Common Pitfalls of Contracts

Buffington Law Firm offers a program for clients known as the "Corporate Counselor Program." For a modest monthly fee, clients can call our Firm, speak to a knowledgeable attorney, and receive advice concerning legal issues without being charged by the hour. The old adage that "an ounce of prevention is worth a pound of cure" is nowhere truer than within the context of legal matters. In business there is no easier way to make a costly mistake than to sign a contract that is subtly slanted to favor one side.

A poorly drafted contract, or a contract drafted by the other side, can work to the enormous detriment of the unwary. There are many pitfalls that contracts often contain that are easy to avoid. About half of the time spent on the Corporate Counselor Program involves reviewing contracts for our clients to avoid these pitfalls. One client has reported that their Liability Insurance rates are lower because they receive a credit for having their counsel review contracts before signing.

Many lawsuits are the result of contract agreements that simply went bad. This is sometimes unavoidable. Sometimes one side or the other becomes unwilling or unable to perform under the contract, and the other side, unable to negotiate a settlement, must sue to preserve its rights. That is how our system is supposed to work and sometimes things even do work that way. Never forget that perhaps the primary goal of a contract is to enable either side to go into court to enforce his or her rights under that contract. Contracts should always be drafted to provide a sound basis for a lawsuit in the event that the agreement goes sour. When contracts are drafted this way a lawsuit is actually less likely because each party understands that the other side has both rights and obligations under the contract that a court of law will respect and enforce. Generally, of course, when parties enter into a contract, a lawsuit is the furthest thing from their minds. It should not be.

Very commonly when a party decides that it is necessary to sue for breach of contract ("suing on the contract") that party discovers ugly things about the contract that make the lawsuit much more difficult, or even impracticable. In this brief article I will discuss a few of the countless "litigation traps" that can derive from either drafting errors, or from one side or the other deliberately slipping in seemingly innocent contract provisions that unfairly bias the contract against the other party. All of these problems are things that I have dealt with repeatedly in breach of contract lawsuits.

1. Arbitration Clauses.

It is very common these days for contract drafting attorneys to slip in an Arbitration Clause. Many contract attorneys (many of whom are transactional attorneys who do not deal with lawsuits) insert these clauses into their contracts almost as a matter of routine. Clients see these clauses and almost always assume that they are "legalese" of no great importance. Many form contracts contain Arbitration Clauses and people innocently agree to them without any understanding as to the very significant implications of an Arbitration Clause. Arbitration basically means that instead of litigating one's case in a court of law, the parties agree to litigate before an arbitrator who works for a private arbitration company.

In reality, an Arbitration Clause is one of the most far-reaching options that a contract can contain. When a party agrees to arbitrate, that party is giving up all rights to a jury trial. Arbitration generally means that there is no right to appeal. Not even if the Arbitrator chooses not to follow the law. Arbitrators typically (no, invariably) charge tens of thousands of dollars for their services whereas a Judge in Superior Court is paid for by the taxpayers. While there are advantages to arbitration, the disadvantages are significant. Any decision to litigate via arbitration rather than ordinary court should be one that a party makes carefully, in consultation with his or her attorney. But in practice, unthinking contract draftsmen often insert Arbitration Clauses in contracts without much thought.

Arbitration clauses can make the decision to litigate far more expensive due to the cost of paying the arbitrator. Typically the arbitrator, who is a retired judge or a lawyer, will charge as much or more than either of the attorneys in the case will charge. Thus, an Arbitration Clause, instead of keeping legal costs down, can add very significantly to the cost of litigation. This is rarely a good thing from the perspective of the persons writing the check. The pros and cons of arbitration are complex, and well beyond the scope of this article. The decision to arbitrate is a crucial one. It is not always a good idea. Never agree to an arbitration clause without consulting your attorney. The rights to appeal and to a jury trial are fundamental civil rights. Arbitration eliminates these rights. No one should give these rights up without knowing what they are doing and why.

2. AAA Arbitration Clauses.

One of the most irksome things about Arbitration Clauses is that contract draftsmen often specify that arbitration will occur "before, and under the rules of, the American Arbitration Association ("AAA")." This sounds official enough. Clients usually assume that an agreement to AAA Arbitration is the decision of a thoughtful contract draftsman, wise in the ways of the law and knowledgeable about contracts. In reality specifying "AAA Arbitration" often makes an already-bad Arbitration Clause even worse. Which arbitration company to appear before is almost as important as the decision to arbitrate at all. In California, in my opinion, AAA is one of the very least desirable arbitration forums. Many contract draftsmen specify AAA Arbitration simply because it has an authoritative sounding name and is the only arbitration firm that non-litigation attorneys have heard of. To put it mildly, this is a poor basis for making this decision.

In California AAA is sufficiently "second string" that AAA does not even have an office in many major California cities. Further, relatively few AAA arbitrators in California are even retired judges. Most of the arbitrators on AAA's panel are currently practicing attorneys who are evidently trying to break into the lucrative arbitration business, which is (for good reason) dominated by retired judges. Many attorneys, myself included, believe that a retired judge makes the best arbitrator in most cases. (For example, retired judges are much less likely to be on friendly terms with the other side's attorney than is a practicing attorney.) But in Southern California and perhaps elsewhere most retired judges do arbitration within other arbitration companies than AAA. Personally, I prefer the Judicial Arbitration and Mediation Services ("JAMS") Judicate West, Alternative Dispute Resolutions, and certain other arbitration companies.

3. The Venue/Jurisdiction Clause.

One of the sneakiest provisions that a party will try to slip into a contract is the Venue/Jurisdiction Clause. (These are technically different issues but functionally both deal with where the litigation will occur.) When non-lawyers examine a contract they often assume that the "Jurisdiction and Venue Clause" is irrelevant legalese. In fact, this is a very critical provision. These clauses function to specify where, i.e. which county, state, or even country, any litigation will occur. I have seen commercial contracts contain Venue and Jurisdiction Clauses for products sold in California that specify that "the sole venue for any legal dispute arising from this contract shall be [insert name of obscure European country]." Or the Venue Clause will specify a distant state that just happens to be the home office location of the other side. This is a very significant disadvantage to the side against whom this provision was concocted. This clause means that in the event of breach you can look forward to litigating the lawsuit in a distant location in which your own lawyer is almost surely not licensed to practice. You must now seek out an unfamiliar lawyer in another state, and pay for travel costs, etc. The expense to you, and the advantage to the other side, is almost always very considerable. There is the risk of being "home towned" in a distant venue (it happens). Usually venue for a lawsuit will be governed by various factors in the Code of Civil Procedure which factors, by and large, are fair to both sides. A Venue Clause is intended to (and usually does) override these factors and work to the unfair advantage of one side.

4. Attorney's Fee Provision.

Under most circumstances (with notable exceptions) in the United States the law conforms to what has been called the "American Rule" which simply means that in a lawsuit each side pays its own attorney fees no matter which side wins. This contrasts with the "British Rule" under which the loser pays the winner's attorneys fees. In California the "American Rule" can usually be overridden by contract. A contract can contain an "Attorney Fee Provision" which specifies that the prevailing party may collect attorney's fees from the loser. In my experience laymen usually pay little or no attention to these provisions when they sign contracts. But in reality an "Attorney's Fee Provision" is overriding 250 years of American law, usually to the advantage of the wealthier side. Attorney's fee provisions can have far-reaching effects. It is not uncommon for the winner to claim legal fees for winning a lawsuit that are as much money as the amount that was in controversy in the lawsuit. ("The tail wags the dog.") This is a huge deterrent to the weaker party in a contract. A small company or an individual rarely can afford the risk of having to pay for the other side's legal bills. And while I regret saying it, it is not at all uncommon for the amounts claimed as attorneys fees after such a lawsuit is over to have, to put it charitably, at best a faint connection with reality. While courts will sometimes reduce amounts claimed, the bottom line is that when there is an Attorneys Fee Provision in a contract the loser is going to take an ugly and often unfair financial hit.

Conclusion.

The decision to arbitrate, the choice of AAA arbitration, unfair venue and jurisdiction clauses, and attorney fee provisions are often bad ideas that outrageously favor one side. And yet they are rarely understood by the side that agrees to them. Do not expect a Court to rescue you from these provisions once you have signed a contract. Arbitration clauses in particular are just about impossible to get out of, courtesy of the Federal Arbitration Act which overrides conflicting state law on this subject. The same is true for attorney's fee provisions and to a slightly lesser extent, venue clauses in commercial contracts. The time to think about these provisions, and many others that I have not mentioned in this article, is before you sign the contract. These are just a few of the hidden pitfalls that often lurk in a contract. I would go so far as to say that more than half of the contracts that I am asked to review will contain one or more of these little gems. A contract is a negotiation. When you negotiate, it is rarely a good idea to straight away accept everything that the other side offers. Consult a lawyer before signing a contract. I can hardly remember a time when a client paid for a contract review where the client was not glad that he or she did so.