Contracts

February 11, 2011

Basic Business Contract Provisions – Part One

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.

November 2, 2010

Why Oral Partnerships Are a Bad Idea

by Donald Oder

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.

August 18, 2010

Understanding Your Lease – What Happens to Your San Diego Business After Landlord Foreclosure?

by Donald Oder

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.
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July 29, 2010

The Advantages and Disadvantages of Arbitration Clauses In Business Contracts

by Donald Oder

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.

November 13, 2009

Non-Competition Clauses in California Employment Contracts

by Donald Oder

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.

May 4, 2009

Basic Contract Principles Should Guide San Diego Businesses and Their Lawyers In Any Negotiation

by Donald Oder

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.