Negotiating a customer’s code-of-conduct compliance request in a contract
July 9, 2008
I just posted to the Drafter’s Choice blog a short piece on “Negotiating a customer’s code-of-conduct compliance request in a contract.” It tells of a client negotiation I helped with last week.
Contracts should explain their terms as necessary
May 2, 2008
I couldn’t disagree more strongly with my friend Ken Adams’s comment that, apart from the opening recitals, “in a contract you don’t reason or explain. You just state rules.” That’s way too categorical a statement for my taste. Contracts are read and followed by people, not by computers, and people sometimes need to be persuaded to do the things they’re theoretically supposed to do. That’s where it can be extremely helpful to record reasons and explanations into a contract.
Suppose Company A signs a contract requiring it to do X. It won’t necessarily happen that way automatically. One or more people need to make X happen, and those people might balk at doing so:
- Company A’s management might decide they want the company to do Y instead of X because of changed circumstances.
- Or it might be that Alice at Company A negotiated the contract, but her colleague Allen is now responsible for making X happen, and Allen thinks doing X is a bad idea.
If Company A’s lawyer can think of even a faintly-plausible rationale for not doing X, the odds are that the company will simply fold its arms and say “nope.” (I speak from hard experience on this score.)
That’s where reasons and explanations can come in handy: If the contract explains the business reasons that Alice committed the company to doing X, there’s a better chance that Allen will understand her reasoning and go along with her commitment.
The same is true in contract litigation: Judges sometimes need to be persuaded too. This is especially true if there’s more than one way to read the contract — again, this is where reasons and explanations can come in very handy.
Reduce out-of-state taxes: Give your affiliates arms-length terms
April 17, 2008
If your company has subsidiaries in other (U.S.) states, you need to think about whether those states can make you pay taxes on the income of other members of the corporate family. As a rule of thumb, the more separation there is between businesses, the lower the odds of being forced to pay out-of-state income taxes.
The U.S. Supreme Court hinted this week that doing inter-company business on arms-length terms may strengthen the case against out-of-state taxation. The parties to the case were Ohio-based MeadWestvaco Corporation ("Mead") and the state of Illinois. Mead realized $1 billion in capital gains when it sold off its Illinois subsidiary Lexis/Nexis. Illinois taxing authorities assessed a $4 million state capital-gains tax. Mead paid under protest and sued for a refund.
The Supreme Court held unanimously that Illinois isn’t allowed to levy the tax unless it can prove on remand that Mead and its subsidiaries operated as a "unitary" business. I’m not a tax lawyer, so I won’t try to go into the details of Justice Alito’s (very readable) opinion. The New York Times article thought it was noteworthy that Justice Alito specifically mentioned the arms’-length nature of Mead’s intercompany business dealings with its subsidiary Lexis/Nexis; the opinion says:
Lexis was subject to Mead’s oversight, but Mead did not manage its day-to-day affairs.
Mead was headquartered in Ohio, while a separate management team ran Lexis out of its headquarters in Illinois.
The two businesses maintained separate manufacturing, sales, and distribution facilities, as well as separate accounting, legal, human resources, credit and collections, purchasing, and marketing departments.
Mead’s involvement was generally limited to approving Lexis’ annual business plan and any significant corporate transactions (such as capital expenditures, financings, mergers and acquisitions, or joint ventures) that Lexis wished to undertake. In at least one case, Mead procured new equipment for Lexis by purchasing the equipment for its own account and then leasing it to Lexis.
Mead also managed Lexis’ free cash, which was swept nightly from Lexis’ bank accounts into an account maintained by Mead. The cash was reinvested in Lexis’ business, but Mead decided how to invest it.
Neither business was required to purchase goods or services from the other. Lexis, for example, was not required to purchase its paper supply from Mead, and indeed Lexis purchased most of its paper from other suppliers. Neither received any discount on goods or services purchased from the other, and neither was a significant customer of the other.
MeadWestvaco Corp. v. Illinois Dept. of Revenue, No. 06–1413, slip op. at 4 (U.S. Apr. 15, 2008) (extra paragraphing added)
Confidential information notes posted
April 3, 2008
I just posted a long article with general notes about confidentiality clauses.
An oral understanding might not get you off the hook for a written contractual obligation
April 1, 2008
You have to wonder whether to feel sorry for the loan broker in Wheeler vs. Blumling. This broker found a business loan for a customer, and then went along with the lender’s insistence that the broker himself sign a guaranty. Unfortunately, things went badly awry (including the indictment of one of the borrower’s business associates for wire fraud), and the lender sued the broker and others for repayment.
(Interestingly, the loan bore interest at what the appeals court described as the “breathtaking” rate of 1,000% per annum.)
The broker tried to escape liability on his guaranty by claiming he had an oral understanding with the lender. It didn’t work; the court had no trouble holding that the broker was bound by his written obligation:
… [The broker's] evidence does not support a modification of the agreement, but rather consists of assertions of prior oral negotiations that contradict the written instrument he executed. …
[The broker] wants to contradict particular terms of a contract which has already been performed on [the lender's] side and of which [the broker] has already enjoyed the benefits (fleeting though they were). This is exactly what the parol evidence rule forecloses.
Wheeling v. Blumling, No. 07-1992, slip op. at 8-9 (1st Cir. Mar. 25, 2008).
What surprises me most about this case is that the court didn’t hammer the loan broker and his lawyer for making the oral-modification argument in the first place. From the facts reported in the appeals-court opinion, it looks to me like the argument was … thin (at best), and that there was no good reason for the broker’s lawyer to have made the lender spend extra time and money enforcing his rights. Maybe there’s more to it than that; I sure hope so.
Supreme Court nixes expanded judicial review of arbitration awards (but stay tuned ….)
March 26, 2008
Yesterday the Supreme Court rejected the view that parties to an arbitration agreement, at least under the Federal Arbitration Act, can agree to expanded judicial review of the arbitrator’s award. See Hall Street Assoc., L.L.C. v. Mattel, Inc., No. 06-989 (U.S. Mar. 25, 2008) (hat tip: SCOTUSblog).
I’ve put a more detailed write-up at the 100 Feet Up wiki.
Signing a contract without indicating it’s for your company can get you sued personally
March 24, 2008
I recently ran across a case from California where:
• a company officer signed a letter agreement, on his company’s letterhead, but with no indication of his title;
• the company backed out of the deal;
• the other side sued both the company and the officer in his personal capacity; and
• the company’s D&O insurance carrier successfully denied coverage, on grounds that D&O coverage doesn’t include garden-variety breaches of contract; and
• the insurance carrier therefore didn’t have to pay for the officer’s litigation defense expenses.
See August Entertainment, Inc. v. Philadelphia Indemnity Ins. Co., 146 Cal.App.4th 565 (2007).
Of course, there was a wrinkle, one that likely didn’t sit well with the court. The two companies had settled their dispute. Under the settlement, the officer agreed to allow a $2 million judgment to be entered against him. The plaintiff agreed to look solely to the insurance carrier for recovery of the money, and to dismiss its claims against the officer’s company, which was now insolvent.
Regardless, the court had no trouble holding that the D&O policy did not cover the plaintiff company’s claim for breach of contract.
Source code escrows usually aren’t worth the bother
March 19, 2008
Shawn C. Helms and Alfred Cheng, two associates in Jones Day’s Dallas office, write in CIO Magazine about something I’ve been saying for years: Source code escrow clauses are almost never worth negotiating in a software license agreement, because it’s seldom ever cost-effective for a customer to get source code out of escrow and use it. The authors articulate several specific reasons, some of which I’ve paraphrased below:
- The software vendor is likely to go to court to fight a release of source code from escrow. The resulting delay alone might destroy much of the business value of the escrow to the customer.
- The customer’s IT staff likely doesn’t have time to do anything significant with the escrowed source code (including the non-trivial task of coming up to speed in how it works). And there’s probably no budget to hire the additional bodies that would be needed.
- The odds are that the escrowed materials will be incomplete, sometimes materially so, because the vendor likely considers it a low priority and the customer doesn’t police the vendor’s contractual compliance.
A source-code escrow can sometimes be highly appropriate. If a customer’s business relies on custom-built software that’s unavailable anywhere else, then an escrow might be crucial — but in that situation, the customer has to monitor the vendor’s compliance and be ready to do the needful with the code.
If the software is a commercial package, however, the customer often won’t even bother trying to use escrowed source code: Instead, it will simply rip out the offending software and switch to a competitor’s offering. (In situations like this, competitors are often happy to give away displacement licenses for free in order to get the future maintenance revenue stream, and so that their sales reps can tell prospective customers that they displaced the fired vendor.)
Contract creation - an industry, not a craft
August 27, 2007
We contract drafters and -reviewers tend to strive for perfection. We’ve been trained to craft language that gives our clients as much of an "edge" as possible. We can cite compelling ethical reasons for doing so; we also have reputational pressures and other institutional incentives that move us in that direction. And many wordsmiths (like many computer programmers) are secretly convinced, in the depths of their souls, that "I can do it better."
But in the bigger picture, we may be doing more harm than good that way.
The forceps experience
I was struck by an analogous "case study" in the world of medicine, described by surgeon and Harvard Medical School assistant professor Atul Gawande (who is also a Rhodes Scholar and a 2006 "genius grant" MacArthur Fellow).
Gawande reports that obstetricians began questioning their use of forceps and other techniques for handling difficult deliveries, as well as their preference for avoiding surgical Cesarean-section deliveries where possible. Their questioning was motivated in part by their competitive desire to improve their newborns’ Apgar scores (and doubtless also by the threat of malpractice liability).
The obstetricians knew that, in the hands of skilled practitioners, forceps can produce fine results. But they also recognized that the proper use of forceps is based largely on feel, which is very hard to learn (and to teach). And improper use of forceps can seriously injure both child and mother. In contrast, while Cesarean-section surgery is surgery, and thus has inherent risks, it also is readily capable of being taught (because the instructor can observe and coach the new doctor in real time).
So the obstetrical profession found itself having to decide whether occasional terrible results from the use of forceps were an acceptable price to pay for the quest for perfection, viz., the avoidance of C-section surgery:
If medicine is a craft, then you focus on teaching obstetricians to acquire a set of artisanal skills—the Woods corkscrew maneuver … , the Lovset maneuver …, the feel of a forceps for a baby whose head is too big. … You accept that things will not always work out in everyone’s hands.
But if medicine is an industry, responsible for the safest possible delivery of some four million babies a year in the United States alone, then a new understanding is required. The focus shifts. You seek reliability.
You begin to wonder whether forty-two thousand obstetricians in the Unites [sic] States could really safely master all those techniques. You notice the steady reports of terrible forceps injuries to babies and mothers, despite all the training that clinicians received.
After Apgar, obstetricians decided they needed a simpler, more predictable way to intervene when a laboring mother ran into trouble. They found it in the Cesarean section.
Atul Gawande, Better: A Surgeon’s Notes on Performance, at 192 (Henry Holt & Co. 2007) (emphasis and extra paragraphing added).
A baseball analogy
You could think of delivering babies in baseball terms. Obstetricians knew that, in the clutch, their leading players could regularly "hit home runs" by using forceps. But not all their players could do this when needed, especially the rookies.
The obstetricians realized that their collective clutch performance was not what they wanted. So team-wide, they de-emphasized swinging for the fences, i.e., using forceps, in problem situations. Instead, they began stressing doing what it takes to just "get on base," i.e., C-sections.
Contract creation is likewise an industry, not just a craft
We contract creators can take some lessons from the obstetricians’ experience. Many of us tend to think of contract creation primarily as a craft: within the constraints of professional ethics, we focus almost entirely on achieving the best result for this client. We sometimes secretly take pride in fashioning (what we imagine is) the best possible contract language for the situation. We inculcate this ethos into our junior professionals, both expressly and by subtle cues.
But contract creation is an industry, too. This means we professionals must also think in terms of achieving the safe and healthy "delivery" of thousands of new business relationships every year.
And therein lies a problem: Fashioning the best possible contract language, like using forceps (or hitting clutch home runs), is tough to learn and to teach. Doing it wrong can lead to significant complications. Moreover, many of those complications are hard to predict in advance even for seasoned pros — yet much of everyday contract creation is done by junior professionals who have not always had the requisite experience.
Just as obstetricians found themselves rethinking their use of forceps, we may have to rethink our emphasis on custom-crafting the language of each contract. As Dr. Gawande notes about delivering babies (see id. at 192), sometimes reliability is more important than "the possibility of occasional perfection."
Amazon, Borders Face Market-Division Claims
March 31, 2004
According to this story at CNet News, last week a federal district judge in San Francisco said that a private antitrust claim against Amazon and Borders, for allegedly divvying up portions of the on-line book market between them, could proceed to trial. (The judge dismissed a companion price-fixing claim as “ludicrous on its face.”) The claim related to a teaming agreement that Amazon and Borders signed in 2001. The CNet story reports that:
[Judge] Patel said one section of the contract, which is similar to one Amazon inked for the online store of Toys “R” Us, is “troubling.” A restriction prohibiting Borders from competing with Amazon means that “Borders could not even provide overstock books to another online marketer, even if there were no mention online that these books came from Borders,” Patel said.