San Diego Business Lawyer Blog

There are countless franchise opportunities available to San Diego entrepreneurs.  The majority of these opportunities are offered by out of state franchise companies.  Purchasing and operating a franchise can be a lucrative option for those looking for alternatives to starting a new business from scratch.  Franchises offer economies of scale, proven systems and existing markets.  It is a known quantity that is typically well marketed, often nationally.  These advantages are obvious.  However, franchising is not a guaranty of success.  Much depends on the geographic location of the franchise, the proximity to other franchises, the proximity of similar businesses, the market for the franchises goods or services in the area, the economy and the skill and commitment of the franchisee.  When lucrative, franchises rarely result in conflict and the terms of the franchise agreement seem less important.  When the franchise is not profitable for whatever reason, the terms of the franchise agreement become critical.    

Virtually all franchise agreements include a venue provision wherein any litigation and/or arbitration will be heard in the home state of the franchisor.  For San Diegans, this means somewhere other than California.  This is of course problematic especially for the small businesses with limited resources.  Litigating or arbitrating a case in a distant jurisdiction is more costly and time consuming than it would otherwise be here in San Diego.  In many cases, franchisees are simply priced out of the process and have little recourse but to try and negotiate some sort of reasonable solution with the franchisor in lieu of facing a default judgment and/or bankruptcy.  

Unfortunately for franchisees, it is almost always impossible to negotiate away venue provisions in franchise agreements.   This is particularly true with national chains.  Venue provisions provide the national chains legal consistency, and it's the rare circumstance that they would be willing to give up this important benefit.  Nonetheless, it's important for franchisees to discuss the matter with their business attorney and/or try to negotiate the provision's removal.  Understanding the consequences of the provision better prepares the franchisee should a dispute later arise with the franchisor.  It also provides the franchisee the opportunity to explore other options.  Selecting a franchise located in one's home state is a better option all other factors being equal.  If you are considering the purchase of a franchise, consult a San Diego franchise attorney for assistance.

Continued from Negotiating Power - The Often Neglected Contract Position.

In most cases, the party with the greater bargaining power presents a draft contract to the other and asks them to sign it as is.  The draft will set forth the major contract terms already discussed by the parties such as price, delivery method, term of a lease, etc.  The remaining terms tend to favor the party who prepared the contract.  If you are an entrepreneur looking to capitalize on a new shopping center for your small café, you will have a harder time convincing the landlord to agree to changes in a commercial lease than a national chain that will anchor the center.  

Understanding your bargaining position prepares you for the negotiation process whether or not you are working with an attorney.  If you really want to open your café in the new shopping center, you will want to tread carefully during negotiations.  First, understand your rights and obligations as set forth in the proposed contract.  If you are negotiating without the benefit of legal counsel, consider asking a San Diego contract attorney to at least explain these rights and obligations.  Next, consider those terms you would like to change and prioritize.  What are the most important changes?  Remember, less bargaining power is not zero bargaining power.  By focusing your negotiations on only the most important issues, you preserve leverage.  Direct your discussions to the success of the transaction.  If we change Term X, it will improve both our volumes.  If you keep Term Y in the lease, I will lose significant business.  Stressing the success of the transaction shows that you are focused and professional, and the other side has little choice but to accept it as a valid concern.  Avoid the temptation to play "hard ball" with a party holding all the cards.  Finally, where possible increase you bargaining power by giving yourself alternatives.  No deal should be so important that you are willing to agree to terms destructive to the end goal.  If you are convinced there are no reasonable alternatives, make sure the other side doesn't know the extent of your desire.  

There are of course a myriad of negotiation schemes (too many to address in this short article).  Whatever the scheme, understand and accept your bargaining position and ensure that your attorney does as well.

Because San Diego businesses routinely enter in to contracts with vendors, clients, customers and other partners, it is important that they are familiar with basic contract principles and the need for negotiating favorable contract terms.  This is true whether or not they retain the services of a San Diego contract attorney.  The art of negotiating contracts requires a careful balancing of nuance and tactic.  Contract lawyers must weigh the needs of their clients against the desire for and/or business necessity of the contractual relationship.  The business contract binds the parties to its terms.  It defines the rights and obligations of the parties moving forward and can have far reaching effect, especially where disputes arise.  

In the vast majority of contract negotiations, one side is considerably more concerned about ensuring the success of the agreement.  In such circumstances, the "more concerned" party must decide how much they are willing to give up.  This defines the "more concerned" party's negotiating power.  The more the party is willing to walk away from the agreement, the more power that party has.  Negotiating power is probably the single most important factor in contract negotiation.  It is simultaneously one of the most often overlooked factors.  

The issue of course is not black and white.  The mere fact that one side has more negotiating power than the other does not necessarily mean that no negotiation is possible - although clearly this is the case sometimes.  The key is to recognize your negotiation power and leverage it to its fullest with skill, tact, bluff and perhaps a tad bit of humbleness.  Humbleness may seem counter-intuitive to some, especially attorneys, but it can and should make up at least a small part of your negotiation tactics.  No matter how hard seasoned attorneys and negotiators work to dehumanize the negotiation process, it is still conducted by people.  A soft touch often disarms even the most purposeful intent.

Continued in The Importance of Negotiating Power - Part Two.

Continued from The Business Contract - Part Two.  

Integration Clauses:  The integration clause states that the written contract entered into by the parties is their entire agreement.  A typical clause reads: "This Agreement constitutes the entire agreement between the parties with respect to the subject matter of this Agreement and supersedes all prior agreements, oral and written, between the parties hereto with respect to the subject matter of this Agreement."  The integration clause ensures that neither side will be able to later claim that there were additional terms agreed to in a side agreement, orally or otherwise.  All contracts should include an integration clause.  

Modification Clauses:  The modification clause is a simple but important clause that requires contract changes be set forth in writing and signed by all parties to be enforceable.  

Severability Clauses:  It is sometimes possible that a particular clause in a contract is unenforceable under California law for a myriad of reasons.  To avoid having such clauses invalidate the entire contract, parties routinely include severability clauses which state that in such cases the remainder of the agreement is valid and enforceable to the fullest extent permitted by law.  

Authority to Execute Clauses:  When corporations, limited liability companies or other formal business entities enter into contracts it is important that the person that signs the contract actually has the authority to bind the corporation, limited liability company or other business entity.  The "authority to execute" clause warrants that those signing for the company have said authority.  This important language is often overlooked by businesses informally contracting with each other without attorney consultation.  

Attorney Consultation Clauses:  It is always wise when one side prepares and presents a contract to the other to include an "attorney consultation" clause asking the other side to acknowledge that it has had an opportunity to consult with independent legal counsel.  This reduces the likelihood that the party may later try and argue that the agreement was so one sided that it was not freely bargained for (adhesion contract) or that the contract was entered into under duress or fraudulent circumstances.  

Counterpart Clauses:  Counterpart clauses are clauses of convenience allowing all parties to sign separate copies of the contract.  It is often the case that parties wish to execute a contract in different locations and on different dates.  With a counterpart clause, the parties may do so while maintaining an otherwise enforceable contract.  

This is not an exhaustive list of common contract provisions, nor is the list intended as a substitute for critical analysis of the four corners of any contract entered into.  Contract drafting and negotiation is a complex process requiring careful review of each clause, and the rights and obligations of the parties.  Consultation with a San Diego contract attorney, despite the understandable hesitation to involve a lawyer, remains the safest way to protect your business.

Continued from Basic Business Contract Provisions - Part One.

Mediation/Arbitration Clauses: Mediation and arbitration are alternative methods of conflict resolution. ADR ("Alternative Dispute Resolution") has grown in popularity of late especially with judges. For the most part, ADR relieves pressure on overcrowded courts, reduces litigation costs and results in faster resolution. It's important that parties understand the consequences of mediation and arbitration clauses. Mediation, the tamer of the two, may require that the parties submit their case to a mediator (experienced attorney or retired judge) who will help the parties navigate through the realities of their respective positions. It often results in early resolution, but the mediator's findings are not binding on the parties. Mediation is not cheap. The parties generally share the cost and if the mediation fails, the parties still face all of the additional costs of full scale litigation. Those with limited resources may want to consider forgoing mediation clauses in their contracts. The scenario with non-binding arbitration is similar to that of mediation except that the procedures differ.

Binding arbitration on the other hand has significant consequences, not the least of which is that the parties waive their right to a jury trial and, except in limited circumstances, waive their right to appeal. Foregoing these fundamental rights leaves parties at the mercy of arbitrators who are typically more business oriented and conservative than juries. It's not surprising then that big business routinely includes arbitration clauses in their contracts. Nonetheless, resolving disputes without the significant costs associated with litigation is an appealing alternative to many businesses regardless of their size. Binding arbitration provides an affordable venue for dispute resolution that is otherwise unattainable for some due to the costly nature of full scale litigation.

Applicable Law Clauses: All contracts should clearly define the applicable law to be followed should a dispute arise. This is especially so where the parties (whether individuals or corporate entities) reside in different states. It is best for San Diego businesses that their contracts be governed by California law.

Jurisdiction and Venue Clauses: These clauses often go hand in hand with Applicable Law clauses. It is common for national corporations and other large businesses that operate in multiple states to include jurisdiction and venue clauses calling for actions to be filed in the company's home state. This can create significant problems for San Diego businesses. It is always best that disputes are litigated in a party's home territory, as it requires considerable resources to litigate a case in a foreign state. Of course, this may not always be practical. Generally, the party with the greater bargaining power will insist that disputes be heard in its home state. However, where possible, parties should seek jurisdiction and venue clauses that favor their place of residence.

Continued in Basic Contract Terms - Part Three.

It's probably not too far of a reach to say that most San Diego business owners would prefer closing their deals over a hand shake rather than involve their attorneys in another contract negotiation.  Attorney fees alone are enough to convince even the most seasoned business owners to try and work out an agreement informally.  Yet, all San Diego business owners understand the importance of memorializing their agreements.  The business climate is dynamic requiring contract drafters to anticipate remote eventualities in order to provide the greatest protection to their clients.  While most business relationships are conflict free, business owners understand that they need a well written contract that sets forth the terms of their agreements in clear and concise terms should a dispute arise.  

A well written contract is enforceable (offer, acceptance, consideration, etc.), defines the rights and obligations of the parties (payment, services, warranties, indemnification, etc.), and accounts for contingencies (early termination, death of a party, natural disaster, disputes, etc.).  The principles of contract formation that determine enforceability, while certainly important, will be left to another article.  Specific contract terms unique to each contractual relationship are far too broad to cover in a single article.  The rights, obligations and contingencies outlined in an entertainment contract, a sales contract, a service contract, a franchise agreement, a buy-sell agreement or a commercial lease differ widely.  This article focuses on some common provisions found in most contracts.  It is not intended as a substitution for consultation with a contract attorney.  Rather, it is intended as a guide for businesses to better understand the contracts they enter into.  

Attorney Fee Clauses:  Most people believe that as a matter of course attorneys' fees are recoverable if they win a law suit.  Generally, however, this is not the case with contract disputes.  Under California law, the contract must include an attorneys' fee provision in order for a party to recover attorney fees in a breach of contract action.  A good attorney fee clause provides for attorneys' fees to be recovered by the prevailing party, provides that said fees are recoverable whether or not the case is tried to judgment, defines "prevailing party" and includes language for recovery of litigation costs (apart from legal fees).  Look for attorney fee clauses in all of your contracts.   In general, such clauses benefit all parties.  

Continued in The Business Contract - Part Two.

In this writer's experience, the most common cause of business failure is the lack of a written agreement between partners. No one ever enters into business with a friend or trusted associate thinking that the deal will collapse around them. Yet, business relationships routinely run into difficulties, and without a written contract defining the contours of the relationship, the difficulties are often destructive. Even minor disputes result in financial ruin for unwary partners who had vastly different expectations regarding the minutia of the business relationship. Moreover, partners expose themselves to substantial liability for the debts incurred by their partners on behalf of the partnership and for the conduct of their partners.

Partnerships are complex and demand serious commitment much like any business relationship, whether a corporation, limited liability company or other formal business entity. Along with the financial resources necessary to start up the partnership, partners invest their time and energy. In most cases, they make a personal and emotional commitment to the venture hoping for significant financial reward. This personal investment makes it all the more difficult to deal with the inevitable conflicts. The key to success is planning and this starts with a well drafted partnership agreement.

People often start out in business together with nothing more than a hand shake, but they rarely anticipate the number and variety of decisions they will have to make moving forward. It is common for young partners to exhibit flexibility in the beginning but as businesses grow or struggle, the decisions become more complex and more important and partner flexibility starts to wane. If the partners cannot agree on key decisions, the partnership falls apart. See "Ending Bad Partnerships". Without a well drafted written agreement, the partners have no mechanism for operational continuity or for winding up the company's affairs. Will one partner be bought out? If so, for how much? How should the business be valued? If both partners wish to continue, who will retain the company's assets, including the company's name, website, location and customer lists? If both partners have personally guaranteed a lease, how will the exiting partner be relieved of his obligations? What other continuing debt obligations will the exiting partner retain? If the partners decide to dissolve the partnership, how will the company's debt be paid? How will the remaining assets be divided? Who will be responsible for winding up the company's affairs? What if one partner abandons a failing business entirely and disappears? What recourse does the remaining partner have to recover losses? A well drafted partnership agreement will set forth mechanisms to deal with such contingencies.

Continue reading "Why Oral Partnerships Are a Bad Idea" »

As the San Diego commercial real estate market continues to struggle, foreclosures are becoming more and more common.  The prevailing wisdom is that it's going to get worse before it gets better.  While this writer cautiously takes a more optimistic view, there can be little doubt that many San Diego businesses are being and will be confronted with landlord foreclosures.  Businesses invest more than just lease payments in the premises they occupy.  They make tenant improvements, invest in advertisements and marketing materials using the premises address, build customer loyalty and benefit from a well known and popular location.  Under these circumstances, being forced out as a result of a landlord's default would be disastrous.
 
So what does happen to a business when a landlord defaults on its loan?  The answer depends on the terms of the lease, when it was executed and whether or not it was recorded.  Senior commercial leases will generally survive foreclosure sales, especially where the commercial lease is recorded prior to the recordation of the third party encumbrance.  Tenant possession of the premises may also serve as constructive notice of the senior lease to third party encumbrancers.  However, where a trust deed or other encumbrance is recorded prior to the execution of the lease, the lease is subordinate to the trust deed.  In such circumstances, a foreclosure will extinguish the lease.  A foreclosure purchaser may then evict the tenant as an unlawful occupant.
 
Experienced commercial landlords and tenants, savvy business owners and those represented by commercial lease attorneys look to address these potential consequences before entering into long term leases.  Whatever the terms, it is sound business practice to record all leases including amendments and other related instruments.  If the parties are concerned with confidential terms, they may record a "memorandum of lease" which identifies the unrecorded lease, the parties, the property and the lease term.

Continue reading "Understanding Your Lease - What Happens to Your San Diego Business After Landlord Foreclosure?" »

Arbitration clauses are typical in business contracts for several reasons. Most importantly, they allow businesses to settle disputes in a timely and cost-effective manner, without entering into costly, time-consuming litigation. Arbitration significantly limits discovery costs such as interrogatories, depositions, and pretrial motions that often constitute the bulk of litigation expense. In addition, arbitrators are often specialists in their various fields and tend to be more knowledgeable than juries.

Arbitration may be binding or non-binding. Non-binding arbitration involves the determination of liability without the dispensation of an award. While the arbitrator may suggest possible awards, parties are not legally obligated to accept the suggestions. Binding arbitration, on the other hand, involves not only the determination of liability, but also the terms of the award for the wronged party. Moreover, the arbitrator's determination is final (with few exceptions), and precludes further dispute and appeal. In California, an arbitration clause may be disregarded where all parties agree, where the clause exists as part of an invalid contract or where third parties are involved in the litigation (where third party claims arise out of the same transaction or series of related transactions).

Binding arbitration has significant advantages to both small and large business. Avoiding costly litigation is priceless to small business owners especially because they are typically priced out of litigation by large corporate entities. Large corporate entities like binding arbitration because they fear the uncertainty of jury trials. Putting the decision in the hands of an experienced arbitrator assists larger businesses in anticipating outcomes. In addition, binding arbitration is faster and less formal. On the other side of the coin, small businesses give up the right to a jury trial in exchange for affordable conflict resolution and large businesses give up their ability to steam roll smaller opponents. Other cons include the potential for being stuck with a bad arbitrator, being stuck with a bad and/or legally incorrect decision that cannot be appealed and having less time to properly investigate claims. Either way, courts, bar associations and state bar entities across the country are encouraging parties to look to informal resolution before resorting to the court house steps.

It's important that businesses consider these pros and cons carefully and enter into contracts that clearly set forth the terms of arbitration. Significantly, in order to put teeth into a binding arbitration clause, it needs to specifically state that binding arbitration is mandatory. Arbitration law in California is evolving and now allows for judicial review of "legal" errors by arbitrators where the parties specifically contract for it. In addition, contracts may include language that: requires claims be made within certain time limitations; requires parties to first negotiate in good faith before demanding arbitration; requires the party demanding arbitration advance arbitrator fees (which can be substantial); requires the losing party to pay the other side's attorney fees; requires the parties to comply with pre-set procedural rules created by entities such as the American Arbitration Association; and/or puts limits on the types of damages allowed (such as prohibiting punitive damages). A contracts attorney will assist San Diego businesses in navigating the pros and cons of arbitration clauses and ensure that they are drafted appropriately.

In California, post employment non-competition clauses are generally unenforceable. The prohibition of such clauses stems from the state's strong public policy favoring freedom of employment and competition, and there can be little doubt that savvy California businesses are aware of this. Yet businesses in San Diego and throughout the state routinely include non-competition clauses in their employment contracts, especially those with upper management. Businesses likely feel justified in including non-compete language because they know it is legal in nearly every other state in the country. In addition, many businesses have legitimate concerns regarding the protection of trade secrets. Companies invest in the creation of customer lists, customer loyalty, and in methods and procedures for maintaining and building a customer base, and they want to protect their investment.

Most employees don't intend to steal their former employer's secrets. They are simply interested in taking advantage of employment opportunities. The problem arises because of the difficulties in distinguishing between a former employee's inappropriate use of trade secrets and that same employee's utilization of personal skill and experience for the new employer. Competitors often solicit business from the same customer pool and use similar mechanisms to seek out and maintain a customer base. Who can say for certain that the former employee isn't soliciting clients consistent with the new employer's standard operating procedures? Whatever the case, California has chosen to err on the side of competition.

Employers, on the other hand, have chosen to err on the side of inclusion. Despite their illegality, businesses still include non-compete clauses in their employment contracts. Most prospective employees are unaware of California's employment laws and are unlikely to consult an attorney, and employers know that in most cases their employees will honor non-compete agreements upon the termination of their employment.  Moreover, employers merge non-compete language with trade secret language. If a former employee chooses to go to work for a competitor, employers will look past the non-compete language and allege theft of trade secrets. California courts have long recognized a "trade secrets" exception to the prohibition on non-compete clauses. By alleging theft of trade secrets, employers reduce the risk of having the case dismissed early for failure to state a cause of action, and increase the pressure on the former employee now faced with prolonged and costly litigation. Sometimes, the new employer will absorb the cost, but not often.

There is anecdotal evidence that California's competitive friendly approach has been successful. Some argue that the success of Silicon Valley compared to other technology corridors is in large part due to California's competitive environment. Whatever position one takes, recent developments make it clear that California businesses should exercise caution when including non-compete language in their employment contracts. California Labor Code § 432.5 makes it a misdemeanor to include illegal terms in an employment contract, and Labor Code § 2699 provides for a private right of action for any alleged violation of California's Labor Code and provides for a penalty for each violation of up to $200 per employee per pay period. With 25% of the penalty going to the prevailing plaintiff, employees concerned about non-compete clauses have an additional incentive to bring such actions. Moreover, a recent case casts doubt on the continuing validity of the trade secret exception. In Dowell v. Biosense Webster, Inc., the appellate court found a non-compete clause unenforceable and questioned, but did not rule on, the "continued viability of the common law trade secret exception to covenants not to compete."

Considering these developments, employers and their business attorneys should at the very least take care to ensure that non-compete language is narrowly tailored to address the protection of trade secrets. Including broader non-compete language risks liability under California law.

On December 22, 2008, the California Supreme Court ruled in Patel V. Liebermensch that the parties had entered into an enforceable option contract for the sale of real property despite the absence of terms specifying the time and manner of payment. The controversial decision was widely reported by the media and in attorney blogs and the moral of the story appeared to be that parties could forego the inclusion of contract terms setting forth the time and manner of payment (at least for the purchase of real property in California). Although the decision is important, businesses entering into contracts should not be lulled into thinking exclusion of such terms is acceptable simply because their exclusion does not render a California contract unenforceable. Time and manner of payment is an important detail in any contractual relationship, and prudent business owners do not enter into contracts (for the sale of real property or otherwise) without knowing when and how they will be compensated.

The purpose of entering into a contract is set forth clearly and concisely the material terms agreed to by the parties and to affect a means of enforcing those terms should there be a dispute. A good attorney or other negotiator will ensure that all material terms are agreed to and that important factors such as the time and manner of payment are included in the contract regardless of any law or court decision that may appear to minimize their importance. Having a clear understanding of the contractual relationship is the best way to minimize potential misunderstandings and avoid future disputes. Whether a court will ultimately enforce the contract has little benefit to parties embroiled in a battle over when and how each side is to be compensated. The object of a good contract is to avoid these kinds of disputes in the first place. Such disputes are costly to businesses even with the long term prospect of prevailing in court. A business' goodwill, reputation and bottom line all may suffer by the dispute's mere existence. Too often, businesses and their lawyers lose sight of these practical aspects.

Of course, the Patel decision will impact the enforceability of many existing California contracts, particularly those executed by unsophisticated parties without the benefit of a contract attorney. In fact, the contract at issue in Patel was a short contract in the form of a proposal sent by fax. The point of this article is that while Patel may be the law of the land for California, San Diego businesses shouldn't rely on it and similar decisions in place of common sense and sound contractual negotiation.