Lawyers
say that a contract is an agreement the court will
enforce; this is a rich concept which bears exploring.
As
children, we learned about the three branches of government:
executive, legislative and judicial. As adults, we
observe soberly that to the governed, the distinction
makes little ultimate difference. A fine, a tax, or
a toll must be paid all the same, regardless of which
branch originates the charge, or enforcement will proceed
under penalty of law by armed officers of the State.
Like
the other branches of the government, the court enforces
its will through men with guns. Backed by sheriff’s
deputies to carry out foreclosures, levies, and auction
sales, and police officers to carry off the intransigent,
a judgment for contract damages can be a powerful thing
in the hands of determined creditor. The prudent business
person learns to see the government as a shadow party
to every contract. Before you sign your next contract,
consider for a moment the downside risk of the government
enforcing it in the event of your breach.
But
also consider, downside risks are what contracts are
all about. The reason for any contract is to manage
and fix risk. People can be rascals. Things happen. The
ball takes a bad hop. Absent express agreement on
essential terms, the risks of misunderstanding, conflict,
sharp practice and inequitable behavior rise to unacceptable
levels, and so business people everywhere use contracts
to allocate their respective rights and obligations
in an exchange. With an express contract, these business
risks are minimized, and transactions overall proceed
more quickly and at lower cost.
Despite
the admitted benefit of expressly allocating business
risks, the benefit doesn’t have to fall evenly on both
sides. In some contracts, terms and conditions are
so one-sided as to be unenforceable by the courts because
of one public policy reason or another. The judges
in their wisdom will not enter judgments which they
would not wish to see enforced, and at the heart they
understand that bringing men with guns to compel injustice
invites revolution. Petitioned to enforce an unjust
term of agreement, and in doing so undermine the status
quo, the courts will most often discern (or invent)
a public policy against enforcement. As a result of
this predictable conservatism, lawyers say, “When the
facts are against you, argue the law. When the law
is against you, argue the facts. When the facts and
the law are against you, argue public policy.”
Whether
through the opinions of reported cases or by the passage
of statutes, public policy in time becomes law, but
the two do not advance everywhere in the same direction
or at the same pace. Overbearing contract terms enforceable
in one jurisdiction may be banned in another. There
are, moreover, competing public policies, and fundamental
fairness is ever at war with freedom of the marketplace. Everywhere
we find contracts which are the product of a gross
imbalance of bargaining power, and the courts enforce
them all the same. The business ethic remains: if
you can’t run with the big dogs, stay on the porch.
Now,
if you’d like to come down off the porch, there certain
things you should know. You need to keep your eyes
on the fine print - on the contract terms to watch
for and avoid.
I. CONTRACT
TERMS TO WATCH FOR AND AVOID
A. Waivers,
Releases and Exculpatory Clauses.
A
waiver is the relinquishment of a right. In contract
terms, it means that one party is giving up a right
it would otherwise have. Waivers may be express (i.e.,
explicit in the contract) or implied, and include releases
and exculpatory clauses.
A
release (in the contracting sense of the word) is a
waiver of rights by which you give up present or future
claims of a certain type against a particular person
or group. Such a clause may require that you release
the other party from specific acts, omissions or violations
of law, or it may constitute a blanket release, in
which you (on paper at least) give up every claim you
ever had or may ever have.
An
exculpatory clause is language contained in a waiver
that releases a party from damage which his own fault. It
usually lets him off the hook for liability for negligent
acts that cause injury. A valid and enforceable exculpatory
clause will, in most states, absolve a person from
responsibility for her own negligence, but must contain
clear, explicit, unequivocal language of waiver. Specifically,
the potential plaintiff must be put on notice of the
range of dangers assumed, including reference to the
types of activities, circumstances, or situations encompassed
in which the plaintiff agrees to relieve the potential
defendant of his duty of reasonable care.
The
inclusion of releases, exculpatory clauses and blanket
waivers in form contracts has become common, and offers
a trap for the party who fails to negotiate them out. A
cardinal danger is presented for an insured party,
whose liability carrier may deny coverage for claims
caused by a released party. Since a surety has the
right to stand in the shoes of its insured and to pursue
reimbursement from the party who caused the harm, to
the extent that the negligent party has been released
by the insured, the carrier is released from its contract
of insurance under a legal doctrine known as impairment
of subrogation. The carrier in such case can rightfully
refuse to pay out on the claim, and the insured is
left with no rights against the released party and
no rights against the excused insurer.
The
courts will generally enforce a waiver only to the
extent that it can be shown to have been the voluntary
and intelligent relinquishment of a known right, and
the extent to which unknown rights can be released
changes from place to place. (See, California Civil
Code Section 1542: “A general release does not extend
to claims which the creditor does not know or suspect
to exist in his favor at the time of executing the
release, which if known by him must have materially
affected his settlement with the debtor.”)
Moreover,
waivers and releases can apply not only to the right
to sue for damages, but also to other substantive legal
rights such as the right to lien, and to procedural
rights such as the right to appeal, the right to a
jury trial, and even the right to proceed through the
courts in the event of a dispute. Some states, like
New Jersey, have declared lien waivers void as against
public policy, and by contrast have favored commercial
arbitration clauses for the same reason. The question
of waiver of procedural rights, such as the right to
sue rather than arbitrate, is contested all over the
country. These issues are furthermore situation-specific,
and the enforceability of a release or waiver will
depend not only on the jurisdiction involved but on
whether the provision appears in a labor agreement,
a commercial agreement, or a consumer contract.
Many
contracts contain a “waiver of breach” or “implied
waiver” clause which is, in actuality, a waiver of
waiver. Such a clause states that the failure of either
party to require the performance by the other of any
of the contract terms will not affect their respective
rights to enforce those terms, nor will the waiver
of any breach of any contract provision be construed
to be a waiver of any succeeding breach or as a waiver
or modification of the said provision. As you can
see, things can get complicated.
B. Indemnification
/ Hold Harmless.
An
indemnification clause, in which you agree to reimburse
the other party for loss or liability which he may
suffer through no fault of your own, is worse than
a release or a waiver. With an obligation to indemnify,
you risk the obligation to pay actual dollars, as opposed
to risking your own loss which you might simply absorb. The
typical indemnification clause obligates you to pay
for the other guy’s lawyer to defend him in the event
of suit, and to pay for any adverse judgment or even
for any settlement he chooses to make.
As
with releases, indemnification can impact your exposure
to uninsured risk. If your employee falls through
a skylight, workers compensation insurance won’t relieve
you from indemnification of the owner for premises
liability.
Indemnification
clauses are notoriously open-ended, and yield unlimited
exposure. Unknown claims by third parties are difficult
to evaluate or even anticipate, and may be made long
after your work is done. When offered an indemnification
clause you can’t get rid of altogether, it would be
far better for you to try to cap your potential liability
to the extent of your own insurance coverage. Don’t
indemnify the other party for any negligence or willful
acts on its own part, and always negotiate the right
to participate in, or assume control of the defense
against any claims which third parties may bring and
which may trigger your duty to indemnify.
C. Choice
of Forum/Venue.
A
choice of venue or venue selection clause picks the
location of the court that the parties must use if
they end up in litigation relating to the contract. Being
forced into a far-away court implies increased costs
of suit in the event of breach, and the peril of being “home-towned.” Venue
selection carries with it by default in many instances
the law of the host jurisdiction, which may directly
impact your ability to present legal theories for recovery. Choice
of law principles found in the law of the forum will
govern in the absence of contractual selection.
Generally,
a choice of forum or venue clause will be upheld unless
the court concludes that the result would be unreasonable
or unjust under the circumstances. A court will decline
to enforce such a clause only if it fits into one of
three exceptions to the general rule: (1) the clause
is a result of fraud or "overweening" bargaining
power; (2) enforcement would violate the strong public
policy of the state; or (3) enforcement would seriously
inconvenience trial. Note, however, that a particular
state (such as Michigan) may not enforce choice of
venue clauses at all, leaving its own local rules as
the sole source of authority for venue selection.
If
you’re going to be signing on to a choice of forum
or venue outside your own, be very careful in the case
where you are also dealing with third parties who have
not signed such a clause. Your subcontractors or suppliers
may have no legal reason to join in a far-off lawsuit,
and unless they have consented to the jurisdiction
of the foreign court, cannot be compelled to do so.
D. Choice
of Law.
As
with choice of venue, choice of law clauses can make
a huge difference in the extent of your rights under
a contract, as for example, where the timeliness of
contract claims might be determined alternatively by
reference to New York's limitation period or under
California's shorter limitation period. With a California
choice of law clause, you could be time barred when
you go to sue.
Another
problem results where a lawsuit is filed in one jurisdiction,
but the contract says that the laws of another are
to apply. In such a case, the judge’s lack of familiarity
with foreign law may lead to a wrong call. In actual
practice, the judge and local lawyers for both sides
may tacitly ignore the issue, or give it lip service
only.
E. Liquidated
Damages.
A
liquidated damages clause provides for payment of a
certain fixed amount, in place of actual damages which
legally flow from a breach of contract. The government
and big businesses love liquidated damages clauses
- they avoid so very much fuss when it comes to actually
proving a case.
Be
careful. When you sign a liquidated damages clause,
you are almost asking for an expensive legal battle
in the event of the slightest and possibly inconsequential
breach. The courts will uphold a liquidated damages
clause if it is reasonable under the circumstances,
if actual damages are difficult to ascertain by any
satisfactory or known rule, and if it is not intended
to serve as a penalty. However, a liquidated damages
clause will be avoided and not enforced if it is far
in excess of the amount of damages the parties may
reasonably forecast, or the other side (usually an
owner) has not acted reasonably in attempting to mitigate
costs to the breaching party (usually a contractor),
or the other side (the owner) prevents or delays performance.
F. Jury
Waiver.
Waiver
by contract of the right to trial by jury is a matter
of evolving public policy across the country. Jury
waiver is still enforceable in most commercial transactions,
but elsewhere only enforceable if it is conspicuous,
bargained for and between parties that are not of greatly
disparate bargaining power; a jury waiver is therefore
usually no good in a boilerplate consumer contract. People
argue against the increased costs of trying a case
to a jury, but what they really mean is that they are
afraid that the jury will deliver a verdict which they
cannot control. Juries level the playing field for
the big and the little without concern for political
fallout. Don’t give up the right to trial by jury
unless the thought of punitive damages makes you lose
sleep.
G. Arbitration.
An
arbitration clause is akin to a jury waiver, since
it restricts the remedies developed to achieve justice
by the common law over the centuries. A binding arbitration
clause always acts as a jury waiver, and can be used
by design to take a potentially inflammatory lawsuit
away from a jury. While much in fashion, there are
pros and cons to arbitration, and maybe more cons.
Chief
among the points in favor of arbitration are the speed
and potential for reduced cost resulting primarily
from limitations on the parties’ right to discovery. While
a pro or con depending on your point of view, the limitation
on discovery gives a direct advantage to the better
informed party (or the bigger rascal). Arbitration
also speeds resolution by allowing the parties to avoid
the backlog of a court docket, where criminal matters
are given priority on a congested trial calendar.
Arbitration
allows the parties to select an expert arbitrator. For
example, where the issue is an accounting problem,
an accountant can be selected to act as arbitrator.
While
overall costs may be lessened, they are telescoped
inward and front-end loaded. A party whose lawsuit
can be filed for a pittance, and affordably budgeted
for over several years, will find herself paying her
proportionate share of an arbitrator’s and administrator’s
fees, venue rental, and day after day of attorney’s
time from the first hearing until the award is rendered.
There
is also less procedural protection for an arbitrating
party, and limited grounds for appeal or collateral
attack on a bad result. Working against the effort
to save costs, there is a chance the entire controversy
may not be decided in arbitration, since the arbitrability
of tort claims and availability of equitable relief
is a matter of local law.
Once
you’ve elected to go with arbitration, it is critical
to select a set of procedural rules. There are a variety
of statutory and private alternative dispute resolution
(ADR) administrative schemes. You need to remember
that despite the existence of complete sets of rules
provided by statute or by established arbitration associations,
the parties to a contract can further limit or partially
change those established rules by their contract, such
as limiting the number of arbitrators or designating
the arbitrator. Whichever rules you select, be certain
you know whether costs of the proceedings are to be
shared or shifted from one party to the other - again,
the matter is one for agreement.
Finally,
arbitration (which is really just rent-a-court) is
to be distinguished from mediation, where a hopefully
skilled intermediary tries to broker settlement by
agreement. Some contracts call for mediation as a
precondition to arbitration; this will serve to insulate
the big wrongdoer by exhausting the injured little
guy.
H. Pay-When-Paid
/ Pay-If-Paid (contingency payment clauses).
A
pay when paid clause attempts to shift the risk of
an owner's insolvency from the prime contractor to
the subcontractor. There are several views on the
propriety of these types of clauses as a matter of public
policy. Most courts refuse to construe a pay when
paid clause as a valid defense to non-payment, and
instead read them as timing provisions which fix the
subcontractor’s right to payment within a reasonable
time after the work is performed regardless of when
the general contractor is paid by the owner.
The
minority views break in opposite directions. One minority
of jurisdictions (including Florida) further distinguishes
such a clause as either a condition precedent or a
time of payment provision, and if it is a condition
precedent, they see it as stating an obligation to
pay only if paid. If so, it will be enforced in accordance
with its terms. The second minority (including California)
holds that a typical "pay if paid" provision
in a contract is contrary to public policy and thus
unenforceable.
I. Attorneys’ Fees.
The
so-called American Rule states that the parties to
a lawsuit will each bear their own attorneys’ fees,
unless some statute or contractual provision states
otherwise. Be on guard for fee-shifting contract clauses,
which sound fair but seldom are.
First,
there is the trouble of picking the “winner” in a multi-party,
multi-issue case, with claims on both sides. More
modern expressions of shifting fees to the “substantially
prevailing” party offer little practical help, and
may even act as a hindrance to quick resolution of
the dispute.
Second,
as if it weren’t clear by now, the bigger, richer party
not only has an advantage in the lawsuit, but their
lawyers always cost more than your lawyers. Think
of the biggest law firm in the biggest city in your
State, and consider if you could afford their fees. Now
think if you’d like to pay their fees (including travel
time) and your own lawyer’s fees at the same time you
have a judgment against you. Now consider that these
types of fee shifting clauses seldom if ever consider
the issue of where it all ends - judgment, appeal,
remand, or never?
J. Incorporation
by Reference.
The
effect of incorporation by reference is to make other
documents part of the contract. While commonplace
for plans and specifications too bulky to include in
the text of the main contract, this technique presents
the menace of multi-level layering of referenced documents. Incorporated
project plans and specifications can themselves incorporate
other documents, such as the prime contract or government
regulations. These pose a significant risk of hidden
obligations - a subcontractor may inadvertently agree
to additional obligations and limitations of rights
of which he has no knowledge. A commonplace example
is where a subcontractor, bound by the provisions of
an incorporated prime contract, files suit only to
be bounced out of court on a motion for stay pending
arbitration.
Incorporation
by reference is easy to do wrong. When you try your
hand at drafting your next contract on the bones of
the last one your lawyer did, remember that to effectively
make one document part of another you must contain
a statement of incorporation, which should include
the words "incorporated by reference." Defective
incorporation of documents not (yet) in existence,
no longer in existence, and laws no longer in force
has deviled scriveners and contracting parties for
hundreds of years.
Correct
incorporation by reference gets to be a moving target
on the issue of version control, with updates and revisions
to plans and specifications, and updates and revisions
to laws and regulations never reaching back to become
part of the contract. This becomes especially problematic
where the contract also contains an integration clause.
K. Integration.
An
integration clause, sometimes in a contract under the
headings “No Oral Modification” or “Entire Agreement,” states
that the written contract represents the entire understanding
of the parties with respect to the subject matter thereof
and no changes are valid unless made in writing and
signed by the parties. Such a clause will knock out
oral understandings, and even common-sense incorporation
by reference of updated collateral documents. An integration
clause will probably prevent you from successfully
suing for any misrepresentations preceding the signing
of the contract, knocking out your fraud in the inducement
defense to the deceiver’s claims of breach.
L. No
Damages for Delay.
A
no damages for delay clause means exactly what it says,
and is a clearly one-sided clause that has been the
topic of much recent legislative and judicial action. The
effect is to provide that if the contractor experiences
a delay on the project, its sole recourse is to seek
an extension of the time to complete. The innocent
contractor can go right out of business, waiting for
the work to resume, without any claim for damages whether
such delay was avoidable or unavoidable. Some states,
such as Ohio, prohibit no damages for delay clauses,
when the delay is caused by the owner or prime contractor. Other
states, such as Minnesota, prohibit public owners from
using no damages for delay clauses in public construction
contracts, while others enforce them or less narrowly
restrict them, such as New Jersey, which has extended
the ban to school projects, but not other public works.
M. Termination
for Convenience.
A
termination for convenience clause brings the concept
of one-sidedness to its ridiculous extreme, providing
that the owner may, at any time, terminate the contract
for the owner's convenience and without cause. Such
a clause limits an owner’s liability in the event that
the owner for any good faith reason decides to abandon
its project, and generally limits the contractor's
recovery to cost incurred plus profit on work completed,
together with the costs of preparing the termination
settlement proposal, and precludes recovery of anticipatory
profit.
These
clauses were introduced by federal government in the
fifties; recently, the concept has recently gained
acceptance in private contracts. Look out for a termination
for convenience clause buried in popular form contract “General
Conditions.” As a rule of thumb, treat all “general
conditions” as “generally suspect.”
II. SECTION
HEADINGS.
Many
contracts have misleading (and maybe deliberately misleading)
section headings, labels which have nothing to do with
the stated name of the clause. You can’t depend on
the section headings in any contract of adhesion, and
since the advent of word processing you’re better off
ignoring them altogether. You use a section heading
as a shortcut to the sense of a clause at your own
risk.
Many
contracts squeeze the overbearing terms into one catchall
clause at the end. Be very concerned whenever you
see a “Miscellaneous Clause,” whose banal name may
conceal a litany of one-sided terms.
III. CONCLUSION.
When
an overbearing clause is met with objection, its proponent
will likely offer the stock reply, “It’s only boilerplate. We
have it in all our contracts.” The correct rejoinder
is, “So what? How does that affect our deal?” Boilerplate
is no substitute for thoughtful expression of agreement
or rational allocation of risk. Moreover, the foregoing
list of objectionable terms is by no means exclusive,
and offers room to discuss confidentiality, time of
the essence, no reliance, cooperation, separability,
additional-named insured, no assignment, confession
of judgment, survivorship, force majeure, warrant of
attorney, notice provisions, warranties, and other
potentially oppressive clauses.
Be
on your guard. A contract, as an agreement the court
will enforce, heightens the risks it seeks to manage. If
you give up a right or take on an obligation at the
bargaining table, the government waits in the wings. Remember
to keep your eyes on the fine print - on the contract
terms to watch for and avoid.
