Part I: Preparing to Negotiate and Negotiating the Deal
[mk_mini_callout title=”Tip #1″ ]Always Know the Critical Features of Your Contract Before You Start Negotiating the Transaction[/mk_mini_callout]
- Have you identified the material elements of the transaction: what is being exchanged for what, and are you getting enough for what you are agreeing to give up?
In other words, have you specifically identified the basis of the transaction: what are you giving up and what is it in exchange for? Do these have value to both sides and are you really getting something of value for what you are giving up?
- Have you identified the economic substance of the transaction and outlined it?
In other words, is this an exchange of promises to be performed in the future or right away, or is it a purchase of goods for delivery and payment thereof? Do they have to be performed in particular sequence or at the same time? Does the agreement cover a period of time, the relationship of the parties, or a single transaction?
- Have you identified the major contingencies that could interrupt or disrupt performance, and decide what an acceptable outcome would be?
The contingencies that could interrupt performance are things such as if a third party appraisal had to meet a threshold value for a sale to go through, if there is an accident that prevents delivery of the goods or services, if there is an act of God that prevents performance, or if one side is negligent, or the like—anything that could prevent timely or complete performance.
Deciding what should happen in these unintentional circumstances is very important because these are not necessarily intentional acts to breach the agreement, but they could frustrate the economic value of the contract to the non-contracting party. Potential outcomes include waiver of, shifting of costs, continuation of performance, or outright declaration of material breach. These each have important economic implications on your agreement.
- Have you identified the injuries or contingencies for breach of the agreement by either side, and determine what the acceptable outcomes would be?
Understanding what would happen if the other side breached their agreement is crucial to negotiating things like price, return performance, demands for assurances or satisfaction, limitations on warranty or damages, termination, and things like that.
Contracts can address provisions for notice of impending breach, a period to cure the breach, materiality of the breach, suspension of performance by the non-breaching party, termination, and the remedies one can seek when there is a breach. These can all make like easier and avoid tons of litigation.
But it is important for you to know these things ahead of time mainly so that you do not waive your rights improvidently by agreeing to a termination clause or waiver clause that you didn’t think would affect you. Quite often they do.
- Have you identified any terms or provisions that deviate from industry, or legal norms or default rules that you are going to ask for or that they are asking of you, and determine the proper way to compensate for those, if necessary?
You have to know whether specific terms that are bring requested by you or from you go against the standard terms in the industry and/or under the common or statutory contract law. These types of concessions, especially if you’re the one giving them, have economic substance and usually one can extract other concessions or compensation (by adjusting the price you’ll agree to pay or receive) under the agreement.
They also create a strategic element in contract negotiation where you are demanding the status quo terms: these are terms that you may have no interest in negotiating and therefore, this can save you time and leverage in negotiating the remainder of the contract.
- Have you identified the universe of parties who may claim—or would want to claim—an interest in the subject matter of the agreement, and determine whether they should be made parties or who bears the risk of their claimed interest?
Often, agreements may involve third parties without expressly meaning to. This is especially so in discussing contracts that involve interests in property (real property, intellectual property, securities). Third parties may claim an interest and therefore disrupt the transaction, or worse, vitiate the contract’s performance or enforcement. That is why it is always a good practice to be vigilant and make sure no third-party interests are implicated. Where they might be, you should negotiate who bears the risk of those claims.
Furthermore, contracting parties may inadvertently create a definition that binds another, third party (typically corporate affiliates or subsidiaries) without that party’s consent. Sometimes they may try to do it on purpose. Making sure that third parties are left out, or necessary parties are brought in is a job to be done very early on.
- Have you insisted on a written agreement that is only effective once it has been signed by all the parties to the agreement?
Oral agreements are generally enforceable except in some limited circumstances where agreements have to be in writing. As one lawyer famously put it: “Oral agreements aren’t worth the paper they’re written on.”
Although email agreements and electronic agreements, despite being in pieces, fairly satisfy the legal requirement that an agreement be in writing, it is always best to have a single final agreement in place that makes it easier for the court to decide the issues.
Part II: The Contract’s Substance
[mk_mini_callout title=”Tip #2″ ]“He Who Controls the Paper Controls the Deal” – be in Charge of the Master Drafts of the Contract and offer to do the first draft (some 75% of the terms in any agreement were there as of the first draft)[/mk_mini_callout]
[mk_mini_callout title=”Tip #3″]Negotiate the Transaction Before You Start Drafting the Agreement[/mk_mini_callout]
- Have you identified the purpose of the agreement if possible, and articulate it and its grounds right at the beginning?
Articulating a simple purpose of the agreement in the recitals is important—especially in a complex transaction that has a long contract—because that can be used by the court as a guide for contract interpretation and fulfilling the parties’ intent. Otherwise, the parties have free reign to say the purpose of the contract is whatever suits them at the time of the lawsuit.
This process should not be used to vitiate the terms of the agreement however, and so you should be careful when crafting the purpose language. There may be strategic times when you do not want to include the purpose language, such as when you foresee the need for flexibility in the contract.
- Did you specify on what terms the agreement becomes a binding “contract” and make sure that those are valid premises for contract formation?
This is not very controversial but it is often overlooked. Too often agreements are said to be binding and effective when executed without looking to see whether the formalities of valid contract formation were observed. The formalities of contract formation include: the parties’ assent (which is handled), the exchange of genuine promises or the exchange of valuable consideration, reliance by the parties on the others’ promises or consideration in entering the agreement, and the legality of the agreement.
A commercial contract should recount the bases for its formation, and then specify that its formation is effective when fully executed by the parties.
- Have you identified any statutory or regulatory requirements that the contract must conform to and make sure it meets those formalities.
This does not come up very often, but when it does, it is a magnificently large issue. Contracts that fail to meet formalities such as size, length, content, or form requirements are often said to be void or voidable.
Either way they are potentially unenforceable if you are the one trying to enforce it. Even if you are not, often, defendants think that they are out of the woodwork when a contract is voided in this way—but they soon find that the plaintiff still has a claim for unjust enrichment (now that there’s no contract) and the defendant would have preferred to have the other contractual provisions in place to protect it.
- Did you specify each of the promises or other consideration that is being exchanged?
This may seem obvious, but it is too often the case that the promises are set forth in general terms and are not articulated as promises. All promises that are foundational to the contract should be set forth specifically (unless you see a strategic advantage in ambiguity—which is a dangerous game). Each promise should specify who the sponsor is – who is making the promise. Each promise should specifically state who will perform it. And each promise should affirmatively state to whom or for whom performance will be made.
- Have you stated the shared factual assumptions that underlay the agreement?
Every contract is predicated on a belief about the state of the world that the parties may share. If yours is, and that belief could be incorrect, then you should specify in the recitals that shared belief. A mutual mistake of fact about any aspect of the context in which the contract arises will demise the contract and render it unenforceable and will problematize your efforts.
So, for example, a contract about real estate will often recite the real estate’s location, size, abutments, covenants, etc. to be sure that everyone is talking about the same piece of real estate. An agreement for purchasing a business should likewise do the same, but may also include recitations about the business value, legal structure, ownership, and the like.
- Have you stated in writing what representations of fact you are relying on—especially if there is a merger clause?
This is a biggie that frustrates the heck out of litigators. Deep in the bowels of an agreement is usually a term called a “merger clause,” and it will state that the parties disavow any reliance on any statements or oral representations or promises that are not in the agreement. Only to find out that the client did rely on several conversations, discussions, emails, reports, etc. that they had with their counterparties, but that were never incorporated into the agreement as representations that he or she was relying on. Inevitably, the client cannot even sue for breach of contract or commercial fraud because there was nothing in the contract itself that was breached.
It is crucially important not to fall into this trap. Facts you relied upon that were presented by the other side should be recited in the agreement under the “Representation & Warranties” Section. Otherwise, they should be referred to and incorporated by reference and made part of the agreement. That way, if those end up not being true, you can sue for breach of contract, or better yet, fraud in the inducement (which gives you a lot more flexibility and latitude in the litigation). Note that if you incorporate external documents or information by reference, you have to amend, or eliminate the merger clause. There are strategic reasons behind whether, how and when to do this.
- Have you made sure you are not agreeing to any representations and warranties that could put you in violation of the contract?
The flip-side to the previous issue is that you do not want to be in violation of the agreement by virtue of a representation of fact that has been incorporated into the agreement. Parties often make representations and warranties regarding the facts and circumstances about which they have provided information to their counterparties. If their counterparties want to rely on it, they may insist that it become part of the contract.
You may have provided—verbally or in writing—many facts to the other side to help them decide whether to do business with you. How these are characterized and drafted can make or break your contract defense if that ever arises.
A merger clause under these circumstances will not help you. Although I generally favor merger clauses, if it is too difficult to synthesize the information and facts given in a way that does not expose you to excess liability, then it makes sense to incorporate those by reference, and either restructure the merger clause (by excepting incorporated information or documents) or by jettisoning it altogether.
- Have you specifically stated whether any obligation is contingent on a prior event or another party’s commencement or completion of performance.
Often, transactions are structured in a way that makes one side’s obligations conditioned on an event or the satisfactory or complete performance of the other’s obligation. Where that is the economic nature of the transaction, the commercial litigator knows that the contract better specifically state that one party’s performance does not come due until X event or until the other party’s prior performance is complete.
The best example of the former type are option contracts. A party who sells the option to buy X if it is appraised at or above X never has to perform (never has to tender the sales price) if the appraisal (a) is never done, or (b) comes in below X. Now, he cannot actively defeat the appraisal, that would be tantamount to a breach of the agreement. But he is otherwise without any contractual obligation. Similarly, an agreement for the purchase of widgets contingent on the second party constructing them out of better material is a valid contract, but the purchaser has no obligation if the manufacturer never makes them out of better material.
In these scenarios, however, the contingency has to be spelled out. Otherwise, the parties have co-obligations to the other, and one cannot wait until the other is done to tender performance.
- If there are particulars about how their performance is to be made to you, then have included those specifications?
Often, there are specific needs for when or how performance is to be tendered or made. For example, if time is of the essence for a party’s performance, then the receiving party should make sure that the contract specifically states that “time is of the essence” for performance, or better yet, set a deadline. If there is a procedure that has to be followed, for performance, such as taking particular steps or using particular materials or products, then those must be specified in the agreement to be enforceable.
As an alternative to specifying these things in the agreement, parties often incorporate procedures from other sources, where they can be sure that the procedures are relatively static and unlikely to change during the course of the contract period.
- Are all critical contingencies you identified as part of your initial process in the written agreement?
Every deal will have its own critical contingencies which will include things like partial non-performance, delayed performance, defeated assumptions. Every deal will also include critical contingencies that will be heavily transaction- or industry-dependent such as market performance for key commodities, market prices for the product or service, exigencies such as third-party performance (i.e., shippers, suppliers’ ability to meet demand), and the like.
These impact the value of your agreement. To the extent you need to, contract law will determine who bears the risks and costs of these contingencies unless the parties specify otherwise explicitly in the agreement.
- Have you ensured that you have no agreed to boilerplate terms that undermine the economic value of your transaction or that impede your ability to enforce the agreement?
We have discussed certain default, or boilerplate, terms already. They are quite often thrown in at the end of agreements under “Miscellaneous Provisions” or some other benign looking heading to avoid detection. But they are far from benign if you are not the one that inserted them.
These include merger and integration clauses, “Act of God” waivers (also called Force majeur), construction waiver clauses (also called contra proferentem – waiving the canon that the contract is construed against the drafter), waiver of representations clauses, choice of law clauses, jurisdiction clauses, choice of forum clauses, venue or arbitration clauses, waiver or limitation of liability clauses, limitations on damages clauses, statute of limitation clauses, severance clauses, red-pen clauses, cost-shifting or attorneys fees clauses, relationship-binding clauses, assignment clauses, headings disclaimers, confidentiality or announcement clauses, and execution clauses. (Read what these mean here)
Some of these are fine—such as execution clauses (these say that the contract can be executed, or signed, in multiple parts. Not everyone has to sign the original). But many are strategic decisions that are too often tacked on at the end and nobody pays attention to them until the lawsuit: at which point it is too late for at least one party. Merger and integration clauses can foreclose your reliance if done incorrectly. Choice of law clauses can result in unfavorable law being chosen that hurts you. Liability and damages limitations clauses may seem innocuous until you realize what you’ve given up. Red-pen and severance clauses could result in your losing advantages you negotiated for but still bound to the agreement. And so forth.
- Did you specify any limitations on liability, warranty, or indemnity that you have negotiated in specific terms.
Limitations on liability, warranties, or indemnities can be a crucial part of the risk-shifting features of a contract. However, courts will not enforce these unless they are precisely and carefully drafted. Courts hold provisions like these to extra-high standards of clarity. Thus, if you wanted these, make sure they are clear as a bell lest they be deemed unenforceable.
- Are all provisions or terms that deviate from the default common law or statutory contract rules, and which are necessary to protecting your rights clearly set forth?
Along the same lines as the last issue, where you have negotiated a term or provision that is advantageous to you, but that deviates from the norms of the industry, the common law or statutory law, then these have to be stated very clearly. Otherwise, the term runs the severe risk of being held ambiguous, at which point the court will construe it consistent with the industry norm or the common law/statutory law.
The purpose of any of these provisions is often to shift risk to the party or person who can best handle the risk—and they may even be compensated within the agreement for doing so. For that reason, be extra-careful with these provisions since the results can be catastrophic.
- Did You Include the Grounds for Termination and a Procedure that Leaves Sufficient Room to Maneuver?
It is difficult to fathom a commercial contract or transaction that does not include how and when a party can terminate. These provisions easily save everyone tens of millions of dollars in litigation expense by avoiding lawsuits. They are very important to include.
However, these types of provisions often include preconditions for termination, requirements for cure, notice, and the like, which can hamstring a non-breaching party that needs to cover its losses, or move quickly to find substitutes in other ways. These types of provisions can likewise stifle the flexibility of a breaching party by essentially guaranteeing liability for breaches of the agreement.
Thus, it is important to have an understanding under which you may be the breaching party, or the non-breaching party, and craft the agreement to comport with the on-the-ground realities that will occur once that happens.
- Are you being strategic about when you leave terms ambiguous—or where agreement cannot be reached on language?
The truth is that sometimes, parties have 90% of a deal done, and some terms (contingencies, boilerplate) risk holding up, if not killing the deal. Parties often make the decision internally that the cost of losing the deal due to these hang-ups is not worth hammering some of these final terms out, especially when they are only contingency related. This is an understandable, and not unusual occurrence.
However, even in these cases it is often best to leave terms out or leave them ambiguous rather than leaving them disadvantageous provisions, carved into an agreement that you signed (and therefore, consented to).
Part III: Managing the Contract’s Style
[mk_mini_callout title=”Tip #4″]Remember, Your Primary Audience is the Judge or Jury Who Might Have to Enforce this Agreement[/mk_mini_callout]
- Have you outlined a macro-structure that makes sense and makes it easy to read and follow the contract?
Macro-structure, in other words, how the contract is organized, is so important that I put it first. Without structure, terms lose meaning, and the contract’s power is significantly diminished.
The typical Macro-structure would look something like this:
- Representations and Warranties
- Obligations of the Parties
- Termination and Enforcement
There is no reason that these should be the only macro-structures. Sometimes issues that would normally be buried in the Miscellaneous section are too important in that transaction, they may involve greater complexity than normal and so deserve their own macro treatment.
- Did you use major and sub-headings and make sure that the subject matter under the heading jives with the heading?
Although just about every contract I have seen lately disavows that headings are substantive parts of the agreements, realize that the people who read them: judges and juries, follow them anyway. Headings and sub-headings frame the issue, provide sign-posting, and inform the expectations of the reader. These are strategic advantages regardless of whether they have legal substance.
- Is the Contract as short as possible?
You’ll see a theme. Contracts should be able to be hammered out in as few pages as possible. Most contracts are 10% substance and 90% legalese. Legalese is the sign that the writers do not speak good English. A well-written agreement is typically very concise.
- Make sure each sentence is written in short sentences (no more than 1 comma).
Short sentences make contracts easy to read and understand. The one comma rule was told to me by my German colleague and I have lived by it ever since. Sentences that run on for more than a comma tend to be too long, too cumbersome to understand and generally unintelligible. Think of it this way, by the time you get to the end, you forget what was at the beginning. If you have to have along provision because there are multiple facets to a directive or obligation, or to define the scope of something, then consider using multiple lines as sub paragraphs to list them out.
- Write in clear, plain English unless there are legal terms of art that are appropriate?
I will say it again: Legalese is bad, and that includes legal jargon. Contracts often have to be interpreted by judges, but they are often enforced by non-lawyer juries. They want the contract in English, and they will vote to enforce the provision that they intuitively understand.
That is also why you should stay away from industry jargon if at all possible and resist the temptation to “over define” words, especially words that are otherwise intuitively understood—find a different way to say the thing you need to say in plain English.
- Did you use a large font if possible?
The judge or jurors who have to read and understand it may not be as young as your or your client.
- Did you separate each provision by a paragraph if at all possible?
Sometimes, contracts have page-long, or longer, single-paragraph provisions. These are incomprehensible to most lawyers, to say nothing of judges and juries. It is torture to them and they will punish you for making them do it. Instead, long paragraphs (over 10 lines) should be broken up into smaller paragraphs. This also allows for there to be more white-space which makes it easier to read and comprehend what is being read.
- Did you keep all paragraphs on a single page?
Similar to the other issues, this has a more to do with how people read contracts than it has to do with the law. A contract that breaks from one page to the next is harder to read, harder to process, and therefore, harder to enforce. So be strategic about what you let break across pages.