Copyright 2013, Andrew C. Spacone. All rights reserved.

Common Mistakes Attorneys [and Their Clients]Make Drafting and Negotiating Contracts –

Lessons Learned

Andrew C. SpaconeAdler Pollock & Sheehan P.C.Formerly Deputy General Counsel & Assistant Secretary,Textron Inc.

June 2013

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Introduction• My Background

• My Perspective

• Why I am Doing This

• Audience:

In-house Counsel

Each faces its own challenges

Outside Counsel

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Objectives

•Provide practical common sense lessons learned for drafting and negotiating good contracts which can save your clients time and money

Although critical, we won’t be discussing at any length the mechanics or technical aspects of contract drafting

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Ground Rules

• Your perspective or even differences of opinion are welcome

• Ask questions anytime you like but try to be brief and stick to the subject

• Let’s have a little fun

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What type of contracts are we talking about?•Commercial [non-finance] contracts of all

shapes and sizes-materials, products, personal services, software, IT outsourcing agreements

•This doesn’t mean the practical suggestions we discuss today are not applicable to any contract or agreement, however

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What is a Good Contract?[Premise: Most contract disputes are not legal in nature-

think about it] • A good contract is one where each party gets what it

bargained for without any material disruptions during or disputes post performance

This means more than a legally enforceable document which sets forth the intentions of the parties-there is a difference between the two “definitions”

Enforceable implies equitable and legal remedies, which are fine as far as it goes

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What is a Good Contract? (Cont'd)

Without disruption implies no need for enforcement [contracts should be more than enforcement tools]

 • Why is this important to your business clients?

Precisely because they are business people, which means they need to run their business, not spend more time with lawyers and the legal system than absolutely necessary

The cost accounting equation explained

Cost of non-performance =disruption to the business through delay, defect or non-delivery of the product or service + cost and uncertainty associated with litigation

This is the true cost of a bad contract

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What is a Good Contract? (Cont'd) •The former (disruption) often results in

costs which can dwarf the latter [e.g. lost profits, customers, damage to the brand]

Not to mention the fact that litigation rarely makes your client whole

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The Business Person/Lawyer Paradigm and How This Can Affect Contracts and Their Negotiation

• Business people: risk takers who look for practical and quick solutions with an overriding desire to obtain profits to sustain and grow their business [plus, while they may value lawyers, generally they view you as a necessary evil]

• Lawyers: risk adverse, prone to legalese to justify their existence [only half kidding], often not very knowledgeable concerning their client’s business let alone business in general [even in-house lawyers can suffer from this to a certain extent] and live by the billable hour

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The Business Person/Lawyer Paradigm and How This Can Affect Contracts and Their Negotiation (Cont'd)

•This gap needs to be closed in the contract process and it isn’t easy

But it can be done: both parties need to contribute to obtaining good contracts

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Major Themes Which Have Emerged and Will Be Developed

• Over-arching theme:Contracts should be drafted to avoid disputes, not just provide mechanisms for enforcement [although inter rorem provisions can deter disputes]

• A good contract involves the education of both parties

• Know the subject of the contract/and your client’s business

• Due diligence of the other side’s ability to perform can lead to reduced risks

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Major Themes Which Have Emerged and Will Be Developed (Cont'd)

• Early risk assessment can reduce the risk of non-performance

• Clear and concise terms and conditions, performance specifications, etc., will solve a lot of problems

• One sided terms and negotiations can create performance problems, not to mention make dispute resolution difficult

• Forgetting about the contract once it is executed it is generally a bad idea

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APPLICATION OF LESSONS LEARNED

Simple, mundane contract

The complex, multifaceted contact

Not every contract is the sameNot every lesson learned applies

Apply 0 Lessons Learned Apply 100% Lessons Learned?

*outsourced product contracts

domestic foreign

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Hypotheticals [Contract Administrator; paying attention to internal

compliance]

1. Company A enters into a software license with Adobe. The license agreement requires that each user-the term is not defined-is required to have a license for which there is a modest fee. A penalty is attached to unlicensed use. The contract is let by the IT department and the company’s business units are advised that Adobe is now available across the company. The license agreement itself is maintained at Corporate and the business unit IT personnel are provided with basic information. No one at Corporate or the business units is assigned to administer the agreement per se. It is one of several the company has and every one regards it as “pretty standard.”

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Hypotheticals (Cont'd) Over a three year period the following happens: the company installs the software on group workplace computers that have multiple access, that is, several employees can access the computer and hence the software. Also, the company does not keep good records concerning who installed the software on their individual computers, even though the internal policy requires that installation be approved by the IT department and avows adherence to license requirements. Thus, the company loses track of which employs actually are licensed to use the software, which means that Adobe is not paid the actual amount it is owed in license fees. The company has thousands of employees who use Adobe. In year four, Adobe exercises its rights under the license agreement to do a compliance audit.

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Hypotheticals (Cont'd)

2. Company A decides to switch forgers for its cast iron crankshafts which are used in its piston engine aircraft. They have done business with the former forger for thirty years and never had a problem with the crankshafts. The new forger-who they haven’t done any business with and has only been in business for a few years-is willing to do just in time delivery as opposed to sell off an inventory of crankshafts, which means less overall cost for Company A. It is critical that crankshafts be properly heated/treated to a very specific temperature so they don’t fail in operation for obvious reasons. Company A gives the new supplier the specifications for forging and waits for delivery.

[Due Diligence of new business partners; building in mechanisms to avoid non-performance]

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Hypotheticals (Cont'd)

The contract does not provide for quality control certification by the company prior to acceptance and installation nor is there a provision for on-site quality control by a Company representative. The crankshafts come in ‘certified’ by the supplier’s quality control department and the company pays (acceptance) and then installs the crankshafts in its engines for piston aircraft. In due course, crankshafts begin to fail from over-heating; planes crash and over 10,000 crankshafts are recalled world-wide, all at great expense to Company A. As it turns out, the forger has limited insurance and assets.

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Hypotheticals (Cont'd)

3. A young Associate is asked to draft a ‘simple settlement agreement and release’ by a senior partner who provides about twenty minutes of explanation and provides a few documents discussing the underlying business transaction which involves a complex series of companies and several foreign transactions involving the client and certain third parties. The Associate is given the client’s telephone number and told to call him if he has any questions. The Associate begins outlining the document then decides it is time to call the client because he doesn’t fully understand the issues let alone the facts, not to mention the parties. This leads to a series of short conversations with the client each of which result in new facts, which results in a revised settlement agreement and release and comments by the client. Some fifteen hours and ten drafts later, the Associate manages to get the client’s approval on a final draft of the document. The Associate never learns whether all his time was billed to the client let alone whether or not the client paid for whatever time was billed.

[Knowing the subject matter of the contract]

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Hypotheticals (Cont'd)

4. Company A [again; when will they learn?] enters into a tailored software contract with a developer which contains a myriad of performance specifications and time tables for delivery which are not clearly understood by the business person let alone the lawyer who is drafting the contract. In other words, the Statement of Work [SOW] lacks precision and clarity on the deliverables. The business person says this is a fairly simple matter and doesn’t spend a lot of time with the lawyer on the background and gives her a SOW and says go with it. The vendor isn’t much better and basically adopts the SOW with little modification. Time goes on and the business person is unhappy with the project and says to the lawyer: “ The other side has breached the contract; what are my options”?

*Based on my direct personal experience

[Lack of clear and precise performance specifications and standards]

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Lesson #1Know your client’s business but most importantly, understand the subject matter before you begin drafting let alone negotiating

Do you and your client understand the subject matter

[see hypo 3]Need a specialist?Are you experienced enough?Are you talking to the right person?

Have a game plan beforehand – major objectives and give points on anticipated issuesYou wouldn’t fight a military battle without an operations order

(OPORD) so why would you start the contract process without a game plan?

Preparation is critical

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Lesson #1(Cont’d)

Who is going to negotiate the contract?

when a lawyer negotiates a contract privilege is imperiled

is a senior representative from the client with authority necessary?

What are your client’s imperatives; What can he give on?

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Lesson #2Due diligence of the other side concerning their ability to perform (business background/history = “track record”) and otherwise stand behind the contract is imperative for “unfamiliar” partners or those new to the industry [Hypo 2]

Especially critical for outsourcing contracts here and overseasAnd don’t forget third-party vendors hired by your supplier

Well, I am just the lawyer so shouldn’t I rely on my client to do this?

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Lesson #2 (Cont'd)Maybe, but remember, you are more than just a lawyer, you are a counselor

What to look for in the other side experience and expertise – “track record” financial capability quality workforce suppliers, other third-party vendors litigation history insurance coverage lots of stuff

Just knowing the risks presented by the other side will allow you to draft contracts that anticipate the risks and provide incentives to performance and protection [e.g., termination, escrow accounts, milestones, automatic attachment/retrieval of owned equipment]

Knowing the other side’s level of sophistication will better allow you to anticipate how much time you need to spend educating the other side concerning the performance standards, etc.

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Lesson #3

Early risk identification and drafting to minimize or eliminate [enough said above] [hypo 4]

but there may be potential legal issues which are unresolved that are likely to come up

And you may be able to draft to them

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Lesson #4

Drafting clear, concise and ‘simple’ contracts with emphasis on precise and easily understood performance requirements and specifications

Use the contract itself to further educate both sides of what is expected of them

Clarity and brevity will make life easier for both parties

Spend as much time educating as you do drafting

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Lesson #4 (Cont'd)

Plain “English” is preferred as opposed to legalese for the sake of legalese [besides, if the judge and jury can’t understand it, this is generally not a good thing for at least one of the parties]

The simpler the better-and don’t say that it can’t be done because it can if you understand the subject matter

cross referring to a myriad exhibits and attachments; combining multiple contracts into one, just make life so much more difficult

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Lesson #4 (Cont'd)Clear and concise performance standards and specifications are really important

Performance

e.g. software hosting service agreements (e.g. uptime guarantee and recourse for failure to achieve)

Enforcement

Drive out ambiguity (unless there is a very good reason not to)

The “foreign factor” briefly discussed

Risk factors go up considerably with outsourced production (event service) agreements

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Lesson #4 (Cont'd)

In sum, can a layman [okay, an educated layman] pick up the contract and figure out what each side needs to do? If so, you have a good contract.

And remember, if all goes to hell in a hand basket, a judge or jury or both will be looking at the contract

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Lesson #5The importance of internal compliance mechanisms and early dispute identification and resolution-The Contract Administrator as Gatekeeper [hypo 1 and 4]

All too common mistake: filing the contract away and forgetting about it until severe problems arise [and then it is often too late because the problems are too big to solve or the parties hate each other or both]

this is a particular problem for outsourcing contracts, especially in China and the Far East

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Lesson #5 (Cont'd) Monitoring performance

ensure managers/employees responsible for fulfilling the contract have a copy of it and thoroughly understand it

pay attention to the performance phase

build into contract on site representative at vendor’s facility to monitor quality control, compliance with specs, etc.

The Contract Administrator-The Gatekeeper [mini-cooling off period”] [Hypo 4]

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Lesson #5 (Cont'd)both sides

monitor performance

identify and solve little problems before they become big problems

‘control’ course of conduct, admissions, etc.

make sure a clear line of communication to management before the situation gets out of control

when the lawyer –in-house or outside – needs to get involved

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Lesson #6One sided contracts and negotiations may be great now but can lead to problems later

Good contracts are win-win propositions [or at least should be but you can’t ignore the human condition entirely]

Makes performance too difficult

Create distrust or a least “revenge”

Other ramifications

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Lesson #7If all else fails, there should be mutually-agreed-upon and realistic dispute resolution mechanisms

If handled openly and in good faith, a conversation worth having

Lesson #7A-don’t wait until the end to negotiate dispute resolution provisions

sloppy dispute resolution provisions create obvious problems

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Options

•Cooling off period works more in theory than in practice, but worth a try

•Litigation

•Alternate Dispute Resolution

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ConclusionA good contract is one where both parties get what they bargained for without major disruptions or disputes

Contracts can [and should] be vehicles for dispute avoidance

You as lawyers can play a significant role in drafting and negotiating good contracts if you keep these practical suggestions in mind

Hopefully, all or some of these practical suggestions will save you and your client time and money [the cost accounting equation]

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Questions