I was working my way through a contract recently and, like I always do, I flipped to the last several pages. This is where you find the real action in any commercial agreement. That’s right, the “boilerplate” clauses are where I like to spend a lot my time. Why? Because if you get it wrong it can lead to big problems down the road. Trust me, I’ve seen it. Like many in-house lawyers, I did not begin my legal career focusing on contracts. I started in litigation where I got see up close and personal the results of well-drafted contract clauses and poorly-drafted contract clauses. When I went in-house, I taught myself a lot about drafting contracts, stumbling along with the help of some great mentors, a couple of books on contract drafting, and, most importantly, by reading a boatload of contracts – trying to figure out how all the pieces worked together. My realization was that contracts simply tell the story about an agreement between two parties. How the story turns out depends in large part on who is doing the writing.
I remember very clearly one of the first commercial agreements assigned to me when I started working in-house. The attorney who asked me to work on it told me not to worry too much about all the boilerplate, saying, “it’s all pretty standard stuff.” Since the boilerplate clauses took up almost half the agreement, that didn’t feel like the right way to go. So, contrarian that I am, I spent a lot of time on the boilerplate. And I am glad I did because I found a lot of little twists and turns that were anything but standard, fair, or balanced. The lesson was if you ignore or skip lightly through the boilerplate, you are begging for problems or surprises down the road. Since all in-house counsel should have a working knowledge of contracts, this edition of “Ten Things” describes some of the key boilerplate clauses you will find in most commercial agreements along with a few words of advice from someone who still likes to get his hands dirty reading every sub-paragraph of every clause “stuck in the back” of most contracts. Hey, I know it’s only boilerplate… but I like it:
1. Term/Termination. Surprisingly, one of the most litigated parts of any contract are the term and termination provisions. The term sets out how the long the contract will be in effect. It can be a fixed term, e.g., 3 years. Or an “evergreen” term, i.e., the contract remains in effect (or keeps renewing) until either party gives notice of termination. A key component of the term is the effective date – the day the contract starts to run. It can be the day of signature, a specified date in the contact, upon delivery or acceptance, or some other mark in time. It is very important to always be clear when the contract will start. Additionally, be sure to spell out any conditions for renewal such any type of price escalation rights. On the other side is termination, i.e., when the contract ends. In the agreement it can be on a fixed date (it simply expires), so many days after notice is given (often called “termination for convenience”), upon a triggering event of some nature, or upon an uncured breach (material or otherwise) or a failure to make payment (and there are also ways to terminate a contract that arise under the Common Law, e.g., rescission). A question to ask yourself when negotiating a contract is whether you can terminate one part of the contract (e.g., a Statement of Work), and keep the main contract in place (a Master Services Agreement)? Like the start date of the contract, being crystal clear on when the contract ends can save you a lot of heartaches. Spend the necessary amount of time thinking about all of the reasons you’d want to the agreement to terminate and make sure those are included.
2. Dispute Resolution. While it is always very exciting to enter into a new agreement with another party, I always remember that you need to plan for the divorce. The time to do that is at the beginning of the relationship. Dispute resolution clauses can be short or an entire exhibit to the contract. I like to make them as detailed as possible because I have seen the fallout of poorly drafted dispute resolution clauses. Here are the essential items for a good provision:
- Choice of Law – which jurisdiction’s law will apply to disputes? If you want all disputes between the parties covered (vs. just disputes related to provisions of the contact) state that and ensure the language covers contract, tort, and other claims.
- Forum – where do you want disputes heard? Ideally, your choice of law will match the forum (if not, be sure your choice of law includes procedural law and not just substantive law, or you could find yourself in a different forum). Designate both state and federal courts and note that both parties consent to the jurisdiction and waive any objections)
- Arbitration – if the parties want to arbitrate you need to state that clearly and in the proper manner. For more on drafting arbitration clauses, click here.
- Jury waiver – do the parties want to waive the right to a jury? This makes sense in a lot of commercial arrangements.
- Dispute escalation process – many parties to an agreement prefer to have a formal dispute escalation process written into their agreement. This allows problems to be escalated to a series of executives with set times frames to reach a resolution or pass it up the chain. Only when the process is exhausted may a party file a lawsuit or seek arbitration. These clauses are fine but be sure to keep the time frames short and do not include mediation as a mandatory step before either party may seek relief in court or through arbitration. Mediation can take a very long time to set up and complete. Unless you’re interested in a long delay before either party can take the next step, a requirement to mediate may be included in the process, just not as a gating item to filing arbitration or a court case.
- Fees and costs – most dispute resolution clauses include a provision that the prevailing party in any dispute is entitled to have the other party reimburse them for their legal fees and related costs arising from the dispute. A “loser pays” clause make spurious litigation under the agreement very unlikely.
3. Force Majeure. I am not sure what it means in French (I think it means “superior force”), but it sure sounds cool. Force majeure is a provision that covers situations that will excuse performance by one of the parties. Since the term has no separate legal definition that you can fall back on, it is important to draft carefully. If the clause is drafted broadly, e.g., “circumstances beyond the reasonable control of the affected party” it can be a path for one party to get out of the contract simply by claiming something is beyond their reasonable control. The other way to go is to list specific events that constitute an excuse of performance. If drafted too narrowly, however, you can find yourself in a spot where something truly unforeseen happens and it’s not listed. Most clauses cover, at a minimum, “acts of God” such as a hurricane, fire, flood, earthquakes, etc. Some include situations specific to the business, e.g., internet outage. Typically, payment obligations and confidentiality obligations are not excused during a force majeure event. And most clauses include time limits whereby if the force majeure event continues past a certain time frame (e.g., more than 30 days), the contract will – or can be – terminated with both parties excused from further performance.
4. No Wavier. This is one of those clauses that is very easy to pay no attention to or not even notice it is missing. But, it is very important. As many of you know, when one side breaches or defaults on a contract the non-breaching party usually takes its time to consider its options. Depending on the circumstances and/or the relationship between the parties, not every breach or default warrants a lawsuit or even a stern letter. But, if you do nothing for too long, that silence becomes acquiescence to a change in the terms of the contract, including eliminating your right to terminate the contract if it happens again. A “no waiver” clause simply provides that any failure, omission, or delay on the part of the non-breaching party to exercise a contractual right does not constitute a waiver of that right. Without such a provision you must constantly be alert for any material deviations from the contract and take action or else risk amendment of your agreement.
5. No Assignment. Under the Common Law, unless there is a specific provision to contrary, either party to a contract may – with some exceptions – assign their rights to a third party. They may not, however, transfer their obligations under the contract to a third party. This can all get quite messy in the event of an asset sale or the desire of one party to sub-contract some of their obligations under the contract (sub-contracting is generally permitted because the party to the contract remains obligated to the other party for services). Consequently, the parties need to spend some time here thinking about the assignment clause and how they want their relationship to operate. For example, it may be appropriate for one party to sub-contract some of its obligations (or, in the case of a general contractor, all of their obligations). Or there is agreement that the contract may be assigned to affiliates, successor organization, or in the event of a sale or merger of one of the parties. Likewise, the parties may want no assignment whatsoever, “neither this Agreement, nor any rights or obligations hereunder may be assignable or otherwise transferable.” In my experience, assignment is usually subject to the consent of the other party which “may not be unreasonably withheld or delayed.” Finally, the contract should provide for what happens in the case of an assignment made in violation of the terms. The contract should specifically say that such assignments or transfers are “null and void.” Without such a provision, the assignment will occur and all the other party has is a breach of contract claim.
6. Notice. Under any contract, it is important to set out who must receive any required notices. For example, if the parties have a termination for convenience right, to whom must they send notice of exercise of that right? Equally important is the “how” the notice must be sent. Is it in writing, signed, via regular mail, email, certified mail, FedEx, facsimile, telegraph, smoke signals, courier, phone call, or some other method? What address must be used? Do multiple people receive the notice, e.g., the head of marketing and the legal department? A well-prepared notice provision puts an obligation on each party to update the identity of who must receive notice and where. If your offices move, for example, you need to inform the other side, otherwise, notice sent to your old address is valid – even if you never actually receive it. You should also include a method of calculating time, such as is notice valid upon receipt or two business days after mailing? As you can see, once you select your method of notice, time must be dedicated to thinking about and setting out the mechanics of when notice is deemed received. Otherwise, as is too often the case, there will be fights about whether notice was properly given (a game that many insurance companies like to play). My personal belief is that is it foolish to rely on any method other than one which requires some proof that delivery was made. The other thing to keep in mind is that Common Law courts will typically overlook the formalities of notice under the contract and look to see if notice was actually received by someone in a position to do something with it (and so long as there is no substantial prejudice to the receiving party). While this is comforting in the event you screw up notice, it can be challenging to prove. So, as in-house counsel, an easy but important job is to make sure any notice under any contract is properly given the right person using the right method.
7. Entire Agreement. This clause is sometimes also called an “integration” clause or a “merger” clause. It usually says something like this: “This Agreement constitutes the entire agreement between the parties and supersedes all previous agreements, understandings, and discussion between the parties…” In other words, if it ain’t written into the contract it didn’t happen. This means counsel for both sides need to carefully review their agreement with their business colleagues before signing to ensure that it covers everything discussed and agreed to by the parties during the negotiations. While under the Common Law outside (parol) evidence cannot be used to vary or supplement a written contract, there are so many holes in this doctrine that it is often mistaken for Swiss cheese. I’ll just say that if you’re banking on the parol evidence rule to keep things limited to the four corners of the agreement I have a bridge to sell you in San Francisco. The entire agreement clause therefore is designed to provide certainty that the written agreement signed by the parties includes everything they agreed to and should nip in the bud any post-signing claims that the agreement between the parties contains additional terms and obligations. To be extra safe, many drafters embellish this clause by adding language along the lines of “Neither party has entered into this agreement in reliance on any promises, representations, or statements of any kind (whether written or oral) except as expressly provided in this agreement.”
8. Severance. This is another one of those sneaky clauses that will be missed if the right circumstances arise. Simply put, litigation is a risky business and there is always a chance that a clause in your contract will turn out to be illegal, invalid, or otherwise unenforceable. For example, a court may find your non-compete clause to be onerous. Without a severance clause (sometimes called a “savings” clause), a voided clause may cause the entire agreement to fail. Yikes! A severance clause sets out that if any provision of the agreement is found by a court or government agency/legislation to be void or unenforceable, the parties agree that the rest of the contract remains intact. While this clause will usually save the day, note that if the voided clause is so central to the underlying purpose of the contract, the voiding of that one clause may still render the entire contract worthless because – even with a severance clause – the contract has no real meaning without the now-voided language. This should caution you as in-house counsel to work hard to include provisions that fall within the well-defined confines of the law if possible.
9. Confidentiality. If you do not designate your agreement (or discussions and materials exchanged over the course of the agreement) as confidential, the other side is free to disclose the agreement terms and any information (price, trade secrets, etc.) shared by your company. Consequently, it is a rare commercial agreement that lacks a fulsome confidentiality provision. Typically, the agreement and its terms are deemed confidential by the parties, and there is provision made for confidential information exchanged by the parties over the course of the agreement and how that information may be used (usually only for the purposes of performing the agreement and shared internally on a need-to-know basis). Confidential information exchanged before an agreement is reached is usually covered by an NDA which is then folded into the definitive agreement. It is worth your time to try to capture all of the specific types of confidential information you expect to exchange and require that each party mark its confidential information as “confidential.” But, given people are people, you should also include a catch-all phrase making information confidential if it should – by its nature – be considered confidential (even if one party failed to mark it as such). Likewise, include a process whereby either party can – within a reasonable time frame – backdate materials and discussions as confidential even if they were originally disclosed to the other party without such a designation. And you want to be sure to include an obligation that if a party is permitted to reveal confidential information to third parties, they must obligate those third parties to agree to the same confidentiality obligations as the parties to the agreement. Even if a piece of information is thought to be highly confidential by one party, virtually all confidentiality clauses carve out information that is already publicly available (thank you Internet) or already known by the other party. Lastly, include provisions noting that when the agreement terminates, each party must return or destroy the other party’s confidential information.
10. The Big Three. If someone said you can only work on one section of a contract, I would always pick the section dealing with indemnification, limitation of liability and warranty. Or, as I call them, the “Big Three.” While usually falling in the boilerplate section of the agreement, there is little that is standard about these three clauses. They are also typically the most heavily negotiated clauses in the entire agreement. Why? Because they shift and cap/uncap exposure when things go wrong under the contract.
- Indemnification. An indemnity provision requires one party to take on the defense costs – directly or through reimbursement of legal fees and/or damages – for losses incurred by the other party for something arising under the contract. For example, third-party claims for IP infringement. The parties to the contract will spend a lot of time negotiating which party owes indemnification to the other and for what. Watch out for first-party indemnification clauses, i.e., where you would have to indemnify the other party for bringing a lawsuit against you for something you did. Keep it expressly limited to third-parties. Also, think about whether your indemnification clause can pull back in damages you excluded in your limitation of liability clause (e.g., consequential damages) and whether this is the result you want. There should also be a detailed process for how claims for indemnity must be tendered, who controls the defense, hires counsel, timing, settlement, etc.
- Limitation of Liability. This clause sets limits for each party’s liability under the contract. It could be unlimited or it could be capped, either a fixed amount (e.g., $500,000) or a formula (e.g., 3 times the amount paid by the other party under the agreement). In the end, it becomes a balancing act, i.e., for the amount paid and the type of service or products provided, what is a reasonable level of risk for either party to assume? For SaaS agreements when the customer pays a very small amount vs. operating the system themselves, there is almost always a cap tied to some multiple of what is paid by the customer. To make it unlimited would wipe out the efficiencies gained by the SaaS platform and would dwarf monies paid by the customer. There are also carve-outs (or different/higher caps) from the liability caps, typically around things like data breach, personal injury, gross negligence, etc. – whatever the parties can negotiate. There can even be an overall cap on liability, with different caps for different issues falling under the umbrella capped amount. Lastly, this is where you typically exclude all damages but direct damages, i.e., consequential, punitive, lost profits, indirect, and so forth. I would specifically mention lost revenue and lost profits as carved out and not rely solely on no “consequential” or no “indirect” damages because it can be very confusing as to when lost profits and lost revenue are direct damages vs. consequential damages.
- Warranty. The parties to a commercial agreement usually warrant several things to each other, such as that they are authorized to enter into the agreement, they have employees competent to perform the services purchased under the agreement, and so on. Additionally, there may be standard warranties about the product purchased, i.e., it will work substantially as described in the documentation, that it does not infringe anyone’s intellectual property, etc. The types of warranties given depend on the type of contract. Equally – if not more – important to the warranty language are the disclaimers of warranty, i.e., disclaiming any implied warranties such are merchantability or fitness for a particular purpose.
The above is only for the purpose of familiarizing readers with some of the key “boilerplate” clauses common to most commercial agreements in the US (and other Common Law countries). If you are in a Civil Code country, you know it is usually very different. While I provide some helpful tips, you probably know you are not getting a contract drafting lesson here (though I have included hyperlinks to additional helpful resources throughout). If you are looking for a good drafting resource and got the dough, Ken Adam’s A Manual of Style for Contract Drafting 4th ed. is a must have (and the earlier editions are less expensive). I also like this free resource Basic Principles of Contract Drafting. There are plenty of resources on the ACC website and continuing legal education programs about contract drafting abound. Of course, if you have Practical Law, you are already way ahead of the game (just search for “general contract clauses”). As I look at my notes, I realize I can probably write another “Ten Things” post on the boilerplate clauses I have left out. So, watch for that later this year. To end, I still believe the best way to learn about contracts is to read a bunch of them. And, if anyone tells you that you can ignore the “boilerplate” you have my permission to kick them in the shins!
March 15, 2018
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