Buried within the standard terms and conditions of most contracts are pitfalls which, if not carefully reviewed, will trap the unwary. When contracting, parties spend most of their efforts negotiating price. As they reach agreement, the vendor pulls out its standard contract, the buyer confirms the price, and both parties sign. Only months later does the business learn the fine print in the contract converts the contract from something to be celebrated into a profit-eating lawsuit.
Skyrocketing litigation costs make lawsuits an inefficient means of resolving disputes — especially contract disputes, given the parties had a chance to address the issue during contracting. Businesses that have poured money into contract disputes quickly learn that “an ounce of prevention is better than a pound of cure.” No contract should be signed until it is fully understood and clearly delineates the obligations of the parties. In reviewing contracts, five provisions require close scrutiny.
- The Termination Provision. The contract should provide whether it can be terminated with or without cause and the financial ramifications of the termination. The cost of termination should be based on the reason for termination.
For example, there is a licensing company that touts that its contracts can be terminated “without cause” at any time. While true, the fine print provides the licensee must pay the full contract price whether the contract is terminated with or without cause. Not only is the sales pitch misleading, but the distinction between with/without cause is meaningless since, either way, the buyer owes the full contract price.
Before signing any contract, the business must understand what happens if it must terminate the contract.
- The Integration Provision. Contracts are filled with non-controversial, “boilerplate” provisions that are inserted with little thought by the drafter. One such provision is the “integration clause,” which provides that all agreement terms are included in the written document. The clause is important because, during the sales pitch, the vendor inevitably made promises about its performance that were critical factors in selecting the vendor.
However, the integration clause makes these oral promises difficult, if not impossible, to enforce unless they are spelled out in the agreement.
- The Indemnification Provision. Another ubiquitous provision is an indemnification provision. Indemnification requires one party to “indemnify” and “hold harmless”, i.e., pay, all costs incurred by the other party (the indemnitee).
The problem with indemnification is it frequently requires indemnification for the misconduct of the indemnitee and is not limited to the contract price. For example, an indemnification provision in a $10,000 subcontractor agreement might require the subcontractor to spend ten times the contract price indemnifying the general contract for the misdeeds of the general contractor.
Contracts should never be signed until the business understands its potential exposure under the indemnification provision and what triggers the obligation.
- Limitation of Liability. The limitation of liability provision is the inverse of the indemnification provision and, as the name implies, limits the liability of a party. Typically, the provision benefits only the vendor and limits the vendor’s liability to the contract price — often a wholly insufficient amount.
- Attorney’s Fee Provisions Incentivize Parties. Parties to a lawsuit must pay their own legal fees unless, among other exceptions, the contract provides for the recovery of attorney’s fees. Not all attorney fee provisions are created equal and some of them, especially one-sided provisions, can create a perverse incentive for a party to litigate non-meritorious claims.
Before signing any contract with an attorney fee provision, the business must understand how the provision will incentivize the parties if a dispute arises.
Businesses enter into contracts every day. Regardless of whether the contract is a formal 60-page document or a two-page agreement written on the back of a napkin, the business must fully understand all of the terms and how every provision will impact the company, especially in the event of a breach.
Christopher J. Marino is a shareholder at the Boston law firm Davis, Malm & D’Agostine P.C., of Boston, practicing in the Litigation, Business Law, Employment, and Real Estate and Environmental areas. He has extensive experience in the trial and appeal of complex business litigation in the areas of shareholder disputes, corporate governance, securities, real estate, construction and development, employment relations, contracts, and insurance coverage disputes. He can be reached at [email protected].