Five Costly Contract Mistakes that Commonly Lead to Disputes and Litigation [1]
The beginning of a business relationship is an exciting time. The parties have struck a deal pertaining to one venture or another, and they believe everyone will benefit through the accomplishment of their mutual business goals. In the positive atmosphere surrounding a new business relationship, it is easy to see how the parties may not pay close attention to the minutiae of the contract memorializing their agreement. They may already have a verbal understanding of how they believe the relationship is to function in practice and thus be less likely to proactively protect themselves or engage legal counsel. Further, they might be loath to dwell on provisions governing negative potentialities like termination or breach at a time when business is good and the future is bright.
However, the time when the parties are solidifying their respective rights and responsibilities and putting them in a signed writing is also the time when they must be the most vigilant about protecting their interests. Careful attention to contract language at the outset is one of the most effective ways to avoid later disputes. Here are five common—and costly—contract mistakes that we, as business litigators, see in the course of our work:
1. The Use of Colloquialisms and Imprecise, Ambiguous Language.
Frequently, parties commit their agreement to paper using colloquialisms and imprecise language that, while common in everyday conversation, do not translate well into legally binding contracts. This is because the use of words with multiple meanings or no clear definitions introduces ambiguity into the parties’ legally binding obligations that can cause problems later. Ambiguity almost always benefits the party arguing against enforcement. For example:
- The use of terms like “promptly,” or “within a reasonable time,” in places where it should specifically delineate the number of days for an event to occur. Contractual rights and obligations are much clearer—and therefore easier to enforce—where the contract says, for example, that “Party A must deliver the Products within 14 calendar days of the Effective Date of the Contract.”
- The use of terms like “good quality” or “industry standard” in places where it should specifically identify the quality of the products or services to be provided. If there is a statutory standard, quote from the statute. If the industry in question has published rules or regulations regarding quality, quote from them.
Other problematic terms include: (a) “Etc.” and other nondescript catch-all terms, and (b) terms like “commercially reasonable” and “reasonable efforts” without accompanying context. The bottom line is that the more specificity with which you can identify the “who, what, when, where, and how” of the contract, the more you will understand your rights and obligations, and the more comprehensively protected you will be. Otherwise, in litigation, you could be leaving these questions for the judge or jury or other third parties, people who simply do not have the level of knowledge that you do with respect to the business relationship and contract at issue.
2. Overuse of “Boilerplate” Provisions & the Failure to Examine Their Effects.
Another contractual issue that business litigators oftentimes see is the overuse of “boilerplate” provisions in a contract, and parties’ failure to thoroughly vet them before signing. Generally speaking, the term “boilerplate” is used to describe the formulaic language that is or can be reused from contract to contract without significantly changing it. Typical boilerplate provisions include those pertaining to confidentiality, stock language on how the contract will be interpreted and which State’s law will govern the contract, whether the contract can be assigned or subcontracted out, and more.[2]
Many parties simply copy-paste boilerplate provisions from their previous contracts or from the internet, picking and choosing different items from different contracts that sound appropriate or useful without critically analyzing whether the ultimate patchwork will fit together—frequently, it does not. For example, it is not uncommon to see a forum selection provision that calls for disputes to litigated in one state, but a choice of law provision that calls for the application of the laws of another state. Likewise, business litigators commonly see overly onerous confidentiality provisions covering business relationships that do not involve disclosure of confidential information, or conflicting provisions that both limit recoverable damages but also call for uncapped indemnity. Typically, these internal conflicts are the result of careless drafting, and parties’ failure to analyze their specific needs for a specific contractual relationship.
Many boilerplate provisions will be useful and desirable in a given situation, and to be clear, most commercial contracts contain them. The key, however, is to recognize that they are not “one size fits all,” and they should be appropriately tailored to fit the given situation. Will confidentiality be an issue? Identify the specific items that should be kept confidential. Will intellectual property be involved? Identify the specific licensing and ownership issues. Closely examine the contract’s language for internal conflicts, clauses that do not apply to the given situation, and other inconsistencies that should be avoided at the time of contracting, not later when the matter is being litigated. A brief, thoughtful review of boilerplate language can prevent avoidable and expensive disputes.
3. The Failure to Include an “Integration” Clause in the Contract.
Contracts do not appear out of thin air and are usually the product of lengthy negotiations. Sometimes, during these negotiations, parties may make offhanded promises or representations along the way to a final deal. If your contract does not contain an “integration” clause, however, these pre-contract representations could cause you trouble down the road.
An integration clause is another boilerplate provision, which states that the terms of a given contract are the “complete and final agreement between the parties,” and that, resultantly, “any previous agreements that may conflict with the final terms covered by the integration clause—whether written or verbal—cannot be entered as evidence if there is a contract dispute.” In other words, it is an express recognition by the parties that the final, written contract represents the sum total of their agreement, and that differing items from the negotiation phase are inadmissible and of no legal effect.
Integration clauses can be extremely important in commercial litigation. This is because, under the “parole evidence” rule, where the parties to a contract included an integration clause in their contract, they typically cannot introduce evidence of prior oral or written agreements that contradict or modify the terms of the final contract. This helps prevent parties from attempting to rewrite the deal in hindsight.
An example is illustrative. Suppose Party A and Party B engage in pre-contract negotiations, at which time Party A provides a preliminary written quote stating that it can provide Party B with 10,000 units of a “Product” at $5.00 per unit, and that this price is locked in for 12 months. Later, Party A and Party B execute a written contract, but the contract includes a caveat that the price-per-unit of the Product is “the rate published on Party A’s website at the time an order is received.” In turn, the price-per-unit of the Product on Party A’s website when Party B submits an order is $7.50. If the parties failed to include an integration clause in their contract, Party B could potentially introduce evidence of Party A’s preliminary quote and seek to pay only $5.00 per unit. Conversely, if the parties included an integration clause, Party B would be prohibited in most cases from introducing extrinsic evidence of Party A’s pre-contract quote of $5.00 per unit.
When parties put their final agreement to paper and sign, they should feel secure that the written agreement contains the controlling terms of the business relationship. Integration clauses can go a long way towards providing that security in the event of litigation.
4. The Failure to Adapt the Change Order Process to Your Specific Needs.
While parties are typically quick to address time, location, and price in their contracts, an oftentimes overlooked provision that should be included in commercial contracts, and tailored to your specific needs, pertains to change orders. This is especially true with contracts covering construction, distribution, manufacturing, and logistics, and will frequently apply to technological and intellectual property contracts as well.
In essence, a change order provision in a commercial contract addresses the process by which the parties can adapt to the changing landscape in their given field and amend things like the pricing of goods or services, the timing of delivery of same, construction or design errors, budgeting issues, weather delays, and more. For example, in a residential construction contract, a change order might be necessary for the contractor to complete additional work on an individual’s home not contemplated in the original contract, or the contractor may need additional time given prolonged severe weather. Likewise, in a distribution contract, a change order might be necessary where the purchaser desires to obtain (and the distributor agrees to provide) additional product on an expedited basis not contemplated by the contract’s terms.
Textbook change order provisions in commercial contracts will include requirements that change orders provide: (a) a detailed description of the change; (b) the reason for the change; (c) the cost of the change and by whom it is to be borne; (d) the goods or services to be provided under the change; and (e) a precise timeline for the provision of said goods or services. Where applicable, the contract should also require that change orders note the overall impact on the contract’s cost and timeline in light of the change. Finally, all change orders should be required to make explicit reference to the underlying contract to ensure the change order is legally linked to the overall contract and its other terms.[6]
Specificity is key because if issues arise and the matter is ultimately litigated, the contemporaneous paperwork memorializing change orders should tell the story for you. If you are seeking payment, the documentation will tell the court exactly what you did, when you did it, the purpose for which you did it, and how much it cost. It will likewise show the other side’s approval. On the other hand, if you are contesting unapproved additional costs on a project or in the course of a business relationship, the other side will have a much more difficult time justifying the costs where the documentation does not support their claims for payment. In either case, papering these matters immediately when they arise is crucial to bolstering your position.
5. The Failure to Adequately Address Termination and Remedies.
Finally, business litigators frequently observe disputes between parties that arise out of a failure to address termination rights and remedies with sufficient specificity. It is of the utmost importance that parties are cognizant of (a) whether and when they may terminate a contract, and (b) upon doing so, what remedies are available to them. Failure to properly address these items in the drafting phase can lead to headaches down the road in litigation.
For this item, let’s assume that Party A enters into a contract with Party B, whereby Party A agrees to manufacture and supply “Products” to Party B in exchange for payment. Business is good now, but what happens if Party A fails to deliver on time, or at all? What if Party A delivers the Products and they are defective? On the other hand, what if Party B pays late, or only makes a partial payment, or fails to pay at all? Often, parties to a contract believe that if something doesn’t go their way, this means “breach,” and, in turn, they may terminate the contract and pursue recovery of all their losses. However, in the absence of language specifically addressing termination and remedies, it may not be that simple.
This is where termination and remedies provisions come into play. Parties should insert clear and concise provisions explaining the circumstances under which the subject contract may be terminated, including the conditions justifying termination (i.e., for “cause” and/or for “convenience”), notice periods before the termination becomes effective, and the method by which notice of termination must be given. Similarly, to provide guidance post-termination, parties should likewise include remedies provisions in order to more appropriately allocate their risk. Common provisions include a waiver (or express non-waiver) of incidental or consequential damages, caps on a party’s liability, indemnity requirements, and liquidated damages clauses. With these items in place from the outset, parties can more accurately assess the litigation landscape in advance of proceeding.
By avoiding these common mistakes in the contract negotiation and drafting process, parties can more thoroughly protect themselves in their business relationships and in litigation.
1 This article was authored and first published by Andy Hagerman, Esq. who is a Member of Stoll Keenon Ogden PLLC’s Louisville, Kentucky office. This article has been republished with permission. To contact Andy, email him at Andrew.hagerman@skofirm.com.
Questions? Contact Jared Burke for more information.