Many businesses, particularly small businesses hungry for new opportunities, simply sign whatever contractual terms are put in front of them by the other party. In general, this is a mistake, because the terms are almost always worded to favor the party presenting them. Further, businesses often do not understand some of the key terms that may have particular significant effects on their potential liabilities. Some of these key terms include the following.
Warranties. In Part I of this article, we discussed how sales talk can create unintended express warranties, and how that potential issue can be avoided. We also discussed how, if not disclaimed, the law creates implied warranties. This discussion is not about those circumstances, but is about written warranties contained in the contract.
Many business people simply ignore the warranty language. Obviously, whether a party is a buyer or a seller will affect their view of whether it is advantageous for a warranty to provide broad or narrow protection. In any event, a party considering signing a contract should carefully review these key warranty provisions: (a) what is covered and not covered; (b) the length of the warranty; and (c) the remedies that are provided.
Regarding the remedies provided, the Uniform Commercial Code generally permits parties to limit the available remedies. Accordingly, sellers will often limit the remedy for a breaching warranty to repair or replacement of the goods in question. This may well be reasonable, but it depends on the circumstances. The important point is to evaluate these issues from the perspective of your side’s interests in entering the contract.
Indemnity Provisions. Indemnity provisions are often misunderstood. In a general sense, an indemnity provision is a promise by one party to “hold harmless” the other party in the event a third party asserts a claim against the party indemnified. Typically, the “hold harmless” obligation includes two parts: First, an obligation to provide or pay for a defense of any lawsuit or legal proceedings, and, second, an obligation to pay any settlement for judgment. Indemnities are often very broadly worded in form contracts. As such, a business on the receiving end of a request to provide an indemnity should be very careful.
Some of the key issues in reviewing an indemnity are as follows. First, consider the breadth of the indemnity. Does the indemnity, for example, include claims that are based on the indemnified party’s negligence or fault? Many indemnities include such claims, although some states limit the enforceability of such provisions. If enforceable, these types of indemnities can obviously have substantial consequences for the party providing the indemnity. Second, is there any dollar limitation on the indemnity obligation? The potential harm associated with an indemnity can sometimes be limited by restricting the indemnity obligation to no more than a fixed amount.
Third, and most importantly, is the indemnity obligation covered by your liability insurance? Any party that is asked to provide an indemnity in a contract should provide a copy of the indemnity language to their insurance broker for review. The broker can usually provide advice on whether your liability insurance will come in and pay for the defense and other obligations in the event of an indemnity claim, subject, of course, to policy limits and other policy terms and conditions.
Limitations of Liability. Many contracts contain provisions limiting one party’s liability to the other. For example, a contract may limit a party’s total liability to the sales price of the contract or the amount of fees received under the contract. In many instances, these limitations are enforceable.
It is also common for contracts to exclude various types of damages. For example, incidental and consequential damages are often excluded. Although a discussion of what constitutes incidental and consequential damages could fill at least several chapters of a legal treatise, the most common example of consequential damages is probably lost profits.
Many businesses will insist on excluding consequential damages. Such limitations are common in many types of contracts, such as for the sale of production or manufacturing equipment. The reason is simple: All equipment, no matter how well made, can break or malfunction. If the equipment is production equipment, the customer’s business may be shut down for hours or even days. If the equipment supplier is faced with the prospect of having to pay for the customer’s lost profits, it in effect becomes an insurer, and not an equipment seller. Sellers undertaking such an obligation might be driven out of business by a single claim. As a result, these types of exclusions are quite common, and are typically enforceable. Parties should carefully consider whether such limitations and exclusions are appropriate for their circumstances.
Termination Provisions. At the time parties enter into a new business agreement, they are often positively giddy about the prospects of their future success. As the new venture is being toasted with champagne and praised, no one expects that anything will go wrong. Unfortunately, over 25 years of litigation experience have taught me that things sometimes do go wrong. Therefore, it becomes important to consider termination provisions at the outset.
Parties should consider the following issues. First, how long does the contract last? A long term may involve greater risk. Second, what right does your business have to terminate the contract for the other party’s non-performance before the end of the ordinary term? Third, under what circumstances can the other party terminate the contract before the end of the term? Fourth, can either party terminate the contract early for convenience, instead of for cause? Finally, what rights and duties continue to exist following termination? Contracts are often drafted so that certain provisions (such as, for example, confidentiality obligations) continue to apply long after the contract has terminated. Again, such provisions may well be reasonable for particular transactions. However, it is important to consider those issues at the outset and to understand the risks being assumed before the contract is signed.
Dispute Resolution Provisions. Many contracts contain dispute resolution provisions. For example they may contain a forum selection clause, which requires any claims or disputes to be brought only in the courts of a certain state, or perhaps even a certain county. In most instances, these provisions will be enforced. Contracts may also contain provisions requiring binding arbitration of any disputes. Arbitration clauses require that disputes be resolved outside of the court system by an arbitrator or panel of arbitrators. Arbitrators are usually lawyers or retired judges. There are pros and cons to arbitration that are beyond the scope of this article. The important thing to know is that, particularly in commercial contracts, arbitration provisions are almost always enforced. Accordingly, whether your company should agree to arbitration is something that should be considered at the outset. However, in my experience, parties often overlook dispute resolution provisions in their contractual review.
Mistake No. 7: Assuming it’s Non-Negotiable
Many businesses, and particularly small businesses, assume that the other side’s form is non-negotiable when it is presented to them. My experience is that is generally not true. The key point is getting to a decisionmaker with the authority to agree to reasonable changes to the contractual terms.
Occasionally, a business will encounter another party that absolutely refuses to discuss contractual changes. At that point, the value of the potential business should be carefully weighed against the contractual obligations that will be assumed. This can only be done through a careful review and analysis of the contract.
One option that is always on the table is walking away from the potential transaction. You may wish to consider what it would be like doing business with another company that is not even willing to discuss contractual terms. In this regard, I offer the words of a very experienced mentor of mine when I was a younger lawyer: “Some of the best deals are those that were never made.”
Mistake No. 8: Using Internet Forms
In this day and age, the Internet affects everything we do. There are forms available on the Internet for free or services that provide supposedly “professionally drafted” forms for various business and legal needs. If you are considering the use of such forms, I would ask you to review and remember the prime directive (see Part I, Mistake No. 1). Saving a little money now by using an Internet form instead of seeking professional advice and counsel may seem like a good idea. However, if you do not really understand the form and you are not able to interact with a lawyer concerning what the document means and your business’s particular needs and circumstances, I strongly doubt the result is going to be very satisfactory.
One truth in the law is that “one size does not fit all.” Documents need to be tailored and crafted to the particular client and to the client’s particular circumstances. Small businesses can find competent legal counsel who can serve their needs for a reasonable price, and that money is usually well spent. Someone recently remarked to me, “What is the value of the lawsuit avoided?” I think that pretty much sums up why “do-it-yourself’ is probably not a good idea regarding legal issues.
Mistake No. 9: Letting Your Employees Vary Your Terms and Conditions
If you have worked with an attorney and have developed a set of terms and conditions of sale, there may well be a time when a customer will ask for changes. As you can tell from the discussion above, I certainly think you should be willing to discuss reasonable changes with the other party. However, it is not a good idea to allow your employees (particularly sales people) to vary terms and conditions at a whim or any time a customer requests a change.
For example, consider the issue of a forum selection clause, a topic that was discussed earlier. If your company is a small business doing business in Georgia, it may have a strong interest in making sure that any disputes are resolved in Georgia so that it does not have to bear the potential expense and difficulty in litigating out of state. If a customer from the West Coast requests that the forum selection clause be changed to mandate the courts of say, Montana or Oregon, that would prove to be highly detrimental in the event of a dispute.
The point is that any changes should be carefully considered in light of the needs and circumstances of your business and the legitimate requests and interests of the other party. Sometimes, changes will be acceptable. However, allowing employees to disregard terms established in consultation with your counsel any time they see fit effectively undermines your company’s efforts to manage legal risks.
So there you have it. In Parts I and II of this article we have discussed nine common mistakes that businesses (particularly small and medium sized businesses) often make. We have also discussed ways in which those mistakes can be avoided. Of course, this article is purely for information, and is no substitute for discussing these or other issues with your own lawyer. Please note that this discussion is based on general principles of Georgia law, and that you should always discuss legal issues with an attorney licensed in your jurisdiction.
John L. Watkins is a Shareholder of Chorey, Taylor & Feil, a business litigation and business law firm in Atlanta. John represents domestic businesses and a number of international companies or their U.S. subsidiaries, and has spoken frequently at public and private seminars on various aspects of the U.S. legal system and doing business in the U.S. John has litigated almost every type of civil dispute, but currently concentrates on trade secret, insurance coverage, corporate, shareholder, and commercial contract disputes. John also negotiates and drafts equipment sales contracts, non-disclosure agreements and other contracts.