June 2007 - Channel Crossing: Legal

Drafting a Contract: Why It’s Important to Consult a Lawyer

By Greg Sater and Andrew M. Apfelberg

Let’s face it. With money being tight and legal fees what they are these days, it’s a natural inclination to try to save money by not using a lawyer during the process of negotiating and documenting a deal. Why waste money on a lawyer? Everybody’s happy, both sides are getting along fine and both sides appear to understand what the deal is all about. It’s a simple and straightforward arrangement, there’s no reason to overcomplicate it or rock the boat, and the show may bomb anyway so why spend the money?

But while avoiding the legal fees that it would take to have a lawyer involved at the outset of a contractual relationship may sound like a good idea, particularly if you feel you’ve been around long enough to “do it yourself,” what you may fail to consider (if you haven’t been through the pain and suffering of business litigation before!) is that you are going to have to live with that contract for a long period of time-through good times and bad-and that without competent assistance from an attorney on day one, it is quite possible that you are going to be forced to incur far more significant legal fees down the road, when the relationship runs into problems and a lawsuit is born. All of a sudden, every word of that “contract” you wrote without a lawyer is going to be scrutinized: every word that you said in it, and every word you didn’t say in it, but should have said.

ACME VS. STAR MANUFACTURING
Let’s take as an example the current experience of a company that we will just call Acme Dietary Supplements. In better times, Acme and Star Manufacturing signed an agreement, drafted by lawyers, that explained the terms and conditions of Star’s employment as the exclusive supplier of certain constituent elements of Acme’s products.

After a few years, the president of Star met with the president of Acme to discuss their continuing relationship. This time, Acme did not involve its lawyer. In a meeting with Star’s president, Acme’s president composed what he believed was a minor modification to his company’s agreement with Star. Both men signed that “modification.” After about a year, however, Acme’s relationship with Star soured, and Star demanded “compliance” with the “modification,” which Star asserted was a separate “stand-alone” deal. Acme then terminated its relationship with Star by providing 30 days’ notice as permitted under their original agreement. Star sued, claiming the “modification” was a separate agreement with a 10-year term and no provision for early termination. Star claimed $10 million in damages, leaving Acme no choice but to defend the lawsuit. In the first three months of litigation, even doing the bare minimum to defend itself on a limited legal budget, Acme already has spent 10 times the attorneys’ fees that it would have spent had it involved a lawyer in drafting the “modification.” To get through the rest of the case all the way to trial, Acme obviously will need to spend an even larger multiple of that sum.

For Acme, the problem lies with the wording of the “modification.” Read literally, the document, consisting of five paragraphs, says nothing about the prior agreement and contains no mention of any right to terminate on 30 days’ notice or otherwise. On the other hand, it does mention something about “10 years” and contains language that suggests it is a stand-alone deal. Even though Acme may have intended otherwise, the document reads in a way that is favorable to Star and, not surprisingly, Star claims the document accurately reflects the intention of the parties at the time they signed it. The difficulty for Acme is that many, if not most, judges like to interpret contracts, if possible, based solely on the written language contained within the four corners of the agreement-without going into the “he said, she said” issues of what the parties did or didn’t intend.

In California, for example, the Civil Code provides that “[w]hen a contract is reduced to writing, the intention of the parties is to be ascertained by the writing alone, if possible.” Civ. Code §1639. It further provides that “[t]he language of a contract is to govern its interpretation, if the language is clear and explicit, and does not involve an absurdity.” Civ. Code §1639.

Other states have similar laws favoring adherence to the written terms of a contract, and disfavoring “he said, she said” battles in court. Why? Because the judicial system wants to discourage situations like the one in which Acme finds itself, where a document says one thing but one of the signatories, in this case Acme, contends that the parties’ intent was something else. By holding people to the meaning of the words that they have used in their contract documents, the judicial system encourages people to express the terms to which they are agreeing as clearly, and as completely, as possible.

Does this mean Acme stands no chance in the case? No. There are other rules of contract interpretation beyond the two mentioned above. There are always exceptions, and exceptions to the exceptions. But this bears repeating: in a few short months of litigation, it already has cost Acme 10 times more to litigate this contract dispute with Star than it would have cost it to have a lawyer comment on the “modification” when it was in draft. And, there are a lot more litigation fees to come (not to mention that Acme could lose the case and have to pay damages).

Many other such horror stories can be given involving other companies in our industry that have had to go through costly litigation that could have been avoided had a lawyer been involved, even for a few minutes, when their contracts were written.

AVOIDING FUTURE HEADACHES
What can you do to avoid the kind of problem Acme now faces, but still keep your legal fees down? For starters, before going to a lawyer (and preferably, one who knows your industry) you and the other side should discuss, and make clear, all of the important aspects of your prospective relationship, including terms that may be awkward for you to talk about, such as what will happen at the end of the relationship if it doesn’t work out (who can terminate, when, on what grounds, and who gets patent, trademark, customer lists or other “IP” rights that may exist then?).

Do not avoid discussing such thorny issues! Sit down, discuss them and jointly prepare a term sheet that you then can give to your lawyer: a term sheet that is explicitly non-binding (because that is another common source of litigation, the “term sheet” or “letter of intent” that people prepare without a lawyer, then proceed upon, without ever getting to a true contract, thereby engendering litigation later on whether or not that “term sheet” qualifies as an enforceable contract).

In the “term sheet,” set forth all the key points of the deal. After both sides have agreed on those, then you call the lawyer. By coming to a written understanding directly with the other side prior to putting pen to paper on a contract, you will reduce, or even eliminate, the need for the attorney to do anything but simply “wordsmith” the contract (as opposed to having him or her spend time negotiating it).

Tell your attorney about any existing relationship you have with the other side; identify any prior agreements; articulate your goals; articulate your fears and identify every term you need. Once a contract is prepared, read it, front to back, word for word. Ask your lawyer to explain terms you don’t understand. Think about not only the start of the relationship when everybody is getting along, but also the end. Does the contract adequately deal with the end? Who gets what? And is there an arbitration clause? Remember, if the relationship does go south and you end up in court, you may be held to what the document says within its four corners, and never get a chance to tell the judge what you meant or intended at the time you signed it.

Last but not least, think of Acme. If you and the other side use a lawyer for a contract but then later decide to do a “modification” thereof or a “supplement” thereto, please, discuss it with your lawyer before signing. As Acme and many, many other companies in this business will tell you (perhaps over a strong drink!), it’s wiser to spend a few dollars now than to end up in litigation and spend a whole lot more later!

Greg Sater is a partner at Rutter Hobbs & Davidoff Inc. in Los Angeles. He can be reached via e-mail at [email protected] Andrew M. Apfelberg is a corporate attorney at the law firm. He can be reached via e-mail at [email protected].

 

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