Dodging Contractual Battlegrounds: Vital, But Often Overlooked, Provisions in Commercial Contracts
When parties enter into a domestic commercial contract, their focus is typically on memorializing their agreement and getting the deal done; unfortunately, rushing to meet an end goal doesn’t mean a party truly met the end goal. As a result, they may not think critically enough about what will happen if the relationship goes south and how the contract provisions that they chose to include—or did not choose to include or accepted without negotiation—will affect how and where they resolve a dispute and shape the remedies to which they may be entitled.
Contractual provisions that parties choose to include in their agreement depend on a number of factors including, among others, the identity of and relationship between the parties, costs affiliated with consummating the transaction, and the size and nature of the transaction. This article identifies only four types of provisions commonly included in commercial contracts that can have significant ramifications for contracting parties if a dispute between them arises.
Alternative Dispute Resolution Provisions
Many commercial contracts include provisions that chart the path that parties must follow to resolve disputes arising from or relating to their agreement and can include various dispute resolution mechanisms. Agreements may include mandatory arbitration clauses or clauses requiring negotiation and/or nonbinding mediation as a prerequisite to arbitration.
Nevertheless, when carefully drafted, these provisions can simplify and allow the parties to efficiently, swiftly, and cost-effectively resolve their disputes, and do so without stepping into court. Parties often choose dispute resolution mechanisms to avoid the costly draining of resources litigation can have on a business. Dispute resolution alleviates those costs; however, it is important to note that you can be stuck with the decision made in a dispute resolution mechanism depending upon which one the parties selected. The unintended consequences of a selection are often what hurts parties because they did not draft a dispute resolution clause properly.
When less than carefully drafted (or not negotiated by the parties), however, these provisions can create a countless ancillary procedural distractions relating to their enforceability, scope, and applicability that the parties will be forced to resolve even before they get to the merits of that dispute. Ineffectively drafted or incomplete provisions also can take important decisions out of the control of the parties and leave them in the hands of third parties or default rules in the law, which may not be favorable to either party. A good example is simple arbitration clauses businesses have put in a contract just to satisfy the requirement, and that simply provides that all disputes between the parties will be resolved “by the American Arbitration Association (“AAA”) in accordance with its Commercial Arbitration Rules.” While such a provision commits the parties to arbitrate disputes, the provision does not address, among other issues, the number of arbitrators, how those arbitrators are selected, confidentiality, the ability of the parties to communicate with the arbitrator(s) ex parte, the location of the arbitration proceeding, or the substantive law that will govern. Rather, these decisions are left to the AAA’s default or gap-filler rules that may be contrary to what the parties desired.
Choice of Forum and Law Provisions and Jury Trial Waivers
If dispute resolution mechanisms are not selected or applicable, for the parties that agree to litigate their disputes in court, they may include provisions that identify the court in which a lawsuit must be filed, the substantive law that will apply, and whether their dispute should be decided by a judge or a jury. For example, consider a contract that includes a jury trial waiver, a clause requiring the parties to file in the United States District Court for the requisite District of Florida, and a Florida choice of law provision. These terms may, at first glance, appear to give the parties security and a measure of certainty as to how (and where) future disputes will be resolved.
What parties may not realize—and likely will not realize until a dispute between them arises—is that their pre-dispute jury trial waiver may be unenforceable depending on the applicable law and/or the court in which they agreed to file (and do file) their claims. Forum selection clauses and choice of law provisions also may be enforced differently depending on the subject matter of the contract. It is important to check with an attorney as to whether or not your agreement can be affected by state law, where, for instance, forum selection and choice of law clauses in construction contracts selecting another locale or state’s law are void where the work is to be performed in that state.
Damages Clauses
In a situation where the other party to your contract breaches it, your company may have to spend money to obtain goods or services to replace the ones it was to receive under the contract. It may lose profits and business opportunities and suffer other damages as well. You may also need to engage outside counsel to represent the company in a lawsuit or arbitration based on the breach. But how much of those damages and other costs incurred as a result of the breach are recoverable? What can you actually get compensated for a result of losses you incurred? In general, losses for breach of contract are limited to those damages that follow naturally from the breach or that were reasonably foreseeable to the breaching party at the time the contract was made. In certain circumstances, the types of damages that meet this description are not entirely clear and can lead to litigation. Thus, parties should consider provisions that identify the type of damages that a party may or may not recover if a dispute arises under the contract, including: limitation of liability and indemnification provisions; consequential damages waivers;liquidated damages provisions; andfee-shifting provisions. However, even when such provisions are included in a contract, disputes relating to damages can—and do—arise, frequently relating to the scope of those provisions and their applicability to a specific situation.
More specifically, Indemnification provisions are prime examples. Under the laws of most states, indemnification obligations are strictly construed and courts will not extend them to include damages or duties that the parties did not intend to assume. If the court finds that the indemnification provision is clear, it will enforce that provision as written. If, however, the court determines that the contract’s language is ambiguous, the court will look to extrinsic evidence (such as prior drafts of the contract and communications between the parties during negotiations) to interpret the contract and determine the scope of the indemnification provision. Thus, it is important for a party to understand the standards under state law that will govern the enforceability of these provisions and use those standards in drafting the provisions.
Insurance Provisions
One significant way to shift risk between contracting parties is through contractual insurance provisions. Often, purchasers of goods or services will require the party with whom they are contracting to obtain certain types and limits of liability insurance. Many purchasing parties also require the selling party to name them as an additional insured under those policies, presumably with the goal of affording them coverage for claims or lawsuits that may be filed against them. However, all additional insured coverage is not created equal. Additional insured status is often conferred through an endorsement to the policy. Some policies are blanket in scope where “Additional Insured” endorsements apply broadly to any person or organization the named insured has agreed to include as an additional insured under a written contract. Others are narrower in scope, and limit an entity’s status as an additional insured under the policy to only those liabilities arising out of the operations, acts or omissions of the named insured (i.e., the selling party) in the performance of its operations for the additional insured. Unfortunately, more often than not, questions about whether the proper insurance was procured and about the scope of the coverage afforded are not asked until after a loss has occurred It is important to request a copy of the insurance policies ahead of time to make sure your coverage under the contract provides the protection desired.
When it comes to drafting commercial contracts, risk prevention is worth every penny when it may prevent a seemingly innocuous or boilerplate provision from creating delays, costs, or other hurdles that could have been avoided through careful drafting. Understanding and identifying the provisions that can, and frequently do, lead to disputes and affect resolution of those disputes is invaluable. Understanding that there are not short cuts to good drafting is the first step for any business to realize success; otherwise, effortless and vague contract clauses will not put any party in a good position fight the battlegrounds from a lawsuit, or, if it does, minimize the impact (both financially and otherwise) on its business and operations.