk about the comma in the very last sentence?"
  22. TEXT, from the Sheryl Sandberg employment agreement in the Supplement, starting at page 101, lines 72-73: "[Y]our Employment will not infringe the rights of any other person." QUESTION: From a drafting-technique perspective, what's wrong with this provision?
  23. TEXT, from a Paul Krugman column, NY Times, Aug. 27, 2018: "What Freedom House calls illiberalism is on the rise across Eastern Europe. This includes Poland and Hungary, both still members of the European Union, in which democracy as we normally understand it is already dead." QUESTION: Where is democracy supposedly already dead?
  24. TEXT, from the Washington Post: "Tapper said that Conway’s boss, the president, has been the subject of numerous sexual assault allegations and has said that those women lied about them." QUESTION: Who, exactly, said "those women lied" — was it Tapper, or Conway's boss? How could this be clarified?
  25. TEXT, from this tweet: "Man trampled to death by elephant trying to take a SELFIE". EXERCISE: Rewrite.
  26. TEXT: See the strip of July 17, 2017. EXERCISE: Rewrite.
  27. TEXT: "WASHINGTON (AP) – A Russian billionaire close to President Vladimir Putin said Tuesday he is willing to take part in U.S. congressional hearings to discuss his past business relationship with President Donald Trump's former campaign chairman, Paul Manafort." (AP.com) QUESTION: Who exactly is willing to take part in U.S. congressional hearings? QUESTION: How could this be clarified?
  28. TEXT: See this Pearls Before Swine cartoon. (The author, Stephan Pastis, is a non-praticing lawyer.) QUESTION: How could the first panel's wording be "improved"?
  29. TEXT, from a Facebook posting: "A man's success has a lot to do with the kind of woman he chooses to have in his life. (Pass this on to all great women.)" QUESTION: What's another, grossly-sexist interpretation of this quote? (Please don't be offended by this example; we're learning here to spot — and fix — unintentional ambiguities that can be subject to intentional, motivated misinterpretation.)
  30. TEXT, In honor of Rosh Hashana (fall semester) or Passover (spring semester), from Joshua Rothman in The New Yorker: "My grandmother is ninety-three and, to my knowledge, has never kept kosher." QUESTION: Is there any way the bold-faced part could be misinterpreted — perhaps intentionally? QUESTION: How could this be rewritten to clarify?
  31. TEXT (from a dispute that I arbitrated): A contract states that payments remaining past due more than 30 days after the due date will bear interest at “a rate per annum equal to the prime rate published by the Wall Street Journal on the business day before the date on which such interest begins to accrue, changing with each change in such published rate, plus two percent (2%)." FACTS: On the relevant date, the Journal's published U.S. prime rate was 4.00%. QUESTION: On its face, from a drafting style perspective, what's wrong with this interest-rate provision? QUESTION: What interest rate should be applied to the late payment — 6%, or 4.08%? QUESTON: How could the interest-rate language be clarified?
  32. TEXT: In November 2018, former president Barack Obama said "a challenge of working in the White House is not always getting credit 'when nothing happens. And nothing happening is good," Obama said, to laughs." (From here.) QUESTION: What's another possible meaning of the italicized portion — a meaning that might also have triggered laughter? (Hint: Think of who was occupying the Oval Office at the time.)
  33. TEXT: Adapted from my church's Easter Sunday service booklet of a few years ago (with the family's name changed): "Easter flowers and decorations are given | to the glory of God | and in memory of their grandmother Jane Doe | In honor of all Christians, | Especially those persecuted/ | By the Doe family." QUESTION: How could this be fixed with just one additional character?
  34. FACTS: 1. Alice and Bob enter into a referral agreement; under that agreement, Alice must pay Bob a finder's fee for every contract that Alice "consummates" with anyone referred to her by Bob during a specified time period. 2. During the specified time period, Bob refers Carol to Alice. Before the specified time period ends, Alice signs a contract with Carol; BUT: Alice does not actually begin performing her obligations under the contract with Carol until after the specified time period ends. 3. Alice claims that she therefore does not owe Bob a finder's fee for her contract with Carol. QUESTION: What result? QUESTION: How could the finder's-fee agreement have been clarified? SOURCE: Fed Cetera, LLC v. Nat’l Credit Servs., Inc., 938 F.3d 466 (3d Cir. 2019) (reversing and remanding summary judgment in favor of "Alice").
  35. TEXT, from Spanski Enterprises, Inc. v. Telewizja Polska S.A., No. 19-4066 (2d Cir. Oct. 29, 2020) (nonprecedential summary order affirming judgment below): "The term of this Agreement is 25 (twenty-five) years and it comes into effect on the date of its signing. TVP and SEI may extend its term by subsequent 10 year periods." QUESTION: May either party extend the term, or must both? QUESTION: How could this be clarified? QUESTION: Do you see any other drafting "fail"? (In Q3, note how the question mark is outside the closing quotation mark, because the question mark isn't part of the quotation.)
  36. TEXT, from the Wikipedia page about Michigan Governor Gretchen Whitmer: "Gretchen Esther Whitmer (born August 23, 1971) is an American politician serving as the 49th governor of Michigan since 2019." QUESTION: Has Michigan really had 49 governors since 2019? QUESTION: How could this be rewritten to clarify?
  37. TEXT, from a WaPo story about two announced Nobel laureates in economics: "The two men will receive a cash award of 10 million Swedish krona, worth a bit more than $1.1 million." QUESTION: How much will each man receive?
  38. TEXT, from the Washington Post: "Rep. Sean Patrick Maloney (D-N.Y.) walked [acting ambassador to Ukraine William] Taylor through his U.S. Military Academy and military career, including that he was No. 5 in a class of 800 and took a tough infantry assignment in Vietnam, in an apparent effort to embarrass Republicans." QUESTION: Who, exactly, did what, "in an apparent effort to embarrass Republicans"? How could the ambiguituy be fixed?
  39. TEXT, from this church sign: "Don't Let Worries | Kill You | Let The Church | Help"

9 General writing rules

Those new to contract drafting should learn — even memorize — the rules in this section. Note: This chapter "steals” from the following sources: • The U.S. Securities and Exchange Commission’s Plain English Handbook (Aug. 1998) at https://goo.gl/DZaFyT (sec.gov). • The PlainLanguage.gov Web site at https://goo.gl/FcvL (PlainLanguage.gov), by “a group of federal employees from many different agencies and specialties who support the use of clear communication in government writing.” • The U.S. Air Force’s writing guide, The Tongue and Quill (rev. Nov. 2015), at https://goo.gl/1y1b0j (static.e-publishing.af.mil). This “theft” is legal because under 17 U.S.C. § 105, copyright is not available for works that were created by officers or employees of the U.S. Government in the course of their official duties; see generally the Wikipedia article Copyright status of work by the U.S. government.

9.1 Style guide for numbers

This section sets out some stylistic conventions that are commonly followed in drafting contracts. As with all stylistic conventions: • If your supervisor prefers one way over another, then do it that way (see § 6.1). • Don't make purely-stylistic revisions in another party's draft contract (see § 6.2).

1.  Spell out the numbers one through ten; use numerals for 11, 12, 13, etc. Some style guides say to spell out numbers one through nine. See also When Should I Spell Out Numbers? (Grammerly.com)

2.  Both in the same sentence? Consider using just numbers: The quiz will contain between 8 and 12 questions.

3.  Don’t start a sentence with numerals; either spell out the numerals in words or (preferably) rewrite the sentence.

BEFORE AFTER
42 was Douglas Adams’s answer to The Ultimate Question of Life, the Universe, and Everything. According to the late novelist Douglas Adams, the answer to The Ultimate Question of Life, the Universe, and Everything is … 42.

4.  Spell out million, billion, trillion — but not thousand. Example: More than 300,000,000 300 million people live in the United States. Example: Alice will pay Bob $5 thousand $5,000.

5.  Important: Don’t spell out a number in words and then restate the number in numerals. Example: More than three hundred 300 million (300,000,000) people live in the United States. Why this rule? Because there’s too much danger of changing one but inadvertently neglecting to change the other. (See  § 8.8, "D.R.Y. — "Don't Repeat Yourself" for how this can be a very expensive mistake, costing a Dallas-area lender $693,000.)

6.  Don't say "in United States dollars" if there's no possibility of confusion. If you feel the need to be clear that dollars refers to U.S. dollars, you can do that in your definitions & usages section (see § 4).

7.  If currency confusion is a possibility, then use ISO 4217 currency abbreviations such as USD, as in: Buyer will pay USD $30 million. (The USD abbreviation goes where indicated, not after the numbers.)

8.  Don't spell out dollar amounts in words. Example: Alice will pay Bob five thousand dollars $5,000.

9.  Omit zero cents unless relevant. Example: Alice will pay Bob $5,000.00 $5,000. But: Alice will pay Bob $3,141.59.

10.  Spell out a percentage if it’s at the beginning of a sentence — or just use numbers and rewrite the sentence to avoid starting with the percentage. Example: 30% Thirty percent of the proceeds will be donated to charity. Better: Of the proceeds, 30% will be donated to charity.

11.  Time is written with digits: 5:00 p.m. not five p.m.

9.2 Parallelism in lists: Be consistent

In lists, you should be able to delete any item in the list and still have the sentence make sense grammatically. Example: The police officer told us to observe the speed limit and we should dim to dim our lights.

9.3 Avoid gobbledygook

From the PlainLanguage.gov Website:

BEFORE AFTER
Consultation from respondents was obtained to determine the estimated burden. We consulted with respondents to estimate the burden.

9.4 Active voice is better — usually

Active voice gets to the point by putting the actor first. Look at the following before-and-after examples:

BEFORE AFTER
A song was sung by her. She sang a song.

But sometimes passive voice is better, for example if the doer or actor of the action is unknown, unimportant, obvious, or better left unnamed:

  • The part is to be shipped on 1 June. (If the actor is unclear or unimportant.)
  • Presidents are elected every four years. (The actors are obvious.)
  • Christmas has been scheduled as a workday. (The actor is better left unsaid.)

And clear, forceful, active-voice language might be inappropriate in diplomacy; in political negotiations — or in contract negotiations. The original USAF sentence said “… may be inappropriate,” but it’s better to stick with “might be” — use "may" for permission, "might" for possibility (see § 9.7).

9.5 Streamline your sentences

It’s too easy to let a sentence get fat and sloppy. Here are a few examples:

BEFORE AFTER
They made the decision to give their approval. They decided to approve it.
Or: They approved it.
The team held a meeting to give consideration to the issue. The team met to consider the issue.
Or: The team considered the issue.
We will make a distribution of shares. We will distribute shares.
We will provide appropriate information to shareholders. We will inform shareholders.
We will have no stock ownership of the company. We will not own the company’s stock.
There is the possibility of prior Board approval of these investments. The Board might approve these investments in advance.
The settlement of travel claims involves the examination of orders. Settling travel claims involves examining orders.
Use 1.5 line spacing for the preparation of your contract draft. Use 1.5 line spacing to prepare your contract draft.
  Better: Use 1.5 line spacing for your draft contract.

9.6 Word order might matter

Example: “We want only the best” has a slightly-different meaning than “We only want the best.”

Another example, excerpted from StackExchange:

I eat fish only when I'm sick.

I eat only fish when I'm sick.

And another example, also excerpted from StackExchange:

(2) In 1996, only Ford sold a rebadged Mazda 626 GV over here as its rebranded Japanese mid-size stationwagon. (Ford was the only manufacturer)

 * * *

(4) In 1996, Ford sold a rebadged Mazda 626 GV over here as its only rebranded Japanese mid-size stationwagon (there were no others, I assume?)

9.7 "May" and "might" are different

To avoid possible confusion:

  • Use may to indicate permission: ABC may delay payment until December 31.
  • Use might to indicate possibility: It might rain tomorrow.

This can be summarized in the acronym MPMP: May for Permission, Might for Possibility.

9.8 Exercises and discussion questions

  1. Which is it: "Class starts at X o'clock": A) ten B) 10:00
  2. Which is it: "More than X people voted to re-elect President Trump": A) 74,000,000 B) seventy-four million C) 74 million.
  3. Which is used to indicate permission: May, or might?
  4. Which is used to indicate possibility: May, or might?

10 Interlude: Microsoft Word

10.1 Microsoft Word key features

[Students: Items 1-5 are fair game for testing; the remaining items are nice to know but won't be tested.]

1. The safest way to format a paragraph without corrupting the document and crashing the Word program is to format the style of the paragraph, not the individual paragraph itself. See, e.g., The Styles advantage in Word (https://goo.gl/v8Jbej); Item 3 in the 2013 list of tips to avoid crashing Word, by John McGhie (https://goo.gl/VxqJKs). NOTE: McGhie's tip no. 2 is to avoid Track Changes, but I've never had a problem with it — at least so far as I know ….

2. To create a heading, use Heading styles: Heading 1, Heading 2, etc.

3. Headings can be automatically numbered by using the Bullets and Numbering feature under Format. The following apply mainly to the formatting of styles, but can be used with caution to format individual paragraphs:

4. On rare occasions, to adjust the line spacing within a specific paragraph, use the menu sequence: Format | Paragraph | Indents and Spacing | Spacing (almost smack in the middle of the dialog box on a Mac).

5. To adjust the spacing between paragraphs, use the menu sequence: Format | Paragraph | Indents and Spacing menu. Don’t use a blank line to separate paragraphs — adjust the spacing instead. See generally Practical Typography: Spacing Between Paragraphs (PracticalTypography.com: https://goo.gl/vNjeKF).

6. To keep one paragraph on the same page with the following paragraph (which is sometimes useful), use the menu sequence Format | Paragraph | Line and Page Breaks | Keep with Next.

Here are some other tips:

7. A table of contents can be useful in a long contract. To create a table of contents, in the References tab, use the Table of Contents dropdown box and select Custom Table of Contents.

8. Tables can sometimes be useful in contracts. To remove the borders from a table (the way Word normally creates them), first use the menu sequence: Table | Select | Table. Then use the menu sequence: Format | Borders & Shading | Borders | None.

9. To copy and paste a short snippet from a Web page into a Microsoft Word document without messing up the formatting of the paragraph into which you’re pasting the snippet, use the menu sequence: Edit | Paste Special | Unformatted text. (Alternatively: Edit | Paste and Match Formatting.)

10.2 Exercises and discussion questions

  1. Explain if false: One valid way to add space between two paragraphs in Microsoft Word is to just put an extra blank line between the paragraphs.

11 Drafting tips

11.1 False imperatives: Who is responsible?

Passive voice is often disfavored in contracts (and elsewhere). But passive voice isn't necessarily a serious error — unless the passive-voice provision leaves it unclear who must do what. This is sometimes referred to as a "false imperative."

Think of a false imperative two baseball outfielders who let an easily-catchable fly ball drop to the ground between them because neither one "calls it" and each assumes that the other will get it.

Example: A limited-partnership agreement provided that a partner was to be paid money, but the agreement used the passive-voice "shall be paid." This led to litigation over just who was supposed to make the payment — was it the limited partnership, or the general partner? An appeals court summarized the situation:

"In section 6.2, the Partners used the passive voice in the critical sentence. They stated "shall be paid or distributed" without identifying which entity or entities must pay or distribute the Partnership Capital Event Receipts." ASR 2620-2630 Fountainview, LP v. ASR 2620-2630 Fountainview GP, LLC, 582 S.W.3d 556, 561 (Tex. App.–Houston [14th Dist.] 2019, no pet.) (affirming, in relevant part, judgment on jury verdict).

Hypothetical example: Suppose that:

  • A real-estate developer enters into a construction agreement with a general contractor;
  • Under the construction agreement, the contractor is to build a building;
  • Because of the nature of the building site, special safety procedures will be needed for all personnel coming on the site;
  • The construction agreement says simply: "All Developer personnel are to be trained in special safety procedures for the Building Site."

This is another example of a so-called "false imperative," because it arguably leaves unclear just who is responsible for training the developer's personnel in the special safety procedures.

(Other portions of the construction agreement might shed light on the question, but that's not the ideal situation.)

A useful business expression (albeit a bit trite from overuse) is One Throat to Choke! See, e.g., Wiktionary.

Drafting lesson: Even when passive voice is appropriate, a contract provision should not leave any room for doubt about who is responsible for making Item X happen, or preventing Event Y from happening).

11.2 Roadblock clauses

It can be useful for a contract to explicitly rule out an argument that the other side might someday make. For example, the Texas supreme court rendered a take-nothing judgment, reversing a $100M jury verdict for punitive damages against Mercedes-Benz USA, because the plaintiff's fraudulent-inducement claim was conclusively negated by the contract's express terms. The supreme court summed up its holding and rationale:

The issue here is whether Carduco’s belief that Mercedes had promised the McAllen [sales] area to it was justified in light of the parties’ written agreement. Because that agreement[:]

  • approved and identified only Harlingen as Carduco’s dealership location,
  • provided that Carduco could not move, relocate, or change any dealership facilities without Mercedes’s prior written consent,
  • provided that Carduco’s right to sell cars in any specific geographic area was nonexclusive, and
  • stated that the agreement was not intended to limit Mercedes’s right to add new dealers in the area,

we conclude that the parties’ written agreement directly contradicts Carduco’s alleged belief and thereby negates its justifiable reliance as a matter of law. The court of appeals’ judgment affirming the award of actual and punitive damages is accordingly reversed and judgment rendered that Carduco take nothing.

Mercedes-Benz USA, LLC v. Carduco, Inc., 583 S.W.3d 553, 554-55 (Tex. 2018) (emphasis, bullets, and extra paragraphing added).

11.3 Sunset provisions

It's usually worth considering whether a particular right — or obligation — should have an explicit "sunset" date, i.e., a date certain (or a date-determinable) when the right or obligation comes to an end.

Example: Suppose that ABC Corp. is negotiating a confidentiality agreement under which ABC will be receiving confidential information of XYZ Inc. for a stated purpose. ABC might want its confidentiality obligations to come to an end automatically in X number of years, so that it won't have to think about and manage those obligations after that time.

11.4 Conspicuousness: Go easy on the all-caps

11.4.1 Overview

In some jurisdictions, certain types of clauses might not be enforceable unless they are "conspicuous." For clauses in this category, courts typically want extra assurance that the signers knowingly and voluntarily assented to the relevant terms and conditions.

Example: Under the "express negligence" doctrine in Texas law, an indemnity provision that purports to protect a party from the consequences of its own negligence must not only be expressly stated, it must also be "conspicuous" in accordance with the Uniform Commercial Code standard. See Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508-09 (Tex. 1993) (adopting UCC's standard of conspicuousness for express-negligence indemnification doctrine).

11.4.2 All-caps ≠ "conspicuous" – and might be dangerous?

Contract drafters sometimes put entire paragraphs into all-capital letters in the hope of making them "conspicuous." The reader has probably seen examples of this particular disorder in warranty disclaimers and limitations of liability.

But keeping the all-caps going for line, after line, after line, can be self-defeating. A Georgia supreme court justice noted that the drafter of a contract in suit had made the justice's job more difficult — which is not a good look, to put it mildly:

No one should make the mistake of thinking, however, that capitalization always and necessarily renders the capitalized language conspicuous and prominent.

In this case, the entirety of the fine print appears in capital letters, all in a relatively small font, rendering it difficult for the author of this opinion, among others, to read it.

Moreover, the capitalized disclaimers are mixed with a hodgepodge of other seemingly unrelated, boilerplate contractual provisions — provisions about, for instance, a daily storage fee and a restocking charge for returned vehicles — all of which are capitalized and in the same small font.

Raysoni v. Payless Auto Deals, LLC, 296 Ga. 156, 766 S.E.2d 24, 27 n.5 (2014) (reversing and remanding judgment on the pleadings) (emphasis and extra paragraphing added).

In a similar vein, the Ninth Circuit's Judge Alex Kozinski noted acerbically:

Lawyers who think their caps lock keys are instant"'make conspicuous" buttons are deluded. … A sentence in capitals, buried deep within a long paragraph in capitals will probably not be deemed conspicuous.

Formatting does matter, but conspicuousness ultimately turns on the likelihood that a reasonable person would actually see a term in an agreement.

In re Bassett, 285 F.3d 882, 886 (9th Cir. 2002) (cleaned up, emphasis and extra paragraphing added).

Even worse, drafting a long block of text in all-caps might actually hurt the drafter's own client. Here's a tweet by Boston-area tech lawyer turned entrepreneur Luis Villa: "Love to see an ALL CAPS AND BOLD section of a contract that is so typographically painful to read that the company’s lawyers didn’t actually proof it, and made a substantive error in my favor as a result." (Emphasis added.)

The drafting tips here, of course, are:

  1. Be judicious about what you put in all-caps.
  2. Don't use too-small a font for language that you want to be conspicuous.

If you want an example of what NOT to do to make something conspicuous, just glance at (don't even try to read) the following abomination, which is near the very front of a real-estate purchase agreement for a Dallas-area "gentlemen's club":

Section 1.02. Disclaimer and Indemnity. THE PROPERTY SHALL BE CONVEYED AND TRANSFERRED TO PURCHASER “AS IS, WHERE IS AND WITH ALL FAULTS”. EXCEPT FOR THE REPRESENTATIONS, WARRANTIES AND COVENANTS OF SELLER SET FORTH IN ARTICLE V OF THIS AGREEMENT, SELLER DOES NOT WARRANT OR MAKE ANY REPRESENTATIONS, EXPRESS OR IMPLIED, AS TO FITNESS FOR A PARTICULAR PURPOSE, MERCHANTABILITY, DESIGN, QUANTITY, QUALITY, LAYOUT, FOOTAGE, PHYSICAL CONDITION, PERATION, COMPLIANCE WITH SPECIFICATIONS, ABSENCE OR LATENT DEFECTS OR COMPLIANCE WITH LAWS AND REGULATIONS (INCLUDING, WITHOUT LIMITATION, THOSE RELATING TO HEALTH, SAFETY AND THE ENVIRONMENT) OR ANY OTHER MATTER AFFECTING THE PROPERTY AND SELLER SHALL BE UNDER NO OBLIGATION WHATSOEVER TO UNDERTAKE ANY REPAIRS, ALTERATIONS OR OTHER WORK OF ANY KIND WITH RESPECT TO ANY PORTION OF THE PROPERTY. FURTHER, PURCHASER SHALL INDEMNIFY, DEFEND AND HOLD HARMLESS SELLER AND SELLER’S REPRESENTATIVES FROM AND AGAINST ANY CLAIMS OR CAUSES OF ACTION ARISING OUT OF THE CONDITION OF THE PROPERTY BROUGHT BY ANY OF PURCHASER’S SUCCESSORS OR ASSIGNS, OR ANY THIRD PARTY, AGAINST SELLER OR SELLER’S REPRESENTATIVES. INFORMATION PROVIDED OR TO BE PROVIDED BY SELLER IN RESPECT OF THE PROPERTY WAS OBTAINED FROM A VARIETY OF SOURCES. SELLER HAS NOT MADE AN INDEPENDENT INVESTIGATION OF SUCH INFORMATION AND MAKES NO REPRESENTATIONS AS TO THE ASSURACY OR COMPLETENESS THEREOF. PURCHASER HEREBY ASSUMES ALL RISK AND LIABILITY RESULTING FROM THE OWNERSHIP, USE, CONDITION, LOCATION, MAINTENANCE, REPAIR OR OPERATION OF THE PROPERTY, WHICH PURCHASER WILL INSPECT AND ACCEPT “AS IS”. IN THIS REGARD, PURCHASER ACKNOWLEDGES THAT (a) PURCHASER HAS NOT ENTERED INTO THIS AGREEMENT IN RELIANCE UPON ANY INFORMATION GIVEN TO PURCHAWSER PRIOR TO THE DATE OF THIS AGREEMENT, INCLUDING, BUT NOT LIMITED TO, PROMOTIONAL MATERIALS OR FINANCIAL DATA , (b) PURCHASER WILL MAKE ITS DECISION TO PURCHASE THE PROPERTY BASED UPON PURCHASER’S OWN DUE DILIGENCE AND INVESTIGATIONS, (c) PURCHASER HAS SUCH KNOWLEDGE AND EXPERIENCE IN REAL ESTATE INVESTIGATION TO EVALUATE THE MERITS AND RISKS OF THE TRANSACTIONS PROVIDED IN THIS AGREEMENT, AND (d) PURCHASER IS FINANCIALLY ABLE TO BEAR THE ECONOMIC RISK OF THE LOSS OF SUCH INVESTMENT AND THE COST OF THE DUE DILIGENCE AND INVESTIGATIONS UNDER THIS AGREEMENT. IT IS UNDERSTOOD AND AGREED THAT THE PURCHASE PRICE HAS BEEN ADJUSTED BY PRIOR NEGOTIATION TO REFLECT THAT THE PROPERTY IS SOLD BY SELLER AND PURCHASED BY PURCHASER SUBJECT TO THE FOREGOING. Disclaimers similar to the foregoing in form satisfactory to Seller as well as Seller’s reservation of the mineral estate shall be inserted in any and all documents to be delivered by Seller to Purchaser at Closing.

This example is from https://www.sec.gov/Archives/edgar/data/935419/000114036108012368/ex10_2.htm. If you're wondering who's responsible for this piece of [work], the names and addresses of the parties' counsel are included in the addresses for notice in section 10.03.

11.4.3 The UCC definition of conspicuousness

The [U.S.] Uniform Commercial Code doesn't apply to all types of transaction, nor in jurisdictions where it has not been enacted.

Still, the UCC's definition of "conspicuous," such as in section UCC § 1-201(10) (Texas version) nevertheless provides useful guidance:

"Conspicuous," with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it.

Whether a term is "conspicuous" or not is a decision for the court.

Conspicuous terms include the following:

(A) a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and

(B) language in the body of a record or display in larger type than the surrounding text,

or in contrasting type, font, or color to the surrounding text of the same size,

or set off from surrounding text of the same size by symbols or other marks that call attention to the language.

Tex. Bus. & Com. Code § 1.201(10) (emphasis and extra paragraphing added).

Courts often adopt the UCC standard for conspicuousness, as explained in the next section.

11.4.4 Courts tend to focus on "fair notice"

In a non-UCC context, the Supreme Court of Texas held that — with a possibly-significant exception — an indemnity provision protecting the indemnitee from its own negligence must be sufficiently conspicuous to provide "fair notice." The supreme court adopted the conspicuousness test stated in the UCC, quoted above; the court explained:

This standard for conspicuousness in [Uniform Commercial] Code cases is familiar to the courts of this state and conforms to our objectives of commercial certainty and uniformity. We thus adopt the standard for conspicuousness contained in the Code for indemnity agreements and releases like those in this case that relieve a party in advance of responsibility for its own negligence.

When a reasonable person against whom a clause is to operate ought to have noticed it, the clause is conspicuous.

For example, language in capital headings, language in contrasting type or color, and language in an extremely short document, such as a telegram, is conspicuous.

Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508-09 (Tex. 1993) (citations omitted, emphasis and extra paragraphing added).

The court also pointed out that the fair-notice requirement did not apply to settlement releases: "Today's opinion applies the fair notice requirements to indemnity agreements and releases only when such exculpatory agreements are utilized to relieve a party of liability for its own negligence in advance." Id., 853 S.W.2d at 508 n.1 (emphasis added).

11.4.5 Fair notice will often depend on the circumstances

What counts as "conspicuous" will sometimes depend on the circumstances. In still another express-negligence case, the Texas supreme court said that the indemnity provision in question did indeed provide fair notice because:

The entire contract between Enserch and Christie consists of one page; the indemnity language is on the front side of the contract and is not hidden under a separate heading.

The exculpatory language and the indemnity language, although contained in separate sentences, appear together in the same paragraph and the indemnity language is not surrounded by completely unrelated terms.

Consequently, the indemnity language is sufficiently conspicuous to afford "fair notice" of its existence.

Enserch Corp. v. Parker, 794 S.W.2d 2, 8-9 (Tex. 1990) (extra paragraphing added).

11.4.6 Proven actual knowledge might be enough

Texas's Dresser court noted an exception to the conspicuousness requirement: "The fair notice requirements are not applicable when the indemnitee establishes that the indemnitor possessed actual notice or knowledge of the indemnity agreement." Dresser, 853 S.W.2d at 508 n.2 (emphasis added, citation omitted).

Note especially the italicized portion of the quotation, which implies that the burden of proof of actual notice or knowledge is on the party claiming indemnification from its own negligence.

In contrast, a federal district judge in Houston granted Enron's motion to dismiss Hewitt Associates' claim for indemnity, on grounds that the contract in question did not comply with the conspicuousness requirement of the "express negligence" rule, namely that an agreement to indemnify a party for the consequences of the party's own negligence must be both express and conspicuous).The judge surveyed prior cases in which actual knowledge (of an indemnity clause) had been sufficiently established, including by ways such as:

  • evidence of specific negotiation, such as prior drafts;
  • through prior dealings of the parties, for example, evidence of similar contracts over a number of years with a similar provision;
  • proof that the provision had been brought to the affected party's attention, e.g., by a prior claim. See Enron Corp. Sav. Plan v. Hewitt Associates, LLC, 611 F.Supp.2d 654, 673-75 (S.D. Tex. 2008).

11.5 Safe-harbor clauses

The term "safe harbor" is used to denote one, non-exclusive way of definitively complying with a requirement. The term is used in, for example, tax law and securities law. See generally, e.g.:

11.6 Boomerang clauses could hurt you later

In the Kingston Trio's (somewhat-offensive) 1958 version of the risqué Spanish-language song Coplas, Dave Guard's "translation" of one verse is, Tell your parents not to muddy the water around us — they may have to drink it soon. Contract drafters will often do well to heed similar advice: Their clients might someday have to live with the hardball provision they force the other side to accept. This section discusses a few examples.

11.6.1 Example: Trump Corporation's lease terms

(Author's note: This section was written before Donald Trump announced his successful 2016 presidential campaign.)

Trump Corporation ("Trump") has been a real-estate landlord, among other things. According to AmLaw Daily, years ago Trump's lawyers took one of the company's leases, changed the names, and used it for a deal in which Trump was the tenant and not the landlord.

Later, Trump-as-tenant found that its lease-agreement form gave Trump's landlord significant leverage:

"The funny part of it is what one of his internal lawyers must have done years ago," [the landlord's president] says. "Normally Trump is the landlord, not the tenant. So what they did is they took one of their leases and just changed the names. And so it's not a very favorable lease if you're the tenant."

See Nate Raymond, Trump Misses Rent Payments …, http://goo.gl/B72TIr (AmLawDaily.Typepad.com) (accessed Apr. 27, 2015).

Ouch ….

11.6.2 Example: Tilly's sets the signature bar too high

Tilly's, Inc. and World of Jeans & Tops, Inc. ("Tilly's") had an employee sign an employment agreement (the "2001 employment agreement") containing an arbitration provision. The 2001 employment agreement included a carve-out for statutory claims (which thus could be brought in court, not in arbitration). Importantly, the 2001 employment agreement also stated that any modifications to the agreement would need the signatures of three executives: The company's president; senior vice president; and director of human resources.

In 2005, the company had its employees sign an acknowledgement of receipt of an employee handbook containing a different arbitration provision, which didn't contain the carve-out for statutory claims. BUT: The signed acknowledgement didn't contain the three executive signatures needed to modify the 2001 employment agreement.

So: Because Tilly's set the so bar high for modifying the 2001 employment agreement — requiring three executive signatures — the company found itself facing high-stakes litigation by a class of plaintiffs, whereas it had thought it would be arbitrating low-stakes claims individually. See Rebolledo v. Tilly's, Inc., 228 Cal. App. 4th 900, 924, 175 Cal. Rptr. 3d 612 (Cal. App. 4th Div. 2014) (affirming denial of motion to compel arbitration).

11.6.3 Example: A one-way NDA later leaves a party unprotected

With a one-way nondisclosure agreement, only the originally-intended disclosing party's information is protected. This means that any disclosures by the receiving party might be completely unprotected — resulting in the receiving party's losing its trade-secret rights in its information.

That's just what happened to the plaintiff in a Seventh Circuit case: The plaintiff signed a confidentiality agreement with the defendant, but that agreement protected only the defendant's information. Consequently, the plaintiff's later disclosures of its own confidential information were unprotected. See Fail-Safe, LLC v. A.O. Smith Corp. 674 F.3d 889, 893-94 (7th Cir. 2012) (affirming summary judgment for defendant).

(It's not hard to imagine the thought process that the plaintiff's business people's went through: "We need to disclose our information to you, but hey, we've already got an NDA in place, so sure, let's do it." But the NDA didn't do what the plaintiff needed.)

11.7 Jerks: Drafting for them

It's inevitable: Sooner or later, every contract drafter (and reviewer) will come up against a counterpart for The Other Side who is implacable and maybe even just plain unreasonable. This section offers some suggestions for dealing with such folks. There's no guarantee that any of these suggestions will work in a given case, but they might help.

11.7.1 Don't kick a sleeping dog

The scene:

  • You're in a contract negotiation, representing The Good Guys Company.
  • The other side, Nasty Business Partner Inc., insists on requiring The Good Guys to get NBP's consent before assigning the agreement.
  • Nasty Business Partner has all the bargaining power; the Good Guys decide they have no choice but to go along.

Trying to salvage the situation, you ask Nasty Business Partner for some additional language: "Consent to assignment may not be unreasonably withheld, delayed, or conditioned." But Nasty Business Partner refuses. Have you just screwed your client?

In some jurisdictions, The Good Guys might otherwise have benefited from a default rule that Nasty Business Partner Inc. had an implied obligation not to unreasonably withhold consent to an assignment of the contract. See, e.g., Shoney's LLC v. MAC East, LLC, 27 So.3d 1216, 1220-21 (Ala. 2009); Pacific First Bank v. New Morgan Park Corp., 876 P.2d 761 (Or. 1994).

But you asked for an express obligation — only to have Nasty Business Partner reject the request — and The Good Guys signed the contract anyway.

A court might therefore conclude that the parties had agreed that Nasty Business Partner would not be under an obligation not to unreasonably withhold its consent to assignment — that NBP could grant or withhold its consent in its sole discretion.

This is pretty much what happened, on somewhat-different facts, in both the Shoney's LLC and Pacific First Bank cases cited above.

The Team Coco example: You might remember that TV talk-show host Conan O'Brien's stewardship of The Tonight Show proved disappointing to NBC. The network decided to move Jay Leno back into that time slot and bump Conan back to 12:05 a.m. This led Conan to want to leave the show and start over on another network — but if he had, he would arguably have been in breach of his contract with NBC.

Conan's contract apparently did not state that The Tonight Show would always start at 11:35 p.m. Conan's lawyers were roundly criticized for that alleged mistake by ex-Wall Streeter Henry Blodget and some of his readers. See Conan's Lawyers Screwed Up, Forgot To Specify "Tonight Show" Time Slot (BusinessInsider.com Jan. 11, 2010), especially the reader comments following the article.

But then wiser heads pointed out that Conan's lawyers might have intentionally not asked for a locked-in start time:

  • The Tonight Show had started at 11:35 p.m. for decades; Conan's lawyers could have plausibly argued that this start time was part of the essence of The Tonight Show, and thus was an implied part of the contract.
  • Suppose that Conan's lawyers had asked for the contract to lock in the 11:35 p.m. start time of The Tonight Show, but that NBC had refused. A court might then have interpreted the contract as providing that NBC had at least some freedom to move the show's start time.
  • Indeed, NBC might have responded by insisting on just the opposite, namely a clause affirmatively stating that NBC was free to choose the start time.
    • Given that NBC had more bargaining power than Conan at that point, Conan might then have had no choice but to agree, given that he wanted NBC to appoint him as the host of the show.
    • And in that case, there'd be no question that NBC had the right to push the start time of the show back to 12:05 p.m.

Ultimately, Conan and NBC settled their dispute; the network bought out Conan's contract for a reported $32.5 million. This seems to suggest that NBC was concerned it might indeed be breaching the contract if it were to push back The Tonight Show to 12:05 a.m. as it wanted to do. As an article in The American Lawyer commented:

… If O'Brien had asked that the 11:35 p.m. time slot be spelled out in any agreement—and had NBC refused—the red pompadoured captain of "Team Coco" would be in a weaker position in the current negotiations.

"If you ask and are refused, or even worse, if you ask and the other side pushes for a 180, such as a time slot not being guaranteed, you can end up with something worse," [attorney Jonathan] Handel adds.

Without having their hands bound by language in the contract on when "The Tonight Show" would air, O'Brien's lawyers are in a better position to negotiate their client's departure from NBC.

Brian Baxter, Legal Angles Abound as Conan-NBC Standoff Nears Endgame (AmLaw Daily Jan. 19, 2010) (extra paragraphing added).

Judging by the outcome, it may well be that Conan's lawyers did an A-plus job of playing a comparatively-weak hand during the original contract negotiations with NBC.

The lesson: Be careful what you ask for in a contract negotiation — if the other side rejects your request but you do the deal anyway, that sequence of events might come back to haunt you later.

11.7.2 Hamburger for the guard dog

When drafting a contract, it can pay to include a clause that you know the other side will insist on getting, even if you'd really prefer to omit the clause.

EXAMPLE: Suppose that you're drafting a contract under which your client is obligated to pay the other side a percentage of its (your client's) sales. The contract might be an intellectual-property license agreement, or perhaps a real-estate lease.

It might be tempting to omit an audit clause from your draft. Your reasoning could be that the other side's contract reviewers might not think to ask for such a clause, and it's not your job to remind them.

But consider these points:

• In imagining that the other side's reviewer won't notice the absence of an audit clause omission, you might be indulging in wishful thinking — the other side's reviewer might be an expert who knows exactly what to look for and what to demand.

•  If the other side's contract reviewer were to see an audit clause in your draft, he or she might well mentally check the box — yup, they've got an audit clause — and move on to other matters, without making significant changes to your wording. That's a win, not least because it's one less thing to negotiate.

• You might be better off setting the tone with an audit clause that you know your client can live with, and then standing on principle to reject unreasonable change requests.

• Suppose the other side doesn't really know what they're doing. Chances are you'll get the other side to signature faster — and you'll be laying a foundation for a trusting relationship — if the draft you're proposing seems to address the other side's needs as well as your client's needs.

11.7.3 The reality: Personal incentives matter

Berkshire Hathaway's vice-chairman Charles Munger has said that "Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower. * * * Never, ever, think about something else when you should be thinking about the power of incentives." Charles T. Munger, The Psychology of Human Misjudgment (fs.blog), archived at https://perma.cc/LNG7-JG6Y.

When drafting a contract, it can pay dividends to give some thought to how to manage the so-called "agency costs" that can arise from these personal interests and incentives of individual players. That's because when disputes arise, the involved individuals will naturally want to protect their own interests, such as: • not having fingers pointed at them; • being thought of by their side as a committed team player who's willing to fight to win, not a defeatist who throws in the towel; • protecting their bonus, their commission, their pay raise, their promotion, etc. See generally Agency cost (Wikipedia.org); a somewhat more-readable presentation is at Agency Costs (Investopedia.com).

These desires can manifest themselves in a variety of ways; some of the Tango Terms can help to channel these incentives and manage individuals' expectations.

11.7.4 What if you can't just say "no"?

Your client might not have the bargaining power to get its way in contract negotiations. When that's the case, you have to try to come up with other ways to help protect the client's legal- and business interests.

Imagine, for example, that your client is a customer that is negotiating a master purchasing contract with a vendor.

  • Your customer client would love to flatly prohibit the vendor from raising prices without the customer's consent. But the vendor's negotiators won't go along with such a prohibition.
  • The vendor would love to have the unfettered discretion to raise your customer client's prices whenever the vendor wants. But your client's business people are insisting on having at least some protection on that score.

What to do? In no particular order, here are some approaches that you could try.

Non-discrimination language? A non-discrimination requirement at least brings a bit of overall-market discipline into the picture.

Example: "Vendor will not increase the prices it charges to Customer except as part of a non-targeted, across-the-board pricing increase by Vendor, applicable to its customers generally, for the relevant goods or services."

Comment: Vendor might want to qualify this language, so as to limit how general a price increase must be before it can be applied to Customer.

Advance warning or -consultation? An advance-warning or advance-consultation requirement can buy time for its beneficiary to look around for alternatives (assuming of course that the contract doesn't lock in the beneficiary somehow, for example with a minimum-purchase requirement or a "requirements" provision).

Example: Vendor will give Customer at least X [days | months] advance notice of any increase in the pricing it charges to Customer under this Agreement.

Transparency requirement? Requiring a party to provide information justifying its action, upon request, can force that party to think twice about doing something, even though it technically has the right to do it.

Example: If requested by Customer within X days after notice of a pricing increase, Vendor will seasonably provide Customer with documentation showing, with reasonable completeness and accuracy, a written explanation of the reason for the increase, including reasonable details about Vendor's relevant cost structures relevant to the pricing increase. Customer will maintain all such documentation in confidence any non-public information in such explanation, will not disclose the non-public information to third parties, and will use it only for purposes of making decisions about potential purchases under this Agreement.

Comment: Note the if-requested language, which relieves the vendor from the burden of continually managing this requirement — although a smart vendor would plan ahead and have the required documentation ready to go.

Draw the thorn from the lion's paw? When a party makes tough contract demands, it could be because the party has been burned before. Institutionally, it may still "feel the pain" of a bad experience; its response is to roar at other counterparties.

The counterparty being roared at can try to find out why the lion is roaring. If it can identify the source of the pain, it might be able to figure out another way to make it better, without undertaking burdensome obligations. The allusion here, of course, is to the ancient folk tale about Androcles and the lion.

Cap the financial exposure for the onerous provision? A party with bargaining power will often demand that its counterparty agree to an onerous provision. In response, the counterparty could ask the first party to agree to a dollar cap on the amount of the counterparty's resulting financial exposure, e.g., capping the amount of money that the counterparty would be required to spend or the liability that it might someday face.

If the first party agrees, the onerous provision might look less dangerous to the counterparty than it would with the prospect of unlimited expense and/or liability.

(This is a variation on the old saying: When in doubt, make it about money.)

Impose time limits? When a party asks its counterparty to agree to an onerous contract provision, the counterparty might try to make its business risk more manageable by imposing time limits on the onerous provision.

For example, if a party demands an oppressive indemnity, the counterparty might counter by asking for a time limit on claims covered by the indemnity.

Or if a party demands a cap on pricing increases, or a most-favored-customer clause, the counterparty could counter with time limits on those as well.

Explain why the provision hurts the demanding party? A counterparty can to try to explain to a demanding party why, in the long run, the onerous provision being demanded would ultimately cause problems for the demanding party.

Package as part of a premium offering? Suppose that a smallish supplier is regularly asked by its customers to agree to an onerous contract provision (e.g., an extended warranty). If the supplier plans ahead, it can package the onerous provision as part of a higher-priced premium offering — with the relevant contract language being written in a way the supplier knows it can support.

This approach has a huge advantage: The bargaining over whether to give a customer the premium offering is no longer about legal T&Cs: it becomes a negotiation about price. This means the supplier's legal people might not even have to get involved — which often can be crucial when sales people are working hard to close deals before the shot clock runs down on the fiscal quarter.

Another advantage: The supplier might well score points with customers for anticipating their needs and offering a solution for them.

A third advantage: Some customers are far less price-sensitive than they are service-sensitive: They're willing to pay more if they feel they're getting premium treatment.

Maybe it's is worth the risk? The supplier and its lawyer should assess the actual business risk of agreeing to the customer's request — in the real world it might not be as big a problem as the supplier imagines.

(It's the client's call, of course.)

11.8 Terms to avoid

11.8.1 Reduce - better than "minimize"

A cautious drafting approach is to use the term reduce in lieu of minimize, against the chance that an adversary might later claim that "minimization" didn't actually occur, i.e., that the reduction that was actually achieved was not the greatest amount of reduction possible.

(Ditto for using the term increase, or enhance, in lieu of maximize.)

11.8.2 True and correct [sic]: Don't

You might see contract language such as (hypothetically): "ABC certifies that each statement in its request for expense reimbursement is true and correct." What does that mean, exactly?

The present author doesn't like stating that a report, etc., must be "true and correct" because:

  • The phrase is arguably redundant — is there a difference between true and correct? If so, what is that difference? (To paraphrase a former student of the present author: That's a conversation we don't want to have.)
  • The phrase arguably doesn't go far enough: Let's assume that the statement: Jane was in the room is accurate, in that Jane was indeed in the meeting. Does that make the statement "true" or "correct" if others were also in the room?

In the present author's view, the phrase complete and accurate does the job better.

11.8.3 "Provided, that …": Don't. Just don't

Take a look at section 2.15 of the contract by which Verizon took over Yahoo: It makes you want to cry out, "My kingdom for a period!"

(a) (i) Each material lease or sublease (a “Lease”) pursuant to which Seller (to the extent related to the Business) or any of the Business Subsidiaries leases or subleases real property (excluding all leases or subleases for data centers) (the “Leased Real Property”) is in full force and effect and Seller or the applicable Business Subsidiary has good and valid leasehold title in each parcel of the Leased Real Property pursuant to such Lease, free and clear of all Encumbrances other than Permitted Encumbrances, except in each case where such failure would not, individually or in the aggregate, reasonably be expected to have a Business Material Adverse Effect and (ii) there are no defaults by Seller or a Business Subsidiary (or any conditions or events that, after notice or the lapse of time or both, would constitute a default by Seller or a Business Subsidiary) and to the Knowledge of Seller, there are no defaults by any other party to such Lease (or any conditions or events that, after notice or the lapse of time or both, would constitute a default by such other party) under such Lease, except where such defaults would not, individually or in the aggregate, reasonably be expected to have a Business Material Adverse Effect.

Stock Purchase Agreement by and among Yahoo! Inc. and Verizon Communications Inc. dated as of July 23, 2016, § 2.15.

It's reminiscent of early English translations of some of the Christian gospels, which literally translated the Greek conjunction καί (kai, "and") instead of using it as a separator, almost a punctuation mark, as the authors did — which led to some interesting run-on translations. See, e.g., Multifunctionality of δέ, τε, and καί (chs.harvard.edu; undated).

See, for example, the Gospel of Mark, chapter 10, verses 33-34, in an almost-literal, word-for-word translation from the Greek "original":

Lo, we go up to Jerusalem and the Son of Man shall be delivered to the chief priests and to the scribes and they shall condemn him to death and shall deliver him to the nations and they shall mock him and scourge him and spit on him and kill him and the third day he shall rise again.

(Emphasis added.) The King James Version's translation of that passage, published in 1611, didn't change much:

Saying, Behold, we go up to Jerusalem; and the Son of man shall be delivered unto the chief priests, and unto the scribes; and they shall condemn him to death, and shall deliver him to the Gentiles:

And they shall mock him, and shall scourge him, and shall spit upon him, and shall kill him: and the third day he shall rise again.

Contrast the above translations with the modern New International Version (NIV) translation of the same passage:

"We are going up to Jerusalem," he said, "and the Son of Man will be delivered over to the chief priests and the teachers of the law. They will condemn him to death and will hand him over to the Gentiles, who will mock him and spit on him, flog him and kill him. Three days later he will rise."

The modern translation seems much more readable, right?

Go ye and do likewise ….

11.8.4 Consummated - not a great word (commentary)

Caution: Be careful about using terms such as "consummated" sales — that led to what must have been an expensive lawsuit over a finder's fee: the court ruled that a finder's-fee agreement did not require the resulting federal contract to be "performed" in order for the transaction to be "consummated"; the finder's fee was therefore due and owing. See Fed Cetera, LLC v. Nat'l Credit Servs., Inc., 938 F.3d 466 (3d Cir. 2019).

12 Litigation planning

Very, very few contracts end up in litigation. But drafting for litigation anyway —

  • signals The Other Side that you possess some street smarts; and
  • can come in handy if the parties get into a dispute.

12.1 Draft the preamble to help out trial counsel

See Section 3.5: , "Preamble: Front-load some useful information."

12.2 Use bright-line standards for significant triggers

Vague language can sometimes lead to trouble if the vagueness can lead to disputes about whether particular rights or obligations have been triggered. Here are a couple of examples:

• It's better to refer to the contract's being "signed" instead of "executed," because the latter could be interpreted as the contract's being performed by the parties; this happened in a Delaware case. See Akorn, Inc. v. Fresenius Kabi AG, No. 2018–0300–JTL, text accompanying n.333 (Del. Ch. Ct. Oct. 1, 2018), aff'd, 198 A.3d 724 (Del. 2018).

• A particular referral agreement stated that a referring party would be paid a commission by a supplier whenever the supplier "consummated" a transaction with a referred customer during a stated time period. For one referred transaction, the supplier signed a contract with a referred customer during the stated time period, but nothing else happened until after the time period had ended. This led to litigation whether the transaction had been "consummated" during the time period, and thus whether the referring party was entitled to a commission for that transaction. See Fed Cetera, LLC v. Nat’l Credit Servs., Inc., 938 F.3d 466 (3d Cir. 2019) (reversing and remanding summary judgment).

Lesson: Refer to a more-certain date, such as: • the date the contract was signed; • the date of the invoice; • the date payment was collected.

Likewise, don't write that notice must be "given" by a certain date; instead, say that notice must be "received" or "effective" (if effectiveness is defined) or "sent" by that date.

For situations where bright-line standards aren't practicable (or desired), consider: • "baseball arbitration" determination of disputes to promote settlement, where the arbitrator's only power is to pick one or the other of the parties' respective final proposals — this provides a powerful incentive for each party to be reasonable; or • expert determinations, as often seen in construction contracts. See, e.g., Peter Godwin, David Gilmore, Emma Kratochvilova, Mike McClure, and Conal McFadyen, Expert Determination: What, When And Why?, at https://perma.cc/2NJN-GHS2 (Mondaq.com 2017).

12.3 Acknowledgements: Like an admission in court

An acknowledgement is tantamount to an admission under the (U.S.) Federal Rules of Civil Procedure. Fed. R. Civ. P. 36(b). Tango Clause 22.1 - Acknowledgement Effect makes this explicit.

Apropos of this subject, California Evidence Code § 622 provides: "The facts recited in a written instrument are conclusively presumed to be true as between the parties thereto, or their successors in interest; but this rule does not apply to the recital of a consideration." (Emphasis added.)

12.3.1 An example

Imagine that you are negotiating a patent-license agreement with a patent owner:

  • In the license agreement, you "acknowledge" that one of your company's products is covered by the other party's patent, which means that you must pay royalties to the patent owner for your sales of that particular product.
  • But later you conclude that your product in question actually isn't covered by the patent after all. You decide that you needn't pay those particular royalties to the patent owner after all.

You might be out of luck: Your acknowledgement of patent coverage in the license agreement might well block you from taking a different position later. That's essentially what happened in a Tenth Circuit case. See Cellport Sys., Inc. v. Peiker Acustic GmbH & Co., KG, 762 F.3d 1016, 1022 (10th Cir. 2014) (reversing and remanding trial-court judgment in part).

12.3.2 Words other than "acknowledge" can have that effect

In an Eighth Circuit decision, an investment bank's client agreement included a first-person statement in which the client said, "I agree that all transactions with respect to any such Account shall be subject to the following terms," and those terms included that transactions would be "subject to" external rules, including FINRA rules. The Eighth Circuit agreed with the Second Circuit that this "I agree" and "subject to" language was an acknowledgement that put the client on notice of how transactions would be handled but didn't constitute a contractual commitment by the bank to do so. See Luis v. RBC Capital Markets, LLC, No. 19-2706, slip op. at 7, 9, 11 (8th Cir. Dec. 28, 2020) (affirming summary judgment dismissing clients' breach-of-contract claims against bank; citing numerous cases).

12.3.3 Pro tip: Don't be a jerk in asking for acknowledgements

Acknowledgements can be useful to establish facts for future litigation … but don't be a jerk about it. Some inexperienced drafters include statements in which another party "acknowledges" a supposed fact that would be against that party's interest.

Here's an overreaching example that's sometimes seen in confidentiality agreements: "Recipient acknowledges that Discloser would be irreparably harmed by a breach or threatened breach of Recipient's confidentiality obligations under this Agreement." (The intent here is presumably for Recipient to waive Discloser's burden of proof in seeking a preliminary injunction or comparable relief; see [LINK NEEDED] and its commentary.) Most Recipient counsel would probably:

  • delete this equitable-relief acknowledgement entirely, or
  • change "would be …" to "could be irreparably harmed"; and
  • be irritated at Discloser's counsel for the obnoxious drafting.

12.4 Consider contract clauses to promote settlement

Business relationships can be fragile things. When drafting a contract, it can be useful to include specific provisions to reduce the odds that a dispute will cause the parties to drift helplessly into a lawsuit, such as:

Status-review conference calls upon request: Many business-contract disputes could be avoided if the participants would just talk with each other every now and then, so strongly consider including such a requirement in the contract. See the Tango Terms "Status Conferences" provisions for an example.

Consultation in lieu of consent: Sudden, unexpected moves by one party to a contract can make the other party nervous. For example, the business relationship between a service provider and a customer could be damaged if the serv­ice provider were to suddenly replace a key person assigned to the customer's work with­out notice.

The usual, sledge-hammer approach to dealing with this problem is to contractually require the provider to obtain the customer's prior consent before taking such an action. The provider, though, will usually push back against such a consent requirement — the provider will be reluctant to give the customer a veto over how it runs its business. Moreover, it could be a management burden for the provider to have to check every customer's contract to see what internal management decisions required prior customer approval.

As an alternative (and compromise), the provider might be willing to commit to consulting with the customer before taking a specified action that could cause heart­burn for the customer. That way, the customer would at least get notice, perhaps an explanation, and an opportunity to be heard, which could make a big difference in the customer's reaction and to the parties' business relationship.

Example: A services contract could say that, for example, "Except in cases of emergency, Service Provider will consult with Customer at least ten business days in advance of replacing Service Provider's supervisor in charge of the Project." That would at least get the parties talking to one another, which can help avoid strains in their business relationship.

(Of course, a party must also keep track of its consultation commitments, just as much as its consent obligations.)

Dispute management: Strongly consider including the provisions such as the Tango Terms dispute-management clauses, for the reasons discussed in the commentary there.

12.5 Litigation prep: Include "demonstrative exhibits"?

Remember the cliché about a picture being worth a thousand words? Nowhere is that more true than the courtroom. That's why in litigation, lawyers and expert witnesses often use so-called demonstrative exhibits — diagrams, time lines, charts, tables, sketches, etc., on posters or PowerPoint slides — as teaching aids to help them get their points across to the jury during testimony and argument.

In a lawsuit, the jurors might or might not be allowed to refer to the parties' demonstrative aids while they're deliberating.

•  Jurors normally take "real" exhibits — like a copy of the contract in suit — into the jury room with them and refer to them during deliberations.

•  Judges, however, sometimes won't allow the jury to take demonstrative exhibits with them, on the theory that the jurors are supposed to decide the case on the basis of the "real" evidence and not on documents created solely for litigation by the lawyers. True, in U.S. federal-court cases, Rule 1006 of the Federal Rules of Evidence allows summaries and the like to be admitted into evidence. Trial judges, however, have significant discretion over evidentiary matters; if a particular judge were to decide that a particular demonstrative aid should not be given to the jury for use in its deliberations, that'd normally the end of that discussion. See, e.g., Allen Hinderaker & Ian McFarland, Demonstrative Evidence Under the Rules: The Admissable and Inadmissable (MerchantGould.com 2015), discussing Fed. R. Evid. 611 and 1006.

So: If you plan ahead when drafting a contract, your client's trial counsel might later be able to sneak a demonstrative aid or two into the jury room through the back door — no, through the front door, but at the back of the contract — as "real" evidence, not just as a demonstrative exhibit, to help the jurors understand what the parties agreed to.

Ask yourself: Is there anything we'd want the jurors to have tacked up on the wall in the jury room — for example, a time line of a complex set of obligations? If so, think about creating that time line now, and including it as an exhibit to the contract. The exhibit will ordinarily count as part of the "real" evidence; it should normally be allowed back into the jury room without a fuss.

Of course, before the contract is signed the parties would have to agree to include your stealth demonstrative exhibit in the contract document. But their reviewing your exhibit for correctness could be a worthwhile exercise — and if their review makes them realize they don't agree about something, it's usually better if they find that out before they sign.

And to be sure, there's always the risk of unintended consequences: The demonstrative exhibit you create today might not create the impression you want to create in a jury room years from now. But that's always a risk even when you write the contract itself.

Your time line, chart, summary, diagram, etc., doesn't necessarily have to be a separate exhibit: modern word processors make it simple to include such things as insets within the body of the contract. (The author used to do just that when writing patent-invalidity or -noninfringement opinions: I'd prepare the PowerPoint slides that I'd want to use if I were testifying as an expert witness, and then I'd insert those slides as insets in the body of the opinion itself.)

12.6 Remember the burden of proof in contract enforcement

Contract drafters should keep in the back of their minds that contract enforcement might come down to whether a trier of fact will be persuaded by a party's claim: • If "Alice" claims that "Bob" breached a contract, then Alice must convince the jury — or the judge, in a non-jury "bench" trial, or arbitration tribunal, if applicable — that Bob in fact did something that was a breach. • Conversely: Bob might claim, as an affirmative defense, that even if he did breach, the breach was justified by, say, Alice's own breach, and so he should not be held liable for his own breach. In that situation, it's up to Bob to persuade the jury, etc., that Alice in fact did something that was a breach on her part.

Here's where it can get important: Suppose that — based on the evidence that was admitted at trial — reasonable people could go either way about whether Bob did or didn't do what Alice claimed he did. When that occurs, the jury's or judge's finding on the point is pretty much unassailable (and even more so in arbitration cases).

(The same is true for Bob's affirmative defense: If Bob fails to persuade the trier of fact that Alice did what Bob claims, then Bob loses on that defense.)

The Fifth Circuit illustrated this point in a trade-secret case, where a company's former employee and his new firm claimed that the company was using a trade secret, owned by the former employee, without authorization. The company denied that it was using the trade secret. In a non-jury trial, the trial judge ruled that the plaintiffs had not proved their case — i.e., had not persuaded the trial judge that the defendant company was in fact using the trade secret. The appeals court affirmed because the trial judge's finding was not clearly mistaken: "… it was unclear to the district court, as it is unclear to us, how a gas and a chemical compound commonly used in lamps and lasers can be a trade secret. … We conclude that Olstowski and ATOM’s proclaimed legal issue is indeed a factual one, and that they failed to carry their burden of proof at trial. ATOM Instrument Corp. v. Petroleum Analyzer Co., 969 F.3d 210, 216 (5th Cir. 2020) (emphasis added).

Another example: A digital ad agency and an e-cigarette manufacturer entered into a contract for the ad agency to place online ads. The manufacturer refused to pay a large invoice from the ad agency because, the manufacturer said, it had not received an itemized invoice that would allow the manufacturer to check for misleading ads and click-fraud. The contract, however, had addressed this, stating that the manufacturer could get out of its payment obligations only if the manufacturer provided the ad agency with documentary evidence "proving fraud beyond a reasonable doubt[.]" The manufacturer was held liable to the ad agency for more than a million dollars in unpaid ad fees. See CX Digital Media, Inc. v. Smoking Everywhere, Inc., No. 09-62020-CIV, slip op. at 12 (S.D. Fla. Mar. 23, 2011).

The drafting lesson: Consider trying to phrase contract obligations to put the burden of proof on the other party. Here's a grossly-simplified hypothetical example:

•  Consider the phrase: Bob will bill Alice for his services at $X per hour, but Alice need not pay Bob if it does not rain on Sunday. The "default" position here is that if Alice doesn't want to pay Bob, she must prove that it didn't rain on Sunday.

•  In contrast, consider the phrase: Alice must pay Bob for his services at the rate of $X per hour if it rains on Sunday. This wording suggests that if Bob wants to get paid, it's up to him to prove that it did rain on Sunday.

Tangentially related: The Tango Terms expense-reimbursement language prohibits a party incurring expenses from even submitting reimbursement requests for ineligible expenses. The idea is to forbid the incurring party from brazenly billing the reimbursing party for ineligible expenses, and then writing off the charge with a shrug and a smirk if the reimbursing party spots the improper charge and refuses to pay it. If the Tango Terms language said merely that the incurring party had no obligation to pay ineligible expenses, it would put the burden on the reimbursing party to pay closer attention to the incurring party's invoices.

12.7 Watch out for "optics"

In a past semester, a student wrote: "The parties agree and acknowledge that Gigunda will not liable for a breach of warranty and/or misrepresentation." (Emphasis added.) Two comments:

1. "The parties agree and acknowledge" isn't a good way to phrase anything — just say "Gigunda will not be liable …."

2.  More importantly: For "optics" purposes, Gigunda might want to say instead that its liability for breach is limited to some low figure such as, say, $100.

12.8 Exercise: Acknowledgement

  1. What does it mean to "acknowledge" something, and why might it be dangerous?
  2. Cite (or make up) an example of how acknowledging something in a contract might be dangerous (other than the example in the reading above).

13 Representations and warranties

13.1 Introduction

When parties do business together, each party generally presupposes that certain things were true in the past, or are true now, or will be true at some point in the future. But sometimes those presuppositions turn out to be wrong.

With that in mind, it's often prudent for parties to divide up the responsibility for making sure that specified things were — or are — or will be — as planned. This can include provisions for parties representing certain things and/or warranting certain things, as discussed in this chapter.

Each representation or warranty does two things:

  1. sets out a particular factual state of affairs that one party (or both) wants to be true; and
  2. allocates, as between the parties, the risk that the state of affairs might turn out not to be true.

But as discussed below, representations and warranties have different proof requirements and, upon proof, different available remedies.

13.2 What is a "representation"? A "warranty"?

A representation is generally understood as:

  • a statement of past‑ or present fact,
  • made to one or more specified other parties,
  • in connection with:
    • the Contract, or
    • a matter relating to:
      • (i) the Contract, and/or
      • (ii) a transaction or relationship resulting from the Contract.

The "past or present fact" formulation is suggested by Professor Tina Stark in her highly-regarded Drafting Contracts textbook. ¶ The term transaction or relationship term is modeled on an arbitration provision that was litigated in both the Fifth and Eleventh Circuits; see Sherer v. Green Tree Servicing LLC, 548 F.3d 379, 382-83 (5th Cir. 2008), citing Blinco v. Green Tree Servicing LLC, 400 F.3d 1308, 1310 (11th Cir. 2005). ¶ See also the Tango Terms definition of "representation."

Special case: A representation could be a statement of future fact IF the future fact is uniquely within the control of the representing party — for example, if Alice owes money to Bob, Alice might represent that she will pay Bob on a particular date. (Rule: Don't do action commitments like this as representations; they should be promises, i.e., covenants, as discussed in more detail in Section 13.6.1: below.)

Importantly: If the represented fact turns out not to be true, then the representing party could be liable, but only if certain additional facts are proved, as discussed below; this differs significantly from if the representing party had also warranted the represented fact.

A warranty is much like a representation, except that:

  • a warranty concerns one or more past, present, and/or future facts; and
  • the warranting party promises to take specified actions if the warranted fact is shown not to be true — if no particular action is specified, then the warranting party reimburses the warranty beneficiary for any damages incurred by the latter as a result of the untruth.

13.3 Ninja Warrior: Two paths up "The Hill of Proof"

Let's consider a hypothetical example: Alice wants to sell her car to Bob; suppose that she represents — or perhaps warrants, or perhaps both — that her car has never been in an accident [past fact] and is in good working order [present fact].

But now suppose that after Bob takes delivery of the car and drives it, he learns that it has significant mechanical problems, and he wants to sue Alice (probably in small-claims court) for damages. To help visualize how this works, think in terms of the American Ninja Warrior TV show, with an evidentiary “Hill of Proof” that Bob must climb in making his claim(s) against Alice:

  • As plaintiff, Bob starts out at the bottom of the Hill of Proof, equidistant between the "representation" claim on the left side of the hill and the "warranty" claim on the right side.
  • As Bob clambers up the Hill of Proof, he tries to "hit" various evidentiary checkpoints along the way, with his left hand (on the representation-claim side) or his right hand (on the warranty-claim side).
  • The “prizes,” i.e., the remedies available to Bob, are positioned at different points up the hill.
The Hill of Proof

(“The Hill of Proof” sounds like something from a Harry Potter novel, no?)

13.3.1 Breach of warranty: Less for Bob to prove — but fewer remedies

As seen on the right side of the Hill of Proof, if Bob sues Alice for breach of warranty, he needn't show reasonable reliance nor scienter, but simply that (i) a warranty was made, (ii) a warranted fact proved untrue, and (iii) Bob suffered damages as a result. A leading case on point is CBS v. Ziff-Davis, from the Court of Appeals of New York (that state's highest court), which in essence characterized a warranty as a kind of conditional covenant, akin to an insurance policy, a contractual commitment to assume certain risks:

[A warranty is] an assurance by one party to a contract of the existence of a fact upon which the other party may rely.

It is intended precisely to relieve the promisee of any duty to ascertain the fact for himself[.]

[I]t amounts to a promise to indemnify the promisee for any loss if the fact warranted proves untrue ….

CBS, Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496, 503, 553 N.E.2d 997, 1001 (1990), quoting Metropolitan Coal Co. v Howard, 155 F.2d 780, 784 (2d Cir 1946) (Learned Hand, J.) (emphasis by the Ziff-Davis court edited, extra paragraphing added). See also Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., 848 N.W.2d 539, 543-46 (Minn. 2014) (on certification from 7th Cir.), where Minnesota's supreme court held that proof of reliance was not required for a breach of contract action, but the court declined to decide whether such proof was still required for a breach of warranty claim (the only pleaded action in the case).

In other words: If Bob successfully shows breach of warranty, on the right side of the Hill of Proof, that's enough to entitle him to breach-of-warranty damages — generally, either (i) the cost of fixing the car's problems, or if that's not economically feasible, then (ii) the difference between the value of the car Bob actually received versus the value of the car he bargained for. Concerning damages for breach, see generally Hawkins v. McGee, 84 N.H. 114, 146 A. 641 (1929) (the "hairy hand" case).

In another case, the Seventh Circuit, applying Illinois law, held that: "The warranty sued on here was part of the parties' agreement, so the plaintiff did not need to prove further reliance." Abellan v. Lavelo Prop. Mgmt. LLC, 948 F.3d 820, 832-33 (7th Cir. 2020), citing, among others, CBS v. Ziff-Davis. See generally Matthew J. Duchemin, Whether Reliance on the Warranty is Required in a Common Law Action for Breach of an Express Warranty, 82 Marq. L. Rev. 689 (1999).

Footnote: A different situation might be presented, however, if — before the contract was signed — the warranting party disclosed that a warranty was inaccurate. While the law seems still to be evolving in this area, the influential U.S. Court of Appeals for the Second Circuit once summarized New York law thusly:

[W]here the seller discloses up front the inaccuracy of certain of his warranties, it cannot be said that the buyer — absent the express preservation of his rights — believed he was purchasing the seller's promise as to the truth of the warranties.

Accordingly, what the buyer knew and, most importantly, whether he got that knowledge from the seller are the critical questions.

Rogath v. Siebenmann, 129 F.3d 261, 264-65 (2d Cir. 1997) (vacating and remanding partial summary judgment that seller had breached contract warranty; emphasis and extra paragraphing added).

13.3.2 Breach of warranty vs. breach of contract

The Fifth Circuit explained the difference between a breach of contract and a breach of warranty (under the Texas version of article 2 of the Uniform Commercial Code):

Breach of contract and warranty claims are distinct causes of action under Texas law and provide for different remedies, and Texas law forbids conflating breach of warranty and breach of contract.

A breach of contract claim exists when a party fails to deliver the goods as promised. Damages are only permitted under a breach of contract cause of action when [i] the seller has failed to deliver the goods, [ii] the buyer has rejected the goods, or [iii] the buyer has revoked his acceptance.

  • Texas law allows a buyer to revoke acceptance of a good if the good was accepted without knowledge of the nonconformity and `acceptance was reasonably induced either by the difficulty of discovery before acceptance or by the seller's assurance.
  • If a buyer retains and uses, alters, or changes the goods, it will be found to have accepted them. …

[A] breach of warranty claim … arises when a seller delivers nonconforming goods.

The UCC recognizes that breach of contract and breach of warranty are not the same cause of action.

The remedies for breach of contract are set forth in Texas Business and Commerce Code section 2.711, and are available to a buyer where the seller fails to make delivery.

The remedies for breach of warranty, however, are set forth in section 2.714, and are available to a buyer who has finally accepted goods, but discovers the goods are defective in some manner.

Thus, the critical factor in whether the buyer has a breach of contract or breach of warranty claim is whether the buyer has finally accepted the goods.

Baker Hughes Process & Pipeline v. UE Compression, L.L.C., 938 F.3d 661, 666-67 (5th Cir. 2019) (affirming summary judgment dismissing Baker Hughes's claims) (formatting altered).

13.3.3 Misrepresentation: Bob's extra proof requirements

It's a different story on the upper left side of the Hill of Proof: If Bob wants to sue Alice for misrepresentation, he must show:

  1. that Bob in fact relied on Alice's representation; that usually won’t be a heavy burden if that representation is explicitly stated in the contract — and in fact one state's supreme court has held that "a claim for breach of a contractual representation of future legal compliance is actionable under Minnesota law without proof of reliance." Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., 848 N.W.2d 539, 540 (Minn. 2014) (on certification from 7th Circuit) (emphasis added).
  2. that Bob's reliance on Alice's representation was reasonable under the circumstances; reasonableness of reliance would likely be presumed, but reliance could be unreasonable if the representation was obviously false or misleading when made; and
  3. that Alice acted negligently, or recklessly, or even intentionally (i.e., fraudulently), in making the (mis)representation — i.e,. he must show that Alice acted with scienter.

If Bob can prove these additional elements, over and above the elements required for breach of warranty, then he might well be entitled to tort-like remedies such as punitive damages and/or rescission of the contract, neither of which is normally available for a simple breach of warranty. Rescission might be available under the Uniform Commercial Code if it applied and the facts were such that Bob was entitled to revoke his acceptance of the car; that possibility is beyond the scope of this discussion.

Authority: As to negligent misrepresentation:

… under New York law, the plaintiff must allege that (1) the defendant had a duty, as a result of a special relationship [such as privity of contract–DCT], to give correct information; (2) the defendant made a false representation that he or she should have known was incorrect; (3) the information supplied in the representation was known by the defendant to be desired by the plaintiff for a serious purpose; (4) the plaintiff intended to rely and act upon it; and (5) the plaintiff reasonably relied on it to his or her detriment.

Anschutz Corp. v. Merrill Lynch & Co., 690 F.3d 98, 114 (2d Cir. 2012) (granting motion to dismiss claim of negligent-misrepresentation; cleaned up, citations omitted), quoted in Kortright Capital Partners LP v. Investcorp Investment Advisers Ltd., 257 F. Supp. 3d 348, 355 (S.D.N.Y. 2017) (denying motion to dismiss claims of negligent misrepresentation).

Somewhat similarly, in Texas as in many other states, the courts follow Restatement (Second) of Torts § 552 (1977) in defining negligent misrepresentation as:

(1) the representation is made by a defendant in the course of his business, or in a transaction in which he has a pecuniary interest;

(2) the defendant supplies ‘false information’ for the guidance of others in their business;

(3) the defendant did not exercise reasonable care or competence in obtaining or communicating the information; and

(4) the plaintiff suffers pecuniary loss by justifiably relying on the representation.”

Federal Land Bank Ass'n of Tyler v. Sloane, 825 S.W.2d 439, 442 (Tex. 1991) (affirming judgment for prospective borrowers on jury verdict of negligent misrepresentation by bank loan officer; extra paragraphing added), followed in McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991 S.W.2d 787, 791 (Tex. 1999) (claim against attorneys by non-client) and Grant Thornton LLP v. Prospect High Income Fund, 314 SW 3d 913, 920 (Tex. 2010) (investors’ claim against auditors).

It bears noting that “California courts have expressly rejected that requirement [of privity of contract or other a special relationship], holding that negligent misrepresentation claims may be brought angainst any person who negligently supplies false information for the guidance of others in their business transactions and intends to supply the information for the benefit of one or more third parties.” Anschutz Corp., 690 F.3d at 113 (cleaned up; emphasis added).

As to fraud, New York law is fairly typical: “The elements of a cause of action for fraud require a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance by the plaintiff and damages.” Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 559, 910 N.E.2d 976, 883 N.Y.S.2d 147 (2009) (citations omitted).

Similarly, under Texas law:

The elements of fraud are:

(1) that a material representation was made;

(2) the representation was false;

(3) when the representation was made, the speaker knew it was false or made it recklessly without any knowledge of the truth and as a positive assertion;

(4) the speaker made the representation with the intent that the other party should act upon it;

(5) the party acted in reliance on the representation; and

(6) the party thereby suffered injury.

Italian Cowboy Partners, Ltd. v. Prudential Ins. Co., 341 S.W. 3d 323, 337 (Tex. 2011) (emphasis and extra paragraphing added, citation omitted). Note the absence here of a requirement that the plaintiff prove that the reliance was justified or reasonable.

If Bob successfully proves his claim of misrepresentation against Alice, then he could be entitled to tort-style remedies such as punitive damages and/or rescission of the contract.

13.4 Implied warranties: Disclaimers

If you've ever even partially read a contract, such as the online "terms of service" for a Website, you've almost certainly seen disclaimers of (implied) warranties.

13.4.1 Examples of specific disclaimers

A contract could state that its disclaimer of implied warranties has the effect of disclaiming — without limitation — any and all implied warranties, etc., concerning the following matters:

  1. merchantability of goods — see the definition of "merchantability in UCC § 2-314; such a disclaimer should be in bold or all-caps to make it "conspicuous" as required by UCC § 2-316;
  2. fitness of goods for a particular purpose, whether or not the disclaiming party or any of its suppliers or affiliates know, have reason to know, have been advised, or are otherwise in fact aware of any such purpose — any such disclaimer should also be in bold or all-caps to make it "conspicuous" as required by UCC § 2-316;
  3. quiet enjoyment — this relates mainly to real property;
  4. title — UCC § 2-312 includes specific requirements for a disclaimer of this implied warranty;
  5. noninfringement — see the (limited) implied warranty in UCC § 2-312; many contracts where this is relevant will include an express warranty of noninfringement with specific remedies, such as in [LINK NEEDED];
  6. absence of viruses or other malware in software;
  7. results;
  8. workmanlike performance or ‑effort — see the discussion in the commentary to [LINK NEEDED];
  9. quality — this disclaimer is a UK formulation, discussed in § 13.4.5;
  10. non-interference;
  11. accuracy of content;
  12. correspondence to description — This is a UK formulation roughly analogous to the implied warranty of merchantability in subdivision 1 above.

13.4.2 Implied warranties for sales of goods can arise automatically

In the U.S., article 2 of the Uniform Commercial Code (adopted in all states except Louisiana) provides a number of implied warranties that sellers are deemed to make when they sell "goods," namely the following:

  • an implied warranty of clean title, "free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge," under § 2-312(1);
  • an implied warranty of noninfringement of third-party rights, under § 2-312(3) —
    • but only if the seller is "a merchant regularly dealing in goods of the kind";
    • and with an exception if the buyer furnishes specifications and the infringement;
  • an implied warranty of merchantability, under § 2-314, with a definition that could be paraphrased as, in essence, goods that a reputable merchant would be willing to offer to the public under the contract description; and
  • an implied warranty of fitness for the buyer's particular purpose, under § 2-315, but only if "the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller's skill or judgment to select or furnish suitable goods …."; whether this prerequisite was met, of course, could be a disputed fact issue, resulting in expensive litigation.

UCC implied warranties can be disclaimed, as discussed in § 13.4.4.

13.4.3 Some services might come with implied warranties

This is discussed in the commentary to [LINK NEEDED] (performance standards for services).

13.4.4 UCC implied warranties for goods can be disclaimed

In the (U.S.) Uniform Commercial Code, section 2-316 (governing sales of goods) specifically allows sellers to disclaim warranties that are not expressly stated in the contract, with some limits:

(2) Subject to subsection (3), to exclude or modify the implied warranty of merchantability or any part of it the language must mention merchantability

and in case of a writing must be conspicuous,

and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and conspicuous.

Language to exclude all implied warranties of fitness is sufficient if it states, for example, that "There are no warranties which extend beyond the description on the face hereof."

(3) Notwithstanding subsection (2)

(a) unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like "as is", "with all faults" or other language which in common understanding calls the buyer's attention to the exclusion of warranties and makes plain that there is no implied warranty; and

(b) when the buyer before entering into the contract has examined the goods or the sample or model as fully as he desired or has refused to examine the goods there is no implied warranty with regard to defects which an examination ought in the circumstances to have revealed to him; and

(c) an implied warranty can also be excluded or modified by course of dealing or course of performance or usage of trade.

(Emphasis and extra paragraphing added.)

Caution: A special case is the warranty of title: UCC § 2-312, which requires that any disclaimer of the automatic warranty of title must be expressly stated. From a business perspective this makes sense, of course; as an example, even if Alice were to sell Bob a car "as is," Bob should still be entitled to assume that Alice isn't trying to sell him stolen property.

13.4.5 (UK:) Disclaiming only implied warranties isn't enough

A vendor doing a sales transaction under UK law (England, Wales, Northern Ireland) will want to be sure to disclaim not only implied warranties but also implied conditions and implied terms of quality. An oil seller failed to do so and learned that its disclaimer of implied warranties didn't shield it from liability. See KG Bominflot Bunkergesellschaft Für Mineralöle mbh & Co KG v. Petroplus Marketing AG, [2009] EWHC 1088, ¶ 49 (Comm).

13.4.6 Representations can be deemed to be UCC warranties

Suppose that in a contract for the sale of goods in the U.S., the seller only represents that Fact X is true, without using the word warranty: That representation can itself be a warranty, because under UCC § 2-313(1):

(a) Any affirmation of fact or promise made by the seller to the buyer

  • which relates to the goods
  • and becomes part of the basis of the bargain

creates an express warranty that the goods shall conform to the affirmation or promise.

(b) Any description of the goods which is made part of the basis of the bargain creates an express warranty that the goods shall conform to the description.

(c) Any sample or model which is made part of the basis of the bargain creates an express warranty that the whole of the goods shall conform to the sample or model.

(Emphasis and extra paragraphing added.)

Of course, it might be hotly disputed whether "the basis of the bargain" included a particular affirmation of fact, description of the goods, or sample or model.

Because the representation is (putatively) an express warranty, it likely can't be "disclaimed" as such (but see the next section about waiver of reliance on representations).

13.5 "Disclaiming" external representations

Disclaiming a representation requires a bit more work than disclaiming an implied warranty. That's generally because, for obvious reasons, a court is likely to be reluctant to let a party off the hook if it appears that the party was untruthful or simply negligent in what it said to another party.

What drafters do to (try to) preclude later claims of misrepresentation is to include reliance waivers, such as that in [LINK NEEDED].

13.5.1 Legal background: Fraudulent inducement - "they lied!"

In a contract dispute, an aggrieved party might well claim that another party "fraudulently induced" the aggrieved party into entering into the contract by making supposedly-false statements that weren't set out in the contract itself. Such claims, though, can turn a simple dispute into an expensive mess of a lawsuit. The above language seeks to forestall that possibility.

13.5.2 An entire-agreement clause might not be enough

Entire-agreement provisions (a.k.a. merger clauses or zipper clauses) often state, in effect: Neither party makes any representations beyond those stated in this Agreement and its exhibits, attachments, and appendixes. That might be enough in some jurisdictions.

But in some other jurisdictions, merely stating that there are no other representations is not enough to avoid a claim of fraudulent inducement. Putting it another way: A no-representations clause alone would not necessarily defeat "they lied!" Example: The Supreme Court of Texas explained that under that state's law:

Pure merger clauses, without an expressed clear and unequivocal intent to disclaim reliance or waive claims for fraudulent inducement, have never had the effect of precluding claims for fraudulent inducement. …

There is a significant difference between a party[:]

  • disclaiming its reliance on certain representations, and therefore potentially relinquishing the right to pursue any claim for which reliance is an element, and
  • disclaiming the fact that no other representations were made.

[DCT comment: In the context of a fraudulent-inducement analysis, though, don't these two disclaimers logically amount to exactly the same thing? As explained further down in this excerpt, though, the Texas supreme court seems to have felt that a disclaimer of extrinsic representations, standing alone, wasn't sufficiently explicit and "in your face" to alert the other side about what it was being asked to give up.]

 * * *

We have repeatedly held that to disclaim reliance, parties must use clear and unequivocal language. this elevated requirement of precise language helps ensure that parties to a contract — even sophisticated parties represented by able attorneys — understand that the contract's terms disclaim reliance, such that the contract may be binding even if it was induced by fraud.

Here, the contract language was not clear or unequivocal about disclaiming reliance. For instance, the term "rely" does not appear in any form, either in terms of relying on the other party's representations, or in relying solely on one's own judgment.

This provision stands in stark contrast to provisions we have previously held were clear and unequivocal [three-column table, contrasting different clauses, omitted].

Italian Cowboy Partners, Ltd. v. Prudential Ins. Co., 341 S.W. 3d 323, 333-37 (Tex. 2011) (reversing court of appeals; merger clause did not preclude tenant's claim that landlord had fraudulently induced agreement to lease by misrepresenting condition of property) (extra paragraphing and bullets added, citations and some internal quotation marks omitted).

13.5.3 A reliance waiver could defeat a misrepresentation claim …

So, drafters worried about possible fraudulent-inducement claims often approach the problem from a different direction: Under the law in many U.S. jurisdictions, a contracting party that claims misrepresentation by the other side normally would have to prove, among other things, that it reasonably relied on the alleged misrepresentation. That gives the other side's contract drafter a reason to include a disclaimer of reliance.

Here's a hypothetical example: Suppose that the following takes place:

  • Alice and Bob enter into a contract for Alice to sell Bob a house located several hundred miles away from either of them.
  • In the contract, Alice represents to Bob that the house is in good condition, but does not warrant it.
  • After the closing, the house turns out to be a wreck.

Even though Alice didn't warrant the condition of the house, Alice might be liable for misrepresentation. For Bob to succeed with a misrepresentation claim, though, he would have had to "hit the checkpoints" for some additional elements of proof: Bob would have to show (probably among other things) that he had reasonably relied on Alice's representation.

Of course, Bob might well have a powerful incentive to prove his reasonable reliance: If he could establish Alice's liability for misrepresentation, then he might be able (i) to rescind the contract, and/or (ii) perhaps even to recover punitive damages from Alice; neither remedy is normally available in a breach-of-warranty action.

And even more basically: In a complex business- or technology case, a non-expert fact finder, such as a judge or juror, might not fully understand the details of a case, but she probably would understand the simple claim "they lied!."

Alice will want to head off such accusations. So planning ahead, she will want to include, in the contract, a statement that Bob isn't relying on any representations by Alice. That way, if Bob were to sue Alice for misrepresentation, a judge might very well rely (so to speak) on the disclaimer and summarily toss out Bob's claim by dismissing it on the pleadings.

When a reliance disclaimer is sufficiently clear, and the contracting parties are big enough to take care of themselves, many courts might well give effect to the disclaimer under freedom-of-contract principles.

Examples:

• The Texas supreme court held that under Texas law, "a party may be liable in tort for fraudulently inducing another party to enter into a contract. But the party may avoid liability if the other party contractually disclaimed any reliance on the first party's fraudulent representations. Whether a party is liable in any particular case depends on the contract's language and the totality of the surrounding circumstances." IBM v. Lufkin Industries, LLC, 573 S.W.3d 224, 226 (Tex. 2019). The court held: "Specifically, courts must consider such factors as whether (1) the terms of the contract were negotiated, rather than boilerplate, and during negotiations the parties specifically discussed the issue which has become the topic of the subsequent dispute; (2) the complaining party was represented by counsel; (3) the parties dealt with each other at arm's length; (4) the parties were knowledgeable in business matters; and (5) the release language was clear." Id. at 229 (paragraphing omitted).

• The contract between an alarm-system company and its jewelry-store customer contained the following reliance disclaimer: "In executing the Agreement, Customer is not relying on any advice or advertisement of ADT." The Fifth Circuit held that this language "was sufficiently clear as to disclaim any reliance by plaintiffs on any alleged misrepresentation ADT made prior to Plaintiffs entering into the contract. Accordingly, Plaintiffs' fraudulent inducement claim is barred under Texas law." Shakeri v. ADT Security Services, Inc., 816 F.3d 283, 288, 296 (5th Cir. 2016) (per curiam).

• New York's highest court ruled that a fraud complaint should have been summarily dismissed, because "plaintiffs in the plainest language announced and stipulated that they were not relying on any representations as to the very matter as to which they now claim they were defrauded." Pappas v. Tzolis, 20 N.Y.3d 228, 233-34 (2012).

13.5.4 … but maybe not

Of course, fraud claims might survive even a no-reliance provision. Suppose that Alice claims that Bob misrepresented facts to induce Alice to enter ito a contract, and that Bob's misrepresentation wasn't merely negligent, but intentional. And suppose also that the contract contains a no-reliance clause. In that situation, Bob should not hold out much hope that a court would summarily toss out Alice's fraudulent-inducement claim against him; the judge might very well insist on a full trial. See generally Andrew M. Zeitlin & Alison P. Baker, At Liberty to Lie? the Viability of Fraud Claims after Disclaiming Reliance, Apr. 23, 2013; see also Neal A. Potischman, Stephen Salmon, Alyse L. Katz, John A. Bick, Kirtee Kapoor and Lawrence Portnoy, Will Anti-Reliance Provisions Preclude Extra-Contractual Fraud Claims? Answers Differ In Delaware, New York, And California (Mondaq.com 2016).

And a no-reliance clause in a contract might not enough to convince a court to toss out a fraudulent-inducement or negligent-misrepresentation claim, for example if the plaintiff was not "sophisticated" and/or was not represented by counsel in the transaction in question. See Carousel's Creamery, L.L.C. v. Marble Slab Creamery, Inc., 134 S.W.3d 385 (Tex. App.–Houston [1st Dist.] 2004) (reversing and remanding directed verdict for defendant on negligent-misrepresentation claim).

13.5.5 Reliance waivers in M&A agreements

In merger- and acquisition ("M&A") deals, reliance disclaimers are often used because one party, typically the seller,

doesn't want to be deceived by the buyer into entering into an agreement (with agreed caps on liability) based on something that may or may not have been said by someone that is not written in the agreement, and of which the selling shareholders may not even be aware,

and that the buyer may determine to use post closing to make a claim not subject to the cap.

And this is particularly true for the private equity seller concerned about post closing certainty in distributing proceeds to its limited partners.

Glenn D. West, Private Equity Sellers Must View "Fraud Carve-outs" with a Gimlet-Eye, Weil Insights, Weil's Global Private Equity Watch (2016) (emphasis and extra paragraphing added).

Delaware courts are likely to hold parties to the terms of their non-reliance disclaimers — "[b]ut even when fraud claims premised upon extra-contractual representations have been precluded by a non-reliance clause, the express written representations can sometimes provide a basis for a claim of fraud, at least at the motion to dismiss stage." See Glenn D. West, Recent Delaware Cases Illustrating How Uncapped Fraud Claims Can and Cannot Be Premised Upon Written Representations (PrivateEquity.Weil.com 2020) (emphasis added).

13.5.6 Drafting tip: Be specific about what's disclaimed?

Courts seem to have more sympathy for a reliance disclaimer if, in the words of a Second Circuit opinion, the disclaimer "tracks the substance of the alleged misrepresentation." The court reversed a lower court's dismissal of a claim under federal securities law, but the underlying principle might well apply in contract cases as well. See Caiola v. Citibank, NA, 295 F.3d 312, 330 (2d Cir. 2002) (reversing dismissal of claim under federal securities law) (citing cases).

13.5.7 Drafting tip: Initial the disclaimer?

If there's a concern that a party might someday try to repudiate its reliance disclaimer, it can't hurt to have that party separately initial the contract as close as possible to the disclaimer, and be sure the party actually does initial it.

Otherwise, the drafting party might have an even worse problem: the uninitialed blank line could help persuade a judge or jury that the signing party really did overlook the disclaimer; that's just the opposite of what the drafting party wanted.

And in some circumstances, the law might require initialing of a reliance disclaimer.

Example: In a New York case, an estranged married couple reconciled — temporarily, as it turned out. During their reconciliation, the wife voluntarily dismissed her three pending lawsuits against the husband, and they signed a settlement agreement to that effect. But then the couple separated again, and the wife sued the husband again, this time claiming that he had fraudulently induced her to dismiss her other lawsuits by promising that he would return to her and permanently resume their marital relationship.

Unfortuantely for the wife, the settlement agreement she signed included a reliance disclaimer, which she had specifically initialed; as the court acidly noted: "There is no allegation in the complaint that plaintiff did not read or did not understand the agreement; in fact, she initialed the agreement in the margin opposite the very paragraph disclaiming the alleged representation." See Cohen v. Cohen, 1 A.D.2d 586 (N.Y. App. Div. 1956) (per curiam; affirming dismissal of complaint for insufficiency).

13.6 Pro tips about reps and warranties

13.6.1 Drafting goof: Don't use represents to commit to future action

Contract drafters shouldn't use the term represents to indicate that a party will take or abstain from action — commitments to future action should instead be written as promises (covenants).

Alice represents that she will pay Bob $1 million.

Alice represents and warrants that she will pay Bob $1 million.

Alice will pay Bob $1 million.

Alice represents that she will not use Bob's confidential information except as stated in this Agreement.

Alice will not use Bob's confidential information except as stated in this Agreement.

(Leave out the italics, usually.)

Why? Consider the “Before” example above: If Alice failed to pay Bob, she might try to claim that she should not be liable for nonpayment because when she made the representation, she had no reason to believe that she would not make the payment. A court might treat such a “representation” as a simple promise, but the drafter would do all concerned a disservice by not making the obligation explicit and unconditional. See Lyon Fin. Serv., Inc. v. Illinois Paper & Copier Co., 848 N.W.2d 539 (Minn. 2014) (on certification from 7th Circuit) (holding that "a claim for breach of a contractual representation of future legal compliance is actionable under Minnesota law without proof of reliance").

13.6.2 Disclaim investigation of representations?

[LINK NEEDED] explicitly states that a party making a representation is also certifying that the party has a reasonable basis for the representation. This is to try to forestall parties from recklessly making representations about things of which they know not.

This could end up being important; for example, in 2019 a natural-gas provider was hit with a judgment for some $9 million for fraudulent inducement and negligent misrepresentation, because (the court found) the provider had recklessly represented to a customer that the provider had certain capabilities, when the provider "did not do any investigation as to whether [it] could satisfy this obligation …." Rainbow Energy Marketing Corp. v. American Midstream (Alabama Intrastate) LLC, No. 17-24591 slip op. ¶ 54 (Harris Cty. Dist. Ct. Jul. 29, 2019) (findings of fact and conclusions of law).

Here's a hypothetical example: Suppose that Alice is selling Bob a used car that she has been keeping in a garage in another city; she wants to represent, but not warrant, that the car is in good working order. She could phrase her representation in one of two basic ways:

Phrasing 1: Alice says, "I represent that the car is in good working order." Under [LINK NEEDED], Alice is implicitly making an ancillary representation, namely that she has a reasonable basis for her main representation that the car is in good working order, perhaps because she recently drove it or had it checked out by a mechanic.

Phrasing 2: "So far as I know, the car is in good working order." By using the phrase so far as I know, Alice should be held to have implicitly disclaimed any such ancillary representation.

(Alice could make the disclaimer of Phrasing 2 even strongly by saying, for example: "So far as I know, the car is in good working order, but it's been sitting in the garage for years and I have no idea what kind of shape it's in.")

Pro tip: Some representations use phrasing such as "to Representing Party's knowledge, X is true" — this is unwise, in the author's view, because it could be argued to mean that Representing Party is implicitly representing that it does indeed have knowledge that X is true. That argument should not prevail, but (to paraphrase a former student) that's a conversation we don't want to have.

13.6.3 Warranting a present or future fact? (It might matter.)

Drafters of representations and warranties should be careful to be clear just what is being represented warranted: Is it a present fact, or is it a future fact? The distinction can be important because in many jurisdictions:

  • The "clock" for the statute of limitations will not start to tick for a warranty of future performance (for example, a warranty that a car will not have any mechanical problems for X years or Y miles) until the warranty failure is discovered;
  • In contrast, for a warranty of present fact — for example, that goods as delivered are free from defects — the clock starts ticking at delivery.

This is illustrated in an Indiana case in which the state's supreme court noted that:

Under the UCC, a party's cause of action accrues (thus triggering the limitations period) upon delivery of goods.

However, if a warranty explicitly guarantees the quality or performance standards of the goods for a specific future time period, the cause of action accrues when the aggrieved party discovers (or should have discovered) the breach. This is known as the future-performance exception.

Kenworth of Indianapolis, Inc., v. Seventy-Seven Ltd., 134 N.E.3d 370, 374 (Ind. 2019).

In that particular case, said the supreme court, a truck manufacturer's warranty for its vehicles was worded in such a way as to constitute a warranty of future performance; the court said that:

Courts and commentators generally agree that, in order to constitute a warranty of future performance under UCC section 725(2), the terms of the warranty must unambiguously indicate that the seller is warranting the future performance of the goods for a specific period of time.

Id. at 378 (cleaned up).

The court also said:

[W]e reject the premise that Sellers' duty to repair and replace defective goods alone constitutes a future-performance warranty under the UCC. The promise must explicitly extend to the goods' performance, not the sellers' performance, for a specific future time period.

Id. at 379 (emphasis added).

13.6.4 Be careful what you warrant

Recall that a warranty is in effect an insurance policy against the occurrence of a future event — even if the future event is someone else's fault. In a British Columbia case:

  • A supplier sold water pipes to a customer for use in a construction project designed by the customer. The pipes conformed to the customer's specifications — in other words, the supplier delivered what the customer ordered. But flaws in the customer's design led to problems.
  • The contract's warranty language stated that the supplier warranted that the pipes were "free from all defects arising at any time from faulty design" (emphasis added).

The trial court ruled in favor of the supplier because the design problem was the customer's fault — but the appeals court reversed, holding that the supplier was liable because of its warranty. See Greater Vancouver Water Dist. v. North American Pipe & Steel Ltd., 2012 BCCA 337 (CanLII).

The appeals court said:

[24] North American was obliged to deliver pipe in accordance with the appellant’s specifications. North American agreed to do so.

Quite separately, it warranted and guaranteed [sic] that if it so supplied the pipe, it [sic; the pipe] would be free of defects arising from faulty design. These are separate contractual obligations. The fact that a conflict may arise in practice does not render them any the less so.

The warranty and guarantee provisions reflect a distribution of risk.

* * * 

[34] Clauses such as 4.4.4 distribute risk. Sometime they appear to do so unfairly, but that is a matter for the marketplace, not for the courts.

There is a danger attached to such clauses. Contractors may refuse to bid or, if they do so, may build in costly contingencies. Those who do not protect themselves from unknown potential risk may pay dearly. …

Parties to construction or supply contracts may find it in their best interests to address more practically the assumption of design risk. To fail do to so merely creates the potential for protracted and costly litigation.

Id. at ¶¶ 24, 32 (emphasis and extra paragraphing added).

13.6.5 Is a warranty a guarantee?

Colloquially the terms "warranty" and "guarantee" are alike, but technically there are some differences; see the commentary accompanying [PH].

13.6.6 A hypothetical case: Alice and Bob, again

Let's return to our Alice-and-Bob hypothetical to examine the differences between a representation and a warranty.

13.6.6.1 Alice and Bob (1): Warranty only

Suppose that Alice only warranted a fact, but she did not represent it. For example, suppose that Alice sold her car to Bob, and she suspected, but didn’t know for sure, that the engine was going to need work.

In that case, Alice might:

  • warrant, but not represent, that the car was in good working order, and
  • limit Bob’s remedy to Alice’s reimbursing Bob for up to, say, $200 in repair costs.

In that situation, at trial Bob would be trying to climb the right side of the above Hill of Proof. The only three evidentiary checkpoints that Bob would need to reach, in reaching out with his right hand toward that side of the Hill, would be the following:

  1. Proof that Alice warranted a statement of past or present fact, to use Tina Stark’s formulation [I’ll leave out future facts for now]. Here, Alice’s statement is “the car is in good working order”;
  2. Proof that Alice’s statement was false — her car, as delivered to Bob, turned out to need some significant work; and
  3. Proof that Bob incurred damages as a result, i.e., repair costs.

If, at the trial, Bob can successfully get past those three evidentiary checkpoints on right side of the Hill of Proof, then he will be entitled to recover warranty damages (generally, benefit-of-the-bargain damages) for Alice’s breach of warranty — but in this case, limited by the contract to $200 in repair costs.

And that’s it; without more, Bob needn't prove that he reasonably relied on Alice's warranty — but neither will he be entitled to tort-like remedies for fraudulent inducement or negligent misrepresentation, such punitive damages and/or rescission, i.e., unwinding the contract, as he would on the left side of the Hill.

13.6.6.2 Alice and Bob (2): Representation and warranty

But now suppose that Alice both represented and warranted the statement of fact, i.e., that her car was in good working order. And then suppose that Bob successfully hits the first three evidentiary checkpoints on the left- and right sides of the Hill of Proof. In that situation, Bob can try to keep going to hit still more checkpoints on the left side of the Hill, namely:

  1. Proof that Bob in fact relied on Alice's representation — that will probably be almost a given, of course, by virtue of the representation’s being expressly set forth in the contract;
  2. Proof that Bob's reliance was reasonable — ditto, although Alice could try to prove that Bob's reliance was not reasonable under the circumstances; and
  3. Proof that Alice intended for Bob to rely on Alice’s representation — ditto; and
  4. Proof that Alice made the false representation intentionally (or possibly, in some jurisdictions, was negligent or reckless in doing so). This is usually the biggie, from a proof perspective.

If Bob can successfully hit all of these additional evidentiary checkpoints on the left side of the Hill of Proof (and if Alice fails to show that Bob’s reliance on her representation was unreasonable), then Bob would be additionally entitled to more “prizes,” namely tort-like remedies such as rescission and perhaps punitive damages.

At trial, Bob might well assert both breach of warranty and fraudulent inducement or negligent misrepresentation. That way, if Bob proves unable to show scienter on Alice’s part, then he can still fall back on his warranty claim.

The same would be true if Alice could persuade the factfinder that Bob’s reliance on her (mis)representation was unreasonable: Bob would lose on his claim for fraudulent inducement or negligent misrepresentation would fail, but he might still be able to win on his warranty claim.

13.6.6.3 Alice and Bob (3): Representation only

Let’s change up the hypothetical once more: Suppose that Alice had no reason to think her car had any problems, but she also didn’t want to bear any risk that it did have problems. In that case, Alice might represent, but not warrant, something like the following: "So far as I know, the car is in good working order, but I'm not a mechanic and I haven't had it checked out by a mechanic."

In that situation, if the car did turn out to have problems, then Bob would have to hit all six checkpoints on the left side of the Hill of Proof to recover damages from Alice; the first three alone, on both the left- and right sides, would not be enough — even though the first three would be enough if Alice had warranted the car’s good condition.

13.6.7 "Which do I want for my client – a rep, or a warranty?"

Here's a rule of thumb:

• A party that is asked to represent or warrant something (such as a seller) will always want to consider whether to warrant the thing or to represent it; this might well vary depending on the party's actual knowledge and the potential financial exposure if the represented- or warranted thing turns out not to be true.

• In contrast, any party asking for a representation or warranty (such as a buyer) will always want to push for both a representation and a warranty, so as to give that party more flexibility in litigation — see the two sides of the Hill of Proof in § 13.3 — in case the represented- or warranted thing turns out to be false.

This suggests the following strategy for drafting with a future trial in mind:

– If your client is being asked to represent and warrant some fact — say, if your client is a supplier being asked for a commitment about its products or services — then consider whether the client should only represent the fact, or whether the client should only warrant the fact. As a matter of negotiation strategy the client might eventualy end up agreeing to do both, but as a drafter it’s worth giving some thought to the question.

– On the other hand, if your client is asking someone else to represent and warrant a fact — say, if you're a customer asking for a commitment from a supplier — then you’ll want to ask for the contract language to include both a representation and a warranty. Your client might not have the bargaining power to insist on getting both, but if it does, then having both will give the client more flexibility if litigation should ever come to pass.

Why would a customer ask for both a representation and a warranty? Because "they lied!" is a stinging charge — and when a big contract fails, trial counsel will pretty much always try hard to find opportunities to accuse the other side of having misrepresented facts. Doing so can work, sometimes spectacularly well: Jurors and even judges might not understand the nuances of the dispute, but they will definitely undertand the accusation that "they lied!"

Bryan Garner points this out in his famed dictionary of legal usage:

representations and warranties. … Some have asked this: if the warranty gives so much more protection than a representation, why not simply use warranty alone—without representation? It’s a fair point, perhaps, but here’s the reason for sticking to both: some parties to a contract don’t want merely a guarantee that so-and-so will be so in the future; they also want an eye-to-eye statement (representation) that the thing is so now. If it later turns out not to have been so when the representation was made, the the party claiming breach can complain of a lie. …

If only a warranty were in place, the breaching party could simply say, “I’ll make good on your losses—as I always said I would—but I never told you that such-and such was the case.” Hence representations and warranties. Bryan A. Garner, Representations and warranties, Garner’s Dictionary of Legal Usage (3d ed. 2011) (emphasis edited, extra paragraphing added), quoted in Ken Adams, Revisiting “Represents and Warrants”: Bryan Garner’s View (AdamsDrafting.com 2011).

Example: Oregon v. Oracle. We see the above in the civil suit filed by the state of Oregon against Oracle, in which the second paragraph of the complaint said, in its entirety (with extra paragraphing added for readability):

Oracle lied to the State about the “Oracle Solution.”

Oracle lied when it said the “Oracle Solution” could meet both of the State’s needs with Oracle products that worked “out-of-the-box.”

Oracle lied when it said its products were “flexible,” “integrated,” worked “easily” with other programs, required little customization and could be set up quickly.

Oracle lied when it claimed it had “the most comprehensive and secure solution with regards to the total functionality necessary for Oregon.”

The state named various Oracle managers and executives, personally, as co-defendants in a multi-million lawsuit over a failed software development project, with the state suing one Oracle technical manager for $45 million (!). Here's a wild speculation, based on zero evidence: It seems possible that the state sued the individuals personally to try to motivate them to cooperate with the state, akin to when criminal prosecutors bring indictments against all kinds of people to encourage them to cooperate in return for dismissal or a lighter sentence.

The lawsuit was later settled — Oracle agreed to pay Oregon $25 million in cash and provide the state with another $75 million in technology.

Example: British Sky Broadcasting v. EDS. British Sky Broadcasting ("Sky") contracted with EDS to develop a customer relationship management (CRM) software system. The project didn't go as planned, and Sky eventually filed suit. See BSkyB Ltd. v. HP Enterprise Services UK Ltd., [2010] EWHC 86 (TCC).

  • In the (non-jury) trial, the judge concluded that EDS had made fraudulent misrepresentations when one of EDS's senior UK executives, wanting very much to get Sky's business, lied to Sky about EDS's analysis of the amount of elapsed time needed to complete the initial delivery and go-live of the system. See id. at ¶ 2331 and ¶¶ 194-196.
  • The judge also concluded that during subsequent talks to modify the contract, EDS made additional misstatements that didn't rise to the level of fraud, but still qualified as negligent misrepresentations. See id. at ¶ 2336.
  • A limitation-of-liability clause in the EDS-Sky contract capped the potential damage award at £30 million. By its terms, though, that limitation did not apply to fraudulent misrepresentations; the judge held that the limitation didn't apply to negligent misrepresentations either. See id. at ¶¶ 372-389.

Arguably one of the most interesting aspect of the judge's opinion is its detailed exposition of the facts, which illustrate how even just one vendor representative can make a deal go terribly wrong for his employer.

In early June 2010, EDS reportedly agreed to pay Sky some US$460 million — more than four times the value of the original contract — to settle the case. See Jaikumar Vijayan, EDS settles lawsuit over botched CRM project for $460M, Computerworld, June 9, 2010.

13.6.8 Insurance for representations & warranties?

If you're being asked — or asking another party — to make representations and warranties, you might want to investigate whether insurance coverage is available for those reps and warranties. (It appears that such insurance might be available primarily for merger- and acquisition ("M&A") deals.) See generally, e.g.: • Joseph Verdesca, Paul Ferrillo, and Gabriel Gershowitz, Representations and Warranties Insurance: What Every Buyer and Seller Needs to Know (Weil.com 2016), archived at https://perma.cc/RSU3-66V3; • Eric Jesse, Reps & Warranties Insurance: Five Myths Dispelled (JDSupra.com 2020), archived at https://perma.cc/9FWX-3HSH.

13.7 Recap: Key takeaways about reps and warranties

Here are some things every contract drafter and reviewer should know about representations and warranties:

  1. A representation is not the same thing as a warranty, at least not in U.S. law. The two terms relate to different categories of fact, and they have different legal ramifications in litigation.
  2. A representation is, in essence, a statement of past or present fact.
  3. A representation might be paraphrased as: So far as I know, X is true, but I’m not making any promises about it.
  4. When qualifying a representation as in #3 above, use a term such as, so far as I know, and not the term to my knowledge: In a lawsuit, an aggressive trial counsel might claim that the latter term amounts to an implicit representation that the representing party did indeed have knowledge.
  5. A representation can include the disclaimer "without any particular investigation"; this could be paraphrased as: I'm not aware that X isn't true, but I’m not saying that I’ve looked into it.
  6. In contrast: The term warranty is a shorthand label for a kind of conditional covenant, a strict-liability promise — akin to an insurance policy — that if the warranted fact(s) are shown to be untrue, then the warranting party will make good on any resulting losses suffered by the party to whom the warranty was made. A warranty is a strict-liability obligation that applies even if the warranting party wasn't at fault.

Example: Consider the simple warranty, Alice warrants to Bob that Alice’s car will run normally for at least 30 days. This is tantamount to a promise by Alice that, if Alice’s car fails for any reason to run normally for at least 30 days, then Alice will pay for repairs, a rent car, and any other foreseeable damages resulting from the failure.

  1. A warranty might be paraphrased as: I’m not going to say that X is or isn’t true, but I’ll commit that, if it turns out that X isn’t true, then I’ll reimburse you for any resulting foreseeable losses that you suffer — or alternatively: then I’ll take the following specific steps, and only those steps, to try to make it right for you.
  2. Representations and warranties can be carefully drafted so as to be narrowly specific.
  3. A warranty can be drafted to limit the remedies available if the warranted facts turn out not to be true. (A typical triad of remedies can be summarized as: repair, replace, or refund, as discussed in [LINK NEEDED].)
  4. A party that is asked to make both a representation and warranty about particular facts (e.g., a seller of goods being asked to represent and warrant the quality of the goods) should consider whether it really wants to make both of those commitments for all the requested facts — that party might want to make only representations as to some facts and only warranties as to other facts.
  5. On the other hand, suppose that a services provider and a customer are entering into a contract for services. If the provider will be giving any kind of warranty about its services, the customer should always at least try to get both a representation and a warranty; that will give the customer more flexibility in litigation.

13.8 Warranties: A checklist for business planners

Drafters should consider the following issues:

  1. What exact past, present, or future fact will a party "warrant"?
  2. Would the warranting party prefer to make a representation about the warranted fact instead of a warranty? See § 13.6.7 for discussion. (BUT: The party that is to benefit from the warranty will always prefer that the warranting party do both: Represent, and warrant.)
  3. Will the warranting party be warranting —
    • a present fact (for example, when a seller warrants the condition of goods as delivered)?
    • a future fact (e.g., when a seller warrants that goods will perform in a certain way for a stated period of time)? This can make a difference for when the statute of limitations begins to run for a claim of breach of warranty, as discussed in Section 13.6.3: .
  4. What exactly does the warranting party commit to do if a warranted fact turns out not to be true — anything specific, such as the Three Rs? (Repair, Replace, or Refund)?
    • If the contract is silent on that point, then the warranting party would liable in damages for any breach of the warranty.
  5. Are there any time limits to the warranting party's obligation? For example: Warranty issues must be reported to the warranting party within X days after delivery.
  6. Are there any monetary limits to the warranting party's obligation? For example:
    • Cap: The warranting party will not be liable for more than $XXX if a warranted fact turns out to be untrue; or
    • Basket: The warranting party will not be liable for breach of warranty until the resulting damages exceeds $XXX, at which point:
      • Deductible basket: The warranting party will be liable only for damages in excess of that amount (known as a "deductible basket"); or
      • Tipping- or first-dollar basket: The warranting party will be liable for all damages after the specified amount has been reached.basket").

13.9 Asset purchases: Where reps and warranties come in

Here's a brief, greatly-simplified overview of how major asset purchases generally proceed:

  1. The buyer and seller sign a contract that commits each of them to the transaction. (If only one party is committed, it's known as an "option" contract.) The purchase-and-sale contract includes, among other things:
    • a specific identification of the asset being purchased;
    • the price and how it is to be paid — in money (currency, check, wire transfer, etc.) and/or assets (e.g., shares of the buyer's stock);
    • a closing date, with a time and place (often remote), at which the formal exchange is to take place; and
    • representations and warranties by each party — the seller's reps and warranties typically set forth a "platonic ideal" of what the purchased asset should be (both factually and legally, e.g., ownership claims), together with a disclosure schedule that lists all ways that the purchased asset is acknowledged to differ from that ideal;
    • a period for pre-closing due diligence during which the buyer gets to "kick the tires" more and confirm that the seller's reps and warranties are accurate;
    • a list of conditions to closing — these are events (or circumstances) that can allow one or both parties to abandon the deal, such as one or more of the seller's reps and warranties proving to be materially inaccurate;
    • a go / no-go date by which the buyer has to decide: Am I going to close the deal, or not?;
    • each party's obligations during between signature and closing — e.g., the seller mustn't do anything that would impair the value of the asset.
  2. The buyer does due diligence — nearly always, the seller is contractually required to cooperate with the buyer's due diligence (and the buyer can walk away from the deal, and perhaps sue for specific performance and/or damages, if the buyer doesn't cooperate).
  3. The parties obtain the required government approvals, if any.
  4. At the closing — assuming that neither party has walked away — the agreed consideration changes hands, and ownership is conveyed.

13.10 Additional citations

For extensive additional citations in this area, see Professor Tina Stark's scholarly pummeling of the misguided notion that representations and warranties amount to the same thing, which she offered in two comments on Ken Adams's blog.

For an earlier piece on the same subject by Stark, also responding to an Adams essay, see her Nonbinding Opinion: Another view on reps and warranties, Business Law Today, January/February 2006.

Some of Adams's earlier pieces espousing the purported synonymity of representation and warranty can be found at: • A lesson in drafting contracts — What's up with 'representations and warranties'?, The Business Lawyer, Nov./Dec. 2005, as well as • here, here and here.

See also Robert J. Johannes & Thomas A. Simonis, Buyer's Pre-Closing Knowledge of Seller's Breach of Warranty, Wis. Law. (July 2002) (surveying case law).

An English court decision highlighted the difference between representations and warranties: See Sycamore Bidco Ltd v Breslin & Anor [2012] EWHC 3443 (Ch) (2012), discussed in, e.g.: • Raymond L. Sweigart and Christopher D. Gunson, ‘Reps’ and Warranties: One Could Cost More Than the Other Under English Contract Law (PillsburyLaw.com 2013); and • Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence Upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud Carve-Outs” in Acquisition Agreements, 69 Bus. Lawyer LAW. 1049, 1058 n.47 (2014).

13.11 Exercises and discussion questions

13.11.1 Exercise: Selling a car

FACTS: Your elderly, childless Uncle Ed is selling his car to a stranger. He says he doesn't know of any mechanical problems.

QUESTION: If the stranger asks Uncle Ed to represent and warrant in writing that the car has no problems, how might he respond as to —

  • the requested representation?
  • the requested warranty?

13.11.2 Exercise: Buying a car

See Section 13.9: for a brief overview of how asset purchases typically work.

FACTS: Your elderly, childless Uncle Ed now wants to buy a car, namely a 1962 Ferrari 250 GTO, for which he'll pay $50 million. The same car sold for $48.4 million [note how this number is written] at a 2018 Sotheby's auction (link).

EXERCISE: As Uncle Ed's attorney, make a simple list — don't worry about legalese — of the following:

  • the representations and/or warranties that you might want — think about things such as:
    • who actually owns the car;
    • whether anyone else has any claims to the car, whether of partial- or outright ownership or of security interests (liens) in the car;
    • what kind of shape the car is in;
    • has the car been in any accidents;
  • what if any "due diligence" you might want the seller to allow Uncle Ed to conduct after the contract is signed but before the closing;
  • what obligations Uncle Ed would want the seller to comply with between signing and closing — not just "thou shalt" obligations but also "thou shalt not" obligations as well;
  • how the closing will work mechanically, such as:
    • how will money hands;
    • how will Uncle Ed get the keys;
    • how will Uncle Ed get any additional deliverables that he needs to establish or confirm his ownership;
    • what must be done at the closing to satisfy Uncle Ed that "we're done here" (the deal is complete, there's nothing left to do).

14 Export controls

The export-controls laws in the U.S. are a bit complicated, but it’s extremely important for companies and counsel to get a handle on them.

Here are a couple of examples of "exports" that might be surprising:

  • Disclosure of controlled technical data to a foreign national in the U.S. can constitute an "export" that requires either a license or a license exception.
  • Emailing controlled technical data to a U.S. citizen located in a foreign country could constitute an export of the data.

Want to do ten years in prison? Just do an "export" of technical data witout the required export license (or license exception). Even without prison, you could be heavily fined and/or denied export privileges.

EXAMPLE: A 71-year old emeritus university professor was sentenced to four years in prison for export-controls violations. The professor had been doing research, under an Air Force contract, relating to plasma technology designed to be deployed on the wings of remotely piloted drone aircraft. Apparently, his crime was to use, as part of the project staff, two graduate students who were Iranian and Chinese nationals respectively. (It probably didn’t help that the professor was found to have concealed those graduate students’ involvement from the government.) See Bloomberg.com 2012: https://goo.gl/gfvGhR; FBI.gov 2012: https://goo.gl/jtZR7C.

EXAMPLE: In a related vein, in late 2019 a cryptocurrency expert was arrested for having traveled to North Korea to present at a Pyongyang blockchain and cryptocurrency conference, despite having been warned by the State Department that doing so was prohibited by sanctions legislation. See a Department of Justice press release at https://preview.tinyurl.com/v5hhf6r.

For additional information, see, e.g.:

Note: In 2020, the U.S. Government began looking at expanding export-controls restrictions to cover "foundational" technology, commodities, and software. See Dechert LLP, Potential Expansion of U.S. Export Controls: “Foundational” Technologies, Commodities and Software (JDSupra 2020); Department of Commerce, Bureau of Industry and Security, Identification and Review of Controls for Certain Foundational Technologies, 85 FR 52934 (Aug. 27, 2020).

15 Foreign Corrupt Practices Act

Bribing foreign "officials" can lead to prison time. See generally the 2020 resource guide issued by the Criminal Division of the U.S. Department of Justice and the Enforcement Division of the U.S. Securities and Exchange Commission, at https://www.justice.gov/criminal-fraud/file/1292051/download.

16 Getting to signature quickly

As noted at Section 2.2: , a client will very often prefer an "OK" contract — that is, one that can be signed quickly and provides adequate legal protection against reasonably-likely problems — over a contract that theoretically maximizes the client's position in every imaginable situation. This chapter discusses some ways of trying to get sensible contracts to signature sooner.

Contents:

16.1 Balanced terms get signed sooner

If you're doing the drafting, you can help speed things up considerably by being reasonable in what you offer to the other side. That's because many busy business people greatly prefer to sign contracts that are reasonably balanced.

The author learned this from personal professional experience: I used to be vice president and general counsel of BindView Corporation, a public network-security software company based in Houston, until we were acquired by Symantec Corporation, the global leader in our field. As outside counsel, I'd helped BindView's founders to start the company.

As soon as I went in-house, I had to handle all our negotiations with customers about our standard contract form. We dramatically speeded up our deal flow by revising the contract form to proactively provide balanced legal terms that our customers typically asked for, in ways that we knew we could support.

In addition to helping us get to signature sooner, the (re)balanced contract form indirectly promoted our product in another way: Customers began to tell me how much they liked our contract, which validated their decision to do business with us.

I started making notes of customers’ favorable comments, and eventually quoted some of the comments (anonymously) on a cover page of our contract form. Here are just a few of those customer comments, which I posted online some years ago; all are from negotiation conference calls except as indicated:

• From an in-house attorney for a multinational health care company: I told our business people that if your software is as good as your contract, we’re getting a great product.

• From an in-house lawyer at a U.S. hospital chain: I giggled when I saw the "movie reviews" on your cover sheet. I’d never seen that before — customers saying this was the greatest contract they’d ever seen. But the comments turned out to be true.

• From a contract specialist at a national wireless-service provider: I told my boss I want to give your contract to all of our software vendors and tell them it’s our standard contract, but I know we can’t do that.

• From an in-house attorney at a global media company: This is a great contract. Most contracts might as well be written in Greek, but our business guys thought this one was very readable.

On a couple of occasions, BindView was the customer. On each of those occasions, instead of taking time to negotiate the other vendor's contract form, we proposed just using our form, with us as the customer instead of as the vendor; each time, the other vendor quickly agreed.

You might wonder whether BindView ever experienced legal- or business problems from having a balanced contract form. I’ll note only that:

  • With the CEO’s permission, I talked about our balanced-contract philosophy in continuing-legal-education ("CLE") seminars, and even included a copy of our standard form in written seminar materials; and
  • In due course we had a successful "exit" when we were approached and acquired by Symantec Corporation, one of the world’s largest software companies and the global leader in our field.

To be sure: Some business people just love to "win" as much as they can in every contract negotiation, often violating Wheaton's Law ("Don't be a d**k"). If that's you, please consider whether that approach best serves your long-term goals.

16.1.1 Trying to play "hardball" will slow things up

Some say it's best to start a contract negotiation by sending the other side your "hardball" or "killer" contract form that's extremely biased toward your side. By doing so (the theory goes):

  • you do what's called "anchoring" the other side's expectations, thus increasing the odds that you'll eventually get more of what you want; and
  • you create a batch of potential concessions that you don't really care about (sometimes known as "the sleeves from my vest") that you can use for horse-trading.

Certainly there are transactions in which it makes at least some sense to do this.

CAUTION: Some people like to play "the art of the deal"; for those folks, it feels just plain good to come out "on top" when negotiating the legal fine points. But don't underestimate the immediate price you'll pay for these putative benefits:

  • You'll spend more business-staff time.
  • You'll spend more in legal expenses.
  • You'll incur opportunity costs: As the 'shot clock' runs down at the end of the fiscal quarter, you'll be spending time on legal T&Cs instead of on closing additional business.

So when negotiating a deal, you might want to ask yourself whether "hardball" legal negotiation is really what you want to be spending your time doing.

It might make sense instead to lead off with a balanced contract form that represents a fair, reasonable way of doing business — one that ideally the parties could "just sign it" and get on with their business.

Moreover, hardball contract drafts send the wrong message: Everyone wants reliable business associates, but how does someone know the other side is friendly and trustworthy? On that score, offering a fair and balanced contract can help.

16.1.2 Wounded tigers

Even if your client has a lot of bargaining power, you might well be better off not trying to use it to overreach against the other party. Research indicates that hardball negotiation often lead to worse overall outcomes:

If people start with a high anchor and concede slowly, use aggressive tactics, express some anger, they end up achieving favorable negotiated deal terms.

But what we’re finding — and this is our central thesis — is that sometimes by being more assertive, by being more aggressive, you might end up with a better negotiated outcome …

but ultimately, through that process, create conflict that causes you to end up with worse value overall.

The above quote is from the transcript (wharton.upenn.edu) of an interview with Wharton professor Maurice Schweitzer and postdoctoral researcher Einav Hart (emphasis, extra paragraphing, and bullets added. See also Einav Hart and Maurice E. Schweitzer, Getting Less: When Negotiating Harms Post-Agreement Performance (2017), available at SSRN: https://ssrn.com/abstract=3039256. For some other perspectives on this article, see the Hacker News discussion, at https://news.ycombinator.com/item?id=22209072.)

For example, suppose that you represent a customer company that has a lot of bargaining power. And suppose that your client wants to use that power to force a vendor to make some tough concessions in a contract negotiation. • Your client's negotiators might well regard those concessions as an entitlement: We're the customer, we're the big dog; of course we get what we want. • But the customer's negotiators should also recall that ultimately, all contracts have to be performed by people. And people will almost certainly be influenced, not just by the words of the contract, but by their employer's then-current interests — and by their own personal interests as well.

If the vendor's people feel they've been crushed by the customer, they're unlikely to harbor warm and fuzzy feelings for the customer. (This is at least doubly true if the contract later proves to be a train wreck for the vendor — most business people know that being associated with a train wreck is seldom good for anyone's professional reputation.)

In this situation, the vendor's people are not likely to be motivated to go out of their way for that customer. They might well be tempted to "work to rule," to use an expression from the labor-relations world — to do just what the contract requires, and no more. That does neither party any favors.

And the reverse can be true when the shoe's on the other foot. Suppose that the customer thinks that it's been taken advantage of by a vendor. When it comes time for renewals, or repeat business, or recommendations to other companies, that vendor probably won't have a lot of brownie points with the customer's people.

Example: In a Sixth Circuit case, a software customer did a corporate reorganization by, in relevant part, a series of mergers. As a result of the mergers, the named licensee technically became part of a different corporation that was owned by the same parent company; nothing else had change. The software vendor demanded that the customer re-buy the license; when the customer refused, the vendor took the customer to court — and won. After treating its customer that way, what are the odds that the software vendor would ever be able to sell anything again to that customer — let alone convince the customer to be a reference for the vendor's future sales efforts? Talk about pennywise and pound-foolish …. See Cincom Sys., Inc. v. Novelis Corp., 581 F.3d 431 (6th Cir. 2009) (affirming summary judgment in favor of software vendor).

The lesson for contract drafters and negotiators: Even if you've got the power to impose a killer contract on the other side, think twice before you do so. You could be setting up your client to have to deal later with a wounded tiger.

16.2 How to kill a deal: Insist on using your contract form

For reasons good and bad, big companies usually want to use their contract forms, not yours. Certainly it's important to offer to draft the contract. And if the big company reeaally wants to do a deal with you, then you might get away with insisting on controlling the typewriter.

But bad things can happen, though, if you simply fold your arms and refuse to negotiate the other side's contract paper. Even if the big company's negotiators grudgingly agree to work from your draft contract, they'll start the negotiation thinking your company is less than cooperative (which isn't good for the business relationship). Then later, when you ask for a substantive concession that's important to you, they may be less willing to go along. And in any case, their agreement to use your contract form, in their minds, will be a concession on their part, meaning that you now supposedly owe them a concession.

For a vendor lawyer, there's another danger in insisting on using your own contract form: Your client's sales people will blame their lack of progress on you. Sales folks are always having to explain to their bosses why they haven't yet closed Deal X. Your insistence on using your contract form gives them a ready-made excuse: They can tell their boss that you're holding up the deal over (what they think is) some sort of petty legal [nonsense]. Even if that's not the whole story, it's still not the kind of tale you want circulating among your client's business people.

16.3 Combat Barbie: Consider using "distractor" terms

Military people learn early that when preparing for inspection, you don't want to make everything perfect. That's because the inspector will keep looking until he (or she) finds something — because if the inspector doesn't find anything, his superior might wonder whether the inspector really did his job.

The trick is instead to make everything pretty squared away — but then [mess] things up just a little bit. That way, the inspector will have something to find and report to his superior and can go away.

Illustrating the point: In an online form, a British lawyer, who had graduated from Sandhurst (the UK equivalent of West Point), told the following story, paraphrased here:

Combat Barbie
Photo: Pinterest

At Sandhurst as at U.S. military academies, first-year cadets are hounded relentlessly by upper-class cadets. The British lawyer told of a female first-year cadet who did a good job of squaring away her bunk and gear for inspection — but then she carefully placed a "Combat Barbie" doll on her bunk.

Of course the inspectors immediately noticed Combat Barbie — and they used up their entire alloted time for that cadet's inspection in "counseling" her about the unmilitary appearance of having a doll on her bunk. That saved the cadet quite a bit of trouble: Otherwise, the inspectors might have left the cadet's bunk, gear, etc., strewn all over the floor, with orders for the cadet to restore the environment as "additional training."

A similar "distractor" psychology can apply in drafting a contract: Be sure to give the other side's reviewer something to ask to change, if for no other reason than to give the reviewer something to report to her boss or client.

But make it a fairly minor point; otherwise, the reviewer and her client might dismiss you as naïve — and worse, they might start to question whether your client was a suitable business partner.

Example: If you're a supplier, consider specifying payment terms of net-20 days, and be prepared to agree immediately to net-30 days if asked. But don't specify net-5 days, which in many situations would risk branding you as unrealistic about "how things are done."

16.4 Which to use: Shall? Will? Must?

When representing a provider of goods and services, you might want to be very sparing about saying in a contract that the customer "shall" or "must" do this or that.

  • An imperious manner might send the wrong signal about whether your client, the provider, will be "a good business partner."
  • A softer, more-deferential approach is to say instead, "Customer will do" this or that.

On the other hand, if you anticipate trouble from a counterparty, you might want to use the term must.

16.5 Incorporation by reference

Drafting can sometimes be speeded up by incorporating external material by reference. CAUTION: The incorporated material must still be reviewed, because it has the same force and effect as though the incorporated text or other material had been fully set forth in the body of the document itself. See generally, e.g., Clauses Incorporated by Reference, 48 C.F.R. § 52.252-2.

16.5.1 Caution: Incorporated material should be readily available

If an incorporation by reference of external terms is not clear and unmistakable, a court might hold that the external terms are not part of the contract. For example: The Oklahoma supreme court ruled that a form contract for the sale of hardwood flooring, which referenced "Terms of Sale" but gave no indication where to find them, did not incorporate the external terms. The court held that: "a contract must make clear reference to the extrinsic document to be incorporated, describe it in such terms that its identity and location may be ascertained beyond doubt, and the parties to the agreement had knowledge of and assented to the incorporated provisions. … BuildDirect's attempt at incorporation was nothing more than a vague allusion." Walker v. BuildDirect.com Technologies, Inc., 2015 OK 30, 349 P.3d 549, 551, 554 (2015) (on certification from 10th Circuit).

Pro tip: At the very least, provide a Web link — preferably a short, memorable one — where the additional incorporated terms can be found.

16.5.2 Attachment "for general reference" might not work

A Nebraska case reinforces the lesson that incorporation-by-reference language must be clear: An architectural-services contract stated that "[t]he Architect’s Response to the District’s Request for Proposal is attached to this Agreement for general reference purposes including overviews of projects and services." But the architect firm's response to the RFP wasn't attached to the contract — for that matter, the title wasn't even as stated in the contract provision.

Agreeing with the trial court, the state's supreme court held that "[t]he expression 'for general reference purposes,' interesting though it may be, contrasts with a provision, common in contract law, which incorporates another document by reference. … [The contract language] simply does not incorporate [the architect firm's] responses into the contract." Facilities Cost Mgmt. Group v. Otoe Cty. Sch. Dist., 291 Neb. 642, 653-54, 868 N.W.2d 67, 71, 75 (2015) (affirming partial summary judgment but reversing and remanding on other issue); after retrial, 298 Neb. 777, 906 N.W.2d 1 (2018).

Caution: It's not hard to see how another court might have held that the contract did incorporate the architecture firm's guaranteed-maximum-price response. Still, the contract's drafters, who presumably worked for the school district, might have been more clear about their client's intent.

16.5.3 But a clear intent to incorporate might suffice

In a 2014 case, the Fifth Circuit held that a supplier's price quotation sufficiently incorporated by reference a standard-terms-and-conditions document published by the European Engineering Industries Association (the "ORGALIME"), which contained an arbitration provision. The supplier's price quotation didn't expressly incorporate the ORGALIME by reference; instead it stated, "Terms and conditions are based on the general conditions stated in the enclosed ORGALIME S2000." (Emphasis added.)

The Fifth Circuit reviewed Texas law on the point, summarizing that "when the reference to the other document is clear and the circumstances indicate that the intent of the parties was incorporation, courts have held that a document may be incorporated, even in the absence of specific language of incorporation." The appeals court concluded that "the district court erred in holding there was no agreement to arbitrate." Al Rushaid v. National Oilwell Varco, Inc., 757 F.3d 416, 420-21 (5th Cir. 2014) (reversing denial of motion to compel arbitration) (cleaned up, citations omitted, emphasis added).

16.5.4 Caution: A purchase order might implicitly incorporate text

In a California case, a prime contractor issued a purchase order to a subcontractor. The purchase order mentioned, but did not expressly incorporate by reference, a sales quotation that the subcontractor had previously sent to the prime contractor. Further down in the purchase order, though, the P.O. language referred to "the contract documents described above or otherwise incorporated herein …." (Emphasis added.)

Applying the contra proferentem rule of contract interpretation (without using that Latin phrase) — and therefore construing the quoted term against the prime contractor — the court held that the "described above or otherwise incorporated" term had the effect of incorporating the subcontractor's sales quotation by reference into the purchase order. See Watson Bowman Acme Corp. v. RGW Construction, Inc., No. F070067, slip op. at 18, 21-22 (Cal. App. Aug. 9, 2016) (affirming, in pertinent part, judgment on jury verdict awarding damages to subcontractor). Oddly, that portion of the court's opinion was not certified for publication; the published version, which omits the discussion summarized above, is at 2 Cal. App. 5th 279, 206 Cal. Rptr. 3d 281, 283 n.* (2016) .

16.5.5 Mentioning part of a document might not incorporate it all

Drafters should pay attention to just what portion or portions of another document are being incorporated by reference. That issue made a difference in a Second Circuit case, where:

… Addendum 5 [to the contract in question] refers only to a single specific provision in [another agreement] – the non-compete clause. Where, as here, the parties to an agreement choose to cite in the operative contract only a specific portion of another agreement, we apply the well-established rule that a reference by the contracting parties to an extraneous writing for a particular purpose makes it part of their agreement only for the purpose specified.

VRG Linhas Aereas S/A v. MatlinPatterson Global Opportunities Partners II L.P., No. 14-3906-cv (2d. Cir. July 1, 2015) (nonprecedential summary order affirming denial of petition to confirm arbitration award) (cleaned up).

16.5.6 A party might deny having received referenced documents

In one Eighth Circuit case, a buyer's purchase-order form referred to an external document with additional terms and conditions, and said the document would be provided on request. In a subsequent lawsuit, however, the seller denied having ever received the additional document. That led to (what had to have been) an expensive court fight over whether an arbitration provision and an indemnification provision were part of the contract. The case presents a nice illustration of the Battle of the Forms; the Eighth Circuit ruled that the district court should have conducted a bench trial (there having been no jury demand) to make findings of fact about just who had received what contract documents, and therefore just what terms were or were not part of the parties' contract under UCC § 2-207. See Nebraska Machinery Co. v. Cargotec Solutions, LLC, 762 F.3d 737 (8th Cir. 2014).

Lesson: It's understandable that the buyer didn't want the hassle and expense of having to provide a hard copy of its additional terms and conditions form with every purchase order. Merely offering to provide a copy of the form, though, might well have been insufficient to bind the seller to its terms. The buyer could have put itself in a stronger position in court if it had posted the form on its Web site and then included a link to the form in its printed purchase order.

16.5.7 Provisions after signatures should be clearly incorporated

In a Kentucky case, a for-profit school used a one-page contract. The basic terms and signature blocks were on the front of the page; additional terms and conditions — including an arbitration provision — were on the back of the page, as part of what the state supreme court described as "a sea of plain-type provisions dealing with tuition refunds, curriculum changes, … and arbitration." (Emphasis in original.) Citing a state statute requiring signatures to be at the end of an agreement, the supreme court said that the arbitration clause was not part of the school's agreement. Dixon v. Daymar Colleges Group, LLC, 483 S.W.3d 332, 345-46 (Ky. 2015) (affirming denial of motion to compel arbitration).

16.5.8 Incorporation fits with an entire-agreement clause

The Seventh Circuit rejected an argument that incorporation by reference negated a contract's entire-agreement clause. See Druckzentrum Harry Jung GmbH & Co. v. Motorola Mobility LLC, 774 F.3d 410, 416 (7th Cir. 2014) (affirming take-nothing summary judgment in favor of Motorola on Druckzentrum's claims for breach of contract and fraud).

16.6 Exercises and discussion questions

17 Limitations of liability

Limitation-of-liability provisions usually rank at or near the top of the annual surveys done by World Commerce & Contracting (formerly the International Association for Contract and Commercial Management), a global nonprofit trade association, concerning the most-frequently-negotiated contract terms. Ironically, the same surveys indicate that contract professionals fervently wish they could spend their time negotiating collaborative provisions, to try to keep trouble from happening, instead of liability provisions, for when trouble does come to pass. See Most Negotiated Terms Report - 2020 (WorldCC.com).

The root of the complaint is often the generic one-size-fits-all limitation of liability clause. It's true that negotiators do sometimes debate whether particular types of damage (e.g., damages covered by an indemnity obligation) should be carved out entirely from the damages cap. But that's a false dichotomy; it assumes, for no reason, that a given type of damages will be either subject to the 'default' cap, or not subject to any cap at all.

This section offers suggestions to help parties come to a reasonable compromise about limitations of liability.

17.1 Try risk‑by‑risk limitations of liability

Contract drafters can often speed up discussions of liability limitations by breaking up generic boilerplate language into more-concrete statements of risks that are of particular concern, which the parties can focus on more readily.

One technique that works well is to list specific categories of risk and, for each category, state what if any liability limits are agreed. The categories of risk could include, for example, the following:

  • Personal injury
  • Tangible damage to property (not including erasure, corruption, etc., of information stored in tangible media where the media are not otherwise damaged)
  • Erasure, corruption, etc., of stored information that could have been avoided or mitigated by reasonable back-ups
  • Other erasure, corruption, etc., of stored information
  • Lost profits from any of the above
  • Lost revenue from any of the above
  • Indemnity obligations
  • Infringement of another party's IP rights (including without limitation rights in confidential information)
  • Willful, tortious destruction of property (including without limitation intentional and wrongful erasure or corruption of computer programs or -data)

To be sure, if the non-drafting party won't care much about the limitation of liability anyway, then including such detailed limitation language could actually hinder the overall negotiations.

But remember, by hypothesis we're talking about contract negotiations in which the limitation language is indeed going to be carefully negotiated — in which case this kind of systematic approach will almost always make sense.

17.2 Negotiate variable limitations of liability?

Exclusions of consequential damages (see [LINK NEEDED]) and damage-cap amounts (see [LINK NEEDED]) don't necessarily have to be carved in stone for all time. The parties could easily agree to vary them, either as time passed or as circumstances changed.

Example: Suppose that: • A software vendor is negotiating an enterprise license agreement with a new customer for a mature software package. • The customer has successfully completed a pilot project, but it hasn't rolled out the software for enterprise-wide production use. • Knowing how tricky a production roll-out can sometimes be, the customer is concerned about the vendor's insistence on excluding all 'consequential' damages, whatever that really means. See the commentary to Tango Clause 22.35 - Consequential Damages Exclusion for a review of the difficulty of determining what constitutes "consequential damages."

Our vendor might try offering to waive the consequential-damages exclusion during, say, the customer's first three months of production use of the software, subject to an agreed dollar cap on the vendor's aggregate liability for all damages — which might be a higher dollar amount than at other times, as discussed below. This approach could make the customer more comfortable that the vendor is 'standing behind its software' during the roll-out phase.

In theory, certainly, the vendor would be exposed to additional liability risk during those first three months. But the business risk might be eminently worth taking. Remember, we're assuming that the software is mature, that is, most of its significant bugs have already been corrected. This means that the vendor might be willing to take on the additional theoretical risk — which in any case would go away after three months — in order to help close the sale.

Example: As another illustration, perhaps such a vendor could agree that the damages cap would be, say: 4X for any damages that arise during, say, the first three months of the relationship, or possibly until a stated milestone has been achieved; 3X during the nine months thereafter; and 2X thereafter.

In the 4X / 3X / 2X language, X could be defined: • as a stated fixed sum; • as the amount of the customer's aggregate spend under the contract in the past 12 months, 18 months, etc.; • in any other convenient way.

The details in the above examples aren't important. The point is that sometimes 'standard' limitation-of-liability language is too broad to allow the parties to specify what they really need. Negotiators might have more success if they drilled down into the language.

17.3 Discussion questions: Limitations of liability

  1. QUESTION: What could happen in some jurisdictions if an exclusive remedy were to "fail of its essential purpose"?
  2. QUESTION: What are some common limitations of liability that are seen in contracts?

18 Exclusive remedies

18.1 Defect correction can be an "exclusive remedy" …

Under section 2-719 of the [U.S.] Uniform Commercial Code, a contract for the sale of goods can specify that a remedy is exclusive (but there are restrictions and exceptions to that general rule).

A real-world example of this supplier approach was the BAE v. SpaceKey case:

  • A supplier delivered lower-quality integrated circuits ("ICs") to a customer than had been called for by their contract. The supplier had previously alerted the customer in advance that the ICs in question would not conform to the agreed specifications; the customer accepted the ICs anyway. (The customer later asserted that it assumed the supplier would reduce the price.)
  • The customer refused to pay for the nonconforming ICs.
  • The supplier terminated the contract and sued for the money due to it.
  • The customer counterclaimed — but it did not first invoke any of the contract's specified remedies, namely repair, replace, or credit (as opposed to refund).

For that reason, the trial court granted, and the appellate court affirmed, summary judgment in favor of the supplier. See BAE Sys. Information & Electr. Sys. Integration, Inc. v. SpaceKey Components, Inc., 752 F.3d 72 (1st Cir. 2014).

18.2 But failure of "exclusive" remedies might blow the doors open

Providing the right to a refund as a fail-safe "backup" remedy might be crucial in case other agreed remedies fail. Consider that UCC § 2-719(2) provides: "Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this Act."

(True, UCC article 2 applies only to the sale of goods, of course, but courts have sometimes looked to article 2 for guidance in non-goods cases.)

In other words, if providing a correction or workaround for a defect is the customer's exclusive remedy, but the provider is unable to make good on doing so, then in some jurisdictions all limitations of liability might be out the window, including for example an exclusion of consequential damages or a cap on damages.

Teton Dam failure
Photo: U.S. Dept. of Interior - Bureau of Reclamation.0

See, e.g., John F. Zabriskie, Martin J. Bishop, and Bryan M. Westhoff, Protecting Consequential Damages Waivers In Software License Agreements (2008).

For a now-dated student note reviewing case law in this area, see Daniel C. Hagen, Sections 2-719(2) & 2-719(3) of the Uniform Commercial Code: the Limited Warranty Package & Consequential Damages, 31 Val. U. L. Rev. 111, 116-18 (1996).

19 Business planning

[Note to the author's law students: You can just skim this chapter; you won't be tested on it, but you might find it useful.]

19.1 Introduction

If you don't know where you're going, you might not get there. – Yogi Berra.

Be Prepared. – Boy Scout motto.

Plans are worthless; planning is everything. – Dwight D. Eisenhower.

[N]o plan of operations extends with any certainty beyond the first contact with the main hostile force. – Helmuth von Moltke the Elder (often paraphrased as "no plan survives first contact with the enemy").

19.1.1 Stephen Colbert proves the benefits of thinking ahead

Stephen Colbert

Stephen Colbert and his agent showed that there's more to contract drafting than just putting words on the page: They planned ahead, setting up Colbert's contracts with Comedy Central so that the contracts would expire at the same time as David Letterman's contracts with CBS. That way, if Letterman ever decided to retire, Colbert would be able to leave the Comedy Central show that made him famous, The Colbert Report, and throw his hat in the ring to take over Letterman's The Late Show on CBS. See Bill Carter, Colbert Will Host ‘Late Show,' Playing Himself for a Change, New York Times, Apr. 11, 2014, at A1.

This worked out well for both Colbert and CBS — in 2019, they agreed to a three-year contract extension through 2023; a New York Times article commented that "The move was a no-brainer for CBS. Mr. Colbert is, by far, the most-watched late-night host." John Koblin, Stephen Colbert Signs a New ‘Late Show’ Deal Through 2023 (NYTimes.com Oct. 17, 2019).

19.1.2 Danger: Hope is not a plan

Wishful thinking can be dangerous, but some people are prone to it — including business people. Contract negotiators should keep this in mind in brainstorming scenarios and action plans.

Example: Where will the money come from? When drafting a critical contract obligation for the other side — for example, an indemnity obligation — consider imposing additional requirements to be sure that there's money somewhere to fund the obligation, such as:

  • an insurance policy;
  • a third-party guaranty;
  • a letter of credit from a bank or other financial institution;
  • or even taking a security interest in collateral that could be seized and sold to raise funds.

Apropos of wishful thinking, there's an old joke about economists that seems to have been first published in 1970:

  • A physicist, a chemist, and an economist are shipwrecked on a desert island with nothing to eat.
  • A pallet full of cans of food washes up on the beach, but the castaways have no tools with which to open the food cans.
  • The physicist and the chemist each propose ingenious but complicated mechanisms to open the cans, using the materials at hand.
  • The economist has a simpler solution: "We'll assume we have a can opener." See Wikipedia, Assume a can opener, quoting Kenneth E. Boulding, Economics as a Science at 101 (McGraw-Hill 1970).

19.1.3 Example: Tesla's supply-chain issues

Here are some dangers that a company can encounter: (1) Not getting paid; (2) not being able to build your product because your suppliers won't supply you with parts unless you pay cash on delivery (C.O.D.); (3) having a supplier go out of business because you didn't pay them. From a Bloomberg story:

… [A short-seller of Tesla stock] said her firm sees some suppliers to Tesla filing for bankruptcy, which poses particular risk to the carmaker because many of its components are single-sourced.  * * *

The Wall Street Journal reported in August on an Original Equipment Suppliers Association survey of executives that found most respondents believed Tesla posed a financial risk to their companies. Some small suppliers claimed in the previous several months that they failed to get paid, the newspaper reported, citing public records.

Gabrielle Coppola, Tesla Short Seller Warns of ‘Massive’ Supply-Chain Disruption, Bloomberg.com, Oct. 19, 2018.

19.2 "Hey, you: Learn the business!" OK, fine — but how?

One of the big complaints clients have about lawyers is that "they just don't understand the business."  But it's singularly unhelpful to just say to a lawyer: Hey, you: Learn the business! The beneficiary of such advice might not know what to do to make that happen.

Neither is it particularly useful to add, Just ask questions! It might not be obvious what questions should be asked.

So, this chapter presents a series of questions, with handy mnemonic acronyms, to help contract professionals and their clients:

  • identify threats and opportunities that might need to be addressed in a contract;
  • develop action plans to prepare for and respond to those threats and opportunities; and
  • flesh out the details of the desired actions;

all with the goal of drafting practical contract clauses.

19.3 T O P   S P I N: Identifying threats and opportunities

h-diagram

The acronym T O P   S P I N can help planners to identify threats and opportunities of potential interest. (The acronym is inspired by the business concept of SWOT analysis, standing for Strengths, Weaknesses, Opportunities, and Threats.)

The first part of the acronym, T O P, refers to the threats and opportunities that can arise in the course of the different phases of the parties' business relationship. (Those phases can themselves be remembered with the acronym S N O T S: Startup; Normal Operations; Trouble; and Shutdown.)

The second part of the acronym, S P I N, reminds us that various threats and opportunities can be presented by one or more of the following:

• S: The participants in the respective supply chains in which the contracting parties participate, both as suppliers and as customers, direct and indirect. If the parties are "Alice" and "Bob," then we can think of Alice's and Bob's respective supply chains as forming a capital letter H, as illustrated below:

• P: The individual people involved in the supply chains — all of whom have their own personal motivations and interests;

• I: Interveners such as competitors; alliance partners; unions; governmental actors such as elected officials, regulators, taxing authorities, and law enforcement; the press; and acquirers. Don't forget the individual people associated with an intervener, all of whom will have personal desires, motives, and interests; Political issues can raise their heads; for example, in 2019, convention organizers attracted attention for inserting "morals clauses" into their contracts: "Organizations will not bring events to Texas if [anti-LGBTQ] discriminatory bills become law, and most convention contracts allow organizers to cancel if such laws take effect." Chris Tomlinson, Bigot bills would damage Texas economy, Houston Chronicle, April 3, 2019, page B1, at B7 col. 2 (emphasis added).

• N: Nature, which can cause all kinds of threats and opportunities to arise in a contract relationship.

ICE-CREAM EXAMPLE:  Mother Nature might create a threat — and an opportunity for competitors —  if an ice-cream manufacturer's products were to become contaminated with listeria bacteria (as happened in 2015 to famed Texas dairy Blue Bell). See the U.S. Department of Justice press release, Blue Bell Creameries Agrees to Plead Guilty and Pay $19.35 Million for Ice Cream Listeria Contamination – Former Company President Charged (May 2020).

19.4 I N D I A   T I L T: Deciding on responsive actions

Once planners have compiled a list of threats and opportunities of interest, they should think about the specific actions that might be desirable — or perhaps specific actions to be prohibited ­— when a particular threat or opportunity appears to be arising. Many such actions will fall into the following categories:

• I: Information to gather about the situation in question;

• N: Notification of others that the threat or opportunity is (or might be) arising. Refer to the SPIN part of the TOP SPIN acronym above for suggestions about players who might be appropriate to notify.

• D:  Diagnosis, i.e., confirmation that the particular threat or opportunity is real, as opposed to being an example of some other phenomenon (or just a false alarm).

• I: Immediate action, e.g., to mitigate the threat or to seize the opportunity.

• A: Additional actions, e.g., to remediate adverse effects or take advantage of the opportunity.

ICE-CREAM EXAMPLE:  Consumers have been known to become ill, and a few have died, after eating ice cream that, during manufacturing, became contaminated with listeria bacteria. The grocery store's planners might want to use the I N D I A checklist to specify in some detail how the ice-cream manufacturer is to respond to such reports, with requirements for notifying the grocery store; product recalls; and so on.

Some plans are likely to require advance preparation. Planners can use the T I L T part of the acronym to decide whether any of the following might be appropriate:

• T:  Acquisition of tools — such as equipment, information, consumables, etc. — for responding to the threat or opportunity.

• I:  Acquisition of insurance (or other backup sources of funding).

• L: Posting of a lookout, that is, putting in place a monitoring system to detect the threat or opportunity in question.

• T:  Training of the people and organizations who might be called on to respond to the threat or opportunity.

19.5 W H A L E R analysis: Fleshing out the action plans

In specifying actions to be taken, planners will often want to go into more detail than just the traditional 5W + H acronym (standing for Who, What, When, Where, Why, and How). Planners can do this using the acronym W H A L E R:

• W:  Who is to take (or might take, or must not take) the action.

• H:  How the action is to be taken, e.g., in accordance with a specified industry standard.

• A:  Autonomy of the actor in deciding whether to take or not take the action.  Depending on the circumstances, this might be:

  • No autonomy:  The action in question is either mandatory or prohibited, with nothing in between.
  • Total autonomy:  For the action in question, the specified actor has sole and unfettered discretion as to whether to take the action.
  • Partial autonomy:  The decision to take (or not take) the action must meet one or more requirements such as:
    • Reasonableness — be careful: that can be complicated and expensive to litigate;
    • Good faith — ditto;
    • Notification of some other player, before the fact and/or after the fact;
    • Consultation with some other player before the fact; or
    • Consent of some other player (but is consent not to be unreasonably withheld?  A claim of unreasonable withholding of consent could itself be one more thing to litigate.)

• L:  Limitations on the action — for example, minimums or maximums as to one or more of time; place; manner; money; and people.

• E:  Economics of the action, such as required payment actions (each of which can get its own W H A L E R analysis), and backup funding sources.

• R:  Recordkeeping concerning the action in question (with its own W H A L E R analysis).

19.6 The "bow tie method": A diagrammatic approach

A more-complicated approach to identifying and planning for risks is the so-called "bow tie" method, developed by oil-and-gas giant Shell and later adopted in other industries. See, e.g., the detailed explanation (with examples) in Julian Talbot, Risk BowTie Method (JulianTalbot.com 2020), archived at https://perma.cc/ATN7-FGAU; see also the Hacker News discussion at https://news.ycombinator.com/item?id=24130809.

The bowtie method of diagramming risks and consequences is reminiscent of Feynman diagrams in the world of physics. See generally, e.g., Frank Wilczek, How Feynman Diagrams Almost Saved Space (QuantaMagazine.org 2016). (Wilczek is a Nobel Prize-winning physicist and MacArthur Foundation "genius grant" recipient who was a colleague of Richard Feynman.)

19.7 Finally, ask the investigator's all-round favorite question

When I was a baby lawyer at Arnold, White & Durkee, I worked a lot with partner Mike Sutton. One of the many things Mike taught me was that when interviewing or deposing a witness, a useful, all-purpose question consists of just two words:  Anything else?

That same question can likewise help contract planners get some comfort that they've covered the possibilities that should be addressed in a draft agreement.

19.8 Term sheet drafting tips

Here are some basic tips for drafting a term sheet to accompany a Tango email agreement.

  • Short sentences are best.
  • One (short) sentence per paragraph is best.
  • Be very clear who is responsible for doing what, when. As the business cliché puts it: Whose throat gets choked?
  • Specify any relevant time frames such as:
    • deadlines;
    • earliest- and latest start dates; and/or
    • maximum- or minimum time periods.
  • Fences: Spell out any relevant restrictions or limitations. For example: If payments must be made by wire transfer, then say so.
  • If a party is or will be relying on information provided by another party, then say so.
  • Bullet points are fine as long as they're clear.
  • Hypothetical examples can be really useful to illustrate points and educate future readers, such as:
    • business people who need to get up to speed;
    • judges and jurors.
  • Diagrams? Tables? Flow charts? Footnotes? Why not — when in doubt, serve the reader.

20 Most-favored customer

20.1 Examples of most favored customer language

Section 12 of a Honeywell purchase order terms-and-conditions document, archived at https://perma.cc/CUV6-NKTY, sets forth a fairly-typical most-favored-customer clause ("MFC") clause and price-reduction clause ("PRC").

12. Price: Most Favored Customer and Meet or Release

[a] Supplier warrants that

  • the prices charged
  • for the Goods delivered under this Purchase Order
  • are the lowest prices charged by Supplier
  • to any of its external customers
  • for similar volumes of similar [sic] Goods.

[b] If Supplier charges any external customer a lower price for a similar volume of similar Goods, Supplier must

  • notify Honeywell
  • and apply that price to all Goods ordered under this Purchase Order.

[Comment: The above language does not limit the price-reduction obligation to goods ordered in the future; Honeywell could try to argue that the obligation applied retroactively as well, requiring refunds for past orders. A court, however, might interpret the language as limited to future orders, under the contra proferentem principle discussed in § 8.4.2.]

[c] If at any time before full performance of this Purchase Order

  • Honeywell notifies Supplier in writing
  • that Honeywell has received a written offer from another supplier
  • for Goods similar [sic] to those to be provided under this Purchase Order
  • at a price lower than the price set forth in this Purchase Order,
  • Supplier must immediately meet the lower price for any undelivered Goods.

If Supplier fails to meet the lower price Honeywell, at its option, may terminate the balance of the Purchase Order without liability.

(Extra paragraphing, bullets, and bracketed text added.)

In a Notre Dame Law Review article, two Skadden Arps lawyers offer other examples of MFC language:

• "Contractor warrants that the price(s) are not less favorable than those extended to any other customer (whether government or commercial) for the same or similar articles or services in similar quantities."

•  "The Contractor certifies that the prices, warranties, conditions, benefits and terms are at least equal to or more favorable than the prices, warranties, conditions, benefits and terms quoted by the Contractor to any customers for the same or a substantially similar quantity and type of service."

•  "The Contractor warrants that prices of materials, equipment and services set forth herein do not exceed those changed by the Contractor to any other customer purchasing the same goods or services under similar conditions and in like or similar quantities."

Mitchell S. Ettinger and James C. Altman, Compliance with Most Favored Customer Clauses: Giving Meaning to Ambiguous Terms While Avoiding False Claims Act Allegations, 90 Notre Dame L. Rev. Online 1, 4-5 (2015).

20.2 Dangers of a most-favored-customer clause for suppliers

For a supplier, a most-favored-customer clause and price-reduction clause in a customer contract can be both dangerous and a major compliance burden. For example, in 2011, the software giant Oracle Corporation paid just shy of $200 million to settle a U.S. Government lawsuit — sparked by a whistleblower claim — that Oracle had overbilled the Government by knowingly charging federal customers more than allowed by an MFC clause in Oracle's federal-government contract over some eight years; according to the Department of Justice. See U.S. Department of Justice, Oracle Agrees to Pay U.S. $199.5 Million to Resolve False Claims Act Lawsuit - Largest False Claims Act Settlement Obtained by General Services Administration (Justice.gov Oct. 6, 2011) (extra paragraphing added). See generally Andrew Harris and David Voreacos, Oracle Settles U.S. Agency Overbilling Case for $199.5 Million (Bloomberg.com Oct. 6, 2011) (paywalled), which says in part: "The U.S. …. claimed Oracle gave companies discounts of as much as 92 percent, while the government’s cuts ranged from 25 to 40 percent."

The Oracle-employee whistleblower who reported the breach to the government collected $40 million, according to the DOJ press release linked above.

The case also attracted class-action plaintiffs, who sued Oracle and the members of its board directors. Various class-action lawsuits were consolidated in the Northern District of California; the cases were apparently settled on terms requiring that Oracle adopt some corporate-governance measures and pay $1.9 million in attorney fees. See Jessica Dye, Oracle investor sues over $200 million settlement (Reuters.com 2012).; Stipulation of Settlement, In re Oracle Corp. Deriv. Litigation, No. C-11-04493-RS (May 28, 2013). (The present author has not been able to confirm positively that the stipulation of settlement was approved by the court.)

In another case in which the present author's former law firm was involved, semiconductor chip maker Texas Instruments settled its patent-infringement lawsuit with Samsung in part because Samsung discovered that Texas Instruments had breached a most-favored-licensee provision in a previous patent-license agreement between the two companies — according to Samsung, when the parties had negotiated the previous license agreement, TI had fraudulently told Samsung that Samsung was getting as good a deal as any other TI licensee for the relevant patent, when apparently that proved not to be the case. See Evan Ramstad, Texas Instruments Reaches Agreement With Samsung (WSJ.com Nov. 27, 1996), archived (behind paywall) at https://perma.cc/PAC5-9VNU; David Beck, The Trial Lawyer: What it Takes to Win at 235-36 (American Bar Association 2006), excerpt at https://goo.gl/ad33DQ.

Both the danger and the compliance burden arise from the fact that business people doing transactions with other customers often won't remember that they must comply with the MFC and PRC clauses in the earlier customer contract. And if the business people do remember the MFC and PRC clauses, they might choose to ignore it, to roll the dice that they won't get caught.

Violating the MFC clause in a U.S. Government contract (a "GSA schedule") can lead to severe consequences, possibly including "government claims, prosecution under the False Claims Act (FCA), terminations for cause and suspensions and debarments to name a few. Most Favored Customer Clause (GovContractAssoc.com, undated).

20.3 Dealing with customer MFC requests

When a customer asks a supplier for an MFC commitment, the supplier can try to limit the commitment. For example:

• Try to limit the MFC commitment to pricing currently offered to other customers, without a "lookback" to prior sales.

• Try to avoid a future price-reduction obligation of the kind seen in paragraph [b] of the Honeywell language quoted above.

• Include limiting qualifiers for "same" and "similar" products and services.

• Limit the universe of other customers that are used for comparison — as an (absurd) illlustrative example, an MFC clause could say something like, "This is the best pricing we're offering today to companies headquartered in Montana whose corporate names begin with the letter 'Y.'" (This brings to mind a line from a Kingston Trio concert album that the present author listened to as a teenager: "We'd like to introduce one of the finest bass players on stage at this time.")

A U.S. Government manual for contracting officers (purchasers) sets out some factors that suppliers can use to try to limit an MFC clause:

(e) When establishing negotiation objectives and determining price reasonableness, compare the terms and conditions of the … solicitation with the terms and conditions of agreements with the offeror’s commercial customers.

When determining the Government’s price negotiation objectives, consider the following factors:

(1) Aggregate volume of anticipated purchases.

(2) The purchase of a minimum quantity or a pattern of historic purchases.

(3) Prices taking into consideration any combination of discounts and concessions offered to commercial customers.

(4) Length of the contract period.

(5) Warranties, training, and/or maintenance included in the purchase price or provided at additional cost to the product prices

(6) Ordering and delivery practices.

(7) Any other relevant information, including differences between the … solicitation and commercial terms and conditions that may warrant differentials between the offer and the discounts offered to the most favored commercial customer(s).

For example, an offeror may incur more expense selling to the Government than to the customer who receives the offeror’s best price,

or the customer (e.g., dealer, distributor, original equipment manufacturer, other reseller) who receives the best price may perform certain value-added functions for the offeror that the Government does not perform.

In such cases, some reduction in the discount given to the Government may be appropriate.

If the best price is not offered to the Government, you should ask the offeror to identify and explain the reason for any differences.

Do not require offerors to provide detailed cost breakdowns.

General Services Acquisition Manual § 538.270 (acquisition.gov) (emphasis and extra paragraphing added).

• Develop a protocol for cross-checking pending transactions against MFC requirements; train relevant personnel to use the protocol. See Ettinger and Altman, supra, at 11; see also id. at part III (other suggestions for dealing with customer requests for MFC clauses).

20.4 Additional reading about MFC clauses

See generally:

21 Selected special topics

21.1 Acceleration of due date

An "acceleration clause" is a term in a contract that requires a party to make payments on a specified schedule; the term allows the payee to demand (typically) immediate payment in full, sometimes known in loan documents as "calling the loan." See generally Acceleration Clause (Investopedia.com)

Example: A promissory note might include loan covenants that require the borrower to refrain from taking certain actions. If the borrower were to violate those covenants, then the lender would have the right to accelerate the due date of future payments and demand full payment. If the borrower were unable to make full payment (as is often the case), then the lender would have the right to demand payment from guarantors (if any) and/or to start foreclosure proceedings against any collateral pledged to secure the promissory note.

21.2 Background section in settlement agreements

When parties enter into an agreement to settle a dispute, it can be really advantageous for the agreement's background section to be clear that the parties were not relying on each other's representations; they could use language such as Tango Clause 22.133 - Reliance Waiver for that purpose. Doing so can help to forestall at least some subsequent fraud claims. Cf. Pappas v. Tzolis, 20 N.Y.3d 228, 982 N.E.2d 576, 958 N.Y.S.2d 656 (2012) (plaintiff's own pleadings made it clear that it would not have been reasonable for plaintiff to rely on defendants' alleged fraudulent statements). See also the Tango Terms commentary concerning reliance disclaiers.

21.3 Flowdown requirements

The term flowdown can be relevant when a contract is between a customer and a so-called "prime" contractor that is expected to use subcontractors. The prime contract might require the prime contractor:

  • to comply with various requirements concerning confidentiality, safety, and the like; and
  • to include some or all of those requirements in subcontracts — these are referred as "flowdown" clauses.

For government contracts, depending on the law, a subcontractor could be subject to specific requirements imposed by statute or regulation, for example:

  • equal-opportunity reporting requirements;
  • affirmative-action obligations;
  • prohibitions of various employment practices;
  • restrictions of various kinds, e.g., on assignments;
  • failure to keep required records.

See generally, e.g., Robin Shea, Applicant tracking and the EEOC: "You can SUE us for that?" (EmploymentAndLaborInsider.com 2016).

Flowdown requirements are often seen in U.S. Government contracts under the Federal Acquisition Regulations (FARs) and Defense Federal Acquisition Regulations (DFARs). For a few examples of actual flowdown clauses, see Kaiser Permanente, Federal Flow‐Down Requirements for Vendors, Contractors and Suppliers (2018), archived at https://perma.cc/AEZ4-L3ML.

In U.S. Government contracts, under the so-called Christian doctrine from 1963, a flowdown clause required by federal regulations might — as a matter of law — be deemed included in a subcontract, even if the subcontract itself didn't actually include the flowdown clause. The Federal Circuit explained in 2018: "For a court to incorporate a clause into a contract under the Christian doctrine, it generally must find (1) that the clause is mandatory; and (2) that it expresses a significant or deeply ingrained strand of public procurement policy." K-Con, Inc. v. Sec'y of the Army, 908 F.3d 719, 724 (Fed. Cir. 2018) (affirming administrative decision that flowdown clause was deemed incorporated in subcontract), citing G.L. Christian & Assoc. v. United States, 312 F.2d 418, 424-27 (Ct. Cl. 1963). See generally, e.g., Jack Delman, Protecting a Forgetful Government – "Christian Doctrine" Alive and Well! (2019), archived at https://perma.cc/Q4DS-L4VK.

To help parties avoid being ambushed by undisclosed flowdown requirements, the Tango Terms "Government Subcontract Disclaimer" can be included in a contract.

21.4 Hollywood accounting

Suppose that Party A and Party B agree that A will share in the profits from B's business — after Party B deducts its expenses. This type of "net profit" is common in movie- and TV-series production deals, where actors, producers, and others get (percentage) "points" that can add up to large sums over time. See generally Wikipedia, Hollywood Accounting.

Obviously, in this type of arrangement, Party B has an incentive to take as many deductions from gross revenue as it can, to try to minimize its payout to Party A. That can produce bizarre results, as illustrated in the following examples.

Return of the Jedi logo

Example: Return of the Jedi. In 2009, actor David Prowse, a.k.a. Darth Vader in the Star Wars films, said that Lucasfilms had notified him that Return of the Jedi had still not made a profit, some 26 years after its initial release and grossing nearly half a billion dollars on a $32 million budget. (And that was probably before the incessant replaying of the film on cable TV.) See Derek Thompson, How Hollywood Accounting Can Make a $450 Million Movie 'Unprofitable' (TheAtlantic.com 2009).

An online commenter once opined that in Hollywood, net points "are about as valuable, and confer as much status, as collecting beads for taking your top off at mardi gras. Everyone gets them and they're never worth anything." Gabriel Snyder, How Movie Stars Get Paid (Gawker.com 2009). (The Snyder piece provides a readable overview of how movie deals supposedly work for actors.)

For more examples, see Wikipedia, Hollywood Accounting.

21.5 Inspections: Why they're worthwhile

Most people try to live up to their commitments. But it might be unwise to count on that, because sometimes, people —

  • can get in over their heads;
  • can misunderstand instructions — possibly because the people who gave the instructions didn't state them clearly;
  • can cut corners, perhaps because they'd prefer — or they're under pressure — to do other things;
  • can suffer a brain cramp, i.e., a momentary mental lapse;
  • can lie, cheat, and/or steal.

These all-too-human tendencies can have severe adverse consequences. It's not hard to find examples:

NYC crane collapse - OSHA photo

NYC building-crane collapse: Seven people were killed, and numerous others injured, in the collapse of a building crane in New York City in 2008; the accident was attributed to sloppy work on the part of workers involved in erecting the crane; both criminal charges and civil actions were brought against various people and companies. See John Eligon, Rigging Contractor Is Acquitted in the Collapse of a Crane (NYTimes.com 2010).

Olympic rings

Falsified earthquate safety data: A Japanese firm "admitted to doctoring earthquake safety data for buildings across the country, including some venues for the 2020 Tokyo Olympics." This represented "only the latest example of corner cutting and data fudging by Japanese firms. … industrial giant Kobe Steel admitted it falsified information on products sold to major brands including Boeing and Toyota, while care [sic] maker Nissan had to halt production after problems in its inspection process emerged." Junko Ogura and James Griffiths, Tokyo 2020 Olympics venues linked to earthquake safety data scandal (CNN.com Oct. 20, 2018).

Thresher photo

Submarine sinking: In 1963, the American nuclear-powered submarine USS Thresher sank, killing all 129 people aboard, likely because of defective work on non-reactor systems by shipyard workers. See generally USS Thresher (SSN 593) (Wikipedia.com).

On the financial front, cheating can have its own adverse consequences:

Volkswagen logo

Dieselgate: German car maker Volkswagen caused certain of its car models to cheat on pollution-control tests so that they would appear to be "cleaner" than they really were: For some types of diesel engine, the company designed the software that controlled the engines to detect when the engines were being tested for pollution and only then activate certain pollution controls. As of June 2020, the resulting cost to Volkswagen of recalls and legal actions had reached $33 billion and the company had pleaded guilty to criminal charges — and criminal charges had also been brought against various engineers and executives who were accused of being involved in the test-rigging. See Volkswagen emissions scandal (Wikipedia.com).

BMW logo

BMW: The German auto manufacturer BMW agreed to pay $18 million to settle charges by the U.S. Securities and Exchange Commission that the company had inflated its reported retail sales in the U.S. by:

  • "banking" (failing to report) retail sales in one period, so that those sales could be used to make up a shortfall in a later sales period;
  • paying dealers "to inaccurately designate vehicles as demonstrators or loaners so that BMW would count them as having been sold to customers when they had not been"; and
  • "improperly adjust[ing] its retail sales reporting calendar in 2015 and 2017 to meet internal sales targets or bank excess retail sales for future use."

As a result, according to the SEC, "the information that BMW provided to investors … contained material misstatements and omissions regarding BMW’s U.S. retail vehicle sales." U.S. Securities and Exchange Commission, SEC Charges BMW for Disclosing Inaccurate and Misleading Retail Sales Information to Bond Investors, press release 2020-223 (SEC.gov).

So: If you're expecting another party to a contract to live up to its commitments, consider adding inspection provisions to the contract, perhaps including incorporation of the Tango Terms "Inspections" protocol by reference.

21.6 Interest charges

It's not uncommon for contracts to allow a payee to charge interest on past-due payments. But local usury laws can cause nasty surprises — sometimes even extending to the forfeiture of all right to payment, even of the underlying amount due — if a particular charge is deemed "interest" that results in unlawful interest being charged or paid.

21.6.1 Pro tip: Is charging interest even worth it?

Is the right to charge interest even worth seeking? If you expect to get paid, it's understandable that you might want to include an interest-charges clause in your draft contract.

But whether you'll actually charge and try to collect interest is a real question. For example:

  • If you're a supplier that gets repeat business from a customer, you might hesitate to to charge interest on late payments because you don't want to annoy the customer and jeopardize the repeat business.
  • Some large customers have been known to announce, imperiously: We don't pay interest, period, and if you want our business, that's the way it is.
  • But on the other hand, some customers can be notoriously slow payers, insisting on as high as 120-day terms from their suppliers.

In the end, it's a business decision whether, on balance, a contract should include an interest-charges provision.

21.6.2 Maximum interest rate, earliest starting date?

Drafters might want to consider the following::

  1. What interest rate may be charged? In many contracts, the rate is 1.5% per month on past-due amounts, but be sure to check local usury law.
  2. When will interest begin to accrue — immediately upon an amount becoming past due, or does local law require a grace period?
  3. Will the interest rate be compounded? If so, will the compounding be quarterly? monthly? daily?

21.6.3 Caution: Usury laws have teeth

Even invoicing for unlawfully-excessive interest, or charging interest too early, can trigger civil- and even criminal usury penalties. And in some jurisdictions, if you charge interest that violates applicable law, you could end up forfeiting your claim to the entire amount owed to you, not just to that portion of the interest that exceeds the maximum amount. See generally Ross Spence, Usury and How to Avoid It: Impact of New Legislation on Collection Practices at part VI-B, pp.24-25, (SnowSpenceLaw.com; undated), which includes extensive citations to Texas case law.

But in some jurisdictions — not all — the law allows parties to reduce the chances of usury problems by agreeing in advance to take certain actions in case of unlawful interest charges. Tango Clause 22.160 - Usury Savings seeks to do so.

21.7 Liquidated damages (reading)

21.7.1 Introduction: Liquidated damages as a partial, advance settlement

One could even think of a liquidated damages clause as a partial settlement, as in cases in which damages are stipulated and trial confined to liability issues. And of course settlements are favored. —Judge Richard Posner, in XCO Int'l, Inc. v. Pacific Scientific Co., 369 F.3d 998, 1001 (7th Cir. 2004).

Relying on freedom-of-contract principles, courts in the U.S. will enforce a liquidated-damages clause if the clause genuinely represents a reasonable estimate of agreement — but not if the clause is actually a penalty (in contract law, penalties are unenforceable), disguised as an agreement to settle uncertain damages claims. See, e.g., American Consulting, Inc. v. Hannum Wagle & Cline Engineering, Inc., 136 N.E.3d 208 (Ind. 2019) (affirming, in pertinent part, summary judgment that liquidated-damages clause was unenforceable; remanding for trial of claim for actual damages).

(In theory, a liquidated-damages clause spares the parties from having to engage in expensive battles of expert witnesses about the amount of damages owed. In practice, however, parties in a contract dispute will often litigate whether a liquidated-damages clause is enforceable; that battle might eat up any savings from not having to try a damages case.)

21.7.2 "Penalties" are unenforceable …

The Supreme Court of Ohio court explained the difference between liquidated damages and penalties:

[A penalty is] a sum inserted in a contract, not as the measure of compensation for its breach, but rather as a punishment for default, or by way of security for actual damages which may be sustained by reason of nonperformance, and it involves the idea of punishment.

A penalty is an agreement to pay a stipulated sum on breach of contract, irrespective of the damage sustained. Its essence is a payment of money stipulated as in terrorem of the offending party,

  • while the essence of liquidated damages is a genuine covenanted pre-estimate of damages.

The amount is fixed and is not subject to change;

  • however, if the stipulated sum is deemed to be a penalty, it is not enforceable
  • and the nondefaulting party is left to the recovery of such actual damages as he can prove.

Boone Coleman Constr., Inc. v. Village of Piketon, 2016 Ohio 628 (Ohio), ¶ 17 (reversing holding that liquidated-damages clause in a public road construction contract was an unenforceable penalty; edited), on remand, 2016 Ohio 1557 (Ohio App.).

21.7.3 … but just saying "it's not a penalty!" probably won't work

Some liquidated-damages provisions say that the breaching party will pay, as liquidated damages and not as a penalty, a stated (or computable) amount. Many courts tend to ignore such self-serving exculpatory language. See, e.g., Purcell v. Schweitzer, 224 Cal. App. 4th 969, 974 169 Cal. Rptr. 3d 90 (2014).

21.7.4 There must be a reasonable correlation with actual damages

The New York Court of Appeals (that state's highest court) affirmed the unenforceability of a liquidated-damages provision:

Under our well-established rules of contract, the Surrender Agreement’s liquidated damages provision does not fairly compensate plaintiff for defendant’s delayed installment payments. The provision calls for a sum more than sevenfold the amount due if defendant had complied fully with the Surrender Agreement. We cannot enforce such an obviously and grossly disproportionate award without offending our State’s public policy against the imposition of penalties or forfeitures for which there is no statutory authority.

Trustees of Columbia Univ. v. D'Agostino Supermarkets, Inc., 2020 NY Slip Op 06937 (N.Y. Nov. 24, 2020) (cleaned up, emphasis added).

As an example of what not to do, in an Indiana case, the state supreme court affirmed striking down the liquidated-damages clauses in question for breach of an employment agreement's post-employment covenant in which the employee agreed not to solicit the employer's customers or recruit the employer's employees; the court summarized those clauses:

He agreed that if he breached this agreement and such a breach resulted in termination, withdrawal or reduction of a client's business with ASI, he would pay liquidated damages in an amount equal to 45% of all fees and other amounts that ASI billed to the customer during the twelve months prior to the breach.

The contract further precluded Knowles from causing an employee to end their employment with ASI, and if he breached this provision, he agreed to pay liquidated damages equal to 50% of the employee's pay from ASI during the twelve months prior to the breach.

Day and Lancet, who were both resident project representatives at ASI, also executed agreements that precluded them from hiring or employing ASI employees. They agreed that if they breached their agreements, they would pay liquidated damages in an amount equal to 100% of that employee's pay from ASI during the twelve months prior to breach.

See, American Consulting, Inc. v. Hannum Wagle & Cline Eng'g, Inc., 136 N.E.3d 208, 209-10 (Ind. 2019) (affirming, in pertinent part, summary judgment that liquidated-damages clause was unenforceable; remanding for trial of claim for actual damages) (quotation altered). The court did not see much correlation between the liquidated damages and the actual damages that the non-breaching party was likely to have suffered; see id. at 212.

21.7.5 Caution: Don't be ridiculous — in hindsight

Continuing the theme explored above: It can be dangerous to set a liquidated-damages amount that — in hindsight — ends up being ridiculously disproportionate to the "real" damages. In 2014 the Supreme Court of Texas held that:

  • actual damages must be difficult to estimate, and the agreed liquidated damages must be a reasonable forecast of the actual damage; but also:
  • if in practice the actual damages and the agreed liquidated damages end up being too far apart, then the liquidated-damages provision will be struck down as a penalty.

In that case, the supreme court noted that the highest actual damages supported by the evidence was $6 million, but the liquidated-damages amount assessed by the court below was $29 million. The court said that this was an unacceptable disparity: "When the liquidated damages provisions operate with no rational relationship to actual damages, thus rendering the provisions unreasonable in light of actual damages, they are unenforceable." FPL Energy, LLC, v. TXU Portfolio Management Company, L.P., 426 S.W.3d 59,69-70, 72 (Tex. 2014) (reversing court of appeals and holding that liquidated-damages provision was unenforceable) (emphasis added, citations omitted).

To like effect, the Seventh Circuit rejected a claim for liquidated damages for breach of a confidentiality provision in a settlement agreement. • The liquidated-damages provision required a payment of $10,000 for each unauthorized disclosure of the terms of the settlement agreement. • The party accused of breaching the confidentiality provision had included detailed information about the settlement in a franchise disclosure document that was distributed to about 2,000 people, not all of whom were required by law to be given a copy. • The plaintiff sued for liquidated damages of 2,000 times $10,000, or $20 million.

Applying Texas law, the trial court held that this was unreasonable, because the plaintiff had not proven that she had suffered any harm at all, let alone $20 million worth. The Seventh Circuit affirmed; Judge Posner said that, "when there is an unbridgeable discrepancy between liquidated damages provisions as written and the unfortunate reality in application, we cannot enforce such provisions." Caudill v. Keller Williams Realty, Inc., 828 F.3d 575, 577 (7th Cir. 2016) (internal quotation marks and citation omitted), quoting FPL Energy, supra; see also Atrium Medical Center, LP v. Houston Red C LLP, 595 S.W.3d 188, 198 (Tex. 2020) (affirming court of appeals).

Notice the "hill of proof" here:

  • The plaintiff first must "get up the hill" (discussed at Section 13.3: ) by showing what things looked like to the parties at the time the agreement was made;
  • If the plaintiff is successful, the defendant can still try to "force the plaintiff off the hill" by showing that as things turned out, there was an "unbridgeable discrepancy."

21.7.6 But some judges argue: No Monday-morning quarterbacking

In contrast to the holdings discussed above, some courts discourage the use of hindsight in assessing liquidated-damages provisions in public-works contract. For example, the Ohio supreme court explained:

{¶ 35} We reaffirm that Ohio law requires a court, when considering a liquidated-damages provision, to examine it in light of what the parties knew at the time the contract was formed.

If the provision was reasonable at the time of formation and it bears a reasonable (not necessarily exact) relation to actual damages, the provision will be enforced.

{¶ 36} This prospective or "front end" analysis of a liquidated-damages provision focuses on the reasonableness of the clause at the time the contract was executed rather than looking at the provision retrospectively, i.e., ascertaining the reasonableness of the damages with the benefit of hindsight after a breach.

The prospective approach properly focuses on whether[:]

(1) the parties evaluated, at the time of contract formation, the probable loss resulting from delay in completing the construction,

(2) the parties clearly intended to use liquidated damages in case of a delay because actual damages would be difficult to ascertain, and

(3) [in per-diem cases,] the parties reached an agreement as to a per diem amount for delays.

[P]rospective analysis resolves disputes efficiently by making it unnecessary to wait until actual damages from a breach are proved and eliminates uncertainty and tends to prevent costly future litigation.

The reasonableness of the forecast or estimate in a liquidated-damages provision is usually determined in view of the facts known at the time of contracting, and not at the time of the breach or delayed completion.

Boone Coleman Constr., Inc. v. Village of Piketon, 2016 Ohio 628 (Ohio), ¶ 35-36 (reversing holding that liquidated-damages clause in a public road construction contract was an unenforceable penalty; quotation altered, extensive citations omitted), on remand, 2016 Ohio 1557 (Ohio App.).

In the same case where he talked about liquidated damages as "a partial settlement," legendary Seventh Circuit judge Richard Posner mused:

Indeed, even if damages wouldn't be difficult to determine after the fact, it is hard to see why the parties shouldn't be allowed to substitute their own ex ante determination for the ex post determination of a court. Damages would be just another contract provision that parties would be permitted to negotiate under the general rubric of freedom of contract.

XCO Int'l, Inc. v. Pacific Scientific Co., 369 F.3d 998, 1001 (7th Cir. 2004) (Posner, J.)

Judge Posner's view was quoted in a dissent by an Indiana supreme court justice, who argued that:

Rather than condemning such [liquidated] damages when judges conclude they are facially problematic, courts should get out of the business of deciding whether the parties' estimate of the harm underlying liquidated damages is reasonable. … This approach to liquidated damages here would have the virtue of honoring the parties' freedom of contract, including their settlement of a disputed issue it has taken our Court more than a year to resolve.

American Consulting, Inc. v. Hannum Wagle & Cline Engineering, Inc., 136 N.E.3d 208, 220 (Ind. 2019) (Slaughter, J., dissenting in part). (quotation altered).

21.7.7 Pro tip: Provide an alternative performance standard instead?

Drafters might want to consider setting up an alternative-performance structure instead of liquidated damages. For example:

•  What amounts to an early-termination fee was upheld in a First Circuit case where the court of appeals affirmed a summary judgment that Alasko, a Canadian food distributor, owed Foodmark, a U.S. marketing firm, a fee for electing not to renew the parties' "evergreen" agreement. See Foodmark, Inc. v. Alasko Foods, Inc., 768 F.3d 42 (1st Cir. 2014).

•  A California appeals court reversed and remanded a summary adjudication that certain payment provisions in a contract were an unenforceable penalty; the court held that "the trial court erred because More-Gas's motion for summary adjudication failed to eliminate the possibility that the contractual provisions in question were instead valid provisions for alternative performance." See McGuire v. More-Gas Investments, LLC, 220 Cal. App. 4th 512, 163 Cal. Rptr. 3d 225.

•  Washington state's supreme court ruled that an early termination fee in a cell-phone service agreement was "an alternative performance provision and not a liquidated damages clause." Minnick v. Clearwire US LLC, 275 P.3d 1127, 1129 (Wash. 2012).

•  But a California court ruled that Sprint that "Plaintiffs introduced contemporaneous Sprint internal documents referring to the ETF as a '$150 contract penalty fee,' and as a 'Penalty or Contract Cancellation Fee.'" See Cellphone Fee Termination Cases, 193 Cal. App.4th 298, 306, 122 Cal. Rptr.3d 726 (2011).

21.7.8 Other ways to compute liquidated damages

For language setting forth liquidated damages calculated per day of delay, see Federal Acquisition Regulations § 52.211.11.

Liquidated damages based on revenue, not profit, might be enforceable; see the Eighth Circuit's discussion in RSA 1 L.P. v. Paramount Software Assoc., Inc., 793 F.3d 903 (8th Cir. 2015) (affirming summary judgment awarding liquidated damages; applying Texas law).

21.8 Master agreements

A company will sometimes negotiate a "master agreement" that (usually) doesn't itself commit either party to do anything; instead, the master agreement serves as a set of pre-negotiated terms and conditions that the parties (and often their affiliates) can use to do short-form actual contracts for specific transactions.

Example: A vendor wanting to sell to U.S. Government agencies will often enter into an agreement under the General Services Administration's "Multiple Award Schedule Program," also referred to as "the Schedule," which has been described as "the premier contract vehicle for the federal government. The Schedule Program is a long term government-wide contract between commercial suppliers and the federal government." In a nutshell, a vendor with a GSA schedule can sell to virtually any federal agency with just a purchase order, because the terms, conditions, and discount are already established. See generally How GSA Buys: Schedules and Contracts (GSA.gov).

Customer purchase orders sometimes say (and should say) that if the parties have entered into a master agreement, then that master agreement will control.

For example, the Honeywell terms of sale document referenced above states, in the very first sentence:

Unless and to the extent that a separate contract executed between the procuring party (“Buyer”) and Honeywell International Inc. (“Honeywell”) applies, any purchase order covering the sale of any product (“Product”) contained in this Catalog (“Order”) will be governed solely by these Conditions of Sale ….

See https://perma.cc/5MB9-H6VK at § 1 (emphasis added).

Likewise, a Cisco purchase order form says:

Notwithstanding the foregoing, if a master agreement covering procurement of the Work described in the Purchase Order exists between Supplier and Cisco, the terms of such master agreement shall prevail over any inconsistent terms herein.

See, e.g., Cisco Standard Terms and Conditions of Purchase – United States § 1, archived at https://perma.cc/SD47-YCHU.

Courts tend to give effect to statements that a master agreement will prevail. Example: In a New Jersey case, UPS and a GE subsidiary entered into a master agreement, which contained a provision stating that the master agreement would take precedence over any bill of lading or other shipment document:

E. To the extent that any bills of lading, or other shipment documents used in connection with transportation services provided pursuant to the contract are inconsistent with the terms and conditions of this contract (including the terms and conditions of Appendices or Exhibits incorporated by reference), the terms and conditions of this Contract (and any incorporated Appendices and Exhibits) shall govern.

In the lawsuit, UPS claimed that its bill of lading form limited its liability for damage to some $15,000, while the GE subsidiary claimed that the bill of lading was inapplicable, and that under the master agreement, UPS should be held liable for the full value (some $1 million) of the shipment in question. The court granted partial summary judgment that the master agreement controlled. Indem. Ins. Co. of N. Am. v. UPS Ground Freight, Inc., No. 13-3726, slip op. (D.N.J. Jun. 3, 2016).

21.9 NDAs for VCs and other potential investors (reading)

Potential investors in a company might be reluctant to sign a nondisclosure agreement ("NDA"). Venture capitalists in particular often flatly refuse to do so, because they don't want to say "no" to an investment opportunity with a startup company, only to be sued years later for allegedly disclosing the startup's technology to someone else.

It's not like that sort of thing doesn't happen — even with an NDA in place. Amazon's venture-capital fund allegedly did just that to small tech companies DefinedCrowd, Nucleus, LivingSocial, and others. See Dana Mattioli and Cara Lombardo, Amazon Met With Startups About Investing, Then Launched Competing Products (WSJ.com Jul. 23, 2020).

As a practical matter, going without an NDA with non-corporate venture capitalists might not be a bad bet, because:

  • You can try to be very, very selective about what you disclose without an NDA, so that you're not giving away the "secret sauce" of your idea.
  • Investors and others generally do have one or two other things on their minds. They generally see lots of entrepreneurs who are convinced they've got a world-beating idea. You'll probably be lucky to get these investors to pay attention for two minutes. Ask yourself how likely it is that they'll want to take your idea and spend time and money building a business around it without you.
  • Contracts aren't the only thing that discourage bad behavior. If an investor stole someone's idea, and if word got around, then that investor might later find it hard to get other people to talk to him.
  • You have to decide what risks you want to take. Your business might fail because an investor steals your idea and beats you to market. Or it might fail because you can't raise the money you need to get started.

It's sort of like having to take a trip across the country. You have to decide whether to fly or drive. Sure, there's a risk you could die in a plane crash flying from one side of the country to the other. But if you were to drive the same route, your risk of dying in a car crash has been estimated as being something like 65 times greater than flying.

As the old saying goes, you pays your money and you takes your choice.

21.10 Patent infringement basics (reading)

21.10.1 The claims of a patent are what determine infringement

People sometimes get all worked up about the fact that a patent describes X or Y or Z that can be found in prior art.

What matters for infringement purposes, however, is not so much what the patent describes, as what it claims. The exact wording of the patent claims will be crucial.

21.10.2 Each claim in a patent is a separate infringement checklist

You can also think of each individual claim in a patent as being a separate infringement checklist: At trial, the patent owner’s lawyers and expert witness(es) will methodically talk the jury through that claim (and probably others as well), putting on evidence to show that every claim element is present in what the defendant is doing.

Here are a couple of canonical hypothetical examples (simplified — they do not address the doctrine of equivalents):

Claim 1: A seating structure comprising:

  • (a) a substantially-horizontal seating platform, and
  • (b) at least three legs extending generally downward from the seating platform.

Claim 5: A chair comprising:

  • (a) a substantially-horizontal seating platform; and
  • (b) four legs extending generally downward from the seating platform.

In these examples:

  • A three-legged stool with a back support would infringe our hypothetical claim 1 above, because all of the checklist elements in that claim are present in the three-legged stool. Importantly, the additional presence of the of the stool's back support is irrelevant.
  • In contrast, a three-legged stool would not infringe hypothetical claim 5 above, because that claim requires an infringing chair to have four legs.

21.10.3 Patent-claim interpretation is often a big deal

Very often, patent owners and accused infringers engage in expensive legal battles over "claim construction," that is, the proper interpretation of different words and phrases in a patent claim. In the examples above, such a battle might break out over whether the term "seating platform" encompasses a camp chair with a soft, foldable cloth seat.

As a general rule, a given word or phrase in a claim will be interpreted in light of considerations such as the following:

  • the ordinary meaning of the term in the relevant art(s);
  • any special meaning stated by the inventor in the patent’s written description — the inventor is free to be his- or her own lexicographer;
  • how the term was used in the back-and-forth correspondence between the inventor and the patent examiner, referred to as the ‘prosecution history’ of the patent application;
  • whether a particular meaning is required — other things being equal, a narrower interpretation that will preserve the patentability of the claim will be preferred over a broader interpretation that would result in the claim being invalidated by prior art. (If this issue comes up during the prosecution of the patent application, the patent examiner is supposed to require the applicant to amend the claim to eliminate the ambiguity.)

21.10.4 Only one patent claim need be proved infringed

As long as the patent owner proves that at least one claim is infringed, and the defendant doesn’t prove that the infringed claim(s) are invalid, then the defendant is liable for infringement.

Suppose hypothetically that the example claims above were actually in an unexpired patent, and that they were not proved to be invalid.

In that case, anyone who made, used, sold, offered for sale, or imported a three-legged stool would be liable for infringement, even though the stool infringed only claim 5 and not claim 1.

Here's an analogy: Imagine that the claims of a patent are like arrows in a quiver, and that a hostile archer (a patent owner) were to shoot several arrows in your direction:

  • Some arrows might clearly be going to miss you; those are analogous to patent claims that you clearly don't infringe. (This assumes a judge and/or jury agrees that these arrows have missed you, which isn't always a given.)
  • But suppose that some of the arrows in flight appear on their way to hitting you somewhere on your body. It's up to you to try to knock down all of those arrows before they hit you.

21.10.5 "Freedom to operate" patent-infringement searches aren't cheap

This section states that Supplier hasn't necessarily made any particular investigation into possible infringement claims of the type covered. Supplier might want to consider commissioning a "freedom to operate" investigation and opinion of counsel to provide both Supplier and Beneficiary with at least some comfort.

Such investigations can be costly, but if there's a lot at stake, that cost might be worthwhile. See generally: • Linda J. Thayer, When Is a "Freedom to Operate" Opinion Cost-Effective?, Today's General Counsel (2013), archived at https://perma.cc/R7BB-9VVT (the author is a partner in the Finnegan Henderson firm, perhaps the leading intellectual-property law firm in the United States); • World Intellectual Property Organization, IP and Business: Launching a New Product: freedom to operate (wipo.int 2005).

21.11 Price fixing

21.11.1 Resale price maintenance is (now) judged by a rule of reason

Again, the FTC:

Reasonable price, territory, and customer restrictions on dealers are legal. Manufacturer-imposed requirements can benefit consumers by increasing competition among different brands (interbrand competition) even while reducing competition among dealers in the same brand (intrabrand competition).

  • For instance, an agreement between a manufacturer and dealer to set maximum (or "ceiling") prices prevents dealers from charging a non-competitive price.
  • Or an agreement to set minimum (or "floor") prices or to limit territories may encourage dealers to provide a level of service that the manufacturer wants to offer to consumers when they buy the product.

These benefits must be weighed against any reduction in competition from the restrictions.

Until recently, courts treated minimum resale price policies differently from those setting maximum resale prices. But in 2007, the Supreme Court determined that all manufacturer-imposed vertical price programs should be evaluated using a rule of reason approach.

According to the Court, "Absent vertical price restraints, the retail services that enhance interbrand competition might be underprovided. This is because discounting retailers can free ride on retailers who furnish services and then capture some of the increased demand those services generate."

Note that this change is in federal standards; some state antitrust laws and international authorities view minimum price rules as illegal, per se.

United States Federal Trade Commission, Manufacturer-imposed Requirements (accessed June 21, 2020) (extra paragraphing and bullets added). See generally Meytal McCoy, DOJ Test Drives New Vertical Merger Guidelines In Closure Of LSEG/Refinitiv Deal (MayerBrown.com 2020).

21.11.2 Price fixing by competitors can lead to prison time

In the United States, "horizontal" price-fixing among competitors is per se illegal under section 1 of the Sherman Act and can call down the wrath of government prosecutors and plaintiffs' lawyers.

Corporate executives have gone to prison for price-fixing. EXAMPLE: The former chief executive officer of Bumble Bee Foods was sentenced to more than four years in prison and a $100,000 criminal fine for his leadership role in a three-year antitrust conspiracy to fix prices of canned tuna; the company pleaded guilty and was sentenced to a $25 million fine — and co-conspirator StarKist was sentenced to the statutory maximum $100 million fine. See Press Release, United States Department of Justice, Former Bumble Bee CEO Sentenced To Prison For Fixing Prices Of Canned Tuna (June 16, 2020).

According to the New York Times, the tuna price-fixing scheme came to light when a food wholesaler in New York noticed that prices for canned tuna were staying the same even though the price of raw tuna were dropping; this led to lawsuits by the wholesaler and by grocers such as Walmart, Target, and Kroger. See Sandra E. Garcia, Former Bumble Bee C.E.O. Is Sentenced in Tuna Price-Fixing Scheme, New York Times, June 16, 2020.

Another example:

What kinds of inter-company dealings can be deemed "price fixing"? The U.S. Federal Trade Commission explains:

Price fixing is an agreement (written, verbal, or inferred from conduct) among competitors that raises, lowers, or stabilizes prices or competitive terms.

Generally, the antitrust laws require that each company establish prices and other terms on its own, without agreeing with a competitor. When consumers make choices about what products and services to buy, they expect that the price has been determined freely on the basis of supply and demand, not by an agreement among competitors.

When competitors agree to restrict competition, the result is often higher prices. Accordingly, price fixing is a major concern of government antitrust enforcement.

A plain agreement among competitors to fix prices is almost always illegal, whether prices are fixed at a minimum, maximum, or within some range.

Illegal price fixing occurs whenever two or more competitors agree to take actions that have the effect of raising, lowering or stabilizing the price of any product or service without any legitimate justification.

Price-fixing schemes are often worked out in secret and can be hard to uncover, but an agreement can be discovered from "circumstantial" evidence.

  • For example, if direct competitors have a pattern of unexplained identical contract terms or price behavior together with other factors (such as the lack of legitimate business explanation), unlawful price fixing may be the reason.
  • Invitations to coordinate prices also can raise concerns, as when one competitor announces publicly that it is willing to end a price war if its rival is willing to do the same, and the terms are so specific that competitors may view this as an offer to set prices jointly.

Not all price similarities, or price changes that occur at the same time, are the result of price fixing. On the contrary, they often result from normal market conditions.

  • For example, prices of commodities such as wheat are often identical because the products are virtually identical, and the prices that farmers charge all rise and fall together without any agreement among them.
  • If a drought causes the supply of wheat to decline, the price to all affected farmers will increase.
  • An increase in consumer demand can also cause uniformly high prices for a product in limited supply.

Price fixing relates not only to prices, but also to other terms that affect prices to consumers, such as shipping fees, warranties, discount programs, or financing rates. …

United States Federal Trade Commission, Price Fixing (accessed June 21, 2020) (emphasis, extra paragraphing, and bullets added).

21.12 Privacy

When a company ("Collector") collects personal information of an individual, applicable privacy laws might require Collector to do some or all of the following:

  1. disclose to the individual:
    • what types of information Collector collects;
    • what Collector might do with the information;
    • how long Collector might keep the information;
    • whether Collector will sell the information to others;
  2. take reasonable security measures to protect the information;
  3. alert the individual in cases of security breach (actual or, sometimes, potential)
  4. report security breaches to government authorities;
  5. purge the information upon request (the "right to be forgotten")

Students: You're expected to know that privacy law is most definitely "a thing" — and in many jurisdictions (especially California and Europe) a thing with big, sharp teeth.

For a(n incomplete) list of privacy laws, see Tango Clause 22.124 - Privacy Law Definition.

Optional reading:

21.13 Security requirements (commentary) [TODO]

21.14 Sole [TO DO]

21.14.1 "Sole and exclusive" – what does it mean?

21.14.2 "Sole cost and expense" – what does it mean?

Accountants apparently distinguish between cost and expense:

A cost might be an expense or it might be an asset. An expense is a cost that has expired or was necessary in order to earn revenues. We hope the following three examples will illustrate the difference between a cost and an expense. …

What is the difference between cost and expense?, AccountingCoach.com

And:

An expense is a cost that occurs as part of a company's operating activities during a specified accounting period. A retailer will likely incur the following expenses: the cost of goods sold, commissions earned by the sales staff, rent for the retail space, the cost of the electricity used, advertising that took place, wages and salaries that were incurred, etc.

What is an expense?, AccountingCoach.com

21.15 Subcontracts (commentary)

21.15.1 Basics: What is a "subcontractor"?

Let's illustrate the subcontractor concept with a simple example. Suppose that a would-be homeowner buys an old house (a "tear-down") in a desirable neighborhood and wants to put up a new house on the site. After obtaining architectural plans:

  • The owner will typically hire a prime contractor, which is commonly referred to as the general contractor, or "GC," to actually get the house built.
  • The general contractor will in turn engage various other companies such as: • a demo company to demolish the old house and clear the site; • a foundation company to pour a new foundation; • a framing company to erect the frame of the house; • a roofing company; etc.
  • Each of these other companies is referred to as a subcontractor or "sub"; the subs will normally deal only with the general contractor and not with the owner.

21.15.2 Should subcontracting be allowed?

That will depend on the parties and the situation. Sometimes one party might want —

  • to prohibit the other party from using subcontractors at all, or
  • to require the other party:
    • to obtain the first party's prior written consent to any use of subcontractors, or
    • to get the first party's approval of the specific subcontractor(s) to be used, or
    • to notify the first party before using subcontractors, or
    • to impose specific obligations (e.g., confidentiality obligations) on any subcontractor(s), e.g., in the form of specific terms in a written subcontract;
    • to provide the first party with a copy of each written subcontract (possibly redacted to black out confidential information).

21.15.3 Contractor liability for subcontractor employee wages

Wage theft, where companies fail to pay their low-wage employees what they're owed, is by no means unheard of. "A study by the University of Texas and Workers Defense Project, an advocacy group, found that 1 in 5 construction workers are the victims of wage theft, the practice of denying workers pay or benefits rightfully owed them." Rebecca Carballo, Construction workers claim wage theft at Sheldon ISD project, Houston Chronicle, Jan. 10, 2021, at B1, col. 1. ("ISD" stands for Independent School District, which is how public schools are organized in Texas.)

A partner in a prominent employment-law firm observes:

Recently, states have started creating statutory liability for general contractors for certain actions and inactions of their subcontractors. Virginia is an example. The state passed a series of employment laws this summer that includes statutes on nonpayment of wages, worker misclassification, and wage theft that contain new penalties, damages, and causes of action. * * * 

With state statutes like these becoming more commonplace, contractors will want to act now to limit this type of liability. Start by closely reviewing contracts with subcontractors. Consider including indemnification provisions and coverage of attorneys’ fees and costs in the event of a claim. Consider enhanced payroll requirements on contracts or use of certified payrolls. Review lien release language for wage and hour and misclassification claim liability. Moreover, consider requiring insurance verification and being named as an additional insured. Finally, ask subcontractors to attest to compliance with state and federal employment law requirements.

Kristina Vaquera, General Contractors Can Face Increased Liability For Employment Actions Of Their Subcontractors (JDSupra 2020).

21.16 Subject to (reading)

In an Eighth Circuit decision, an investment bank's agreement with its investor-clients said that the bank's performance would be "subject to" external rules, specifically FINRA rules. The appeals court agreed with other courts that the "subject to" language did not constitute a contractual commitment by the bank to comply with those rules. See Luis v. RBC Capital Markets, LLC, No. 19-2706, slip op. at 7-11 (8th Cir. Dec. 28, 2020) (affirming summary judgment dismissing clients' breach-of-contract claims against bank; citing numerous cases).

21.17 Subrogation (commentary)

Author's note: In Carter v. Pulte Home Corp., No. A154747 (Cal. App. Jul. 23, 2020), the court summarized the law of subrogation in that state; an extensive excerpt from the court's opinion follows, lightly edited and with citations omitted.

Pulte Home Corporation (Pulte), a residential developer and general contractor, was sued for construction defects by the owners of 38 homes in two housing developments.

Many subcontractors worked on the projects, under contracts requiring each subcontractor to indemnify Pulte and to name it as an additional insured on the subcontractor’s commercial general liability insurance.

These contracts required each subcontractor to indemnify Pulte against "all liability, claims, judgments, suits, or demands for damages to persons or property arising out of, resulting from, or relating to Contractor’s performance of work under the Agreement (‘Claims’) unless such Claims have been specifically determined by the trier of fact to be the sole negligence of Pulte . . . ."

Pulte cross-complained against the subcontractors who worked on some or all of the homes at issue, alleging it was entitled to a defense and indemnity, and tendered its defense of the homeowners’ suit to the subcontractors and their insurers.

Travelers, the insurer for four of the subcontractors, accepted the tender and provided a defense.

The "Blanket Additional Insured Endorsements" to Travelers’s named insureds’ policies stated that the "person or organization is only an additional insured with respect to liability caused by ‘your work’ for that additional insured."

Respondents are seven subcontractors who did not respond to the tender of Pulte’s defense and whose insurance carriers denied that the additional insured endorsements to their policies required the insurers to provide a defense.

Travelers filed a complaint in intervention against respondents and other subcontractors no longer involved in the litigation. …

Pulte eventually settled the homeowners’ claims and its claims against all the subcontractors. Travelers ultimately paid $320,491.82 for Pulte’s defense.

At trial, [Travelers] sought to recover $156,091.82 from respondents, having recovered $164,400 from other subcontractors. Travelers’s position at trial was that respondents were each jointly and severally liable for the remainder of its costs for defending Pulte, as each respondent had a contractual obligation to defend Pulte.

* * * 

Subrogation is the substitution of another person in place of the creditor or claimant to whose rights he or she succeeds in relation to the debt or claim.

In the case of insurance, subrogation takes the form of an insurer’s right to be put in the position of the insured in order to pursue recovery from third parties legally responsible to the insured for a loss which the insurer has both insured and paid.

The subrogated insurer is said to "stand in the shoes" of its insured, because it has no greater rights than the insured and is subject to the same defenses assertable against the insured.

Thus, an insurer cannot acquire by subrogation anything to which the insured has no rights, and may claim no rights which the insured does not have.

As now applied the doctrine of equitable subrogation is broad enough to include every instance in which one person, not acting as a mere volunteer or intruder, pays a debt for which another is primarily liable, and which in equity and good conscience should have been discharged by the latter.

The essential elements of an insurer’s cause of action for equitable subrogation are as follows:

1. the insured suffered a loss for which the defendant is liable, either as the wrongdoer whose act or omission caused the loss or because the defendant is legally responsible to the insured for the loss caused by the wrongdoer;

2. the claimed loss was one for which the insurer was not primarily liable;

3. the insurer has compensated the insured in whole or in part for the same loss for which the defendant is primarily liable;

4. the insurer has paid the claim of its insured to protect its own interest and not as a volunteer;

5. the insured has an existing, assignable cause of action against the defendant which the insured could have asserted for its own benefit had it not been compensated for its loss by the insurer;

6. the insurer has suffered damages caused by the act or omission upon which the liability of the defendant depends;

7. justice requires that the loss be entirely shifted from the insurer to the defendant, whose equitable position is inferior to that of the insurer; and

8. the insurer’s damages are in a liquidated sum, generally the amount paid to the insured.

Author's note: The court affirmed the trial court's ruling that Travelers had failed to prove its entitlement to equitable subrogation.

21.18 Time is of the essence

When a contract states that time is of the essence, it generally means that if a party misses a deadline, then the other party will have the right to cancel the contract. See generally Restatement of Contracts § 242, comment d.

But a court might look past a time-of-the-essence provision if it appeared that the provision was included as a mere "stock phrase" as opposed to being genuinely negotiated and agreed to. Example: A California appeals court held that "a provision in the parties' contract making time of the essence does not automatically make Rugger's untimely performance a breach of contract because there are triable issues regarding the scope of that provision and whether its enforcement would result in a forfeiture to Rugger and a windfall to MCR." Magic Carpet Ride LLC v. Rugger Investment Group LLC, 41 Cal. App. 5th 357, 360 (2019) (reversing and remanding summary adjudication).

21.19 Writing around the law might not work

Inexperienced contract drafters sometimes think they can "write around" inconvenient provisions in the law by simply agreeing otherwise. That often doesn't work, however, if an important public policy is involved.

Example: In 2014 a three-judge panel of the Ninth Circuit held that under California law, the plaintiffs in a class-action suit, who were drivers for FedEx, were not independent contractors, as stated in their contracts, but instead were employees of FedEx. A concurring opinion noted: "Although our decision substantially unravels FedEx's business model, FedEx was not entitled to 'write around' the principles and mandates of California Labor Law …." See Alexander v. FedEx Ground Package System, Inc., 765 F.3d 981, 984 (9th Cir. 2014); id. at 998 (Trott, J., concurring).

[TO DO: Add case where contract said Texas law applied, California court said "no it doesn't."]

22 The Tango Terms

A work in progress: This playbook is still a work in progress; I'm "freezing" this draft for the semester so that students can print it out if they wish.

Printing: For many students, this playbook will work just fine if read on the screen. By student request, however, I've tried to set up the playbook for printing to hard copy. Typographically, the setup is less than optimal for printing — for example, there are some page breaks immediately after a heading, instead of keeping the heading together on the same page with the following text. (It's not supposed to do that, but I haven't figured out why it does, nor how to fix it.)

22.1 Acknowledgement Effect

IF: The Contract includes language in which a party acknowledges something; THEN: The acknowledging party WAIVES (see the definition in Clause 22.162):

  1. any right to contest the truth of the thing being acknowledged; and
  2. any right to require another party to the Contract to prove the acknowledged thing.

Commentary

This definition concerns about acknowledgements made within the body of a contract, as discussed in the commentary at [BROKEN LINK: ack-cmt][BROKEN LINK: ack-cmt][BROKEN LINK: ack-cmt].

For acknowledgements in notary-public certificates, see the reading at Section 3.12: .

22.2 Affiliate Definition

22.2.1 Control relationship

  1. For purposes of the Contract, two persons A and B are "affiliates" (or "affiliated") if one or more of the following things is true:
    1. B "controls" A, as defined in this Definition,
    2. or A controls B,
    3. or B and A are each under common control of a third person,
    4. or the Contract clearly identifies A and B as being affiliates.
  2. For this purpose, control can be direct, or it can be indirect through one or more intermediaries.
    • Example: If A controls B, and B controls C, then A controls C indirectly.
Commentary
22.2.1.1 Business purpose for defining affiliate

In some cases, the Contract might give rights to "affiliates" of one or another party, for example the right to acquire goods or services on the same terms as in the Contract. In such a case, it could be important to define just who qualifies as an affiliate of the relevant party. For example:

  • A software license agreement might grant the right to use the software not only to the named licensee company, but also to "affiliates" of the licensee company. Such an agreement will almost certainly impose corresponding obligations on any affiliate that exercises the right to use the software.
  • A customer might want its "affiliated" companies to be allowed to take advantage of the contract terms that the customer negotiates with a supplier. (The supplier, though, might not be enthused about an expansive definition of affiliate: The supplier will often want to be free to negotiate more-favorable terms with the customer's affiliates.)
22.2.1.2 Language origins

This basic definition is largely adapted from (a portion of) the definition promulgated by the U.S. Securities and Exchange Commission ("SEC") in Rule 405; substantially-similar language can be found in other sources, notably Black's Law Dictionary. See Rule 405, 17 C.F.R. § 230.405; see also, e.g., Securus Technologies Inc. v. Global Tel*Link Corp., 676 Fed. Appx. 996 (Fed. Cir. 2017) (quoting Black's Law Dictionary and citing Texas law recognizing the dictionary's authority); McLane Foodservice, Inc. v. Table Rock Restaurants, LLC, 736 F.3d 375, 379 & n.3 (5th Cir. 2013) (same); UBS Securities LLC v. Red Zone LLC, 77 A.D.3d 575, 578 (N.Y. App. Div. 1st Dept. 2010) (quoting Black's Law Dictionary and citing NY and Del. statutes).

The definition provides parties with two separate "proof paths" for establishing affiliate status:

  • By showing a direct- or indirect control relationship between two persons (including common control by a third person); or
  • By specifically agreeing that two named persons (each, an individual or organizations) are affiliates for purposes of the Contract, regardless whether a control relationship exists between them. If it's not possible to determine in advance who all the named affiliate groups will be, the parties could consider:
    • letting one party unilaterally name additional affiliates with the other party's consent, not to be unreasonably withheld; and/or
    • designating specific "open enrollment" periods in which affiliates can be named.
22.2.1.3 Pro tip: Plan for changes in affiliate status

Contract drafters and reviewers should plan for changes in affiliate status, in case one or more of the following things happens:

  • A party acquires a new affiliate, e.g., because its parent company makes an acquisition;
  • Two companies cease to be affiliates of one another, e.g., because one of them is sold off or taken private;
  • A third party – perhaps an unwanted competitor – becomes an affiliate of "the other side."
22.2.1.4 The timing of affiliate status can be important

In some circumstances, affiliate status might exist at some times and not exist at others. That could be material to a dispute. Compare, for example:

• New York's highest court held that: "Absent explicit language demonstrating the parties' intent to bind future affiliates of the contracting parties, the term 'affiliate' includes only those affiliates in existence at the time that the contract was executed." See Ellington v. EMI Music Inc., 24 N.Y.3d 239, 246, 21 N.E.3d 1000, 997 N.Y.S.2d 339, 2014 NY Slip Op 07197 (affirming dismissal of complaint).

• The First Circuit held that Cellexis had breached a settlement agreement not to sue GTE or its affiliates when it sued a company that, at the time of the settlement agreement, had not been a GTE affiliate, but that later became an affiliate. Reversing a summary judgment, the appeals court reasoned that when read as a whole, the contract language clearly contemplated that future affiliates would also be shielded by the covenant not to sue. See GTE Wireless, Inc. v. Cellexis Intern., Inc., 341 F.3d 1, 5 (1st Cir. 2003).

22.2.2 Voting power for control

If B is a corporation or other organization, then A is considered to control B if A has the power to vote more than 50% of the voting power entitled to vote for members of:

  1. the organization's board of directors, or
  2. the equivalent body in a non-corporate organization.
Commentary
22.2.2.1 Where to set the voting percentage

A minimum voting percentage of 50% seems to be pretty typical. Drafters, though, should think about why they're defining the term affiliate, because the answer might warrant changing the percentage — and it doesn't necessarily have to be the same percentage for every situation or condition. [TO DO: Examples]

22.2.2.2 Voting power can arise by contract

A voting trust or voting agreement might give Shareholder A the power to vote Shareholder B's shares, even though Shareholder B retains ownership of the shares (for example, to be paid dividends for the shares). See generally, e.g.,

22.2.2.3 Other possible approaches to voting control

Some drafters might want voting control also to arise from one or more of the following:

  • a legally-enforceable right to select a majority of the members of the organization's board of directors or other body having comparable authority — note that this alternative does not say that control exists merely because a person has a veto over the selection of a majority of the members of the organization's board;
  • a legally-enforceable right, held by a specific class of shares or of comparable voting interests in the organization, to approve a particular type of decision by the organization; or
  • a legally-enforceable requirement that a relevant type of transaction or decision, by the organization, must be approved by a vote of a supermajority of the organization's board of directors, shareholders, outstanding shares, members, etc. (The required supermajority might be two-thirds, or three-fourths, or 80%, etc.)

22.2.3 Affiliate ≠ party to the Contract

IF: The Contract identifies a party to the Contract as (for example) "ABC Corporation and its affiliates" (emphasis added);

THEN: That means only that the (specified) affiliates of ABC Corporation are entitled to certain benefits — possibly accompanied by obligations — but not that the affiliates are partiies to the Contract.

Commentary
22.2.3.1 Business context

Some agreements, in identifying the parties to the agreement on the front page, state that the parties are, say, "ABC Corporation and its Affiliates." In the author's view, that's a bad idea unless each such affiliate actually signs the agreement as a party and therefore commits, on its own, to the relevant contractual obligations.

The much-better practice is to state the specific rights and obligations that affiliates have under the contract. This is sometimes done in "master" agreements in which, for example, affiliates of a buyer can place orders on the same terms.

22.2.3.2 Caution: Affiliates could be implicitly bound

An affiliate of a contracting party might be bound by the contract if:

  • the contracting party — or its signatory — controls the affiliate, and
  • the contract states that the contract is to benefit the affiliate.

That was the result in one case where: (i) the contract stated that it was creating a strategic alliance for the contracting party and its affiliates, and (ii) the contract was signed by the president of the contracting party, who was also the sole managing member of the affiliate. The court held that the affiliate was bound by, and violated, certain restrictions in the contract. See Medicalgorithmics S.A. v. AMI Monitoring, Inc., No. 10948-CB, slip op. at 3, 52-53, 2016 WL 4401038 (Del. Ch. Aug. 18, 2016). See also Mark Anderson, Don't Make Affiliates parties to the agreement (2014); Ken Adams, Having a Parent Company Enter Into a Contract "On Behalf" of an Affiliate (2008).

22.2.4 Control by management power must be by contract

  1. Party A is also considered to control Party B if a legally-enforceable contract unambiguously gives A the power to direct B's relevant management and policies.
  2. A statement in the Contract that affiliate status can arise through "management power" (or comparable terminology) is to be interpreted and applied in accordance with the standard stated in subdivision a.
Commentary

This Definition does not subscribe to the notion that affiliate status can arise through non-contractual forms of management power, even though that concept can be found in U.S. securities regulations. See, e.g., SEC Rule 405, 17 C.F.R. § 230.405. That's because the vagueness of the quoted term could lead to expensive litigation. See, for example:

  • A Fifth Circuit case in which the parties had to litigate who had had "control" of a vessel destroyed by fire, and thus which party or parties should be liable for damages; See Offshore Drilling Co. v. Gulf Copper & Mfg. Corp., 604 F.3d 221 (5th Cir. 2010).
  • A New York case in which the parties litigated whether a global financial-services firm was entitled to a $10 million fee for a corporate acquisition deal — and in the aftermath, a blue-chip NYC law firm was hit with a $17.2 million malpractice judgment for not nailing down an agreed definition of control to govern when the deal fee would be earned. See UBS Securities LLC v. Red Zone LLC, 77 A.D.3d 575, 578, 910 N.Y.S.2d 55 (N.Y. App. Div. 1st Dept. 2010). Concerning the malpractice award, see Red Zone LLC v. Cadwalader, Wickersham & Taft LLP, 45 Misc.3d 672, 994 N.Y.S.2d 764 (N.Y. Sup. Ct. 2013), aff'd, 2014 NY Slip Op 4570, 118 A.D.3d 581 988 N.Y.S.2d 588 (App. Div. 1st Dept. 2014).

22.4 Amendments

22.4.1 Writing requirement for amendments

  1. To be effective, a purported amendment to the Contract (or any related document):
    1. must be in writing; and
    2. must be clearly labeled as an amendment.
  2. The labeling must be reasonably prominent, for example (without limitation) by including the word "Amendment" as part of the title of the amending document,
    • so that a party that is presented with such a writing will have fair notice about its intended effect.
Commentary
22.4.1.1 Purpose

Amendments-in-writing requirements are extremely common in contracts; otherwise, the parties could end up disagreeing later about just what change was agreed to. But in some jurisdictions, such requirements might not be enforceable — on the theory that, in the right circumstances, such requirements can be orally waived — as discussed in the commentary at [LINK NEEDED].

22.4.1.2 Subdivision a.2: Labeling requirement

Requiring an amendment to be clearly labeled as such should help reduce the chances that parties will dispute whether a particular communication constituted an amendment. That was an issue in a Fourth Circuit case in which a tenant of an office building signed an estoppel certificate — the court held that the estoppel certificate did not modify the tenant's lease, in part because "the Estoppel Certificate does not label itself as an amendment to the Lease." Expo Properties, LLC v. Experient, Inc., No. 19-1759, slip op. at 11 (4th Cir. Apr. 15, 2020) (affirming summary judgment).

Pro tip: To reduce the chance of possible future confusion, it might be helpful to give an amendment a series number and date in its title, and perhaps even include a (brief) mention of its purpose.

Example: "First Amendment, Dated December 25, 20X7, to Asset Purchase Agreement (Increase of Purchase Price)."

Pro tip: An extensive amendment could be done as a complete "amended and restated agreement.

Example: As of March 22, 2020, the title of the Enterprise Products Partners limited-partnership agreement is "Sixth Amended and Restated Agreement of Limited Partnership of Enterprise Products Partners L.P." (emphasis added).

22.4.2 What individual(s) must sign an amendment

  1. Except as provided in subdivision b, an amendment may be signed, on behalf of a organizational party (a corporation, LLC, etc.), by any individual having apparent authority to do so on.
  2. The Contract may specify that an amendment will not be effective unless signed by a particular person or by a person holding a particular title.
Commentary
22.4.2.1 Subdivision a: Apparent authority to sign

A signer's apparent authority to sign on behalf of a party will generally override the party's internal signature policies.

For example in one case, a company was held to be bound by a contract signed by an executive vice president, even though that individual did not have internal authorization to sign the contract. See Digital Ally, Inc., v. Z3 Tech., LLC, 754 F.3d 802, 812-14 (10th Cir. 2014); see generally Apparent authority (Wikipedia.org).

22.4.2.2 Subdivision a: Limiting amendment authority

A contract could expressly limit the range of individuals authorized to sign amendments on behalf of a party; this would (presumably) put the other party on notice that other signers would not have "apparent authority" to sign amendments. Such language could be along the following lines:

An amendment will not be binding on an organization unless it is signed on behalf of the organization by an individual at the vice-president level or higher, or in a comparable position in an organization not having a vice-president.

or

To be effective against [PARTY NAME], an amendment must be signed by [e.g., a vice president or higher] of that party.

Language like this is often seen in boilerplate forms; for example, a car dealer might well ask its customers to sign a contract that explicitly states that the sales person doesn't have authority to offer a better warranty. (That's another case of trying to avoid future "he said, she said" disputes about what was allegedly promised.)

Such language might take a form such as: "NO PERSON HAS AUTHORITY TO MODIFY THESE WARRANTIES ON BEHALF OF THE DEALER EXCEPT A VICE PRESIDENT OR HIGHER."

22.4.3 Governing law for this Clause

IF: The parties disagree about whether or how this Clause is to be applied; THEN:

  • New York's General Obligations Law 15-301(1) (which expressly validates amendment-in-writing requirements in contracts) is to control the interpretation and application of this Clause,
  • along with the interpretation of that statutory provision by the state- and federal courts having jurisdiction in New York,
  • no matter what law might otherwise apply.
Commentary
22.4.3.1 The cited New York statute

New York's General Obligations Law 15-301(1) provides that:

A written agreement … which contains a provision to the effect that it cannot be changed orally, cannot be changed by an executory agreement unless such executory agreement is in writing and signed[:] [i] by the party against whom enforcement of the change is sought or [ii] by his agent.

(Emphasis and bracketed text added.)

22.4.3.2 Purpose of a clause-specific governing law

It might seem strange to specify a choice of law to govern one particular provision in a contract. But it's not unprecedented, as discussed in the commentary at Section 22.70.14: .

This Clause chooses a New York statute to govern because in some jurisdictions, a court (or other tribunal of competent jurisdiction) might hold that the parties were free to amend the Contract without doing so in writing, for example orally, even though the parties had agreed to the amendments-in-writing requirement, which could lead to undesirable uncertainty.

Example: Under a century-old New York precedent (which this author refers to as the "Cardozo Rule," after its author, later a Supreme Court justice) (now effectively overruled by the statute cited above), parties are free to orally waive a contractual requirement that amendments and waivers must be in writing, subject to any possible impact of the statute of frauds. See Beatty v Guggenheim Exploration Co., 225 N.Y. 380, 387-88 (1919) (Cardozo, J.), quoted in Israel v. Chabra, 12 N.Y.3d 158, 163-64 (2009).

And California still allows oral waiver of an amendments-in-writing provision. This rule came into play, for example, in a case involving profits from the TV series Home Improvement.

The plaintiffs, who were writers and producers of the show, sued the Walt Disney company for failing to properly report and pay profit-based amounts that Disney allegedly owed under its contract with the plaintiffs.

A trial court granted summary judgment in favor of Disney on grounds that a provision in the contract stated that Disney's profit reports and payments would become incontestable after 24 months.

The appeals court reversed, holding that a jury must decide whether Disney orally waived or agreed to modify the incontestability provision. See Wind Dancer Production Group v. Walt Disney Pictures, 10 Cal. App. 5th 56, 78-79, 215 Cal. Rptr. 3d 835 (2017).

On the other hand:

• In some jurisdictions, courts will uphold requirements that amendments and waivers must be in writing.

See, e.g., a Seventh Circuit case in which the appeals court, looking to Michigan precedents, upheld summary judgment giving effect to an "anti-waiver" clause in Ford's dealership agreement. DeValk Lincoln Mercury, Inc. v. Ford Motor Co., 811 F.2d 326, 334 & n.2 (7th Cir. 1987).

• The United Kingdom's Supreme Court expressly rejected the Cardozo Rule, concluding that "the law should and does give effect to a contractual provision requiring specified formalities to be observed for a variation." Rock Advert. Ltd v MWB Bus. Exch. Ctrs. Ltd, [2018] UKSC 24 para. 10.

A statute might expressly validate amendments-in-writing and waivers-in-writing provisions.

See, e.g., New York's General Obligations Law 15-301(1), discussed above, as well as UCC § 2-209(2) for amendments to agreements for the sale of goods.

• On the other hand, a California statute has been relied on by courts to allow oral waiver of provisions requiring amendments amendments to be in writing.

"Nothing in this section precludes in an appropriate case the application of rules of law concerning estoppel, … [or] waiver of a provision of a written contract…." California Civil Code § 1698(d), quoted in Wind Dancer Productions, 10 Cal. App. 5th at 78 (modifications by the court).

22.4.4 Stricter proof requirement for alleged oral amendments

  1. IF: A court allows a party (the "asserting party") to assert that a non-written amendment is effective notwithstanding the amendments-in-writing requirement of this Agreement;
    • THEN: The asserting party must show, by clear and convincing evidence (see the definition in Clause 22.30), that each other relevant party agreed to each of the alleged nonwritten amendments.
  2. In case of doubt, this section is not intended as an implicit authorization of non-written amendments.
Commentary

As defined in [LINK NEEDED], clear and convincing evidence requires reasonable corroboration of statements by interested witnesses, for reasons explained in the commentary to [LINK NEEDED].

22.4.5 Which party must sign an amendment

To be effective, an amendment must be signed on behalf of at least the party sought be be bound by the amendment.

Commentary
22.4.5.1 Language origin: The UCC

The above one-party signature approach is inspired by the (U.S.) Uniform Commercial Code's statute of frauds provision, which provision requires only that a written contract must be signed "by the party against whom enforcement is sought …." UCC § 2‑201.

This one-party signature requirement also comports with a Seventh Circuit holding that "[t]he critical signature [on an amendment] is that of the party against whom the contract is being enforced, and that signature was present." See Hess v. Kanoski & Assoc., 668 F.3d 446, 453 (7th Cir. 2012).

22.4.5.2 Alternative: Signed by both parties

Some parties might prefer amendments to be signed by both parties, using language such as the following:

To be effective, an amendment must be signed on behalf of by each party.

It seems likely that a court would enforce a contract's requirement that both parties sign an amendment. That happened in a Fourth Circuit case, Expo Properties, LLC v. Experient, Inc., No. 19-1759, slip op. at 10,11 (4th Cir. Apr. 15, 2020) (affirming summary judgment).

#+endASIDE

Why have amendments signed by both parties? Consider this hypothetical example: Suppose that you are an apartment dweller. You and the landlord agree to amend your lease: The landlord agrees to reduce your monthly rent in exchange for your agreeing to extend the lease by one year. Each of you is being bound by the amendment, so each of you must sign it.

Pro tip: It's a good practice to have amendments signed by all parties, but it's also better not to require signatures by all parties, in case for some reason one party's signature is not obtained. (This is an example of the R.O.O.F. drafting principle: Root Out Opportunities for F[oul]ups.)

22.4.6 Terms affected by an amendment

In case of doubt, an amendment will affect only the specific provision(s) of the amended document that are clearly identified in the amendment; all other terms of the amended document will remain in effect as before the amendment.

Commentary

This is a comfort clause preferred by some "meticulous" drafters. See generally, e.g., Title Guaranty Escrow Services, Inc., v. Wailea Resort Co., 456 P.3d 107, 109 (Haw. 2019), where an amendment to the contract in suit contained similar language (the language was not relevant to the lawsuit).

22.5 Amendments (Unilateral)

22.5.1 Applicability

When agreed to, this Clause will apply if the Contract allows a party, referred to as an "Amending Party,"

  • to unilaterally amend the Contract or a related document,
  • or some portion of it, such as (without limitation) an annex, schedule, etc.,
  • without first getting the express agreement of another party.
Commentary

See also Tango Clause 22.4 - Amendments.

Unilateral-amendment provisions are fairly common in, e.g., Web sites' terms of service, cable- and telephone-service contracts, and the like. See, for example, the Facebook Statement of Rights and Responsibilities § 14; Google Terms of Service (under the headline "About These Terms").

22.5.2 Unilateral amendment procedure

  1. The Amending Party must give the other party at least 30 days' advance written notice of any unilateral amendment that it wishes to make.
  2. The notice of amendment must conspicuously (see Section 11.4: ) state the following:
    1. that an amendment is being proposed;
    2. when the proposed amendment would go into effect;
    3. that the other party may opt out of the amendment;
    4. the deadline for the other party to take the opt-out action described in subdivision c.2 below; and
    5. whether any action on the other party's part would constitute affirmative acceptance of the proposed amendment (for example, continuing to use an online service after the effective date of the proposed amendment).
  3. The notice of unilateral amendment must also clearly state:
    1. the details of the proposed amendment; and
    2. what one or more actions the other party may take to opt out of the proposed amendment (for example, giving notice of termination of the Contract, or terminating a user account).
Commentary
22.5.2.1 Opt-out right

It's pretty conventional for unilateral-amendment provisions to give the non-amending party the right to opt out of the agreement if it doesn't want to accede to a unilateral amendment.

Or, in a mass-market form contract, a unilateral-amendment provision might instead allow (or require) a non-amending party simply to terminate its account with the amending party or to cease utilizing the amending party's services, as opposed to giving notice of termination.

22.5.3 No retroactive effect

Any unilateral amendment will be prospective only; that is, the amendment will not substantively expand or limit either party's rights or liabilities under the Contract that had already come into effect as of the effective date of the unilateral amendment.

(Of course, the parties can jointly agree to amend with retroactive effect; see Tango Clause 22.4 - Amendments.)

Commentary
22.5.3.1 Caution — the danger of "illusory" contracts

If a unilateral-amendment provision might have retroactive effect, then:

  • The unilateral-amendment provision might cause some or all of a contract — for example, an arbitration provision with a class-action waiver — to be unenforceable, on grounds that the contract was illusory.
  • That, in turn might strip a provider of legal protection that the contract might otherwise have provided, in the form of, e.g., an arbitration clause with class-action waiver; a forum-selection or governing-law clause; and so forth.

This is essentially what happened in Harris v. Blockbuster Inc.:

A Blockbuster customer sued the company for allegedly violating her privacy rights and sought class-action status.

  • Blockbuster sought to parry the suit by moving to compel individual, case-by-case arbitration, as required in the Blockbuster on-line terms of service.
  • Harris opposed arbitration, because for her lawyers, many onesie-twosie arbitration proceedings would be much less economically attractive than class arbitration.

The court denied Blockbuster's motion to compel arbitration, on grounds that the company's terms of service were "illusory" — because the unilateral amendment didn't include a so-called Halliburton exception, discussed below — and therefore was unenforceable under the relevant state law. See Harris v. Blockbuster, Inc., 622 F Supp. 2d 396, 400 (N.D. Tex. 2009), citing In re Halliburton Co., 80 S.W.3d 566 (Tex. 2002).

Much the same occurred in Carey v. 24 Hour Fitness USA:

A former employee filed a lawsuit against 24 Hour Fitness. The company moved to compel arbitration, citing an arbitration provision in the company's employee handbook.

The court held that the arbitration provision was unenforceable because the company reserved the right to change the employee handbook at will — and that, in turn, meant that the handbook was "illusory"; consequently, the arbitration provision was ineffective and the former employee's case would be tried in court instead of being heard privately by an arbitrator. See Carey v. 24 Hour Fitness USA, Inc., 669 F.3d 202 (5th Cir. 2012).

• Advance notice of a unilateral amendment might be required to make the amendment effective:

A company's employment handbook contained an agreement to binding arbitration. The handbook also stated that "Any change to this Agreement will only be effective upon notice to Applicant/Employee and shall only apply prospectively." According to the Fifth Circuit, that wasn't enough to save the arbitration agreement from being illusory and therefore unenforceable, because the agreement didn't include the advance notice required for the Halliburton exception discussed in Section 22.5.3.2: . See Watch House Int'l, LLC v. Nelson, 815 F.3d 190 (5th Cir. 2016) (reversing and remanding order compelling arbitration).

• For agreements that are posted to a Website, just changing the agreement at the Website likely won't be enough notice of a unilateral amendment.

That was the result in a case involving Talk America Inc., a long-distance telephone service provider, which changed its service agreement to require arbitration and a waiver of class actions. See Douglas v. United States District Court ex rel. Talk America Inc., 493 F.3d 1062, 1066 (9th Cir. 2007) (vacating district court's order compelling arbitration).

Accord: Stover v. Experian Holdings, Inc., No. 19-55204 (9th Cir. Oct. 21, 2020) (affirming order compelling arbitration; consumer could not claim benefit of new arbitration terms when she had not received notice of the terms); Rodman v. Safeway Inc., No. 11-cv-03003-JST part III-C (N.D. Cal. Dec. 10, 2014) (granting class plaintiff's motion for summary judgment that Safeway had overcharged on-line customers).

22.5.3.2 The Halliburton exception saves the day

In the cited Halliburton case, the Texas supreme court held that an employer could unilaterally impose a change the terms of at-will employment to require arbitration of disputes, as long as :

  • the employer gave advance notice; and
  • the change did not apply to claims of which the employer had already been given notice. See In re Halliburton Co., 80 S.W.3d 566, 569-70 (Tex. 2002); see also Lizalde v. Vista Quality Markets, 746 F.3d 222 (5th Cir. 2014) (reversing denial of motion to compel arbitration).

See also the commentary at [LINK NEEDED].

22.5.4 Additional rejection opportunity for existing disputes

  1. If an Amending Party proposes a change to a dispute-resolution procedure in the Contract,
    • for example, a binding-arbitration provision,
    • then the other party may reject the proposed change,
    • by giving the Amending Party notice to that effect within 30 days after the effective date of the Amending Party's notice of unilateral amendment.
  2. If the other party does reject the proposed unilateral amendment to the dispute-resolution procedure,
    • then the Contract's then-existing dispute resolution provisions (if any) will remain in effect,
    • for any disputes that were pending at (what would otherwise have been) the effective date of the proposed amendment.
  3. If the other party does not timely reject the proposed dispute-resolution amendment
    • then the proposed amendment will go into effect as to all disputes,
    • including but not limited to any dispute that was pending at the time of the notice of unilateral amendment.
Commentary

The provision is modeled on a comparable one in section 2 of the Uber ride-sharing terms of service of November 17, 2020 (last visited November 27, 2020).

A somewhat-similar provision was responsible for saving an arbitration clause from invalidation:

An arbitration agreement was terminable by the employer, but it expressly stated that the termination would be prospective only and would not be effective until the employer had given the employee ten days' notice. See Lizalde v. Vista Quality Markets, Inc., 746 F.3d 222, 224 (5th Cir. 2014) (reversing district court's denial of employer's motion to compel arbitration of employee's claim for on-the-job injury).

22.6 And/Or Definition

When the term "and/or" is used in a list, such as "A, B, C, and/or D," it refers to one or more (or, some or all) of the listed items, not to just one of them.

Hypothetical example: The parties expect to meet on Tuesday, Wednesday, and/or Thursday. This means that the parties expect to meet on one or more of those days, not just on one and only one of them.

Commentary

Some people loathe the term and/or. Used properly, however, the term can be a serviceable shorthand; it's equivalent to the inclusive-or, as opposed to the exclusive-or (which is expressed mathematically as XOR).

One state-court judge excoriated the use of and/or as "indolent"; the judge — who evidently was no slave to brevity — proclaimed that a drafter could instead "express a series of items as, A, B, C, and D together, or any combination together, or any one of them alone." Uh, sure, Your Honor …. Carley Foundry, Inc. v. CBIZ BVKT, LLC, No. 62-CV-08-9791, final paragraph (Minn. Ct. App., Apr. 6, 2010).

More sensibly: Ken Adams, author of A Manual of Style for Contract Drafting, suggests that, when dealing with a list of three or more items, use "one or more of A, B, and C." Kenneth A. Adams, "A, B, and/or C", (2012), http://goo.gl/m9U3p (adamsdrafting.com).

Granted, it's possible to use and/or inappropriately. See, e.g., the examples collected by Wayne Scheiss, director of the legal-writing program at the University of Texas School of Law, in In the Land of Andorians (Jan. 2013).

But trying to ban and/or is likely a bootless errand, because many drafters will use the term anyway. So the better practice is just to define the term and be done with it. (W.I.D.D. — When In Doubt, Define!)

Footnote: In a related danger, a court could easily read the term and as being disjunctive — that is, as tantamount to oror vice versa. See Capital Finance, LLC v. Rosenberg, 364 F. Supp. 3d 529, 540, 544-45, 546 (D. Md. 2019) (citing cases), aff'd in relevant part, No. 19-1202, slip op. (4th Cir. Sept. 21, 2020).

22.7 Arbitration

22.7.1 Introduction

This Clause applies when the Contract calls for some or all disputes to be arbitrated.

Commentary
22.7.1.1 Background: Overview of arbitration

Arbitration is, in essence, a form of private dispute resolution in which, by agreement of the parties, an arbitrator (or a panel of three arbitrators) decides the dispute instead of a court's doing so.

Note that arbitration is not the same as mediation, in which a neutral mediator has no authority to decide the dispute, but does attempt to broker an agreed settlement between the disputing parties, often using "shuttle diplomacy."

Arbitration by agreement is usually binding.

By law and treaty (the New York Convention) in the U.S. and many other countries:

•  If the parties to a dispute agree to arbitration, and the arbitrator renders an award, then the party that wins the arbitration can go to court to have the arbitrator's award "confirmed," that is, entered into the court records as though it were a judgment of the court itself. See, e.g., 9 U.S.C. § 13 (entry of judgment on arbitration award).

•  If the award requires the losing party to pay money to the winning party, but the losing party doesn't pay up, then once the award has been "confirmed" (i.e., entered as a judgment of the court), the winning party can have the confirmed award "executed." This is typically accomplished by obtaining a writ of execution from the court — this is a document commanding the sheriff (or other law-enforcement authority) to seize the losing party's bank funds and deliver them to the winning party (or to seize the losing party's non-monetary assets, cause them to be sold, and deliver the proceeds to the winning party).

22.7.1.2 Public policy favoring arbitration

Arbitration used to be disfavored by U.S. courts, but Congress and the Supreme Court have instructed lower courts to reverse that stance.

The [Federal Arbitration Act] was enacted in 1925 in response to widespread judicial hostility to arbitration agreements. Section 2, the primary substantive provision of the Act, provides, in relevant part, as follows:

"A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction… shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract."

We have described this provision as reflecting both a liberal federal policy favoring arbitration and the fundamental principle that arbitration is a matter of contract. In line with these principles, courts must place arbitration agreements on an equal footing with other contracts and enforce them according to their terms.

AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 131 S. Ct. 1740, 1745-46 (2011) (cleaned up, emphasis added).

22.7.1.3 Some pros and cons of arbitration

Some parties prefer to arbitrate disputes, because:

Properly managed, arbitration can serve as a faster, less-expensive way of resolving business disputes.

For arbitration-management suggestions, see this streamlining article by the present author — I sometimes serve as an arbitrator in tech-contract and IP disputes — as well as my arbitration procedures.

• For transnational arbitrations: Because of the international treaty on arbitration (the New York Convention), if a case is arbitrated in Country A, it's often easier for the winning party to get a court in Country B to enforce the arbitrator's award (e.g., by ordering seizure of the losing party's assets located in Country B) than it would be if the case had been litigated in Country A.

But others regard arbitration as being the worst of both worlds; it has been said that —

• Arbitration has supposedly been "captured" by litigation counsel who, for reasons of their own, prefer to agree with their counterparts to run arbitration proceedings in the same, expensive- and time-consuming ways as they're familiar with in court; and

• Arbitrators — desirous of getting future business from counsel — can be reluctant to anger counsel by overruling them, even though that would help to keep costs down. See Thomas J. Stipanowich, Arbitration: The New Litigation, 2010 Ill. L. Rev. 1.

22.7.1.4 Consider "baseball" arbitration

To promote settlement, drafters should seriously consider including a "baseball" arbitration clause such as that of [LINK NEEDED], for reasons discussed in the commentary there.

22.7.1.5 Pro tip: Be clear that arbitration is mandatory

An arbitration clause should be very clear that arbitration is mandatory: Feel-good language making it seem that arbitration is optional can kill an arbitration requirement.

In one case, the arbitration clause said that "[i]f the dispute is not resolved through mediation, the parties may submit the controversy or claim to Arbitration. If the parties agree to arbitration, the following will apply: …."

In that case, both the trial court and appellate court concluded that under the arbitration clause, arbitration was not required and therefore the appellant's motion to compel arbitration must be denied. Quam Construction Co. v. City of Redfield, 770 F.3d 706, 708 (8th Cir. 2014) (emphasis edited).

22.7.2 Broad definition of "arbitrable dispute"

To the extent not affirmatively prohibited by law, the parties must arbitrate any Agreement-Related Dispute (see the definition in Clause 22.3) in accordance with this Clause. This includes, without limitation, the following:

  1. any claim under a statute or a common-law doctrine; and
  2. any claim that a party was induced to enter into the Contract by another party's fraud or negligent misrepresentation.
Commentary
22.7.2.1 Statute-based claims can be arbitrable — if so agreed

American courts have held that statute-based claims can be arbitrated, but only if the parties agree.

• An employer tried to force an employment-discrimination case to be heard in arbitration under the employer's collective-bargaining agreement ("CBA") with a union. The employer managed to convince the district court to rule in its favor.

But the Fifth Circuit disagreed: The appeals court said that the arbitration provision in the CBA didn't cover discrimination claims because the provision didn't include a clear and unmistakable statement that statutory claims were to be arbitrated. See Ibarra v. United Parcel Service, 695 F.3d 354, 356 (5th Cir. 2012) (reviewing Supreme Court cases; vacating and remanding summary judgment in favor of employer).

• In contrast, another employer's collective-bargaining agreement did include what the [U.S.] Supreme Court described as "a provision … that clearly and unmistakably requires union members to arbitrate claims arising under the Age Discrimination in Employment Act of 1967 (ADEA)"; the Court held that that arbitration provision was enforceable. See 14 Penn Plaza LLC v. Pyett, 556 U.S. 249 (2009) (reversing court of appeals; citation omitted).

22.7.2.2 BUT: Not all claims will be forced into arbitration

Not all arbitration provisions will be readily enforced by U.S. courts. For example:

• Drafters working in the financial-services arena should check the Dodd-Frank Act's prohibition of mandatory arbitration of Sarbanes-Oxley Act "whistleblower" claims. See generally, e.g., Federal Courts Split on Whether Dodd-Frank's Bar on Arbitration of Whistleblower Retaliation Claims Under Sarbanes-Oxley Is Retroactive (Oct. 9, 2012) (sutherland.com).

BUT: The Second Circuit has held that this prohibition does not bar mandatory arbitration of whistleblower-retaliation claims. See Daly v. Citigroup, Inc., 939 F.3d 415 (2d Cir. 2019) (affirming order compelling arbitration).

• In the Truth in Lending regulations, Regulation Z prohibited pre-dispute arbitration clauses in mortgages secured by dwellings until overturned in 2017 by the GOP Congress and President Trump.

• Government contractors and subcontractors should check "Franken Amendment" restrictions on arbitration clauses in employment agreements relating to certain government contracts. See, e.g., Frank Murray, Assessing the Franken Amendment (Feb. 16, 2011).

Moreover, in July 2014, President Obama signed an executive order stating that in federal government contracts for more than $1 million, "contractors [must] agree that the decision to arbitrate claims arising under Title VII of the Civil Rights Act of 1964 or any tort related to or arising out of sexual assault or harassment may only be made with the voluntary consent of employees or independent contractors after such disputes arise"; the order includes a flowdown requirement for subcontracts for more than $1 million.

(The order sets out exceptions for (i) the acquisition of commercial items or commercially available off-the-shelf items; (ii) collective bargaining agreements; and (iii) some but not all arbitration agreements that were in place before the employer placed its bid for the government contract in question.)

The Fourth Circuit has held, however, that when accounting firm PricewaterhouseCoopers ceased being a government contractor, the firm regained its right to enforce the mandatory-arbitration provision in its employment agreements. See Ashby v. PricewaterhouseCoopers LLP, No. 18-1958 (4th Cir. Apr. 3, 2020) (reversing and remanding denial of motion to compel arbitration).

• Federal law provides that in franchise agreements between automobile manufacturers and their dealers, pre-dispute arbitration agreements are unenforceable. See 15 U.S.C. § 1226(a)(2).

• The regulations implementing the Military Lending Act render unenforceable any agreement to arbitrate consumer credit disputes between lenders and active-duty military personnel or their eligible dependents.

These regulations do not distinguish between pre-dispute and post-dispute agreements to arbitrate, even though the statute appears to make just such a distinction. See 10 U.S.C. § 987(e)(3), implemented in 32 C.F.R. § 232.9(d).

• Federal regulations governing livestock and poultry production impose restrictions on certain contracts mandating the use of arbitration.

Under these regulations, such contracts must include, on the signature page, a specifically-worded notice, in conspicuous bold-faced type, allowing the producer or grower to decline arbitration; moreover, the Secretary of Agriculture seems to have the power to review agreements to determine "whether the arbitration process provided in a production contract provides a meaningful opportunity for the poultry grower, livestock producer, or swine production contract grower to participate fully in the arbitration process." 9 C.F.R. § 201.218.

22.7.2.3 Arbitration of employee claims at NLRB, etc.

Anyone drafting an arbitration clause for an employment agreement should consider that the (U.S.) National Labor Relations Board has held that a mandatory arbitration provision, in a company's sales-commission agreement, unlawfully interfered with employees' right of access to the Board's processes, in violation of section 8(a)(12) of the National Labor Relations Act.

The Board distinguished the arbitration provision from another arbitration provision that contained an adequate exception for Board charges. See Beena Beauty Holding, Inc., 368 NLRB No. 91 (2019); see also, e.g., Four Seasons Healthcare & Wellness Center, LP, 370 NLRB No. 8 (2020) (arbitration provision saved by an exception for Board charges).

22.7.3 Exception for small claims

a.  Who may opt out: Either party may opt out of arbitrating a claim, and instead take the claim to a court of competent jurisdiction, if (but only if), all told, the aggregate amount being sought under the claim is no more than USD $10,000.

b.  Required court for small claims opt-out: If the Contract includes a forum-selection provision (see [LINK NEEDED]), then the opted-out small claim must be brought in a court permitted by that provision.

c.  Class action? In case of doubt:

  1. this small-claims exception to arbitration does not itself authorize class- or collective-action arbitration (see below); and
  2. if either party asserts that the claim must be arbitrated despite this small-claims exception, then that assertion is to be decided by the court, and the arbitral tribunal will have no power to do so.
Commentary

Arbitration is not cost-free, because arbitrators and arbitration administrators charge for their services. If a particular dispute doesn't have a lot of money at stake, it probably would be more cost-effective for the parties to take the dispute to small-claims court instead.

Alternative:

All otherwise-arbitrable claims must be arbitrated, no matter how small the amount in controversy is.

Subdivision c.2: This carve-out is an exception to the delegation of arbitrability disputes in [LINK NEEDED]. (Concerning the "no power" phrasing, see the commentary at Section 22.7.17.1: .)

See also [LINK NEEDED] concerning class arbitration.

22.7.4 Arbitral law

Any arbitration is to be governed by the internal laws of the State of Texas.

Commentary

This section adopts Texas arbitration law for U.S. arbitrations, because Texas law lays out a sensible process that allows:

  • compulsory depositions of adverse witnesses — but outside of Texas, of course, that provision might well be unenforceable against non-party witnesses; and
  • an expanded right of appeal if desired (discussed in more detail at [LINK NEEDED]), which is not available under the Federal Arbitration Act per se. See Tex. Civ. Prac. & Rem. Code §§ 171.050 and 171.051.

Note that in the U.S., the Federal Arbitration Act will generally apply in cases involving or affecting interstate commerce "absent clear and unambiguous contractual language to the contrary" — and this section does not attempt to rule out applying the FAA — in which the contract "expressly references state arbitration law." BNSF R.R. Co. v. Alston Transp., Inc., 777 F.3d 785, 790-92 (5th Cir. 2015) (vacating district court's vacatur of arbitration award and remanding with instructions to reinstate award) (cleaned up; citations omitted).

Nor does this section try to specify a particular governing law for non-U.S. arbitrations, because that would be subject to too much variation.

22.7.5 Arbitration rules

  1. Applicable rules: Any arbitration is to be governed by:
    1. the Commercial Arbitration Rules of the American Arbitration Association ("AAA"), for cases where all parties to the arbitration are citizens and/or residents of the United States, or
    2. the International Arbitration Rules of the International Centre for Dispute Resolution ("ICDR"), the international division of the AAA, otherwise,

in either case, as in effect at the time of the demand for arbitration.

  1. Choice of rules, not of forum: In case of doubt, the parties' agreement to the arbitration rules is intended as a choice of rules and not of forum.
Commentary
22.7.5.1 Subdivision a: AAA / ICDR rules

Many arbitration rules are sufficiently well-developed that they could be thought of as the arbitral version of the Federal Rules of Civil Procedure: Once you agree to such rules, you've agreed, in great detail, how any arbitration proceeding would be conducted.

Drafters have considerable choice in their selection of arbitration rules, such as, for example:

• For U.S. arbitrations, [LINK NEEDED] specifies the Commercial Arbitration Rules of the American Arbitration Association, which are a typical "default" standard in the U.S.

The AAA also has expedited rules that can be used if desired, as well as rules for appeal of arbitration awards to an appellate panel of arbitrators. (Disclosure: The author is a member of the AAA's commercial arbitration panel.)

• For non-U.S. arbitrations, [LINK NEEDED] specifies the International Arbitration Rules of the International Centre for Dispute Resolution ("ICDR"), the international division of the AAA.

The ICDR rules are said to be based on the UNCITRAL Rules (mentioned below) but with administration features included.

For a discussion of the 2014 revisions to the ICDR rules, see Eduardo R. Guzman and Joseph M. Kelleher, International Centre for Dispute Resolution ("ICDR") Revised Rules Came Into Effect on June 1, 2014.

• The LCIA Arbitration Rules of the London Court of International Arbitration (LCIA) are popular in international arbitrations.

• The ICC arbitration rules of the International Chamber of Commerce (ICC) are believed to be among the most popular world-wide, in part because the arbitration award prepared by the Arbitral Tribunal will be scrutinized, before being released to the parties, by the ICC's International Court of Arbitration.

Others, though, believe that these putative benefits must be weighed against the likely cost of an ICC arbitration; see, e.g., Latham & Watkins, Guide to International Arbitration, ch. IV.

• The UNCITRAL arbitration rules do not provide for administration; to some, the absence of administration would be a serious deficiency.

• The World Intellectual Property Organization (WIPO) has published arbitration rules and expedited arbitration rules.

• The JAMS Streamlined Arbitration Rules have been praised by some arbitrators as effective; JAMS also has a set of international arbitration rules.

• The International Institute for Conflict Prevention and Resolution (CPR) rules are favored by some.

For a brief comparison of various rules, see an article by Mark Anderson on the IP Draughts blog at http://goo.gl/ZX1iy.

For a more-detailed comparison of arbitration rules in the U.S. (AAA, JAMS, and CPR), see Liz Kramer, ArbitrationNation Roadmap: When Should You Choose JAMS, AAA or CPR Rules?

For international arbitration, see this October 2014 chart (CorporateCounsel.com), by Kiera Gans and Amy Billing, of selected key aspects of different rules.

22.7.5.2 Subdivision b: Choice of forum, not rules

This subdivision seeks to avoid the result in the Second Circuit's 1995 Salomon securities class-action case, where an arbitration provider's refusal to accept a case resulted in the court's ruling that this negated the parties' agreement to arbitrate. See In re Salomon Inc. Shareholders' Derivative Lit., 68 F.3d 554 (2d Cir. 1995); see also, e.g., PoolRe Ins. Corp. v. Organizational Strategies, Inc., 783 F.3d 256 (5th Cir. 2015) (citing cases).

Other courts have reached the opposite result, holding that, just because the designated arbitral body isn't available, that won't negate the agreement to arbitrate unless that designation was material to the agreement. See, e.g., Ferrini v. Cambece, No. 2:12-cv-01954 (E.D. Cal. June 3, 2013) (citing cases); Nachmani v by Design, LLC, 901 N.Y.S.2d 838, 74 A.D.3d 478 (N.Y. App. Div. 2010) (agreement to AAA rules was choice of rules, not of administrator).

22.7.6 Arbitral tribunal: Number of arbitrators

The arbitral tribunal is to consist of a single arbitrator.

Commentary

At least in theory, three arbitrators are more likely than a single arbitrator to consider everything that needs to be considered and not overlook significant issues or evidence. It's also possible that a reviewing court might be more inclined to confirm an arbitration award rendered by three arbitrators instead of just one.

BUT: Many arbitrators and counsel agree that three arbitrators will cost more than three times the cost of a single arbitrator, because three arbitrators will spend time conferring with each other and negotiating the language of the award.

Contract negotiators therefore might want to specify appointing a single arbitrator in cases of comparatively low value, perhaps using three arbitrators for "big" cases.

Under Rule R-16 of the AAA's Commercial Arbitration Rules, the AAA can in its discretion decide to appoint three arbitrators, but otherwise a single arbitrator is used unless the arbitration agreement specifies otherwise.

22.7.7 Arbitral tribunal: Selection

The arbitral tribunal is to be selected:—

  1. as provided in the arbitration rules or,
  2. failing that, as provided by law.
Commentary
22.7.7.1 Purpose of arbitrator selection by law

This section takes into account that the arbitrator selection method prescribed by the arbitration rules might not succeed in picking a tribunal. In that circumstance, a court might refuse to compel arbitration. At this writing, this is the subject of a circuit split among U.S. federal courts. For that reason, this section says that a court can serve as a backup selector. See Frazier v. Western Union Co., 377 F. Supp. 3d 1248, 1265-66 (D. Colo. 2019) (citing cases); cf. Trout v. Organización Mundial de Boxeo, Inc., 965 F.3d 71, 82 (1st Cir. 2020), discussed in the next section.

22.7.7.2 Should a party get to choose, or even be, the arbitrator?

Some arbitration agreements, especially in sports, provide for a senior authority figure in one of the parties to serve as arbitrator. Consider, for example, the famous "Deflategate" case, which centered on legendary (U.S.) National Football League quarterback Tom Brady. The Second Circuit rejected Brady's contention that NFL commissioner Roger Goodell could not properly sit as arbitrator in Brady's challenge of his four-game suspension, holding in essence that that the players' union and the team owners had known full well the consequences of their agreement, and that they could have done things differently if they wished. See NFL Mgmt. Council v. NFL Players Ass'n, 820 F.3d 527, 548 (2016).

On the other hand, the First Circuit held that, under the applicable Puerto Rican law, the arbitration provision in the World Boxing Organization's agreement with boxers was unconscionable because it gave the WBO the power to select the arbitrator. See Trout v. Organización Mundial de Boxeo, Inc., 965 F.3d 71 (1st Cir. 2020). The appeals court remanded the case for consideration of a savings clause that might allow arbitration to go forward anyway with an arbitrator appointed by the district court. See id., 965 F.3d at 82.

In an earlier California case, an appeals court held that a "review committee" procedure in an employer's "Employee Guide" did not constitute an agreement to arbitrate because "a third party decision maker and some decree of impartiality must exist for a dispute resolution mechanism to constitute arbitration." Cheng-Canindin v. Renaissance Hotel Associates, 50 Cal. App. 4th 676, 687 (1996).

22.7.8 Arbitral tribunal: Arbitrator qualifications

The Contract may specify particular arbitrator qualifications, but if an arbitrator lack those particular qualifications, it will not affect the validity or enforceability of any award by the tribunal unless either party objects to the member's participation:

  1. within the time provided by the arbitration rules; or
  2. if the arbitration rules do not provide a time limit for objection, within ten business days after being informed in writing (by any means) of the tribunal member's appointment.
Commentary

Some contracts (usefully) specify different arbitrator qualifications for different types of dispute. One such case involved the sale of certain oil and gas properties for $1.75 billion; the contract called for title disputes to be arbitrated by consultants familiar with the energy industry, but for accounting disputes to be arbitrated by an accounting referee. See BP America Production Co. v. Chesapeake Exploration LLC, 747 F.3d 1253, 1256 (10th Cir. 2014) (affirming a variety of orders by the district court).

Caution: A very few contracts get extremely (and overly) explicit about who may serve as an arbitrator, e.g., "ten years practicing law in the computer-software field and five years' experience as an arbitrator." Doing that, though, might seriously limit the pool of available arbitrators.

22.7.9 Arbitration administrator

Unless unambiguously agreed otherwise, the arbitration is to be administered by:

  1. if all parties to the arbitration are citizens and/or residents of the United States: the American Arbitration Association;
  2. all other arbitrations: the International Center for Dispute Resolution; or
  3. if no agreed-to administrator is willing or able to serve in that role: the arbitral tribunal.
Commentary

As far as "administration" of arbitration goes, it comes in two flavors: Administered, and ad hoc. Among the reasons to prefer administered arbitration: Arbitration requires doing a number of chores such as scheduling, invoicing, etc. It's usually more cost-effective to have those chores handled by the AAA, the ICC, or other arbitral institution, than it would be to pay the arbitrator's hourly rate.

Moreover, an experienced arbitrator points out that:

• "AAA's vetting process formalizes disclosures of potential conflicts/biases and thus minimizes [sic; reduces] the likelihood of a flawed proceeding."

• In addition, a party might have a complaint about an arbitrator, for example a perception that the arbitrator is biased toward another party. It will usually be better if the complaining party can take its complaint to an arbitral institution, than to risk angering the arbitrator by raising the complaint with the arbitrator himself.

•  And "a competent administrator will goad an arbitrator who is not moving the proceeding apace." Gary McGowan, 12 Ways to Achieve Efficiency and Speed in Arbitration, Corporate Counsel (Apr. 22, 2013) (modified for readability) (now behind a paywall).

Another commentator says that "the conventional wisdom is that it is easier to enforce an award given by an arbitral institution than one given by an ad hoc arbitrator." Eric S. Sherby, A Checklist for Drafting an International Arbitration Clause (Sept. 10, 2010).

Quite a few arbitration-administration organizations are available.

Examples:

22.7.10 Arbitration location

The arbitration hearing is to be conducted in the location specified by the arbitration rules, which is to be considered the "seat" of the arbitration.

Commentary

The choice of arbitral location — sometimes referred to as the "seat" of the arbitration — can have significant procedural implications, such as in determining the arbitral law. (The arbitration rules might specify the arbitral location to be applied in the absence of the parties' agreement otherwise.)

Example: Suppose that the parties' agreement specifies that the arbitral location will be (say) London, but the agreement does not specify an arbitral law. In that case, procedurally the arbitration proceedings might well be governed by English arbitration law — even if the agreement's governing-law provision specified another law to govern the interpretation and enforcement of the Agreement. See, e.g., Zurich American Insurance Co. v. Team Tankers A.S., 811 F.3d 584, 588 (2d Cir. 2016).

22.7.11 Arbitral language

The English language, as used in the United States, is to be used for all proceedings, notices, and decisions in the arbitration.

Commentary

In transnational contracts, the parties might well be fine with using English, the global lingua franca of business, as the arbitral language. But drafters should also consider where an arbitration award might have to be enforced, with an eye to reducing the expense (and time delay) of providing a sworn translation, which might be necessary under Article IV.2 of the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention).

Requiring notices to be in the arbitral language could be important.

Example: A U.S. retailer, in a business relationship with a Chinese manufacturer, was served with a notice of arbitration — written in Chinese. The retailer did not get the notice translated in time. As a result, the retailer found itself losing an arbitration in China, and having a sizable damages award entered against it. Fortunately for the retailer, a U.S. court refused to enforce the award, on grounds that a different agreement controlled, under which the arbitration notice was required to be in English, not Chinese. See CEEG (Shanghai) Solar Science & Tech. Co. v. LUMOS LLC, 829 F.3d 1201 (10th Cir. 2016), affirming No. 14-cv-03118 (D. Colo. May 29, 2015).

(The CEEG case also illustrates the principle that a contract might be worthless if the assets of a party that breaches the contract are effectively beyond the reach of the other party.)

22.7.12 No class arbitration

  1. Unless the Contract clearly and unmistakably states otherwise, a claimant must arbitrate only its own dispute —
    1. without consolidation with claims of other parties, and
    2. without purporting to be (i) a plaintiff or representative class member in a purported class action, collective action, or representative proceeding, nor (ii) a private attorney general under laws such as (for example) California's Private Attorneys General Act.
  2. The arbitral tribunal will have no power to decide whether arbitration is allowed in any manner other than as stated in this Clause unless the Contract expressly and unmistakably allows class arbitration.
Commentary
22.7.12.1 Why no class arbitration?

In the United States, the Supreme Court has held that a class arbitration is not permitted under the Federal Arbitration Act unless the parties expressly agreed to it, on grounds that arbitration differs from litigation in crucial ways and that a party's consent to class arbitration could not be inferred or implied.

A majority of the Court took the view that arbitration is so different from litigation — with very different procedures and, crucially, very little right of appeal — that the "default" rule, at least for arbitrations under the Federal Arbitration Act, is that class-action arbitration is not allowed unless the parties expressly agree to it: "[C]lass-action arbitration changes the nature of arbitration to such a degree that it cannot be presumed the parties consented to it by simply agreeing to submit their disputes to an arbitrator"; the Court listed several examples of these changes, for example the significant raising of the stakes with little prospect of appellate review. See Stolt-Nielsen SA v. AnimalFeeds International, 559 U.S. 662, 130 S. Ct. 1758, 1775 (2010).

In other cases, the Court has similarly held that:

  • The Act preempts state law barring enforcement of a class-arbitration waiver. See AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 131 S. Ct. 1740 (2011) (reversing Ninth Circuit); see also, e.g., Davis v. Nordstrom, Inc., 755 F.3d 1089, 1092-94 (9th Cir. 2014) (reversing denial of Nordstrom's motion to compel employee to arbitrate her claims individually and not as a class)
  • A contractual waiver of class arbitration is enforceable under the Act even if the plaintiff's cost of individually arbitrating a federal statutory claim exceeds the potential recovery. See American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013) (reversing Second Circuit).

Caution: Drafters should be extremely explicit that class arbitration is not allowed; otherwise, a court might well find that the court had no power to overrule the arbitrator's conclusion that class arbitration was allowed, as discussed in the next section.

22.7.12.2 Subdivision b: Court is to decide class-arbitration questions

This subdivision is informed by a Supreme Court holding that if an arbitration agreement delegates to the arbitrator the decision whether class arbitration is allowed (see [LINK NEEDED]), then the arbitrator's decision about class-action arbitrability cannot be overruled by a court except on extremely-limited grounds. See Oxford Health Plans LLC v. Sutter, 569 U.S. 564 (2013) (affirming denial of motion to vacate arbitrator's approval of class action).

Arbitrator mischief might be countenanced by this Supreme Court holding: The present author once read an arbitration award in which the arbitrator held that class arbitration was implicitly agreed to — egregiously (IMHO) flouting the Supreme Court's contrary direction in Stolt-Nielsen (see the discssion in Section 22.7.12.1: ). After Oxford Health Plans, it's not clear that such a misguided arbitrator holding could be overturned in court.

22.7.12.3 No class arbitration? Be careful what you wish for …

The food-delivery service DoorDash used a contract with delivery drivers that included an arbitration clause that prohibited class arbitrations — so thousands of drivers flooded DoorDash with demands for arbitration, and the company was ordered to pay $9.5 million in arbitrator fees as required by the contract. See Nicholas Iovino, DoorDash Ordered to Pay $9.5M to Arbitrate 5,000 Labor Disputes (CourthouseNews 2020).

Likewise, more than 5,000 food-delivery drivers for Postmates, Inc., submitted arbitration demands, but Postmates refused to tender its share of the arbitration costs, claiming that "the demands are tantamount to a de facto class action in violation of the class action waiver." The court granted the drivers' motion to compel arbitration so that the arbitrator could take up Postmates's claim, as required by the arbitration provision's delegation clause.

The court said: "… the possibility that Postmates may now be required to submit a sizeable arbitration fee in response to each individual arbitration demand is a direct result of the mandatory arbitration clause and class action waiver that Postmates has imposed upon each of its couriers."

(The court later ordered that Postmates show cause why it should not be held in civil contempt for violating the order compelling arbitration, and still later refused to grant a stay to allow Postmates to appeal.)

See Adams v. Postmates, Inc., No. 19-3042 SBA, slip op. at 1-2, 7 n.2 (N.D. Cal. Oct. 22, 2019).

22.7.12.4 Allow opting out of a class-arbitration prohibition?

Some companies include opt-out provisions in their arbitration agreements, especially in employment agremeents and customer agreements. Opting out of arbitration would preserve an employee's or customer's right to bring class-action litigation.

Many people might not actually bother to opt out; this was the case in a Ninth Circuit appeal, where an employee failed to timely opt out of arbitration when given the chance, and so was held to have waived the right to go to court. See Johnmohammadi v. Bloomingdale's, Inc., 755 F.3d 1072, 1074 (9th Cir. 2014) (affirming grant of Bloomingdale's motion to compel arbitration of employee's claim and dismissal of her class-action suit).

22.7.12.5 Alternative: Allow class arbitration?

Parties wishing to allow class arbitration could consider using the following in the Contract:

Class arbitrations are permitted in accordance with the Supplementary Rules for Class Arbitrations of the American Arbitration Association.

Parties agreeing to class arbitration might also want to agree to an enhanced right of appeal, as stated in [LINK NEEDED].

22.7.13 Forum for enforcement of arbitration award

  1. An arbitration award may be confirmed or otherwise enforced in any forum having jurisdiction.
  2. The Contract may specify that a particular forum is the only permissible forum for enforcement.
Commentary

One or another party to an arbitration might want to have the ability to enforce, or challenge, the award in a preferred jurisdiction; this section provides a vehicle for specifying the jurisdiction.

See also Tango Clause 22.63 - Forum Selection.

22.7.14 Preliminary relief

  1. A party may seek temporary, interim, or preliminary injunctive relief, in accordance with applicable law, from one or more of (i) a court or other tribunal of competent jurisdiction; and/or (ii) the arbitral tribunal.
  2. A party's seeking of such relief in court (or other forum), instead of from the arbitral tribunal, will not in itself waive that party's right to arbitrate.
  3. If a party seeks such relief in a court, then the arbitrability of that request for relief is to be decided by that court.
Commentary

This section leaves it up to the relevant tribunal to decide whether a party's request for preliminary relief must be arbitrated — to try to avoid the extra expense and uncertainty that, in one still-unresolved case, is requiring not one but two trips to the (U.S.) Supreme Court. See Henry Schein, Inc. v. Archer & White Sales, Inc., 586 U.S.    , 139 S. Ct. 524 (2019), on remand, 935 F.3d 274, 283 (5th Cir. 2019), cert. granted, No. 19-963 (U.S. Jun. 15, 2020).

22.7.15 Authority to decide arbitrability disputes

Except as otherwise provided in this Clause or elsewhere in the Contract, the parties delegate to the arbitral tribunal the authority to decide any claim whether — for any reason — a particular dispute between the parties is not to be arbitrated, unless the dispute manifestly and indisputably does not fall within the scope of the parties' agreement to arbitrate.

Commentary
22.7.15.1 Background: Who decides arbitrability?

If parties disagree about whether a particular dispute must be arbitrated, it can matter greatly whether the arbitration agreement "delegates" this decision to the arbitrator. Such a disagreement might arise about (for example) the following questions:

  • whether the parties in fact entered into an agreement to arbitrate that covers the particular dispute in question;
  • whether the agreement to arbitrate (if any) is binding; is enforceable; and/or is in conflict with a non-waivable legal right; and
  • whether a party seeking arbitration has waived arbitration.

Delegating such arbitrability disputes to the arbitrator, instead of having a court decide, helps to avoid piecemeal litigation. That's because under U.S. law, it's the court, not the arbitrator, that normally must determine whether the parties have agreed to arbitrate — but the arbitration agreement itself can clearly and unmistakably delegate that power to the arbitrator, in which case the arbitrator will decide that question. See First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938 (1995) (reversing court of appeals and holding that agreement in question did not give arbitrator power to determine arbitrability).

Of course, even then, any challenge specifically to the "delegation agreement" itself will be heard by the court. See Rent-a-Center, West, Inc. v. Jackson, 561 U.S. 63, 68-69 (2010) (reversing 9th Circuit holding that court must determine enforceability of arbitration agreement).

22.7.15.2 The arbitration rules might include a delegation provision

Many arbitration rules include a delegation provision; if an arbitration agreement adopts those rules, then the delegation agreement follows automatically. See, e.g., the American Arbitration Association's Commercial Arbitration Rules, which were the agreed rules in Henry Schein, Inc. v. Archer & White Sales, Inc., 586 U.S.    , 139 S. Ct. 524, 528 (2019), on remand, 935 F.3d 274, 283 (5th Cir. 2019), cert. granted, No. 19-963 (U.S. Jun. 15, 2020).

22.7.15.3 Challenges to the arbitration agreement itself

A related issue: What if a party claims that it never agreed to an arbitration agreement in the first place? In that situation, then the arbitration clause's adoption of won't be enough to delegate the arbitrability dispute. See VIP, Inc. v. KYB Corp., 951 F.3d 377, 385-86 (6th Cir. 2020) (affirming denial of motion to compel arbitration). For a useful survey of the law in this area, see Paul T. Milligan, Who Decides the Arbitrability of Construction Contracts? in The Construction Lawyer, Vol. 31, No. 2, Spring 2011.

See also this Clause's specific carve-outs, in [LINK NEEDED] and [LINK NEEDED], from the delegation of authority to the arbitrator.

22.7.16 Confidentiality obligations in arbitration

  1. The obligated parties described in subdivision b below must, at all times:
    1. maintain in confidence all non-public information disclosed, in the course of the arbitration proceedings, by any party to the arbitration;
    2. use any such information only for purposes of the arbitration and any related court proceedings; and
    3. not disclose any such information to any third party, except to the minimum extent authorized or required by: (i) the arbitration rules; (ii) the disclosing party; or (iii) applicable law.
  2. The confidentiality obligations of subdivision a are intended to be binding on:
    1. each party to the dispute;
    2. each member of the arbitral tribunal; and
    3. each other participant in the arbitration proceedings.
  3. To the extent that any other persons listed in this section are subject to a party's control,
    • for example, party employees, contractors, etc.,
    • that party is to ensure that the person:
  1. agrees in writing to comply with the confidentiality obligations of this Clause, and
  2. if the person is an organization: causes its own employees, and others under its direction, to do the same.
  1. But if someone breaches the confidentiality obligations of this section, that will not affect the enforceability of any arbitration award.
Commentary
22.7.16.1 Confidentiality requirements in arbitration rules

A primary reason parties opt to arbitrate their disputes is to try to avoid having their business affairs made public in court proceedings. The agreed arbitration rules might include confidentiality provisions.

Examples:

  • Rule R-23(a) of the Commercial Arbitration Rules of the American Arbitration Association allows the arbitrator to impose secrecy requirements in connection with the pre-hearing exchange of confidential information and the admission of confidential evidence at the hearing.
  • Article 30 of the LCIA Arbitration rules of the London Court of Interntional Arbitration automatically provide for secrecy of arbitration proceedings.

A survey of some relevant holdings in various countries, and of various arbitration rules that do or do not contain confidentiality provisions, can be found in a 2007 article (paywalled). See Claude R. Thomson & Annie M. K. Finn, Confidentiality in Arbitration …, Dispute Resolution Journal, May-Jul 2007 (paywalled).

22.7.16.2 The arbitral law might require confidentiality

Local law governing the arbitration might independently require confidentiality. For example, apparently English arbitration law implies a duty of confidentiality in arbitration proceedings; a failure to maintain confidentiality where required may result in the imposition of severe sanctions or the institution of legal proceedings against the discloser by other parties to the arbitration. See generally Chantal du Toit, Reform of the English Arbitration Act 1996: a nudge towards reversing the presumption of confidentiality (PracticalLaw.com 2017).

Independently of arbitration law, the applicable substantive law might impose a duty of confidentiality, for example if personal health information or export-controlled information is involved.

22.7.17 Limits on arbitral tribunal's power

  1. Introduction: Under this Clause, the arbitral tribunal has no power to award relief in contravention of this section.
  2. Award must conform to law: The arbitral tribunal will have no power to award relief of a kind that a court could not award if the dispute were being litigated instead of being arbitrated,
    • taking into account the applicable law — including, without limitation, any applicable statute of limitation or of repose.
  3. Award must conform to contract: The arbitral tribunal will have no power to award relief inconsistent with the Contract, including, without limitation:
    1. any agreed limitation of liability — and that term includes, without limitation, exclusions of remedies; and
    2. any shortened limitation period stated in the Contract.
Commentary
22.7.17.1 Subdivision a: No arbitrator power

The language, "has the power only to award such relief," has in mind that, under the (U.S.) Federal Arbitration Act, one of the very few grounds allowing a federal court to vacate an arbitration award is that "the arbitrators exceeded their powers …." 9 U.S.C. § 10(a)(4).

22.7.17.2 No amiable compositeur or ex aequo et bono

Subdivision a's power-limitation language might be especially important because, under the law and the agreed arbitration rules, an arbitrator might have the power to decide a case as she sees fit, in accordance with her own notions of fairness, and the arbitrator might not need to stay within the strict bounds of either the agreement or the law.

The legalese names for this arbitrator freedom to go beyond the law and the contract are:

  • amiable compositeur, which refers to the arbitrator's varying what would otherwise be the effect of the law and the parties' agreement; and
  • ex aequo et bono, which refers to the arbitrator's deciding the case "according to the equitable and good."

See generally, e.g., Alexander J. Belohlavek, Application of Law in Arbitration, Ex Aequo et Bono and Amiable Compositeur (2013), available at SSRN: https://ssrn.com/abstract=2230302.

Such expansive arbitrator freedom can sometimes cause parties to fear that an arbitrator might "go rogue," imposing an award that no one could have foreseen, acting on his or her own individual sense of justice.

And depending on the applicable law and the arbitration rules, such fear might not be unwarranted: while most arbitrators seem to stick to the law and the contract, it's not unheard of for arbitrators to "get creative" in fashioning awards.

Example: Some thought the arbitrators ran amok in a software-copyright dispute between competitors IBM and Fujitsu. In that case, the arbitrators ultimately ordered IBM to provide its operating-system source code and other secret information to Fujitsu and ordered Fujitsu to pay significant money to IBM for the privilege. See David E. Sanger, Fight Ends For I.B.M. And Fujitsu, NY Times, Sept. 16, 1987. For more background on that dispute, see a student note from the 1980s by Anita Stork (now a prominent antitrust litigator), The Use of Arbitration in Copyright Disputes: IBM v. Fujitsu, 3 Berkeley Tech. L.J. 241 (1988).

See also the commentary about limited appealability of arbitration awards, at [LINK NEEDED].

22.7.17.3 Subdivisions b and c: Conformity to law and contract

Absent language such as that of these subdivisions, an arbitrator might be able to ignore a statute of limitations that would otherwise bar a claim — and compounding the concern, arbitration awards cannot be appealed except on very-limited grounds (in some jurisdictions the parties can agree otherwise), as discussed the commentary to Option 22.7.23. See generally Liz Kramer, Don't Find Yourself SOL: Know Whether the Statute of Limitations Applies to Your Arbitration (ArbitrationNation.com 2016).

22.7.18 Attorney fees for failed arbitration challenge

  1. IF: A party (a "challenging party") goes to court to try: (i) to get out of arbitration, and/or (ii) to set aside an arbitration award (each, an "arbitrability challenge");
    • AND: The arbitrability challenge fails;
    • THEN: The challenging party must reimburse the other party for its attorney fees (see the definition in Clause 22.16) incurred in connection with the failed arbitrability challenge,
    • in both trial- and appellate courts.
  2. The court, not the arbitral tribunal, is to determine the amount of the reimbursement.
Commentary

At almost any point in an arbitration, a party desiring to delay the proceedings might go to court to challenge the propriety of the arbitration. This section tries to discourage such stalling tactics by imposing attorney-fee sanctions for unsuccessful stalling attempts, as suggested by an experienced arbitrator. See Gary McGowan, 12 Ways to Achieve Efficiency and Speed in Arbitration § 2, Corporate Counsel (Apr. 22, 2013) (no longer available online).

Subdivision b is an exception to the delegation of arbitrability decisions to the arbitral tribunal in [LINK NEEDED].

22.7.19 WAIVER OF JURY TRIAL

Each party WAIVES (see the definition in Clause 22.162) any right it might have to trial by jury for any dispute that the Contract requires to be arbitrated.

Commentary

This waiver of the right to a jury trial is probably overkill for most jurisdictions, but it's one of those instances where a few extra words could be cheap insurance against future disputes raised by "creative" litigation counsel.

Normally, advance waivers of jury trials are unenforceable in California and Georgia, as explained in the commentary to [LINK NEEDED] — but those state laws likely would be preempted in cases where the Federal Arbitration Act applied. See generally, e.g., AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 131 S. Ct. 1740 (2011) (FAA preempts state law barring enforcement of waiver of class arbitration).

Contra: The New Jersey supreme court held that an arbitration provision was unenforceable because the provision did not expressly waive jury trial; to the surprise of many observers, the Supreme Court declined to hear the losing side's appeal. See Atalese v. US Legal Serv. Group, LLP, 219 N.J. 430 99 A.3d 306 (2014).

On the other hand, the Nevada supreme court held that a state statute imposing requirements on arbitration agreements was indeed preempted. See MMAWC, LLC v. Zion Wood Obi Wan Trust, 135 Nev. Adv. Op. 38, 448 P.3d 568 (2019).

22.7.20 Survival of arbitration provisions

Even if the Contract comes to an end in some way (whether by termination or expiration), the provisions of the Contract relating to arbitration will still remain in effect.

Commentary

This section is a precautionary measure to forestall contrary arguments.

22.7.21 Required notice of an enforcement action

IF: A party files an action, in any forum, seeking to confirm or enforce an arbitration award, or to vacate an award in whole or in part,

THEN: That party must promptly cause notice to be given to the other party,

  • in the arbitral language (see the definition in Clause 22.7.11),
  • that the action has been filed.

(An actually-received or ‑refused written notification, in the arbitral language, from an arbitration administrator (see the definition in Clause 22.7.9), will suffice for this purpose.)

Commentary

This particular notice requirement seeks to avoid trouble analogous to the situation in which a U.S. retailer found itself.

The U.S. retailer had entered into a contract with a Chinese manufacturer. The retailer received notice that the manufacturer had demanded arbitration. The notice was written in Chinese, and the manufacturer didn't get the notice translated for a while, which led to the Chinese arbitration tribunal entering an award against the manufacturer. (The American courts refused to enforce the award on grounds that the notice was not reasonably calculated to apprise the retailer of the proceedings. See CEEG (Shanghai) Solar Science & Tech. Co. v. LUMOS LLC, 829 F.3d 1201, 1207 (10th Cir. 2016), affirming No. 14-cv-03118 (D. Colo. May 29, 2015).)

22.7.22 Attorney fees for failure to comply with award

IF: A party is required to take action under an arbitration award;

  • BUT: That party does not timely comply with the requirement on its own,
  • and another party successfully goes to court or other forum to confirm and/or enforce the requirement;

THEN: As damages for the noncompliance, the noncompliant party must pay or reimburse the other party's reasonable attorney fees (see the definition in Clause 22.16) for those confirmation and/or enforcement proceedings —

  • at all stages of the confirmation- and/or enforcement proceedings, at both trial- and appellate levels; and
  • in addition to any other relief granted to the successful party, either in the confirmation / enforcement proceedings or in the arbitration.
Commentary
22.7.22.1 A "one way" prevailing-party rule

This section seeks to avoid what likely would happen under the "American Rule" (see the commentary to [LINK NEEDED]) for attorney fees: A party that won an arbitration case, but then had to go to court to enforce the award, might well be denied attorney fees for the court proceedings. See Diathegen, LLC v. Phyton Biotech, Inc., No. 04-14-00267-CV (Tex. App.—San Antonio Aug. 26, 2015, pet. denied).

On a related note: Also invoking the American Rule, the Second Circuit held that, when the parties' contract provides only for awarding attorney fees for breach of the contract, such fees cannot be awarded to a respondent that successfully defended against a claim of breach in arbitration and then successfully defended against the claimant's attempt to vacate the award in court. See Zurich American Insurance Co. v. Team Tankers A.S., 811 F.3d 584 (2d Cir. 2016).

(The Zurich American ruling is of a piece with the "Texas rule" (see Section 22.16.1.4: ) concerning attorney fees, which is largely to the same effect.)

Compare Westgate Resorts, Ltd. v. Adel, 2016 UT 24, 378 P.3d 93 (2016), where the Utah supreme court affirmed that the state's arbitration statute did not authorize the arbitration panel to award fees (in advance) for post-arbitration judicial enforcement of award. Id. ¶ 16, 378 P.3d at 95. The supreme court noted that the parties had not briefed the question whether the district court could have awarded such fees, and so the supreme court did not address that question. See id. at 93 n.1.

22.7.23 Option: Enhanced Right of Appeal

  1. Specific agreement required: This Option is part of the Contract only if unambiguously agreed.
  2. Limit on arbitrator power: Under this Option, the arbitral tribunal's powers do not include the power to render an award that:
    1. is based on errors of law or legal reasoning that would be grounds for reversal if made by a judge in a civil trial to the court (sometimes known as a "bench trial"); or
    2. is based on evidence that would not satisfy the requirements of law in such a trial; or
    3. grants relief prohibited by the Contract or not available under applicable law.
  3. Enhanced appeal right: IF: A court of competent jurisdiction finds that an arbitration award is based, in whole or in part, on one or more of the factors enumerated in subdivision b of this Option;
    • THEN: The parties desire that, upon application of either party, the award is to be vacated, on grounds that (without limitation) the arbitral tribunal thereby exceeded its agreed powers.
  4. California law to apply: The interpretation and enforcement of this Option is to be governed by the law of the State of California applicable to contracts made and performed entirely in, by residents of, that state.
  5. Jettison: (Opt-in required) IF: This Option is found to be unenforceable; AND: The parties have agreed to jettison this Option in such event; THEN: The parties' agreement to arbitrate may be rescinded; all as provided in Option 22.7.24.
Commentary
22.7.23.1 Hall Street: Federal law restricts arbitration appeals

In its Hall Street case, the (U.S.) Supreme Court held that, when the sole authority for an arbitration proceeding is the Federal Arbitration Act, the courts may not entertain an appeal of the award except on the limited, misconduct-based grounds provided in section 10 of that statute. See Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576, 128 S. Ct. 1396 (2008).

In a later case, the Court later explained:

Because the parties bargained for the arbitrator's construction of their agreement, an arbitral decision even arguably construing or applying the contract must stand, regardless of a court's view of its (de)merits.

Only if the arbitrator acts outside the scope of his contractually delegated authority — issuing an award that simply reflects his own notions of economic justice rather than drawing its essence from the contract — may a court overturn his determination.

So the sole question for us is whether the arbitrator (even arguably) interpreted the parties' contract, not whether he got its meaning right or wrong.

Oxford Health Plans LLC v. Sutter, 569 U.S. 564, 133 S. Ct. 2064, 2068 (2013) (cleaned up, citations omitted, emphasis and extra paragraphing added).

22.7.23.2 Enhanced judicial review under state law?

Drafters can keep in mind another possibility for enhanced appellate review: In its Hall Street decision, the Court expressly left open the possibility that enhanced review might be available under some other authority, such as state law or (in the case of court-annexed arbitrations) a court's inherent power to manage its docket. See Hall Street, part IV, 128 S. Ct. at 1406-07.

• Subsequently, both the California and Texas supreme courts ruled that, in proceedings under the arbitration acts of their respective states, the parties were free to agree to enhanced judicial review. See Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal.4th 1334, 82 Cal. Rptr.3d 229, 190 P.3d 586 (2008) (reversing and remanding reversal of district court's vacating of arbitration award); Nafta Traders, Inc. v. Quinn, 339 S.W.3d 84 (Tex. 2011) (reversing and remanding confirmation of arbitration award that failed to address losing party's allegation that arbitrator did not comply with law as required by arbitration agreement).

• In contrast, the Tennessee supreme court reached the opposite conclusion; the court held that the arbitration agreement's expansion of the scope of judicial review was invalid. See Pugh's Lawn Landscape Co. v. Jaycon Dev. Corp., 320 S.W.3d 252 (Tenn. 2010) (vacating judgment confirming arbitrator's award).

• By statute, New Jersey law provides that "nothing in this act shall preclude the parties from expanding the scope of judicial review of an [arbitration] award by expressly providing for such expansion in a record." N.J. Stat. Ann. § 2A:23B-4(c); see also Hogoboom v. Hogoboom, 924 A.2d 602, 606, 393 N.J. Super. 509 (App. Div. 2007) (explaining history of expanded-review statute, and holding that initial review must be by trial court, not appellate court). (Hat tip: arbitrator Laura Kaster.)

22.7.23.3 An express state-law reference might be needed

Parties desiring enhanced review should seriously consider specifying that the arbitral law is that of a jurisdiction that permits such review. In one Fifth Circuit case, a party lost an arbitration, and on appeal the losing party cleimed that the arbitration panel had "completely botched" certain issues. The appellate court held that under the Supreme Court's Oxford Health Plans decision, the losing party was stuck with the arbitration panel's interpretation of the relevant contract, even if that interpretation was arguably incorrect. The court explained: "Because the Agreement does not refer to [state law], or any other body of law offering a competing standard of review, we hold that the FAA's standard of review controls." BNSF R.R. Co. v. Alston Transp., Inc., 777 F.3d 785, 790-91 (5th Cir. 2015) (vacating district court's vacatur of arbitration award and remanding with instructions to reinstate award; citations omitted, emphasis and extra paragraphing added), citing Action Indus., Inc. v. U.S. Fid. & Guar. Co., 358 F.3d 337, 341 (5th Cir. 2004).

22.7.23.4 Subdivision b: Limit on arbitrator power

The language, "has the power only to award such relief," has in mind that, under the (U.S.) Federal Arbitration Act, one of the very few grounds allowing a federal court to vacate an arbitration award is that "the arbitrators exceeded their powers …." 9 U.S.C. § 10(a)(4).

22.7.23.5 Subdivision d: Choice of California law

In California and some other states, the law expressly allows appeal from an arbitration award if the parties so agree; see the commentary at Section 22.7.23.2: . This section explicitly adopts California law because enhanced review might require an express reference to a congenial arbitral law, as discussed above.

Concerning choosing different governing laws for different purposes, see the discussion in the commentary at [LINK NEEDED].

22.7.23.6 Subdivision e: Jettison of arbitration?

When drafting an arbitration provision with an agreement to enhanced judicial review, consider whether to use Option 22.7.24 to provide that the arbitration provision is to be "jettisoned" if a reviewing court declines to provide an enhanced review.

22.7.24 Option: Jettison of Arbitration Agreement

  1. Specific agreement required: This Option is part of the Contract only if unambiguously agreed.
  2. Prerequisites: If this Option is agreed to, it applies if the following prerequisites are satisfied:
    1. the parties have agreed in writing that a particular provision of their agreement to arbitrate is subject to this Option; and
    2. a court of competent jurisdiction holds that the particular provision is unenforceable; such a holding must be in a final judgment from which no further appeal is taken or possible (a "Final-Final" judgment).
  3. Rescission option: Either party may, by notice to the other party and to the court, unilaterally rescind the parties' arbitration agreement and thereby automatically vacate any arbitration award.
  4. Rescission deadline: The notice of rescission must be effective no later than five court days (i.e., days on which the court is open for routine business) after the judgment becomes Final-Final, as defined above.
  5. Tolling: If a party exercises this rescission right, then any applicable statute of limitation or ‑repose is to be deemed to have been retroactively tolled beginning with the date on which the demand for arbitration was made and ending five court days after the effective date of the notice of rescission.
Commentary

In some cases, a party might regard a particular agreed feature of arbitration — for example, an enhanced right of appeal, see [LINK NEEDED]) — as being so important that the party isn't willing to agree to arbitration without that feature. For that situation, this Option can be included in the Contract.

This Option is informed by a case in which Tennessee's supreme court held that an agreement to arbitrate in a contract must be judicially rescinded for mutual mistake, in view of that court's holding that the parties' agreement to expanded judicial review was invalid. See Pugh's Lawn Landscape Co. v. Jaycon Dev. Corp., 320 S.W.3d 252 (Tenn. 2010).

22.7.25 Option: Severability of Arbitration Provisions

  1. Specific agreement required: This Option is part of the Contract only if unambiguously agreed.
  2. Applicability: This Option will apply automatically — except as provided in Tango Clause 22.7.24 - Option: Jettison of Arbitration Agreement — if the following prerequisites are satisfied:
    1. the Contract clearly states, in substance, that some or all of the parties' agreement to arbitrate is severable; and
    2. a court of competent jurisdiction determines, in a decision from which no further appeal is taken or possible, that one or more provisions of the parties' agreement to arbitrate is void, invalid, or otherwise unenforceable for any reason.
  3. Severance request: In any such case, the parties desire that the unenforceable provision be severed from the remainder of the agreement to arbitrate, while the remainder of the agreement to arbitrate is to be enforced.

22.7.26 Option: Prohibition of Punitive Sanctions

  1. Specific agreement required: This Option is part of the Contract only if unambiguously agreed.
  2. Prohibited arbitrator actions: The arbitral tribunal will have no power to order punitive sanctions against a party, in respect of an issue (or multiple issues), in the form of:
    1. preclusion of evidence or defense concerning the issue, or
    2. entry of judgment concerning the issue.
Commentary

This optional language seeks to avoid the result in a case where a disk-drive manafacturer sued a defecting employee and his new employer for theft of trade secrets.

The arbitrator found that the defecting employee had fabricated evidence and that the new employer was complicit in the fabrication. As a punitive sanction, the arbitrator:

  1. barred the defecting employee and the new employer from contesting the manufacturer's position about the validity and misappropriation of the trade secrets in question, and
  2. based on the former employer's evidence, awarded the disk-drive manufacturer more than $600 million. See Seagate Technology, LLC v. Western Digital Corp., 854 N.W.2d 750, 760 n.7 (Minn. 2014) (with extensive citations).

22.7.27 Option: Prohibition of Punitive Damages

a.  Specific agreement required: This Option is part of the Contract only if unambiguously agreed.

b.  Prohibited arbitrator actions: The arbitral tribunal will have no power to award punitive damages, exemplary damages, multiple (e.g., treble) damages, or similar relief.

Commentary

Portions of this prohibition are adapted from a provision at issue in another Eighth Circuit case. See Wells Fargo Bank, N.A. v. WMR e-PIN, LLC, 653 F.3d 702 (8th Cir. 2011) (affirming confirmation of award, albeit for procedural reasons).

Subdivision b: This prohibition is phrased without the qualifier, "to the maximum extent permitted by law"; otherwise, the prohibition might be disregarded, as happened in an Eighth Circuit case. See Stark v. Sandberg, Phoenix & von Gontard, P.C., 381 F.3d 793 (8th Cir. 2004).

If more detail is desired in spelling out remedies that the arbitral tribunal is not permitted to award, see the examples provided in a construction-law article. See Charles M. Sink, Negotiating Dispute Clauses That Affect Damage Recovery in Arbitration, The Construction Lawyer, vol. 22, no. 3, summer 2002.

22.8 Archive Copies

22.8.1 Applicability

This Clause applies if and when the Contract:

  1. requires a specified party, referred to here as "Retainer," (i) to return documents or other materials (collectively, "documents") to another party ("Owner") or (ii) to destroy the documents; BUT
  2. allows Retainer to retain archive copies (or "archival copies") of the documents.
Commentary

This Clause is perhaps most likey to be used when the Contract requires information to be purged, such as in Tango Clause 22.81 - Information Purges.

22.8.2 Permissible custodian(s) of archive copies

As a safe harbor, one possible (and non-exclusive) way for Retainer to comply with [LINK NEEDED] would be for Retainer to maintain the archive copies in the custody of a reputable commercial storage organization,

  • as long as that organization was contractually obligated to securely maintain the copies in confidence.
Commentary

Alternatives:

Retainer must use an outside organization to maintain the archive copies; the outside organization must meet the requirements of the safe-harbor option of this section.

or:

Retainer must maintain all archive copies itself, without using an outside organization.

22.8.3 Permissible location(s) for archive copies

Archive copies may be kept in one or more locations reasonably chosen by Retainer.

22.8.4 Number of archive copies

Retainer may cause a reasonable number of archive copies (including but not limited to backup copies) to be maintained.

22.8.5 Retention duration

Archive copies may be retained indefinitely — but all such retention is subject to the requirements of this Clause.

22.8.6 Security requirements for archive copies

Retainer must cause at least prudent measures to be taken to maintain the security of archive copies.

Commentary

For especially-sensitive information, an Owner might want to require specific security precautions.

22.8.7 Confidentiality obligations for archive copies

Retainer must comply with Tango Clause 22.34 - Confidential Information for any information in archive copies that qualifies as Confidential Information of Owner.

Alternative

Retainer need not maintain the archive copies or their contents in secrecy.

22.8.8 What may be retained

Unless the Contract clearly states otherwise, Retainer may cause archive copies to be made and/or retained of the following (without limitation):

  • electronic documents;
  • photographs and video / audio-visual recordings;
    • including, without limitation, those made to document tangible objects and/or events; and
  • sound recordings of audible events.
Alternative

Retainer may cause archive copies to be made, and/or retained, of the following items only: [DESCRIBE].

22.8.9 Permissible access to archive copies

Retainer must take prudent measures to ensure that archive copies are not made accessible to anyone, except from time to time in one or more of the following ways:

  1. by Retainer's personnel who maintain the archive copies (if applicable);
  2. as agreed in writing by Owner;
  3. as directed (or permitted) by a legal tribunal having jurisdiction; and/or
  4. in response to a compulsory legal demand, as provided in [LINK NEEDED].

22.8.10 Permissible use of archive copies

Retainer must not use archive copies, nor allow or knowingly assist in such use by others, except, from time to time, for one or more of the following purposes:

  1. determining, and confirming Retainer's compliance with, Retainer's continuing obligations under the Contract;
  2. documenting the parties' past- and present interactions relating to the Contract;
  3. reasonable testing of the accuracy of the archive copies;
  4. and/or as otherwise agreed in writing.

22.9 As-Is Disclaimer Definition

  1. For purposes of this Definition, the term "Factual Commitment" refers to any of:
    1. a warranty (see the definition in Clause 22.163);
    2. a representation (see the definition in Clause 22.134); and/or
    3. a condition or term of quality.
  2. The term as-is — whether or not capitalized — operates as a disclaimer of all Factual Commitments concerning performance and noninfringement.
  3. An as-is disclaimer negates, without limitation, any implied Factual Commitment that might otherwise apply concerning merchantability or fitness for a particular purpose.
  4. An as-is disclaimer does not negate:
    1. any express Factual Commitment; nor
    2. any Factual Commitment that might be implied under applicable law concerning title to goods.
  5. An as-is disclaimer may be expressed in variations such as "as is, where is, with all faults," which will have the same meaning as stated in this Definition.
Commentary

This definition is modeled on § 2-316 of the (U.S.) Uniform Commercial Code, which covers disclaimer of implied warranties in sales of goods. It's included here in case the UCC doesn't apply (for example, if this Agreement is not for the sale of goods or if the transaction is governed by a law that doesn't include some version of the UCC).

One common formulation for disclaiming warranties is "AS IS, [and sometimes: WHERE IS,] WITH ALL FAULTS," in all-cap, bold-faced type, or other conspicuous manner.

Caution: Drafters should check for any applicable legal requirement of conspicuousness for warranty disclaimers.

Caution: The definition does not exclude implied warranties of title. This carve-out is modeled on UCC § 2-312, which requires that a disclaimer of an implied warranty of title must be expressly stated. From a business perspective this makes sense, of course; as an example, even if Alice were to sell Bob a car "as is," Bob should still be entitled to assume that Alice isn't trying to sell him stolen property.

22.10 Assignment - Assignee Assumption

  1. Any assignee of the Contract must agree in writing to abide by the assigning party's obligations the Contract,
    • including but not limited to any covenants concerning confidentiality and/or noncompetition,
    • and deliver the agreement to the other party;
    • the assignment will be void until the assignee does so.
  2. In case of doubt: this Clause in itself neither authorizes nor prohibits assignment of the Contract.
Commentary

This policy seeks to avoid the result in a Florida federal case: A franchisor terminated a franchise agreement but was unable to enforce a contractual noncompetition covenant against the franchisee, because:

  • the franchisee was not the original franchisee that had signed the contract containing the noncompetition covenant, but instead was the successor in interest to the original franchisee;
  • under a Florida statute, a noncompetition covenant could not be enforced against a party that did not sign the writing containing the covenant; and
  • the successor franchisee had not signed the franchise agreement. See Interim Healthcare, Inc. v. Interim Healthcare of Se. Louisiana, Inc., No. 19-CV-62412, slip op. at part III.B.2.a (S.D. Fla. June 10, 2020), citing Fla. Stat. § 542.335(1)(a).

22.12 Associated Individual Definition

Associated Individual, as to an organization, refers to any individual who, at the time in question, falls into one or more of the following categories:

  1. an employee of the organization;
  2. an officer or director of the organization, if it is a corporation;
  3. a holder of a comparable position, if the organization is of another type, such as a limited liability company; and/or
  4. any other individuals expressly specified in an agreement, if any.
Commentary

This is a convenience definition.

22.13 Attorney Fees - ADR Nonparticipation

  1. If this Clause is agreed to, it applies if a party:
    1. fails to participate in efforts or proceedings required by a dispute-resolution provision of the Contract; and/or
    2. unsuccessfully challenges the enforceability of such a dispute resolution provision.
  2. The nonparticipating party will not be entitled to recover attorney fees (see the definition in Clause 22.16) or other dispute-related expenses, of any kind, and that party hereby WAIVES (see the definition in Clause 22.162) any such claim; this will be true even if:
    1. the nonparticipating party would otherwise have been entitled to such a recovery, whether under the Contract or under applicable law; and/or
    2. the nonparticipating party prevails in the dispute in question or in the challenge against the validity or enforceability of the dispute-resolution provision in question.
Commentary

Subdivision a is modeled on a mediation provision, which has been enforced by courts, in a standard California residential real-estate purchase agreement. See Cullen v. Corwin, 206 Cal. App. 4th 1074, 142 Cal. Rptr. 3d 419 (2012) (reversing award of attorney fees to prevailing defendant, on grounds that the defendant had refused to participate in mediation as required by contract); Lange v. Schilling, 163 Cal. App. 4th 1412 (2008) (reversing award of attorney fees to prevailing plaintiff). Cf. Thompson v. Cloud, 764 F.3d 82 (1st Cir. 2014), where the court denied the winning party's request for attorney fees under an analogous clause, on grounds that the winning party never asked for mediation and thus the losing party didn't refuse to mediate. See id. at 92.

Subdivision b is modeled on a provision in a real-estate sale contract, which stated that "if a party does not agree first to go to mediation, then that party will be liable for the other party's legal fees in any subsequent litigation in which the party who refused to go to mediation loses …." Wuestenberg v. Rancourt, No. 2020 ME 25, slip op. at 10, ¶ 18 (Me. Feb. 25, 2020) (cleaned up).

22.14 Attorney Fees - American Rule

When this Clause is agreed to, each party is to bear its own attorney fees in all litigation, arbitrations, or other Agreement-Related Disputes.

Commentary

See the introductory commentary to [LINK NEEDED].

22.15 Attorney Fees - Grave Accusations

22.15.1 Introduction; applicability

  1. When this Clause is agreed to, it applies if the following prerequisites are met:
    1. a party (the "Accuser") makes a "Grave Accusation" (defined in subdivision b below), against another party; but
    2. in the final judgment or arbitration award, as the case may be, from which no further appeal is possible,
      • the tribunal does not affirmatively find that the accusation was proved by:
      • (i) the proof required by law, or
      • (ii) if greater, the proof required by the Contract.
  2. The term "Grave Accusation" refers to any assertion that one or more other individuals and/or organizations (each, an "accused") engaged or is engaged in one or more of:—
    1. conduct punishable as a felony under applicable law; and/or
    2. fraud.
Commentary
22.15.1.1 Purpose

This Clause could be included to discourage litigation counsel from loading up their pleadings with accusations of fraud, gross negligence, bad faith, breach of fiduciary duty, and the like — whether or not such accusations are really warranted by the facts. For an example of such accusations, see Falco v. Farmers Ins. Gp., 795 F.3d 864 (8th Cir. 2015), in which the appeals court affirmed summary judgment in favor of defendants, including dismissal of the plaintiff's claim that the defendants had supposedly breached a fiduciary duty.

When counsel do this, the strategic thinking often seems to be something like the following: What the hell, we might as well go ahead and make these accusations — there's no downside to us for doing so, and the jury might believe us. That will raise the stakes for the other side; this in turn will give us more leverage to force the other side to settle the case on our terms.

22.15.1.2 The harm of unproven Grave Accusations

Unfortunately, even when Grave Accusations are baseless, they can pose major problems for their targets, because:

  • such accusations can unfairly influence jurors;
  • in themselves such accusations can damage a defendant's reputation (because third parties can tend to think, where there's smoke, there's fire), even if the defendant is ultimately vindicated — and the later vindication seldom receives the same level of publicity as the earlier accusation;
  • such accusations are almost always expensive and time-consuming both to prosecute and to defend against, because wide-ranging discovery and expert testimony will usually ensue; and
  • such accusations can be tough to get rid of quickly, either on the pleadings or on summary judgment, because judges will often find that a full trial (usually a jury trial in the U.S.) is required to decide the truth of the matter.

22.15.2 Expense shifting

When this Clause applies, the Accuser must reimburse the other party for all of the other party's Attorney Fees (see the definition in Clause 22.16) incurred in the entire case, not merely in defending against the unproved Grave Accusation, unless the tribunal determines otherwise for good reason.

Commentary

The risk of expense-shifting is intended to encourage parties to think long and hard before making a Grave Accusation, by giving them a significant financial downside if they make such an accusation but then fail to prove it.

22.15.3 No cost- or expense recovery by Accuser

In addition, when this Clause applies, the Accuser may not recover any of its own Attorney Fees of the litigation or arbitration,

  • and the Accuser hereby WAIVES (see the definition in Clause 22.162) any such recovery,
  • regardless whether the Accuser would have been otherwise entitled to such a recovery under the Contract and/or applicable law.

22.15.4 Liquidated damages

When this Clause applies, the Accuser must also pay the other party USD $10,000 as liquidated damages,

  • representing the parties' best guess of what the other party would suffer in the way of additional expense, burden, and inconvenience for defending against the unproved Grave Accusation(s) in the case,
  • unless the tribunal determines otherwise for good reason.
  • (This is over and above the Accuser's Attorney-Fee obligation under [LINK NEEDED].)
Commentary

The good-reason exception is intended to give the tribunal some flexibility in close cases, and also to protect the enforceability of the other sections of this Clause.

22.15.5 Severability

  1. Except as provided in subdivision b, any and all parts of this section are severable from the Contract if found to be unenforceable for any reason.
  2. Exception: [LINK NEEDED], in which the Accuser waives any right to cost- or expense recovery, is not severable.
Commentary

The intent here, again, is to give a tribunal some discretion in close cases, while not allowing the Accuser to recover attorney fees if it fails to prove a Grave Accusation.

22.16 Attorney Fees - Prevailing Party

22.16.1 Definitions: Attorney Fees; Proceeding

  1. The term Attorney Fees (whether or not capitalized) refers to any and all of the following:
    1. reasonable fees billed by attorneys, law clerks, paralegals, and others acting under attorney supervision, and expert witnesses;
    2. reasonable expenses incurred by any persons described in subdivision 1 in connection with the Proceeding in question (defined below),
      • such as, without limitation, printing, photocopying, duplicating, and shipping; and
    3. costs of court and/or arbitration, including without limitation arbitration-administration fees and arbitrator fees and expenses.
  2. Definition — "Proceeding": For purposes of this Clause:
    1. The term "Proceeding" refers, without limitation, to:
      • (i) pre-hearing and hearing proceedings, in a court- or contested-administrative action or arbitration;
      • (ii) an appeal at any level; and/or
      • (iii) any other contested proceeding in the action or arbitration.
    2. The term Proceeding includes but is not limited to:
      • (i) interim proceedings such as motion- and petition practice; and
      • (ii) appeals from decisions in such interim proceedings (to the extent permitted under applicable law).
Commentary
22.16.1.1 Subdivision a: Definition of Attorney Fees

The definition in this subdivision is informed in part by the attorneys-fees clause in the contract in suit in a Delaware case. See Seaport Village Ltd. v. Seaport Village Operating Co., No. 8841-VCL (Del. Ch. Sept. 24, 2014) (letter opinion awarding attorney fees).

22.16.1.2 Subdivision b: Definition of Proceeding

The definition in this subdivision has in mind that pre-hearing motion practice can be a major expense in a lawsuit or arbitration. Allowing a court to award attorney fees for motion practice and other interim proceedings can help encourage the parties to be reasonable in the positions they take.

22.16.1.3 Background: American Rule vs. Loser-Pays Rule

Attorney fees are a major expense (perhaps the major expense) of contract disputes.

• In U.S. jurisdictions the so-called "American Rule" is that each party must bear its own attorney fees. See, e.g., Zurich American Insurance Co. v. Team Tankers A.S., 811 F.3d 584, 590 (2d Cir. 2016) (reversing award of attorney fees and discussing American Rule), citing Baker Botts LLP v. ASARCO LLC, 576 U.S. 121, 135 S. Ct. 2158 (2015).

(The American Rule can be explicitly adopted using [LINK NEEDED].)

• On the other hand, in most non-U.S. jurisdictions, under the so-called prevailing-party rule — sometimes called the "loser pays" rule or the "everywhere but America" rule — a prevailing party is entitled to recover its attorney fees from the losing party. Many contracts adopt the prevailing-party rule using language such as that of this Clause.

22.16.1.4 The "Texas rule": Some contract claimants can recover fees

If a party negotiating a contract thinks it might be more likely to be the defendant in a dispute than the plaintiff, AND Texas law will apply, then that party it might want to affirmatively include the American Rule option in subdivision g. That's because under Texas law, absent an agreement otherwise, a party is entitled to recover its attorney fees if:

  • it successfully enforces a claim
  • against an individual or corporation
  • on an oral or written contract. 

See Tex. Civ. Prac. & Rem. Code § 38.001; see Hoffman v. L&M Arts, No. 3:10-CV-0953-D, slip op. at part III (N.D. Tex. Mar. 6, 2015) (citing cases) (subsequent history omitted).

Importantly: A party that successfully defends against an enforcement action is not entitled to recover attorney fees under that Texas statute. "Chapter 38 does not provide for recovery of attorneys' fees by defendants who only defend against a plaintiff's contract claim and do not present their own contract claim." Polansky v. Berenji, 393 S.W.3d 362, 368 (Tex. App.—Austin 2012) (reversing and rendering award of attorney fees to defendant that prevailed against breach-of-contract claim), citing, e.g., Energen Resources MAQ, Inc. v. Dalbosco, 23 S.W.3d 551, 558 (Tex. App.—Houston [1st Dist.] 2000).

22.16.1.5 Statutes might entitle particular parties to attorney fees

By statute, legislatures have allowed or even required awards of attorney fees to specified classes of parties. For example:

• U.S. antitrust law requires "a reasonable attorney's fee" to be awarded to "any person who shall be injured in his business or property by reason of anything forbidden in the antitrust laws …." 15 U.S.C. § 15(a).

As one example, a federal district court in California awarded more than $40 million in attorney fees to a group of current and former student athletes who sued the NCAA over the college sports rule that prohibited student athletes from being paid for use of their names and likenesses in advertising and video games. See O'Bannon v. NCAA, No. 09-3329 (N.D. Cal. Mar. 31, 2016), aff'd, No. 16-15803 (9th Cir. Jun. 29, 2018) (unpublished). The district court had reduced the original fee award of nearly $46 million, granted by a magistrate judge. See 114 F. Supp. 3d 819 (N.D. Cal. 2015) (magistrate judge award).

•  Under Cal. Civ. Code § 1021.9: "In any action to recover damages to personal or real property resulting from trespassing on lands either under cultivation or intended or used for the raising of livestock, the prevailing plaintiff shall be entitled to reasonable attorney’s fees in addition to other costs, and in addition to any liability for damages imposed by law." (Emphasis added.)

As explained by a court: "The statute is intended to ensure that farmers are able to protect their land from trespassers through civil litigation." Kelly v. House, 47 Cal. App.5th 384, 390 (Cal. App. 2020) (reversing denial of statutory attorney fees), citing Cal. Civ. Code § 1021.9.

22.16.1.6 The "California rule": It's all "prevailing party"

California Civil Code § 1717 provides, in essence, that any one-way attorney fees provision (as is sometimes seen in consumer-facing contract forms) is to be treated as a prevailing-party provision, and states that attorney fees under the section cannot be waived.

Likewise in Oregon: Or. Rev. Stat. § 20.096 (2017).

In Florida, Fla. Stat. 57.105(7) has a somewhat-similar provision that allows, but does not require, a court to award prevailing-party attorney fees to either party if a contract contains a one-way attorney fees provision. See generally Ham v. Portfolio Recovery Associates, LLC, No. SC18-2142 (Fla. Dec. 31, 2020).

22.16.1.7 One-sided attorney-fee clauses might well be enforced

Some contracts contain unilateral attorneys' fee clauses; for example, a real-estate lease might state that the landlord can recover its attorney fees if it has to sue the tenant, while remaining silent as to whether the tenant can ever recover its attorney fees. Such unilateral clauses might well be enforceable. See, e.g., Allied Indus. Scrap, Inc., v. OmniSource Corp., 776 F.3d 452 (6th Cir. 2015) (reversing district court's holding that unilateral fee-shifting provision was unenforceable under Ohio law), discussing Wilborn v. Bank One Corp., 906 N.E.2d 396 (Ohio 2009) (affirming dismissal of borrowers' lawsuit against lenders claiming that unilateral attorneys' fee clause in residential mortgage loan agreement form was void as contrary to public policy).

(Under the 'American rule,' that would normally mean that the tenant could not recover, even if it were the prevailing party in a suit brought by the landlord — unless a statute provides otherwise, as in the Texas and California examples mentioned above.)

22.16.1.8 Apostrophe, or not?

The term "attorney fees" is most-often rendered as attorneys' fees or attorney's fees, following the usage in, e.g., some statutes. See, e.g., 42 U.S.C. § 1988 (civil rights), which uses "a reasonable attorney's fee"; 28 U.S.C. § 1927, which provides for awards of excess "attorneys' fees" against attorneys who "multiplies the proceedings in any case unreasonably and vexatiously …."

The Tango Terms generally omit the apostrophe, following something of a trend noted by preeminent legal lexicographer Bryan Garner. See Bryan A. Garner, LawProse Lesson #115: Is it attorney’s fees or attorneys’ fees? (no year listed; the comments to the post are from 2013).

22.16.2 Prevailing-party recovery of Attorney Fees

  1. Entitlement: In any Proceeding, the prevailing party is entitled to recover its Attorney Fees, in addition to any other interim- and/or final relief to which the prevailing party shows itself to be entitled.

b.  Determination of prevailing party: In determining which is the "prevailing" party, the tribunal is requested (if a court) or directed (if an arbitral tribunal) to take into account:

  1. the claims asserted;
  2. the amount(s) of money sought versus the amount(s) awarded; and
  3. offsets and counterclaims asserted (successfully or otherwise) by the other party.
Commentary

This language is adapted from a slide in a June 2020 CLE Webinar on "Commercial Contract Pitfalls" by Locke Lord attorneys Janet E. Militello and Brandon F. Renken.

Just what constitutes a "prevailing" party can be very fact-specific; some courts have held that, if the putatively winning side did not receive any monetary damages or equitable relief, then it will not be considered the prevailing party for purposes of an attorney fee award. See, e.g., Intercontinental Group Partnership v. KB Home Lone Star LP, 295 S.W.3d 650 (Tex. 2009), where a 5-4 majority of the state supreme court reversed a $66,000 attorney-fee award to a plaintiff that had received a zero-dollar damages award and no declaratory‑ or other equitable relief.

22.16.3 No appeal or recapture of interim awards

  1. No appeal of interim denials: To reduce the chance of satellite litigation over Attorney-Fee demands in motion practice and other interim Proceedings, each party WAIVES (see the definition in Clause 22.162) any right to appeal a decision by a tribunal not to award some or all requested Attorney Fees for an interim Proceeding.
  2. No recapture of interim awards: If a party is required to pay or reimburse Attorney Fees for an interim Proceeding, that party WAIVES (see the definition in Clause 22.162) any right it might have to recapture the payment or reimbursement if that party is later awarded damages, or its own Attorney Fees, or any other monetary amount.

22.17 Audits

22.17.1 Introduction; parties

This Clause applies if and when, under the Contract, a specified party (an "auditing party") may have audits conducted of specified records kept by another specified party (a "recordkeeping party").

Commentary
22.17.1.1 Purpose

Trust, but verify. — Russian proverb, often quoted by the late President Ronald Reagan.

Any time a party will be depending on information reported by another party, the party that will be receiving the reports should consider negotiating to get the right to audit the reporting party's records.

One fraud examiner asserts that "entities often implicitly trust vendors. but just as good fences make good neighbors, vendor audits produce good relationships"; he lists a number of things that fraud examiners watch for, including, for example:

  • fictitious "shell entities" that submit faked invoices for payment;
  • cheating on shipments of goods, e.g., by short-shipping goods or sending the wrong ones;
  • cheating on performance of services, e.g., by performing unnecessary services or by invoicing for services not performed;
  • billing at higher-than-agreed prices;
  • kickbacks and other forms of corruption;

and others. See Craig L. Greene, Audit Those Vendors (2003).

22.17.1.2 An audit-provision checklist

The subheadings of this Clause provide a list of issues that an audit provision could address, such as:

  • how often audits may be conducted;
  • deadlines for asking for an audit of a particular record;
  • how much advance notice of an audit must the auditing party give;
  • how big a discrepancy should be required before the recordkeeping party will be required to reimburse the auditing party for its audit expenses;
  • whether the recordkeeping party should be entitled to reimbursement for its audit expenses.

See also Tango Clause 22.84 - Inspections Protocol

22.17.2 Definition: Auditable records

The term "auditable records" refers to records sufficient to document each of the following, as applicable under the Contract:

  1. labor and/or materials billed to the auditing party;
  2. other items billed to the auditing party;
  3. compliance with specific requirements; and
  4. any other clearly-agreed auditable matters;

unless the Contract clearly provides otherwise.

Commentary

For particular contracts, parties might want to add items to the above list, remove items, or go into more detail about certain already-listed items.

22.17.3 Form of records to be provided to auditors

The recordkeeping party must make all auditable records available to the auditors in the form in which the records are kept in the ordinary course of business.

Commentary
22.17.3.1 Purpose

Auditors will usually want to see records in the form in which they're kept in the ordinary course of business. That's because:

22.17.3.2 Pro tip: Restrict auditors' access?

A recordkeeping party might want to restrict auditors' access to the party's facilities, computers, etc. For example, in audits of a licensee's usage of software, a possible compromise might be to allow a third-party auditor to have limited access to the licensee's computer systems, etc., under a strict confidentiality agreement. See Christopher Barnett, Top Three Revisions To Request In Software License Audit Clauses (ScottAndScottLLP.com 2015).

(The recordkeeping party might want to consider including Tango Clause 22.33 - Computer System Access in the Contract.)

22.17.4 Maximum allowable frequency of audits

An auditing party may request an audit only up to once per 12-month period and once per period audited, whichever is more restrictive, unless good reason exists (see the definition in Clause 22.84.11) for more-frequent audits.

Commentary

An audit might well be at least somewhat burdensome and disruptive to the recordkeeping party. Some recordkeeping parties might therefore want to negotiate limits stated in this section.

22.17.5 Advance notice requirement

An auditing party must give the recordkeeping party at least ten business days' notice (see the definition in Clause 22.112) of any proposed audit, unless good reason (see the definition in Clause 22.84.11) clearly exists for an audit on shorter notice.

Commentary

Normally both parties will benefit if the recordkeeping party has a reasonable time to collect its records, remedy any deficiencies, etc., before the auditor(s) get there.

On the other hand, a surprise audit might be in order if the auditing party has reasonable grounds to suspect cheating or other malfeasance.

22.17.6 Deadline for requesting an audit

An auditing party may request an audit of any particular record only on or before the later of the following dates:

  1. the end of any legally enforceable record retention period for that record, if any; and
  2. the end of three years following the end of the calendar quarter in which the substantive content of the record was most-recently revised.
Commentary

A recordkeeping party might want to negotiate a deadline for requesting an audit, after which the records in question become uncontestable absent good reason. That's because:

  • at some point, the recordkeeping party might want to be able to get rid of its records;
  • the recordkeeping party likely wouldn't want to have to support an audit of (say) 20 years of past records; and
  • "sunset" provisions can be a Good Thing generally.

EXAMPLE: In a Hollywood-related case, an audit deadline came into play in a dispute over profits from the TV show Home Improvement; the plaintiffs were writers and producers of the show. See Wind Dancer Production Group v. Walt Disney Pictures, 10 Cal. App. 5th 56, 78-79, 215 Cal. Rptr. 3d 835 (2017).

Absent a deadline for requesting an audit, a creative counsel might try to argue that the counsel's client still had the right to conduct an audit even when, for example, the underlying agreement had expired or been terminated — a labor union tried (unsuccessfully) to make such an argument in a First Circuit case. See New England Carpenters Central Collection Agency v. Labonte Drywall Co., 795 F.3d 271 (1st Cir. 2015) (affirming judgment).

22.17.7 Incontestability of records after audit deadline

After the relevant deadline for requesting an audit has passed (see [LINK NEEDED]), the particular record in question is to be deemed uncontestable, unless the auditing party shows, by clear and convincing evidence (defined in [LINK NEEDED]) — that good reason (see the definition in Clause 22.84.11) exists for a later audit.

Commentary

This section is a corollary to the audit-request deadline in [LINK NEEDED].

22.17.8 Permissible auditors

  1. No contingent-fee auditors: An audit may not be conducted by any auditor working on a contingent-fee basis, even if that auditor would otherwise be eligible under this section.
  2. Big Four accounting firms: An auditing party may engage any Big Four accounting firm to conduct an audit under this Clause unless otherwise stated in this section.
  3. Recordkeeping party's own regular auditor(s): An auditing party may engage any independent accounting firm that regularly audits the recordkeeping party's relevant records; the auditing party WAIVES (see the definition in Clause 22.162) any conflict of interest in that regard.
  4. Consent requirement for other auditors: Any other auditor(s) must have the recordkeeping party's consent.
    1. Such consent is not to be unreasonably withheld.
    2. The recordkeeping party is deemed to have consented to a proposed auditor if the recordkeeping party does not give the auditing party notice (see the definition in Clause 22.112) of its objection within five business days after receiving or refusing the auditing party's written proposal to use that auditor.
Commentary

An auditing party might not want to bear the expense of having an outside auditor do the job, and instead might prefer to send in one of its own employees to "look at the books." BUT: A recordkeeping party might not want the auditing party's own personnel crawling around in the recordkeeping party's records, but might be OK with having an outside accountant (or other independent professional) do so.

Subdivision a (no contingent-fee auditors): This is sometimes seen in real-world audit provisions.

Subdivision b (Big Four firms): It's pretty typical for audit clauses to allow Big Four accounting firms to conduct audits.

Subdivision c (recordkeeping party's own auditors): Contracts consultant John Tracy, suggests, in a LinkedIn discussion thread (membership required), that an auditing party should consider engaging the outside CPA firm that regularly audits the recordkeeping party's books. He says that this should reduce the cost of the audit and assuage the recordkeeping party's concerns about audit confidentiality; he also says that "the independent CPA will act independently rather than risk the loss of their [sic] license and accreditation and get sued for malpractice."

Subdivision d (reasonable consent requirement for other auditors): A recordkeeping party might want the absolute right to veto the auditing party's choice of auditors, instead of having the right to give reasonable consent. On the other hand, the auditing party might not trust the recordkeeping party to be reasonable in exercising that veto, and could be concerned that a dispute over that issue would be time-consuming and expensive. This provision represents a compromise.

(The specific time limit for objection by the recordkeeping party might be something to be negotiated.)

22.17.9 Location and working hours for audits

Unless otherwise agreed, the recordkeeping party must allow each audit to be conducted:

  1. at the location or locations where the auditable records are kept in the ordinary course of business;
  2. during the regular working hours, at that location, of the party having custody of the records; and/or
  3. at one or more other reasonable times and places, designated in advance by the recordkeeping party in consultation with the auditing party.
Commentary

For any given audit, the parties might want to agree — in writing, of course, albeit informally, e.g., by email — to different working hours and/or location for the audit.

22.17.10 Auditor workspace

IF: An audit is to be conducted at one or more sites controlled by the recordkeeping party;

THEN: The recordkeeping party, at its own expense, is to cause the audit site(s) to be furnished with appropriate facilities, of the type customarily used by knowledge-based professionals.

Commentary

In an unfriendly audit, an uncooperative recordkeeping party might try to make the auditors work in a closet, a warehouse, or worse.

22.17.11 Cooperation with auditors

Except as otherwise provided in this Clause, the recordkeeping party must:

  1. make its relevant personnel reasonably available to the auditors, and
  2. direct those personnel to answer reasonable questions from the auditors.
Commentary

This section anticipates the possibility of "unfriendly" audits.

22.17.12 Off-limits information

The recordkeeping party need not allow the auditor(s) to have access to any of the following:

  1. information that, under applicable law, would be immune from discovery in litigation, including without limitation on grounds of attorney-client privilege, work-product immunity, or any other privilege;
  2. trade secrets and other confidential information relating to formulae and/or processes; and
  3. clearly-unrelated or -irrelevant information.
Commentary

In the case of the attorney-client privilege, disclosure of privileged information to outsiders likely would waive the privilege in many jurisdictions and thus make the privileged information available for discovery by others, including third parties.

A recordkeeping party might also want to specify other particular audit exclusions.

Subdivision 3's exclusion might be open to dispute, but at least it gives the recordkeeping party ammunition with which to oppose an unreasonable "fishing expedition" by the auditing party.

22.17.13 Auditors' confidentiality obligations

Auditors must agree in writing to comply with the same confidentiality obligations that apply to the auditing party.

Commentary

Outside auditors might not want to take the time (and expense) of reviewing, negotiating, and signing a confidentiality agreement. An advantage of using independent accounting firms is that (in most jurisdictions) they will have at least some ethical obligations to maintain the confidentiality of the records they audit, regardless whether a written confidentiality agreement is in effect.

22.17.14 Auditor retention of copies

  1. Retention: The auditors may make and keep copies of auditable records, in accordance with professional practice standards,
    • subject to the confidentiality- and return-or-destruction provisions of this Clause.
  2. Destruction in due course: In due course, the auditors must destroy or return any copies that they retain under this section,
    • in accordance with the auditors' regular, commercially-reasonable policies and processes.
Commentary

An auditing party's auditors might well find it burdensome (and therefore more expensive for the auditing party) to be precluded from making copies of the recordkeeping party's records. Moreover, outside auditors might insist on being able to take copies with them to file as part of their work papers.

However, in some circumstances, the recordkeeping party might want to negotiate for limits on the types of records that the auditor(s) are allowed to copy and take away.

Of historical interest: The Big-Five accounting firm Arthur Andersen was destroyed because it belatedly shredded its files concerning its audits of Enron, which led to the firm's conviction for obstruction of justice — the U.S. Supreme Court unanimously reversed the conviction, but by then it was too late to save the firm. See Arthur Andersen (Wikipedia.org)

Also of interest to lawyers: Andersen's belated shredding of documents was prompted by a "reminder" email from an Andersen in-house lawyer, who was never criminally charged but became practically unemployable as a result of the fallout:

"It might be useful to consider reminding the [Enron] engagement team of our documentation and retention policy," [the in-house lawyer] wrote in an e-mail to an Andersen partner before Enron filed for bankruptcy. "It will be helpful to make sure that we have complied with the policy." * * * 

In 2002, [the lawyer's] options were limited. She couldn’t return to BigLaw, including Sidley Austin where she had once worked. No public company would be willing to hire her. So she became a solo, taking a route "far from the white-shoe legal world she had known, through criminal law, risky contingent-fee cases and small-fry clients," Crain’s says.

Debra Cassens Weiss, How an Arthur Andersen Lawyer Rebuilt Her Career (ABAJournal.com 2010) (emphasis added); see also Nancy Temple (Wikipedia.org) for a more-detailed account of the lawyer's advice email.

During President Donald Trump's efforts to overturn the results of the 2020 presidential election that turned him out of office, Ms. Temple appeared as counsel on an amicus brief for 17 individuals who opposed the Texas attorney general's attempt to file an original-jurisdiction lawsuit in the Supreme Court against six swing states that had voted for President-elect Joseph Biden.

22.17.15 Copy of audit report to recordkeeping party

IF: the recordkeeping party so requests in writing to the auditors,

  • with a copy of the request to the auditing party;

THEN: The auditors must promptly furnish the recordkeeping party with a complete and accurate copy of the audit report, at no charge.

Commentary

A recordkeeping party might not care about getting a copy of the audit report if all the report says is, basically, everything's cool here.

But if the recordkeeping party will have to come up with extra money — or if the audit report says that the auditing party has materially breached the Contract — then the recordkeeping party likely will indeed want a copy of the audit report.

An auditing party might not want to provide a copy of the audit report to the recordkeeping party. But let's face it:

  • If the dispute goes to litigation or even arbitration, the odds are high that the recordkeeping party's lawyers will be able to get a copy of the audit report as part of the discovery process (for example, by issuing a subpoena to the auditors).
  • And any confidential information in the audit report is presumably the recordkeeping party's confidential information.

So it's hard to think of a good reason for the recordkeeping party not to get a copy of the audit report.

22.17.16 Corrective action after an audit

  1. Each party must promptly correct any discrepancy revealed in an audit,
    • where that party was responsible for the discrepancy,
    • for example, an overbilling or an underpayment.
  2. In case of doubt: No invoice need be sent for a payment required under this section; a complete and accurate copy of the audit report (if not already provided) and a written request for payment will suffice.
Commentary

Subdivision b's "no invoice" provision is for clarity.

22.17.17 Interest rate for past-due amounts

  1. A party that is found by an audit to owe money due to that party's error (or other fault) must pay simple interest to the other party on the unpaid balance of the amount(s) owed,

    at the rate of 1.5% per month, or if less, the maximum rate permitted by law,

    beginning on the date the money was originally due, or if later, the earliest start date permitted by law,

    and continuing until paid in full.

  2. Tango Clause 22.160 - Usury Savings will apply.
Commentary

The interest rate might be negotiated, but too-low a rate would give a party an incentive (possibly a small one) to cheat.

22.17.18 Audit expense shifting

  1. Triggers for expense-shifting: This section applies if the audit was occasioned by, or revealed or confirmed, one or more of the following, (i) on the part of the recordkeeping party, or (ii) for which the recordkeeping party is responsible either by law or as stated in the Contract:
    1. overbilling or underpayment (as applicable) by more than 5% for the period being examined;
    2. fraud; and/or
    3. material breach (see the definition in Clause 22.102.2).
  2. Expense-reimbursement requirement: When this section applies (see subdivision a), the recordkeeping party must reimburse the auditing party for its reasonable out-of-pocket expenses actually incurred, including without limitation reasonable fees and expenses charged by the auditor(s).
  3. No expense shifting otherwise: As between the recordkeeping party and the auditing party, each party is responsible for all of its audit-related expenses unless the Contract clearly says otherwise.
Commentary

Subdivision a.1: The threshold for shifting audit expenses to the recordkeeping party might well be negotiable. It often will fall in the range between 3% and 7% for royalty-payment discrepancies and perhaps 0.5% for billing discrepancies in services.

This section calls for expense-shifting if a discrepancy of a stated percentage is revealed "for the period being examined." Why? Suppose that in an audit of five years' worth of records, the auditors discover a 5% discrepancy in the records for a single month. In that situation, the recordkeeping party shouldn't have to foot the bill for the expense of the entire five-year audit.

Subdivision c: Reimbursement of the recordkeeping party's expenses can be addressed with [LINK NEEDED]. A recordkeeping party might want that, because its own audit expenses might not be trivial: An article notes that "audit provisions rarely address the apportionment of the costs incurred by the contractor or its subcontractors in facilitating the audit, managing the audit, reviewing and responding to the audit results, and other related activities if the audit fails to demonstrate significant overbilling by the contractor." Albert Bates, Jr. and Amy Joseph Coles, Audit Provisions in Private Construction Contracts …, 6 J. Am. Coll. Constr. Lawyers 111, 132 (2012).

22.17.19 Option: Recordkeeping Party Expense Reimbursement

  1. This Option applies only if the Contract unambiguously says so.
  2. IF: For a particular audit, the recordkeeping party is not required to reimburse the auditing party's expenses of the audit;
    • THEN: The auditing party must reimburse the recordkeeping party,
      • and the recordkeeping party's subcontractors, if applicable,
    • for reasonable expenses that the recordkeeping party (and/or its subcontractors) actually incurred in connection with the audit.
  3. Such expenses would include, without limitation, reasonable fees and expenses for an auditor engaged by the recordkeeping party (if any) to monitor the audit.
Commentary

Audits aren't cost-free for the recordkeeping party, so such a party might ask to be reimbursed for its audit expenses if the audit doesn't reveal significant problems.

See also the commentary to [LINK NEEDED] (audit expenses).

22.17.20 Option: True-Up as Exclusive Audit Remedy

  1. This Option applies only if the Contract unambiguously says so and both of the following are true:
    1. The auditor's report provides clear support for the existence of a discrepancy for which the recordkeeping party is responsible; and
    2. The recordkeeping party complies with the discrepancy-related requirements of this Option within ten business days after the recordkeeping party receives a copy of the auditor's report.
  2. Except as provided in subdivision c, the recordkeeping party's compliance with those discrepancy-related requirements will be the recordkeeping party's only liability, and THE AUDITING PARTY'S EXCLUSIVE REMEDY, for the discrepancy.
  3. The exclusive-remedy limitation of subdivision b will not apply, however, if the audit revealed or confirmed—
    1. fraud (see § 22.65); or
    2. a material breach (see § 22.102.2) of the Contract,

in either case for which the recordkeeping party was responsible by law and/or under the Contract.

Commentary

A software customer might want to include this Option in the Contract as a shield against a forceful software licensor (cough, Oracle), if an audit by the licensor revealed that the customer was making more use of the software than it had paid for. See, e.g., Christopher Barnett, Top Three Revisions To Request In Software License Audit Clauses (ScottAndScottLLP.com 2015), archived at https://perma.cc/Y9U5-LKXE.

Software licensors might well be willing to go along with such a limitation of liability — but possibly with the proviso that any catch-up license purchases would be at full retail price, regardless of any negotiated discount; otherwise the customer would have an incentive to roll the dice and cheat on obtaining licenses.

On the other hand, an auditing party might object to this provision if it wanted to be free also to demand a greater measure of damages for the discrepancy revealed by the auditor's report if that were available by law — such as indirect damages resulting from copyright infringement if the audit showed that the recordkeeping party had used licensed software for more than the recordkeeping party had paid for.

Something like this came to pass in a case where a jury awarded $5 million, or 2.2% of defendant's total profits for the period in question, as "disgorgement" copyright damages for the defendant's infringement of the plaintiff's computer software. See ECIMOS, LLC v. Carrier Corp., 971 F.3d 616 (6th Cir. 2020) (affirming judgment on jury verdict); see also the commentary to [LINK NEEDED].

22.17.21 Option: Audit Requirement Flowdown

  1. This Option applies only if the Contract unambiguously says so.
  2. The recordkeeping party must cause each of its subcontracts under the Contract, if any, to include "flowdown" provisions as follows:
    1. a requirement that the subcontractor permit audits by the auditing party in accordance with the Contract's audit provisions; and
    2. an authorization for the subcontractor to deal directly with the auditing party and its auditors in connection with any such audit.
Commentary

Contracts that are expected to involve subcontracts will often contain flowdown requirements, as discussed at [LINK NEEDED].

22.17.22 Reading review: Recordkeeping and audits

FACTS: MathWhiz and Gigunda are agreeing to a variation of their basic data-analysis deal: Instead of a flat monthly rate, MathWhiz will charge Gigunda hourly rates plus out-of-pocket expenses.

Working together in your breakout rooms:

1.  List one point from this reading that you're glad you knew before doing the reading — or that you're glad you learned from doing it.

2.  List three points in this reading that you would want MathWhiz to be sure to know if you were representing that company.

3.  Same as #2, but this time as if you were representing Gigunda.

22.18 Background Checks

22.18.1 Introduction; parties

This Clause applies if and when, under the Contract:

  • a specified party (a "checking party") has background checks performed on one or more individuals (each, a "checked individual"),
  • in connection with the performance of services or other obligations for another party (a "requesting party").
Commentary
22.18.1.1 Business context

It's not uncommon for customers to want service providers to have background checks done on the providers' key personnel. The goal is normally to identify people with criminal records, drug problems, or other indicia of potential trouble. This can be a sensitive topic, possibly with legal complications.

A customer might especially want (or need) for a supplier to have background checks run on the supplier's personnel, for example:

  • if the customer is a government contractor;
  • if the supplier will have access to the customer's confidential- or sensitive information; or
  • if the supplier's personnel will "face" the customer's own customers or clients, that is, be seen or heard by them.

Contract drafters can use the defined terms in [LINK NEEDED] to specify particular background checks to be performed.

22.18.1.2 Caution: Hazards of background checks

Background checks can pose dangers for parties requiring them:

  • Suppose that a customer requires a provider to have background checks done on all provider personnel who will be accessing the customer's premises.
  • Then suppose that an employee of the provider complains that the background check violated his rights under applicable law.

The provider's employee might be tempted to sue the customer, not just the provider.

(In that situation, [LINK NEEDED] would require the provider to protect the customer from the cost of defending and/or paying damages for such claims.)

22.18.1.3 Caution: Consent requirements

Parties conducting (or commissioning) background checks should be sure to check applicable law to see if any particular form of consent is required; see, for example, the discussion of consent requirements in Section 22.18.1.4: .

It might be prudent to obtain consent to a background check even if the law doesn't require consent: If the individual were to learn of an unconsented background check, his displeasure might go viral on social media, especially given today's heightened sensitivity to privacy concerns.

22.18.1.4 Credit checks: Special federal consent requirements

Credit checks, if not done correctly, can get a checking party in trouble under the [U.S.] Fair Credit Reporting Act ("FCRA"). One particular procedural requirement comes up in class-action lawsuits: Section 1681b(b)(2)(A) of the FCRA, which states that, with certain very-limited exceptions:

… a person may not procure a consumer report, or cause a consumer report to be procured, for employment purposes with respect to any consumer, unless—

(i) a clear and conspicuous disclosure has been made in writing to the consumer at any time before the report is procured or caused to be procured, in a document that consists solely of the disclosure, that a consumer report may be obtained for employment purposes; and

(ii) the consumer has authorized in writing … the procurement of the report by that person.

(Emphasis added.) Hat tip: Ken Remson, Employers Hit With Background Check Lawsuits, May 20, 2014.

Noncompliance with background-check consent requirements has hit some well-known companies with sizable settlement costs. See, e.g., Todd Lebowitz, Publix to Pay $6.8 Million Settlement over Noncompliant Background Check Forms (EmploymentClassActionReport.com Nov. 3, 2014); David M. Gettings, Timothy St. George and David N. Anthony, Chuck E. Cheese Settles Background Check Lawsuit For $1.75 Million (Mondaq.com 2015).

22.18.2 Required types of background check

Criminal History Checks (defined in [LINK NEEDED]) are required if not otherwise specified in the Contract.

Commentary

See generally the definitions in [LINK NEEDED] (and consider other possible background checks).

Liens and bankruptcy: As an adjunct to a credit check, a party might want to know about an individual's past financial difficulties.

Criminal background checks: See the commentary at [LINK NEEDED].

Drug testing: See the commentary at [LINK NEEDED].

Education checks are sometimes used because résumé padding is not an uncommon occurrence. Examples: • The chief spokesman of Walmart resigned after the retail giant learned that he had falsely claimed to have graduated from college, when in fact he had not finished his course work (DailyMail.com 2014). • Ditto the former dean of admissions at MIT (NPR.org 2015).

Employment checks: Verification of employment dates, in particular, can help expose undisclosed résumé gaps — or "fudging" of employment dates as listed on the résumé to shorten or eliminate gaps.

It's thought by some that a good practice is not to rely on employer contact information provided by the (former) employee, but instead to find the contact information independently. Otherwise, it's possible that the "employer" is actually someone colluding with the former employee to provide false information.

Some parties might want to obtain more than just the listed information, adding (for example) job duties, salary history, reason for leaving, and/or eligibility for rehire.

Some parties want employment history for the past five to ten years, or for the past two to five employers.

Residence address checks have in mind that an individual might omit one or more previous addresses in the hope of evading a criminal-records check.

22.18.3 Whose backgrounds must be checked

The backgrounds of anyone engaged in Restricted Activities (defined in [LINK NEEDED]) must be checked.

Commentary

The definition of Restricted Activities in [LINK NEEDED] is set up with a view to safety of person and property.

22.18.4 Independent sources of contact information

As a safeguard against falsified references, all reference checks, if any,

  • other than personal character references,
  • are to be completed using contact information obtained from a source other than from the checked individual him- or herself.
Commentary

By requiring independently-obtained contact information, [LINK NEEDED] helps to guard against the possibility that an applicant might provide a checking party with fake contact information for such references — so that when the checking party contacts the "references," the checking party ends up talking to one of the applicant's friends who is in on the scam.

22.18.5 Costs of background checks

The checking party must bear all costs of background checks unless the Contract specifies otherwise.

Commentary

Service providers often take the view that any customer that wants background checks to be conducted on the provider's personnel should pony up for that cost.

On the other hand, a customer might take the position that background checks should be an overhead expense that the provider must bear.

This section comes down on the side of the customer as a "default" provision, but of course the parties are free to agree otherwise.

22.18.6 Standards for self-performed background checks

If a checking party itself performs a background check, it must do so:

  1. in a commercially-reasonable manner; and
  2. in compliance with law, including without limitation:
    • any applicable privacy laws, including for example any requirement to obtain the consent of the checked individual; and
    • any applicable notification requirement, for example, in credit-reporting laws, that the checked individual must be notified before or after a decision is made using information learned in the background check.
Commentary

This section sets out a semi-strict standard for a checking party that does background checks itself, as opposed to hiring out the job to a reputable service provider as provided in [LINK NEEDED].

22.18.7 Standards for outsourced background checks

If the checking party does not perform the background check itself, it must:

  1. engage a reputable service provider to do so; and
  2. contractually obligate the service provider to comply with the requirements of subdivision 1.
Commentary

This section establishes a safe harbor if the checking party hires a reputable service provider, instead of DIY (for that alternative, [LINK NEEDED]).

Even if contracting parties are capable of conducting their own background checks, they're likely to want to outsource the job and offload the responsibility by engaging a reputable outside service, because professionals in that field —

  • can use economies of scale to do the work more cost-effectively;
  • can be thrown under the bus if something goes wrong; and
  • can provide a layer of liability protection against claims by people who had their backgrounds checked (but claims of negligent hiring against the engaging party could still be viable).

22.18.8 Procedure if criminal history revealed

IF: A checked individual's background check reveals any Criminal History (see the definition in Clause 22.18.11);

THEN: The checking party must not assign, nor permit, that individual to engage in any Restricted Activity (see the definition in Clause 22.18.11) for the benefit of the requesting party

  • without first consulting with the requesting party.
Commentary
22.18.8.1 Where to get criminal-records checks

Criminal records checks in basic form seem to be available from any number of Web sites at low cost, including from government agencies.

Examples: • FBI: https://www.edo.cjis.gov. • Texas Department of Public Safety: https://records.txdps.state.tx.us/DpsWebsite/CriminalHistory/.

22.18.8.2 Caution: Unlawful-discrimination charges could ensue

Using criminal-records checks to deny employment might lead to trouble with government agencies or with the persons checked if the denials have the effect of unlawful discrimination against minorities or other protected classes. A blanket prohibition against using personnel with criminal records could be problematic: It might be alleged to have a disproportionate impact on racial- or ethnic minorities and thus to be illegal in the U.S.

The U.S. Equal Employment Opportunity Commission (EEOC) has filed lawsuits against employers who allegedly "violated Title VII of the Civil Rights Act by implementing and utilizing a criminal background policy that resulted in employees being fired and others being screened out for employment …." EEOC press release, June 11, 2013; see generally the EEOC general counsel's enforcement guidance published in April 2012.

For example, a blanket prohibition against using personnel with criminal records could be alleged to have a disproportionate impact on racial- or ethnic minorities and thus to be illegal in the United States. See generally the EEOC general counsel's enforcement guidance published in April 2012.

22.18.8.3 Caution: "Ban the box" statutes can trip up employers

In addition, some states might likewise restrict an employer's ability to rely on criminal background information in making employment-related decisions. Drafters should pay particular attention to the law in California, New York, Massachusetts, Illinois, and Pennsylvania (not necessarily an exhaustive list). This is because in recent years the practice of automatically disqualifying people with criminal convictions has come under fire from government regulators and the plaintiff's bar as being potentially discriminatory (the so-called "ban the box" movement). For a list of states and cities with ban-the-box laws, see Beth Avery, Ban the Box: U.S. cities, counties, and states adopt fair hiring policies (NELP.com 2019).

22.18.9 Procedure if drug use revealed

IF: A checked individual's background check indicates use, by that individual, of one or more of the following: (i) illegal drugs; and/or (ii) prescription drugs other than in accordance with a lawfully-issued prescription;

THEN: The checking party must not assign, nor permit, that individual to engage in —

  1. any Critical Activity (see the definition in Clause 22.18.11) for the requesting party without the express prior written consent of the requesting party; nor
  2. any other Restricted Activity (see the definition in Clause 22.18.11) for the requesting party without first consulting with the requesting party.
Commentary
22.18.9.1 Reasons for drug testing

Customers with safety concerns might want its contractors' employees to be drug-tested. Depending on the duties to be assigned, even the use of legal drugs might disqualify an individual — for example, an individual taking certain prescription medications might be disqualified from (say) driving a bus or other commercial vehicle.

For obvious reasons, if a background check indicates that a person might have a drug-misuse problem, then tighter restrictions are imposed on using the person for Critical Activities than for other Restricted Activities.

22.18.9.2 Caution: Running afoul of disability laws

Companies should be cognizant of disability laws such as the Americans with Disabilities Act, which might affect a company's ability to deny employment because of prescribed drug use.

Companies might also consider the possible effect on employee morale of asking them to take a drug test – and about what they might have to do if a valued employee were to bust the test. As the saying goes, be careful about asking a question if you're not prepared to deal with the answer.

22.18.10 Responsibility for third-party claims

  1. This section applies if a third party (see subdivision c) makes any kind of claim against the requesting party, and/or any other member of the requesting party's Protected Group (see the definition in Clause 22.126), where:
    1. the claim arises out of the conduct of a background check under the Contract; and
    2. the background check is done (i) by the checking party and/or (ii) at the checking party's request or direction.
  2. In such an event, the checking party must defend (as defined in Clause 22.46) the requesting party's Protected Group (as defined in Clause 22.126) against the claim.
  3. In case of doubt: The checking party's obligation under this section applies, without limitation, to any claim:
    1. by a Checked Individual, and/or
    2. by a government authority.
Commentary

Caution: As with any indemnity obligation, a party expecting to be indemnified should consider pairing the indemnity- and defense obligation with an obligation for the indemnifying party to maintain insurance or other backup financing source, in case the indemnifying party doesn't have the money to comply when the time comes.

22.18.11 Definitions for Background Checks

Credit Check refers to standard credit reporting from all major credit bureaus serving the jurisdiction in question. See the commentary at [LINK NEEDED].

Criminal History, as to a checked individual, refers to the checked individual's having been convicted of, or having pled guilty or no contest to, one or more of: (1) a felony; and/or (2) a misdemeanor involving fraud or moral turpitude.

Criminal-History Check refers to a nationwide check of records of arrests, convictions, incarcerations, and sex-offender status. A Criminal-History Check need not include fingerprint submission to confirm identity. See [LINK NEEDED] and its commentary.

Critical Activity refers to any activity involving a substantial possibility of:

  1. bodily injury to or death of one or more individuals, including but not limited to a checked individual; and/or
  2. loss of, or damage to, tangible or intangible property, of any kind, of any party other than the checking party; such loss or damage might be physical and/or economic.

Driving-Record Check refers to a check of records of accidents; driver's-license status; driver's-license suspensions or revocations; traffic violations; and driving-related criminal charges (e.g., DUI).

Drug Testing refers to testing for illegal drugs and controlled pharmaceuticals. See [LINK NEEDED] and its commentary.

Education Verification refers to confirmation of dates of attendance, fields of study, and degrees earned.

Employment Verification refers to confirmation of start- and stop dates and titles of employment for the past seven years. See the commentary at [LINK NEEDED].

Lien, Civil-Judgment, and Bankruptcy Check refers to a check of records of tax- and other liens; civil judgments; and bankruptcy filings. See the commentary at [LINK NEEDED].

Personal Reference Check refers to telephone- or in-person interviews with at least three personal references, seeking information about the individual's ethics; work ethic; reliability; ability to work with others (including, for example and where relevant, peers, subordinates, superiors, customers, and suppliers); strengths; areas with room for improvement; personality.

Residence Address Verification refers to confirmation of dates of residence addresses for the past seven years. See the commentary at [LINK NEEDED].

Restricted Activity refers to any one or more of the following, when engaged in, in connection with the Contract, by an employee of, or other individual under the control of, a checking party:

  1. any Critical Activity (defined above in this section);
  2. working on-site at any premises of a requesting party;
  3. having access (including without limitation remote access) to the requesting party's equipment or computer network;
  4. having access to the requesting party's confidential information; and
  5. interacting with the requesting party's employees, suppliers, or customers.

22.19 Baseball Arbitration

22.19.1 Introduction; covered disputes

This Clause is to be followed in any dispute between the parties — before a court or any other tribunal — where the dispute is about one or more of the following:

  1. which is the correct number, e.g., an amount owed; and/or
  2. what action is required to comply with an agreed standard or requirement — for example, what would constitute "commercially-reasonable efforts" if the Contract required a party to make such efforts.
Commentary
22.19.1.1 Promoting settlement through "baseball" arbitration

Final-offer or last-offer arbitration, a.k.a. "baseball arbitration" or "pendulum arbitration," promotes settlement because the decision maker will choose between the parties' competing final proposals; that gives each party an incentive not to be unreasonable in its proposal.

As one commentator put it, baseball arbitration is "designed to produce a settlement, not a verdict." Thomas Gorman, The Arbitration Process – the Basics, in Baseball Prospectus (2005) (http://perma.cc/CZR4-9XC7).

Baseball arbitration seems to work quite well in Major League Baseball as a settlement incentive: in 2018, fully 179 out of 201 arbitration-eligible players, or 89%, reached a settlement with their teams without having to go to hearing; in 2019, it was 12 settlements out of 14 arbitration-eligible players, or 86%; and in the coronavirus-pandemic year of 2020, it was 11 settlements out of 14 players, or 78%. See Arbitration Tracker 2018, 2019, and 2020.

22.19.1.2 Advantage: Fencing in the arbitrator

Another perceived advantage of baseball-style decision-making is that, because the tribunal must choose between the parties' last offers, the tribunal is not allowed to "go rogue," a possibility that worries some parties (see Section 22.7.17: ), nor is the tribunal allowed to "split the baby," as some are concerned that arbitrators are prone to do (the present author, who sometimes serves as an arbitrator, does not share this concern).

The two categories of dispute listed in this section are especially amenable to promoting settlement by incentivizing the parties to be reasonable.

22.19.2 Exchange of settlement proposals

  1. Number of proposals: The parties are to exchange, in succession, two written proposals to resolve the dispute.
  2. Copies to tribunal: Each party is to provide the tribunal with a copy of each of that party's settlement proposals.

c.  Explanations: Each party may include, in any proposal, a brief explanation why it believes the tribunal should select that proposal.

Commentary
22.19.2.1 Language origins

This section borrows from a set of final-offer arbitration rules published by the International Centre for Dispute Resolution (the international division of the American Arbitration Association). See ICDR Rule 2, Final Offer Arbitration Supplementary Rules (adr.org), archived at https://perma.cc/5TJ6-UKHH (perma.cc).

22.19.2.2 Subdivision a — two rounds of settlement proposals:

Doing two successive rounds of settlement proposals should help nudge each party into assessing whether the other party's proposal might look better to the tribunal, which can promote reasonable positions and thus improve the odds of settlement. See Edna Sussman and Erin Gleason, Everyone Can Be a Winner in Baseball Arbitration: History and Practical Guidance (sussmanadr.com), in N.Y. State Bar Association, New York Dispute Resolution Lawyer, Spring 2019, at 30, archived at https://perma.cc/QW76-C7BB.

22.19.2.3 Subdivision b: Telling the tribunal about the proposals

This subdivision will help the tribunal to size up which party proposal is "closest to the pin" of what the tribunal would award if free to do so.

A variation on this approach is "night baseball," in which the tribunal is not given copies of the parties' respective proposals; instead, after the hearing or trial, the tribunal indicates which party wins, and that party's settlement proposal then goes into effect. (That variation, however, seems far less likely to have the settlement-promoting effect of "regular" baseball.) See CPR, Final Offer or Baseball Arbitration (cpradr.org).

22.19.2.4 Subdivision c: Explanations of proposals

This subdivision will give the parties' counsel an opportunity to write (what amount to) "post-trial briefs."

22.19.3 Tribunal's preliminary expression of views

  1. Advice to parties: The tribunal, in its sole discretion, may advise the parties of the tribunal's views about the matter in dispute.
  2. Resubmission opportunity: If the tribunal does advise the parties of its views, it should allow a reasonable time for the parties to submit, and confer about, revised proposals if they so choose.
Commentary

It can be helpful if the member(s) of the tribunal disclose their preliminary, provisional impressions of the merits before the parties submit their final proposals. Such a disclosure by the tribunal can likely help the parties reassess their settlement positions and thus formulate their next proposals for resolution of the dispute.

Some might be concerned that an arbitrator's preliminary comments could create an impression of arbitrator bias. And a party perceiving that it was going to lose the case could run to court to try to stop the arbitration (this sort of thing has actually happened).

But the ABA/AAA code of ethics for arbitration expressly contemplates that arbitrators will "comment on the law or evidence …. These activities are integral parts of an arbitration." Commentary, Canon I of the ABA/AAA Code of Ethics for Arbitrators in Commercial Disputes (https://perma.cc/Y6TX-M97V).

Certainly arbitrators must be vigilant against creating an appearance of bias. But neither should arbitrators be overly fearful of being attacked for bias, because:

  • Arbitrators and judges and jurors routinely and unavoidably form one or more initial impressions of the merits after the parties' opening statements. What is expected of them (nay, demanded) is that they they withhold judgment until all the evidence is in.
  • An arbitrator's disclosure of her initial impressions will help to increase the overall transparency of the arbitration proceeding, in the same vein as her disclosure of any past- or present relationships with the parties, counsel, witnesses, etc. If the arbitrator really does have a genuine bias, her disclosure of her impressions might help counsel to identify that bias.

22.19.4 Tribunal selection of one proposal

  1. IF: The parties' exchange of proposed resolutions does not lead to settlement;
    • THEN: The tribunal is respectfully requested to select (if a court),
      • or is directed to select (if an arbitral tribunal),
    • as the resolution of the dispute — without modification —
    • the one, party-proposed resolution that the tribunal regards as most-closely matching the resolution that the tribunal would award on its own.
  2. The tribunal's selection of a party proposal will be binding as an arbitration award.
  3. In case of doubt: If the tribunal is an arbitral tribunal, this Clause does not grant the tribunal any other power to decide the parties' dispute.
Commentary

The no-other-power language in subdivision c has in mind the case in which the arbitral tribunal does something other than choose between the two alternatives; in such a case, subdivision c should trigger one of the (very few) grounds under which a U.S. court will ordinarily set aside an arbitration award under the Federal Arbitration Act, namely that the arbitrators "exceeded their powers …." 9 U.S.C. § 10(a)(4).

(Of course, a court likely would not be bound by the no-other-power language.)

22.20 Best Efforts Definition

  1. Best efforts refers to the diligent making of reasonable efforts to achieve an objective.
  2. Actions not required: In case of doubt, a party obligated to use best efforts:
    1. need not take any unreasonable action;
    2. need not take every conceivable reasonable action to achieve the stated objective; and
    3. need not materially harm its own lawful interests.

Commentary

22.20.1 Cross-references

This definition should be read in conjunction with the definitions of commercially reasonable efforts ([LINK NEEDED]) and reasonable efforts ([LINK NEEDED]). See also the commentary to [LINK NEEDED] for additional reading about best efforts.

22.20.2 Subdivision a: Diligence in making reasonable efforts

This approach comes from Restatement (Second) of Agency, which states: "Best efforts is a standard that has diligence at its essence." Restatement (Second) of Agency § 13, comment a (1957), quoted in T.S.I. Holdings v. Jenkins, 924 P.2d 1239, 1250, 260 Kan. 703, 720 (1996), quoted in Corporate Lodging Consultants, Inc. v. Bombardier Aerospace Corp., No. 6:03-cv-01467-WEB, slip op. at 9 (D. Kan. May 11, 2005) (finding that CLC had not failed to use its best efforts to obtain lowest and most-competitive hotel rates for Bombardier).

22.20.3 Subdivision b.1: No unreasonable actions required

In its Hospital Products opinion (1984), Australia's highest court held that "an obligation to use 'best endeavours' does not require the person who undertakes the obligation to go beyond the bounds of reason; he is required to do all he reasonably can in the circumstances to achieve the contractual object, but no more … [A] person who had given such an undertaking … in effect promised to do all he reasonably could …." Hospital Prods. Ltd v. United States Surgical Corp., 1984 HCA 64, 156 CLR 41, ¶¶ 24, 25.

22.20.4 Subdivision b.2: Not every reasonable action required

This subdivision is a roadblock term, intended to forestall any contention that best efforts requires the taking of every conceivable reasonable action — because with 20-20 hindsight, an opposing party's trial counsel and expert witness will surely think of something that could have been done but in fact wasn't done, and argue that this means that best efforts weren't used. For case law supporting this standard, see the commentary at Section 22.20.10: .

22.20.5 Subdivision b.3: No material harming of own interests

This subdivision is likewise a roadblock term — again, see the commentary at Section 22.20.10: for supporting case law.

22.20.6 Business context of best-efforts requests

Best-efforts obligations are especially common when one party grants another party exclusive rights, for example exclusive distribution rights or an exclusive license under a patent, trademark, or copyright. See, e.g., Kevin M. Ehringer Enterprises, Inc. v. McData Servs. Corp., 646 F.3d 321, 325-27 (5th Cir. 2011).

To many business people, it may seem self-evident that when a contract uses the term best efforts, it calls for "something more" than mere reasonable efforts — otherwise, why bother even saying best efforts? That is to say:

  • reasonable efforts will cover a range of possibilities,
  • while best efforts refers to somewhere near the top of that range.

22.20.7 A sports analogy: Bring your "A" game

By analogy, to many business people:

  • "C" is a passing grade in (U.S.) schools, and is equivalent to reasonable efforts.
  • In contrast, best efforts means an "A" effort — or in basketball slang, bring your "A" game, not your "C" game.

Another analogy:

  • On major U.S. highways, the speed-limit signs often include both maximum and minimum speeds of (say) 60 mph and 45 mph. Those two speeds establish the upper- and lower bounds of reasonableness.
  • Now, suppose that a trucking company were to agree that its driver would use her "best efforts" to drive a shipment of goods from Point A to Point B on such a highway, where drivers must drive between 45 mph and 60 mph.
  • In good weather with light traffic, driving at 45 mph might qualify as reasonable efforts. But driving at that speed likely wouldn't cut it as best efforts.

22.20.8 Possible variation: "All reasonable efforts"

A drafter could specify that best efforts requires the diligent making of all reasonable efforts. Delaware's supreme court has held, in essence, that this is a synonym for best efforts. See Williams Cos. v. Energy Transfer Equity, L.P., 159 A.3d 264, 272-73 (Del. 2020).

Relatedly, all reasonable efforts is reportedly a common formulation in the UK and Australia as well. See generally, e.g., Menelaus Kouzoupis and Margaux Harris, "Best endeavours" vs "reasonable endeavours": Not two sides of the same coin (SHLegal.com 2020); Shawn C. Helms, David Harding, and John R. Phillips, Best Efforts and Endeavours – Case Analysis and Practical Guidance Under U.S. and U.K. Law (JonesDay.com 2007).

A drafter could also add the phrase, leaving no stone unturned in seeking to achieve the stated objective; that language derives from an opinion by the supreme court of British Columbia. See Atmospheric Diving Systems Inc. v. International Hard Suits Inc., 1994 CanLII 16658, ¶¶ 63, 71-72 (BC SC), 89 B.C.L.R. (2d) 356 (reviewing English and Canadian case law).

Similarly, in Australia, the term best endeavours seems to be treated as synonymous with all reasonable endeavours;

22.20.9 Best efforts might mean different things to different courts

Depending on the jurisdiction, a court might not share the view of best efforts just described.

• As one court explained, "[c]ontracting parties ordinarily use best efforts language when they are uncertain about what can be achieved, given their limited resources." On the facts of the case, the court affirmed summary judgment that an oil refiner had failed to use its best efforts to meet a commitment, remarking that "[a]s a matter of law, no efforts cannot be best efforts." CKB & Assoc., Inc. v. Moore McCormack Petroleum, Inc., 809 S.W.2d 577, 581-82 (Tex. App. – Dallas 1990) (affirming summary judgment that defendant had failed to use its best efforts).

• Some — but not all — U.S. courts have seemingly equated best efforts with mere reasonable efforts, contrary to what business people are likely to think they're getting in a best-efforts clause. As one 2005 review of case law puts it, "For years U.S. courts have used the phrases 'reasonable efforts' and 'best efforts' interchangeably within and between opinions. Where only one of the terms is used, the best-efforts obligation frequently appears indistinguishable from a reasonable-efforts obligation. Some recent cases have gone so far as to equate best efforts and reasonable efforts." See Scott-Macon Securities, Inc. v. Zoltek Cos., Nos. 04 Civ. 2124 (MBM), 04 Civ. 4896 (MBM), part II-C (S.D.N.Y. May 11, 2005) (citing cases).

(Some of those cases, though, might be interpreted more narrowly as holding merely that a best-efforts obligation does not require the obligated party to make unreasonable efforts, while still requiring diligence in the making of reasonable efforts.)

• Fortunately, still other U.S. courts seem to have recognized that best efforts means something more than merely reasonable efforts (such as the Delaware supreme court in its Williams Cos. opinion discussed at Section 22.20.8: above).

For example, the Third Circuit held that, at least where the contract involved an exclusive-dealing arrangement, "[t]he obligation of best efforts forces the buyer/reseller to consider the best interests of the seller and itself as if they were one firm." Tigg Corp. v. Dow Corning Corp., 962 F.2d 1119 (3d Cir. 1992).

Likewise, a Massachusetts appeals court construed the term best efforts "in the natural sense of the words as requiring that the party put its muscles to work to perform with full energy and fairness the relevant express promises and reasonable implications therefrom." Macksey v. Egan, 36 Mass. App. Ct. 463, 472, 633 N.E.2d 408 (1994) (reversing judgment on jury verdict that defendant had breached best-efforts obligation; extensive citations omitted).

Adding to the difficulty, some U.S. courts have held that the term best efforts is too vague to be enforceable unless the parties agree to some sort of objective standard of performance, "some kind of goal or guideline against which best efforts may be measured …." Kevin M. Ehringer Enterprises, Inc. v. McData Servs. Corp., 646 F.3d 321, 326 (5th Cir. 2011) (citation omitted).

One court held that "as promptly as practicable" and "in the most expeditious manner possible" were sufficient to meet that requirement. See Herrmann Holdings Ltd. v. Lucent Technologies Inc., 302 F.3d 552, 559-61 (5th Cir. 2002) (reversing dismissal under Rule 12(b)(6); citing cases).

22.20.10 Best efforts ≠ every conceivable effort

The Seventh Circuit has noted that "[w]e have found no cases, and none have been cited, holding that 'best efforts' means every conceivable effort …." Triple-A Baseball Club Assoc. v. Northeastern Baseball, Inc., 832 F.2d 214, 228 (7th Cir. 1987) (reversing district court holding), cited in California Pines Property Owners Ass'n. v. Pedotti, 206 Cal. App. 4th 384, 394, 41 Cal. Rptr. 3d 793 (2012) (affirming trial-court rejection of claim that party had failed to use best efforts).

Likewise, the First Circuit has held that best efforts "cannot mean everything possible under the sun[.]" Coady Corp. v. Toyota Motor Distributors, Inc., 361 F.3d 50, 59 (1st Cir. 2004) (affirming rejection of dealership's claim that Toyota distributor had failed to use best efforts; citation omitted), cited in California Pines Property Owners, 206 Cal. App. 4th at 394.

And a best-efforts obligation "does not require the promisor to ignore its own interests, spend itself into bankruptcy, or incur substantial losses to perform its contractual obligations." California Pines Property Owners, 206 Cal. App. 4th at 394 (citations omitted), citing Bloor v. Falstaff Brewing Corp., supra, 601 F.2d 609, 613-614 (2d Cir. 1979) (affirming judgment that party had failed to use best efforts).

22.20.11 "Every effort" clauses are often interpreted similarly

"When confronted with idiosyncratic contractual language expressing sentiments akin to doing all that one can or 'all that is necessary' to complete a task, Texas courts often interpret such language as requiring 'best efforts'–an expression with a more clearly established meaning and history." Hoffman v. L & M Arts, 774 F. Supp. 2d 826, 833 (N.D. Tex. 2011) (citing cases).

"[C]ourts and arbitrators interpreting similar phrases [the phrase in question was 'every effort'] have determined, like the district court here, that they impose an obligation to make all reasonable efforts to reach the identified end." Aeronautical Indus. Dist. Lodge 91 v. United Tech. Corp.., 230 F.3d 569, 578 (2d Cir. 2000) (citations omitted).

22.20.12 Asking for best efforts can make business sense

Sure, there's some legal uncertainty associated with a best-efforts commitment. But from a business perspective it can make good sense to ask the other side for such a commitment anyway: a party that makes a best-efforts commitment — to the extent that it later thinks about that commitment at all — will at least be aware that it might well have to make more than just routine, day-to-day, "reasonable" efforts. That alone might be worthwhile to the party asking for the commitment.

22.20.13 Agreeing to make best efforts could lead to trouble

If you commit to a best-efforts obligation, and the other side later accuses you of breaching that obligation, and you can't settle the dispute, then you're likely to have to try the case instead of being able to get rid of it on summary judgment. That's because:

•  No matter what you do, if a problem arises, the other side's lawyers and expert witness(es), with 20-20 hindsight, will argue that there were X number of things that you supposedly could have done to achieve the agreed goal but didn't, and so you necessarily failed to use "best" efforts, Q.E.D.

•  You're unlikely to be able to get summary judgment [TO DO: Link to discussion] that you didn't breach the best-efforts obligation. Instead, you're likely to have to go to the trouble and expense of a full trial or arbitration hearing. The judge or arbitrator could well say that the question involves disputed issues of material fact — those issues would have to be resolved by witness testimony and cross-examination about such things as industry practices; the then-existing conditions; etc. According to the rules of procedure in many jurisdictions, that will require a trial and will not be able to be done in a summary proceeding. Your motion for summary judgment is therefore likely to be denied.

•  The tribunal, after hearing the evidence, could find that in fact you did not use your best efforts. If that were to happen, you'd likely have a very hard time convincing an appeals court to overturn that finding.

22.20.14 Best-efforts takeaways

• Drafters should try very hard to be as precise as possible in specifying just what goal the best efforts are to be directed to achieving.

• Obligated parties should think long and hard before agreeing to a best-efforts obligation, because in the long run it could prove to be burdensome and expensive.

22.20.15 Optional: Further reading about best efforts

See also:

22.21 Binding Agreement Declaration

22.21.1 Opportunity to consider terms

By entering into the Contract, each party voluntarily acknowledges (see the definition in Clause 22.1) that:

  1. The acknowledging party had an opportunity to read and understand the Contract in its entirety,
    • including without limitation the Tango Terms provisions incorporated by reference into the Contract; and
  2. The acknowledging party had an opportunity to seek clarification of any provision that it did not understand.
Commentary

This language addresses the possibility that a party might try to get out of its contractual obligations, or to excuse its breach, by claiming that it was rushed into signing the contract.

22.21.2 Opportunity to consult counsel

By entering into the Contract, each party voluntarily acknowledges (see the definition in Clause 22.1) that:

  1. in deciding whether to enter into the Contract on the terms stated in it, the acknowledging party had an opportunity to consult licensed legal counsel of its choosing;
  2. if the acknowledging party did not consult such counsel, it made an informed, voluntary decision not to do so; and
  3. the acknowledging party has not relied, and will not rely, on advice from counsel for any other party.
Commentary

In a contract dispute, a party might claim that it misunderstood a contract provision and therefore shouldn't be bound by it. That usually won't be a winning argument — only rarely will unilateral mistake be enough to set aside a contractual obligation — but the argument can still be a time-waster.

So: The acknowledgement in subdivision 1 above states that the parties have had the opportunity to consult counsel — it does not say that the parties have been represented by counsel, because that might not be true for one or both parties.

This acknowledgement also refers to consultation with counsel when the parties were entering into their agreement, not to when they were negotiating the agreement (because there might not have been any negotiation).

In subdivision 3 above, the disclaimer of reliance on other parties' counsel can help shield each party's attorneys against later claims, by a disgruntled counterparty, to the effect of, wait, I thought you were my lawyer; you had a conflict of interest and didn't disclose it.

(It can be tempting for disgruntled counterparties to make such accusations: In malpractice lawsuits against attorneys, a standard tactic by plaintiffs' lawyers is to claim that the attorney accused of malpractice had an undisclosed conflict of interest — and that's a claim that's easier for nonlawyer jurors to understand, akin to They lied!)

22.21.3 Parties' intent

Each party acknowledges that it intends:

  1. that it will be bound by the Contract, except for provisions, if any, that the Contract clearly identifies as nonbinding;
  2. that each other party will rely on the acknowledging party's acknowledgements in this Declaration;
  3. that the Contract will bind not just the acknowledging party itself,
    • but also the acknowledging party's successors and (if any) permitted assigns,
    • as well as the acknowledging party's heirs and legal representatives, if the acknowledging party is an individual.
Commentary

Subdivision 1: For more on nonbinding provisions, see Tango Clause 22.97 - Letters of Intent and its commentary.

Subdivision 3: Concerning permitted assigns, see generally Tango Clause 22.11 - Assignment Consent and its commentary.

22.22 Blue Pencil Request

IF: A court or other tribunal of competent jurisdiction holds that a provision of the Contract is invalid, void, unenforceable, or otherwise defective;

THEN: The tribunal is respectfully requested (if a court or other governmental body), or directed (if an arbitral tribunal),

  • to reform the defective provision, if practicable,
  • to the minimum extent necessary to cure the defect,
  • while still given effect to the intent of the defective provision.
Commentary

A noncompetition covenant or other restrictive provision might contain a "blue-pencil" clause that says, in effect, to a judge: Your Honor, if you find that this restrictive covenant is unenforceable, then please modify it so that it is enforceable.

As an example, New York courts can engage in blue-penciling of restrictive covenants, as authorized by a landmark Court of Appeals decision, "if the employer demonstrates an absence of overreaching, coercive use of dominant bargaining power, or other anti-competitive misconduct, but has in good faith sought to protect a legitimate business interest, consistent with reasonable standards of fair dealing …." BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 395, 712 N.E