Wednesday, June 24, 2009

Are Your Contracts Litigation Waiting to Happen?

The law school definition of a “contract" is simple: offer, acceptance and consideration. I offer you $100 for a “car.” You pocket the money and hand over a set of keys. We have formed and performed a contract and all is right in the world. Unless I expected the keys to a Ferrari and received keys to a rusty, unreliable East German Trabant. You might say "My mistake, let me get the correct keys.” More realistically, you might respond “You want a Ferrari for $100? Here, take your money back; I can't afford such a deal.” If I insist that you took my money and are now required to deliver a Testarossa, you might respond: “So sue me.”

Our lawyers will begin shopping for vacation homes, while you and I start taking money from productive programs and setting aside time for depositions, discovery and hearings. Consider the vast array of issues our learned counsel may dispute:

  • Was there a "meeting of the minds"?
  • Was buyer simply mistaken or confused?
  • Did seller mislead buyer?
  • Would it be against public policy to enforce the deal as buyer understands it?
  • Was buyer hoping to take advantage of a seller he thought to be unsophisticated (i.e. one who didn't know the true value of that “strange looking” foreign car)?
Of course, the fireworks may be short - circuited by an impolitic question from the judge: ''What does the contract say?''

You may have noticed that I have made no mention of a written contract. Therefore the case is merely my word against yours. Did you really offer a Ferrari for $100? Did I hand over my money without at least specifying what make and model vehicle I expected in return? This uncertainty explains the old legal proverb that “oral contracts are not worth the paper they are written upon.” Without a document setting forth the agreement, and without any witnesses regarding whether you offered me a Ferrari, the judge has limited options. She can tell me to accept the Trabant, or a similarly priced vehicle, or take my money back.

This example, although a bit extreme, illustrates the value of a written agreement. That document provides an independent source of information regarding the nature, extent and terms of the agreement. It provides a reference a third party – typically a judge – may consult when asked to enforce the agreement. As such, it forces the parties to focus on the details of the transaction. Winston Churchill once quipped that “there's nothing quite like being fired upon to focus one's attention." The business equivalent is being asked to sign a contract, to say, in effect, “I believe this document, this deal, represents a good deal for MY company." By signing, one also implies that "I have done my homework on this transaction and we are adequately protected."

Yet, even if our agreement for “a car,” had been put in writing, dispute would not have been precluded. We failed to define the “car,” to specify make, model, year, color, engine, interior, etc. We would have given our attorneys lots to argue over. Despite the risks that can result from a poorly prepared contract, drafting is often an afterthought. “We'll let the attorneys fill in the details later” may get the project started quickly, but it also creates a variety of potential exposures, such as:
  • Lost savings opportunities;
  • Late or flawed performance;
  • Expensive, time consuming disputes over what is, or is not, to be delivered;
  • Delivery of unsatisfactory services or final product.
A sound contract will tell a story, without any unanswered questions. It will identify who will do what, when, how, why, and for how much. It will also provide a “safety net” of remedies to protect the parties in the event something goes wrong. A contract that addresses both obvious and reasonably foreseeable contingencies is one with reasonable chances of success. In contrast, a contract filled with undefined terms and unanswered questions is a litigation waiting to happen.

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