SUSTAINABLE ENTREPRENEURSHIP PROJECT

Transcription

1 A Guide for Sustainable Entrepreneurs SUSTAINABLE ENTREPRENEURSHIP PROJECT Dr. Alan S. Gutterman

2 : A Guide for Sustainable Entrepreneurs Published by the Sustainable Entrepreneurship Project ( and copyrighted 2017 by Alan S. Gutterman. All the rights of a copyright owner in this Work are reserved and retained by Alan S. Gutterman; however, the copyright owner grants the public the non-exclusive right to copy, distribute, or display the Work under a Creative Commons Attribution- NonCommercial-ShareAlike (CC BY-NC-SA) 4.0 License, as more fully described at About the Project The Sustainable Entrepreneurship Project ( engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business. In furtherance of its mission the Project is involved in the preparation and distribution of Libraries of Resources for Sustainable Entrepreneurs covering Entrepreneurship, Leadership, Management, Organizational Design, Organizational Culture, Strategic Planning, Governance, Corporate Social Responsibility, Compliance and Risk Management, Finance, Human Resources, Product Development and Commercialization, Technology Management, Globalization, and Managing Growth and Change. Each of the Libraries include various Project publications such as handbooks, guides, briefings, articles, checklists, forms, forms, videos and audio works and other resources; management tools such as checklists and questionnaires, forms and training materials; books; chapters or articles in books; articles in journals, newspapers and magazines; theses and dissertations; papers; government and other public domain publications; online articles and databases; blogs; websites; and webinars and podcasts. About the Author Dr. Alan S. Gutterman is the Founding Director of the Sustainable Entrepreneurship Project and the Founding Director of the Business Counselor Institute ( which distributes Dr. Gutterman s widelyrecognized portfolio of timely and practical legal and business information for attorneys, other professionals and executives in the form of books, online content, webinars, videos, podcasts, newsletters and training programs. Dr. Gutterman has over three decades of experience as a partner and senior counsel with internationally recognized law firms counseling small and large business enterprises in the areas of general corporate and securities matters, venture capital, mergers and acquisitions, international law and transactions, strategic business alliances, technology transfers and intellectual property, and has also held senior management positions with several technology-based businesses including service as the chief legal officer of a leading international distributor of IT

3 products headquartered in Silicon Valley and as the chief operating officer of an emerging broadband media company. He received his A.B., M.B.A., and J.D. from the University of California at Berkeley, a D.B.A. from Golden Gate University, and a Ph. D. from the University of Cambridge. For more information about Dr. Gutterman, his publications, the Sustainable Entrepreneurship Project or the Business Counselor Institute, please contact him directly at alangutterman@gmail.com.

4 Contract Management 1 1 Essential elements of effective contract management Contract management, sometimes referred to as contract administration, refers to the processes and procedures that companies may implement in order to manage the negotiation, execution, performance, modification and termination of contracts with various parties including customers, vendors, distributors, contractors and employees. While businesspeople often dismiss contract preparation as lawyer s work that has little or nothing to do with the important aspects of the working relationship between the contractual parties, contracting is actually one of the crucial activities in determining the success of any business arrangement. While the essential steps in the contracting process will vary depending on the type and scope of the transaction, and the point at which counsel is brought into the discussions, contract formation and management typically involves most or all of the following: Investigation of the business and legal background for the particular transaction and determination of the role that counsel is expected to play in the contracting process. Identification of the contracts and related documents required to complete the transaction and establishment of a time and responsibility schedule for drafting, review, discussion, revision and completion of all of the required items. Review and evaluation of the related contracts and existing obligations of the company that might be impacted by the specific contract currently under discussion. Collection and review of information regarding the business and legal affairs of the other party to the proposed transaction. Preparation of the initial draft of each of the required contracts and related documents or, in cases where the opposite party is responsible for drafting, review of the initial draft of such items prepared by the opposite party. Discussion of necessary changes in the initial drafts, negotiation of the same and preparation of the final drafts of the contracts and related documents for signature. Preparation for, and completion of, the closing of the transaction at which time all contracts and related documents are executed and exchanged and any required performance at the closing (e.g., cash payments) is completed. Ongoing review of the performance of each of the parties under the terms of the contract, at least in those cases where the contract is long-term and calls for continuous performance over an extended period of time. The timing and sequence of these steps may be impacted by other conditions unique to the transaction. For example, while the parties may quickly reach agreement on the content of the contracts, the actual closing may be deferred pending receipt of approvals from governmental officials or completion and delivery of various reports and opinions from third parties. The role of counsel is treated more fully below and the discussion in this Guide is primarily directed at the legal advisor who will be representing the interests of the

5 company in contract negotiations with other parties. In some instances companies will look to attorneys outside of the company to take the lead in a contract matter. For example, outside counsel (e.g., law firm attorneys) may be used when the company does not have an in-house legal team or the head of the in-house team (i.e., the general counsel) determines that the team does not have necessary resources and/or expertise for a particular contract. When outside counsel is used it is important for the attorney and his or her client (i.e., the company) to determine in advance the scope of the attorney-client relationship and to identify the person(s) within the company with authority to provide directions to outside counsel on negotiation and drafting issues. In general, the discussion below assumes that the general counsel or a member of his or her legal department will be the attorney who is responsible for all of the applicable activities; however, this does not fundamentally change the steps that counsel should be taking when overseeing a contract project. Specifically, in-house lawyers still need to define their role in the contracting process and advise other involved managers and employees about what is expected of them in terms of providing information and communication clearly with their counsel. 1 2 Table 1 Contract Formation and Administration Checklist Investigate the business and legal background for the contract and the transaction in which the contract is to be used. Special consideration should be given to the actual and potential impact on existing obligations and relationships. Identify the steps that need to be taken in order to comply with the requirements of any contract review and signature authority policies and procedures that have been established by the client. Discuss with the client the role of counsel in the contract process and, if necessary, draft and execute an engagement letter. In the course of these discussions, attention should be paid to relevant ethical considerations, including identification and resolution of any actual or potential conflicts of interest. Identify the contracts and related documents required to complete the transaction. If warranted by the complexity of the proposed transaction, prepare a time and responsibility schedule for drafting, review, discussion, revision and completion of all required items and activities. Collect and review examples of the contracts necessary for the drafting process and prepare a drafting checklist and master document for each contract. Negotiate the essential terms of each contract and, if appropriate and useful, prepare a term sheet or letter of understanding to be sure that the parties are in agreement regarding the essential terms before time and effort is spent on contract preparation. Prepare the initial draft of each of the required contracts and related documents or, in cases where the opposite party is responsible for drafting, review the initial draft of such items prepared by the opposite party. Discuss and negotiate necessary changes in the initial drafts and circulate revised drafts for review and finalization. Prepare for the closing of the transaction, including pre-closing meetings and preparation of closing checklists and memoranda. Complete the closing of the transaction at which time all contracts and related documents are executed and exchanged and any required performance at the closing (e.g., cash payments) is completed. Organize the closing documents and make sure that copies are delivered to all interested parties. In 1 Except as other noted, the term counsel in this Guide includes any attorney with responsibility for representing the company in the contracting process whether such attorney is part of the company s legal department or regularly practices with an outside law firm that the company has engaged to provide legal representation in connection with the transaction for which the contract is prepared.

6 addition, counsel should organize the files relating to the transaction and calendar any dates that may require follow up action, such as performance milestones and option elections. Plan for ongoing review of the performance of each of the parties under the terms of the contract, at least in those cases where the contract is long-term and calls for continuous performance over an extended period of time. 3 2 Measurement of performance in the contracting process As with any formal organization process it is important and informative to develop appropriate performance measures for regularly evaluating the contracting process and ensuring that it is making a positive and valuable contribution to the activities of the various organizational units within the company. The primary measure of performance in the contracting process is whether or not the final contract clearly and completely memorializes the intent of the parties with respect to the particular transaction. It is not sufficient for the parties to have good ideas about the goals and purposes of the relationship if the contract does not provide a clear and unambiguous roadmap for the parties to follow in order to achieve their objectives. In order to prepare an effective contract, counsel must fully understand the key details of the transaction and have access to all of the important background relating to the negotiations, and prior relations, between the parties. In addition, counsel must have sufficient information and experience to make sure that the contract fulfills the following roles and purposes: The contract must cover all the essential elements necessary for formation, interpretation and performance of a legally binding agreement under applicable laws. In order to meet this requirement, counsel must fully understand the company s intent with regard to all material terms, such as goods covered by a sale of goods contract and the pricing and delivery terms. In cases where the contract is intended to govern a continuing relationship between the parties, it should include all necessary policies and procedures for managing the exchange of performances between the parties. Parties are often able to achieve this goal in a simple, shorthand fashion, such as by incorporating the latest version of INCOTERMS, which is the International Chamber of Commerce s widely accepted rules for the interpretation of trade terms, to identify delivery terms in an international contract. In other situations, however, the parties may rely on comprehensive operations manuals that are more extensive than the original contract and cover a variety of issues in detail. The contract should clearly state all of the rights of the parties necessary in order form them to achieve their underlying business objectives. This can be as simple as defining the right of the seller to receive payment within a specified period of time; however, counsel must carefully consider all relevant and reasonable rights when preparing the contract. While the parties obviously anticipate, and hope, that the exchange of performance between the parties will flow smoothly, counsel does a disservice by not anticipating potential problems and crafting remedies in the contract before it is signed. For example, a default in payment obligations will certain trigger collection rights in

7 favor of the party expecting payment; however, consideration should be given to charging interest and allocating collection costs to the defaulting party. Counsel should be able to provide reasonable assurances to the company that the contract will be enforced and interpreted in the manner described by counsel before the contract is signed. In order to provide effective counsel in this area, it may be necessary to engage experts to review particular provisions and provide an opinion regarding the enforceability of a particular right or remedy included in the contract. 4 Counsel should also understand and acknowledge that a contract may other purposes for a particular transaction. For example, in complex transactions a master contract, which incorporates a number of other contracts by reference, may serve primarily as a way to organize the transaction and identify the conditions that will need to be satisfied in order for all of the contracts to be executed and delivered. Other agreements, such as a letter of intent, may have limited legal effect; however, they can have great symbolic value to the parties as evidence of a willingness to devote further resources to negotiating and consummating a definitive agreement. A security agreement or guarantee is rarely the primary contract in a transaction and is most typically used to provide additional collateral to induce a lender to provide financing or a vendor to offer goods on credit. Finally, companies may require contracts, such as a non-competition agreement, that may not be enforced in their entirety by a court but which may deter the party subject to the covenant from engaging in certain acts thought to be harmful to the company. Counsel must recognize the modern reality that, in the eyes of the company, effectiveness is also measured by the cost of the representation and the amount of time that it takes to complete the contract and the related transaction. When in-house attorneys are involved the costs can be measured by the direct and indirect expenses relating to such attorney. When outside counsel is involved the principal cost is the legal fees incurred by the company; however, ancillary expenses such as travel must also be factored into the analysis. In many cases, counsel will not have the time, or the benefits of a sufficient budget, to negotiate and draft all of the provisions that should go into the contract in the absence of any constraints. If counsel believes that his or her representation is being compromised by the limitations imposed by the company, consideration should be given to memorializing any potential issues in a memorandum to the company. This creates a record of the risks assumed by the company in opting for a less detailed contract provision on an area that might ultimately pose a problem in the relationship between the parties. Outside counsel may direct such a memorandum to the general counsel and other appropriate senior managers. In-house attorneys should direct their memorandum to appropriate senior managers and ensure that the points in the memorandum are part of the record on any internal contract review process. Information in the memorandum should be memorialized in ways the preserve confidentiality and attorney-client privilege. 3 Law of contracts The law of contracts is a mix of private law, principally the terms of the agreement between the parties, common law and state statutory provisions. The main principles of the common law have been outlined in the Restatement Second of The Law of Contracts

8 ( Restatement (2d), Contracts ) developed and published by the American Law Institute. State statutory law sets out certain formal requirements for contracts, including the need for certain contracts to be put in writing, and also provides guidelines for construction of various provisions included in a contract by the parties. In addition, preparation of certain types of contracts requires consideration of specific laws and regulations that may, among other things, impose requirements that must be satisfied in order for counsel to be confident that the contract will be enforced. Examples include the following: 5 Contracts relating to certain commercial transactions, such as sales of goods, secured transactions and leases of goods, will typically be governed by the applicable article of the Uniform Commercial Code ( UCC ). Consumer transactions, notably consumer sales contracts, consumer warranties and consumer credit arrangements, will be subject to a plethora of federal and state laws and regulations which often dictate in some detail the form of the contract (including type size). Transfers and licenses of intellectual property rights, such as patents, trademarks and copyrights, may be subject to specific statutes and procedural requirements. Contracts relating to employment, including covenants not to compete and agreements pertaining to ownership and assignment of intellectual property rights by employees, must be reviewed against specific requirements included in state law and employment laws and federal statutes such as the Americans with Disabilities Act and the Employees Retirement Income Security Act. Contracts that are entered into online will be subject to the relatively new laws and regulations pertaining to electronic signatures and amendments to such contracts must conform to the guidelines that are being established in court decisions. Other domestic laws and regulations that may apply depending on the circumstances include federal and state securities laws, insurance laws, franchise laws and federal and state laws and regulations pertaining to procure (i.e., government contracting rules). As companies begin to engage in cross-border transactions they need to understand that such transactions not only trigger the applicability of various domestic laws, such as export controls, but also require consideration of the laws relating to contract formation and enforceability in the foreign party s home country. Almost all foreign jurisdictions acknowledge the rights of private parties to enter into contracts and create enforceable obligations against one another under local contract law. Depending on the dominant legal tradition within the jurisdiction, contract rules may be established by the common law and/or expressly stated in civil law codes. Each jurisdiction will have its own rules with respect to the issues covered in the Restatement (2d) of Contracts, especially with respect to steps that need to be taken to form a contract that is valid and enforceable. Certain types of contracts (e.g., technology transfer and joint venture agreements) may be subject to special laws and regulations and sometimes may require review and approval by governmental agencies depending upon the subject matter and the obligations to be performed by the local party. Efforts have been made to harmonize international law in certain areas, notably through the development and promotion of universal codes and

9 principles such as the UN Convention on Contracts for the International Sales of Goods and the UNIDROIT Principle of International Commercial Law. 6 The following sections are a brief summary of some of the essential principals of US contract law and are not intended to be a comprehensive guide to all of the exceptions that might apply in a given instance. Reference should always be made to the detailed treatises that are available on the law of contracts. 4 --Contract formation and enforceability Under the Restatement (2d) of Contracts, a contract is a "promise or set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty." 2 Generally, a promise is "a manifestation of intention to act or refrain from acting in a specified way, so made as to justify a promisee in understanding that a commitment has been made." 3 In order for a contract to exist there must be an agreement which is basically a manifestation of mutual assent Elements of a contract The key requirements for a valid contract are an offer, an acceptance, and lawful consideration. An offer "is a manifestation of willingness to enter into a bargain, so made as to justify another person in understanding that his or her assent to that bargain is invited and will conclude it." 5 In order to constitute a valid offer, a promise must contain sufficiently certain terms so as to allow the court to understand just what act the promisor will perform or forbear from performing. The offer must also state sufficiently just what act or promise is demanded in return if the offeree accepts. 6 An offer "may invite or require acceptance to be made by an affirmative answer in words or by performing or refraining from performing a specified act, or may empower the offeree to make a selection of terms in his acceptance... Unless otherwise indicated by the language or the circumstances, an offer invites acceptance in any manner and by any medium reasonable in the circumstances." 7 An offer creates in the offeree a power of acceptance and this power of acceptance continues until the offeree accepts or the offer is terminated. 8 If the offeror has not communicated a definite and specific time limit to the offeree relevant to acceptance, the general rule is that the power of acceptance continues for a reasonable time. An offeree may have the power of acceptance terminated by 2 Restatement (2d), Contracts, 1; Stentor Elec. Mfg. Co., Inc. v. Klaxon Co., 115 F2d 268, 271 (CA3 1941), rev d 313 US 487, 85 L Ed 1477, 61 S Ct 1020 (1941); Friedman v. Jackson, 266 Cal App 2d CalRptr129, 132 (1968). 3 Restatement (2d), Contracts, 2; United States v. Kemmel, 188 F Supp 736, 741 (MD Pa 1960), affd 295 F2d 712 (1961), cert den 368 US 988 (1962). 4 Restatement (2d), Contracts, 3. 5 Restatement (2d), Contracts, 24; Saske v. Barwick, 404 F2d 495, 499 (CA2 1968), cert den 394 US 921 (1969). 6 Williston on Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, 35.

10 rejection or counteroffer by the offeree, lapse of time, revocation by the offeror or death or incapacity of the offeror. 9 7 Consideration has traditionally been defined as a benefit received by the promisor or a detriment incurred by the promisee. Section 71 of the Restatement (2d), Contracts discusses the requirement of consideration as follows: " 71 Requirement of Exchange, Types of Exchange. (1) To constitute consideration, a performance or a return promise must be bargained for. (2) A performance or return promise is bargained for if it is sought by the promisor in exchange for his or her promise and is given by the promisee in exchange for that promise. (3) The performance may consist of an act other than a promise, or a forbearance, or the creation, modification or destruction of a legitimate legal relation. (4) The performance or return promise may be given to the promisor or to some other person. It may be given by the promisee or by some other person." There are some contracts and situations which are viewed as falling outside the general rule requiring consideration for valid formation. Some of these situations are as follows: (1) A promise to pay all or part of an antecedent contractual debt owed by the promisor where the debt is enforceable 10 ; (2) A promise to pay all or part of indebtedness discharged in bankruptcy 11 ; (3) In some situations a promise to perform a duty under an antecedent contract 12 ; (4) A promise to perform part of an antecedent, voidable contract 13 ; (5) Option contracts 14 ; (6) Modification of executory contracts 15 ; (7) Contracts under seal 16 ; and (8) Certain situations involving reliance Contract terms The terms of a contract can be expressed in language or implied from conduct. If a promise is binding, so too are the terms of the promise; it becomes binding within the "square corners" of the contract unless a rule of law prevents that. "A term of a promise or agreement is that portion of the intention or assent which relates to a particular 9 Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, 95.

11 matter." 17 A "term of a contract is that portion of the legal relations resulting from the promise or set of promises which relates to a particular matter, whether or not the parties manifest an intention to create those relations." 18 A term can also be supplied by law as a matter of public policy, or required by statute. Often, for example, a contract for the sale of land may require certain statutory terms which the state mandates. An insurance policy is also an example of a contract which may require specific terms as delineated by statute. Other than statutory terms, however, the choice of terms is up to the contracting parties, limited by public policy, conscionability and fairness Defenses Even if it appears that the necessary elements of mutual assent and consideration are present, various defenses to contract formation and enforceability may be available including duress 19 ; undue influence 20 ; mistake 21 ; fraud and misrepresentation 22 ; and illegality and violation of public policy 23. Other defenses include lack of capacity 24, indefiniteness of contract terms and failure to satisfy the requirements of the Statute of Frauds when applicable Breach of contract A breach of contract is the "non-performance of any contractual duty of immediate performance." 26 In evaluating a breach in light of the available remedies, a court will look at the extent and effect of the breach in relationship to the performance required to determine the appropriate remedy. 17 Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, Restatement (2d), Contracts, 12 provides that [n]o one can be bound by contract who has not legal capacity to incur at least voidable contractual duties. Capacity to contract may be partial and its existence in respect of a particular transaction may depend upon the nature of the transaction or upon other circumstances. The principal list of those with no capacity or limited capacity to contract includes infants, mentally ill, intoxicated persons and persons under guardianship. 25 The Statute of Frauds, while arising from the common law, is presently codified in forty-eight state statutes and the District of Columbia with Maryland and New Mexico enacting the Statute of Frauds by judicial decision. It provides that for certain contracts to be enforceable, they must be memorialized by a written agreement. This includes land contracts; contracts that cannot be performed within one year; suretyship contracts; contracts by executors and administrators on behalf of a decedent; contracts in consideration of marriage, and in certain states, contracts to make a will; and real estate broker contracts. See Restatement (2d), Contracts, 110. In addition, certain areas traditionally governed by the Statute of Frauds, such as the sale of goods in excess of $500, are now governed by the UCC Stanley v. Chris-Craft Corp., 21 NYS2d 898, 899 (1939). See also In re Spagnol Enterprises, Inc., 81 BR 337, 353 (WD Pa 1987) ("Breach of contract is the non-performance of a contractual duty or violation of such obligation."); Clevert v. Jeff W. Soden, Inc., 241 Va 108, 400 SE2d 181, 183 (1991) ("Breach of contract is the failure, without legal excuse, to perform any promise which forms the whole or part of a contract.").

12 9 ----Doctrine of substantial performance The duty to perform is not excused by the failure of the nonbreaching party to completely perform all of its obligations. Under the doctrine of substantial performance, the substantial performance by the obligor of its duties obviates the obligee's ability to terminate the contract; the obligee cannot avoid fulfilling its obligations as a result of the obligor's failure to complete all of its obligations. 27 The doctrine does not, however, apply to the sale of goods The doctrine does not excuse less than full performance, as the injured party is still entitled to recover damages for its injury based on breach of contract. 29 Damages would be based on the cost of bringing the delivered goods into full compliance with the contract price. 30 Substantial performance is typically treated as a minor breach. 31 A willful action, however, will be treated as a material breach to which the doctrine of substantial performance will not apply Nonperformance as minor breach A minor breach occurs if there is an immaterial effect upon the benefit the obligee is receiving under a contract. 33 The effect of a minor breach is that the injured party is not excused from its contractual obligations but is entitled to receive damages for the breaching party's immaterial breach. 34 Examples of a minor breach would include the substantial performance of a construction contract or a slight delay in the timeliness of the completion of a contract. A breach for nonperformance in conjunction with an anticipatory repudiation, however, constitutes a material breach, enabling the injured party to immediately terminate the contract and bring a claim for damages Nonperformance as material breach A material breach is one which "touches the fundamental purpose of the contract and defeats the object of the parties in making the contract." 36 With a material breach, the obligee may terminate the contract without penalty and has the immediate right to all existing remedies as a result of the obligor's breach. 37 Under Restatement (2d) 241, 27 Matador Drilling Co., Inc. v. Post, 662 F2d 1190, 1195 (CA5 1981); Watson Lumber Co. v. Mouser, 30 III App 3d 100,333 NE2d 19, 23 (1975); Alliance Tractor & Implement Co. v. Lukens Tool & Die Co., 194 Neb 473, 233 NW2d 299, 301 (1975); State v. Brand, 2 Ohio App 2d 460, 442 NE2d805 (1981); Cranetex, Inc. v. Precision Crane & Rigging of Houston, Inc., 760 SW2d 298, 302 (Tex App 1988). 28 See Calamari & Perillo, Contracts (3d ed 1987). 29 Cox v. Freemont County Public Bldg. Authority, 415 F2d 882 (CA ). 30 Mirisis v. Renda, 83 AD2d 572, 441 NYS2d 138 (1981). 31 Master Palletizer Systems, Inc. v. T.S. Ragsdale Co., Inc., 725 F Supp 1525, 1532 (D Colo 1989). 32 In re Carson's Estate, 349 Pa 529, 37 A2d 488, 491 (1944); Mort Co. v. Paul, 167 Pa Super 532, 76 A2d 445, 447 (1950). 33 Gulick v. A. Robert Strawn & Associates, Inc., 477 P2d 489, 492 (Colo 1970) P2d at 489, Restatement (2d), Contracts, 243, 250, Comment (a). 36 Rogers v. Relyea, 184 Mont 1, 601 P2d 37, 41 (1979). 37 Wolff & Munier, Inc. v. Whiting-Turner Contracting Co., 946 F2d 1003, 1009 (CA2 1991).

13 several criteria will be used to determine whether a breach is material: the extent of the benefit received by the injured party; the adequacy of available damages (i.e., if damages cannot adequately compensate the injured party, the breach will be viewed as material); the extent of part performance by the obligor (i.e., a failure will be less likely to be material if it occurs after substantial performance or preparation and more likely to be material if it occurs prior to reliance on behalf of the breaching party); the likelihood of curing performance (i.e., if the party in breach will be able to cure, its breach is less likely to be material); and the extent of good faith and fair dealing (i.e., if the breaching party has been acting in good faith, the breach is less likely to be material) Remedies Remedies for breach of contract can be divided into two general categories: monetary damages and equitable remedies. Monetary damages are those damages for which the aggrieved party is compensated monetarily (i.e., in the form of a cash payment). Monetary means are used because the injury is easy to quantify and because the monetary damages are considered to be a satisfactory means of compensation. Monetary damages are classified as either compensatory, including actual, consequential and incidental damages, or noncompensatory, including punitive, nominal and stipulative ( liquidated ) damages. The recovery of damages is limited by the requirement of foreseeability, which means that in order to recover for damages the damages must be foreseeable to the parties when entering into the contract. 38 Equitable remedies are awarded when monetary damages are inadequate and may be awarded in addition to other damages. 39 The principal equitable remedies are specific performance, injunctive relief and restitution. In general, specific performance and injunctive relief will not be imposed if damages are an adequate means to protect the expectation interest of the aggrieved party. 40 Each party must seek to mitigate its damages without undue risk, burden or humiliation, and damages are not recoverable by a party that makes no attempt to mitigate its damages Contract interpretation In interpreting the construction of a contract, the courts will apply a number of rules: (1) The courts will look at the four corners of the document and construe the document as a whole. 42 Specific or individual clauses contained in the agreement will be subordinated to the overall intent of the parties in entering into the agreement, as determined by a reading of the contract as a whole Restatement (2d), Contracts, 351(1). 39 Restatement (2d), of Contracts, 358 (3), Restatement (2d), Contracts, 359(1). 41 Restatement (2d), Contracts, 350(1). 42 Restatement (2d), Contracts, 202(2). 43 Restatement (2d), Contracts, 230, 233.

14 (2) Unless a different intention is manifested by the parties, the courts will apply the ordinary meaning of the words "contained therein." 44 Technical terms and words of art will be given the meaning when used in a transaction within their technical field. 45 If the parties attach different meanings to a word, the court will interpret the meaning attached by one of them. If that party did not know or have reason to know of the meaning attached by the other party, and the other party knew or had reason to know the first party attached a different meaning, the court will enforce the meaning attached by the party without knowledge (3) If inconsistent provisions are contained within the document, the courts will look to the nature of such provisions. Courts will seek an interpretation that gives a lawful, reasonable and effective meaning to all terms rather than one that makes part of the agreement unlawful, unreasonable, or of no affect. 47 (4) Specific terms and exact language will be given preference over general language. 48 Express terms will be given greater weight than course of performance, course of dealing, and usage in trade; course of performance will be given greater preference than usage in trade and course of dealing will be given greater weight than usage of trade. 49 Typed or written provisions will prevail over preprinted or boilerplate language attached to such documents, especially if such provisions appear on the back of a preprinted form. 50 (5) The courts will look to general customs in the usage for particular businesses for the particular account where the contract is made or to be performed unless the context or a usage which is applicable indicates a different meaning. 51 (6) Any inconsistency in an agreement that cannot be resolved will be interpreted against the draftsman of the contract 52 or the person who supplies the words and the meaning that serves the public interest 53. The use of intrinsic evidence in contract interpretation is regulated by the Parole Evidence Rule, which provides that where the parties to an agreement have produced a writing which reflects the agreement of the parties, no evidence, oral or otherwise, may be admitted to vary, contradict or add to the obligations of the parties set forth in such writings. 54 This rule arose to prevent potential fraud by the inclusion of additional claims or counterclaims. To invoke the rule, however, there must be a final writing between the 44 Restatement (2d), Contracts, 202(3)(a). 45 Restatement (2d), Contracts, 202(3)(b). 46 Restatement (2d), Contracts, 201(2). 47 Restatement (2d), Contracts, 203(a). 48 Restatement (2d), Contracts, 203(c). 49 Restatement (2d), Contracts, 203(b). 50 Restatement (2d), Contracts, 203(d). 51 Restatement (2d), Contracts, 230, Restatement (2d), Contracts, 206, Restatement (2d), Contracts, Restatement (2d), Contracts, 213.

15 parties which sets forth their intent. 55 The Parole Evidence Rule does not prevent a party from using additional intrinsic evidence to show that a writing is or is not integrated, or if integrated, that it is a partial or full integration. 56 In addition, intrinsic evidence can be used to determine the meaning of a writing when the intent of the parties is unclear and the court is attempting to interpret the contract Laws and rules applicable to specific contracts While it is important to understand general principles of contract law, many commercial agreements will be governed by topic specific laws, regulations and cases. Perhaps the most common example of this is contracts for the sale and purchase of goods. Parties to a domestic sale of goods contract in the United States will be governed by the provisions of Article 2 of the Uniform Commercial Code ( UCC ), which is a model act that has been adopted, with certain variations, in all of the states except Louisiana. 58 Article 2 of the UCC deals with all of the fundamental issues which arise in a sale of goods 59 transaction including the following: Formation of the sales agreement; The time or event when the risk of loss or destruction of the goods passes from the seller to buyer; The general obligations of the seller under the contract of sale, including the seller's obligations to tender the goods in the manner provided in the contract and to provide goods which conform to specifications set out in the contract. 55 McCormick, Evidence Restatement (2d), Contracts, 214(a), (b). 57 Restatement (2d), Contracts, 214(c). 58 Parties relying on UCC Article 2 should be mindful that some states have modified the model provisions relating to certain subjects, particularly limitations on remedies, and that reference should always be made to the applicable state version of Article 2 covering the specific contract. Also, while this publication assumes that the sale of goods transaction occurs between merchants, a large number of states have adopted legislation relating to sales transactions involving consumer products. Not surprisingly, the states have shown the greatest interest in disclaimers of warranties provided to consumers and in limitations of remedies in sales of consumer goods. See generally Clark and Smith, The Law of Product Warranties 8.05[2]; Clark & Davis, Beefing Up Product Warranties: A New Dimension in Consumer Protection, 23 U. Kan. L. Rev. 567 (1975); Clifford, Non-UCC Statutory Provisions Affecting Warranty Disclaimers and Remedies in Sales of Goods, 71 N.C. L. Rev (1993). Most states have achieved this result by amending their versions of UCC and/or 2-719; however, other states, including California (Cal. Civ. Code 1790 et seq. (Song-Beverly Consumer Warranty Act)), Kansas (Kan. Stat. Ann et seq. (Kansas Consumer Protection Act)) and West Virginia (W. Va. Code 46A et seq. (West Virginia Consumer Credit and Protection Act)) have special warranty protection legislation outside the commercial code that offers consumers broad protection in sales transactions, and specifically curtails the ability of a product seller to disclaim implied warranties. 59 A sale occurs whenever title to goods passes from the seller to the buyer for a price. See UCC 2-106(1). Goods are defined as "all things" movable at the time the contract is formed and is broad enough to include transactions involving all tangible objects and chattels, including raw materials, work-in-process, building materials, standard as well as specially manufactured goods, farm products, inventory items, consumer goods and equipment. See UCC 2-105(1).

16 The warranty obligations of the seller, including the warranties of title, noninfringement, merchantability and fitness for a particular use, and the disclaimer of warranties under the UCC. The general obligations of the buyer under the contract of sale, including the obligations to tender payment when it becomes due and to accept goods which conform to the specifications in the contract and which are tendered in the manner agreed upon by the parties. The remedies for breach of the contract of sale for the seller and the buyer. 13 Sales contracts with foreign parties may also be governed by the rules of UCC Article 2 when the foreign party consents and this is increasingly likely as the foreigners become more familiar with the way the rules operate. Another alternative that might be selected is the United Nations Convention for the International Sale of Goods ( CISG ), to which the US is a party, and some cross-border sales contracts incorporate provisions from the UNIDROIT Principles of International Commercial Contracts. 15 Collecting information for contract negotiations Whenever possible, counsel and the manager or other authorized person within the company who is responsible for the particular contract should meet in advance of contract negotiations in order to discuss the background for the contract and the relationship between the prospective parties to the contract. The meeting serves not only as a valuable source of information for counsel in preparing the contract, it also provides a good opportunity for counsel and the company representative to brainstorm about negotiating strategies and the strategic impact of the contract and business relationship on the company s activities. Among the questions and issues that should be considered at this point are the following: Does the company have any past or current relationship with the other party? Obviously, past or current contracts can be important indicators of how negotiations will play out with respect to any new contractual arrangement. Also, if the other party is already a significant business partner of the company, this may impact the approach that is taken with regard to accommodating certain requests or pressing various issues. What role does the company see for the other party in the company s future business strategies? If the other party is not considered to be a major business partner, counsel and the company may be willing to take a tougher approach on certain issues, particularly if alternatives exist for the particular type of business arrangement. Is the subject matter of the contract material to the company s business? For example, if the contract pertains to a procurement arrangement from a key supplier for goods or services that are material to the company s business, negotiations will focus on performance requirements and the sanctions that may be imposed in the event of a default by the other party. On the other hand, if the contract is routine and the company will not be materially impacted by a default by the other party, counsel and the company may decide not to press on certain issues.

17 What is the proposed term of the contractual arrangement? A contract may cover a one time exchange of actions, such as an isolated sale and purchase of goods, or it may be designed to govern the relationship of the parties over an extended period of time and multiple episodes of mutual performance (e.g., a long-term distribution agreement). Long term contracts require more consideration of events that may impact the ability or willingness of both parties to perform at the originally agreed levels as time goes by. In many cases, difficult legal and business risks may be mitigated to some extent if the company has the ability to terminate the contract without the penalty on relatively short notice. How aggressive can the company be in negotiating the terms of the contract? Counsel should determine what the company believes it has sufficient leverage to engage in hard bargaining on the terms of the contract. This requires inquiry into the bargaining power of the other party and whether or not the company has viable alternatives in the event that negotiations break off. Aggressive bargaining may also be necessary when the subject matter of the contract is material to the company since it cannot afford problems once the contract is in place and the parties are expected to perform in a timely manner without delays caused by the failure to resolve all issues in the negotiation period. How important is the contract to the other party? This is the inverse of the similar inquiry above regarding materiality to the company. If the arrangement is important to the other party, it can be expected that the other party will either drive a hard bargain on certain issues or be willing to concede various points to the company in order to get the deal done quickly. 14 While each of these questions should be asked and evaluated separately, there obviously will be important overlaps that must be considered. For example, while the company may feel that it has significant leverage over the other party at the current time, it may be imprudent to take too much advantage if there is a possibility of expanding the business relationship in the future. Also, consideration should always be given to the availability of alternatives for both parties when developing a negotiating strategy. If counsel pushes too hard in negotiations and the other party decides to seek a different contracting partner, the company will have expended time and resources that led to nothing, a situation that may lead to finger pointing and an unnecessary deterioration in the attorney-client relationship. As counsel begins discussions regarding the scope of the assignment, he or she should be given the opportunity to review all of the documents and communications that the company has relating to the transaction, including letters and communications, internal memoranda and reports, charts, term sheets and any personal notes that might be useful in gaining a better understanding about the business background for the transaction. If the businesspeople have collected information typically requested at the due diligence stage, such as the other party s financial statements, copies of that information should also be perused by counsel. This type of review will give counsel a good idea about the ground that has already been covered and the tone of communications between the parties. Counsel should also be able to gain a better understanding of the company s business objectives. In addition, the review allows

18 counsel to identify gaps in information about the proposed relationship and the legal and business condition of the other party that should be addressed generally through additional due diligence before the contract is finalized Impact of proposed contract on existing obligations and relationships In most cases, it is important to consider how a proposed transaction may impact certain existing obligations and business relationships of the company. Obviously, reference should be made to other contracts between the company and the opposite party in the transaction. In addition, however, it is important to contracts between the company and other parties in order to determine whether the new contract under consideration will conflict with the terms of any other agreements. For example, the company may have a distribution or license agreement with another party that restricts the ability of the company to appoint additional distributors or licensees for a particular market without the consent of the original party. In that situation, which is very common, counsel will need to assist the company by determining whether the proposed contract would, in fact, conflict with the prior agreement or whether it might be possible to structure the new contract to avoid the existing restrictions. In any event, once the general business terms of the proposed transaction are settled, or the main issues have at least been identified, counsel should collect copies of any existing contracts to which the company is a party that might be impacted by the subject matter of the new transaction. The main purpose of this review is to identify any potential violations of covenants already made by the company in other contracts and any approvals or consents of third parties that might be necessary in order for the new contract to be signed. In addition to the possibility that the new contract may conflict with existing distribution or license rights, counsel should focus on the impact that the transaction might have on affirmative and negative covenants included in financing agreements with investors and commercial lenders. Counsel should also review any internal policies and procedures of the company with respect to signature authority for a particular contract (see discussion of such policies and procedures below) to determine whether who has the authority to enter into the contract on behalf of the company. For example, the company s policies and procedures may preclude a manager from executing a contract that creates a financial commitment for the company in excess of a specified amount without the consent of the chief executive officer or even the board of directors of the company. The review of existing contracts also has other benefits to counsel in the documentation process. For example, contracts that have been negotiated with the opposite party can be used to gain a greater understanding of the pattern of dealing with the other party and the way in which the parties have addressed certain issues in the past. Obviously there is a risk that the company may be locked into accepting various positions because of the precedents in existing contracts, if for no other reason than the company does not want to expend time and resources on issues that have already been settled at the same time that discussions are going on with respect to new areas. On the other hand, if rules and