Ten bad business contract decisions

Business contracts often fail to include
specific terms that provide basic, fair
protection to all parties involved. As a result, businesses expose themselves to
unnecessary disputes that, even if they
win, leave them less than whole. Including
sensible protections will help the parties to
a business contract avoid disputes, or
shorten litigation should it arise.

Smart Business spoke with Neil Kenton
“Ken” Alexander, a partner of Porter &
Hedges LLP, to identify the most common
shortcomings in business contracts.

What are the most frequent shortcomings in
business contracts?

My top ten list includes: no default interest rate; no provision for attorneys’ fees
and litigation expenses; reliance on oral
agreements; no notice of claim provisions;
inadequate dispute resolution provisions;
poorly drafted insurance and indemnity
obligations; absence of proper warranties;
no well-considered damage limitations;
failure to conduct a risk assessment; no
qualification of contract counterparties.
These defects appear often in everything
from insurance policies to supply and service agreements to construction contracts.

What is the impact of these shortcomings?

Without proper provisions for interest
rates on default, attorneys’ fees and litigation expenses, well-crafted insurance and
indemnity obligations, and warranties, it is
practically guaranteed that a business
owner will be exposed to risks it did not
want, or will not be kept whole if the contract counterparty breaches. If the contract
is signed without good notice of claim or
dispute resolution provisions, or without
applying proper risk assessment or qualification of the parties, the innocent business
owner may be drawn into an expensive,
time-consuming legal battle.

Why are these defects so common?

Business people sometimes rely on contracts provided by a trade association, an
industry group, a customer, supplier, or even a competitor that are not well-tailored
to the situation. A big reason is complacency. Sometimes business owners focus on
the good things they expect from a transaction, but do not carefully consider the bad
things that may cost far more than the revenue from the contract. They get lulled to
sleep by repeat business, or assume that a
standard contract protects their interests.

How can business owners make sure their
contracts protect their interests?

Two important steps happen before you
ever speak to an attorney. First, consider
the real-world risks that the contract poses
for all parties, not just you. If it places a risk
on a party who does not understand it, or
cannot manage or insure it, the result likely is nonperformance and maybe a nasty
lawsuit. Second, contracts rarely really
fully protect you from a dishonest, incompetent, or under-financed contract counter-party, so qualification of the companies
with which you do business is essential.

I recommend specifying an interest rate
on past-due sums, because the law provides
for interest substantially below what most
business people regard as sufficient to cover
the real cost and risk of delayed payment.

What contract matters especially deserve
review by counsel?

Here are some key examples. Courts
almost never award attorneys’ fees to the
successful defendant, unless the contract
says so. In other words, if the other contract
party brings a meritless lawsuit against your
company, you do not recover your attorneys’ fees. A more level playing field is created in many situations if the contract provides that the prevailing party will recover
attorneys’ fees. There are also many other
expenses of litigation that are not recoverable unless the contract says so.

I encourage my clients to think through
whether they want their contracts to be
subject to arbitration, jury trial, bench trial,
or mandatory mediation. Arbitration is
good for some contracts; it is lousy for others. If you pick arbitration, have some well-considered specifics about the kind of arbitration you want.

Lots of contracts that I see in litigation,
especially standard form contracts, have
poorly drafted insurance and indemnity
provisions. Indemnity provisions are often
under-inclusive, over-inclusive, unenforceable, or downright incomprehensible. If
you cannot figure out what it means, do not
expect a court interpretation that you will
like. Indemnity and insurance provisions
are not one size fits all.

Your contracts need to contemplate what
damages each party is really on the hook
for. Lost profits? Costs of delay? Only outof-pocket costs?

Lawyers are like doctors. A checkup with
one who is qualified to deliver preventive
care is vastly cheaper than dealing with a
problem through surgery or litigation.
Good counsel sophisticated in these matters will help you create contracts that
make all parties happier and lower litigation risks. If you fear involving counsel will
make negotiating a good deal with the
other party more difficult, maybe it is time
to look for new counsel.

NEIL KENTON ALEXANDER is a partner with Porter Hedges
LLP. Reach him at [email protected]. or (713) 226-6614.