Negotiating a Contract: 7 Litigation Risks to Keep in Mind

Negotiating a Contract: 7 Litigation Risks to Keep in Mind

While upfront issues such as price, quantity and length of contract are a focus of contract negotiations, attention to the back end of a contract is critically important and can prevent or mitigate expensive litigation.

Trial lawyers typically don’t get involved with a contract until the back end of the deal – after it has been signed and something has gone wrong between the parties, or a party wants to change the relationship. The initial client call usually starts with a litany of what the other side has done or not done and why that wasn’t “the deal.” The call ends with the question, “They can or can’t do that, right?” The initial response is always, “What does the contract say?”

Often the contract doesn’t say what a party remembers or thinks was agreed to by the parties. Sometimes, the parties simply haven’t considered that the honeymoon may be over someday or that business is dynamic, not static, and changes to the parties’ relationship may be necessary to reflect that reality.

While core terms such as price and quantity are often the focus of contract negotiations, it is important to negotiate considering all the terms. The following issues are frequently the subject of contract lawsuits and should be considered during contract negotiations.

1. If a promise made by a party prior to signing the contract is important to you, it needs to be in the written contract. This seems very obvious but it is not uncommon for a written contract to omit a promise that is material to one party. There are a variety of reasons this can happen – use of form contracts, deadlines to sign the deal or lack of bargaining power.

Another cause is a belief that the discussions leading up to signing the contract are part of the contract even though not included in the written contract. That may not be the case because parole evidence, a fancy legal term for evidence other than the written contract, generally may not be introduced unless the contract is ambiguous. Parole evidence would require the jury to determine the parties’ intent by considering other evidence, such as emails or a witness’ testimony about conversations between the parties before the contract was signed.

So don’t assume that the email, phone conversation or the sales PowerPoint you believe shows the real agreement, but is not included in the written contract (or even contradicts the written contract), can be introduced at trial. If a promise made during negotiations is critical to you, make sure it is in the written contract.

2. How does the contract end? How long a contract will be in place is often one of the core terms negotiated by the parties. However, whether and when a contract can be terminated early is of equal importance. What if during the term of the contract, one party is approached with a better deal for the same services or products, or a line of business is performing poorly and needs to be shut down? In both of those situations, the contract will determine whether a party can simply walk away from the contract, has to make some payment to the other party or, absent a party’s failure to perform under the contract, must stay in the relationship until the contract term ends. A party’s options on how and when to end the contract should be carefully considered during negotiations and clearly stated in the contract.

3. What happens if the parties can’t get along? Most parties to a contract don’t go into the relationship expecting there will be a serious problem or disagreement that ends the relationship. However, failing to negotiate with an eye towards what happens if one party does not perform under the contract can unnecessarily increase risk and exposure to legal costs and damages. The final four sections address a few of the key considerations to more readily resolve such disputes.

4. What law controls the dispute? Where the contract was entered into or where the contract is performed often controls which state’s law will apply to the parties’ dispute. However, where the parties entered into the contract or where the services were performed is not always an academic exercise. If it is important for a particular state’s law to apply, remove the uncertainty by including a provision that provides the state law that will control regardless of any choice or conflicts of law principles.

Who Decides Which Party is Right?

5. Who decides which party is right? Careful consideration must be given to who decides the outcome of your dispute. Unless the parties agree otherwise, the dispute will be decided by a lawsuit filed in a court. In most jurisdictions, either party may request a jury to decide the case. Jury trials are often longer and more expensive than a “bench trial,” which is heard by a trial judge rather than a jury. If a party wishes to have a bench trial, a specific provision waiving the right to a jury trial should be included in the written contract.  In the alternative, the parties may agree to arbitrate a dispute rather than proceed with a lawsuit. Arbitrations are typically heard by one arbitrator or a panel of 3 arbitrators, depending on the parties’ agreement.

While numerous considerations should be deliberated in light of the goods or services provided under the contract, the proprietary nature of the contract and the dollar amounts involved, the differences between a lawsuit versus arbitration should be carefully considered when negotiating dispute resolution terms.

For example, absent a court order, the legal filings and the trial itself are public record and can be reviewed or attended by anyone. Competitors, other vendors and customers therefore may have access to this information. Arbitrations on the other hand are private and not open to the public.

Another significant consideration is what happens if a party disagrees with the outcome of the trial or arbitration? A trial may be appealed as a matter of right in most jurisdictions, while arbitration awards are typically only appealable under specific and limited instances. There can also be significant differences in legal costs between an arbitration and a lawsuit. Finally, because arbitrations are private proceedings, the parties have the ability to determine the manner and type of discovery permitted and the rules of evidence that are applicable.

6. Where will the dispute be decided? Various rules determine where a lawsuit may be filed. Where the parties are incorporated or headquartered, where the breach occurred or where the damages were incurred can all be relevant. Absent a provision stating where the dispute will be resolved, the issue is open to debate.

Clients are often surprised when they learn that they must file or defend a lawsuit halfway across the country because the contract did not specifically address where the dispute would be resolved. If you have a preference for a location, make sure it is in the contract, or you will have limited control over where the lawsuit or arbitration will take place.

7. What damages are recoverable? The type and dollar amount of damages recoverable by an injured party merit careful consideration during contract negotiations. Parties are often surprised to learn that how much a client is paying for services or goods under the contract does not legally limit the damages that may be recovered by an injured party. Additionally, in most jurisdictions, consequential or incidental damages may be recovered in addition to direct damages. Consequential damages are damages that are foreseeable but not directly caused by a party’s failure to perform.

Suppose that a vendor fails to supply raw materials to a manufacturer. The manufacturer goes to the marketplace and purchases the raw materials at a higher price. However, the manufacturer cannot purchase enough raw materials to produce the widgets required under a contract between the manufacturer and its customer, so the customer terminates the contract with the manufacturer. The manufacturer’s direct damages include the additional cost it paid for the raw materials. The lost profits from the contract with its customer, if foreseeable, may be recoverable as consequential damages.

Whether a contract contains provisions that limit the type of damages (for example by excluding consequential damages) or the dollar amount of recoverable damages (for example to the trailing 12 months of fees paid or products purchased) often determines whether a dispute can be resolved quickly and cost effectively.

The front end of a contractual relationship is understandably a focus of any contract negotiation. Price, quantity and length of contract are material terms that merit strategic consideration and negotiation. However, carefully considering what happens on the back end of a contract during the negotiation phase is critically important and should be given the same strategic considerations.

Steele Clayton is an attorney in the Nashville, Tenn. office of Bass, Berry & Sims PLC. He helps clients resolve a wide variety of business and commercial disputes in state and federal courts throughout the United States as well as in private arbitrations and mediations. He can be reached at sclayton@bassberry.com or (615) 742-6205.

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