The Tango Terms

One lawyer's contract manual for helping business get things done together. For students and practitioners – with checklists; template clauses (including options and alternatives); and extensive annotations.
Version 2020B (beta); last revised 2020-08-24 16:29:18 CDT

Offered "AS IS"; not a substitute for legal advice.
A work in progress; see the Disclaimer.

Preface

This manual collects lessons learned in law practice and teaching contract drafting. It aspires to help law students, lawyers, and business people to do two things:

  • gain insight into some of the ways that companies commonly do their everyday business dealings; and
  • get readable, workable contracts to signature sooner.

Dedication: To the insightful (and ever-patient) Maretta Comfort Toedt.

1 Introduction: MathWhiz & Gigunda

1.1 For students: MathWhiz and Gigunda

For teaching purposes, this manual is organized in part around representing a hypothetical company that wants to do business with a larger company.

  1. Your (i.e., students') client will be "MathWhiz LLC" in Houston.
  2. MathWhiz is headed by Mary Marshall, an expert in analyzing seismic data to predict where oil or natural gas deposits might be.
  3. Mary "came up" in the industry working for major oil companies, then started her own company, MathWhiz.
  4. MathWhiz's business has grown; it now employs several junior analysts, and also selectively subcontracts work to others (usually, longtime friends or colleagues of Mary's) to carry out specialized tasks.
  5. The other party is "Gigunda Energy," a (hypothetical) global oil-and-gas company that's headquartered in California but has a significant campus in Houston:
  6. Gigunda Energy expects to collect seismic data, over a period of about a year, from a potential oil field in Outer Mongolia.
  7. As an initial engagement, Gigunda wants to hire Math-Whiz to analyze the seismic data that Gigunda expects to collect.
  8. Gigunda and Math-Whiz have discussed the likely amount of work that will be involved for this initial project.
  9. The parties have agreed that Gigunda will pay Math-Whiz a flat monthly fee of $20K for up to 200 staff hours of work per month.
  10. Additional work is to be billed at $150 per hour.
  11. A partner in your law firm has asked you to prepare a draft contract and to help MathWhiz and Gigunda negotiate it.

1.2 The contract as "deal manual"

Realistically, of course, most contracts stay buried in the (electronic) file drawer. The contracting parties either don't get into disputes in the first place, or they successfully resolve any disputes on their own.

So parties might ask: Why bother with a contract at all?

Prosaically: In the absence of a written contract, it might be that neither party would be able to go to court to enforce its rights under the parties' agreement. That might be fine with the parties if they have a high degree of mutual trust and each party accepts the risk that the other party might not honor its oral commitments.

But in addition, a written contract can and should serve as the "deal manual" for readers — the parties, and sometimes, for a judge, jury, or arbitration tribunal — who want to be able to look up just what the parties agreed to.

Any contract should answer the following questions for each party:

1.  "What are my obligations? That is: In particular circumstances, what must I do — or not do?"

2.  "What are my rights? That is: Again in particular circumstances —

  • "What am I free to do, or not do, whether or not the other party likes it?
  • "What may I expect — and even demand — that the other party do, or not do?

We'll look at this in more detail later.

1.3 Discussion questions

1.3.1 Ambiguity preview: Traffic signs

Ambiguous: See this sign.

More clear: This sign

1.3.2 Selling a used computer

FACTS:

1.  Let's assume you have an Aunt Jean who has no legal background. Aunt Jean wants to sell her used 2012 Macbook Air laptop computer (she wants to "move up" to a more-powerful machine).

Aunt Jean wants to get $350 for her machine (which at this writing is actually close to the going rate) and to sell the computer "as is."

2.  After Aunt Jean mentioned on Facebook that she wants to sell her computer, one of her high-school acquaintances, "Dale," contacted her and said he wants to buy the computer.

3.  Aunt Jean and Dale were never close in high school, and she hasn't seen Dale since graduation 50 years ago.

4.  Aunt Jean has asked you what to do to make sure she's "protected."

QUESTION 1: Is a written contract necessary? Explain your thinking.

QUESTION 2: Assuming Aunt Jean does want to have something in writing, what form could that writing take? (Be creative!)

1.3.3 Ambiguity preview: Nestle and Starbucks

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: Which company will sell which company's coffee —

  • Will Nestle sell Starbucks coffee? or
  • Will Starbucks sell Nestle coffee?

(Which do you think is more likely?)

EXERCISE: In your breakout rooms and the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), rewrite twice — once for each possible interpretation.

2 Drafting the start of the contract

An experienced contract drafter might start with a skeletal template (such as this one) that includes just the preamble and the signature blocks (and perhaps some general terms and conditions), into which the substantive terms and conditions can be copied and pasted. This Part discusses some useful practices for creating such a skeletal template.

(See also § 5.1 for tips on finding previous contract forms to harvest for languge ideas.)

Contents:

2.1 Title of the Agreement: Choose your style

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; perhaps you're doing a document review for a lawsuit or arbitration.

Conider the following styles of title:

Style 1 is simplicity itself but not especially informative:

Agreement

Style 2 is fairly typical for contracts:

Agreement and Plan of Merger

Style 3 is more informative but 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.

Ultimately it's the drafter's choice.

2.2 Drafting the preamble: Front-load 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. 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.

2.2.1 "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 § 6.8.)

2.2.2 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.

2.2.3 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.

2.2.4 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.

2.2.5 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).

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.

2.2.6 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.

2.2.7 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 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 § 2.2.8, 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.)

2.2.8 Caution: Backdating can be dangerous

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.

On the other hand: 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. 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).

2.2.9 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.

2.2.10 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. These are the general rules of corporate and contract law, but they come with exceptions, of course. …

We find no basis for holding Norvax liable for any alleged breach of the contract between Northbound and … the Norvax subsidiary.

2.2.11 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.

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.

2.2.12 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.

2.3 Drafting the background: No "Whereas"!

2.3.1 Use simple background recitals to tell the story

Instead of "Recitals," 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 § 2.3.6 below: 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:

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 § 7.1.

2.3.2 Use plain English

The modern trend is decidedly to use plain language in contracts, and also in just about any other kind of document you can imagine.

Contract drafters can take a leaf from Warren Buffett, who says the following in his preface to the SEC's Plain English Handbook:

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.”

2.3.3 A contract's background statements might be binding — or not

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."

2.3.4 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."

Drafting lesson: Be specific about what a party is:

  • allowed to do, or
  • prohibited from doing — in the Sprint case above, Sprint would have had better odds if its contract had explicitly said, "thou shalt not resell your phone." (Would such a restriction have been enforceable? That's a question beyond the scope of this discussion.)

2.3.5 Special topic: 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 Clause 20.3 (Reliance Disclaimer) for that purpose. Doing so can help to forestall at least some subsequent fraud claims.

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

Note: Like all purely-style tips: (1) this particular style tip isn't worth making a big deal about if you're reviewing a draft prepared by The Other Side, see § 5.9; and (2) if your supervising partner has a preference, then do it that way, see § 5.7.

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?

2.4 Dealing with 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.

Contents:

2.4.1 The benefits of "in-line" definitions

It's often convenient to include definitions "in-line" with the substantive provisions in which they are used; for example, see the definitions of Discloser and Recipient in Clause 16.1 (Confidential Information).

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.

2.4.2 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);
  1. in a separate exhibit or schedule (which can be handy if using the same definitions for multiple documents in a deal).

2.4.3 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.

2.4.4 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 ….

2.4.5 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.

2.4.6 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.

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.

2.5 Skim: Some past student "background" efforts

1.  A student 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 into a substantive section (e.g., concerning IP ownership).

2.  A student used "WHEREAS" several times.

DCT COMMENT: That's OK if the partner wants it, but it's archaic.

3.  A student described Mary as an "expert."

DCT COMMENT: If I were Mary, I wouldn't want that.

4.  A student wrote: "Analyst desires to be retained by Company, and Company desires to retain Analyst, to analyze or cause to be analyzed the seismic data of the OM Field in accordance with the terms and conditions of this Agreement."

DCT COMMENT: That seems superfluous: It's more or less self-evident, and it makes for one more paragraph for the reviewer(s) to have to read.

5.  A student included a section: "Concurrently with the execution and delivery of this Agreement, the Recipient and the Company are entering into a Service Agreement."

DCT COMMENT: No, the agreement we're drafting IS the service agreement.

6.  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.)

7.  A student wrote that "Gigunda will pay MathWhiz as stated in this Agreement."

DCT COMMENT: I think I'd leave that out — the payment provisions will speak for themselves, and it's not really needed for an "executive summary" (readers will assume that MathWhiz will be paid).

8.  A student writes: "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: As long as this is the only place that the specific compensation details are discussed (D.R.Y.), this would work, in the way that the lease details in the Stanford-Tesla lease (see § 2.6.4) are up front in the document.

9.  A student writes: "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, not into the Background section.

2.6 Exercises and discussion questions

2.6.1 Exercise: Draft a title

Draft a title for the Gigunda-MathWhiz agreement.

2.6.2 Questions: Titles

FACTS: Consider this title:

CONSULTING SERVICES AGREEMENT
Among Gigunda Energy and Math-Whiz LLC

QUESTION 1: What's less-than-ideal here?

For the title of a two-party agreement, I'd use "between" instead of "above."

ALTERNATIVE FACTS: Consider another possible title:

CONSULTANT SERVICES AGREEMENT
BETWEEN
GIGUNDA ENERGY,
a California [corporation]
(“Client”)
AND
MATH-WHIZ LLC,
a Texas limited liability company
(“Contractor”)

QUESTION 2: What's a potential concern here?

The title has a bit more information than needed for an index, and there's always the D.R.Y. concern.

STILL OTHER ALTERNATIVE FACTS: Consider another possible title:

SEISMIC DATA ANALYSIS SERVICE AGREEMENT
BY AND BETWEEN
GIGUNDA ENERGY
AND
MATH-WHIZ LLC

QUESTION 3: What could be improved here?

Two things:

  1. For such a long title, all-caps makes the title less readable.
  2. By and between" is perhaps overkill; I'd just say "between."

2.6.3 Exercise: Preamble and background section

In the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ), draft a preamble and background section for the Gigunda-MathWhiz agreement.

2.6.4 Discussion: Stanford-Tesla lease intro

Consider the following excerpt from

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

QUESTIONS FOR CLASS DISCUSSION:

1.  Is "Commercial Lease" the proper term, or should it be "Commercial Lease Agreement"?

"Commercial Lease" is appropriate — a lease is a contract that creates a leasehold interest. See Black's Law Dictionary, 10th ed.

2.  Why state that the Lease is entered into "as of July 25, 2007"?

A contract can state that it is effective as of an earlier- or later date if that's what the parties want. CAUTION: Signers should never backdate their signatures to make it appear that the contract was signed earlier- or later than it was; doing so sent a number of senior executives to prison.

3.  Why do you think the names of the parties are capitalized?

Party names are sometimes capitalized in a preamble so as to make them easy for a skimming reader to spot.

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?

Defining key "business" terms (e.g., "Base Rent") at the beginning of an agreement — and then consistently using those defined terms elsewhere in the agreement — makes it convenient for reviewers and safer for revisers, who need only revised the definitions.

5.  To what extent is the "Each item in this Article 1 incorporates …" worth including?

Including "Each item in this Article 1 incorporates …" is probably unnecessary.

6.  What could go wrong with the italicized portion, "to the extent there is any conflict …"?

Including the italicized portion, "to the extent there is any conflict …" is dangerous because it could lead to inconsistencies during revision of the draft during negotiation.

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 § 2.4.)

Defined terms and their definitions are typically set forth (i) in a separate section at the beginning of the agreement; (ii) in a separate section at the end of the agreement; and/or (iii) "in-line" at the place in the agreement that the defined term is principally used.

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

Both "Term: Five (5) years" and "Year One: $60,000 ($5,000 per month)" violate the "[BROKEN LINK: DRY]" (Don't Repeat Yourself) rule, which can cause major problems if the words are changed but not the numerals, or vice versa; the linked section tells the sad tale of a bank that lost $693,000 because of such a drafting screw-up.

3 Drafting the end of the contract

3.1 Signature blocks

3.1.1 Use a concluding paragraph? (No.)

Some contracts use an entire 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.

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 copy in your possession that bears 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 — even more so at the moment when the first signer affixes his (or her) signature.

But again: If you see this kind of language in a draft prepared by the other side, don't change it (as discussed in § 5.9).

3.1.2 Corporate- and LLC signature blocks

Here are examples of signature blocks 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

In the signature blocks above:

• It’s helpful to start out a signature block with the word "AGREED:" in all-caps and followed by a colon.

• Each organization’s signature block lists the organization’s 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 Clause 25.21 (Effective Date Definition).

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 the commentary at § 3.2.)

3.1.3 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

3.1.4 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 LLC, 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 …."

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.)

3.1.5 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 — and doing so in this way 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 in the commentary at § 2.2.8). 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.

3.1.6 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, in my view, 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."

3.2 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.

Contents:

3.2.1 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.

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.

3.2.2 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.

3.2.3 Apparent authority can save the day

A person with "apparent authority" can bind a company to a contract, unless a hypothetical reasonable person would have reason to suspect otherwise.

Suppose hypothetically that ABC Corporation's actions made it reasonable for others to assume that an individual "Alice" had authority to bind ABC (for example, by allowing Alice to use a title with terms such as "manager" or "executive").

And suppose also that Alice, purportedly on behalf of ABC, signed a contract with XYZ Inc. In that situation, ABC might be bound by the signed contract, even if in fact ABC had directed Alice not to sign it. That 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").

• The company's argument was that, under the company’s internal signature policies, the EVP did not have authority to sign a contract of that type.

• The company's argument didn’t fly — the district court granted, and the appeals court affirmed, partial summary judgment that the EVP did have at least apparent authority to sign the contract.

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.

3.2.4 The gold standard: A board resolution

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.

3.2.5 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.

3.2.6 Or, just take the risk?

The 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.
  • The MathWhiz executive said 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.

3.2.7 Special case: Who has authority to sign for an organization?

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.

3.2.8 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."

3.2.9 Counsel normally won’t want to sign contracts for clients

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:

  • From a client-relations perspective: If the contract later "goes south," the lawyer won’t want her signature on the contract.
  • 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).
  • If the lawyer’s signature is on the contract, it makes it more likely that the lawyer will be deposed as a fact witness in the event of a lawsuit or arbitration about the contract. This might lead to disqualification not only of the lawyer herself but also of her entire firm — and her litigation partners would not be happy about that. (This factor might not be important as a practical matter, though, because as a participant in the negotiations, the lawyer might well be deposed anyway as a fact witness.)

3.3 Exhibits, schedules, etc.

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

Contents:

3.3.1 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 (discussed in Clause 14.3.1) 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.

3.3.2 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.

3.3.3 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.

3.4 Notary certificates

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.

Contents:

3.4.1 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 appeared before the notary, presented sufficient identification, and acknowledged that the signer indeed signed the document. In many jurisdictions, the notary's signed certificate and official seal 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. Let's illustrate the process with a hypothetical example.

  • Suppose that "Alice" is selling her house. To do so, she will ordinarily sign a deed and give it 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, the world 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 is in fact Alice's signature and not a forgery?

The answer is that under the laws of most states, for Alice's deed to Bob even to be eligible for recording in the official records, the deed must include an acknowledgement certificate, signed by a notary public or other authorized official. The notary's certificate must state that Alice:

  • personally appeared before the notary (usually on a stated date);
  • produced sufficient identification to prove that she was indeed Alice; and
  • acknowledged to the notary that she had signed the deed.

If Alice signed the deed in a special capacity (e.g., as trustee of a trust or 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 depends on the jurisdiction).

Typically, the notary is also required to make an entry in a journal to serve as a permanent record.

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.

3.4.2 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.

3.4.3 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.

But see Tex. Civ. Prac. & Rem. Code § 121.002: That statute 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.

3.4.4 A flawed notarization can cause problems

Parties will want to double-check that the notary "does the needful" (it's an archaic expression, but I like it) to comply with any 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 on the agreement were authentic.
  • 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."

3.4.5 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.

(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.)

3.5 Put the signature blocks up front?

3.6 Exercises and discussion questions

3.6.1 Exercise: Signature blocks

Draft the signature blocks for the Gigunda-MathWhiz agreement.

3.6.2 Discussion questions: Backdating

In your groups, discuss: When (if ever) might it be appropriate to do the following:

  1. Appropriate to backdate the effective date of a contract
  2. INappropriate to backdate the effective date of a contract
  3. Appropriate to backdate the signers' signatures
  4. INappropriate to backdate the signers' signatures

3.6.3 Discussion questions: Notary certificates

1.  FACTS: Your client, Landlord, has negotiated a five-year commercial lease agreement 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.

2.  QUESTION: Why might the tenant's lawyer want the lease agreement to be notarized? Would that be in your client Landlord's best interest? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

3.  QUESTION: If the notary public can't find her notary seal, may she sign the notary certificate and skip applying the seal? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

4.  QUESTION: What must the notary public do before signing the notary certificate to confirm that the signers are who they claim to be? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

#+endaside

5.  QUESTION: Must the notary's certificate say anything in particular about the identity of the signer? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

7.  QUESTION: If no notary is around, can you notarize the signatures as an attorney? Should you? Explain, citing relevant statutory- and regulatory provisions, including the relevant subdivision(s) if any.

8.  QUESTION: 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, citing relevant statutory provisions, including the relevant subdivision(s) if any.

9.  QUESTION: Another document in the transaction must be signed and notarized by an individual who's in California. Is anything special required for the notary certificate? What downside risk does the notary have if the notary is asked to sign the certificate in the absence of the individual who's going to sign the document? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

10.  QUESTION: Who in Kuwait could "notarize" the signature? Explain, citing relevant statutory provisions, including the relevant subdivision(s) if any.

11.  QUESTION: Why "notarize" a document signature with an acknowledgement?

To make the document self-authenticating.

4 Contract-law basics: A brief refresher

4.1 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."

4.2 Even emails can form binding contracts

(See also the commentary about the E-SIGN Act and the Uniform Electronic Transactions Act in the electronic-signatures section of Clause 24.19 (Signatures).)

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 emails, their attachments, and the terms that they incorporate by reference, meet the necessary "content" requirements for contracts — these (usually) aren't an issue for everyday business agreements; and
  • the emails 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;
  • the sale of goods;
  • the sale of 88 rail freight cars;
  • a broker's commission for a real-estate transaction;
  • an employment agreement including nine months' severance pay in case of termination;
  • a compromise of a past-due bill for legal fees;
  • settlement of a lawsuit.

New York’s highest court upheld denial of a motion to dismiss a breach of contract claim because 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."

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.

4.3 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 showroom to the other. The seller backed out; the court had no difficulty holding that the parties had entered into an enforceable contract.

• In a federal-court lawsuit in Florida (decided under Delaware law), an IM exchange served as a binding agreement to modify an existing contract — and that agreed modification went on to cost one of the parties more than a million dollars.

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]."

4.4 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).

4.5 Reminder: Many oral contracts can be binding

There's an old 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.

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

  1. The contract cannot be of a type that, by law, must be in writing, as discussed in § 4.6; and
  2. The jury,* after hearing the witness testimony and weighing the evidence, must find that there was, in fact, an oral agreement.

Here's an example from a Texas case:

  • A small 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 jury believed the employee — the jurors didn't buy the company's claim that the employee had been told only that he might get a bonus.

And 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, as discussed in the additional commentary at § 23.2.2.

4.6 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 actually 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.

This 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 an exception applies.

The typical types of contract subjecto 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.

4.7 Important: Battle of the Forms

4.7.1 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 lot 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, our terms and conditions are the only ones that will apply — your terms won't count, no matter what you do.

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.

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.

In both cases, the "we reject your 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 ….

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.

4.7.2 Interlude: 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 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.

(Extra paragraphing and bullets added.)

Federal judge Richard Posner explained:

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 ….

To similar effect is the UCC definition's commentary, apparently reproduced in Nebraska Uniform Commercial Code § 2-104.

4.7.3 The UCC's solution to the Battle of the Forms: 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 § 4.7.2 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.

4.7.4 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."

4.7.5 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 examples:

• From a Honeywell purchase-order form (no longer available on-line) § 1: "This Purchase Order is deemed accepted upon the earlier of the return of the acknowledgment copy of this Purchase Order or the commencement of performance by Supplier."

• From a GE terms-of-sale document (no longer available on-line) § 1: " 'Contract' means either the contract agreement signed by both parties, or the purchase order signed by Buyer and accepted by Seller in writing, for the sale of Products or Services …."

• From Cisco purchase terms § 1: "Supplier's electronic acceptance, acknowledgement of this Purchase Order, or commencement of performance constitutes Supplier's acceptance of these terms and conditions."

4.7.6 A "master" agreement should prevail

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 ….

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."

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.

UPS claimed that its bill of lading limited its liability for damage to some $15,000. In contrast, the GE subsidiary claimed that the bill of lading was inapplicable, and that consequently 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.

4.7.7 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 an implied warranty of "reasonable" duration.
  • Clause 24.2 (Amendments Procedure)
  • Clause 24.7 (Entire Agreement)

4.8 Exercises and discussion questions

4.8.1 Exercise: Short-form contracts

FACTS: MathWhiz's and Gigunda's respective CEOs have met for dinner at a casual dining restaurant in Houston, with lots of little kids running around the place.

  • The restaurant's menus are inexpensive paper, printed in one corner with animal-drawing outlines that kids can color in.
  • The backs of the menus are blank.
  • Using a crayon, on the back of her menu, MathWhiz's CEO outlines a proposal for MathWhiz to do a project for Gigunda.
  • The proposal states, tersely:
    • just what MathWhiz will do for Gigunda;
    • when MathWhiz will deliver its work product; and
    • a price, payable upon delivery.
  • Gigunda's CEO says, "this is great!" He takes the crayon, writes "Agreed!" at the bottom of the proposasl, and signs and dates it.
  • MathWhiz's CEO does the same: She writes "Agreed!" and signs and dates the proposal.
  • Both CEOs use their phones to take a picture of the signed menu.

QUESTION 1: On these facts, have the parties created an enforceable contract? (Possible answers: Yes, No, Maybe.)

Yes.

QUESTION 2: Assuming that the answer to Question 1 is "yes," is the signed proposal a "verbal" agreement?

Yes.

4.8.2 Questions: Oral contracts

QUESTION 1: TRUE | FALSE | IT DEPENDS: Contrary to popular belief, an oral contract can be binding.

True; see § 4.5.

QUESTION 2: TRUE | FALSE | IT DEPENDS: Contrary to popular belief, an oral contract will generally be binding.

It depends; see § 4.5.

4.8.3 Exercise: Dealing with purchase-order terms

FACTS:

1.  You represent a supplier that has persuaded a large customer to place orders.

2.  The customer has its own purchase-order form  — which has lots of teeny-tiny fine print, stating the customer's terms and conditions, which are pretty onerous in favor of the customer.

QUESTION: What would you recommend that the supplier ask the customer to do, so as to avoid having to read the fine print every time the customer submits an order?

Negotiate a master agreement that will supersede the P.O. terms and conditions.

4.8.4 Exercise: Filling a purchase order

FACTS:

  1.  You get a call from a client that manufactures widgets. The client's sales people have just scored a very-big purchase order from a large customer.

2.  The customer's purchasing department (sometimes known as "sourcing") has asked the client to sign the P.O. and return it to the customer.

3.  The client wants to know: Should we sign the P.O. and return it to the customer?

QUESTION: What do you recommend?

1.  Ask the client whether they have a master agreement in place with that customer — and if not, suggest that they try to put one in place.

2.  Recommend to the client that they NOT sign the P.O. and instead just ship the product, ideally with the client's own terms of sale.

4.8.5 Exercise: Battle of the Forms

FACTS:

(A)  Seller regularly sells generic widgets. Buyer regularly buys widgets and incorporates them into, among other products, the pottery wheels that are manufactured and sold in Buyer's factory.

(B)  Buyer sends Sally Sales Rep a purchase order for 10,000 widgets at stated price- and delivery terms. Sally is delighted: Buyer's purchase order will help her make her sales quota for Seller's fiscal quarter.

(C)  The P.O. contains a lot of detailed fine print — including a provision in which the seller warrants that the seller's goods will be fit for the purpose for which Buyer's customers use Buyer's goods; the P.O. doesn't identify those goods and Seller doesn't know that Buyer has pottery wheels in mind.

(D)  On the front, the P.O. says, in big bold letters, that the seller must sign the P.O. and return it with the ordered goods; the P.O. also says (i) that shipment constitutes acceptance of the terms, and (ii) that Buyer rejects any additional or inconsistent terms in any sales confirmation or other document that Seller provides.

(E)  Sally sends a copy of the P.O. to Seller's fulfillment department and tells them to ship the 10,000 widgets as specified in the P.O., but Sally doesn't sign or return the P.O.; Seller invoices Buyer for the stated price.

QUESTION 1: Was a binding contract formed? Why or why not?

Answer: Yes: The P.O. was an offer that could be — and was — accepted by performance. (Hint: This is Contract Law 101.)

QUESTION 2: If a binding contract was formed, is the fit-for-Buyer's-customer's purpose warranty provision part of the contract? (Hint: This is Contract Law 101.)

Answer: Probably, for the same reason as above.

ALTERNATIVE FACTS: Seller doesn't ship the widgets, but instead sends back a "sales confirmation" form with Seller's own version of detailed fine print, including a conspicuous, legally-adequate disclaimer of all warranties, express and implied, AND a rejection of any additional or different terms. Buyer then cancels the order, which shocks and disappoints Seller.

QUESTION 3: Was a binding contract formed? Why or why not? If yes, is the fit-for-purpose warranty provision part of the contract? (Hint: This is Contract Law 101.)

Answer: No: This is a Battle-of-the-Forms situation; Seller's sales-confirmation form materially altered the terms, and the parties didn't conduct themselves in a manner that recognized the existence of a contract, so no contract. See UCC § 2-207.

ALTERNATIVE FACTS: Seller ships the widgets and includes with the shipment the sales confirmation form mentioned in the previous paragraph, but Seller does not sign or return the purchase order.

QUESTION 4: Was a binding contract formed? Why or why not? If yes, what are the warranty terms of the contract? (Hint: See Battle of the Forms.)

Answer: A contract hasn't been formed yet; it depends on whether Buyer accepts the widgets (and, possibly, on whether Buyer pays Seller's invoice). See UCC § 2-207.

ALTERNATIVE FACTS: Sally — whose title at Seller is "Account Manager" — signs and returns the purchase order to Buyer.

QUESTION 5: Was a binding contract formed? Why or why not? If yes, what are the warranty terms of the contract?

Answer: A contract has probably indeed been formed — although see the discussion of apparent authority at  § 3.2 — and the warranty terms are those in Buyer's P.O. form.

5 Special challenges in drafting contracts

5.1 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.

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.

5.2 A clean sheet of paper can be dangerous

[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;
    • as necessary, rewriting legalese to make it sound more like how you'd explain the concept to a 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.”

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.

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.

• 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?

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.)

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.

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 § 7.5.

5.3 The importance of drafting for future readers

The most important near-term readers of any contract are the parties' own business people, obviously.

On the other hand, the most important potential future reader might well be a judge or arbitrator, in case the parties get into a dispute that they can't resolve themselves by agreement.

For any reader, clear contract drafting is important, because the reader:

  • is almost certainly very busy;
  • might have little or no knowledge of the parties' specific area business; and
  • would definitely appreciate it if the contract quickly conveyed the answers to the above questions.

Clumsy drafting:

  • can slow up the non-drafting party's legal review and delay getting the contract to signature;
  • can make it very difficult for the judge, arbitrator, or other reader to figure out what the parties agreed to;
  • can increase the chances of an unforeseen result in litigation or arbitration.

So the drafters (and reviewers) of a contract can serve future readers — not least, the business people who must read the contract — by being as clear as possible about the above questions.

5.4 Your job is to educate, and sometimes to persuade

The author of a 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 people were computers, which do exactly as they're told: nothing more, nothing less. But:

  • People aren't computers.
  • Even in a corporation-to-corporation contract, it's people, not computers, who carry out obligations and exercise rights. (So-called "smart contracts" are a very-different thing.)
  • People's memories are often short and can sometimes be "creative"; this means that people sometimes need to be reminded of what they agreed to.
  • 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, they might have "forgotten" what mattered during the contract negotiations.
  • Let's not us 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 right and fair. Sometimes, the wording of the contract's terms can make a difference in how those future readers might perceive the parties' positions.

In sum: People sometimes need to be educated, and even persuaded, to do the things called for by a contract.

That is 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.

5.5 Keep in mind everyone's personal incentives

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."

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.

These desires can manifest themselves in a variety of ways; some of the clauses discussed in this manual can help to manage expectations.

5.6 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, complicated 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.

(For another example of contract shortening by a General Electric unit, see [BROKEN LINK: ge-slashed][BROKEN LINK: ge-slashed].)

Here's a personal example from years ago, not long after the 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.

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.

5.7 Your supervisor wins on style preference*

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 manual strongly recommends against doing so.

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.

5.8 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 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 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 different companies where he'd been a senior executive (two of which he founded).

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.

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. He would 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. We discussed the residuals clause and came up with a plan for him to approach his contact at the giant company to ask if that clause could be removed.

In this case I didn't follow up with an email to confirm the plan of action, but if I had, it would have been along the following lines:

[Name1] and [Name2], confirming part of our phone conversation just now: [Name1] is going to call [giant company] to find out if they'd be willing to remove the "residuals" clause from their draft NDA. If they're not willing to do that, then y'all can decide whether you're comfortable with the business risk of signing the NDA with the residuals clause still in it.

[Emphasis added]

Note how, in the first sentence, I left a paper trail for future litigation counsel, documenting the fact that we had a phone conversation, and when that conversation occurred.

Note also my use of the term "business risk."

In other circumstances, I might have said something like the following:

[Name1] and [Name2], 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]

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).

5.9 Tips for 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-Agrement-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's faintly insulting — 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. You, as a well-trained drafter, would prefer to have a simple background section without all the legalese (see § 2.3 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, in the manner shown in the template clauses of this manual and as explained in more detail at § 7.1.

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 never 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 that 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. A new vendor 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 payment in full in 90 days (see the explanation of "net days" in the commentary at § 13.12.1).

  • 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 not unwilling to pay net-30. You strongly suspect that the vendor's 90-day terms are a mistake, perhaps left over from a previous contract (i.e., the vendor's contract person took a previous contract and changed the names).

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

The vendor might later embarrasedly 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).

5.10 Exercises and discussion questions

5.10.1 Exercise: Selling a used computer (continued)

FACTS: Same as in § 1.3.2.

EXERCISE: Draft the simplest language you can think of to serve as the written contract.

QUESTION 3: What are some ways that you might get your mom and her high-school acquaintance to "sign" the contract?

5.10.2 Exercise: Finding contract forms online

QUESTION: What factors should you consider in deciding how much confidence to place in a real-world signed contract that you find online, e.g., on the SEC's EDGAR Website?

EXERCISE: Find one example of a limited-liability company "operating agreement" (a.k.a. "company agreement" in Texas).

EXERCISE: Find one example of a litigation settlement agreement.

See, e.g., the settlement agreement in a lawsuit over mortgage-backed securities between the Federal Home Loan Bank and Goldman Sachs, archived at https://perma.cc/9F44-8D92.

5.10.3 Discussion: What to send the other side

FACTS: MathWhiz has asked you to draft a confidentiality agreement to send to another party.

QUESTION: Should you send the other party:
A.  A PDF document, unlocked
B.   A Microsoft Word document, unlocked
C.  A Microsoft Word document, locked into "Track Changes" mode
D.  A PDF document, locked to prevent changes

Answer: B.

5.10.4 Discussion: A bad contract provision

FACTS: For your client MathWhiz, you're reviewing a contract drafted by Gigunda. MathWhiz doesn't have much bargaining power and would really like to see this contract signed. You see a provision that outrages you.

QUESTION: What should be your first action?

A.  Delete the provision.

B.  Try to put yourself in Gigunda's shoes and ask what problem they were trying to solve.

C:  Revise the provision to make it acceptable to MathWhiz.

D.  Accept the provision and advise MathWhiz about it — in writing.

Answer: B

5.10.5 Discussion: Incentives

QUESTION: What are some examples of individuals' personal incentives that could affect the negotiation, and/or the performance, of a contract?

Here are a couple of examples:

1.  A sales person might be eager to get a deal closed in order to make quota or qualify to go on a "club trip" (an all-expenses-paid group vacation to a very-nice place, with families, for sales people who have sold 100% of their quotas).

2.  A successor to a person who originally put a deal in place might want to kill that deal and make a new deal with someone else — perhaps on better terms, perhaps with someone with whom she'd prefer to do business.

6 Ambiguity and its dangers

Ambiguity gets its own chapter in this manual because 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.

Contents:

6.1 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.

There might well be a lot of money riding on the outcome of the ambiguity dispute. For example: In a much-cited case, the Texas supreme court restated the rules about ambiguity in a case about oil-and-gas leases — and in that case, the losing party ultimately missed out recovering the roughly $44 million that it had claimed it was owed under the contract in suit.

Here's what the supreme court had to say about ambiguity in that case:

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.

In other words, if a contract is ambiguous, then the trial judge is not allowed to resolve the ambiguity him- or herself in a comparatively-simple summary judgment proceeding — instead, 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.

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.

Spotting and fixing ambiguities in a contract before signature should be a prime goal of all contract drafters and reviewers.

6.2 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.

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, of 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?

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 December 15 as the agreed move-in date.

6.3 How do courts "construe" ambiguous terms?

Here's a quick recap of some basic principles of "construing," that is, interpreting, contracts:

• 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.

(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.

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,

  • harmonizing 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.

6.4 Do courts apply any specific rules of interpretation?

[Note to students: Skim these; you won't be tested on them.]

Courts often look to specific rules of interpretation such as:

• Specific terms normally take precedence over the general.

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

• 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."

• The rule of the last antecedent can be illustrated with an 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.

• But see the series-qualifier principle: Dissenting in Lockhart, 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."

• Other things being equal, under the contra proferentem principle, discussed at Clause 23.7 (Contra Proferentem Disclaimer), ambiguous provisions will often be construed against the drafting party.

But 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, an extremely-useful general principle of contract drafting is, W.I.D.D. – When In Doubt, Define!

6.5 A dispute about ambiguity can have lots of money riding on it

We saw in § 6.1 how a dispute about ambiguity had millions of dollars riding on it. 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.

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.

6.6 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.

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.

– 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 § 9.6.2. 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 § 5.8): 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 § 6.6) might be more important.

6.7 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.

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 (see the definition in Clause 25.41).

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.

6.8 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.

(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.

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 as discussed in [BROKEN LINK: ambig-yours][BROKEN LINK: ambig-yours].)

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

Bob will pay Alice one hundred thousand dollars ($100,000.00) $100,000 for the House, with 50% due upon signing of this Agreement.

Sometimes, though, repetition can be used (cautiously) to emphasize a point — after all, the drafter's mission is still to educate and persuade (see § 5.4), not merely to slavishly follow drafting guidelines.

6.9 Vagueness example: The "false imperative"

Passive voice is often disfavored, but it's not necessarily a serious error — unless the passive-voice provision leaves it unclear who must do what.

(Think of 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.)

As a business 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 an 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!

Drafting lesson: Even when passive voice is appropriate, a contract provision should not leave any doubt about who is responsible for making Item X happen.

6.10 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).

6.11 Exercises and discussion questions

6.11.1 Exercise: Selling a house

TEXT: Alice will sell the house at 1234 Main Street to Bob. … [and later in the document:] Alice will not alter the house at 1234 Main Street before the Closing.

EXERCISE: Rewrite.

Alice will sell the house at 1234 Main Street (the "House") to Bob. … Alice will not alter the House before the Closing.

6.11.2 Ambiguity: Lola, by The Kinks

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
Lo lo lo lo Lohhh-lahhh. Lo lo lo lo Lohhh-lahhhh

(Emphasis added.)

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.)

6.11.3 Ambiguity: Successful men

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 a different (and possibly-offensive) interpretation of this quote?

That successful men are in a better position to choose great women to have in their lives?

6.11.4 Passive voice and pest control

FACTS: An apartment lease states (in part): "The apartment shall be regularly serviced by a professional pest-control service."

QUESTION: This is an example of what? (Two words, not "passive voice.")

Answer: False imperative

6.11.5 Ambiguity: Plush carpets

From an article in The Guardian:

There will be plush lecture theatres with thick carpet, perhaps named after companies or personal donors.

QUESTION: What, exactly, is named after companies or personal donors?

QUESTION: How could this sentence be rewritten to clarify it?

Rewritten: There will be plush lecture theatres (with thick carpet), perhaps named after companies or personal donors.

Not quite as good: There will be plush lecture theatres — with thick carpet — perhaps named after companies or personal donors.

7 Drafting for readability

7.1 Draft short, single-topic paragraphs (don't be a L.O.A.D.)

You might decide you can't draft clauses in bullet-point format as suggested in § 7.5). But still, you can avoid dense, "wall of words" legalese — 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 short, and (ii) should address a single topic. That's because, other things being equal, 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;
  • 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;
  • are easier to revise if necessary during negotiation;
  • reduce the temptation for the other side's reviewer to tweak more language than necessary — and that's a good thing, because language tweaks take time to negotiate, which in turn causes business people to get impatient and to blame "Legal" for delaying yet another done deal.

So don't be a L.O.A.D. (a Lazy Or Arrogant Drafter): If a sentence or paragraph starts running long, seriously consider breaking it up.

To illustrate the point, consider the following 415-word "wall of words" sentence (!) illustrates the point — it covers not one, not two, but five separate topics (and note the abomination of "provided that"):

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.

(Bold-faced emphasis added.) To repeat: The above paragraph is a single sentence.

7.2 Create defined terms to help shorten sentences

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

Exclusivity.

See subdivision (h) for definitions.

(a) During the Exclusivity Period, Seller:

      (i) will not engage in any Off-Limits Activity, and

      (ii) will cause each other member of the Seller Group not to engage in any Off-Limits Activity.

[DCT comment: This subdivision is an example of BLUF — Bottom Line Up Front — as explained at § 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.

[Other provisions 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.

[Other provisions omitted]

7.3 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.

7.4 White space is your friend

The 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. It had been my 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 feels it received the benefit of its bargain and would be willing to do business with the other side again.)

7.5 Bullet-point clauses are 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:

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? 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.
  • No counterparty or its counsel has ever objected to the bullet points.
  • The parties have always gone on to sign the bullet-points version, not the other side's original wall-of-words version.

7.6 The BLUF Rule: 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.

Before:

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.

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]

(Emphasis added.)

7.7 Omit needless words — but remember  your mission

"Omit needless words" is a famous quotation from Strunk & White's The Elements of Style. Here are some examples of possibly-needless words, from the SEC's Plain English Handbook (slightly edited):

  • in order to : to
  • in the event that : if
  • subsequent to : after
  • prior to : before
  • despite the fact that : although
  • because of the fact that : because; since
  • in light of : ditto
  • owing to the fact that : ditto

But remember your mission: To educate, and possibly persuade, readers (see § 5.4). That’s why it can sometimes be helpful to (judiciously) record reasons and explanations in a contract, to educate later readers about why the negotiators agreed to certain things.

Brevity in a contract is a virtue, to be sure. But it's far from the only one — or even the most important one. Sometimes a few words of explanation or clarification (possibly in footnotes) can be cheap insurance.

7.8 Exercises and discussion questions

7.8.1 Discussion: White space and bullet points

QUESTION 1: What's your opinion about lots of white space in a contract?

QUESTION 2: What's your opinion about using bullet points in contract?

7.8.2 Discussion: The BLUF Rule

QUESTION: What does BLUF stand for — and why is it significant? (Hint: See § 7.6.)

7.8.3 Exercise: Rewriting the 415-word L.O.A.D

Using the principles explained above, just break up the 415-word provision at § 7.1.

(For an idea how to get started, see § 7.2.)

7.8.4 Review: When style preferences clash

FACTS:

• Your client MathWhiz asks you to review a draft contract sent by a potential customer of MathWhiz.

• You notice that the draft spells out all kinds of numbers, e.g., "twenty thousand dollars."

• The draft doesn't also include the corresponding numerals in parentheses, i.e., it doesn't say "twenty thousand dollars ($20,000.00)."

QUESTION: When reviewing and revising the draft contract, do you change "twenty thousand dollars" to "$20,000.00"?

No, that's a purely-stylistic revision — it's not a great idea to spend "negotiating chips" on that kind of change.

8 General writing rules

Contract-drafting students should learn — even memorize — the rules in this chapter.

Contents:

8.1 Style guide for numbers

This section sets out some stylistic conventions that lawyers typically follow in drafting contracts.

1.  Spell out the numbers one through ten; use numerals for 11, 12, 13, etc.

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.

6.  Don't say "in United States dollars" if there's no possibility of confusion.

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.

8.2 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 policeman told us to observe the speed limit and we should dim to dim our lights.

8.3 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.

8.4 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. [DCT comment: The original USAF sentence said “… may be inappropriate,” but it’s better to stick with “might be” — use "may" for permission, "might" for possibility.]

8.5 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.

8.6 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?)

8.7 "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.

8.8 Microsoft Word: Crucial things to know

[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.

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.

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.)

8.9 Exercises and discussion questions

8.9.1 Discussion: Considering the issue

FACTS: One of the "After" examples in § 8.5 is "They met to consider the issue." A fellow student suggests that this sentence could be streamlined even further, to say simply: They considered the issue.

QUESTION: Would this further simplification be a good idea? What information would be lost, and why might that information be important?

The fact of the meeting might be legally significant; this could be the case, for example, in a court's assessment of whether a corporation's board of directors had given sufficient consideration to an issue to qualify for the business-judgment rule that courts generally will decline to second-guess a board's decision about a business matter if it appears that the board used due care to make an informed decision.

8.9.2 Discussion: Broken parts

TEXT: The part must have been broken by the handlers.

DISCUSS: Any issues here?

This is passive voice, but if it's more important to state by whom the part was broken, it might be OK.

8.9.3 Headings in Word documents

In Microsoft Word, how do you indicate that particular text is a heading?

Use a Heading style.

8.9.4 May and might

Of the words may and might:

  • Which is used to express possibility?
  • Which is used to express permission?

Use may for permission, might for possibility.

9 Drafting workable contracts

9.1 Offer balanced terms (and get to signature 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 (warning: crude). If that's you, then the Tango Terms aren't the terms you're looking for.

9.2 You don't want a "wounded tiger" later

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.

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 that 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.

For example, in a Sixth Circuit case:

  • A software customer did a corporate reorganization that resulted in the use of the licensed software being technically switched to an affiliate that wasn't covered by the original license grant.
  • The software vendor demanded that the customer re-buy the license; when the customer refused, the vendor took the customer to court, and won.

So: After treating its customer that way, what are the odds that the 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 ….

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.

9.3 Danger: Too-harsh terms 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.

Kingston Trio Stereo Concert album cover

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.

Example: Trump Corporation's lease terms. 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 lease agreements, changed the names, and used it for a deal in which Trump was the tenant and not the landlord.

Trump Organization logo

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."

Ouch ….

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.

Tilly's logo
  • 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.
  • The signed acknowledgement, though, 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.

Example: A one-way NDA later leaves a party unprotected. With a one-way nondisclosure agreement, only the (original) 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's confidentiality agreement with the defendant protected only the defendant's information; consequently, the plaintiff's afterthought disclosures of its own confidential information were unprotected.

9.4 Try risk‑by‑risk limitations of liability

Limitation-of-liability provisions usually rank at or near the top of the annual surveys done by the International Association for Contract and Commercial Management concerning the most-frequently-negotiated contract terms.

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.

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.

9.5 Negotiate variable limitations of liability?

Exclusions of consequential damages and damage-cap amounts 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.

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;
  • 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.

9.6 Drafting for difficult counterparties

It's inevitable: Every contract drafter (and reviewer) comes up against a counterpart for The Other Side who is implacable and maybe even just plain unreasonable. This chapter 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.

Contents:

9.6.1 Offer the guard dog some "hamburger"

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 agreement.

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:

  • Your notion that the other side's reviewer won't notice the absence of an audit clause omission is likely to be wishful thinking; the other 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.

9.6.2 Be careful about "kicking 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.

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.

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.

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.

9.6.3 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.

9.6.3.1 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.

9.6.3.2 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.

9.6.3.3 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.

9.6.3.4 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.

9.6.3.5 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.)

9.6.3.6 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.

9.6.3.7 Explain why the demanding party loses?

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.

9.6.3.8 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.

9.6.3.9 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.

9.6.4 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.
  • In any case, their agreement to use your contract form, in their minds, will be a concession on their part, meaning that you now 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.

9.7 Exercises and discussion questions

9.7.1 Discussion: Benefits of balanced terms

DISCUSS: What are some pros and cons of drafting a contract with balanced terms?

9.7.2 Discussion: Chief advantage of short paragraphs

Section  7.1 lists several advantages of drafting contracts with short, single-topic paragraphs. QUESTION: Which do you think are the most important? (This could be based on your own experience at work, for example.)

9.7.3 Exercise: Rewriting Rigel's wall of words

Try just breaking up the following into separate paragraphs. (It's from a Collaborative Research and License Agreement between Pfizer and Rigel Pharmaceuticals.)

9.2.12 PATENTS AND TRADEMARKS. To the best of its knowledge (but without having conducted any special investigation), Rigel owns or possesses sufficient legal rights to all patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, and proprietary rights and processes (including technology currently licensed from Stanford University) necessary for its business as now conducted and as proposed to be conducted without any conflict with, or infringement of the rights of, others. Rigel currently licenses certain technology from Stanford University (the "Licensed Technology") on an "as is" basis, with no representation or warranty from Stanford University that such technology does not infringe the proprietary rights of others. To Rigel's knowledge, Rigel has not, as of the date hereof, received any claims from any third party alleging that the use of the Licensed Technology infringes the proprietary rights of such party. Except for agreements with its own employees or consultants and standard end-user license agreements, there are no outstanding options, licenses, or agreements of any kind relating to the foregoing, nor is Rigel bound by or a party to any options, licenses, or agreements of any kind with respect to the patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, and proprietary rights and processes of any other person or entity, other than the license agreements with Janssen Pharmaceutica N.V., Stanford University, SUNY, and BASF. Rigel has not received any communications alleging that Rigel has violated or, by conducting its business as proposed, would violate any of the patents, trademarks, service marks, trade names, copyrights, trade secrets, or other proprietary rights or processes of any other person or entity. Rigel is not aware that any of its employees is obligated under any contract (including licenses, covenants, or commitments of any nature) or other agreement, or subject to any judgment, decree, or order of any court or administrative agency, that would interfere with the use of such employee's best efforts to promote the interests of Rigel or that would conflict with Rigel's business as proposed to be conducted. Neither the execution nor delivery of this Agreement, nor the carrying on of Rigel's business by the employees of Rigel, nor the conduct of Rigel's business as proposed, will, to the best of Rigel's knowledge, conflict with or result in a breach of the terms, conditions, or provisions of, or constitute a default under, any contract, covenant, or instrument under which any of such employees is now obligated. Rigel is not aware of any violation by a third party of any of Rigel's patents, licenses, trademarks, service marks, tradenames, copyrights, trade secrets or other proprietary rights.

Here's how I might rewrite the Rigel representations and warranties below, with selected revisions "redlined": [DCT to show on his computer]

Here it is again without the redlines: [DCT to show on his computer]

9.7.4 Exercise: Streamlining a termination clause

Rewrite the following provision from this license agreement, following the guidelines in this section (don't mess with the substance):

12. TERMINATION

If the royalties due hereunder have not been paid within the time allowed by this Licence Agreement or if either party shall breach of any of the representations, warranties, covenants, promises or undertakings herein contained and on its part to be performed or observed and shall not have remedied such breach within thirty (30) days after notice is given to the breaching party by the non-breaching party requiring such remedy or if either party shall have an Examiner appointed over the whole or any part of its assets or an order is made or a resolution passed for winding up of such party unless such order is part of a scheme for reconstruction or amalgamation of such party then the other party may forthwith terminate this Licence Agreement without being required to give any or any further notice in advance of such termination but such termination shall be without prejudice to the remedy of such party to sue for and recover any royalties then due and to pursue any remedy in respect of any previous breach of any of the covenants or agreements contained in this Licence Agreement.

10 Drafting for possible litigation

Very, very few contracts end up in litigation. But drafting for litigation anyway —

  • signals The Other Side that you're not a clueless newbie; and
  • can come in handy if the parties get into a dispute.

10.1 Draft the preamble to help out trial counsel

See § 2.2, "Drafting the preamble: Front-load useful information."

10.2 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. See § 24.20.

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.

For example, a software-development 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 the lead software developer assigned to 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.)

Escalation of disputes to higher management: Some lawyers believe that a dispute-escalation requirement can increase the chance of an amicable settlement. Getting different, more-senior people involved in the dispute can sometimes bypass individual animosities, hidden personal agendas, and other foibles; this can help break an impasse. See § 23.16.

Early neutral evaluation: When a legal dispute arises, the parties' lawyers can some­times tell their clients what they think the clients want to hear. (In part this may be because lawyers — especially male lawyers — tend to be overly optimistic about whether they're going to win their cases.) That can hamper getting disputes settled and the parties back to their business (if that's possible). Consequently, if a contract dispute starts to get serious, an early, non-binding "sanity check" from a knowledgeable neutral can help the parties and lawyers get back onto a more-productive track before positions harden and relationships suffer — not to mention before the legal bills start to mount up. See § 23.21.

Mini-trial of disputes to parties' senior management: Mini-trials, in which the parties' lawyers put on a one- to two-hour "trial" to senior executives of the parties (and perhaps a neutral facilitator), are thought to enhance the prospect of settling disputes. (The head of litigation for a global services corporation told me that this was his favorite tool of dispute resolution.) See § 23.23.

10.3 Remember the burden of proof in 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.

Olstowski and ATOM could have provided expert testimony to show how the use of krypton-chloride is so unique to their device as to make it an integral part of their protected trade secret as opposed to a generic concept of physics, which is unprotected. They did not. The two witnesses they did call merely testified that Petroleum Analyzer’s MultiTek used krypton-chloride, a fact Petroleum Analyzer does not contest.

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. On this record, we cannot say that the district court’s finding of fact was clearly erroneous.

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.

10.4 Litigation prep: Include "demonstrative exhibits"?

[Note to students: Just skim this section; you won't be tested on it.]

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 judge decides that a particular demonstrative aid should not be given to the jury for use in its deliberations, it's usually the end of that discussion.

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.

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.)

10.5 Note-taking during negotiations: Easy habits your lawyer will love

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 lawyer 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.

10.6 Exercises and discussion questions

10.6.1 Discussion: Burden of proof

Think of a contract-related situation in which careful drafting could make a difference for your client as to who has the burden of proof of a particular fact.

10.6.2 Discussion: Note-taking

Based on your own personal experience — however limited you might think that is — which do you think is the most important tip on note-taking?

10.6.3 Discussion: Terms to promote settlement

Based on your own personal experience — however limited you might think that is — do you think it's actually realistic to include contract terms to try to promote settlement?

11 Getting to signature sooner

11.1 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. This can speed up review and editing.

(For an example, see the first part of the 2007 real-estate lease between Stanford University (the landlord) and Tesla Motors (the tenant), reproduced at § 2.6.4.)

11.2 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. 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.

11.3 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?

11.4 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.

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 — it would have saved them a lot of money in attorneys' fees alone, and possibly helped them win a case against the borrowers.

– The case involved a group of borrowers affiliated with franchisees of restaurants such as Burger King and Chili's; these borrowers had negotiated $49 million dollars' worth of corporate promissory notes.

– During the negotiations, the borrowers asked for a change in the lender's standard definition of "Prepayment Penalty." The quoted term ended up being defined in a certain way in all 34 promissory notes.

– But in practice the definition led to an absurd result (the prepayment penalty would always be zero).

The appeals court reversed a summary judgment in favor of the lender and directed the district court to conduct a trial to determine what the parties really meant — watch the lawyers' meters run.

And in the end, the borrowers prevailed because the court adopted their interpretation of the language, not the lender's interpretation, as being closer to the pin as far as what the parties had in mind.

Worth noting: The court specifically mentioned calculations that the lender had submitted with its motion for summary judgment. It's a shame the promissory-note drafters didn't think to include one or two such calculations in the body of the contract itself — by being forced to work through the calculations, the drafters and their client(s) might well have spotted the problem with the language in time to do something about it.

11.5 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 the same. Future readers – your client's successor, your client's trial counsel, a judge – might thank you for it.

11.6 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 set the other side's expectations, and increase the odds that you'll eventually get more of what you want; and
  • you get a batch of potential sleeves-from-your-vest concessions that you can use for horse-trading.

Certainly there are transactions in which it makes at least some sense to do this.

And for 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.

And 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.

11.7 Combat Barbie: Consider using "distractor" terms

Military people learn early that when preparing for inspection, you don't want to make everything perfect. The inspector will keep looking until he (or she) finds something — because if he doesn't find anything, his superior might wonder whether he 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, and can go away happy.

Illustrating the point: A British lawyer, who had graduated from Sandhurst, the UK equivalent of West Point, once told a story in an online forum:

  • A female first-year cadet did a good job of squaring away her bunk and gear for inspection — and then she put a "Combat Barbie" doll on her bunk.
Combat Barbie
Photo: Pinterest
  • Of course the inspectors immediately noticed Combat Barbie — and they used up their entire alloted time for the cadet's inspection in yelling at her about the unmilitary appearance of the doll. Otherwise, the inspectors might have, shall we say, "found fault with" the cadet's bunk, gear, etc.
  • The inspectors then moved on, without having wreaked the havoc that they might otherwise have done.

This same "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 (explained in § 13.12.1), and be prepared to agree immediately to net-30 days if asked. But don't specify net-five days, which in many situations would risk branding you as unrealistic about "how things are done."

11.8 Redline and explain all changes during negotiation

Most contract professionals know that:

  • When revising documents sent over by the other side, all changes should be redlined or otherwise flagged.
  • On a case-by-case basis, it can also be helpful to explain, in comments — for example, in Microsoft Word comment bubbles — the reasoning behind changes, to save time in negotiation conference calls.

Pro tip: As a "canary in the coal mine" clause, consider including, in the general-provisions section, a representation by each party that the party has redlined all changes it has made to the agreement documents (see Clause 24.18). If the other side objects to including such a representation in the contract, you can ask some pointed questions as to why they object.

(The other side might say, in effect, we don't mind re-reading the entire document before we sign it. You can then point out to your client that the other side obviously doesn't mind wasting not only their money, but the client's, on unnecessary legal fees.)

11.9 Exercises and discussion questions

11.9.1 Discussion: Combat Barbie

What do you think about the lesson of the "Combat Barbie" story?

11.9.2 Discussion: Hardball negotiation

Talk about the pros and cons of playing hardball in contract negotiations.

11.9.3 Discussion: Footnotes in contracts

Have you ever seen footnotes in a contract draft? What did you think?

12 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.]

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; this is often paraphrased as "no plan survives first contact with the enemy."

Contents:

12.1 "Learn the business!" OK, fine — 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.

12.2 T O P   S P I N: Identifying threats and opportunities

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;

• N: Nature, which can cause all kinds of threats and opportunities to arise in a contract relationship.

h-diagram

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).

12.3 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.

12.4 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).

12.5 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.

12.6 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.

12.7 Stephen Colbert proves the benefits of thinking ahead

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
Stephen Colbert

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."

12.8 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."

13 Payments

13.1 Deposits

13.1.1 How are deposits to be applied?

Any deposits and other advance payments provided under the Contract — if any —

  • are to be applied to amounts due under invoices issued in connection with the Contract.

13.1.2 What is to be done with any remaining balance?

Any remaining balance of a deposit

  • is to be promptly refunded
  • upon the conclusion of the parties' dealings under the Contract,
  • or as otherwise stated in the Contract.

13.1.3 Will deposits bear interest?

No.

13.2 Drawbacks

  1. This Clause will govern whenever an order for deliverables is submitted by a party ("Customer") and accepted by another party ("Supplier"),
    • if some or all the deliverables are eligible for one or more "Special Benefits,"
    • namely the following:
      • special status under a free trade agreement;
      • drawbacks; and/or
      • any similar industrial benefit from a governmental authority.
  2. At no extra charge, Supplier is to provide Customer with:
    • all paperwork reasonably requested by Customer,
      • such as certificates of origin and the like,
      • to help Customer to claim the Special Benefit,
      • where Supplier can provide the paperwork without undue burden or expense; and
    • all cooperation that Customer reasonably requests in connection with Customer's efforts to obtain the Special Benefit.
Commentary

This Clause draws on ideas seen in § 2.4 of a Honeywell purchase-order form archived at https://perma.cc/CUV6-NKTY.

A "drawback" is, according to one explanation, "[a] partial refund of an import fee. Refund usually results because goods are re-exported from the country that collected the fee." Supply Chain Glossary (scm-portal.net).

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13.3 Expense Reimbursement Protocol

13.3.1 Terminology: Paying party; incurring party

This Clause will govern when, under the Contract, a party (the "paying party") is to reimburse another party (the "incurring party") for specified expenses.

13.3.2 Must either party reimburse the other's expenses?

  1. In case of doubt, each party is responsible for its own expenses relating to the Contract,
    • except to the extent (if any) that the Contract clearly states otherwise.
  2. The incurring party may seek reimbursement for a particular expense only if:
    • the expense is of a type eligible for reimbursement under the Contract;
    • the incurring party actually incurred the expense; and
    • the expense is reasonable in amount.

13.3.3 May reimbursable expenses be marked up?

An incurring party may not mark up expenses for reimbursement,

  • unless the paying party has clearly agreed otherwise in writing.
Commentary

Many contracts prohibit marking up of expenses, but some contracts are "cost-plus."

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13.3.4 Must expense receipts be submitted?

Yes: The incurring party must provide the paying party

  • with complete and accurate copies of receipts to support each requested reimbursement,
  • unless the paying party clearly says otherwise in writing (e.g., for small expenses).

13.3.5 May a paying party require compliance with a reimbursement policy?

Yes: All requests for reimbursement must comply

  • with any commercially reasonable (as defined in Clause 25.14) written reimbursement policy,
  • that the paying party provides to the incurring party from time to time,
  • as long as the paying party provides each such policy:
  1. in a manner reasonably calculated to let the incurring party know about the policy's requirements; and
  2. a reasonable time before the incurring party —
    • incurs an expense that is subject to the reimbursement policy,
    • or otherwise become obligated to pay that expense.
Commentary

Customers' various expense-reimbursement policies are sometimes an administrative pain for providers, but they're often a practical necessity, especially for large corporate customers that by law must comply with internal-controls requirements.

A customer might or might not want to impose a specific written-reimbursement policy at the time of contracting, but it definitely might that flexibility for the future without having to renegotiate the Contract.

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13.3.6 Option: Direct Billing of Expenses

  1. If this Clause is agreed to,
    • it applies if the Contract clearly states that an incurring party may — or must — arrange for specified individual expenses to be billed directly to the paying party.
  2. The paying party must timely pay any such direct-billed expense.
  3. Otherwise, the incurring party is not to have expenses billed directly to the paying party.
Commentary

Direct billing might be appropriate if, as a matter of prudent cash-flow management, a service provider or other contract party would like for its customer to "front" significant reimbursable expenses.

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13.3.7 Option: Preclearance Requirement

An incurring party will not be eligible for reimbursement of any individual expense of more than FILL IN AMOUNT unless the incurring party consults with the paying party about the expense before the incurring party commits to incurring the expense.

13.3.8 Option: Expense-Flagging Requirement

In each invoice for reimbursement, the incurring party must suitably flag any submitted expense as to which the paying party might reasonably disagree that the expense is eligible for reimbursement.

Commentary

This section is modeled on a clause that the present author saw in a contract form reviewed on behalf of a client.

Caution: A party incurring expenses probably wouldn't want to agree to this option. A paying party could easily claim that the incurring party failed to give the paying party a "heads up" about a particular expense; that could give the paying party an excuse to withhold reimbursement.

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13.4 Factoring (commentary to come)

Please check back later …

Weil Gotshal article about factoring, securitization, asset-based lending

13.5 Guaranties

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract (which may be a standalone guaranty agreement),

  • a party ("Guarantor")
  • guarantees a payment obligation (a "Guaranteed Payment Obligation")
    • that is owed to another party ("Creditor")
    • by a third party ("Payer")
  • under an agreement (the "Guaranteed Agreement").

The Guarantor's obligation is referred to as the "Guaranty."

Discussion checklist:

Commentary

This Clause covers only payment obligations, because guaranties of performance of other types of obligation (for example, an obligation to perform consulting services, repair work, building construction, etc.) might well require considerably-more negotiation and customized language.

Spelling: In U.S. law, the terms "guaranty" and "guarantee" are usually associated with a third party's commitment to make good on a party's failure to comply with an obligation. Traditionally, "guaranty" is the noun, while "guarantee" is the verb.

Guaranteed Payment Obligation: Drafters will want to be careful to define whose payment obligations are being guaranteed; a creditor's aggressive position on this issue can lead to litigation.

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13.5.1 What is guaranteed: Payment? Or collection?

Payment is guaranteed unless the Guaranty clearly says otherwise, as follows:

  1. Each Guarantor guarantees, to each Creditor,
    • to the extent of that Creditor's rights under the Guaranteed Payment Obligation.
    • the full payment, by each Payer, when due, of the Guaranteed Payment Obligation.
  2. For this purpose, it does not matter:
    • how or when the Guaranteed Payment Obligation in question previously came to exist, is coming to exist now, or comes to exist in the future,
      • including, without limitation, by acceleration or otherwise;
    • nor whether the Guaranteed Payment Obligation is direct or indirect, absolute or contingent.
Commentary

Some of this language is informed by the terms of the guaranty in suit in a Seventh Circuit case.

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13.5.2 What Creditor efforts are required if payment is guaranteed?

If the Guaranty is of payment, then Creditor's only obligation is to demand payment, as follows:

  1. Each Guarantor must honor its Guaranty obligations:
    • within five business days after any Creditor asks — in writing — that the Guarantor do so,
    • following a failure by the Payer to comply with the relevant Guaranteed Payment Obligation,
    • and after expiration of any relevant cure period for that failure.
  2. The Creditor is not required to first attempt to collect a judgment against the Payer or the Guarantor,
    • nor need the Creditor first attempt to foreclose on any lien, security interest, or other collateral securing the Guaranteed Payment Obligation.
Commentary

Many guaranties are guaranties of payment, of the kind set out in subdivision a.

NOTE: Under Texas law, the guarantor would have the right to demand that the creditor, "without delay," file a lawsuit against the debtor, failing which the guarantor would not be liable for the guaranteed payment obligation. Subdivision c, however, presumably would waive that guarantor protection.

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13.5.3 What Creditor efforts are required if collection is guaranteed?

If the Guaranty is of collection, then the Guaranty may not be enforced,

  • against any Guarantor,
  • as to any Guaranteed Payment Obligation,
  • until the Creditor has obtained,
    • in a court or other forum of competent jurisdiction,
  • a final judgment against the Payer,
    • from which no further appeal is taken or possible,
  • that enforces — in whole or in part — that Guaranteed Payment Obligation,
  • and the Creditor has been unable to collect the judgment from the Payer,
    • after diligently making reasonable efforts to do so.
Commentary

Creditors will typically object to getting a guaranty only of collection, because they normally want to be able to go after guarantors immediately to get their money, as opposed to incurring the delay, burden, expense, and uncertainty of first having to file suit against their debtors.

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13.5.4 What if Creditor is partially successful in collecting?

The Creditor may not double-dip: If the Creditor is able to collect part of the Guaranteed Payment Obligation,

  • then the amount of the Guaranty will be automatically reduced to that extent.

13.5.5 Are Guarantors jointly and severally liable?

Yes: Multiple Guarantors of a Guaranteed Payment Obligation are jointly and severally liable for any unpaid amounts of that obligation.

Commentary

It's a really good idea for drafters (and reviewers) to be clear about the extent to which multiple guarantors are to be jointly and severally liable for different Guaranteed Payment Obligation(s).

In a given transaction, for example, Alice might guarantee the obligations of Alan, and Bob might guarantee the obligations of Betty, but not vice versa — that is, Alice does not guarantee Betty's obligations nor does Bob guarantee Alan's obligations.

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13.5.6 Will obligation-modification negate the Guaranty?

Yes: If the Guaranteed Payment Obligation is modified in any material respect,

  • then Guarantor will no longer be obligated under the Guaranty,
  • unless Guarantor has given its written consent to the modification.
Commentary

The general rule — which typically is strictly applied by courts — is that "a guarantor is discharged if, without his or her consent, the contract of guaranty is materially altered."

Alternative: "An amendment to or modification of a Guaranteed Payment Obligation does not discharge or otherwise affect Guarantor's obligation under the Guaranty for that Guaranteed Payment Obligation." Comment: For an example of clause language like this, see Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 25 N.Y.3d 485, 488, 36 N.E.3d 80, 15 N.Y.S.3d 277 (2015).

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13.5.7 Is Guarantor's liability capped?

No: Each Guarantor's liability for a Guaranteed Payment Obligation is limited only by the amount of that obligation

  • unless the Contract clearly states otherwise.
Commentary

This is a placeholder and reminder — drafters would presumably go into more detail to cap a guarantor's liability.

In some transactions, a cap on guarantor liability might be a possible negotiation point.

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13.5.8 What law will govern the Guaranty?

The Guaranty is to be interpreted and enforced,

  • and any dispute arising out of or relating to the Guaranty is to be decided,
  • under the law specified in the Contract (see Clause 23.15 (Governing Law)),
  • or if none, by the law that governs the interpretation and enforceability of the Contract.
Commentary

In a complex- or sophisticated transaction, a guaranty might provide that, say, New York law governs the guaranty, even if some other state's law governs the rest of the transaction — or vice versa.

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13.5.9 Where may a Guaranty be enforced?

  1. If it becomes necessary for any Creditor to enforce the Guaranty against any Guarantor
    • in respect of that Creditor's rights under the Guaranteed Payment Obligation,
    • then that Creditor may do so,
    • in any forum having jurisdiction over that Guarantor,
    • without regard to where that Guarantor happens to be domiciled or otherwise located.
  2. In case of doubt, a Guarantor's agreement to a particular forum
    • is not intended as that Guarantor's submission to the general jurisdiction of the forum.
Commentary

Subdivision a allows any Creditor to enforce the Guaranty. This language is included because loans are often packaged and sold to different parties that collect payments (sometimes being "sliced and diced" in the process); the language allows a guaranty to be transferred to the original lender's successors and assigns as part of the "collateral" for the loan.

A specific, permissive forum-selection provision much like this one, allowing a guaranty to be enforced in the courts of Indiana, was readily upheld by the Seventh Circuit in the Knauf Insulation case, even though the guarantors purportedly did not have "minimum contacts" with the state of Indiana; the appeals court remarked that because of the forum-selection clause, the guarantors "didn't have to have any contacts" with that forum.

But if a Guarantor had bargaining power, it might insist that it could be sued under the Guaranty only in a particular jurisdiction, e.g., the Guarantor's home jurisdiction.

Many corporate-finance instruments specify that a guarantor can be sued in New York City, so that successive assignees of the right to payment will know that they can bring suit in that city (probably using their regular law firm(s)), no matter where the guarantor happens to be located.

Subdivision b: Disclaiming submission to general jurisdiction of a forum might be important to some parties.

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13.5.10 Must Creditors sign or accept the Guaranty?

No: In case of doubt, each Guarantor WAIVES (as defined in Clause 24.26):

  1. acceptance of the Guaranty by the Creditor(s);
  2. notice of such acceptance; and
  3. signature of the Guaranty by the Creditor(s).
Commentary

Many guaranties include waiver-of-acceptance and waiver-of-signature language. True, such language might very well merely duplicate applicable law. But it can't hurt to be explicit and thus try to avoid the issue.

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13.5.11 Are Guarantors liable for deficiency after foreclosure?

Yes: In case of doubt: if foreclosure on collateral (if any) does not produce enough money to pay the Guaranteed Payment Obligation or other obligations under the Guaranty,

  • then Guarantor will be liable for any remaining amount to the fullest extent permitted by applicable law,
  • even if the Payer's own liability for such a deficiency were to be wholly- or partly discharged by the foreclosure under a statute or judicial decision.
Commentary

This collateral-deficiency language is relatively common — and makes intuitive sense: Suppose that:

  • a creditor forecloses on collateral but the proceeds aren't enough to pay the debt; and
  • the creditor is not allowed to demand that a guarantor make up the shortfall.

In that situation, the guaranty might not be worth much, if anything.

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13.5.12 Who must pay enforcement expenses?

If a Creditor must take action to enforce the Guaranty against any Guarantor,

  • then that Guarantor must pay or reimburse that Creditor
  • for any court costs and other reasonable expenses —
  • including but not limited to attorney fees —
  • that the Creditor incurs in enforcing the Creditor's rights against Guarantor under the Guaranty.
    • and/or the Guaranteed Payment Obligation in question against the Payer.
Commentary

Expense-shifting language similar to that of this section was used in the guaranty in Eagerton v. Vision Bank, 99 So. 3d 299, 305 (Ala. 2012).

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13.5.13 What is the consideration for the Guaranty?

Each Guarantor is undertaking its obligations under the Guaranty in consideration of each Creditor's entry into the Guaranteed Agreement.

Commentary

The recital of consideration is included because without such a recital (and possibly even with one), a court might hold a guaranty to be unenforceable. EXAMPLE: In a Massachusetts case:

  • A company's bookkeeper signed an order for ad space in a Yellow Pages phone book.
  • Unhappily for the bookkeeper, she didn't read the fine print, which contained a statement that she personally guaranteed payment.
  • A court held that she was not liable on the guaranty, because she had received no consideration for it — although the result would have been different, the court said, had the bookkeeper been an owner, investor, or principal who signed the order.

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13.5.14 Must Guarantors reimburse bankruptcy refunds?

Yes —

  1. This section applies if a Creditor:
    1. makes a refund (as defined below) of a payment made by a Payer on a Guaranteed Payment Obligation,
    2. because of a requirement of bankruptcy law; fraudulent-transfer law; or comparable law; or
    3. makes a partial refund of such a payment in settlement of a claim for a larger refund.
  2. In any such case, Guarantor must reimburse the Creditor for:
    1. the amount of the refund or partial refund; and
    2. the Creditor's attorney fees associated with the refund or partial refund, if any.
  3. For purposes of this provision, the term refund includes without limitation any payments made by the Creditor to third parties, for example to a trustee in bankruptcy, a debtor-in-possession, or a receiver.
Commentary

If a principal of a Guaranteed Payment Obligation were to file for bankruptcy protection (under U.S. law), then creditors might be forced to return any payments that were made by the principal within the 90 days preceding the bankruptcy filing date. Such payments are known as "avoidable preferences."

"Courts have uniformly held that a payment of a debt that is later set aside as an avoidable preference does not discharge a guarantor of its obligation to repay that debt."

A creditor in bankruptcy does have the right to contest its obligation to refund an avoidable preference. That can be difficult, though, because the creditor must successfully jump through some hoops to prove that it was entitled to the payment.

As a practical matter, many avoidable-preference cases are settled, with the creditor making a partial refund in lieu of incurring the expense of jumping through those proof hoops. In such a situation, if the original obligation had been guaranteed, then the creditor likely would want to try to recoup the partial refund from the guarantor.

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13.5.15 Do Guarantors certify their financial information?

Yes: Each Guarantor represents and warrants,

  • to each Creditor,
  • and to that Creditor's successors and assigns, if any,
  • that the credit-related information that Guarantor has provided in connection with the Guaranty (if any),
  • is complete, up to date, and accurate,
  • except to the extent (if any) that the Guarantor has timely and expressly disclosed otherwise to the Creditor in writing.
Commentary

This certification would provide creditors with at least some anti-fraud assurance, to supplement their own financial due diligence on guarantors.

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13.5.16 May Creditor's successors take advantage of the Guaranty?

Yes: Creditor's successors and assigns are intended third-party beneficiaries of the Guaranty

  • unless the Guaranty itself clearly says otherwise.
Commentary

See generally Clause 21.3 (Third-Party Beneficiary Disclaimer).

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13.5.17 Option: Financial Statement Updates

  1. No later than 45 days after the end of each calendar quarter,
    • each, a calendar period unless otherwise specified,
    • each Guarantor will provide each Creditor with a copy of Guarantor's financial statement for that period (the "updated financial statement").
  2. Guarantor will be deemed to have represented and warranted the accuracy of the updated financial statement,
    • to the same extent and in the same manner as the financial information originally provided by Guarantor.
Commentary

Financial-statement updates would give Creditors at least some ongoing comfort that Guarantor(s) continue to have the wherewithal to back up their Guaranty commitments.

Drafters should consider what "Plan B" provisions to include in a guaranty in case a Guarantor's financial position slips below acceptable levels. [TO DO: Research Plan B provisions]

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13.5.18 Option: Standard for Guarantor Financial Statements

Each set of financial statements that Guarantor provides to Creditors

  • must be prepared in accordance with the disclosure requirements applicable to guarantors of guaranteed debt under the U.S. securities laws.
Commentary

Concerning standards for guarantor financial statements, see generally, e.g., Michael H. Friedman, Public Offerings of Guaranteed Debt and the SEC's Proposed Rule Changes (PepperLaw.com 2018), which discusses Rule 3-10(a)(1) of Regulation S-X.

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13.5.19 Option: Audit Requirement for Guarantor Financials

  1. The year-end financial statements that Guarantor provides to Creditors must be audited,
    • and such quarterly financial statements must be reviewed,
    • by an independent public accounting firm.
  2. For each such audit and review,
    • Guarantor must promptly provide each Creditor
    • with a complete and accurate copy of the accounting firm's report.
Commentary

Subdivision b — wording choice: In the author's view, requiring the copy of the auditor's report to be complete and accurate is far better than the pretentious legalese phrase true and correct; the latter:

  • is arguably redundant, and
  • arguably doesn't go far enough.

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13.5.20 Option: Guarantor Waiver of Defenses

Guarantor's obligations under the Guaranty are absolute, unconditional, direct and primary —

  1. any claim or defense that Guarantor's obligations under the Guaranty are allegedly illegal, invalid, void, or otherwise unenforceable;
  2. any claim or defense pertaining to any Guaranteed Payment Obligation, other than the defense of discharge by full performance —
    • this includes, without limitation, any defense of waiver, release, statute of limitations, res judicata, statute of frauds, fraud, incapacity, minority, usury, illegality, invalidity, voidness, or other unenforceability
    • that may be available to the Payer or any other person who might be liable in respect of any Guaranteed Payment Obligation;
  3. any setoff available to the Payer or any other such person liable, whether or not on account of a related transaction;
  4. all rights and defenses arising out of an election of remedies by a Creditor,

    • such as, for example (as defined in Clause 25.23), a nonjudicial foreclosure with respect to security for a Guaranteed Payment Obligation,
    • even if that election of remedies resulted in impairment or destruction of Guarantor's rights of subrogation and/or reimbursement against the Payer; and
  5. any other circumstance that might otherwise give rise to a defense available to, or a discharge of, either the Payer or Guarantor.
Commentary

The "absolute, unconditional" language makes for a strong guaranty; at least in some jurisdictions, such a guaranty is likely to be enforced even in what might seem like unfair circumstances — such as collusion between the Creditor and the Payer.

The waiver-of-defenses language is in part adapted from California Civil Code § 2856(c) and (d).

The use of all-caps type for WAIVES is for conspicuousness; see generally the discussion at Clause 26.2 (Conspicuousness (commentary)).

Subdivisions 2-4: Some of the listed items are based on those of the respective guaranties in two litigated cases.

Subdivision 3: In guaranties, "setoff" language like this is not uncommon; see, e.g., the guaranty in suit in a Texas case.

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13.6 Hollywood accounting (commentary)

[TO DO]

13.7 Income Tax Responsibility

As between the parties to the Contract,

  • each party is solely responsible for all taxes on that party's income arising from or relating to the Contract.

13.8 Interest Charges

  1. A payee may invoice Payer for, and Payer must pay, interest on any past-due amount,
    • at the specified rate, or the maximum rate allowed by law, if less,
    • beginning on the first day after the due date,
    • and continuing (on remaining unpaid amounts only) until the past-due amount is paid in full.
  2. Clause 13.20 (Usury Savings) is incorporated by reference.
Commentary

Caution: Vendors sometimes add interest charges to invoices; doing so without the customer's prior agreement can result in the charge being usurious.

Note that even invoicing for excess interest might constitute usury — and, in some circumstances and jurisdictions, that could result in forfeiture of the entire amount owed; see the commentary to Clause 13.20 (Usury Savings).

Pro tip: Is it worth arguing over an interest clause? Whether a payee will actually charge and try to collect interest is a real question. For example, suppliers sometimes hesitate to charge interest to their customers, even if their contracts permit them to do. Some large customers have been known to announce, imperiously: We don't pay interest, period.

(On the other hand, some customers can be notoriously slow payers, insisting on as high as 120-day terms from their suppliers.)

So, when a drafter's client will be the payee of interest payments, it's worth considering whether it's even worthwhile to push for an interest provision.

Interest start date: The usury laws in some jurisdictions might prohibit charging interest before a specified time.

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Review: Interest rate

QUESTION (with Zoom poll): What if anything is wrong with this provision? (Assume that the payment terms are adequately specified elsewhere.)

Past-due amounts will bear interest at 5% per month, compounded monthly, beginning on the day after the due date until paid.

13.9 Invoicing

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract,

  • a specified party (a "payee")
  • wants to be paid one or more specified amounts
  • by another party (a "Payer").

Discussion checklist:

13.9.1 Are invoices required for payment?

Probably: A party desiring to be paid payee must send Payer an invoice for the amount(s) due,

Commentary

A paying party will almost invariably want to receive an invoice before paying an amount alleged to be due.

(Paying parties might even be legally required to do so as part of their internal financial controls to help detect and prevent fraud.)

Pro tip: a party submitting an invoice might want to confirm the current address to which the invoice should be sent. Otherwise, the invoice be lost in the other party's internal correspondence routing system. (With the rise of electronic invoicing- and payment systems, this provision might become less relevant.)

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13.9.2 What information must be included in invoices?

To aid Payer's compliance with its internal financial controls obligations,

  • each invoice must include such information as Payer reasonably requests in writing.

(See also the sales-tax itemization requirement in Clause 13.16 (Sales Tax Responsibility).)

Commentary

Invoices should be detailed enough to permit the paying party to exercise any audit rights it might have under an agreement. Some companies want invoices to include information such as, for example:

  • a purchase-order number;
  • a supplier identification code;
  • a contract identifier;
  • part numbers;
  • quantities;
  • units of measure;
  • hours billed;
  • unit- and total prices;
  • export- and safety-related information.

For very-detailed invoicing requirements, see section 13 of a Honeywell purchase order at https://perma.cc/84BS-KYXB.

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13.9.3 What language are invoices to be written in?

Each invoice must be written:

  • in the language in which the Contract is written;
  • and, if required by law, in the official language of the destination country.

13.9.4 Must any particular invoice charges be itemized?

In each invoice, separate itemization is required for any charges for:

  • shipping and/or delivery,
  • insurance,
  • and any taxes that the Contract requires or allows to be billed to the Payer.
Commentary

See also Clause 13.16 (Sales Tax Responsibility).

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13.9.5 When must invoices be sent?

  1. If the payee and Payer have agreed in writing to a schedule for invoices to be sent,
    • for example, in the Contract or a statement of work,
    • then that agreement will control.
  2. Otherwise, the payee is to send invoices only when the payee's applicable performance being invoiced has been completed
    • for example, upon delivery of goods or completion of services.
  3. If a payee and Payer agree in writing to an invoicing deadline,
    • and Payer receives an invoice from the payee after that deadline,
    • then it will be up to Payer's sole discretion (as defined in Clause 25.19) to decide when — and whether — to pay the invoice.
Commentary

Invoicing schedules are often a subject covered in construction- and other services agreements, where the service provider wants to be paid as work is done, as opposed to waiting to be paid until the work is 100% complete.

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13.10 Payment Disputes

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when a paying party ("Payer") believes that an invoice (or other request for payment) contains errors.

Discussion checklist:

See also Clause 13.9 (Invoicing).

13.10.1 What must Payer do to dispute an amount due, and when?

  1. Payer must advise the payee in writing that it is disputing the amount due,
    • specifying in reasonable detail why Payer believes the request for payment is in error,
    • no later than five business days before the putative payment due date.
  2. If the payee so requests,
    • Payer must provide the payee with reasonable written documentation to support Payer's position.
  3. Payer must pay any undisputed amounts on or before the original putative payment due date;
    • this subdivision, however, does not in itself excuse Payer's obligation to timely pay the disputed amount(s).
  4. If the payee provides Payer with information satisfactorily demonstrating
    • that some or all of the disputed charge(s) are in fact correct,
    • then Payer must pay those correct charges on or before the original putative due date.
Commentary

Paying parties should timely challenge incorrect invoices, because in some jurisdictions, if a party pays an incorrect invoice without protest, the paying party might not be able to recover its overpayment.

As one court in New York explained:

The common-law voluntary payment doctrine bars recovery of payments made with full knowledge of the facts, and in the absence of fraud or mistake of material fact or law. Where a party pays overcharges without protest or inquiry, was not acting under a mistake of fact, and the overpayment was the result of the party's lack of diligence, the payments are deemed voluntary and cannot be recovered.

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13.10.2 What must the payee do if Payer disputes an amount due?

If Payer so requests in writing,

  • the payee must promptly issue Payer:
  • a refundable credit for any amount
  • that both Payer and the payee agree was incorrectly charged,
  • and, if so requested, one or more appropriate replacement invoices for any remaining balance(s).

13.10.3 What if the parties can't agree about the disputed amount?

If the parties are unable to resolve the payment disagreement at the working level,

  • then the disagreement must be addressed in accordance with Clause 23.9 (Dispute Management Protocol).

13.11 Payment Security

Commentary

This Clause draws on ideas seen in § 2.2 of a General Electric terms-of-sale document archived at https://perma.cc/8LRL-PFL3.

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13.11.1 Is there a deadline for setting up payment security?

  1. Payer must establish,
    • and must keep in force as set forth in this Clause,
    • payment security that meets any and all requirements that are:
      • stated in this Clause, and/or
      • otherwise agreed to in writing,
  2. Payer must provide Supplier
    • with confirmation that the payment security has been established
    • no later than five business days
    • after the parties' agreement to the order that requires payment security.

13.11.2 How long must payment security be kept in place?

Payer must keep the payment security in effect for at least three months after the latest to occur of the following:

  1. the last scheduled shipment of ordered goods, if any;
  2. completion of all ordered services, if any; and
  3. Supplier's receipt of the final payment required under the order.

13.11.3 Who will pay the costs of payment security?

Payer must bear all costs and expenses associated with establishing and maintaining the payment security.

13.11.4 Must Payer ever modify its payment security?

  1. Payer must modify the payment security, upon written request by Supplier, if:
    • in Supplier's reasonable judgment, modification of the payment security is appropriate in view of the circumstances,
    • including, without limitation,
      • Payer's payment history, and
      • other facts that Supplier reasonably deems relevant to Payer's ability and/or willingness to pay.
  2. A modification required under subdivision a could include, without limitation, one or more of the following:
    • an increase in the amount of the payment security;
    • an extension of the term of the payment security;
    • changing to another Bank; and/or
    • any other appropriate modifications to the payment security reasonably requested by Supplier.
  3. Payer must make the requested modification(s) no later than ten business days after receiving (or refusing) Supplier's written request.

13.11.5 Must Supplier perform without acceptable payment security?

  1. Supplier need not begin its performance under an order,
    • nor continue such performance, if already begun,
    • until Supplier has received the fully effective payment security,
    • and/or any required modified payment security,
    • as required by this Clause and/or the applicable order.
  2. All deadlines for Supplier performance will be automatically extended accordingly
    • in any case coming within subdivision a.

13.11.6 What forms of payment security are acceptable?

All payment security under this Clause:

  1. must be in the form of:
    • an irrevocable, unconditional, sight letter of credit or bank guarantee,
    • on terms reasonably acceptable to Supplier; and
  2. must be issued (or confirmed) by a financial institution
    • that is reasonably acceptable to Supplier (the "Bank").
Commentary

"A sight letter of credit is a document that verifies the payment of goods or services, payable once it is presented along with the necessary documents. An organization offering a sight letter of credit commits itself to paying the agreed amount of funds provided the provisions of the letter of credit are met."

13.11.7 What payment types must payment security cover?

The payment security must provide for payments by the Bank to Supplier as follows:

  1. pro-rata payments:
    • for goods as they are shipped,
    • and for services as they are performed,
    • as applicable to the relevant order;
  2. payment of any cancellation- or termination charges under the order; and
  3. payment of any other amount due from Payer in connection with the order.

13.11.8 Will failure to keep payment security in place be a material breach?

Any failure by Customer to timely provide, maintain, and/or update, the required fully effective payment security,

13.12 Payment Terms

13.12.1 When are payments due?

Payer must pay each amount due net 30 days

  • after the date of Payer's receipt of the invoice (or other request for payment).
Commentary
"Net 30 days"

"Net X days" means that payment in full is to be received by the payee no later than X days after the stated date.

Comment: It's not unheard of for customers to want to wait a long time before paying their suppliers. Net 45 and even net 60 are generally considered within the band of reasonableness. But some customers demand net 90 and even net 120 days.

Other due dates

Alternative: "Invoice payments are due net 30 days from the date of the invoice." Payees sometimes want this alternative, but paying parties generally push back because they need (or want) more time to process invoices.

Alternative: "Invoice payments are due 2% 10 days, net 30 days …" means that the paying party may deduct 2% as a discount for payment in full within 10 days, but payment in full is due in any case within 30 days.

13.12.2 What payment methods are acceptable?

  1. Payments under the Contract may be made by any reasonable means.
  2. A payment method is to be conclusively deemed acceptable
    • if the payee does not reasonably and seasonably (as defined in Clause 25.49) object to the payment method
    • after being advised of the proposed form of payment
    • or after receiving a payment using the payment method.
Commentary

Some widely-used payment methods include the following:

• Check: See Investopedia at https://goo.gl/19C7Rv . The check could be required to be drawn on a U.S. bank, or on a specified bank, or on any bank to which the payee does not reasonably object in writing.

Importantly, when an ordinary check is written, the money stays in the payer's account until the check is "presented" to the payer's bank for payment. (These days this is almost always done electronically if the payee uses a different bank.)

Caution: If the payer files for U.S. bankruptcy protection before the check clears, then the check might never clear; see the bankruptcy discussion in section [XXX].

• Automated clearing house ("ACH") electronic debit transaction in lieu of a check: See Investopedia at https://goo.gl/1P9EQa;

Certified check: See Investopedia at https://goo.gl/aVLbsE: a certified check (see above) is written by the payer and drawn on the payer's account, but the bank guarantees to the payee that the bank has put a hold on the payer's account for the amount of the check, meaning that the check should not bounce.

With a certified check, the money stays in the payer's account until the check clears --- this means that the same bankruptcy issues exist as for regular checks.

Caution: Certified checks can be counterfeited, in which case the bank might not have to pay, and if the payee cashes the check, the payee might have to refund the money.

Cashier's check: See Investopedia at https://goo.gl/EZ7Vec. a cashier's check is written by the bank itself, not by the payer. When writing the check, the bank transfers the stated amount of money from the payer's account to the bank's own account. (Note the difference between this and a certified check, discussed above.) The Contract might specify what bank, or what type of bank, is to be used.

Caution: Cashier's checks can be counterfeited.

• Wire transfer (Investopedia at https://goo.gl/t6kisl) to give the payee "immediately-available funds" that can be immediately withdrawn and spent (Investopedia at https://goo.gl/51Ai5A).

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13.12.3 May Payer offset amounts owed to it?

  1. If Payer owes money to a payee under the Contract,
    • and the payee also owes money to Payer, whether under the Contract or otherwise,
    • then Payer may not reduce its payment to the payee
    • unless the Contract clearly states otherwise.
  2. If Payer does offset against a payment obligation as permitted by the Contract, then:
    • 1. Payer must not reduce the payment by more than the amount that the payee owes to Payer; and
    • 2. no later than the due date of Payer's payment, Payer must:
      • advise the payee in writing that Payer is taking an offset; and
      • provide the payee with a reasonable written explanation of each offset, together with reasonable supporting documentation.
Commentary

A payee might be reluctant to agree to allow payment offsets, because the payee might be depending on Payer's timely payment for the cash flow that the payee needs to run its business. Moreover, offsets could lead to difficulties in tracking invoice payments.

Caution: Apparently in some jurisdictions (e.g. France), an automatic right of offset might not be enforceable, according to a LinkedIn commenter (see http://goo.gl/aWpjDv; membership required).

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13.12.4 In what order are payments to be applied to obligations?

The payee may apply Payer's payments:

  • first to accrued interest (if any),
  • then to unpaid principal,

in each case in the order in which Payer's payment obligations were incurred (that is, oldest-first).

Commentary

Provisions of this kind are often seen in promissory notes. This language is adapted from a suggestion in David Cook, The Interest Tail Wags the Profit Dog, in Business Law News Issue No. 3, 2014 (State Bar of California Business Law Section; available on-line to Section members).

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13.12.5 Will payment diminish Payer's other rights?

  1. If Payer pays some or all of an amount invoiced (or otherwise charged) under the Contract,
    • that fact will not diminish any rights that Payer might have concerning the subject matter of the payment,
    • whether under the Contract or by law,
    • unless Payer expressly agrees otherwise in writing.
  2. Payer's rights referred to in subdivision a include, without limitation, any warranty rights concerning goods delivered and/or services performed.

13.12.6 Option: Pay If Paid / When Paid

13.12.6.1 When would this Option be relevant?

If this Option is agreed to, it will apply if:

  • under the Contract, a party ("Payer") must make a particular payment (the "contingent payment"),
  • but the Contract clearly indicates that the payment obligation is contingent on Payer's receipt of one or more third-party payments;
  • and the contingency referred to above is either "pay if paid" or "pay when paid," or comparable wording in either case.
Commentary

Example: Suppose that a contractor enters into a contract with a homeowner, under which the contractor will remodel the homeowner's kitchen. The contractor enters into a subcontract with a painter, under which the painter will do the necessary painting in the kitchen. In this example, pay if paid means that the contractor need not pay the painter unless the homeowner pays the contractor.

In some jurisdictions, a pay-when-paid clause implicitly means within a reasonable time. For example, if an end-customer does not pay a prime contractor within a reasonable time, then the prime contractor — or more likely, the insurance carrier that wrote the prime contractor's payment bond — must pay the subcontractor anyway.

A pay-if-paid clause makes the end-customer's payment a condition precedent to the subcontractor's right to payment; in other words, if the end-customer doesn't pay the prime contractor, then the subcontractor isn't entitled to payment even from the prime contractor's performance bond.

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13.12.6.2 When must a contingent payment be made?

Payer must immediately make the contingent payment

  • after Payer has received,
  • on an unconditional basis,
  • and accepted,
  • the specified third-party payment(s).
13.12.6.3 What Payer collection efforts are required for pay-when-paid?

If Payer owes money under a pay-when-paid obligation,

13.12.6.4 What Payer collection efforts are required for pay-if-paid?

If Payer owes money under a pay-if-paid obligation,

  • then Payer need not make any particular efforts to collect any associated third-party payment,
  • and if Payer does make such efforts, they will be:
  • 1. in Payer's sole discretion (as defined in Clause 25.19); and
  • 2. solely for Payer's benefit.
13.12.6.5 What risk does the payee assume for a pay-if-paid obligation?

If a payee will be owed money under the Contract for an agreed pay-if-paid obligation;

  • then the payee certifies —
  • with the intent that Payer rely on the payee's certification —
  • 1. that the payee has taken into account the risk that the paying party might not get paid by the relevant third party or ‑parties, and therefore that the payee might not get paid;
  • 2. that the payee is relying on the credit and willingness and ability to pay of those third parties, and not on that of the paying party, for the payee to be paid that amount; and
  • 3. The payee KNOWINGLY, VOLUNTARILY, INTENTIONALLY, PERMANENTLY, AND IRREVOCABLY ASSUMES AND ACCEPTS THE RISK that one or more of those third parties might not be able or willing to pay the paying party,
  • in which case the payee might not get paid (or might not be paid in full).
Commentary

Caution: Because a pay-if-paid clause essentially puts the risk of non-payment on the subcontractor, in some jurisdictions the clause might be void as against public policy. For example:

• In New York, pay-if-paid clauses are void, but pay-when-paid clauses are enforceable, according to that state's highest court.

• In contrast, the Ohio supreme court upheld a pay-if-paid clause, affirming a summary judgment that the contract's "condition precedent" payment language was sufficient totransfer the risk of nonpayment by a customer from the prime contractor to its subcontractor.

• In New Jersey, the courts are split about pay-if-paid clauses, according to Michelle Fiorito, The Consequences of "Pay-If-Paid" and "Pay-When-Paid" Construction Contracts Clauses (ZDLaw.com 2012).

• Still another court — in passing, and arguably in a dictum — seems to have implicitly treated a pay-if-paid clause as a pay-when-paid provision.

For additional information, see generally, e.g., Robert Cox, Pay-if-Paid Clauses: a Surety's Defense for Payment Bond Claims? (JDSupra.com 2019).

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13.12.7 Option: COD Terms may be imposed

In case of:

  • multiple late payments,
  • or one or more significant late payments,
  • by a party,
  • the other party may require cash-on-delivery (COD) terms
  • for any subsequent transactions.
Commentary

Applicable law might well implicitly permit a payee to demand COD terms after late payment if the late payment constituted a material breach (as defined in Clause 25.33.2) of the Contract.

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13.12.8 Option: Payment Failure is Not Infringement

If a party does not timely pay another party (the "payee") one or more amounts required by the Contract

  • for goods furnished by the payee,
    • including, for this purpose, without limitation, computer software,
  • and the first party's use of the goods would infringe the payee's intellectual-property rights if unlicensed;
  • then the payee's remedies (if any) will NOT include remedies for such infringement.
Commentary

A customer purchasing and using (or reselling) goods, or acquiring a license to use software, might be interested in this clause, because nonpayment of a software license fee might means that the non-paying user was infringing the copyright in the software.

In one case, the Ninth Circuit observed (in a dictum) that "[a] licensee arguably may commit copyright infringement by continuing to use the licensed work while failing to make required payments …."

And the damage award for such infringement might be significantly more than simply having to pay the required license fee. For example:

  • The MGM Grand Hotel's casino floor show was found to infringe the copyright in the Broadway musical Kismet.
  • The resulting damage award included 2% of MGM's profits from the hotel operations as a whole, including the casino itself.

It didn't help MGM's case that MGM's annual report had praised the infringing floor show's contribution to the hotel- and casino operations, saying that "the hotel and gaming operations of the MGM Grand — Las Vegas continue to be materially enhanced by the popularity of the hotel's entertainment[, including] 'Hallelujah Hollywood', the spectacularly successful production revue…."

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13.12.9 Exercises and discussion questions

13.12.9.1 Early payment

From a contract clause: "10.1 Invoiced payments are due net 30 days from the date that the Buyer receives a correctly stated invoice. 10.2. Invoice payments are due 2% 10 days, net 30 days."

QUESTION: Any issues here?

D.R.Y. — Don't Repeat Yourself

13.12.9.2 Late payment

From a contract clause: "(4) Penalty for late payments: Late payments are subject to a penalty of 5%."

QUESTION: Any issues here?

(Hint: See § 23.20.2.)

13.13 Payments Rider

If this Payments Rider is adopted as part of a contract ("the Contract"), it will apply as set forth in Tango Terms § 24.1 (which includes suggestions for adoption language).

  1. How will deposits and down payments be handled? See Clause 13.1 (Deposits).
  2. How must amounts due be invoiced? See Clause 13.9 (Invoicing).
  3. When are payments due? See Clause 13.12 (Payment Terms).
  4. How will (allowable) expenses be reimbursed? See Clause 13.3 (Expense Reimbursement Protocol).
  5. How are payment disputes to be handled? See Clause 13.10 (Payment Disputes).
  6. Who is responsible for personnel compensation? Each party, for its own personnel; see Clause 13.14 (Personnel Compensation Responsibility).
  7. Who is responsible for paying sales taxes? Normally, the vendor or supplier; see Clause 13.16 (Sales Tax Responsibility).

.

Commentary

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

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13.14 Personnel Compensation Responsibility

13.14.1 Who is responsible for compensating the parties' personnel?

As between the parties, each party is solely responsible for administering and paying the following:

  1. all salary and employment benefits (if any) of that party's employees and other personnel; and
  2. all employment-related taxes and/or fees (if any) that are required, in any jurisdiction, for those personnel.

13.14.2 Will party personnel be entitled to other parties' benefits?

No: Unless the Contract unmistakably states otherwise,

  • no party "ABC" intends for the Contract to confer, on any other party's personnel,
  • any entitlement to the employment benefits (if any) or other benefits (if any)
  • that ABC provides to ABC's own employees or other personnel.

13.14.3 What if someone claims otherwise?

As between any party, referred to as "ABC," and any other party "XYZ,"

13.15 Sales Tax Definition

The term "sales tax," whether or not capitalized, includes (without limitation) all of the following:

  • sales taxes;
  • use taxes;
  • value-added taxes;
  • excise taxes;
  • other forms of ad valorem tax and consumption tax;
  • and equivalent taxes.

13.16 Sales Tax Responsibility

  1. This Clause applies whenever:
    • under the Contract, any party sends an invoice (see § 13.9) to another party
    • for goods, services, or other things potentially subject to sales taxes (as defined in Clause 13.15).
  2. The invoicing party must do the following — at its own expense:
    1. determine what if any sales taxes must be paid to an applicable jurisdiction in connection with the transaction;
    2. separately list all sales taxes in the relevant invoice (see also § 13.9 concerning invoices); and
    3. timely report and remit all sales taxes
      • to all relevant taxing authorities
      • anywhere in the world,

unless the parties clearly agree otherwise in writing in connection with a particular transaction.

13.17 Tax-Indemnity Plan

Each party must defend (as defined in Clause 21.4) each other party's Protected Group (as defined in Clause 25.40)

  • against any claim by a third party,
  • that the first party failed to pay any tax (as defined in Clause 13.18) for which the first party is legally responsible,
    • whether the first party's responsibility arises under the Contract or otherwise.

13.18 Tax Definition

  1. The term tax refers to any tax, assessment, charge, duty, levy, or other similar governmental charge of any nature, imposed by any government authority.
  2. The term tax, however, does not encompass a price charged by a government authority for (i) services rendered, nor (ii) goods or other assets sold or leased, by the government authority.
  3. Illustrative examples of taxes include the following, without limitation, whether or not an obligation to pay the same is undisputed, and whether or not a return or report must be filed:
    1. taxes on:
      • income;
      • gross receipts;
      • employment;
      • franchise;
      • profits;
      • capital gains;
      • capital stock;
      • transfer;
      • sales;
      • use;
      • occupation;
      • property;
      • excise;
      • severance;
      • windfall profits;
      • sick pay;
      • or disability pay;
    2. ad valorem taxes;
      • alternative minimum taxes;
      • environmental taxes;
      • license taxes;
      • payroll taxes;
      • registration taxes;
      • social security (or similar) taxes;
      • stamp taxes;
      • stamp duty reserve taxes;
      • unemployment taxes;
      • value added taxes;
      • or withholding taxes; and
    3. all other taxes;
      • assessments;
      • charges;
      • customs and other duties;
      • fees;
      • levies;
      • or other similar governmental charges of any kind; and
    4. all estimated taxes;
      • deficiency assessments;
      • additions to tax;
      • and fines, penalties, and interest on past-due tax payments.
Commentary

This definition draws on the following:

  • the contract language quoted by the Court of Appeals of New York in upholding a summary judgment that a $20 million-plus water usage charge, levied by a Mexican government entity, was a "tax" within the meaning of the contract's laundry-list definition; and

13.19 Taxing Authority Definition

The term "taxing authority," whether or not capitalized,

refers to any government authority exercising de jure or de facto power

to impose, regulate, or administer or enforce the imposition of taxes.

13.20 Usury Savings

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. Payer and the payee intend for all charges and payments under the Contract to comply with law; this Usury Savings will therefore apply—
    • if any charge by the payee, or any payment by Payer, under the Contract is properly characterized as interest,
    • and the charge or payment is determined to have exceeded the maximum interest permitted by law,
    • after taking all permitted steps to spread such payments over time.
  3. In any such case, the excess interest is to be considered the result of an inadvertent error,
    • even if the payee or Payer intended to take the action(s) that resulted in the excess interest being charged or paid.
  4. If Payer has not yet paid the excess interest, then the payee will cancel the excess-interest charge.
  5. If Payer has paid excess interest, then the payee will promptly refund the excess interest to Payer, and/or credit the excess interest to any balance still owed by Payer,
    • together with interest on the excess interest at the maximum rate permitted by law.
Commentary

Caution: Usury savings clauses might or might not be effective in a given jurisdiction. For example:

• Texas law permits usury-savings clauses.

• On the other hand, Rhode Island's state supreme court acknowledged that Rhode Island's usury statute was "draconian" and "strong medicine"; The court said that the legislature had put the risk of charging too high an interest rate onto the lender in "an inflexible, hardline approach to usury that is tantamount to strict liability …." The court affirmed a trial-court ruling that a commercial loan agreement for more than $400,000 was void as usurious.

Subdivision b: "Properly characterized as interest": Not all so-called "interest" charges will be subject to usury laws. For example, in Texas, interest is defined by statute as "compensation for the use, forbearance, or detention of money. The term does not include time price differential, regardless of how it is denominated. …"

What is this "time price differential" of which the Texas statute speaks? One article explains the quoted term in relation to Texas law:

If certain requirements are met and a transaction is not designed to circumvent the usury laws, a merchant may sell merchandise at a higher price for credit than for cash and the price difference is not usurious. The new statute codifies the common law time-price doctrine.

In order to apply the time-price doctrine, it must be shown that the seller clearly offered to sell goods for both a cash price and a credit or time price, that the purchaser was aware of the two offers, and that the purchaser knowingly chose the higher time or credit price.

If an agreement fails to qualify as a time-price differential contract, then the finance charges may be found to constitute usurious interest.

See generally, e.g.:

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14 Operations: Services, sales, etc.

Beginning with this chapter, this manual is arranged chiefly in a clause-plus-commentary format.

Most clauses beginning with an issues checklist for reviewers and drafters (cleverly disguised as a table of contents).

Contents:

14.1 Orders for Goods & Services

14.1.1 Terminology: Customer; Supplier; Order

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract,
    • specified parties, referred to as "Customer" and "Supplier" respectively,
    • agree to conduct one or more transactions,
    • such as, for example,
      • a sale or other delivery of tangible- or nontangible goods or equipment or other deliverables, and/or
      • the performance of services.
  2. Each such agreement for a transaction is referred to as an "Order."
  3. In case of doubt: Unless otherwise agreed in writing, "Customer" might not be an end-customer, but instead might be a reseller, a distributor, etc.

14.1.2 How must Supplier submit orders?

Supplier may decide, from time to time, how orders are to be submitted,

  • for example via hard copy, Web-based portals, etc.
Commentary

Purely out of economic interest, Supplier should want to make it as easy as possible for Customer to place orders. While the Finance- and Legal Departments might want Customer to jump through a lot of hoops, the Sales Department will surely have something to say about that.

Alternative: "Orders are to be submitted as follows: [DESCRIBE]."

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14.1.3 What information must Customer provide in an Order?

Supplier may decide from time to time what information is to be included in an Order.

Commentary

Again, allowing Supplier to decide what information must be included in an Order should ordinarily be workable — as a practical matter, Supplier probably won't be unreasonable, because Customer will (usually) have the choice whether or not to place the Order.

Alternative: "Orders are to include the following specific information: [SPECIFY]."

As an example, see section 2 of a Honeywell terms-of-sale document, which calls for orders to specify "(1) Purchase Order number; (2) Honeywell's part number; (3) requested delivery dates; (4) price; (5) quantity; (6) location to which the Product is to be shipped; and (7) location to which invoices will be sent for payment."

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14.1.4 A Supplier quotation constitutes an "offer"

  1. If Supplier sends Customer a quotation for a proposed sale or other transaction,
    • then that quotation constitutes Supplier's offer to conduct the transaction,
    • on the terms specified in the quotation,
    • including but not limited to any terms incorporated by reference.
  2. If Customer accepts a Supplier quotation,
    • including but not limited to by sending a purchase order,
    • then that quotation becomes an Order.
Commentary

See also Clause 24.7 (Entire Agreement) concerning the effect of additional terms in purchase orders, etc.

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14.1.5 Supplier's catalogs and price lists are not "offers"

No: Supplier's catalogs or price lists

  • for goods or other deliverables; services; or other items,
  • do not constitute Supplier's offer to sell or otherwise deal in
  • any particular quantity of the items at any particular time or place.
Commentary

The idea for this provision comes from section 1 of a Honeywell terms-of-sale document archived at https://perma.cc/5MB9-H6VK.

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14.1.6 Supplier's quotations can expire if so stated

If a Supplier quotation specifies an expiration date,

  • then the quotation will expire on that date,
  • unless Supplier receives Customer's acceptance of the quotation,
  • before the close of business, at Supplier's relevant location,
  • on that date.

14.1.7 Supplier may modify or withdraw a pending quotation

Supplier may withdraw and/or modify a quotation at any time —

  • until Supplier has received Customer's timely acceptance, if any,
  • or the quotation expires,
  • whichever occurs first,
  • unless the quotation expressly states otherwise.

14.1.8 Must Orders be in writing? What about change orders?

  1. An Order, or a change to an accepted Order ("change order"), must be agreed to in writing unless the requirements of subdivision b are met.
  2. Any assertion of an oral Order, or an oral agreement to modification of an Order, must be supported by clear and convincing evidence (as defined in Clause 25.13).
Commentary

Oral Orders, and oral modifications to Orders, are allowed here because that's how it often happens in the real world.

Alternative: "Any Order, and any change to an Order, must be in writing; no party will assert that an Order was agreed to or modified in any other way."

Caution: In some jurisdictions, courts might not enforce a change-orders-in-writing requirement like the above alternative; see the Amendments & Waivers Rule and its commentary.

Subdivision b – corroboration requirement: See Clause 23.8 (Corroboration Requirement) and its commentary.

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14.1.9 Which party must agree to an Order? A change order?

  1. An Order must be agreed to by both Supplier and Customer.
  2. A change order must be agreed to by (at least) the party against which the change order is sought to be enforced.
Commentary

Subdivision b – agreed to by the party to be bound: This borrows from the approach of UCC § 2-201.

Alternative: "A change order must be agreed to by both parties."

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14.1.10 Who may agree to an Order? A change order?

An Order or a change order may be agreed to on behalf of a party by any person having actual- or apparent authority.

Commentary

Concerning "apparent authority," see the commentary at § 24.2.3.

Alternative: "An Order or a change order must be agreed to on behalf of a party by an officer of the party at the vice-president level or higher."

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14.1.11 Customer's affiliates may submit orders

  1. Customer's affiliates (as defined in Clause 25.2)
    • may submit one or more proposed Orders for transactions with Supplier under the Contract
    • unless the Contract clearly specifies otherwise.
  2. If an Order by a Customer affiliate is accepted by Supplier,
    • then the Order will be governed by the Contract
    • in the same manner as if Customer had submitted the Order.
  3. A proposed Order from a Customer affiliate will not be binding on Supplier
Commentary

A customer will sometimes want its "affiliated" companies to be allowed to take advantage of the contract terms that the customer negotiates with a supplier.

Subdivision c – not binding until acceptance: Supplier might want to decline an order from a Customer affiliate, for example if Supplier doesn't have a basis for believing that the affiliate is sufficiently creditworthy. Supplier might want Customer to guarantee orders from Customer's affiliates.

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14.1.12 Customer is not responsible for its affiliates' Orders

Customer is not responsible for its affiliates' obligations under their Orders (if any),

  • unless the Contract clearly states otherwise,
  • or Customer so agrees in writing, perhaps in the Order itself.
Commentary

Alternative: "If a Customer affiliate enters into an Order with Supplier under the Agreement for a transaction, then Customer is jointly and severally responsible, together with its affiliate, for the affiliate's obligations under that Order."

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14.1.13 What packaging and labeled are required?

  1. Supplier is to cause all deliverables to be appropriately packaged and labeled for shipment and delivery; this includes, without limitation, conformance to:
    1. any requirements of law (including for example any required country-of-origin labeling);
    2. any specific packaging- and/or labeling instructions in the order,
  2. If Customer provides a purchase-order number or other identifier for the order,
    • then Supplier is to cause that identifier to be included on shipping labels, shipping documents, and order-related correspondence.

14.1.14 Orders are to be filled as stated

Supplier is to cause deliverables specified in the Order to be delivered as stated in the Order.

Commentary

This is phrased as "Supplier is to cause delivery" instead of "Supplier will deliver" because in many cases Supplier will use a carrier to actually make the delivery.

Alternative: "Supplier is to endeavor to cause delivery …." (Emphasis added.)

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14.1.15 May Customer specify delivery to a third party?

Possibly:

  1. Customer may designate, in writing, a third party to which deliverables are to be shipped,
    • unless the Contract clearly specifies otherwise.
  2. Customer's designation of the third party must take place a reasonable time before shipment.
  3. Customer must respond promptly
    • to any reasonable requests by Supplier
    • about the third party,
    • for example (as defined in Clause 25.23), to determine whether Supplier may legally ship the deliverables to the third party
      • because of export-control restrictions or other legal factors.
  4. Supplier is to cause the deliverables to be shipped to the third party,
    • absent reasonable objection on Supplier's part,.
  5. Customer is to pay any additional costs arising from Customer's designation,
    • e.g., additional shipping, additional insurance, etc.
Commentary

Subdivision c: Supplier might have legitimate reasons for not wanting to ship ordered goods to particular third parties. For example, a third party might be a competitor of Supplier, or the third party might be on a bar list of some kind, e.g., under the export-control laws.

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14.1.16 When will title and risk of loss pass to Customer?

Title and risk of loss will pass to Customer as specified in INCOTERMS 2020 EXW - Ex Works Supplier's facility.

Commentary

Drafters should usually try to take advantage of the INCOTERMS 2020 three-letter options, which spell out things such as responsibility for freight charges, insurance, and export- and customs clearance, as well as passage of title and risk of loss.

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14.1.17 What if an Order is delivered late — or early?

While an Order might specify a delivery time,

  • Supplier will not be liable if the actual delivery time is early or late,
  • as long as the variation is not unreasonable under the circumstances,
  • unless the Order clearly states otherwise.
Commentary

Alternative: "Time is of the essence for delivery." (See generally the commentary on that subject at § 25.47.)

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14.1.18 Orders are separate agreements

Each Order is to be considered a separate agreement

  • that incorporates the Contract by reference,
  • including but not limited to this Clause,
  • whether or not the incorporation is explicit,
  • unless the Order clearly says otherwise.
Commentary

Alternative: "Each Order is to be considered an addition to this Agreement and not as a separate agreement."

Comment: Language along the lines of the above alternative is seen in some contracts where "netting out" of multiple transactions is desired, such as, e.g., the ISDA Master Agreement.

For standalone commercial transactions, the above alternative would be unwise to use, in the author's view, because:

  • a default in one order could affect other orders — this is sometimes referred to as "cross-default" and should be provided for expressly if desired; and
  • if Supplier's liability for damages were to be capped at "the amounts paid or payable under the Parties' Agreement," then that amount would grow over time as more statements of work were completed; Customer might like that, but Supplier wouldn't be wild about it.

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14.1.19 Exercises and discussion questions

14.1.19.1 Exercise: Order fulfillment

QUESTIONS — discuss in the breakout rooms first, then as a whole:

  1. What are some pros and cons of spelling out, in the contract, the information that Customer must submit in an order?
  2. What are some pros and cons of:
    • having each order become an addition to the master agreement, versus
    • having each order be a separate agreement that incorporates the master agreement by reference.
  3. Why might Supplier want a quotation to have an expiration date?
  4. What are some pros and cons of allowing orders to be modified orally and not requiring written modifications?

FACTS: You represent Supplier. Customer wants its "affiliates" to be listed in the preamble as parties to the agreement, e.g., "The parties are ABC Inc. ('Supplier') and XYZ Inc. and its affiliates ('Customer')."

QUESTIONS: (numbering is continued before)

  1. As Supplier's lawyer, what do you think of this — what do you think Customer really wants?
  2. How might you structure the contract to accommodate Customer's likely desires — and to protect Supplier?
  3. What are the INCOTERMS? What does "EXW" mean?

    (What kind of fences might Supplier and Customer want?)

14.2 Orders: Optional clauses

14.2.1 Option: Stocking Point Delivery

  1. An Order may specify that ordered deliverables are to be delivered to a warehouse (or other stocking point) until called for Customer.
  2. For any such Order, both title and risk of loss for the ordered deliverables will pass to Customer only when those deliverables are released for final delivery to Customer.
Commentary

Just-in-time delivery of parts to stocking points is sometimes used by manufacturers to minimize reduce* the amount of their capital that is tied up in inventory. Such a manufacturer might require a supplier to deliver parts and other components — still owned by the supplier, and thus tying up the supplier's capital —until needed by the manufacturer.

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14.2.2 Option: Deliverables Substitution

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Supplier may not substitute different deliverables for those specified in the Order without Customer's prior written consent.

Supplier may make substitutions for deliverables specified in an Order, but only if all of the following prerequisites are met:

  1. The substituted deliverables must meet any functional specifications stated in the Order for the ordered deliverables.
  2. Supplier must advise Customer of the substitution, in writing, no later than the scheduled time for delivery.
  3. Customer may reject the substituted deliverables on or before 14 days after the date of delivery.

14.2.3 Option: Partial- or Early Deliveries

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

 Customer may, in its sole discretion, reject any delivery that is incomplete or that is not delivered on the date specified in the Order;

  • if Customer does so, that will not affect any right or remedy Customer might have arising from the delivery failure.

Supplier may, in its discretion, ship partial deliveries of ordered deliverables,

  • but not if Customer notifies Supplier otherwise a reasonable time in advance.
Commentary

Customer might want deliveries to be all-or-nothing, so that Customer's people won't have to spend time dealing with deliveries that don't conform exactly to the Order.

On the other hand, Supplier might want to be able to ship things as they're finished, without waiting for the Order to be completed.

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14.2.4 Option: Shortages Flexibility

If Supplier runs short of ordered deliverables, for whatever reason or reasons,

then Supplier may do some or all of the following:

  1. allocate Supplier's available production as Supplier deems appropriate;
  2. delay or stop shipments; and/or
  3. send partial shipments with prior notice.
Commentary

This shortages provision amounts to a barebones (and one-sided) force majeure provision.

Supplier and Customer might want to give more thought to this particular "what-if?" scenario; see generally Clause 19.6 (Force Majeure Protocol).

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14.2.5 Option: Environmental Damage Responsibility

As between Supplier and Customer, Supplier is responsible for any and all environmental damage arising from ordered deliverables to Customer until Customer receives the deliverables.

14.2.6 Option: Shipping-Document Consolidation

Supplier is encouraged to consolidate shipping documents wherever practicable.

14.2.7 Option: Shipment Advice

  1. Supplier will advise Customer in writing when deliverables specified in an Order have been shipped.
  2. Supplier will provide any specific details reasonably requested by Customer,
    • such as tracking information for the shipment.

14.2.8 Option: Release Documentation

Promptly after Supplier delivers ordered deliverables to a carrier for shipment to Customer,

  • Supplier will send Customer any documents necessary for Customer to cause the deliverables to be released
  • to Customer or Customer's designee.

14.2.9 Option: Delivery Delay Warning

Supplier will promptly advise Customer, preferably in writing, if a reasonable person would conclude that a delivery is likely not to meet the schedule specified in the relevant Order.

(In case of doubt: Supplier's advising Customer of a possible delay, in itself, will not affect any right or remedy Customer might have for an actual delay.)

14.2.10 Option: As-Delivered Problem Reporting Requirement

Customer will promptly advise Supplier, in writing,

  • of any mismatch that Customer finds
  • between the type, quantity, and price of deliverables specified in an accepted Order
  • and the deliverables actually delivered.

14.2.11 Option: Customer Handling of Rejected Deliverables

  1. Customer may direct that rejected deliverables be returned to Supplier (at whatever address Supplier specifies) at Supplier's expense.
  2. Customer may store rejected deliverables, at Supplier's risk, pending Customer's receipt of Supplier's return shipping instructions.
  3. Supplier must pay, or reimburse Customer for, all charges for storage, insurance, and return shipping of rejected deliverables.
  4. If Customer rejects one or more deliverables as authorized by this Agreement,
    • but Supplier does not provide Customer with pre-paid return shipping instructions within a reasonable time,
    • then Customer may, in its sole discretion:
      • 1. destroy some or all of the rejected deliverable(s);
      • 2. sell some or all of the rejected deliverable(s), at a commercially reasonable public- or private sale; and/or
      • 3. otherwise dispose of some or all of the rejected deliverables.
  5. If Customer sells some or all of the rejected deliverables, it will apply any proceeds in the following order:
    1. expenses of the sale;
    2. storage charges not paid for by Supplier;
    3. any other amounts due to Customer from Supplier; and
    4. payment of any remaining balance to Supplier.

14.2.12 Option: Supplier Orphaned Deliverables

  1. This Option will apply if,
    • through no fault of Supplier or its contractors,
    • Customer is not ready to receive some or all deliverables under an accepted Order
    • on the schedule specified in the Order.
  2. Supplier may cause the relevant deliverables to be stored at a site reasonably selected by Supplier.
    • Such a site might be under the control of Supplier or a third party (such as, for example (as defined in Clause 25.23), a freight forwarder).
  3. Both title and risk of loss for stored deliverables will immediately pass to Customer (if that has not already happened).
  4. Supplier may deem its delivery of the relevant deliverables to be complete once those deliverables are put into storage
    • (and therefore Supplier may invoice Customer for any remaining amount due).
  5. Customer will reimburse Supplier for all expenses incurred by Supplier in connection with putting the relevant deliverables into storage,
    • in accordance with Clause 13.3 (Expense Reimbursement Protocol).
  6. When Customer is able to accept delivery of the stored deliverables, Supplier will arrange for delivery,
    • but Supplier need not do so if one or more of Supplier's invoice(s) relating to the Order in question is past due.

14.2.13 Option: Terms for Order size

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Customer may submit an Order of any size.

Supplier may decline an Order for goods or other deliverables if the ordered quantity of any single stock-keeping unit (SKU) is less than [QUANTITY].

Supplier may decline an Order where the aggregate Order price is less than [AMOUNT], exclusive of taxes, shipping, and insurance.

Commentary

Suppliers are often concerned with economies of scale — especially for goods that are manufactured to order — and so they might want to establish a minimum order quantity (MOQ).

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14.2.14 Option: Terms for Supplier's acceptance of Orders

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Supplier may decline any proposed Order in its sole discretion. (In case of doubt: Here, decline has the same meaning as reject.)

Supplier will not unreasonably decline an Order.

Supplier will not decline any Order.

If Customer has failed to pay amounts due to Supplier when due,

  • then Supplier may decline subsequent proposed Orders by Customer
  • until all such past-due amounts have been paid.

Supplier is deemed to have accepted an Order,

  • and to have waived its right to decline or otherwise reject the Order,
  • if Supplier has not declined the Order in writing
  • within five business days after Supplier receives the Order.

If Customer has failed to pay amounts due to Supplier when due,

  • then Supplier may revoke Supplier's acceptance of Customer's Orders that Supplier previously accepted but has not yet filled or completed.

Supplier may not revoke its acceptance of an Order.

Supplier may revoke its acceptance of an Order only under the following circumstances: [DESCRIBE].

14.2.15 Option: Terms for Customer cancelation of Order

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Customer may cancel an Order for goods that are not to be specially manufactured for the Order — but Customer may do so only before Supplier has shipped the goods — by sending a written cancellation advice to Supplier.

Customer may not cancel an Order for goods that are to be specially manufactured for the Order.

Customer may not cancel an Order for services.

Customer may not cancel an Order for goods once the Order has been accepted by Supplier.

An Order for goods or other deliverables will not be deemed canceled unless Supplier receives a written cancellation request, signed by an authorized representative of Customer, no later than [SPECIFY DEADLINE].

IF: Customer cancels an Order for goods or other deliverables; THEN: Supplier may invoice Customer for, and Customer will pay, a cancellation fee of [SPECIFY AMOUNT].

14.2.16 Option: Advance Payment Requirement

Supplier reserves the right, in its sole discretion (as defined in Clause 25.19),

  • to require Customer to pay in full, in advance for an Order;
  • this will be true even if the Contract otherwise provides for Supplier to perform first and be paid later.

14.3 Services Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract,

  • a specified party ("Provider")
  • is to cause services to be provided to, or for,
  • another party ("Customer").

Discussion checklist:

Commentary

Consider also the following:

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14.3.1 Written statements of work are required

  1. If the parties have not signed an agreed written statement of work,
    • then Provider need not provide services under the Contract,
    • nor need Customer need not pay for services rendered.
  2. Each written statement of work must be "signed" by each party,
    • but "signature" can be in any way that the law allows.
Commentary

See the commentary at § 24.19.1.

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14.3.2 Statements of work can be changed

  1. Any change to a statement of work,
    • and any waiver of a right or obligation under it,
    • should be in a written change order;
    • see subdivision c concerning claims of oral changes
    • to statements of work.
  2. A written change order or waiver must be signed
    • by the party that is supposedly obligated by the change,
    • or that has supposedly waived a right or obligation.
  3. Here are two examples to illustrate:
    • Example 1: Suppose that —
      • Provider does extra work,
      • and asserts that the extra work was under a written change order,
      • and now Provider wants Customer to pay extra money,
      • as specified in that change order.
    • In that situation, the change order is not enforceable against Customer
      • unless Customer signed it.
    • Example 2: Suppose that Customer pays Provider
      • and asserts that the payment is for Provider to do additional work under a written change order,
      • and now Customer wants Provider to actually do the work,
      • but Provider does not want to do so.
    • In that situation, the change order is not enforceable against Provider
      • unless Provider signed it.
  4. The parties may agree orally to a change in a statement of work,
Commentary

See generally Clause 24.2 (Amendments Procedure) and its commentary.

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14.3.3 Provider is not entitled to a minimum amount of work

The Contract does not entitle Provider to any minimum amount of work,

  • nor to any minimum compensation,
  • unless the Contract clearly says otherwise.
Commentary

This checklist item is intended as a roadblock to "creative" contractor claims to the contrary, as seen in, e.g.:

  • a Louisiana case in which Dow Chemical Co. terminated a contractor "at will" on 90 days' notice, as permitted by the contract, but then did not assign the contractor any work during the 90-day notice period. A jury found in favor of the contractor and awarded lost profits, but the Fifth Circuit held that the contract unambiguously did not require Dow to assign the contractor work during the termination-notice period; and
  • a Chicago lawsuit in which a subcontractor claimed that its prime contractor, IBM, had breached an alleged promise to provide the subcontractor with $3.6 million of work on a project for the Chicago Transit Authority. IBM won the case on summary judgment, but again it still had to defend against the claim;

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14.3.4 Who is to obtain licenses & permits for the work itself?

  1. Provider is to timely obtain any permits and licenses that might be needed for performance of the services,
    • for example, building permits; contractor- and occupational licenses; etc.
  2. If Provider needs any special authorizations for the specific services,
    • then Provider will also obtain those authorizations unless the Contract clearly says otherwise.
Commentary

Subdivision b: As a made-up example, suppose that Provider is to paint a room, but the room is part of the intensive-care unit at a hospital. That might require a special authorization from health authorities. (Again, this is just a made-up example.)

Caution: The law might disregard contract provisions in order to protect other societal interests. For example: Under a California statute, a contractor might forfeit its right to be paid if it undertakes work required to be done by a licensed contractor (e.g., certain construction- or remodeling work), but does not itself have the proper license(s) at all times while performing the work.

Moreover, under a 2002 'disgorgement' amendment to the California statute, such a contractor might have to repay any payments it did receive for the work.

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14.3.5 Who is to obtain authorizations for use of deliverables?

Customer must timely obtain any licenses or permits needed

  • for use of deliverables,
  • by Customer or others authorized by Customer,
  • for example, any necessary patent licenses,
  • unless the Contract clearly says otherwise.
Commentary

Even if Provider warrants that deliverables per se do not infringe third-party IP rights, that might not provide Customer with much comfort about third-party infringement claims arising from Customer's use of the deliverables.

And in the U.S., see UCC § 2-312, which provides in part that:

(3) Unless otherwise agreed a seller who is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like

but a buyer who furnishes specifications to the seller must hold the seller harmless against any such claim which arises out of compliance with the specifications.

(Extra paragraphing added.)

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14.3.6 What if the parties disagree about the need for an authorization?

  1. This section will apply if Provider and Customer disagree about the need for a particular third-party authorization.
  2. Provider will not be in breach of the Contract if, with prompt notice (as defined in Clause 24.17) to Customer, Provider suspends the relevant work until the parties resolve the disagreement.
  3. The parties are to attempt to resolve their disagreement in accordance with Clause 23.9 (Dispute Management Protocol).
  4. If the parties are unable to resolve their disagreement themselves, then Clause 23.4 (Baseball-Style Dispute Resolution) will apply.
Commentary

Suppose that:

  • Provider believes that (let's say) performance of the services would infringe a third party's patent rights,
  • but Customer disagrees.

In that situation, Provider might want to:

Subdivisions c and d are designed to promote settlement by giving each party a strong incentive to be reasonable, as discussed in the commentary to the referenced Tango clauses.

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14.3.7 Who is responsible if authorizations are not obtained?

If a party fails to obtain a particular permit or license as required by the Contract,

  • and as a result, a third party makes a claim against another party to the Contract —
    • this could include, without limitation, something like a building inspector ordering Customer to move out of a building because Provider failed to get an occupancy permit —
  • then the first party must defend and indemnify the other party and its Protected Group (as defined in Clause 25.40) against all foreseeable damages and losses arising from the third party's claim.

14.3.8 What personnel must Provider assign to do the work?

Provider is to see to it that all individuals who are assigned to perform services under a statement of work:

  1. are competent and suitably trained for the task;
  2. are bound by confidentiality- and invention-assignment obligations to Provider sufficient to support any corresponding obligations that Provider has to Customer under an agreement;
  3. are legally able to be employed in any jurisdiction where those personnel are to be physically present; and
  4. meet any specific qualifications set forth in the statement of work.

14.3.9 Will background checks be required for anyone?

Possibly: If the statement of work clearly so states, then:

  • Provider is to cause background checks to be performed,
  • in accordance with Clause 15.2 (Background Checks),
  • on all non-Customer personnel who, under the statement of work, will do any of the following:—
  1. providing services while physically on-site at Customer's site;
  2. having access to Customer confidential information — including but not limited to protected health information of Customer's customers or patients;
  3. interacting with Customer's customers; and/or
  4. having access to Customer's computers or network.

14.3.10 What quality of service performance is required?

  1. Provider is to see to it that all services are performed: (i) safely; and (ii) in a professional manner,
    • where professional refers to work that is performed:
      • by people who have the knowledge, training, and/or experience necessary for the successful practice of the relevant trade or occupation; and
      • in a manner that is generally considered proficient by those capable of judging such work.
  2. If the Contract uses the term workmanlike, the term has the same meaning as professional as defined above.
Commentary
"Professional" = "workmanlike"

The term professional is used here instead of workmanlike because the former term sounds more, well, professional, but the definition of professional is drawn from the Supreme Court of Texas's definition of workmanlike in connection with the implied warranty of good and workmanlike quality of services in connection with the repair of tangible goods.

In the definition of professional, the "without necessarily rising to the level of being exceptional, outstanding, or original" language is adapted from an alternate definition of workmanlike in the Merriam-Webster dictionary, namely "competent and skillful but not outstanding or original."

A covenant, not a representation or warranty

This performance-requirement language sets forth a covenant, that is, a promise, and not a representation or warranty – although a warranty is a type of covenant (specifically, a conditional covenant).

Implied warranties of workmanlike performance

Drafters should be aware that in some states the law might automatically impose a warranty of workmanlike performance, or something close to it. See, e.g., Fed. Ins. Co. v. Winter, 354 S.W.3d 287, 291-94 (Tenn. 2011) (citing numerous authorities but not defining workmanlike).

Implied warranties of workmanlike performance come into play especially in connection with the sale of a new residence. The imposed warranty might even be non-waivable and/or non-disclaimable. For example:

  • Home construction: Forty-three states provide an implied warranty of habitability for new residences, according to the Utah supreme court, while three others provide a warranty of workmanlike manner.
  • Repairs of tangible goods or property: In its Melody Homes decision, cited above, the Texas supreme court held that an implied warranty of good and workmanlike performance extends to repairs of tangible goods or property. But two sharp dissents (in the form of concurrences in the judgment) noted that the court had defined that implied warranty in a manner that might well require expert testimony in many cases (but that would seem to be true of almost any standard of performance of services).

See also Clause 20.7 (Implied Warranty Disclaimer) and its associated commentary.

Alternative performance standards

Some service providers might balk at using the term professional or workmanlike performance because they fear the term could be ambiguous; these providers might prefer in accordance with the specifications, or perhaps competent and diligent.

Of course, any of those terms is likely to involve factual determinations in litigation or arbitration, so it's hard to see how one is more- or less favorable than the other.

On the other hand, some customers prefer stricter standards of performance such as, for example:

  • In accordance with industry standards: This phrase and professional (or workmanlike) seem synonymous, in which case professional is more likely to find acceptance among customers.
  • In accordance with the highest professional industry standards: For a provider, this is the worst of all worlds: Not only is the phrase vague, but a provider that agrees to this might as well hang a "Kick Me" sign on its own back, because anything less than perfection would be open to cricitism in court. (On a related note, see also the discussion of best efforts (as defined in Clause 25.7).)
Performance standards: Further reading

See generally, e.g.:

14.3.11 What specific tasks is Provider responsible for?

Provider is to see to the successful completion

  • of all individual tasks and other actions
  • necessary for the proper rendering
  • of the services set forth in the statement of work,
  • even if one or more such individual tasks is not expressly set forth there.
Commentary

Some customers are likely to want this language for comfort purposes.

A provider might be concerned that such language could lead to disputes about expensive (and delay-causing) "scope creep"; the author's guess, though, is that this language wouldn't do any significant harm — here's why:

  • Suppose the parties were to end up fighting about the scope of what the provider is supposed to do.
  • In that case, the presence or absence of this language seems unlikely to make a difference one way or the other.
  • So, if this language gives a customer some comfort, why not include it, because doing so could help to remove a potential delay on the path to signature.

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14.3.12 What materials, etc., must Provider furnish?

Provider is to see to the furnishing —

  • of all materials, equipment, supplies,
  • computer hardware and -software,
  • work locations,
  • electrical power,
  • Internet- and other communications capabilities,
  • and other items needed to meet Provider's performance responsibilities;
  • this obligation includes any necessary acquisition, installation, and maintenance of all such items.
Commentary

For some services projects, it might make sense for Customer to provide some of the listed items. If so, that should be documented in the statement of work.

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14.3.13 Who is to furnish safety equipment?

Provider is to see to the furnishing,

  • as necessary,
  • of prudent, properly-functioning safety equipment
  • for Provider's personnel
    • and for the personnel of Provider's contractors;
  • this includes, without limitation, any necessary personal protective equipment (PPE).
Commentary

Depending on the situation, it might make more sense for Customer to furnish (some or all) PPE.

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14.3.14 Who is to supervise the individuals doing the work?

Provider is to see to all supervision and, to the extent necessary, training of all individuals engaging in the services.

14.3.15 Who controls the means and manner of the work?

In case of doubt: As between Provider and Customer, Provider has the sole responsibility for controlling the means, manner, time, and place of performance of the services.

14.3.16 What must Customer do to support Provider?

  1. Customer will provide reasonable basic cooperation with Provider,
    • and with Provider's agents and subcontractors, if applicable,
    • as reasonably requested by Provider from time to time.
    • (Note: This section is not intended to implicitly authorize the use of subcontractors, but it does not prohibit such use either.)
  2. Subdivision a is not intended to diminish Provider's responsibilities for accomplishing the services called for by the statement of work.

14.3.17 What must Provider do about defects?

Provider is to proceed in accordance with Clause 14.5 (Defect Correction Protocol) in any case of defective performance of services and/or delivery of defective deliverables.

14.3.18 When are payments for services due?

  1. Provider is to invoice Customer, and Customer is to pay Provider, for services, in accordance with the applicable statement of work and Clause 13.13 (Payments Rider).
  2. If the statement of work does not specify when payments are due,
    • then Provider is to invoice Customer, and Customer is to pay Provider, for services —
      • one-half upon agreement to the statement of work,
      • and the balance upon completion and acceptance of the services.

14.3.19 Must Customer reimburse Provider for expenses?

Customer need not reimburse Provider for expenses incurred in performing services unless the Contract clearly says so — in which case Clause 13.3 (Expense Reimbursement Protocol) will govern.

Commentary

Some statements of work might call for Provider to "pass through" to Customer the expenses incurred by Provider, while other statements of work might require Provider to absorb those expenses as part of Provider's fee for services.

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14.3.20 May Provider suspend services for nonpayment?

If Customer does not pay Provider an amount due under the Contract within seven days following the original payment due date,

  • and the nonpayment is not clearly due to fault attributable to Provider,

then:

  1. Provider may suspend its performance of the relevant services at any time beginning at the end of seven days following the effective date of Provider's notice to Customer of upcoming suspension; and
  2. Any such suspension will be without prejudice to Provider's other remedies for the nonpayment.

14.3.21 May Customer audit Provider's payment-related records?

  1. If the relevant statement of work states that the services are to be provided (i) on a time-and-materials basis, and/or (ii) on a cost-plus basis,
    • then Provider must keep records in accordance with Clause 15.4 (Recordkeeping Protocol),
    • and Customer may audit those records in accordance with Clause 15.1 (Audit Protocol).
  2. Otherwise, Provider need not allow Customer to audit Provider's records concerning the services unless the Contract clearly says otherwise.

14.3.22 Do any confidentiality obligations apply here?

Unless the Contract clearly states otherwise, neither party has any confidentiality obligations relating to the services.

 Provider must preserve in confidence the Confidential Information of Customer in confidence per Clause 16.1 (Confidential Information).

 Each party must preserve in confidence the Confidential Information of the other party per Clause 16.1 (Confidential Information).

14.3.23 Customer need not pay Provider more to use deliverables

  1. This section applies if Provider has any legal right to restrict Customer's use of deliverables,
    • for example under a patent or copyright.
  2. In that situation, Provider will not object to Customer's use,
    • in whatever manner Customer sees fit,
    • of any deliverable resulting from services under the Contract,
    • without additional compensation to Provider,
    • unless the Contract or the statement of work clearly says otherwise..

14.3.24 Customer may have further work done on deliverables

Unless clearly stated otherwise in the Contract, Customer may:

  1. modify or otherwise continue development of any deliverable, and/or
  2. have the same done by others on behalf of Customer,

but only in accordance with the provisions below in this section.

14.3.25 Provider need not support further development by others

No: Provider may, in its sole discretion (as defined in Clause 25.19), decline to provide support for a deliverable

  • if Provider reasonably determines that the request for support
  • arises from, or relates to, modification of the deliverable
    • by any individual or organization other than Provider,
  • except to the extent — if any — that Provider has:
  1. expressly and in writing, authorized or directed the particular modification, and
  2. committed in writing to support the modification.

14.3.26 Are Customer's developers restricted in their actions?

Possibly: Any permitted deliverable-related modification‑ or development activity, by or on behalf of Customer, must not violate:

  1. applicable law such as export-controls laws; nor
  2. any unrelated IP rights assertable by Provider, if any, nor
  3. any additional restrictions specified in the Contract.

14.3.27 May Customer terminate a statement of work "at will"?

Yes: Customer may terminate any statement of work "at will" (or, "for convenience"),

Commentary

Alternative: "Customer may not terminate a statement of work until the following prerequisites are satisfied: [Describe in detail in the Contract]."

Alternative: "Neither party may terminate a statement of work at will."

Pro tip: If Customer wants the right to terminate a statement of work "at will" (or "for convenience"), Provider might want to impose limits, or perhaps require an early-termination fee, so that Provider will have a chance —

  • to recoup at least some of the the investment that Provider makes in tooling, materials, training, etc., to perform the statement of work; and/or
  • to find replacement revenue to support Provider's personnel who are assigned to Customer's account.

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14.3.28 Either party may terminate for material breach

Any specified party may terminate a statement of work for material breach (as defined in Clause 25.33.2) by the other party,

  • effective immediately upon notice of termination to the other party,
  • if both of the following prerequisites are satisfied:
    1. The terminating party gives the breaching party notice (as defined in Clause 24.17) that specifies the breach in reasonable detail; and
    2. Before the end of five business days after the effective date of the notice of breach, either or both of the following have not occurred:

      • (i) cure of the breach, and
      • (ii) effective notice from the breaching party, accompanied by reasonable supporting evidence, informing the terminating party of the cure.

14.3.29 Some Provider breaches are automatically "material"

Yes: Except as otherwise agreed, Customer may terminate a statement of work for material breach, as provided above, if any one or more of the events listed below occurs:

  1. Provider does not timely start to perform the services, if the parties have agreed in writing that a specific start time is material, AND Customer terminates the statement of work before Provider does start performance;
  2. Provider is clearly shown to have permanently abandoned performance;
  3. Provider is clearly shown to have temporarily suspended performance IF the Contract or the statement of work prohibits suspension; or
  4. Provider does not timely complete the services, in compliance with the standards set forth in the Contract and/or the statement of work, IF the parties have agreed in writing that timeliness is material (for example, by stating that time is of the essence).

14.3.30 Termination is not Customer's sole remedy for breach

No: Customer's right to terminate a statement of work for breach by Provider would be in addition to any other recourse available to Customer under an agreement, the statement of work, or the law (subject to any agreed limitations of liability).

14.3.31 What must Provider do after termination?

Promptly after any termination of a statement of work:

  1. Provider is to cause the "Termination Deliverables," namely the following, to be delivered to Customer or to Customer's designee:
    1. all completed deliverables and work-in-progress for that statement of work — those, however, will remain subject to any agreed restrictions on providing them to competitors of Provider;
    2. any equipment that was provided or paid for by Customer for use in connection with that statement of work;
    3. any Customer-owned data that was provided by or on behalf of Customer; and
    4. any Customer-owned data that was generated by or on behalf of Provider, in connection with that statement of work.
  2. Provider is to send Customer one or more final invoices for the statement of work,

14.3.32 What must Customer do after termination?

Promptly upon any termination of a statement of work, Customer is to pay:

  1. all then-pending Provider invoices; and
  2. Provider's subsequent final invoice(s) for previously unbilled services,
    • and/or (if applicable) reimbursable expenses,
    • to the extent consistent with any payment prerequisites in the statement of work,
    • for example, any requirement that particular milestones be achieved as a prerequisite for payment,
    • unless otherwise agreed in writing.

14.3.33 Confidentiality obligations (if any) will continue

Upon termination of a statement of work, each party must continue to honor any applicable confidentiality obligations stated in the Contract and/or in the statement of work.

14.3.34 What if one party goes on another's premises?

Clause 19.16 (Site Visits Protocol) will apply if either party's personnel visit physical premises of another party

14.3.35 What if one party accesses another's computers?

Clause 19.3 (Computer System Access Prococol) will apply if either party's personnel access another party's computer system(s) and/or network(s)

14.3.36 Exercises and discussion questions

14.3.36.1 Discussion: Scope changes not in writing

FACTS: You represent MathWhiz and are helping to negotiate its services agreement with Gigunda.

Gigunda objects to your draft of a "Services" section of the agreement because it says, in effect, that all "scope changes" to the agreed services must be in writing.

Giguna's negotiator says, we don't want to have to bother with a writing — we're in a time-sensitive business where we often have to move fast, so we need to be able to call up MathWhiz and just tell them what changes we need to the services.

QUESTIONS:

  1. If MathWhiz were to accept Gigunda's proposed change, what risks could that pose to MathWhiz?
  2. What kind of language could you propose to address Gigunda's concerns while still providing MathWhiz with protection?
14.3.36.2 Service agreements – discussion questions (1)

1.  Is it generally a good idea to require that statements of work must be in writing?

2.  Is it generally a good idea to require that changes to statements of work must be in writing?

3.  How much time should a lawyer spend reviewing the statement of work for a client?

4.  Should Provider agree to obtain all permits and licenses needed related to the performance of services? (Careful: Think broadly about what permits and/or licenses might be needed "related to" the services.)

5.  What could happen if Provider failed to get required occupational licenses, e.g., construction-contractor licenses?

6.  FACTS: A home builder finishes a new house and turns the keys over to a young couple, who move in with their new baby (and the wife's in-laws, visiting from out of town). BUT: The builder failed to get the final city inspection done, so the city orders the family to move out, and they have to spend three days in a hotel. QUESTION: Who pays the hotel bills?

7.  Why would a customer/client want to require a contractor to use people who are "competent and suitably trained for the task"? (Think: Litigation proof.)

8.  What does "workmanlike performance" mean? Why is that typically used as a standard of performance for services?

9.  Why might a customer want to state that the service provider is responsible for determining the "means and manner" of the work?

10.  What are "the Three Rs" for defects in deliverables?

11.  Under what circumstances might Provider want to prohibit Customer from modifying deliverables?

14.3.36.3 Services - topics for discussion (2)

12.  [@12] What's a sensible "default" payment schedule for services?

13.  Under what circumstances might Customer want to prohibit Provider from suspending services, even for nonpayment?

14.  Why might Customer want to specify that failing to start the services on time is a material breach? (What makes a material breach special?)

15.  More generally: Why list specific events of material breach?

16.  Should Customer have the right to terminate a statement of work "at will" (synonym: "for convenience")? What factors would go into that analysis?

17.  Should Customer own the IP rights in deliverables created by Provider under the statement of work?

14.3.36.4 Drafting quirks: Reps and warranties for services

The following are examples of services-related representations and warranties drafted by students.

1.  "Service Provider warrants that there are no copyright infringement or trade secret violations in the work that Service Provider will provide to Customer." DCT COMMENT: I'd be inclined to say that there will be no copyright infringement, etc. Also: Good job on the "will provide" — MathWhiz will want to warrant only its work as provided, not as perhaps later modified by Gigunda.

2.  "Service Provider warrants that the work will be performed in a professional manner that is serviceable (“Work-Man Like Manner”)." DCT COMMENT: This is three different standards, which could be confusing. "Workmanlike" is pretty much a standard term, as discussed in the reading, so there's no need to define the term (also, it's a single, non-hyphenated word).

3.  "Service Provider represents and warrants that Service Provider’s business includes analyzing seismic data." DCT COMMENT: This doesn't really do much for Customer, and wouldn't normally be included.

4.  "Service Provider represents and warrants that in the past, to individuals and organizations that are not Customer, Service Provider has successfully predicted where oil or natural gas deposits might be." DCT COMMENT: This is creative thinking. One possible problem: If a problem were to arise, Gigunda might demand to see examples of MathWhiz's prior work for other customers — and MathWhiz might be violating confidentiality obligations to its other customers if it were to produce such information.

5.  "Service Provider warrants that Service Provider is headed by Mary." DCT COMMENT: Another interesting idea — although if Mary signs the document on behalf of MathWhiz, does it really do anything significant for Gigunda?

6.  "So far as Service Provider is aware, some individuals have called Mary an “expert” in analyzing seismic data to determine where oil and gas natural deposits may be." DCT COMMENT: Good job in saying "some individuals," but that would open the door to Gigunda's asking (in litigation or arbitration), just who are those individuals, and when can we depose them?

7.  "Service Provider warrants that Service Provider employs several junior associates and subcontracts with others to do specialized tasks to determine where oil and gas natural deposits may be." DCT COMMENT: This doesn't seem necessary; if anything it'd be a disclosure that MathWhiz would want Gigunda to acknowledge so that Gigunda can't later claim that it thought Mary would be doing all the work.

8.  "Unless otherwise provided below, the representations and warranties herein are made only after the representing party has personal knowledge, or has inquired, researched, or otherwise confirmed that the items represented are true." DCT COMMENT: This raises the bar for each representing party; I'd be more inclined to reverse the presumptions.

9.  "The Parties represent that they are not a party to any other agreement or involved in any pending litigation that could reasonably pose a risk of materially interfering with performance of its obligations under this Agreement." DCT COMMENT: I'd change this to say that "Each party represents to the other …." As written, it could arguably be ambiguous, as I'll explain.

10.  "Service Provider represents and warrants it will exercise commercially reasonable efforts, and follow industry standards when analyzing Client’s data." DCT COMMENT: I'd just make this a covenant: Service provider will use commercially reasonable efforts and follow industry standards …. [What standards would those be?]

11.  "Each party to the agreement represents to each other party of the agreement that, so far as the representing party is aware, the following are true:" DCT COMMENTS: (A) Repeating "to the agreement" seems a bit much. (B) I'd be more "granular" in stating the knowledge qualifier: It might be appropriate for some reps and not for others.

12.  "The representing party has made a reasonable inquiry concerning the [above] matters." DCT COMMENT: Same comment as above: This raises the bar.

13.  "Contractor warrants that all of Client’s seismic data relating to the Mongolian Field and all related work product, as well as any other proprietary information shared by Client, will not be shared with any third party unless expressly instructed in writing by Client." DCT COMMENT: I'd make this a covenant, not a warranty — it's a prohibition.

14.  "Client represents and warrants that all seismic data from the Mongolian Field was lawfully obtained and that Client has the legal power to share the data with Contractor." DCT COMMENT: I like this.

15.  "So far as Client knows, without any particular investigation, Client is the true and undisputed owner of the Data at any such time that the Data is submitted to Contractor for analysis." DCT COMMENST: (A) This is a representation — MathWhiz would probably want a warranty. (B) "… true and undisputed owner" seems a bit redundant.

16.  "Contractor represents that all Deliverables will be completed by using Data provided by Client in compiling such Deliverables." DCT COMMENT: It's not clear to me how this works or how it would benefit Client; it seems to state the obvious.

17.  "So far as Contractor knows, Contractor will use only standard industry practices to analyze such Data in completing the Deliverables and will not rely on unproven techniques or methods without Client’s expressed consent." DCT COMMENT: Gigunda would want this to be a covenant, not a knowledge rep. (The student also added a consultation requirement, which is good.)

18.  "[MathWhiz represents that] Math-Whiz LLC employs several junior analysts and selectively engages subcontractors." DCT COMMENT: Same as before: This is more a disclosure, to be acknowledged by Gigunda, than a repreasentation.

19.  "Math-Whiz LLC represents to Gigunda that, so far as it is aware, the following assertions are true: …" (emphasis in original). DCT COMMENT: If I were drafting on behalf of a representing party, I wouldn't italicize "represents"; no point in raising a possible red flag any more than necessary.

20.  "Math-Whiz represents and warrants to Gigunda Energy that: … (iv) that its products do not infringe on any third party’s patent." DCT COMMENTS: (A) "That" is duplicated. (B) MathWhiz would normally not want to represent and warrant that its "products" (meaning what, exactly) don't infringe on third-party patents.

21.  "3.0 GENERAL REPRESENTATIONS AND WARRANTIES [¶] 3.1 During the term of this Agreement, neither party will enter into any agreement that would interfere with that party’s performance of its obligations under this Agreement." DCT COMMENT: Section 3.1 is not a representation, nor is it really a warranty — it's a prohibition.

22.  "Seller represents and warrants that it has or can obtain the necessary tools and expertise to analyze Seismic Data in a manner commensurate with the industry standard at the time of the Seller’s signing of this Agreement." DCT COMMENTS: (A) What industry standard? (B) If I were Gigunda, I'd be nervous about this — I'd want to hire someone who already has "the necessary tools and expertise" to get the job done.

23.  "Seller warrants that it will make a good faith effort to remain in compliance with applicable laws throughout the term of the Agreement." DCT COMMENT: Gigunda will probably want MathWhiz to flat-out commit to remaining in compliance. QUESTION: How might MathWhiz counter such a request?

24.  "Service Provider represents [and warrants] that it has the experience and personnel necessary to perform its obligations under this Agreement in a commercially reasonable manner." DCT COMMENTS: (A) Good idea for Gigunda to ask for this kind of rep — think of the Hill of Proof and how easy it'd be for a judge, jury, or arbitrator to determine (i) that the work wasn't done properly, vs. (ii) that the MathWhiz people didn't know what they were doing. (B) Instead of "in a commercially reasonable manner," use "in accordance with this Agreement" or "in accordance with the Statement of Work." QUESTION: Why B?

25.  "Service Provider represents [and warrants] that it is not infringing on any intellectual property rights." DCT COMMENTS: (A) Gigunda can ask for this, but MathWhiz should be reluctant to agree. QUESTION: Why? (B) "… it is not infringing …." is vague; what should Gigunda want to nail down?

26.  A couple of students wrote really-skimpy warranties that didn't address either (i) performance of the work, nor (ii) infringement risks. Gigunda would definitely want those to be addressed, so it would behoove MathWhiz to offer up something that has a reasonable chance of getting by Gigunda's contract reviewer. Otherwise, Gigunda might copy and paste its preferred language, which might be very onerous to MathWhiz.

14.4 Services terms (optional)

14.4.1 Option: Mitigation of Schedule Slips

  1. This Option applies if a statement of work clearly states that a particular milestone:
    1. is material, and
    2. must be completed by a specified date.
  2. If that milestone is not completed by the specified date,
    • then Provider must make efforts that are reasonable under the circumstances
    • to mitigate any harm resulting from the delay
    • and to get the statement of work back on schedule.

14.4.2 Option: Prohibited Use of Deliverables by Others

Customer may not allow others (for example, Customer's other contractors) to use deliverables under an agreement,

  • not even for Customer's own business purposes.

14.4.3 Option: Customer Ownership of IP Rights

  1. As between Provider and Customer, Customer will own:
    • all intellectual-property rights (if any) in and to any deliverables
    • created in the performance of Provider's obligations under a statement of work,
    • by one or more employees of Provider (and/or of Provider's subcontractors, if any).
  2. Provider is to seasonably (as defined in Clause 25.49) disclose to Customer,
    • in writing, and in as much detail as Customer reasonably requests,
    • all technology and other intellectual property
    • that the statement of work calls for to be owned by Customer.

14.4.4 Option: Loss of Rights for Nonpayment

Customer's timely payment of any amounts required by the applicable statement of work,

  • in respect of a particular deliverable,
  • is a prerequisite to Customer's continued exercise of its rights in that deliverable.

14.4.5 Option: Post-Termination Deliveries Delay

If Provider's already-sent invoices,

  • for any statement of work,
  • are past due when any statement of work is terminated,
  • then Provider may delay delivery of one or more Termination Deliverables,
  • for any statement of work
  • until all of Provider's past-due invoices are paid in full.

14.4.6 Option: Customer Post-Termination Payment Delay

Upon termination of a statement of work,

  • Customer need not pay Provider's final invoice(s) for then-unbilled services, if any,
  • until Provider has complied with its applicable post-termination obligations
  • for that statement of work.

14.4.7 Option: Adjustment of Final Payment for Material Breach

If a statement of work is terminated for material breach (as defined in Clause 25.33.2) by Provider,

  • then Customer's final payment obligation is to be adjusted appropriately,
  • preferably as agreed by the parties in accordance with [BROKEN LINK: disp-mgmt-appx][BROKEN LINK: disp-mgmt-appx] (Dispute Management Rider),
  • but if not, as determined by a tribunal of competent jurisdiction
  • in accordance with Clause 23.4 (Baseball-Style Dispute Resolution).

14.4.8 Option: Expiration as Termination

Unless clearly agreed otherwise in writing,

  • an expiration of a statement of work is to be considered a form of termination.

14.5 Defect Correction Protocol

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when:—
    • a signatory party specified in the Contract,
      • referred to as "Provider,"
    • must correct defects in goods or services provided to another party,
      • referred to as "Customer."
  2. For clarity: The term "Provider" is used for convenience,
    • but the defective goods or services might actually have been provided by another party,
    • for example (as defined in Clause 25.23), if a third-party service provider is to deal with defects as stated in this Clause.

Discussion checklist:

Commentary

This Clause represents a fairly-standard protocol for correction of software defects; it should also be useful in other contexts.

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14.5.1 What is Customer's deadline for reporting defects?

Provider's obligations under this Clause apply only to defects —

  • that Customer reports in writing to Provider (or Provider's designee),
  • on or before 90 days after:
    • the date of delivery of the relevant deliverable,
    • or completion of the relevant service,
    • as applicable.
Commentary

Providers will want to establish a cutoff date for their defect-correction obligations.

Customers, of course, will want to make sure that the cutoff date is far enough ahead that defects are reasonably certain to become apparent.

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14.5.2 What must Provider do about reported defects?

Provider is to address defects as specified in Plan A and Plan B below.

14.5.2.1 Plan A: Repair, replacement, or workaround

For any defect that is timely reported under § 14.5.1,

  • and that Provider is capable of reproducing by making reasonable efforts,

Provider is to do one or more of the following:

  1. Correct the defect, which may include, without limitation:
    • repairing or replacing a defective deliverable, and/or
    • re-performing defective services; or
  2. deliver a commercially-reasonable workaround for the defect,
    • if Provider reasonably determines that correction would be impracticable,

in either case, before the end of 30 days after Provider's receipt of the defect report.

Commentary

The concept of a workaround comes from the software world; it might or might not be relevant in other fields.

This language should not be interpreted as creating a long-term warranty of deliverables' future performance. Indiana's supreme court held that "we 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."

The supreme court did note that "parties could agree that the limitations period will stop running while a seller attempts to repair defective goods and resume when repairs are completed."

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14.5.2.2 Plan B: Refund

If Provider does not timely take the action or actions required by this Clause for a particular defect,

then Provider is to promptly do the following:

  • cancel any unpaid invoice calling for payment, by or on behalf of Customer, for those deliverable(s) and service(s), and
  • cause a refund to be made of all amounts paid, by or on behalf of Customer, for the relevant deliverable(s) or service(s),
  • in either case at Customer's written request.
Commentary

This states that Provider is to "cause" a refund to be made; this language anticipates that Customer might have purchased the relevant goods or services via a reseller or other third party.

Caution: Providing the right to a refund as a "backup" remedy might be crucial in case other agreed remedies fail:

  • Consider: 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."
  • 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.

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14.5.3 Does Customer have any other legal remedies for defects?

No: Provider's defect-correction obligations stated in this Clause

  • are Provider's only obligations,
  • and the EXCLUSIVE REMEDIES available to Customer
    • (or any individual or organization claiming through Customer),
  • for any defect in goods or other deliverables or in services.
Commentary

Suppliers are very prone to include exclusive-remedy provisions like this in their terms of sale. 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.

Some drafters might want to provide a schedule of different reporting deadlines for different categories of defect, based on (for example) how long it might take for a particular category of Defect to become apparent.

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14.5.4 Terminology: What is a "defect"?

For purposes of this Clause, the term defect, whether or not capitalized, refers:

  • to any failure,
    • by one or more deliverables and/or services provided under the Contract,
  • to comply with agreed written specifications, for example (as defined in Clause 25.23), in:
    • the Contract itself;
    • a purchase order for goods;
    • or a statement of work for services.
Commentary

The definition of defect is fairly standard — notably, it does not include a materiality qualifier, because the materiality of defects can be addressed in other provisions.

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14.6 Referrals Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract,

  • a specified party ("Company") is to pay another specified party ("Associate")
  • commissions on Company sales
  • during a specified time period ("Commissionable Sales Period")
  • to otherwise-eligible customers in a specified territory and/or market segment ("Territory")
  • that are referred to Company by Associate during a specified time period ("Referral Term").

Discussion checklist:

14.6.1 How much will each commission be?

Commissions will be 0.001% of eligible sales as specifed in more detail in this Clause.

(This is a placeholder that will apply only if the Contract does not specify otherwise.)

14.6.2 What offerings are eligible for commissions?

All "Company offerings" are eligible for commissions; this refers to Company products and/or services that are —

  • offered for sale by Company,
  • in the Territory,
  • during the Referral Term.

14.6.3 Referrals for what "Territory" are commission-eligible?

The term "Territory" refers to:

  • anywhere in the world,
  • in all market segments.

14.6.4 Referrals during what time period are eligible?

  1. The "Referrals Term":
    • begins upon the effective date of the Contract,
    • and ends at the end of the day (as defined in Clause 25.16) on the date two years after that.
  2. In case of doubt: Only otherwise-eligible referrals made during the Referrals Term are eligible for commission payments.

14.6.5 Could a given referral "go stale?

Yes: For Associate to be entitled to any commissions

  • for Company's sales to an otherwise-eligible referred customer,
  • Company's first sale of a commission-eligible Company offering to that customer
  • must be made on or before the date one year after Associate's initial referral of that customer to Company.

14.6.6 When will a Company sale be considered "made"?

For commission purposes, an otherwise-eligible sale to a customer is considered "made"

  • on the date that Company and the customer in question enter into a binding agreement for that sale,
  • regardless of the putative effective date of that agreement.
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.

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14.6.7 How long will commissions be paid for a referral?

Company need not pay commissions

  • for an otherwise-eligible sale to a customer,
  • if that sale is "made" (see Clause 14.6.6)
  • after the end of one year after Company's first sale to that customer.
Commentary

Note that under Clause 14.6.11, the due date for a commission payment might be after the end of this period.

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14.6.8 Will the Referrals Term be automatically extended?

No: If the Contract does provide for automatic extension of the Referrals Term (defined in Clause 14.6.4),

14.6.9 Are Associate's referral rights exclusive?

Not unless the Contract clearly says so.

If the Contract does provide for any type of exclusivity,

14.6.10 Must Associate meet any performance requirements?

Not unless the Contract clearly says so.

The Contract, however, may provide, for example (as defined in Clause 25.23) for one or more of the following:

  • minimum referrals by Associate,
  • and/or minimum sales by Company,
  • in a specified time period,
  • failing which (for example) Company may terminate Associate's right to receive commissions.

14.6.11 When are commission payments due?

A: 30 days after the end of the fiscal quarter in which which Company collects the associated invoiced price.

Payments are to be in accordance with Clause 13.12 (Payment Terms).

14.6.12 Does anyone have confidentiality obligations?

Yes, as follows:

  1. Clause 16.1 (Confidential Information) will apply,
    • but only as to Company's Confidential Information.
  2. The terms of the parties' commission arrangement are Company's Confidential Information.

14.6.13 How will Company report the commissions due?

With each commission payment, Company will provide Associate with:

  • a complete and accurate written statement of the amount(s) due,
  • with reasonable supporting detail.

14.6.14 What supporting records must Company keep?

Company must keep records to support commission amounts due

14.6.15 May Associate verify Company's reports?

Yes: Associate may have Company's commission records audited;

14.6.16 In general, which sales are eligible for commission?

Associate will be eligible for commissions only —

  • on Company's sales of Commission-Eligible Offerings
  • to new customers that Associate refers to Company (each, a "Prospect"),
  • where each of the following requirements is satisfied:
  1. The Prospect must have substantial operations in the Territory —
    • Company's determination of the substantial-operations question will be final and binding.
  2. Associate must have referred the Prospect to Company during the Referrals Term.
  3. The Prospect must not be barred by law from acquiring the Offering(s) in the Geographic Territory.
  4. The Prospect must not be a competitor of Company
    • unless Company gives its prior written consent.
  5. The Prospect must not have had a previous connection or relationship with Company
    • at the time of Associate's initial referral;
    • Company's determination of that point will be final and binding.

14.6.17 Are any invoiced items not commisionable?

Associate will not be eligible for commissions on any of the following:

  1. separately itemized charges for taxes, shipping, and insurance; nor
  2. a reasonable allowance for returns,
    • in accordance with Company's then-generally-effective return policy,
    • which is to be determined by Company in its sole judgment from time to time,
    • but is to be consistently applied.

14.6.18 May Associate hold itself out as Company's agent?

No.

See also Clause 24.11 (Independent Contractors).

14.6.19 Who will control customer sales negotiations?

  1. Associate's role (if any) in Company's sales negotiations with Prospects will be determined exclusively by Company in Company's sole discretion (as defined in Clause 25.19).
  2. Associate must follow Company's lawful directions in that regard.
  3. Associate must not attempt to insert itself into any such negotiation without Company's prior approval.

14.6.20 Who will be responsible for warranty claims?

If a customer or other third party makes a claim (as defined in Clause 25.12) against Associate

  • because of what the third party alleges was a breach of a Company warranty about a Commission-Eligible Offering,

then Company will defend (as defined in Clause 21.4) Associate's Protected Group (as defined in Clause 25.40) against the claim.

14.6.21 Who will be responsible for alleged Associate faults?

If a third party makes a claim (as defined in Clause 25.12) against Company

14.6.22 Referrals exercise

FACTS: MathWhiz is all excited because Gigunda wants to refer potential clients to MathWhiz — but Gigunda wants to be paid a referral fee for each referral.

QUESTIONS:

  1. From MathWhiz's perspective, what should have to happen before MathWhiz is obligated to pay Gigunda a referral fee?
  2. What what Gigunda prefer to be the trigger for getting a referral fee?
  3. Is there any way to compromise between 1 and 2 above?
  4. Is there any way that MathWhiz could avoid paying a referral fee?

14.7 Resale Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract:

  • a specified party ("Reseller"),
  • is to acquire and resell Resale Offerings,
  • of another party ("Supplier"),
  • during a specified Resale Term (as defined in Clause 14.7.4);
  • this arrangement is sometimes referred to as the "Reseller Relationship."

Discussion checklist:

[Note to drafters: See also the optional terms in Clause 14.8.]

14.7.1 What Supplier offerings may Reseller resell?

Reseller may resell:

  • any and all Supplier products and/or services
  • offered by Supplier
  • during the Resale Term
  • in the Territory,
  • each defined below (the "Resale Offerings").

14.7.2 In what "Territory" may Reseller resell?

Reseller may resell Resale Offerings in the "Territory,"

  • which refers to anywhere in the world, in all market segments.

14.7.3 What discount will Reseller get?

When Reseller acquires Resale Offerings from Supplier,

  • it may do so at a discount of 0.001%
  • from Supplier's then-current, published list price
    • that is applicable in the Territory.
Commentary

The discount level in this section is a placeholder, obviously.

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14.7.4 How long may Reseller engage in resales?

  1. The "Resale Term":
    • will begin on the effective date of the Contract,
    • and will end at the end of the day
      • on the date two years later.
  2. If and when the Resale Term ends, Reseller must permanently cease:
    1. advertising, marketing, or otherwise promote Resale Offerings; and
    2. identifying itself as a channel associate of Supplier.

14.7.5 Will the Resale Term be "evergreen"?

No: Any extension of the Resale Term must be by affirmative mutual agreement.

Commentary

Alternative: The Resale Term will be extended for successive one-year extension terms unless either party opts out, in accordance with Clause 24.8 (Evergreen Extensions).

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14.7.6 This resale channel is nonexclusive

The Resale Relationship is not exclusive to either party unless the Contract clearly says so —

  • but if the Contract does say so,
  • then Clause 25.24 (Exclusivity Definition) will apply.

14.7.7 May Reseller engage subresellers?

  1. Reseller may not appoint a subreseller without first obtaining Supplier's written consent.
  2. Supplier may grant, withhold, or condition its consent to appointment of a subreseller in Supplier's sole discretion (as defined in Clause 25.19).
  3. Before appointing a prospective subreseller (a "prospect"), Reseller must provide Supplier with the following:
    1. the identity of the prospect;
    2. such background information about the prospect as Reseller might reasonably request;
    3. evidence, satisfactory to Supplier in its sole judgment,
      • that the prospect has sufficient training and experience to carry out its duties as a subreseller
      • in a manner that will not reflect adversely on Supplier; and
    4. if requested by Supplier, any authorization required by law
      • for Reseller to cause a background check to be conducted on the prospect.
  4. Each subreseller must enter into an agreement with Reseller (a "Subreseller Agreement"); at a minimum, each Subreseller Agreement must:
    1. impose at least the same restrictions and obligations on the subreseller as this Clause does on Reseller;
    2. clearly state that Supplier will have no liability to the subreseller
      • in connection with the Subreseller Agreement
      • or the subreseller's dealing in Resale Offerings;
    3. prohibit the subreseller from appointing sub-subresellers without Supplier's prior written consent,
    4. terminate automatically at the end of the Resale Term; and
    5. clearly indicate that Supplier is a third-party beneficiary of the Subreseller Agreement.
  5. Reseller must defend (as defined in Clause 21.4) Supplier's Protected Group (as defined in Clause 25.40) against any claim by a third party
    • if the claim arises out of acts or omissions of a subreseller relating to a Subreseller Agreement.

14.7.8 When are Reseller's payments to Supplier due?

Reseller's payments to Supplier for Resale Offering purchases are net 30 days from Reseller's receipt of Supplier's invoice;

14.7.9 Who will support Reseller's customers?

  1. Level 1 support (defined in Clause 14.11.4) for Reseller's customers for Resale Offerings will be provided by Reseller;
    • Level 2 and Level 3 will be provided by Supplier
  2. If Reseller provides support for its customers for Resale Offerings,
    • Reseller will follow any written- and oral guidance for customer support provided to Reseller by or on behalf of Supplier,
    • to the extent that such guidance is not inconsistent with the Contract.
  3. Reseller will promptly notify Supplier if Reseller finds that it is unable to respond effectively to a request for support from a Reseller customer.

14.7.10 What performance requirements must Reseller meet?

During the Resale Term, Reseller must use commercially-reasonable efforts (defined in Clause 25.14) in promoting sales of the Resale Offerings within the Territory.

Commentary

Drafters could come up with a variety of performance-standard terms, such as, for example:

  • dollar revenue to Supplier in a stated period
  • sales penetration in the Territory in a stated period
  • as time goes on, more-stringent standards (to give Reseller a "break-in period")
  • rewards for over-achieving the targets

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14.7.11 What if Reseller fails to perform as agreed?

If Reseller does not meet the performance standard set forth in Clause 14.7.10,

  1. invoke Clause 19.15 (Performance Improvement Plans), and/or
  2. terminate the Reseller Relationship,
    • either immediately
    • or if Reseller does not achieve the goals specified in accordance with Clause 19.15.
Commentary

Subdivision 1, putting Reseller "on plan," allows the parties some flexibility in dealing with Reseller's failure to meet agreed performance goals — in many situations this will be a better approach than having Supplier's only choice be to terminate the Reseller Relationship.

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14.7.12 Reseller must keep its Supplier pricing confidential

Reseller is to treat the pricing extended to Reseller by Supplier as the Confidential Information of Supplier

  • in accordance with Clause 16.1 (Confidential Information).

14.7.13 Reseller must preserve Supplier's other confidences

Reseller is to preserve in confidence any Supplier Confidential Information to which Supplier obtains access,

  • in accordance with Clause 16.1 (Confidential Information).

14.7.14 Reseller will not be Supplier's "agent"

Unless the Contract clearly states otherwise, Reseller is not Supplier's agent,

  • and must conduct itself accordingly at all times.

14.7.15 How may the Reseller Relationship be publicized?

  1. The authorizations in this section are effective only during the Resale Term (as defined in Clause 14.7.4).
  2. Each party (each, a "Publicizing Party") may:
    1. publicly identify itself,
      • in a non-misleading way,
      • as, in effect, a channel associate of the other party, and
    2. provide contact information for the other party:
      • (i) on the Publicizing Party's Website, and/or
      • (ii) in promotional materials approved in advance by the other party,
      • but only if the other party has either:
        • (x) made that contact information public, or
        • (y) authorized the Publicizing Party, in writing, to use the contact information.
  3. A Publicizing Party's identification of itself as a channel associate under this Clause may include commercially-reasonable use (as defined in Clause 25.14) use of the other party's relevant logos and other trademarks and service marks (collectively, "Marks");
    • Reseller, however, may not use any Supplier marks other than those under which Supplier markets the Resale Offerings.
  4. A Publicizing Party's use of another party's Marks must conform to Clause 18.6 (Trademark Use).
  5. A Publicizing Party must promptly stop using another party's Marks upon any termination of the Reseller Relationship.
  6. Nothing in this Clause gives either party any right in, nor any right to use, any Mark of another party except as expressly stated in this Clause.

14.7.16 Reseller customers will get Supplier warranties

  1. Supplier will honor the same Resale Offering warranty terms for Reseller's customers as Supplier does for its own customers of the same Resale Offering(s).
  2. Supplier will defend (as defined in Clause 21.4) Reseller's Protected Group (as defined in Clause 25.40) from any claim by any Reseller customer that acquired a Resale Offering from Reseller,
    • where the customer's claim arises out of an alleged breach of a Supplier warranty concerning the Resale Offering.
  3. Reseller will not purport to make (and has no authority to make), on behalf of Supplier, any commitment to any customer of Reseller except:
    1. as publicly stated by Supplier in, for example (as defined in Clause 25.23), Supplier's published marketing materials, end-user license agreement, terms of service, privacy policy, warranty document(s), etc.; and/or
    2. with Supplier's express, prior, written consent.

14.7.17 Reseller may offer its own warranties

Supplier does not object to Reseller's offering Reseller's own additional warranties or other commitments to Reseller's customers that are more favorable to customers than those offered by Supplier, but —

  1. If Reseller does so, it is at Reseller's own risk;
  2. Reseller must make it clear to its customers that Supplier is not liable for Reseller's commitments; and
  3. Reseller must defend (as defined in Clause 21.4) Supplier's Protected Group (as defined in Clause 25.40)
    • against any third-party claim
    • arising from or relating to
    • any such additional warranty or other commitment offered by Reseller.

14.7.18 May Reseller modify Resale Offerings?

  1. Reseller may not package, repackage, modify, or otherwise alter any Resale Offering
    • without Supplier's prior written consent;
    • Supplier may grant or withhold such consent in its sole discretion (as defined in Clause 25.19).
  2. For example (as defined in Clause 25.23), without Supplier's advance written permission:
    1. If any part of a Reale Offering comes to Reseller in a sealed package —
      • for example, a software license-code envelope —
      • then Reseller must not open the package;
    2. If any Resale Offering comes to Supplier in separable components,
      • then Reseller must not separate the components; and
    3. Reseller must not remove or alter any legend or notice,
      • for example, copyright- or trademark notices and the like,
      • and/or warnings or user instructions,
      • on any Resale Offering, promotional materials, or documentation.

14.7.19 Supplier will have no say in Reseller's pricing

As between Reseller and Supplier, Supplier has no authority to determine the prices that Reseller charges to Reseller's customers.

Commentary

This section is intended to avoid any possible issues of resale price maintenance (a.k.a. verti- cal price fixing) under antitrust laws.

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14.7.20 Supplier may change its Resale Offerings

  1. Supplier reserves the right — at any time and from time to time, in Supplier's sole discretion:
    1. to add to or delete from Supplier's line of offerings (defined below);
    2. to modify any particular item in its line of offerings; and
    3. to modify or discontinue support for any such item.
  2. For this purpose, "line of offerings" includes, without limitation:
    1. items that are part of the Resale Offerings, and
    2. support for any such items.
  3. As a matter of commercial practice, Supplier may elect,
    • in its sole discretion (as defined in Clause 25.19),
    • to consult or notify Reseller in advance of any changes that it makes to Resale Offerings.

Supplier is not obligated to do so, however,

  • and Supplier will have no liability to Reseller for any such action that it does take,
  • whether or not Supplier consults with Reseller about the action.

14.7.21 What if Resale Offerings involve software?

This section applies if the Contract clearly states, in substance,

  • that one or more Resale Offerings includes licenses for the use of software,
  • including but not limited to software-as-a-service, or "SaaS" (the "Software").

Contents:

14.7.21.1 Supplier will provide for customer provisioning
  1. Supplier will provide one or more provisioning systems for Reseller's customers to sign up for access to (and licensing of) the Software,
    • typically Web-based or as part of a Software installation routine.
  2. Reseller is to refer all of its customers to such a Supplier-provided provisioning system.
14.7.21.2 Reseller's customers must agree to Supplier's terms
  1. Supplier may require Reseller's customers to agree to Supplier's then-current terms and conditions
  2. Such Supplier terms and conditions may include, without limitation,
    1. applicable end-user agreement(s);
    2. terms of service or ‑use; and/or
    3. a privacy policy.
  3. Reseller must advise each of its customers in writing,
    • for example (as defined in Clause 25.23), in a written quote form,
    • that the customer will be required to agree to Supplier's terms and conditions.
14.7.21.3 Reseller must "push" Supplier's software updates

If Supplier releases a superseding version of a software Resale Offering —

  • including for example an update, patch, new release, supplement and/or add-on component,
  • then Reseller must promptly:
  1. notify all of Reseller's customers of the availability of the superseding version; and
  2. encourage those customers to acquire and install the superseding version.
14.7.21.4 Reseller may make limited use of the Software
  1. Reseller may use the Software — in executable form only — for purposes of:
    1. demonstrations to prospective customers or clients;
    2. testing; and
    3. internal training for Reseller personnel concerning the Software.
  2. All such use of the Software by Reseller must comply with Supplier's applicable terms and conditions (see Clause 14.7.21.2).
  3. Reseller may make a reasonable number of copies of the Software for purposes of backup, disaster recovery, and disaster testing,
    • in accordance with Reseller's normal IT procedures
    • in conjunction with Reseller's use of the Software under this section.
  4. Otherwise, Reseller must not use the Software in any manner —
    • including, but not limited to, production use for Reseller's own benefit,
    • and/or service-bureau use for the benefit of any Reseller customer —

unless Reseller has obtained the appropriate license(s) from Supplier.

14.7.22 What must Reseller do in case of piracy, etc.?

  1. If Reseller suspects that unauthorized use, copying, distribution, or modification of a Resale Offering (collectively, "unauthorized activities") might be taking place, then Reseller must:
    1. promptly advise Supplier;
    2. provide Supplier with all relevant information reasonably requested by Supplier about the unauthorized activities; and
    3. provide reasonable cooperation with any "Policing Efforts" by Supplier, namely efforts to prevent or stop the unauthorized activities.
  2. Whether Reseller's cooperation under subdivision a.3 above is considered reasonable will depend (in part) on the  following:
    1. the likely expense of such cooperation, and
    2. the extent to which Supplier agrees to bear that expense.
  3. Reseller must not make any Policing Efforts of its own without Supplier's prior written approval.

14.7.23 What must Reseller do with customer feedback?

  1. If Reseller receives any written feedback,
    • as defined in subdivision e,
    • concerning any Resale Offering,
    • at any time,
    • then Reseller will provide Supplier with a complete and accurate copy of the written feedback
    • within a reasonable time after Reseller receives it.
  2. If Reseller receives any oral or other nonwritten feedback, concerning any Resale Offering, at any time,
    • then Reseller will brief Supplier orally about the feedback,
    • on a schedule to be determined by Supplier in its reasonable judgment.
  3. Supplier may use or disclose feedback as Supplier sees fit in its sole discretion (as defined in Clause 25.19).
  4. Supplier will have no financial- or other obligation, of any kind, to Reseller or any of its customers, in respect of feedback,
    • unless expressly agreed otherwise in writing by Supplier.
  5. For purposes of this section, "feedback" refers to any and all suggestions, comments, opinions, ideas, or other input.

14.7.24 What must Reseller do if Supplier issues any recalls?

  1. Reseller must provide reasonable cooperation with Supplier and its designees in connection with any recall of Resale Offerings.
  2. At Reseller's request, Supplier will reimburse Reseller for reasonable out-of-pocket external expenses,
    • such as, without limitation, shipping charges by independent carriers for returning physical Resale Offerings,
    • when actually incurred by Reseller in providing the cooperation required by subdivision a,
    • in accordance with Clause 13.3 (Expense Reimbursement Protocol).
  3. Reseller must make any request for reimbursement under subdivision b no later than three months after Reseller pays the relevant expense,
    • otherwise Reseller will be deemed to have WAIVED (as defined in Clause 24.26) reimbursement of that expense.

14.7.25 What rules apply to Reseller's repairs, etc.?

  1. This section applies if Reseller engages in repair or other servicing of Resale Offerings.
    • (This section, in itself, neither authorizes nor prohibits Reseller from engaging in such servicing.)
  2. Reseller must use parts of equal or better quality than the original parts in the Resale Offering.
  3. Reseller may not offer or provide as "new" any Resale Offering that Reseller has repaired after return by a customer.

14.7.26 Reseller may not rebrand any Resale Offerings

Reseller must not promote or offer Resale Offerings using any brand name or other trademark (including for this purpose service marks) other than those authorized in advance by Supplier.

14.7.27 Reseller is responsible for its business dealings

Reseller must defend (as defined in Clause 21.4) Supplier's Protected Group (as defined in Clause 25.40) from and against any and all claims by any third party arising out of Reseller's activities under an agreement.

14.7.28 Does Reseller get any other rights from Supplier?

No: Supplier reserves all rights not specifically granted by the Contract;

  • this reservation includes (without limitation) copyrights, patent rights, trademark and service mark rights, trade secret rights and other intellectual property rights.

14.7.29 This is not a franchise or business opportunity

  1. This section applies unless the Contract clearly and unmistakably provides otherwise.
  2. No party intends, by entering into the Contract, to create a relationship that would be subject to laws governing franchises and/or business opportunities.
  3. Each party WAIVES (as defined in Clause 24.26),
    • to the fullest extent not prohibited by law,
    • any rights or claims,
      • arising out of or relating to the Contract,
    • under laws governing franchises and business opportunities or similar laws.
Commentary

Caution: In some jurisdictions, this clause will be unenforceable or even void; see, e.g., Cal. Corp. Code § 31512: "Any condition, stipulation or provision purporting to bind any person acquiring any franchise to waive compliance with any provision of this law or any rule or order hereunder is void."

Even so, language like this clause is sometimes seen in contracts.

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14.7.30 Supplier is not responsible for Reseller's finances

Reseller agrees that Supplier has no responsibility for —

  • any dependence that Reseller might have on its ability to resell Resale Offerings for Reseller's revenues,
  • nor for any harm that might come to Reseller from the Resale Term's coming to an end.

14.7.31 May either party terminate at will?

Neither party may terminate the Reseller Relationship at will unless the Contract clearly provides otherwise.

Commentary

Alternative: "Beginning one year after the effective date of the Contract, either party may terminate the Reseller Relationship at will upon 30 days' notice in accordance with the termination-at-will provision in Clause 24.23.8."

Comment: If a party is going to have the right to terminate the Reseller Relationship at will, the other party should carefully consider putting appropriate "fences" around that right, so that the other party does not —

  • get caught unawares and left in the lurch; and/or
  • not be able to recoup its investment in the relationship.

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14.7.32 Termination will not cut of Reseller's customers

In case of doubt: The ending of the Reseller Relationship will not affect any then-established rights or obligations of Reseller's customers concerning Resale Offerings.

Commentary

Reseller might want it "carved in stone" that Supplier won't abandon Reseller's customers after termination of the Reseller Relationship.

(In many cases that should be a given: Supplier won't want to abandon Reseller's customers because Supplier will want to transition those customers into a direct relationship with Supplier or over to a different reseller.)

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14.7.33 May Reseller close pending sales upon termination?

If the Contract clearly says so,

  • after termination of the Reseller Relationship,
  • Reseller may try to close any pending sales,
  • as stated in Clause 14.10 (Wrap-Up Protocol),
  • for five business days after the effective date of termination —
  • but not if the Reseller Relationship was terminated by Supplier
Commentary

This Clause might be a negotiation point.

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14.7.34 Other terms to consider

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

14.8 Resale terms (optional)

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

14.8.1 Data About Reseller Customers

  1. Reseller will provide Supplier with data about Reseller's customers and transactions involving Resale Offerings as follows:
    • from time to time, as reasonably requested by Supplier for purposes relating to the Reseller Relationship; and
    • at the end of the Resale Term, as reasonably requested by Supplier to transition Reseller's customers to a relationship directly with Supplier.
  2. Each party is to follow any restrictions imposed by law on the use and/or disclosure of customer data provided by Reseller.
Commentary

If Supplier has other ways of obtaining customer data from Reseller — e.g., software onboarding; warranty registrations; frequent-user clubs; and the like — then Supplier might not need to get Reseller to commit to providing customer data.

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14.8.2 Reseller's marketing obligations

Without limiting Reseller's other obligations under the Contract, Reseller will engage in the specific marketing efforts set forth in Schedule [FILL IN SCHEDULE NUMBER].

14.8.3 Marketing consultation

To reduce the chances of mutual interference between Supplier's and Reseller's marketing activities, Reseller must consult Supplier in advance about Reseller's own proposed marketing activities concerning Resale Offerings.

14.8.4 No customers outside the Territory

Reseller must not solicit or support any customer for Resale Offerings if the customer has significant operations outside the Territory.

14.8.5 No Reseller facilities outside the Territory

Reseller must not establish or maintain facilities specifically for supporting customers' use of Resale Offerings if such use is reasonably likely to occur outside the Territory.

14.8.6 No extra-Territorial availability

Reseller must not make any Resale Offering available to any individual or organization if Reseller knows, or should know, that the Resale Offering will be taken, installed, or used outside the Territory.

14.8.7 No competition

During the Resale Term and for one year thereafter, Reseller must not participate, nor acquire any interest, in any enterprise that offers or promotes a product or service that competes with any Resale Offering, unless Supplier gives its prior written consent.

14.8.8 Minimum inventory

Reseller must keep a minimum quantity of Resale Offerings in inventory as follows: [DESCRIBE].

14.8.9 Maximum inventory

Reseller must not keep more than [AMOUNT] of Resale Offerings in inventory without Supplier's prior written consent.

14.8.10 Reseller retail sale

Reseller may offer or sell Resale Offerings from physical premises (for example, in stores).

14.8.11 Reseller retail sale

Reseller must not offer or sell Resale Offerings from physical premises (for example, in stores) without Supplier's prior written consent

14.8.12 No other Resale Offering sources

Reseller must not acquire Resale Offerings from sources other than Supplier.

14.8.13 No Resale Offerings to non-end-customers

Reseller must not provide Resale Offerings to others for resale or redistribution.

14.8.14 Reseller delivery to its customers

As between Reseller and Provider, Reseller is responsible for acquiring any physical Resale Offerings and — at its own expense and risk — arrange for all storage and/or delivery to Reseller's customers.

14.9 Marketing Plan [to come]

If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.

Discussion checklist:

14.10 Wrap-Up Protocol

14.10.1 When does this Clause apply?

When this Clause is agreed to, it applies whenever both of the following are true:

  1. a specified relationship, authorization, or grant of rights, governed by the Contract (referred to generically as the "Relationship"), comes to an end,
    • whether by expiration or termination; and
  2. the Contract states that a party will have time after the end of the Relationship in which to wrap up any pending business (the "Wrap-Up Period").

14.10.2 How long can a party wrap up pending business?

The Wrap-Up Period —

  • will begin on the date that the Relationship comes to an end; and
  • will end, at the end of the day, ten business days thereafter,
    • or such other time as specified in the Contract .

14.10.3 What if the party is in material breach?

A party will not have a Wrap-Up Period if that party is in material breach (as defined in Clause 25.33.2) of the Contract when the Relationship ends.

14.10.4 What wrap-up activities are allowed?

A party entitled to a Wrap-Up Period may attempt to complete any then-pending transactions that would have been authorized by the Contract before the end of the Relationship,

  • on the same terms as before the end of the Relationship,
  • except as otherwise stated in this Clause.

14.10.5 Must wrap-up transactions be pre-cleared?

If a party wishes to take advantage of the Wrap-Up Period,

  • then, not later than two business days after the date that the Relationship ends,
  • that party must furnish the other party
  • with a complete written list of pending transactions expected to be completed during the Wrap-Up Period.

14.10.6 Must wrap-up eligibility be confirmed?

If a party asserts the right to complete a particular transaction during a Wrap-Up Period,

  • then the other party may ask the asserting party to furnish evidence,
  • reasonably satisfactory to the other party,
  • that the asserting party had in fact been actively engaged in negotiating that transaction before the end of the Relationship.

14.11 Template clauses for software

14.11.1 Terminology: Software; Licensor; Customer

The clauses in this Chapter 14.11 relate to computer software of any kind in any form ("Software"),

  • provided to a party to the Contract, referred to as "Customer,"
    • even if that party is technically not a customer,
  • by (directly or indirectly) another party, referred to as "Licensor."

14.11.2 Software License Protocol

14.11.2.1 Terminology: Software; Customer; License

Clause 14.11.1 (Terminology: Software; Licensor; Customer) is incorporated into this Clause by reference.

14.11.2.2 How is a "Software License" granted?
  1. A "Software License" must be granted by a written document,
    • which is referred to for convenience as a "License Granting Document."
  2. In case of doubt: In some circumstances, the Software License might be granted
    • via a reseller or other intermediary
    • and not directly by Licensor.
14.11.2.3 What form(s) may a License Granting Document take?

A License Granting Document might take the form of, for example:

  • a purchase order;
  • a quotation agreed to by (or on behalf of) Customer;
  • and/or an on-line sign-up form:
    • for downloading a copy of the Software,
    • and/or for gaining access to an online version of the Software,
      • for example in the case of so-called software as a service (known in the industry as "SaaS").
  1. The License Granting Document might refer to provisions in one or more external usage plans, service plans, maintenance plans, or similar external documents,
    • in which case those referenced provisions are deemed part of the License Granting Document.
  2. The Contract may specify that the License Granting Document is an Order for purposes of Clause 14.1 (Orders for Goods & Services).
14.11.2.4 When will the Software be delivered?

Licensor will cause the Software,

  • its user documentation (if any),
  • and any required license codes for the Software,
  • to be delivered to Customer promptly upon the parties’ agreement to the License Granting Document,
  • if and to the extent not already done.
14.11.2.5 What must Customer pay for the Software License?

Customer need not pay anything for the Software License except as clearly stated in the applicable License Granting Document.

14.11.2.6 What acceptance testing may Customer do?

Once Customer has agreed to the License Granting Document,

  • Customer is deemed to have completed all acceptance testing of the Software that Customer wants to do,
  • unless the License Granting Document clearly says otherwise.
Commentary

Acceptance testing is a revenue-recognition issue for publicly-traded software companies, many of which offer customers a significant pre-license trial period and therefore assume that customers will not buy a license until satisfied with the testing.

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14.11.2.7 What may Customer do with the Software?
  1. Under the Software License, Customer has only a limited, non-exclusive right to use the executable version of the Software,
    • only during a particular time period specified in the License Granting Document (the "License Term"),
      • although that time period might be perpetual if so stated in the License Granting Document or in the Contract;
    • that right is subject at all times to the terms and conditions of the License Granting Document and the Contract.
  2. The License Granting Document might include limitations
    • on the number of users, servers, and the like,
    • for which use of the Software is authorized by the Software License.
  3. The License Granting Document might also include limitations on replacing one user, server, etc., with another.
Commentary

Here's an example of a real-life license limitation provision that the author once did for a client, adapted to use the above terminology:

3.x Customer may not use the Software in connection with more, in the aggregate, than the number of distinct corresponding "license units" (for example, workstations, servers, users, etc.) for which Customer is licensed as set forth in the applicable License Granting Document, except as otherwise provided in the Contract.

HYPOTHETICAL EXAMPLE: Suppose that Customer is licensed to use the Software for 1,000 users. That means Customer may use the Software for an aggregate of 1,000 individual users in total; it does NOT mean that Customer may use it for an unlimited of total users as long as only 1,000 users are using the Software at any given time.

3.y If Customer permanently replaces one license unit with another one and deletes any and all data maintained by the Software and in respect of that license unit, then Customer may use the Software in connection with the replacement license unit in lieu of the replaced one.

HYPOTHETICAL EXAMPLE: Suppose that Customer is licensed to use the Software, and in fact Customer does use the Service, for 1,000 users. Suppose also that ten of those users leave Customer's company, and that Customer completely deletes all data maintained by the Service for those ten users. In that case, Customer may use the Software for an additional ten users (bringing Customer's total users back up to 1,000) without paying additional license fees.

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14.11.2.8 What could happen if Customer doesn't pay?
  1. Customer's right to use the Software under the Software License is expressly conditioned on Customer's payment of any fees or other charges set forth (or referenced) in the License Granting Document.
  2. If Customer does not timely pay such fees or other charges,
    • then Licensor has the option of revoking the Software License,
    • after any grace period stated in the License Granting Document or otherwise in the Contract.
Commentary

Customer might want to negotiate to include a provision such as Clause 13.12.8 so that continued use of Software after nonpayment of fees does not constitute copyright infringement — which could lead to an award of serious damages such as Customer's profits arising "indirectly" from the infringement; see the discussion of the Frank Music Corp. v. MGM case in the commentary to Clause 13.12.8.

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14.11.2.9 Customer may use the Software for disaster recovery

From time to time during the License Term, Customer may make use of the Software for reasonable disaster-recovery testing and disaster-recovery operations,

  • even if such use technically exceeds the use authorized by the License Granting Document,
  • as long as such excess use does not amount to regular business use.
14.11.2.10 Is service-bureau use permitted?

Customer may not use the Software in providing services to third parties,

  • where functions performed by the Software are a material part of those services,
  • unless clearly provided otherwise
  • in the applicable License Granting Document.
14.11.2.11 Who is responsible for computer hardware, etc.?

As between Customer and Licensor,

  • Customer is exclusively responsible for the supervision, management and control of Customer's use of the Software,
  • and for the provision and proper maintenance of Customer's hardware and supporting software,
  • such as, for example, operating-system updates and virus-protection software,
  • unless the License Granting Document clearly says otherwise.
14.11.2.12 Customer may not bypass usage-control mechanisms

Customer may not attempt (successfully or otherwise) to disable or work around any usage-control mechanism that may be built into the Software,

  • nor permit or assist others to do so or attempt to do so.
14.11.2.13 Reverse engineering, etc., is prohibited
  1. Customer may not decompile, disassemble, or reverse engineer any part of the Software,
    • nor permit or assist others to do so.
  2. If applicable law permits Customer to engage in such activity notwithstanding the Contract,
    • then Customer must provide Licensor with advance notice and reasonably detailed information concerning Customer's intended activities.
14.11.2.14 May Customer sublicense or transfer the Software?

No: Customer may not rent, lease, sell, or sublicense any part of the Software,

  • except to the extent — if any — permitted by
    • the License Granting Document
    • or the the applicable agreed usage plan.
14.11.2.15 New versions will not increase usage limits
  1. If Customer is provided with a new or different version of an item of Software ("New Version"),
    • that fact will not in itself increase the number of license units for which Customer is licensed,
    • even if (for example) the New Version has a different license-installation code than a previous version provided to Customer.
  2. Customer may not use both the New Version and another version if such use would exceed the use permitted by the License Granting Document.
  3. In case of doubt, Customer is not entitled to be provided with any New Version of an item of Software,
    • unless the License Granting Document or the Contract clearly say otherwise.
14.11.2.16 Customer does not acquire ownership of the Software
  1. The Software is licensed, not sold; Licensor and/or its supplier(s), as applicable, retain title and all ownership rights, of whatever nature,
    • to the Software,
    • and to any tangible copy or copies of the Software provided to Customer.
  2. Customer has no rights in the Software other than those expressly granted by the License Granting Document.
14.11.2.17 May copies be provided to others?
  1. The Software (and its documentation, if any) remain the confidential property of Licensor or its suppliers, as applicable.
  2. Customer may not provide copies of the Software to others,
    • nor may Customer disclose any license keys or license codes needed to operate the Software to others,
    • except as clearly permitted by the License Granting Document or by the Contract,
    • or with Licensor’s express prior written consent.
14.11.2.18 Backup copies of the Software are OK

Customer may make a reasonable number of copies of the Software and, if applicable, its documentation, for backup purposes.

14.11.2.19 Licensor may audit Customer's Software usage
  1. Licensor may make reasonable requests that Customer report the actual details of usage of the Software under the Software License,
    • to help confirm that Customer is in fact complying with the license-unit restrictions of the License Granting Document and the Contract;
    • Licensor's request may include asking Customer:
      • to run one or more software reporting utilities,
      • and to provide Licensor with electronic and/or hard copies of any output of such reporting utilities.
  2. Licensor will give Customer at least ten business days to respond to any such request for a Customer usage report.
  3. Customer must timely comply with any such Licensor request.
  4. Licensor may audit Customer's usage reports,
    • upon reasonable notice to Customer,
    • in accordance with Clause 15.1 (Audit Protocol).
  5. Licensor will not disclose or use information in Customer's usage reports,
    • except to help ensure Customer's compliance with the Contract,
    • or as otherwise permitted by the Contract and/or by Licensor's written privacy policy.
14.11.2.20 How long will Licensor support "old" versions?
  1. Licensor will continue to support 'outdated' Software versions,
    • that is, any version that released for general availability
      • more than six months after release of a subsequent major- or minor version,
    • for that period of time.
  2. Licensor might offer longer support for outdated versions, but:
    • whether to do so is in Licensor's sole discretion (as defined in Clause 25.19); and
    • such longer support might require a separate contract and/or additional fees.
14.11.2.21 Customer represents that it is not legally barred from using the Software

Customer represents that, to the best of Customer's knowledge, applicable law does not prohibit Customer from using the Software.

Commentary

See the discussion of export controls in the commentary at § 26.4.

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14.11.2.22 U.S. Government customers: The Software is "commercial"
  1. The Software and its accompanying documentation are "commercial computer software" and "commercial computer software documentation," respectively, pursuant to DFAR Section 227.7202 and FAR Section 12.212, as applicable.
  2. Any use, modification, reproduction, release, performance, display or disclosure of the Software and accompanying documentation by the United States Government shall be governed solely by the terms of the Contract and is prohibited except to the extent expressly permitted by the terms of the Contract.

14.11.3 Software licenses — optional terms

The following terms apply only to the extent clearly so stated in the Contract. [Suggestion for drafters: Copy and paste from the options below as desired.]

Defined terms in these options have the same meanings as in Clause 14.11.1.

14.11.3.1 Option: Catch-Up Licenses After Overusage
  1. When agreed to, this Option applies if Customer uses the Software beyond the scope of the Software License.
  2. The parties prefer to resolve the overusage on a business basis, and not as a matter of possible copyright infringement.
  3. Toward that end: Customer must promptly purchase:
    • all additional licenses required for such overuse,
    • plus maintenance for such additional licenses,
      • for the full term of the then-current maintenance subscription for the item(s) of Software in question,
      • or, if longer, for the period during which the unlicensed use has been taking place.
  4. If Customer intentionally used the Software beyond the scope of the Software License,
    • then Customer must purchase enough additional licenses to cover all relevant license units in Customer's entire worldwide network,
    • including but not limited to the network(s) of Customer's affiliates (as defined in Clause 25.2) (if any).
  5. Pricing for catch-up license purchases under this Option will be Licensor's then-applicable list price.
  6. If Customer did not purchase such additional licenses on its own initiative,
    • then as a compromise of any potential dispute over exactly how long Customer was making unlicensed use of the Software,
    • Customer must likewise purchase one additional year of back maintenance,
    • for all license units,
    • or such lower amount of back maintenance (not less than six months) as the parties may mutually agree, each in its sole discretion (as defined in Clause 25.19).
  7. If Customer purchases additional licenses and maintenance as provided in this Option,
    • then that purchase will be Licensor's EXCLUSIVE REMEDY for Customer's unauthorized use of Software described in this Option;
    • in all other events, Licensor reserves the right, in Licensor's sole discretion, to pursue other remedies for Customer's unauthorized use,
    • to the fullest extent permitted by applicable law,
    • in which case any limitations of Customer's liability in the Contract will not apply.
Commentary

Subdivision d: If Customer were intentionally to use the Software beyond the scope of the paid-for Software License, it would be inappropriate for Customer to demand that Licensor take Customer's word for it that Customer would not do so again. Consequently, subdivision d requires that Customer buy enough licenses to cover Customer's entire worldwide network.

Subdivision g: Under this exclusive-remedy clause, Licensor will be precluded from seeking damages or profits under copyright law.

  • This is not an insignificant concession on Licensor's part, because in certain circumstances, Licensor would be entitled to an award of Customer's indirect profits arising from the infringement, as explained in more detail in the commentary to § 13.12.8.
  • In return for Licensor's concession, Customer makes a contractual commitment in this Option to pay for catch-up licenses, and possibly back maintenance, as indicated above.

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14.11.4 Level X Support Definition

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply as set forth in Clause 24.1.
  2. Level 1 support refers to:
    • routine basic support for a product or service; it entails providing customers, where applicable, with:
      • compatibility information,
      • installation assistance,
      • general usage support,
      • assistance with routine maintenance;
      • and/or basic troubleshooting advice.
  3. Level 2 support refers to:
    • more-in-depth attempts to confirm the existence,
    • and identify possible known causes,
    • of a defect in a product or an error in a service that is not resolved by Level 1 support.
  4. Level 3 support refers to advanced efforts to identify and/or correct a defect in a product or an error in a service.
Commentary

See generally, e.g.:

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14.11.5 Software Limited Warranty

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract:

  • a specified party ("Provider"),
  • warrants one or more items of computer software (of any kind, including but not limited to firmware),
  • to another party ("Customer").

Discussion checklist:

14.11.5.1 Software media are warranted for 90 days

If Software and/or its documentation are delivered on physical media (for example, on a DVD or USB "thumb drive"),

  • then those media are warranted for the specified time period after their delivery, as follows:
  1. If Customer reports to Provider,
    • within the time period specified above,
    • that the media on which the Software and/or its documentation were delivered
    • contained material defects,
    • then Provider will deliver a replacement for the defective media to Customer
    • at no charge to Customer.
  2. Provider's obligations in subdivision a are Customer's EXCLUSIVE REMEDY for defective media.
Commentary

Inasmuch as software is increasingly delivered by download, not by media, this warranty seems likely to be less and less relevant.

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14.11.5.2 Is the Software warranted against malware, and for how long?

All Software is warranted against malware for 90 days after delivery of the Software version in question, as follows:

  1. If malware (defined below) is present in any deliverable as furnished by Provider under the Contract,
    • and Customer reports the malware to Provider within the specified time period,
    • then Provider is to pay, or reimburse Customer for:
    • all reasonable foreseeable expenses,
    • actually incurred by Customer,
    • in removing the malware,
    • and of mitigating and repairing any damage caused by the malware,
    • other than expenses that could have been avoided if Customer had taken prudent precautions.
  2. The term "malware" is to be interpreted
    • as those in the computer industry would typically define it at the relevant time;
    • in general, the term refers to computer program instructions and/or hardware designed to do one or more of the following:
      • alter, damage, destroy, disable, or disrupt the operation or use of software, hardware, and/or data;
      • disable or bypass security controls; and/or
      • allow unauthorized personnel to access data (including but not limited to personal data) and/or programming.
  3. The term malware would normally be understood as including, without limitation, the following terms, which are reasonably well-understood in the software- and Internet industry:
    • back doors; ransomware; snoopware; spyware; time bomb; trap doors; Trojan horses; viruses; and worms.
  4. Provider's obligations in subdivision a are Customer's EXCLUSIVE REMEDY for malware in any deliverable furnished by Provider under the Contract.
Commentary

See generally the Wikipedia entry Malware.

Caution: Some customers might ask Provider to commit to making "best" efforts to prevent infection by viruses, etc. The trouble with that is that, if a problem were to arise, with 20-20 hindsight it would almost always be possible for a customer's lawyer and hired expert witness to dream up some additional precaution that theoretically Provider should have taken to prevent the problem, therefore Provider (supposedly) didn't use "best" efforts, Q.E.D. (See also the discussion of best efforts in Clause 25.7.)

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14.11.5.3 How long is the Software's performance warranted?
Applicability; performance warranty

This section will govern if the Software, as delivered, does not perform, in all material respects, in accordance with:

  1. the user documentation furnished by or on behalf of Provider; and
  2. any additional written specifications for the Software's performance,
    • but those additional written specifications must be expressly set forth and identified as such,
    • in a written agreement signed by an authorized representative of Provider.
Performance warranty period for paid perpetual license

If the Software is licensed to Customer under a paid, perpetual license,

  • then the performance warranty period stated in the heading of this section (or in the Contract) will apply;
  • that warranty period will begin on the date of delivery
  • of the first version of the Software that is so licensed to Customer.
Performance warranty period for time-limited license

If the Software is licensed to Customer under a time-limited license,

  • for example (as defined in Clause 25.23), under a software-as-a-service ("SaaS") subscription,
  • then the performance warranty period will be the entire period of the subscription.
Performance remedies

If, during the specified performance warranty period, the Software does not perform as stated in Clause Applicability; performance warranty,

  • then Provider is to:
  • provide Customer with a repair, replacement, or commercially-reasonable workaround for the defective Software in accordance with Clause 14.5 (Defect Correction Protocol); and/or
  • refund amounts paid by Customer for the defective Software, as follows:
    • the entire amount paid for a paid, perpetual license, and
    • a pro-rata portion (amortized on a daily basis) of the amount paid for a time-limited license.
  1. Provider's obligations in subdivision b are Customer's EXCLUSIVE REMEDY for any failure of performance by the Software.
14.11.5.4 Is the Software warranted against third-party IP infringement?
  1. Provider warrants that the Software as delivered complies with Clause 20.6 (Infringement Warranty),
    • subject to the limitations of that warranty,
    • including but not limited to the remedy limitations,
    • during the entire period of Customer's use.
  2. Customer's EXCLUSIVE REMEDIES for any claim of infringement by the Software are as stated in Clause 20.6 (Infringement Warranty).
14.11.5.5 What must Customer do for warranty service?

For Customer to be entitled to the remedies of this Clause, Customer must, at its own expense:

  1. report a potential breach of this Clause to Provider,
    • in writing, with reasonable detail,
    • no later than the end of the relevant warranty period; and
  2. at Provider's request from time to time, provide Provider with reasonable information concerning the potential breach.
14.11.5.6 Are there any general limitations to these warranties?
  1. Provider DOES NOT WARRANT that the Software:—
    1. will be error free;
    2. will meet Customer's need; or
    3. will operate without interruption.
  2. Provider DOES NOT WARRANT that the Software will perform as documented in cases of:
    1. hardware malfunction;
    2. misuse of the Software;
    3. modification of the Software by any party other than Provider —
      • this subdivision is not to be intepreted as implicitly authorizing Customer to make or have made any such modification;
    4. use of the Software in an environment or with other software not described in the documentation or supported by Provider; or
    5. bugs in other software with which the Software interacts.

c.THE SOFTWARE IS NOT DESIGNED OR INTENDED FOR USE IN HAZARDOUS ENVIRONMENTS REQUIRING FAIL-SAFE PERFORMANCE,

  • including but not limited to any application in which the failure of the Software could lead directly to death, personal injury, or severe physical or property damage,
  • except to the extent — if any — explicitly stated otherwise in the Contract.

15 Verifications: Audits, inspections, etc.

You get what you inspect, not what you expect.
           — Admiral Hyman G. Rickover, father of the nuclear Navy

Contents:

Comment: See also the following:

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15.1 Audit Protocol

Commentary

One fraud examiner asserts that "entities often implicitly trust vendors. but just as good fences make good neighbors, vendor audits produce good relationships." See Craig L. Greene, Audit Those Vendors (2003). 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.

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15.1.1 What records are auditable?

The term "auditable records" refers to records sufficient to document each of the following, as applicable under the Contract:

  • labor and/or materials billed to the auditing party;
  • other items billed to the auditing party;
  • compliance with specific requirements; and
  • any other clearly-agreed auditable matters;
  • unless the Contract clearly provides otherwise,

15.1.2 How often may audits be conducted?

An auditing party may request an audit only up to once per 12 months

  • and once per period audited,
  • whichever is more restrictive,
  • unless good reason (as defined in Clause 15.3.10) exists 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 the limits stated in this section.

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15.1.3 How much advance notice is required for an audit?

An auditing party must give the recordkeeping party

Commentary

A recordkeeping party will want to negotiate for reasonable advance notice of an audit, because 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.

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15.1.4 When is the audit-request deadline for a record?

  1. 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. three years
      • after the end of the calendar quarter,
      • in which the substantive content of the record was most-recently revised.
  2. After the relevant date under subdivision a has passed,
    • the particular record in question is deemed uncontestable,
    • absent a showing,
    • by clear and convincing evidence (defined in Clause 25.13),
    • of good reason (defined in Clause 15.3.10).
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;
  • "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. Their contract with the Walt Disney company required Disney to pay them a percentage of the show's profits and to periodically provide accounting statements.
  • The plaintiffs claimed that Disney had underpaid them. Disney responded that under the contract's 24-month deadline for requesting an audit, the accounting statements, and thus the payments, were incontestable. A trial court granted summary judgment in favor of Disney on grounds that the plaintiffs' claims were time-barred by the 24-month deadline provision. The appeals court reversed, holding that a jury must decide whether Disney orally waived or agreed to modify the incontestability provision.

Absent a deadline for requesting an audit, a creative counsel might try to argue that the counsel's client 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.

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15.1.5 What interest rate will be charged on past-due amounts?

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 amount(s) owed,
  • at 1.5% per month,
    • or the maximum rate permitted by law, if less,
  • from the date the money was originally due
    • or if later, from the earliest start date permitted by law,
  • until paid in full,
  • in accordance with Clause 13.8 (Interest Charges).

15.1.6 When must audit expenses be reimbursed?

  1. 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),
    • if the audit was occasioned by, or revealed or confirmed, one or more of the following:
      • that the recordkeeping party overbilled (or underpaid) the auditing party,
        • by more than 5%
        • for the period being examined; and/or
    • fraud,
      • and/or material breach (see § 25.33.2) of the Contract,
    • by the recordkeeping party,
      • or for which the recordkeeping party is responsible,
      • either by law or as stated in the Contract.
  2. Otherwise, as between the recordkeeping party and the auditing party,
    • the auditing party is responsible for all audit expenses referred to in subdivision a
    • unless the Contract clearly says otherwise.
Commentary

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 your records, the auditors discover a 5% discrepancy in your records for a single month. In that situation, you shouldn't have to foot the bill for the expense of the entire five-year audit.

But now looking at the other side of the reimbursement issuse: Should the auditing party be required to reimburse you for your expenses in an audit? Your 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."

Reimbursement of the recordkeeping party's expenses can be addressed with Clause 15.1.17 (Option: Recordkeeping Party Expense Reimbursement).

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15.1.7 In what form are records to be provided?

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

Auditors will usually want to see records in the form in which they're kept in the ordinary course of business. That's because:

  • Handing auditors a stack of hard-copy printouts of computer records would no doubt significantly increase the cost of the audit; and
  • Seeing the records in their original forms could help auditors detect signs of tampering, which might indicate fraud.

Pro tip: 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.

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15.1.8 What cooperation with auditors is required?

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.

15.1.9 Who may serve as auditors?

  1. An auditing party may engage any of the following to conduct an audit:
    1. any Big Four accounting- or consulting firm; and/or
    2. any independent accounting firm that regularly audits the recordkeeping party's relevant records;
      • the auditing party WAIVES (as defined in Clause 24.26) any conflict of interest in that regard.
  2. Any other auditor(s) must have the recordkeeping party's consent, as follows:
    1. The recordkeeping party must not unreasonably withhold its consent to proposed auditors.
    2. The recordkeeping party is deemed to have consented to a proposed auditor
      • if the recordkeeping party does not give the auditing party notice (as defined in Clause 24.17) 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."

On the other hand, 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.2: 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 b: 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.

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15.1.10 During what hours, and where, may audits take place?

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.

15.1.11 Is any information off-limits to auditors?

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.

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15.1.12 What auditor workspace must the recordkeeping party provide?

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, must 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.

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15.1.13 What are the auditors' confidentiality obligations?

Auditors must agree in writing to comply with the same confidentiality obligations that apply to the auditing party.

15.1.14 May auditors retain copies of audited records?

  1. The auditors may make and keep copies of auditable records,
    • subject to the confidentiality- and return-or-destruction provisions of this Clause.
  2. In due course, the auditors must destroy or return any copies that they retain under subdivision a,
    • 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.

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15.1.15 Will the recordkeeping party get copies of audit reports?

If the recordkeeping party so requests in writing to the auditors,

  • with a copy of the request to the auditing party,
  • 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.

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15.1.16 What corrective action is required 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. No invoice need be sent for a payment required under § 15.1.16,
    • other than the audit report and a written request for payment.

15.1.17 Option: Recordkeeping Party Expense Reimbursement

  1. If this Option is agreed to,
    • and 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.
  2. 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

See the commentary to § 15.1.6 (audit expenses).

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15.1.18 Option: True-Up as Exclusive Audit Remedy

  1. If this Option is agreed to, it will apply if 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 Clause
      • 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 § 23.13); or
    2. a material breach (see § 25.33.2) of the Contract,

in either case for which the recordkeeping party was responsible by law and/or under the Contract.

Commentary

If you're an auditing party, you might object to this provision if you 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 your software for more than it had paid you for. This came to pass in a lawsuit involving the MGM Grand Hotel and the Broadway musical Kismet, as discussed in the commentary to § 13.12.8.

As a contrary example, though: 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.

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.

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15.1.19 Option: Audit Requirement Flowdown

If this Option is agreed to,

  • the recordkeeping party must make sure
  • that each of its subcontracts under the Contract, if any,
  • includes "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

See the discussion of flowdown requirements.

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15.1.20 Audits and inspections — topics for discussion

  1. When a customer wants the contract to say that it can audit the supplier's invoices and billing records, who should pay for any audit that gets conducted?
  2. Who should be a permissible auditor?
  3. Should any supplier information be off-limits to an auditor?

15.1.21 Audits exercise

FACTS: Gigunda wants MathWhiz to undertake a time-and-materials project. (What's that?) Gigunda is proposing a draft contract in which MathWhiz must keep records for five years and allow Gigunda to audit the records.

QUESTION: What kind of fences might you want to try to put around Gigunda's audit right in order to save MathWhiz from unnecessary burden and expense? Use the virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ) to make a list (no need for exact language).

15.2 Background Checks

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract:

  • a specified party (a "checking party"),
  • must have 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").

Discussion checklist:

Commentary

It's not uncommon for customers to want service providers to do background checks on the providers' key personnel. The goal is normally to identify people with criminal records or other indicia of potential trouble. As discussed below, 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; 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 to specify particular background checks to be performed.

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 employee might be tempted to sue the customer, not just the provider. (In that situation, § 15.2.8 would require the provider to protect the customer from the cost of defending and/or paying damages for such claims.)

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15.2.1 What specific background checks are required?

Criminal History Checks are required,

  • if not otherwise specified in the Contract.
Commentary

See the definitions in Clause 15.2.9 (and consider other possible background checks).

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15.2.2 Whose backgrounds must be checked?

The backgrounds of anyone engaged in Restricted Activities must be checked.

Commentary

See the definitions in Clause 15.2.9 (and consider other possible background checks).

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15.2.3 Who must pay for background checks?

The checking party must pay for 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.

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15.2.4 What if a criminal history is revealed?

If a checked individual's background check reveals any Criminal History,

  • then the  checking party must not assign, nor permit, that individual
  • to engage in any Restricted Activity for the benefit of the requesting party
  • without first consulting with the requesting party.
Commentary

This section requires the checking party only to consult with the requesting party, as opposed to obtaining the requesting party's consent.

(Consent requirements seem more common in background-checks provisions, but they could lead to legal issues, as discussed below.)

Criminal records checks in basic form seem to be available from any number of Web sites at low cost. (The author has never personally used any such site and can't recommend any particular one; your company's or client's HR people might be able to recommend one.)

Caution: 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 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 …."

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 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.

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15.2.5 What if possible drug misuse is revealed?

  1. This section applies if a checked individual's background check indicates use, by that individual, of one or more of the following:
    1. illegal drugs; and/or
    2. prescription drugs other than in accordance with a lawfully-issued prescription.
  2. The checking party must not assign, nor permit, that individual:
    1. to engage in any Critical Activity for the requesting party
      • without the express prior written consent of the requesting party; nor
    2. to engage in any other Restricted Activity for the requesting party
      • without first consulting with the requesting party.
Commentary

Customers with safety concerns might want its contractors' employees to be drug-tested. Depending on the position, even 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.

Caution: Companies, though, 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.

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15.2.6 What standards must background checks meet?

  1. If the checking party performs the background check itself, 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 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.
  2. 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 a.
Commentary
Strict liability for DIY background checks

This section sets out a strict-liability standard for a checking party that does background checks itself, as opposed to hiring out the job to a reputable service provider — but if the checking party does the latter, it's a safe harbor, meaning that the checking party will have complied with its obligation under this provision.

The present author's impression is that few checking parties will actually conduct their own background checks: Even if they're capable of doing so, they're likely to want to "outsource" that responsibility to an outside party that can do such things more cost-effectively, and at which the finger can be pointed if something goes wrong.

Credit checks have special 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 has hit some well-known companies with sizable settlement costs; for example:

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15.2.7 What contact information must be independently obtained?

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

This section requires independently-obtained contact information for former employers, etc. (other than purely-personal references). This 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.

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15.2.8 Who will take care of any 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 (as defined in Clause 25.40), 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 Protect,
    • as defined in Clause 21.4.2,
    • the Protected Group member 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

This section makes the checking party responsible for any third-party claims arising out of background checks; the obligation is worded carefully to focus on just what breaches of this Clause are covered.

As with any indemnity obligation, drafters should:

  • consider pairing the indemnity obligation with an insurance requirement; and
  • consider whether the indemnifying party might be liable for unforeseeable damages as well as foreseeable damages, and decide whether to be specific about that in the indemnity obligation.

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15.2.9 Definitions for Background Checks

  1. Applicable Background Checks refers to the specific background check(s) that are to be performed under the Contract (see § 15.2.1).
  2. Credit Check refers to standard credit reporting from all major credit bureaus serving the jurisdiction in question.
  3. 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.
  4. Criminal-History Check refers to a nationwide check of records of arrests, convictions, incarcerations, and sex-offender status. A Criminal-History Check is not required to include fingerprint submission to confirm identity.
  5. 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.
  6. 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).
  7. Drug Testing refers to testing for illegal drugs and controlled pharmaceuticals.
  8. Education Verification refers to confirmation of dates of attendance, fields of study, and degrees earned.
  9. Employment Verification refers to confirmation of start- and stop dates and titles of employment for the past seven years.
  10. Lien, Civil-Judgment, and Bankruptcy Check refers to a check of records of tax- and other liens; civil judgments; and bankruptcy filings.
  11. 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.
  12. Residence Address Verification refers to confirmation of dates of residence addresses for the past seven years.
  13. 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. working on-site at any premises of a requesting party;
    2. having access (including without limitation remote access) to the requesting party's equipment or computer network;
    3. having access to the requesting party's confidential information;
    4. interacting with the requesting party's employees, suppliers, or customers; and
    5. any Critical Activity.
Commentary
Applicable Background Checks

The defined term Applicable Background Checks is used here, as opposed to Required Background Checks, for two reasons:

  1. To avoid creating the implication that the Applicable Background Checks are always an absolute, mandatory requirement, because that could create future difficulties if a background check were skipped and then the checked individual did something bad; and
  2. less importantly, to have the term be alphabetized first with the other definitions below.

Some drafters will want to specify additional background checks than those listed.

Critical Activities

This definition is used in the restrictions on assigning personnel to engage in such activities if their background checks indicate drug misuse.

Educational reference checks

Educational-reference checks are sometimes used as a way of detecting people who falsify their résumés about their education. Sadly, résumé padding is not an uncommon occurrence. For example, in 2014 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 verifications

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

The residence-address check has in mind that an individual might omit one or more previous residence addresses in the hope of evading a criminal-records check.

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15.2.10 Option: Checks by Requesting Party

  1. If this Option is agreed to, the requesting party may cause its own background checks to be conducted on any or all checked individuals.
  2. In conducting any such background checks, the requesting party will:
    1. comply with the background-check provisions of the Contract, and
    2. Protect (as defined in Clause 21.4.2) the checking party's Protected Group (as defined in Clause 25.40) against any claims arising out of noncompliance,

as though the requesting party were the checking party and vice versa.

  1. The requesting party must bear its own expenses associated with any background checks that it conducts.
  2. The checking party is to provide reasonable cooperation with the requesting party in attempting to obtain any necessary consent for checks from checked individuals.
  3. The requesting party must provide the same defense and indemnity to the checking party and its Protected Group (as defined in Clause 25.40) (if any) as the checking party must provide under this Option (that is, the parties' roles for this purpose will be deemed reversed).

15.3 Inspections

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract:

  • a specified party ("inspecting party"),
    • is authorized to have one or more inspections, audits, or other examinations (collectively, "inspections") conducted,
    • of facilities, products, books, records, or other items,
    • of another party (a "host").

Discussion checklist:

15.3.1 How much advance notice of an inspection is required?

The inspecting party must give the host

15.3.2 By when must an inspection be completed?

The inspecting party must ensure that each inspection is completed

  • no later than five business days
  • after the effective date of the notice of the inspection
  • unless more time is needed for good reason (as defined in Clause 15.3.10).
Commentary

The author can attest (from long-ago personal experience in the U.S. Navy's nuclear-propulsion program) that having inspectors hanging around for a long time can be a pain.)

15.3.3 What may be included in an inspection report?

Inspectors may report their findings to the inspecting party,

  • subject only to any applicable confidentiality restrictions.
Commentary

Alternative: "Inspectors must disclose to the inspecting party only: (i) whether the inspection revealed a reportable discrepancy, and if so, (ii) the size and general nature of the discrepancy."

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15.3.4 Who may conduct inspections?

Inspections (if any) must be performed by one or more of the following, to be engaged by the inspecting party:

  • any Big Four accounting- or consulting firm; and/or
  • any other inspector that the inspecting party proposes to the host, in writing,
    • if the host does not respond, in writing,
    • with a reasonable objection to the proposal within a reasonable time.

15.3.5 What hours may inspections be conducted?

The host — in consultation with the inspecting party —

  • may make reasonable decisions about just when the inspection is to be conducted,
    • e.g., what day(s) and what time(s) of day,
  • with a view toward balancing the needs of the inspection
    • against possible interference with the host's business.

15.3.6 What workspace must the host provide for inspectors?

  1. The host must provide the inspector(s) with appropriate facilities and equipment,
    • of the type customarily used by knowledge-based professionals,
    • unless the Contract clearly states otherwise.
  2. Such facilities and equipment would normally include, for example (as defined in Clause 25.23),
    • furniture; lighting; air conditioning; electrical power; and Internet access.

15.3.7 What access to host personnel must inspectors be given?

The host must require its personnel to provide reasonable cooperation with the inspectors,

  • including without limitation answering reasonable questions from the inspectors,
  • to the extent not inconsistent with this Clause.

15.3.8 What may inspectors do with confidential information?

  1. The inspecting party must take prudent measures to keep confidential any non-public information that it learns via the inspection.
  2. The inspecting party must not use non-public information learned through the inspection, except:—
    • for correcting discrepancies identified in the inspection,
    • or for enforcing the inspecting party's rights under the Contract.
  3. The inspecting party must not disclose any non-public information of the host to any third party,
    • except as required by compulsory legal process (see below);
    • and/or as expressly permitted by law,
      • including without limitation the (U.S.) Defend Trade Secrets Act.
  4. The inspecting party must:
    1. promptly advise the host
      • if the inspecting party or any of its affiliates or personnel is served with compulsory legal process (such as a subpoena or a search warrant) covering the host's information,
      • unless the inspecting party's doing so is prohibited by law;
    2. provide reasonable cooperation with the host,
      • if and as requested by the host,
      • to preserve the confidentiality of the host's information after a compulsory legal demand to the inspecting party; and
    3. disclose only the minimum information required by a compulsory legal demand.
  5. The inspecting party must ensure that its inspectors have agreed in writing to comply with the confidentiality obligations of this Clause.

15.3.9 Is any host information off-limits to inspectors?

The host must give inspectors access to all information reasonably related to the subject of the inspection,

  • except that the host need not give inspectors access to information,
  • if, under applicable law, the information would be immune from discovery in litigation,
  • for example due to attorney-client privilege, work-product immunity, or any other privilege.

15.3.10 What constitutes "good reason"?

For purposes of this Clause,

  • and any other inspection-related provisions of the Contract,

good reason includes, without limitation, any one or more of the following:

  1. significant lack of cooperation by the host; and/or
  2. the discovery of substantial evidence of:

15.3.11 Will inspection rights survive termination?

The inspection-related provisions of the Contract,

  • including but not limited to those of this Clause:
  1. will survive any termination or expiration of the Contract —
    • but only as to matters that would have been subject to inspection before termination or expiration; and
  2. will remain subject to all deadlines and other limitations stated in the Contract.
Commentary

Caution: Not specifying that inspection rights survive termination of an agreement might result in the inspection right ending when an agreement does. That happened in a case in which a union benefits fund tried to audit an employer's contributions to the fund, as permitted by its agreement with the employer — but this was after the employer had terminated its agreement to participate in the fund. The court held that the union's audit right had died with the agreement.

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15.4 Recordkeeping Protocol

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract, a party (a "Recordkeeping Party") must keep records.

Discussion checklist:

Commentary

Consider also Clause 15.1 (Audit Protocol).

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15.4.1 During what time period must records be kept?

The Recordkeeping Party must cause records to be made and kept,

  • as stated in this Clause,
  • at all times during the term of the Contract.

15.4.2 What records must be kept?

  1. The Recordkeeping Party must cause records (the "Required Records") to be made and kept as stated in this section.
  2. The term "Required Records" refers to records sufficient to document the following, when and as applicable:
    1. all deliveries of goods and services under the Contract by the Recordkeeping Party to another party;
    2. billing of charges or other amounts under the Contract by the Recordkeeping Party to another party;
    3. all payments, by the Recordkeeping Party to another party, under the Contract,
      • of amounts not verifiable by the payee, such as, for example,
      • commissions, royalties, or rents to be paid to the other party as a percentage of the Recordkeeping Party's sales; and
    4. all other information (if any) that the Contract requires the Recordkeeping Party to report to another party.
Commentary

The records required to be kept might include, for example: Sales journals; purchase-order journals; cash-receipts journals; general ledgers; and inventory records.

This list of record categories is adapted from the contract in suit in an Eleventh Circuit case.

A sample clause published by the Association of Certified Fraud Examiners contains a laundry list of specific types of documents that a vendor might want to require a contractor to maintain. #+endaside

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15.4.3 What quality standards must records meet?

The Recordkeeping Party must cause all Required Records:

  1. to be accurate and materially complete;
  2. to comply with at least commercially reasonable (as defined in Clause 25.14) standards of recordkeeping; and
  3. to comply with any stricter recordkeeping standards specified in the Contract.
Commentary

Subdivision 1 — accurate and materially complete: Some drafters use the term true and correct, but that seems both redundant and incomplete. Perhaps in an archaic sense the term true might be interpreted broadly to mean materially complete and accurate, but there seems to be little reason to take a chance that a judge would see it that way.

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15.4.4 How long must records be retained?

The Recordkeeping Party must cause each of the Required Records to be kept

  • for at least the longest of the following (the "Record-Retention Period"):
  1. any retention period required by applicable law;
  2. the duration of a timely-commenced audit (see § 15.1) of the Required Records
    • that is permitted by the Contract, if any; and
  3. such other period as is clearly specified in the Contract, if any.
Commentary

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When services are involved, retaining records for two- to four years after final payment seems to be a not-uncommon requirement; this can be found, for example, in the [U.S.] Federal Acquisition Regulations.

Some industries or professions might require specific record-retention periods.

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15.4.5 Option: Record Retention per FAR Standard

If this Option is agreed to,

  • the Recordkeeping Party must cause each of the Required Records to be maintained
  • for at least the period that the record would be required to be maintained
  • under the (U.S.) Federal Acquisition Regulations ("FARs"), Contractor Records Retention, 48 C.F.R. Subpart 4.7.

(Note: This citation is merely a convenient shorthand reference in lieu of setting out the cited substantive terms; the parties do not intend to imply or concede that the Contract and/or their relationship are in fact subject to the FARs.)

16 Confidentiality- and privacy

16.1 Confidential Information

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when, under the Contract:—

Discussion checklist:

Note to drafters: See also the optional terms at § 16.2, which are not incorporated by reference into the Contract unless it clearly says so.

Commentary
Business context for confidentiality obligations

It's quite common for parties to enter into a confidentiality agreement as a prelude to negotiation of another agreement such as a sale- or license agreement or a merger- or acquisition agreement.

It's also quite common for other types of agreement to include confidentiality provisions, for example services agreements; license agreements; and employment agreements.

Caution: In some jurisdictions, the law might restrict parties' ability to enter into confidentiality agreements in certain circumstances, e.g., when settling claims of discrimination.

Other Tango reference clauses to consider

Drafters might wish to use Clause 16.3 (Confidentiality of Parties' Dealings).

Privacy law

Drafters should also applicable personal-privacy law, e.g., the California Consumer Privacy Act (CCPA) and the European Union's General Data Protection Regulation. See the commentary at § 16.4.

Special topic: NDAs for VCs and other potential investors

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.

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.

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16.1.1 Whose information is protected?

Each party will be "Discloser" with respect to its own Confidential Information (as defined in Clause 16.1.2);

  • each other party will be "Recipient" as to Discloser's Confidential Information.
Commentary: Whose information should an NDA protect?

One of the first issues the parties likely will confront is whether the agreement should protect just one party's Confidential Information, or that of each party.

In many cases, a two-way confidentiality agreement that protects each party's Confidential Information will:

  • get to signature more quickly;
  • be safer for both sides; and
  • reduce the chance of future embarrassment for the drafter(s).

In contrast, a confidentiality agreement protecting just one party's information will usually take longer to negotiate. That's because a confidentiality agreement will (usually) be more balanced — and therefore quicker to negotiate and easier to work with — if its provisions will apply equally to the confidential information of each party, not just one party.

  • If only one party will be disclosing confidential information, and that disclosing party is doing the drafting, then the confidentiality provision might contain burdensome requirements that the receiving party would have to review carefully.
  • Conversely, if the receiving party is doing the drafting, then the disclosing party would have to review the confidentiality provisions carefully to make sure it contained sufficient protection for Confidential Information

A two-way provision is likely to be more balanced — it's a variation of the "I cut, you choose" principle — because each negotiator keeps in mind that today's disclosing party might be tomorrow's receiving party or vice versa.

(Beware, though: even if an agreement is nominally a two-way agreement, it still can be drafted so as subtly to favor the drafter's client.)

Moreover, a two-way agreement can avoid the danger of future, "afterthought" confidential disclosures by the receiving party. With a one-way agreement, only the (original) disclosing party's information is protected, and so 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 the Fail-Safe case: The plaintiff's confidentiality agreement with the defendant protected only the defendant's information. Consequently, said the Seventh Circuit, the plaintiff's afterthought disclosures of its own confidential information were unprotected.

So, a two-way agreement might help avoid future embarrassment: Suppose that Alice and Bob enter into a confidentiality agreement that protects only Alice's information. Also suppose that the agreement's terms were strongly biased in favor of Alice.

Now suppose that, at a later date, the parties decide that they also needed to protect Bob's confidential information as well, so that Bob can disclose it to Alice.

In that case, with the shoe on the other foot, Alice might not want to live with the obligations that she previously made Bob accept. As a result, whoever negotiated the (one-way) confidentiality agreement for Alice might find himself in a doubly-embarrassing position:

  • First, Alice's negotiator would be asking Bob to review and sign a new confidentiality agreement, and having to explain why Alice isn't willing to live with the same terms she pressed upon Bob.
  • Second, Alice might ask pointedly of her negotiator, Why didn't you do this the right way in the first place, instead of wasting everybody's time?

So it's often a good idea to insist that any confidentiality provisions be two-way in their effect from the start, protecting the confidential information of both parties.

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16.1.2 What types of information are potentially protectable?

Confidential Information refers to information as to which:

  • Discloser has taken, and is still taking, reasonable measures to keep the information secret; and
  • the information meets the other eligibility requirements in the Contract.

(Note: As an aid to readers, Confidential Information is sometimes referred to as "Discloser's Confidential Information.")

Commentary

Reasonable secrecy measures are a sine qua non ("without which not") for legal protection of confidential information in the United States and many other jurisdictions. For example, in one case, the Seventh Circuit noted pointedly that the party asserting misappropriation of trade secrets had made no effort to preserve the so-called trade secrets in confidence.

Similarly, in a Nebraska federal case, the Eighth Circuit agreed with a district court that a trade-secret plaintiff had failed to take reasonable measures:

[The plaintiff] shared the information with a third-party contractor without a confidentiality agreement and without other policies or practices for safeguarding secrets. … [The plaintiff] did not take reasonable steps to safeguard its trade secrets. Without such reasonable efforts or measures, there is no secret to protect, and [the plaintiff] cannot maintain a claim under the [Nebraska Trade Secrets Act] or [federal Defend Trade Secrets Act].

In any given case, what constitutes "reasonable' secrecy measures will depend on the circumstances. Fort-Knox security measures aren't necessary (usually); less-strict security measures might well suffice.

As one court remarked: "… there always are more security precautions that can be taken. Just because there is something else that Luzenac could have done does not mean that their efforts were unreasonable under the circumstances. … Whether these [specific] precautions were, in fact, reasonable, will have to be decided by a jury."

The author has long used a three-part rule of thumb:

  • Lock It Up: Require passwords to access confidential information on computer networks. Keep hard-copy confidential information in locked file cabinets and/or behind locked doors.
  • Label It: When documents contain confidential information, mark the documents as such; failure to do so won't necessarily be fatal, but proper marking is a big help in court. (But don't be The Boy Who Cried Wolf: If you go crazy with the Confidential stamp and mark obviously-nonconfidential information as confidential, that will work against you.)
  • "Safe Sex": Be careful both to whom you disclose your own confidential information and from whom you accept confidential information of others; in either case, use "protection" in the form of a confidentiality agreement such as this Clause.

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16.1.3 What are some examples of Confidential Information?

Recipient's confidentiality obligations under this Clause apply, without limitation, to the following categories of information when the information otherwise qualifies as Confidential Information:

  • analyses; compilations; forecasts; interpretations; notes; reports; studies; summaries; and similar materials, prepared by or for Recipient or on Recipient's behalf;
  • "secret sauce" selections and/or combinations of specific items of information — even if some or all of those items of information, taken individually, would not qualify as Confidential Information; and
  • the fact that Discloser is using particular nonconfidential information — but only if that fact itself otherwise qualifies as Confidential Information.
Commentary

It's well-established in U.S. law that if a party makes a specific selection or combination of one or more particular items of information, then that selection or combination can qualify as Confidential Information, even if the individual items of information are not confidential. See, for example:

Negative know-how, i.e., knowledge of experimental dead ends, can qualify as a trade secret. Legendary inventor Thomas Edison is widely quoted as saying, "I have not failed. I've just found 10,000 ways that won't work."

But a court might be skeptical of the economic value of knowing the wrong answers if the right answer has become publicly available. As a federal court in New York put it:

Second, the plaintiffs have failed to allege how these negative trade secrets derive independent economic value from not being generally known given the existence of volumes of information publicly available …. It is difficult to see how negative trade secrets consisting of unsuccessful efforts to develop trade secrets and experimental dead ends can have independent economic value when the end result of the process, the positive trade secrets, have in fact been uncovered.

Zirvi v. Flatley, No. 18-cv-7003 (S.D.N.Y. Jan. 14, 2020) (dismissing complaint with prejudice) (cleaned up; citations omitted).

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16.1.4 Can third-party information be Confidential Information?

Yes — when otherwise eligible, information of third parties

  • that Discloser provides to Recipient
  • can be protectable under this Clause
  • to the same extent as Discloser's own Confidential Information.

BUT: If Discloser does provide Recipient with confidential information of a third party,

  1. then Discloser is deemed to represent to Recipient
    • that Discloser is authorized to make the third party's information available to Recipient; and
  2. if the third party claims

16.1.5 What about protected health information ("PHI")?

If Discloser makes protected health information available to Recipient, then Clause 16.8 (Protected Health Information) will also apply.

Commentary

See the commentary to § 16.8.

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16.1.6 What can qualify as a "trade secret?"

Trade secret refers to Confidential Information that is shown: —

  • to have independent economic value, actual or potential,
  • from not being generally known to,
  • and not being readily ascertainable by,
    • others who can obtain economic value
      • from the disclosure or use of the information,
    • without using improper means

(Note: Trade secrets are entitled to protection for a longer period of time than ordinary Confidential Information, as explained in Clause 16.1.9.)

Commentary

This definition of trade secret adopts, essentially verbatim, the definition in the (U.S.) Defend Trade Secrets Act ("DTSA"), 18 U.S.C. § 1839(3).

A key feature of that statutory definition is that, for Discloser to establish that particular Confidential Information is also a trade secret, Discloser must show that knowledge of the Confidential Information provides an economic advantage to those who know it.

The Judicial Council of California Civil Jury Instructions, 2017 edition, includes a list of factors that jurors may take into account in determining whether particular information has independent economic value, with extensive citations:

In determining whether [e.g., information] had actual or potential independent economic value because it was secret, you may consider the following:

(a) The extent to which [name of plaintiff] obtained or could obtain economic value from the [e.g., information] in keeping [it/them] secret;

(b) The extent to which others could obtain economic value from the [e.g., information] if [it were/they were] not secret;

(c) The amount of time, money, or labor that [name of plaintiff] expended in developing the [e.g., information];

(d) The amount of time, money, or labor that [would be/was] saved by a competitor who used the [e.g., information];

[(e) [Insert other applicable factors].]

The presence or absence of any one or more of these factors is notnecessarily determinative.

Proving up the independent economic value of particular information has sometimes proved a stumbling block. For example, a physician in New York failed in her trade-secret claim against her former employer for allegedly misappropriating her trade-secret billing template; the court said: "We further conclude that Dr. Kairam fails to plausibly allege that the template [to optimize billing] is a trade secret. She does not allege, for example, how the template derives independent economic value from not being generally known to others …."

In contrast, a Microsoft Excel spreadsheet for estimating the financial viability of a possible senior living community, known as an underwriting template, was held to qualify: "Even if there are other underwriting templates publicly available, Brightview's template — containing its own nuanced, data-specific formulas and data amassed over twenty-five years in business — is not, and it likely holds independent value as a secret …."

Customer lists have been viewed differently by different courts concerning their economic value; some courts have treated such lists as qualifying for protection, others not. Compare, e.g., two cases coincidentally decided on the same day by different federal courts:

  • A federal court in Kentucky granted summary judgment in favor of insurance agents who were accused of misappropriating the confidential customer lists of insurance giant Allstate; the court held that on the facts, the customer lists in question were not protectable.
  • In contrast, the federal court in Nevada granted a preliminary injunction against a company that had hired away two sales people from the plaintiff; the court held that "Plaintiff's client information, deployment records, and product pilot programs derive economic value through not being readily available to the public …."
What constitutes "improper means"?

"Improper means" is defined in the (U.S.) Defend Trade Secrets Act as:

the term "improper means"—

(A) includes theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means; and

(B) does not include reverse engineering, independent derivation, or any other lawful means of acquisition ….

The exception in subdivision (B) echoes the U.S. Supreme Court's famous Kewanee Oil opinion: "A trade secret law, however, does not offer protection against discovery by fair and honest means, such as by independent invention, accidental disclosure, or by so-called reverse engineering[.]"

Will breach of a confidentiality obligation be considered "improper means"?

Breach of a confidentiality agreement might or might not be considered improper means of acquiring a trade secret:

• A Texas appeals court had held that under Texas law, "[a] post-acquisition breach of a confidentiality or nondisclosure agreement … cannot support an improper means finding as a matter of law."

• But two weeks later, the Fifth Circuit held (in an unpublished opinion) that under Texas law, "a breach of a duty to maintain secrecy is a way of establishing improper means …."

A commentator pointed out that the Fifth Circuit's Hoover Panel holding "raises a potential Erie concern," in that federal courts sitting in diversity (i.e., the Fifth Circuit) are supposed to apply state law as interpreted by state courts.

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16.1.7 What is excluded from Confidential Information status?

This Clause does not impose any confidentiality obligations on Recipient for particular Discloser information

  • if Recipient shows that,
  • at the relevant time or times,
  • the particular information fell into one or more of the following categories:
  1. The information in question was generally known
    • to people within the circles that normally deal with that kind of information —
    • unless the information became generally known
    • because Recipient did something,
      • or someone to whom Recipient provided the information did something,
    • that breached Recipient's obligations under this Clause; or
  2. The information was readily ascertainable,
    • without using improper means,
    • by people of the kind described in subdivision 1; or
  3. A third party made the information available to Recipient —
    • without restriction, and
    • without breaching an obligation of confidence to Discloser; or
  4. Recipient already knew the information when Discloser first gave Recipient access to it —
    • but on that point,
    • Recipient must provide reasonable corroboration (as defined in Clause 23.8)
    • of any statements by interested witnesses; or
  5. Recipient developed the information independently,
    • or someone did so on Recipient's behalf,
    • without using information of Discloser that was not itself excluded from the definition of Confidential Information —
    • but here again, Recipient must provide reasonable corroboration of statements by interested witnesses; or
  6. Discloser disclosed the information to a third party
    • without requiring the third party to agree to confidentiality obligations
    • that are comparable to those of this Clause.
Commentary
Caution: These exclusions might be preempted by law

Just because this Clause does not protect particular excluded information would not automatically mean that the information was fair game to use or disclose. Both disclosing- and receiving parties will want to check out privacy laws concerning (without limitation):

  • protected health information, for example under the U.S. Health Insurance Portability and Accountability Act of 1996 ("HIPAA");
  • personal financial information, for example under the Gramm-Leach-Bliley Act;
  • the EU's General Data Protection Regulation (GDPR); and
  • American state laws concerning user privacy such as the recently-enacted California Consumer Privacy Act (CCPA).

See generally the data-privacy commentary at § 16.4.

Caution: Don't categorically exclude subpoenaed information

Some badly-drafted confidentiality exclusions state that subpoenaed information is excluded from confidentiality. This could be a big mistake for a disclosing party — a receiving party could later argue that the mere issuance of a third-party subpoena automatically resulted in the subpoenaed information being excluded from confidentiality status, even if a court were to issue a protective order restricting what the third party could do with the information.

The better approach is to state that such disclosures are explicitly authorized as provided in Clause 16.1.21.2.

Subdivision 1: Exclusion of "generally known" information

The phrase "generally known to people within the circles …" phrase is a mashup of section 1(4)(i) of the U.S. Uniform Trade Secret Act, https://perma.cc/XK9G-CLJA at 5, as well as the UK's 2018 draft regulations implementing the EU Trade Secrets Directive (2016/943); see UK IP Office, Consultation on draft regulations concerning trade secrets at 19 (2018), https://perma.cc/PHT8-DQFJ.

Publication is of course a classic way in which allegedly-confidential information can become "generally known." For example: "It is axiomatic that a plaintiff cannot recover for the misappropriation of a trade secret if he revealed that secret in a published patent or patent application."

Caution: It's not a great idea to say that information is excluded because it is in the "public domain," because (at least to IP lawyers) that term refers to information that is available for use by anyone without restriction — and use of information might subject to restriction under patent- or (in the case of computer software) copyright laws.

Subdivision 2: Exclusion of "readily ascercertainable" information

As noted in the [BROKEN LINK: trade-secret-defn] the Defend Trade Secrets Act defines improper means as: "(A) [including] theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means; and (B) [not including] reverse engineering, independent derivation, or any other lawful means of acquisition …."

Subdivision 4: Exclusion of already-known information

The prior-knowledge exception is one of those where a corroboration requirement (as defined in Clause 23.8) comes into play. Suppose that a defendant, accused of misappropriating confidential information, asserts that it can't be liable because: We already knew the information before you gave it to us, so there! A judge or jury might be rightly skeptical of a bald assertion to that effect, in the absence of corroborating evidence.

(See § 23.8 for more discussion of the policy underpinnings and supporting precedent concerning corroboration requirements.)

Pro tip: One way for a receiving party to add credibility to a claim of prior knowledge would be for the receiving party to notify the disclosing party promptly when the disclosing party discloses information already known to the receiving party. That was an actual contractual requirement in one case, but the defendant did not follow that requirement, which contributed to the court's denial of the defendant's motion for summary judgment.

Subdivision 5: Exclusion of independently-developed information

As a practical matter, an accused misappropriator of confidential information might have a hard time convincing a judge or jury that it independently developed the allegedly-misappropriated information on its own. For an example, see the Celeritas v. Rockwell case, where a federal-court jury in Los Angeles awarded a startup company more than $57 million because the jury found that Rockwell had breached a confidentiality agreement; the jury rejected Rockwell's assertion that its engineers had independently developed the technology in question after having been exposed to the startup company's information.

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16.1.8 Are pre-agreement disclosures protected?

No: Discloser's disclosures of Confidential Information before the parties' entry into the Contract will be protected only to the extent that the Contract clearly says so.

Commentary

In some cases drafters might want to specify that information disclosed before the parties signed the Contract will qualify as Confidential Information — this might be appropriate, for example, if the parties are entering into a written confidentiality agreement to confirm a previous oral agreement.

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16.1.9 When — if ever — will confidentiality obligations expire?

Some confidentiality obligations will expire in time, but others will not, as stated below.

16.1.9.1 Confidentiality obligations will end if an exclusion applies

Recipient's confidentiality obligations under the Contract will automatically expire, as to particular Discloser information, if and when the information becomes subject to one or more of the exclusions in Clause 16.1.7.

16.1.9.2 Confidentiality obligations for non-trade-secrets will expire

For Discloser's Confidential Information that does not qualify as a trade secret,

  • Recipient's confidentiality obligations under the Contract will expire
  • at the end of three years after the effective date of the Contract,
  • if not otherwise provided in the Contract.
Commentary

Whether confidentiality obligations should ever expire might depend on the circumstances.

  • Some types of confidential information will have a limited useful life, e.g., future plans. Such information might reasonably have its protection limited to X months or years.
  • Other types of confidential information might have essentially-unlimited useful life — for example (putatively), the recipe for making Coca-Cola® syrup. (For those types of information, see the separate provision above concerning trade secrets.)

A receiving party might want an expiration date for confidentiality obligations as a safe harbor. After X years have gone by, it might well take time and energy for the receiving party to figure out (1) which information of the disclosing party is still confidential, and (2) whether the receiving party might be using or disclosing confidential information in violation of the NDA. The receiving party likely would prefer instead to have a bright-line "sunset," after which the receiving party can do whatever it wants without having to incur the burden of analyzing the facts and circumstances.

A disclosing party might regard an expiration date for confidentiality obligations as acceptable, depending largely on:

  1. how sensitive the information is, in the disclosing party's eyes, and
  2. how long it will be until the confidentiality obligations expire.

For example, suppose that:

  • The confidential information in question relates to the design of a product manufactured and sold by the disclosing party.
  • The disclosing party knows that, in two years, it will be discontinuing the product and will no longer care about the product-design information.

In that situation, the disclosing party might be willing to have the receiving party's confidentiality obligations expire in three or four years — this would:

  • provide the receiving party with a bright-line sunset date, and
  • provide the disclosing party with a year or two of safety margin.

Caution: If the receiving party's confidentiality obligations are allowed to expire, the disclosing party might thereafter find it difficult — or, more likely, impossible — to convince a court to enforce any trade-secret rights in the relevant information.

As Judge Rakoff put it in one case, "a temporary pledge to secrecy is exactly that: temporary. Once a third party's confidentiality obligation (assuming arguendo one exists) expires, so does the trade secret protection."

ALTERNATIVES: The parties could specify that Recipient's confidentiality obligations will expire X months or years after:

  • the date that all copies of the information are returned or destroyed; or
  • the effective date of termination or expiration of the Contract — but sometimes an agreement won't have an expiration date and the parties might forget to terminate it.

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16.1.9.3 Trade-secret confidentiality obligations will not expire

If Discloser discloses trade-secret information (as defined in Clause 16.1.6) to Recipient;

  • and Discloser complies with the requirement to assert trade-secret status in writing,
  • then as to that information, Recipient's confidentiality obligations under the Contract will not expire,
  • unless and until the information becomes subject
    • to one or more of the exclusions from Confidential-Information status
    • in Clause 16.1.7.

16.1.10 Will confidentiality expiration affect other legal restrictions?

No: Even if Recipient's confidentiality obligations under the Contract were to expire,

  • Discloser could still enforce its copyrights, patents, and other rights (if any) against Recipient,
  • unless Discloser had expressly agreed otherwise in writing.

16.1.11 Is confidential information of affiliates protected?

  1. Confidential Information of Discloser's affiliates (as defined in Clause 25.2)
    • is not protected under this Clause
    • unless the Contract clearly states otherwise
  2. If the Contract does state otherwise,
    • then Discloser must treat the information of Discloser's affiliates as Confidential Information,
    • in the same manner as if the information were Discloser's Confidential Information,
    • if the following requirements are met:—
      • 1. The affiliate's information in question must otherwise qualify as Confidential Information; and
      • 2. The affiliate information must be clearly marked as being subject to the Contract,
        • whether or not Discloser's own information would need to be marked as Confidential Information (see § 16.1.12),
      • so that Recipient and its personnel will have fair warning
      • about their obligations concerning confidential information of Discloser's affiliates.
Commentary

When it comes to affiliate information, Discloser and Recipient have conflicting concerns:

  • Discloser might want its affiliates' Confidential Information to be protected without the affiliates' having to negotiate and sign separate confidentiality agreements with Recipient.
  • On the other hand, Recipient might insist on knowing exactly which companies conceivably might sue Recipient someday for breach of contract and/or misappropriation of trade secrets.

So as a compromise, this language, when agreed to:

  • allows affiliate information to be protected,
  • while reducing the chances that Recipient might someday be ambushed by confidentiality claims concerning information that Recipient's people had no real reason to know was confidential.

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16.1.12 Must Confidential Information be marked as such?

Yes, with certain exceptions, as follows:

16.1.12.1 Information is presumed to be confidential if so marked

If Discloser marks its information as Confidential Information in accordance with this Clause,

  • then Recipient must treat the information as Confidential Information,
  • unless the information is excluded from Confidential Information status under § 16.1.7.
16.1.12.2 Marking must be prominent and human-readable

For information to qualify as Confidential Information,

  • Discloser must make sure that the information — as initially disclosed to Recipient —
  • is marked as confidential in a reasonably-prominent, human-readable form,
  • with certain exceptions as stated below.
Commentary
Marking requirements: A compromise

The marking requirements and its exceptions represent a compromise between the legitimate operational interests of Discloser and Recipient. The basic objectives of requiring Confidential Information to be marked as such are usually the following:

  • to alert Recipient's personnel that particular information is subject to confidentiality obligations;
  • conversely, to let Recipient's personnel know what particular information is not subject to confidentiality obligations and therefore is free for use (at least as far as Discloser is concerned); and
  • perhaps most importantly (at least from a litigation perspective), to help courts and arbitrators sift through claims that particular information was or was not subject to confidentiality obligations.
Courts pay attention to the absence of marking.

In assessing whether Discloser in fact maintained particular information in confidence, a court very likely will give significant weight to whether Discloser caused the information to be marked as confidential.

  • In the Seventh Circuit's Fail-Safe case, the court pointedly noted that the plaintiff had not marked its information as confidential; the court affirmed the district court's summary judgment dismissing the plaintiff's claim of misappropriation.
  • To like effect was another Seventh Circuit case in which the court affirmed a summary judgment that "no reasonable jury could find that nClosures took reasonable steps to keep its proprietary information confidential," and therefore the confidentiality agreement between the parties was unenforceable.
Failure to mark can be fatal

A disclosing party's failure to mark its confidential information as such when required by a confidentiality agreement or nondisclosure agreement ("NDA") can be fatal to a claim of misappropriation of trade secrets or misappropriation of confidential information. For example, in Convolve v. Compaq, the computer manufacturer Compaq (now part of Hewlett-Packard) defeated a claim of misappropriation of trade secrets concerning hard-disk technology because the owner of the putative trade-secret information did not follow up its oral disclosures with written summaries as required by the parties' non-disclosure agreement.

Caution: Some unmarked information might be confidential by law

Some categories of information might be confidential by law even without marking — applicable law might independently impose a confidentiality obligation benefiting third parties, regardless of marking.

For example, the U.S. Health Insurance Portability and Accountability Act (HIPAA) imposes such obligations in respect of patients' protected health information.

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16.1.12.3 Obviously-confidential information need not be marked

Discloser's information can qualify as Confidential Information,

  • even if the information is not marked as such,
  • if Discloser shows that the information is clearly of a type
  • that reasonable people in the business
  • would readily recognize
  • as likely to be confidential.
Commentary

Some disclosing parties might not want to be bothered with having to mark their confidential information as such. This section accommodates that preference at least somewhat.

A receiving party, though, might well object to this provision because it's necessarily vague, which could later lead to disputes about whether particular information qualified as "clearly" confidential.

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16.1.12.4 Discloser's internal files need not be marked

Discloser's information can qualify as Confidential Information, even if the information is not marked as such,

  • if Discloser shows that it made the information available to Recipient
  • only by allowing Recipient to have access to Discloser's internal files (hard copy, electronic, etc.),
  • without giving Recipient permission to make and/or take away copies of the information.
Commentary

This section addresses the slightly-tricky situation when Recipient's people are allowed to look at Discloser's internal files but not to make notes, take away copies, etc.

In such a situation, it might well be burdensome for Discloser to have to go through each of its files to ensure that all confidential information is marked, on pain of losing confidentiality protection.

(There might also later be a he-said, she-said proof problem if a dispute were to arise about whether particular information had in fact been marked.)

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16.1.13 Is catch-up marking allowed?

Yes, within limits: Discloser's information can still qualify as Confidential Information,

  • even if the information was not marked as confidential
  • when Discloser initially made it available to Recipient —
    • for example, if Discloser initially disclosed the information to Recipient orally,
    • or in a demonstration, or in an unmarked written disclosure —

if Discloser shows that:

  1. Within ten business days after that initial, unmarked disclosure,
    • Discloser followed up by sending Recipient
    • a reasonably-detailed written summary of the information;
  2. the follow-up summary was marked as confidential as prescribed in this Clause; and
  3. Discloser gave Recipient notice (as defined in Clause 24.17)
    • that Discloser had sent the follow-up summary,
    • so as to make a record of the follow-up.
Commentary

In the real world, parties sometimes have play catch-up on their contract paperwork. This section tries to accommodate that reality.

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16.1.14 Must trade secrets be specifically labeled? How?

  1. Even in cases where the Contract would not require other Confidential Information to be marked,
    • Discloser must do as prescribed in this section for particular Confidential Information
    • if Discloser wants the information to be considered a trade secret (as defined in Clause 16.1.6).
  2. Discloser must clearly assert to Recipient, in writing, that the Confidential Information is a trade secret.
  3. Discloser's written assertion of trade-secret status:
    • must be reasonably prominent; and
    • must contain reasonable identifying details about the information in question.
  4. As one (non-exclusive) "safe harbor" example,
    • Discloser's written trade-secret assertion may take the form, without limitation,
    • of a reasonably prominent, human-readable marking to that effect
    • on the copy of the information initially provided to Recipient.
Commentary

Under § 16.1.9, Recipient's confidentiality obligations will last indefinitely for trade secrets; in contrast, "mere" Confidential Information would automatically lose its protection after a time. For greater fairness to Recipient, this section requires Discloser to alert Recipient about trade-secret claims.

This requirement that trade secrets be explicitly claimed in writing is part of a compromise:

  • it encourages parties to mark all of their confidential information as such;
  • but it does not require marking for garden-variety confidential information that does not qualify as a trade secret (for example, because the information lacks independent economic value).

The written-claim requirement comports with the litigation requirement in some states that a party claiming misappropriation of a trade secrets must identify the alleged trade secret with particularity. See, e.g.:

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16.1.15 When must trade secrets be identified as such?

Discloser's written assertion of trade-secret status under [BROKEN LINK: conf-info-ts-mark-rqmt][BROKEN LINK: conf-info-ts-mark-rqmt]

  • must be received by Recipient
  • before Recipient's confidential obligations would otherwise have ended as to the information in question under § 16.1.9.
Commentary

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16.1.16 What secrecy measures must Recipient take?

  1. This section applies for the entire term of Recipient's confidentiality obligations under this Clause as stated in Clause 16.1.9.
  2. Recipient must take, at a minimum, the specified measures to keep Discloser's Confidential Information secret,
    • and those measures must include, without limitation, at least the same secrecy measures that Recipient takes with respect to Recipient's own confidential information of comparable significance.
Commentary

Failure to impose secrecy obligations on recipients of confidential information can destroy the disclosing party's claims of secrecy. This happened in a case where a supplier had given specific price-quote information to a customer without any sort of confidentiality obligation — and that defeated the supplier's claim of trade-secret misappropriation against a former employee.

To like effect was a case involving a scientist who sued the U.S. Government for infringing his patents and afor misappropriating his allegedly-secret proprietary information. The court granted the government's motion to dismiss the misappropriation claim, saying: "[I]nstances in which Mr. Gal-Or took proactive steps to protect the confidentiality of his trade secrets are simply overwhelmed [emphasis in original] by the number of times he did not. … In sum, because Mr. Gal-Or disclosed trade secrets to others, who were under no obligation to protect the confidentiality of the information, Mr. Gal-Or lost any property interest he may have held." (Emphasis added.)

And in a different case: "[B]ecause Broker Genius regularly disclosed its alleged secrets to each of its customers without notifying them of the information's confidential nature or binding them to confidentiality agreements, Broker Genius is unlikely to be able to show that it undertook reasonable measures to protect the secrecy of its alleged trade secrets."

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16.1.17 How may Recipient use Confidential Information?

  1. Recipient may use Confidential Information only —
    1. as authorized by the Contract, and/or
    2. as otherwise agreed in writing by Discloser.
  2. During the term of the Contract, and only then, Recipient may use Discloser's Confidential Information to the extent – and only to the extent — reasonably necessary for one or more of the following:
    1. performing Recipient's obligations under the Contract;
    2. exercising Recipient's rights under the Contract;
    3. assessing whether to enter into another agreement with Discloser; and/or
    4. any other use expressly agreed to in writing by Discloser.
Commentary

This section should save the parties some time by pre-specifying certain standard authorized uses of Confidential Information.

A receiving party might want to state explicitly that that certain specified uses are authorized.

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16.1.18 What copies of Confidential Information may Recipient make?

Recipient may reproduce Discloser's Confidential Information only to the extent reasonably necessary:

  • for a use or disclosure that is authorized by this Clause, or that Discloser has otherwise agreed to in writing; and/or
  • for Recipient's normal IT processes — for example, automated backups — that would not pose a significant risk of exposing the reproduced Confidential Information to others in violation of the Contract.

16.1.19 Is translation of Confidential Information allowed?

Recipient may not translate Confidential Information into any other language or form, except:

  • to the minimum extent necessary for an authorized use or disclosure under the Contract,
  • or with Discloser's prior written consent.

16.1.20 Is reverse-engineering of Confidential Information allowed?

No — Recipient may not engage in reverse-engineering,

  • or otherwise attempt to discover the inner workings and/or structure of any system containing or operating with Confidential Information,

without Discloser's prior written consent;

this prohibition includes but is not limited to:

  • disassembly and/or decompilation of computer program code, and
  • "black-box" study of internal system functions.
Commentary

Courts in the U.S. routinely enforce prohibitions against reverse engineering of confidential information, especially in software. The basic rationale is that:

  • reverse engineering is not considered "improper means" for discovering a trade secret (see § 16.1.2);
  • but if Recipient bargains away (i.e., waives) its right to engage in reverse engineering, courts will enforce that bargain.

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16.1.21 When may Recipient disclose Confidential Information to others?

Recipient may not make Discloser's Confidential Information available to others —

  • including but not limited to by confirming others' guesses or conjectures —
  • except as provided in this section.
16.1.21.1 Authorized disclosure to certain Recipient personnel
  1. During the term of the Contract, and only then, Recipient may disclose Discloser's Confidential Information — to the extent not prohibited by law — to Recipient's own employees, officers, and directors, BUT ONLY to the extent that those individuals:
    1. have a legitimate "need to know" in connection with an authorized use of the information, and
    2. are bound by obligations of confidence comparable to those of the Contract.
  2. Before Recipient discloses Confidential Information under this section, Recipient must first:
    1. confirm that each intended recipient is bound by the confidentiality obligations of the Contract; and
    2. cause each recipient to be specifically instructed and/or reminded that he or she is obliged to abide by those confidentiality obligations.
Commentary

Drafters should consider the extent — if any — to which Recipient's contractors, affiliates, etc., should be permitted to receive Confidential Information. This will be especially true if Recipient's workforce includes so-called leased employees or other individuals working long-term in independent-contractor status.

Subdivision a.1: Limiting Recipient's disclosures to a need-to-know basis is pretty standard in confidentiality provisions.

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16.1.21.2 Disclosure in response to subpoena, etc.

Recipient will not breach its obligations under this Clause if it discloses Discloser's Confidential Information to the minimum extent required by law in response to subpoenas and other compulsory legal demands — IF Recipient satisfies the following prerequisites:

  1. Recipient must try to give Discloser as much advance notice of the impending disclosure as is allowed by law — but Recipient may use reasonable discretion on that score if a government authority asks Recipient not to notify Discloser.
  2. Recipient must provide reasonable cooperation with any effort by Discloser to limit the disclosure in response to the demand.
  3. Recipient must disclose only so much Confidential Information as, in the written opinion of Recipient's counsel to Recipient, is required by the demand.

(In case of doubt, subdivision 3 does not require Recipient or its counsel to disclose counsel's written opinion to Discloser or anyone else.)

Commentary

A recipient of confidential information could find itself in an awkward position if it were served with a subpoena or a search warrant demanding that the recipient produce the disclosing party's confidential information. This section provides a mechanism for the recipient to deal with such a situation.

Note that under this section, voluntary or discretionary disclosures of Confidential Information are not allowed, for example in public filings with the Securities and Exchange Commission (SEC). If Recipient were to do that, it would breach its obligations under this Clause.

(If the parties want to allow for disclosures in public filings, they can consider Clause 16.2.9 (Option: Disclosure in Public Filings Authorization).)

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16.1.21.3 Legally-immune disclosures
  1. Recipient will not breach its obligations under this Clause if it discloses Discloser's Confidential Information to the minimum extent that the disclosure would be immune from liability under Title 18, Section 1833(b) of the United States Code.
  2. In any such event, Recipient is strongly encouraged, but it is not required, to advise Discloser in advance of any such disclosure.
Commentary

U.S. law limits the ability of individuals and companies to restrict disclosure of confidential information where the restriction would contravene public policy — for example, the (U.S.) Defend Trade Secrets Act, enacted in 2016 and codified at 18 U.S.C. § 1833 et seq. This legislation followed fierce assertions by several U.S. Government agencies that a company may not even arguably discourage, let alone prohibit, the company's employees from disclosing whistleblower information to the agencies.

For example, in 2015 the Securities and Exchange Commission went after well-known government contractor KBR for this; the contractor agreed to the entry of a cease-and-desist order and to pay $130,000 settlement. [SEC press release] [SEC order] [Houston Chronicle article]

See also the commentary in the next section, concerning how the [U.S.] National Labor Relations Board has taken a similar view about employees' discussing salary- and working-conditions with each other.

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16.1.21.4 Disclosures for labor-law purposes
  1. Recipient will not breach its obligations under this Clause if it discloses Discloser's Confidential Information to the minimum extent affirmatively authorized by law or regulation, for example the (U.S.) National Labor Relations Act or other applicable labor- or employment law.
  2. In any such event, Recipient is strongly encouraged, but it is not required, to advise Discloser in advance of any such disclosure.
Commentary

The (U.S.) National Labor Relations Board has been hostile to contractual confidentiality restrictions that purport to limit employees' discussions of wages and working conditions. But note: More recently, Trump appointees to the NLRB appear to be willing to revisit employer-employee confidentiality agreements, at least in the context of settlement- and separation agreements.

Caution: The NLRB might regard this "it's not a violation" carve-out as insufficiently explaining to employees their right to engage in concerted action under the NLRA.

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16.1.22 May Discloser seek a restraining order?

Yes —

  1. This section applies in any case in which:
    • Confidential Information is (i) disclosed, or (ii) used,
    • other than as provided in the Contract,
    • by Recipient, or by an individual or organization to which Recipient disclosed the information.
  2. This section will also apply if it appears that such unauthorized disclosure or use is about to happen.
  3. In either case described in subdivisions a and b, Discloser may go to court (or to private arbitration, if that has been agreed to) to seek an injunction or similar restraining order,
Commentary

This section uses the well-known term "restraining order" because it's likely to be more familiar to non-lawyer readers than "injunctive relief" or "specific performance." In this context, all of these terms are meant to be more-or-less synonyms. See also Clause 23.10 (Equitable Relief).

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16.1.23 Must Confidential Information be returned or destroyed?

  1. Confidential Information need not be returned or destroyed unless the Contract clearly says so.
  2. If the Contract does clearly say so,
    • then if Discloser so requests in writing,
    • Recipient must return or destroy copies of Discloser's Confidential Information,
    • in accordance with Clause 19.8 (Information Purge Protocol),
      • including but not limited to its general exceptions and deadlines,
    • except as provided below in this section.

Contents:

Commentary

An obligation to return or destroy Confidential Information might not be practical if (for example) Confidential Information is embodied in a deliverable (for example, custom-developed computer software, or a physical object) that the receiving party will have the right to keep on using; this might be the case in a services agreement.

PRO TIP: Unfortunately, sometimes parties forget about return-or-destruction obligations. A disclosing party will want to follow up to be sure that the return-or-destruction requirement is actually complied with; if it were to fail to do so, a receiving party (or a third party) could try to use that as evidence that the disclosing party did not take reasonable precautions to preserve the secrecy of its confidential information.

Likewise, if the receiving party were to forget to comply with its return-or-destruction obligations, then the disclosing party might use that fact to bash the receiving party in front of a judge or jury.

PRO TIP: Consider requiring segregation of Confidential Information, as discussed in Clause 16.2.6 — or Recipient could elect to segregate Confidential Information on its own initiative, even without a contractual requirement — for easier compliance with this section.

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16.1.23.1 Exception: Archive copies need not be purged
  1. Recipient may keep archive copies of Discloser's Confidential Information in accordance with the Archive Copies — but see subdivision b for an exception to this exception.
  2. If Recipient is an employee or individual contractor of Discloser,
    • then Recipient must not retain copies of Confidential Information,
    • except solely for the purpose of imminent disclosure under one of the exceptions in this Clause (response to subpoenas, legally-immune disclosures, and disclosures under labor- or employment law).
16.1.23.2 Confidentiality obligations continue for remaining copies

Recipient's confidentiality obligations under the Contract will continue in effect for all copies of Discloser's Confidential Information that are not returned or destroyed.

16.1.24 Will confidentiality provisions end with termination?

No — even if the Contract itself were to come to an end, for example, by being terminated or by expiring,

  • that would not release Recipient from its confidentiality obligations concerning Discloser's Confidential Information,
  • and this would be true no matter what other provisions of the Contract might also deal with survival of the terms of the Contract.
Commentary

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See also the Survival of Terms and Conditions

16.1.25 Other terms to consider adopting

The following terms are not part of this Clause, but drafters can consider selectively incorporating one or more of the following terms by reference in the Contract:

16.1.26 Review questions

16.1.26.1 Gigunda-MathWhiz confidential information exercise

FACTS:

Gigunda wants MathWhiz to sign a separate confidentiality agreement ("NDA," i.e., nondisclosure agreement) before Gigunda will disclose technical details about a new oilfield project that Gigunda will be undertaking.

Gigunda's draft NDA says that it's a two-way NDA, i.e., it will protect each party's confidential information — but MathWhiz doesn't plan to disclose any confidential information to Gigunda.

QUESTION (with Zoom poll): MathWhiz's project director asks you whether the NDA is safe to sign "as is," because it's a balanced NDA that applies equally to each party's information and each party receiving another party's information — what would you say?

MORE FACTS: MathWhiz's project director wants to know if you can add a clause to Gigunda's NDA, to the effect that MathWhiz's confidentiality obligations as to Gigunda's information will expire in one (1) year.

QUESTIONS:

  1. How do you think Gigunda might react?
  2. Is there a way to compromise?
  3. Any drafting issues in the way the "More Facts" paragraph is set out above?
16.1.26.2 Confidential Information — discussion and exercise
  1. If a confidentiality provision is written to protect each party's confidential information, does that pretty much guarantee that the provision will be "fair and balanced"?
  2. FACTS: You represent MathWhiz. Gigunda wants access to MathWhiz's proprietary algorithms (data-processing methods) so that Gigunda can decide whether to pay MathWhiz to crunch Gigunda's Mongolia data. Gigunda is willing to sign an "NDA," but its draft NDA states that the term of the NDA will be two years. QUESTION: Any issues here for MathWhiz?
  3. Now suppose you represent Gigunda: What if it turns out that MathWhiz's proprietary algorithms are just a collection of known techniques?
  4. DRAFTING EXERCISE: In your groups, come up with a minimal confidential-information provision (maybe three or four sentences?) to protect Gigunda's confidential information. Then paste onto virtual whiteboard ( 6:00 p.m. section | 7:30 p.m. section ); we'll discuss.
16.1.26.3 Exercise: Breaking up a confidentiality clause

Break up the following provision to make it more readable; it's from an Atari consulting agreement, at https://goo.gl/ukMKTr (onecle.com via archive.org), between an individual and Atari.

7.    Confidentiality and Security.

Consultant recognizes and agrees that in the course of performing services hereunder Consultant will generate or otherwise become privy to written or orally conveyed information that is proprietary or confidential to Atari, its affiliates, or their customers and/or to other parties to whom they may have confidentiality obligations. This information may include, without limitation, plans to introduce new products or services (including in this regard the existence of the Project), methods of doing business, planned transactions, market information, pricing information, supply sources, license and contract terms, information pertaining to customers' businesses, non-public financial data and operating results, system and component designs, specifications, computer software and technical information. Consultant understands that Atari and/or such affiliates, customers and other parties regard such information as trade secrets, and Consultant will employ Consultant's best efforts to assure the continued confidentiality thereof. Consultant will not disclose such information to anyone or use it for any purpose other than the performance of Consultant's services hereunder. Consultant will take all reasonable measures to prevent any unauthorized person from gaining access to such information and to prevent such information from being accessed, disclosed or used in any unauthorized manner, including complying strictly at all times with all applicable physical and computer system security procedures. Consultant will not break or attempt to break any of Atari's (or such affiliates’, customers' or other persons’) security systems, or obtain, or attempt to obtain access to any program or data other than those to which Consultant has been given access in writing. Upon any termination, cancellation or expiration of this agreement or at Atari's request at any other time, Consultant will deliver to Atari all materials in tangible form containing any of the information referred to in this Section 7, shall purge any and all copies thereof from all files and storage media retained by Consultant, and shall retain no archival or other copies thereof whatsoever. Further in such event, Consultant shall return any keys, security passes, equipment or other items or property supplied to Consultant by Atari or by any such affiliate, customer or other person.

QUESTION 1: If you're representing Consultant, what concern should you have (if any) about the phrases "best efforts" and "all reasonable measures"?

QUESTION 2: How is Consultant supposed to know just what Atari information is subject to the confidentiality restriction?

QUESTION 3: Why should the penultimate sentence be of concern to Consultant?

[DCT to show his first pass]

DCT's first pass: (to show on his computer)

16.2 Confidential information - optional terms

16.2.1 Option: Disclosure to Prospective Acquirer

16.2.1.1 Only certain M&A prospects are eligible
  1. Prospect may be a prospective acquirer of substantially all assets of Recipient's business specifically associated with the Contract.
  2. If Recipient is an organization, Prospect may be —
    1. a prospective acquirer of substantially all shares of Recipient —
      • or equivalent ownership interest under applicable law, if Recipient is an organization that does not have shares; and/or
    2. a party (or an affiliate (as defined in Clause 25.2) of a party) with which Recipient anticipates engaging in a merger, or similar transaction, in which Recipient would not be the surviving entity.
Commentary

Business background: In a merger or acquisition, a company that will be acquired will generally be asked to "open the kimono" to the potential acquiring company, very often by allowing the acquiring company to access electronic documents in a secure data room.

This specific provision was inspired by a blog posting by English lawyer Mark Anderson.

Caution: NDAs and prospective BigCo partners / acquirers: It's not unheard of for a big company to approach a small company about being "partners," perhaps hinting that the big company might want to acquire the small company. In that situation, the small company should be alert to the possibility that the big company might be trying to get a free look at the small company's confidential information. See, e.g., this story told by an anonymous commenter on Hacker News.

An NDA can come in very handy in such situations.

Enforcing an NDA can take a lot of time and money, especially if the big company is convinced (or convinces itself) that it hasn't done anything wrong — or simply folds its arms and says, tough [expletive], sue us.

But a jury might well punish a company that it found breached the NDA. See, e.g., Celeritas v. Rockwell, where a federal-court jury in Los Angeles awarded a startup company more than $57 million because the jury found that Rockwell had breached an NDA.

Similarly, but not quite on point: A Texas jury awarded more than $730 million in damages to a real estate data analytics company because one of its customers, a title-insurance company, had misappropriate the analytics company's trade secrets; the jury also found that the customer had breached its confidentiality agreement with the analytics company, but the supplier elected to recover for fraud and misappropriation instead of for breach of contract. (The appeals court reversed and remanded for a new trial on the fraud and misappropriation claims.)

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16.2.1.2 The Prospect must agree to secrecy obligations
  1. Prospect must agree in writing with Recipient to abide by Recipient's obligations concerning Discloser's Confidential Information.
  2. Discloser will be an intended third-party beneficiary of Prospect's agreement with Recipient.
  3. A copy of Prospect's agreement with Recipient must be provided to Discloser if Discloser so requests,
    • but in case of doubt, neither Recipient nor Prospect are required to advise Discloser that they are contemplating a possible transaction.
16.2.1.3 Disclosure to Prospect's fiduciary advisers is OK

Recipient and Prospect may disclose Discloser's Confidential Information to Prospect's attorneys, accountants, and other advisers having a fiduciary- and/or contractual duty to preserve the information in confidence.

16.2.1.4 Disclosure must be in a secure data room

Any disclosure under this Option must be done:

  1. in one or more secure physical data rooms, and/or
  2. via a secure online data room.
16.2.1.5 Prospect may not take copies without Recipient's consent

Recipient must not allow or knowingly assist Prospect, nor any of Prospect's recipients under this Option, to keep copies of Discloser's Confidential Information, unless Discloser gives its prior written consent.

(Accessing information, without more, is not considered keeping a copy of the information.)

16.2.2 Option: Recipient Indemnity Obligation

Recipient must defend (as defined in Clause 21.4) Discloser's Protected Group (as defined in Clause 25.40) against any claim, by a third party, arising out of any of the following:

  1. Recipient's use of Discloser's Confidential Information, and/or
  2. Recipient's disclosure of the Confidential Information to other parties, whether or not as authorized by the Contract.
Commentary

As with any indemnity- or defense obligation, Discloser should consider:

  • whether Recipient has the financial wherewithal to meet this obligation; and
  • whether to ask Recipient also to contractually commit to maintaining appropriate insurance coverage. [TO DO: LINK].

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16.2.3 Option: Recipient's Compliance Responsibility

If a third party obtains or otherwise accesses Discloser's Confidential Information

  • as a result of the third party's relationship with Recipient;

and the third party uses, discloses, and/or copies Discloser's Confidential Information in a manner not permitted by the Contract;

then:

  • Recipient will be liable to Discloser for any resulting harm to Discloser or to Discloser's interests,
  • to the same extent as if the damage had been caused by Recipient's own use, disclosure, or copying of the Confidential Information.

Note: For this purpose, the term third party includes, without limitation, any employee of Recipient.

Commentary

Recipients might push back if asked to agree to this, but disclosers will usually want "one throat to choke" (a trite but useful expression).

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16.2.4 Option: Recipient's Assignment-Consent Requirement

Recipient may not assign the Contract without Discloser's written consent

Commentary

Consider agreeing to one or more of Clause 24.5 (Assignment Consent).

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16.2.5 Option: Copies of Confidentiality Agreements

  1. If Discloser so requests, Recipient must provide Discloser with a copy of a signed written confidentiality agreement between (i) Recipient and (ii) each individual or organization to which Recipient makes Discloser's Confidential Information available.
  2. Each such agreement must obligate the individual or organization, in effect, to give Discloser's Confidential Information the same protection as is required by the Contract.
  3. Recipient may have such copies redacted — to a reasonable extent — so that Discloser will not get to see confidential information of Recipient and/or of the individual or organization in question.
Commentary

This requirement might be burdensome for Recipient, but sometimes Discloser might have a legitimate need for it.

Subdivision c: The reasonableness requirement for redaction has in mind that some government documents are sometimes supposedly declassified but issued with a risible number of redactions.

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16.2.6 Option: Required Segregation of Confidential Information

Recipient must keep Discloser's Confidential Information reasonably segregated from other information, with a view to:

  • providing additional protection of Confidential Information, and
  • speeding up any necessary return or destruction of Confidential Information (see § 16.1.23).
Commentary

See also the [BROKEN LINK: conf-info-rtn-destr] and its commentary.

This segregation requirement could well be unduly burdensome — on the other hand, a segregation requirement might have been useful in a case where an independent oil-and-gas reservoir engineer disclosed trade-secret information to a production company under a nondisclosure agreement; when the relationship waned, the engineer asked for the information to be returned, but that proved problematic, as one individual ended up retaining some of the information in his files.

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16.2.7 Option: Inspections of Recipient's Compliance

  1. Discloser may cause reasonable inspections —
    • of Recipient's relevant properties and premises (see subdivision b)
    • to be conducted from time to time,
    • at any time that Recipient has Discloser's Confidential Information in its possession,
    • to confirm that Recipient is complying with its confidentiality obligations under the Contract.
  2. For this purpose, the term "relevant properties and premises" includes, without limitation,
    • any and all relevant hard-copy and electronic records, of any kind,
    • that are in Recipient's possession, custody, or control.
  3. Any such inspection must be upon written notice, far enough in advance to be reasonable under the circumstances.
  4. Any such inspection must comply with Clause 15.3 (Inspections).
Commentary

Some Recipients are likely to balk at this Option; in some circumstances, though, Discloser might feel it was necessary.

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16.2.8 Option: Required Cooperation Against Misappropriators

If Discloser so requests, Recipient must provide reasonable cooperation,

  • at Discloser's expense,
  • with any efforts by Discloser to take action:
    • to protect Discloser's Confidential Information against misappropriation,
    • and/or to redress such misappropriation and mitigate its effects.
Commentary

The "reasonable cooperation" qualifier should provide some comfort for a Recipient that thinks it might be opening itself up for burdensome expense in supporting Discloser's protection activities.

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16.2.9 Option: Disclosure in Public Filings Authorization

  1. Recipient may include Discloser's Confidential Information in a submission to a regulatory agency or other governmental body,
    • but only if all of the prerequisites in this Option are met.
  2. The inclusion must be compelled by law to the same extent as if the inclusion were compelled by law in response to a subpoena or other compulsory legal demand, as provided in Clause 16.1.21.2.
  3. Recipient must first consult with Discloser a sufficient time in advance to give Discloser a reasonable opportunity to seek a confidential treatment order or other comparable relief.
  4. Recipient must disclose only so much Confidential Information as is required to comply with the law.
  5. Recipient must provide reasonable cooperation with any efforts by Discloser to limit the disclosure,
    • and/or to obtain legal protection for the information to be disclosed,
    • in the same manner as if the proposed disclosure were in response to a compulsory legal demand.
Commentary

A receiving party whose shares are (or are to be) publicly traded might justifiably feel that it must disclose Confidential Information in its public filings. Such public disclosure, though, would almost certainly destroy the confidentiality of the information.

Example: A financial firm lost its claim to trade-secret protection for a particular financial strategy because its customer agreement explicitly authorized disclosure "to any and all persons, without limitation of any kind," so as to avoid adverse consequences under U.S. tax law.

The mirror-image issue arose in a Delaware case in which Martin Marietta was held to have breached a confidentiality agreement by including Vulcan's confidential information in a public filing with the Securities and Exchange Commission.

Confidential treatment orders are sometimes available to protect confidential portions of filings with the Securities and Exchange Commission. See generally the Investopedia article.

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16.2.10 Option: General Skills Safe Harbor

The Contract's restrictions on Recipient's use of Discloser's Confidential Information

  • do not limit the ability of Recipient's personnel
  • to utilize their general knowledge, skills, and experience
  • in the general field(s) of the Confidential Information,
  • even if improved by exposure to such information.
Commentary

This option is inspired by § 3 of an AT&T nondisclosure agreement (archived at http://perma.cc/G974-2ZH5), which states: "… use by a party's employees of improved general knowledge, skills, and experience in the field of the other party's proprietary information is not a breach of this Agreement."

Caution: This option could be dangerous to Discloser because of the difficulty of determining when the exclusion did or did not apply.

"This is not to say that Teeters and Dingman cannot use, or advertise, the general knowledge and experience they have gained in their years working in the senior living industry. An employee enjoys a right, in competing against his former employer, to utilize general experience, knowledge, memory and skill — as opposed to specialized, unique or confidential information — gained as a consequence of his employment."

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16.2.11 Option: Residuals-Rights Exclusion

  1. Recipient may use "residuals," defined below, as Recipient sees fit, without obligation to Discloser.
  2. The term "residuals" refers to:
    • ideas, concepts, know-how, techniques, and similar information,
    • that are retained in the unaided memory of Recipient's personnel,
    • who did not intentionally memorize the information for that purpose.
  3. This Option does not negate any restriction of the Contract on Recipient's disclosure of Discloser's Confidential Information to third parties.
  4. For the avoidance of doubt, any use of residuals by Recipient will be subject to any applicable patent rights, copyrights, trademark rights, or other intellectual-property ights owned or assertable by Discloser.
Commentary

Some receiving parties (cough, Microsoft) have sometimes tried to include provisions granting them "residual rights" along the lines of this Option. Such residuals rights could later result in he-said-she-said disputes about whether Recipient's personnel were in fact relying on their unaided memories — and that same uncertainty might well tempt Recipient to treat this language as a get-out-of-jail-free card to do whatever it wanted with Discloser's Confidential Information. For that reason, Discloser likely will push back strongly against any request for residuals rights.

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16.2.12 Option: Toolkit Item Exclusion

The term Confidential Information does not include:

  • any concept, idea, invention, strategy, procedure, architecture, or other work,
  • that is, in whole or in part, created by Recipient as a result of working with Discloser's Confidential Information,
  • but is not specific, and/or is not unique, to Discloser and its business,
  • and does not include Discloser's Confidential Information.

16.3 Confidentiality of Parties' Dealings

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when the Contract requires that the parties' dealings be kept confidential.

Discussion checklist:

16.3.1 What information must the parties keep confidential?

In addition to any general requirements of the Contract concerning confidential information, if any,

each party must preserve in confidence,

  • all nonpublic information about the fact, and the terms,
  • of the parties' dealings under the Contract,
  • unless and until particular information becomes public.
Commentary

See also Clause 16.1 (Confidential Information).

Business context

Parties often want the mere fact that they are in discussions to remain confidential, let alone the  details of their business dealings. That can present some tricky issues, though, especially in an employment-related agreement. For example:

  • In a sales agreement, the vendor might want for the pricing and terms of the agreement to be kept confidential. Otherwise, a buyer for a future prospective customer might say, "I know you gave our competitor a 30% discount, and I want to show my boss that I can get a better deal than our competitor did, so you need to give me a 35% discount if you want my business."
  • Conversely, a customer might not want others to know who its suppliers are, possibly because the customer doesn't want its competitors trying to use the same suppliers.
  • Likewise, parties to "strategic" contracts such as merger and acquisition agreements very often want their discussions to be confidential. If the word leaks out that a company is interested in being acquired, that could send its stock price down.
Courts will (sometimes) enforce confidential-dealings clauses

Clauses requiring parties' contract terms to be kept confidential have been enforced. For example, in 2013 the Delaware chancery court held that a party materially breached an agreement by publicly disclosing the agreement's terms in violation of a confidentiality clause, thereby justifying the other party's termination of the agreement.

But a confidential-dealings clause might not be "material." In a different case, the Supreme Court of Delaware held that in a patent license agreement, a provision requiring the terms of the license to be kept confidential was not material, because the gravamen of the contract was the patent license, not the confidentiality provision; as a result, when the licensee publicly disclosed the royalty terms, the patent owner was not entitled to terminate the license agreement for material breach (as defined in Clause 25.33.2).

The government might have a contrary view

Governmental authorities might object to confidential-dealings clauses. For example, in employment-agreement forms, confidentiality provisions sometimes call for the employee to keep confidential all information about salary, bonus, and other compensation; the NLRB and some courts have taken the position that such a requirement violates Section 7 of the National Labor Relations Act.

See also § 16.1.21.3 and its commentary, concerning how the [U.S.] Securities and Exchange Commission has taken a similar view about employees' reporting possible criminal violations to government authorities.

Be careful what you do or don't prohibit

A mother filed a wrongful death suit against a physician, claiming that the mother's daughter died of a drug overdose while under the physician's care. "The patients' deaths were the subject of a Texas Medical Board investigation of Joselevitz, which resulted in a 2014 order curtailing Joselevitz's prescribing privileges and permanently prohibiting him from treating patients for chronic pain."

  • The parties settled the case, entering into an agreement that contained a confidentiality provision.
  • The confidentiality provision prohibited only disclosing the fact or terms of settlement; it did not prohibit the mother from talking about the physician's alleged malpractice.
  • The physician sued for breach of contract and defamation.

A Texas court of appeals affirmed summary judgment in favor of the mother, noting that:

Roane's allegations against Joselevitz were already matters of public record through the filing of her wrongful death lawsuit. Had Joselevitz desired to prevent Roane from speaking further about his treatment of Willens, he could have negotiated that as a term of the Settlement Agreement. Nothing in our record indicates he did so.

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16.3.2 To whom may the parties' dealings be disclosed?

Neither party may disclose, nor confirm, the fact or the terms of the parties' dealings to any third party,

  • except to those of the first party's officers, directors, employees, and agents who —
    • have a need to know in connection with the parties' dealings, and
    • are bound by the same obligation;
  • or as would be authorized for disclosure under Clause 16.1 (Confidential Information),
Commentary

See the commentary to Clause 16.1 (Confidential Information).

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16.3.3 Does the Contract establish a fiduciary relationship?

No; this Clause is not intended as evidence of, nor as establishing, a "confidential relationship" or "fiduciary relationship."

Drafters should be careful to avoid implying that the parties' relationship is confidential, as opposed to the fact and terms of their dealings. If it were otherwise — that is, if an agreement said that the parties' relationship was confidential — then the confidentiality provision might be (mis)interpreted as a declaration of a "confidential relationship"; that in turn might imply unwanted fiduciary obligations. See also [BROKEN LINK: indep-k-agency][BROKEN LINK: indep-k-agency] and its commentary.

16.4 Data privacy (commentary)

This commentary section doesn't pretend to cover the subject of data privacy in any detail, but only to alert the reader to its importance. Data privacy law is most definitely "a thing" — and in many jurisdictions, especially California and Europe, a thing with big, sharp teeth. As just a sample, see:

16.5 Data Privacy - Customer Commitment

If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when a party ("Customer") manages personal data of one or more individuals,

  • using goods, services, or technology furnished,
  • directly or indirectly,
  • by another party ("Provider").

Discussion checklist:

16.5.1 Does Customer have authorization to manage personal data?

Customer warrants (as defined in Clause 20.4),

  • to Provider's Protected Group (as defined in Clause 25.40),
  • that Customer has been authorized by each such individual to manage that individual's personal data,
  • to the extent required by applicable law.

16.5.2 What privacy laws must Customer comply with?

Customer must comply at all times with all applicable Privacy Laws (as defined in Clause 16.7).

Commentary

Caution: Data-privacy law is a big, important topic; see the resources cited at § 16.4.

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16.5.3 Must Customer do any "external" privacy paperwork?

Customer acknowledges that applicable Privacy Law (as defined in Clause 16.7) might require, for example,

  • that Customer register as a data controller with a local privacy data office,
  • and/or to pay a fee.
Commentary

The EU's General Data Protection Regulation (GDPR) no longer requires "data controllers" to register, but national laws might still impose such requirements.

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16.6 Data Use Authorization

  1. If this Clause is adopted in an agreement ("the Contract"), it will apply, as set forth in Clause 24.1, if and when a party ("Customer"),
    • directly or indirectly,
    • discloses personal data of one or more individuals,
    • to another party ("Provider"),
    • whether or not any such individual is employed by Customer,
      • or is a customer or client of Customer.
  2. Customer agrees that Provider may collect, store, and use such personal data
    • as stated in Provider's privacy policy.
Commentary

Caution: Data-privacy law is a big, important topic; see the commentary at § 16.4.

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16.7 Privacy Law Definition

  1. "Privacy Law" refers to any applicable law concerning the privacy, security, or processing of personal information,
    • including without limitation the law in jurisdictions where personal information was collected.
  2. Privacy Laws include, without limitation, the following:
    • the California Consumer Privacy Act of 2018 ("CCPA");
    • the Children’s Online Privacy Protection Act ("COPPA");
    • the Computer Fraud and Abuse Act ("CFAA");
    • the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 ("CAN-SPAM Act");
    • the Electronic Communications Privacy Act;
    • the European General Data Protection Regulation ("GDPR");
    • the Fair Credit Reporting Act ("FCRA");
    • the Fair and Accurate Credit Transaction Act ("FACTA");
    • the Family Educational Rights and Privacy Act ("FERPA");
    • the Federal Trade Commission Act;
    • the Gramm-Leach-Bliley Act ("GLBA");
    • the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), as amended and supplemented by the Health Information Technology for Economic and Clinical Health Act ("HITECH Act") of the American Recovery and Reinvestment Act of 2009;
    • the Telemarketing and Consumer Fraud and Abuse Prevention Act (TCFAP") ;
    • the Telephone Consumer Protection Act ("TCPA").
Commentary

This list is adapted from an underwriting agreement filed with the SEC effective Aug. 5, 2020, with a Form 8-K report by a company named 1847 Goedeker Inc.

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16.8 Protected Health Information

Commentary

For speedier legal review (and acceptance), this Clause is based closely on the sample business associates agreement published by the Department of Health and Human Services on January 25, 2013, at http://goo.gl/0OYWs, which is a shortened link for a page at www.hhs.gov. Some language of the HHS sample agreement has been rephrased for easier reading.

Google's HIPAA Business Associate Addendum seems to be similarly based, with a few variations: https://admin.google.com/terms/cloud_identity/3/7/en/hipaa_baa.html.

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16.8.1 Catch-all definitions from HIPAA Rules

The following terms used in this Clause have the same meanings as stated in the HIPAA Rules (defined below):—

In addition:

16.8.2 What must Provider not do with PHI?

Provider must not use or disclose protected health information,

  • other than as permitted or required by the Contract,
  • or as required by law.

16.8.3 What PHI safeguards must Provider take?

Provider must use appropriate safeguards,

  • and comply with Subpart C of 45 CFR Part 164 (with respect to electronic protected health information),
  • to prevent use or disclosure of protected health information other than as provided for by the Contract.

16.8.4 What reports must Provider make to Customer?

Provider must report to Customer, as required at 45 CFR § 164.410,

  • any use or disclosure of protected health information not provided for by the Contract of which Provider becomes aware,
  • including but not limited to breaches of unsecured protected health information,
  • and any security incident of which Provider becomes aware.

16.8.5 What must Provider have its PHI subcontractors do?

Provider must:

  • ensure,
  • that any subcontractors that create, receive, maintain, or transmit protected health information on behalf of Provider
  • have agreed to the same restrictions, conditions, and requirements that apply to Provider with respect to such information.

16.8.6 What PHI must Provider make available to Customer?

Provider must make protected health information available to Customer,

16.8.7 What if PHI must be revised?

  1. Provider must:
    • make any amendment(s) to protected health information in a designated record set
    • or take other measures as necessary to satisfy Customer's obligations under 45 CFR § 164.526.
  2. Provider may, at its option, make such amendment(s) or take such other action—
    • by storing an updated copy of the specific record(s) containing the information being amended;
    • Provider need not attempt to edit or otherwise update any individual record previously uploaded to Provider's file system by Customer.

16.8.8 What are Provider's PHI recordkeeping obligations?

  1. Provider must maintain,
    • and make available to Customer,
    • the information required to provide an accounting of disclosures
    • as necessary to satisfy Customer's obligations under 45 CFR § 164.528.
  2. Provider must comply with the requirements of Subpart E of 45 CFR Part 164 that apply to Customer,
    • to the extent that Provider is to carry out one or more of Customer's obligation(s) under that subpart.
  3. Provider must make its internal practices, books, and records available to the Secretary
    • for purposes of determining compliance with the HIPAA Rules.

16.8.9 How may Provider use or disclose PHI?

  1. Provider may disclose protected health information to persons whom Customer has authorized to access Customer's records stored in Provider's file servers.
  2. Provider may use or disclose protected health information as required by law.
  3. Provider may not use or disclose protected health information
    • in any manner that would violate Subpart E of 45 CFR Part 164 if done by Customer as a covered entity,
    • except for the specific uses and disclosures set forth below.
  4. Provider may use protected health information:
    1. for the proper management and administration of Provider,
    2. or to carry out the legal responsibilities of Provider.
  5. Provider may disclose protected health information:
    • for the proper management and administration of Provider
    • or to carry out the legal responsibilities of Provider,
    • if all of the following are true:
      • 1. the disclosures are required by law; or
      • 2. Provider obtains reasonable assurances, from the person to whom the information is disclosed,that:
        • A) the information will remain confidential and be used or further disclosed:
          • only as required by law,
          • or for the purposes for which it was disclosed to the person;
        • and
        • B) the person must notify Provider of any instances of which the person is aware in which the confidentiality of the information has been breached.

16.8.10 To whom must Provider make PHI available?

Provider must allow access to protected health information

  • contained in Customer's files that are maintained on Provider's file-server system,
  • to any person who logs in using login credentials that Customer provided, established, or approved.

16.8.11 How must Provider respond to government PHI requests?

  1. Provider must promptly notify Customer
    • of any demand by a governmental entity for disclosure of personal health information,
    • to the extent not prohibited by law or otherwise requested by law enforcement.
  2. Provider must provide reasonable cooperation with Customer in any attempt by Customer to contest or limit such disclosure.

16.8.12 What is the Term of the parties' business associate agreement?

The Term of the parties business associate agreement is that of the Contract.

16.8.13 When may Customer terminate for cause?

Provider authorizes termination of the business associate agreement by Customer if Customer determines that Provider:

  • has violated a material term of this Clause, and
  • has not promptly cured the breach or ended the violation.

16.8.14 What must Provider do upon termination?

Provider's obligations under the parties' business associate agreement,

  • to safeguard protected health information that was:—
    • received from Customer,
    • or created, maintained, or received by Provider on behalf of Customer,
  • will survive any termination or expiration of the business associate agreement.

17 Pricing

17.1 Consumer Price Index / CPI Definition

Consumer Price Index / CPI, unless otherwise specified, refers to the Consumer Price Index – All Urban Consumers ("CPI-U"), as published from time to time by U.S. Bureau of Labor Statistics.

Commentary

CPI clauses are sometimes included in contracts for ongoing sales or goods or services. Such contracts will typically lock in the agreed pricing for a specified number of years, subject to periodic increases by X% per year (let's say) or by the corresponding increase in CPI, whichever is greater (or sometimes, whichever is less). Depending on the industry, CPI-U might or might not be the best specific index for estimating how much a provider's costs have increased. this is explained in the FAQ page of the Bureau of Labor Statistics.

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17.2 Pricing adjustment options

17.2.1 Option: Pricing Adjustment Discretion

Supplier is not restricted

17.2.2 Option: Pricing Cost Pass-Through

  1. During the term of the Contract,
    • if Supplier's relevant costs increase,
    • then Supplier may pass the increase on,
      • without markup,
    • to Customer.
  2. If Customer so requests, Supplier will provide Customer with reasonable supporting documentation
    • that fairly evidences the increase in Supplier's relevant costs.

17.2.3 Option: Pricing Increase Limit

During the term of the Contract,

  • Supplier will not increase the pricing it charges to Customer,
  • for transactions under the Contract:
    • more often than once per calendar year, nor
    • by more than 20% for any given calendar year.

17.2.4 Option: Pricing Increase Notice

During the term of the Contract, Supplier must give Customer at least 30 days advance written notice of any pricing changes.

17.2.5 Option: Pricing Lock-In

During the term of the Contract, all pricing for transactions under the Contract will be as stated in the Contract.

17.2.6 Option: Pricing Generally-Applicable Increases

  • except as part of,
  • and by a percentage no greater than the percentage of,
  • a price increase to Supplier's customers generally
  • for the same items.

During the term of the Contract, Supplier will not increase the prices charged to Customer —

17.3 Most favored customer (commentary)

17.3.1 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 lowe