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Contract Management

A Guide for Sustainable Entrepreneurs

SUSTAINABLE ENTREPRENEURSHIP PROJECT

Dr. Alan S. Gutterman

Contract Management:

A Guide for Sustainable Entrepreneurs Published by the Sustainable Entrepreneurship Project (www.seproject.org) and copyrighted © 2017 by Alan S. Gutterman. All the rights of a copyright owner in this Work are reserved and retained by Alan S. Gutterman; however, the copyright owner grants the public the non-exclusive right to copy, distribute, or display the Work under a Creative Commons Attribution-NonCommercial-ShareAlike (CC BY-NC-SA) 4.0 License, as more fully described

at http://creativecommons.org/licenses/by-nc-sa/4.0/legalcode. About the Project

The Sustainable Entrepreneurship Project (www.seproject.org) engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business. In furtherance of its mission the Project is involved in the preparation and distribution of Libraries of Resources for Sustainable Entrepreneurs covering Entrepreneurship, Leadership, Management, Organizational Design, Organizational Culture, Strategic Planning, Governance, Corporate Social Responsibility, Compliance and Risk Management, Finance, Human Resources, Product Development and Commercialization, Technology Management, Globalization, and Managing Growth and Change. Each of the Libraries include various Project publications such as handbooks, guides, briefings, articles, checklists, forms, forms, videos and audio works and other resources; management tools such as checklists and questionnaires, forms and training materials; books; chapters or articles in books; articles in journals, newspapers and magazines; theses and dissertations; papers; government and other public domain publications; online articles and databases; blogs; websites; and webinars and podcasts. About the Author

Dr. Alan S. Gutterman is the Founding Director of the Sustainable Entrepreneurship Project and the Founding Director of the Business Counselor Institute (www.businesscounselorinstitute.org), which distributes Dr. Gutterman’s widely-recognized portfolio of timely and practical legal and business information for attorneys, other professionals and executives in the form of books, online content, webinars, videos, podcasts, newsletters and training programs. Dr. Gutterman has over three decades of experience as a partner and senior counsel with internationally recognized law firms counseling small and large business enterprises in the areas of general corporate and securities matters, venture capital, mergers and acquisitions, international law and transactions, strategic business alliances, technology transfers and intellectual property, and has also held senior management positions with several technology-based businesses including service as the chief legal officer of a leading international distributor of IT

products headquartered in Silicon Valley and as the chief operating officer of an emerging broadband media company. He received his A.B., M.B.A., and J.D. from the University of California at Berkeley, a D.B.A. from Golden Gate University, and a Ph. D. from the University of Cambridge. For more information about Dr. Gutterman, his publications, the Sustainable Entrepreneurship Project or the Business Counselor Institute, please contact him directly at [email protected].

Contract Management

1 Contract Management

§1 Essential elements of effective contract management

Contract management, sometimes referred to as contract administration, refers to the processes and procedures that companies may implement in order to manage the negotiation, execution, performance, modification and termination of contracts with various parties including customers, vendors, distributors, contractors and employees. While businesspeople often dismiss contract preparation as “lawyer’s work” that has little or nothing to do with the important aspects of the working relationship between the contractual parties, contracting is actually one of the crucial activities in determining the success of any business arrangement. While the essential steps in the contracting process will vary depending on the type and scope of the transaction, and the point at which counsel is brought into the discussions, contract formation and management typically involves most or all of the following:

Investigation of the business and legal background for the particular transaction and determination of the role that counsel is expected to play in the contracting process.

Identification of the contracts and related documents required to complete the transaction and establishment of a time and responsibility schedule for drafting, review, discussion, revision and completion of all of the required items.

Review and evaluation of the related contracts and existing obligations of the company that might be impacted by the specific contract currently under discussion.

Collection and review of information regarding the business and legal affairs of the other party to the proposed transaction.

Preparation of the initial draft of each of the required contracts and related documents or, in cases where the opposite party is responsible for drafting, review of the initial draft of such items prepared by the opposite party.

Discussion of necessary changes in the initial drafts, negotiation of the same and preparation of the final drafts of the contracts and related documents for signature.

Preparation for, and completion of, the closing of the transaction at which time all contracts and related documents are executed and exchanged and any required performance at the closing (e.g., cash payments) is completed.

Ongoing review of the performance of each of the parties under the terms of the contract, at least in those cases where the contract is long-term and calls for continuous performance over an extended period of time.

The timing and sequence of these steps may be impacted by other conditions unique to the transaction. For example, while the parties may quickly reach agreement on the content of the contracts, the actual closing may be deferred pending receipt of approvals from governmental officials or completion and delivery of various reports and opinions from third parties. The role of “counsel” is treated more fully below and the discussion in this Guide is primarily directed at the legal advisor who will be representing the interests of the

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2 company in contract negotiations with other parties. In some instances companies will look to attorneys outside of the company to take the lead in a contract matter. For example, “outside” counsel (e.g., law firm attorneys) may be used when the company does not have an in-house legal team or the head of the in-house team (i.e., the general counsel) determines that the team does not have necessary resources and/or expertise for a particular contract. When outside counsel is used it is important for the attorney and his or her client (i.e., the company) to determine in advance the scope of the attorney-client relationship and to identify the person(s) within the company with authority to provide directions to outside counsel on negotiation and drafting issues. In general, the discussion below assumes that the general counsel or a member of his or her legal department will be the attorney who is responsible for all of the applicable activities; however, this does not fundamentally change the steps that counsel should be taking when overseeing a contract project. Specifically, in-house lawyers still need to define their role in the contracting process and advise other involved managers and employees about what is expected of them in terms of providing information and communication clearly with their counsel.1

Table 1

Contract Formation and Administration Checklist

Investigate the business and legal background for the contract and the transaction in which the contract

is to be used. Special consideration should be given to the actual and potential impact on existing obligations and relationships.

Identify the steps that need to be taken in order to comply with the requirements of any contract review and signature authority policies and procedures that have been established by the client.

Discuss with the client the role of counsel in the contract process and, if necessary, draft and execute an engagement letter. In the course of these discussions, attention should be paid to relevant ethical considerations, including identification and resolution of any actual or potential conflicts of interest.

Identify the contracts and related documents required to complete the transaction.

If warranted by the complexity of the proposed transaction, prepare a time and responsibility schedule for drafting, review, discussion, revision and completion of all required items and activities.

Collect and review examples of the contracts necessary for the drafting process and prepare a drafting checklist and master document for each contract.

Negotiate the essential terms of each contract and, if appropriate and useful, prepare a term sheet or letter of understanding to be sure that the parties are in agreement regarding the essential terms before time and effort is spent on contract preparation.

Prepare the initial draft of each of the required contracts and related documents or, in cases where the opposite party is responsible for drafting, review the initial draft of such items prepared by the opposite party.

Discuss and negotiate necessary changes in the initial drafts and circulate revised drafts for review and finalization.

Prepare for the closing of the transaction, including pre-closing meetings and preparation of closing checklists and memoranda.

Complete the closing of the transaction at which time all contracts and related documents are executed and exchanged and any required performance at the closing (e.g., cash payments) is completed.

Organize the closing documents and make sure that copies are delivered to all interested parties. In

1 Except as other noted, the term “counsel” in this Guide includes any attorney with responsibility for representing the company in the contracting process whether such attorney is part of the company’s legal department or regularly practices with an outside law firm that the company has engaged to provide legal representation in connection with the transaction for which the contract is prepared.

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3 addition, counsel should organize the files relating to the transaction and calendar any dates that may require follow up action, such as performance milestones and option elections.

Plan for ongoing review of the performance of each of the parties under the terms of the contract, at least in those cases where the contract is long-term and calls for continuous performance over an extended period of time.

§2 Measurement of performance in the contracting process

As with any formal organization process it is important and informative to develop appropriate performance measures for regularly evaluating the contracting process and ensuring that it is making a positive and valuable contribution to the activities of the various organizational units within the company. The primary measure of performance in the contracting process is whether or not the final contract clearly and completely memorializes the intent of the parties with respect to the particular transaction. It is not sufficient for the parties to have good ideas about the goals and purposes of the relationship if the contract does not provide a clear and unambiguous roadmap for the parties to follow in order to achieve their objectives. In order to prepare an effective contract, counsel must fully understand the key details of the transaction and have access to all of the important background relating to the negotiations, and prior relations, between the parties. In addition, counsel must have sufficient information and experience to make sure that the contract fulfills the following roles and purposes:

The contract must cover all the essential elements necessary for formation, interpretation and performance of a legally binding agreement under applicable laws. In order to meet this requirement, counsel must fully understand the company’s intent with regard to all material terms, such as goods covered by a sale of goods contract and the pricing and delivery terms.

In cases where the contract is intended to govern a continuing relationship between the parties, it should include all necessary policies and procedures for managing the exchange of performances between the parties. Parties are often able to achieve this goal in a simple, shorthand fashion, such as by incorporating the latest version of INCOTERMS, which is the International Chamber of Commerce’s widely accepted rules for the interpretation of trade terms, to identify delivery terms in an international contract. In other situations, however, the parties may rely on comprehensive operations manuals that are more extensive than the original contract and cover a variety of issues in detail.

The contract should clearly state all of the rights of the parties necessary in order form them to achieve their underlying business objectives. This can be as simple as defining the right of the seller to receive payment within a specified period of time; however, counsel must carefully consider all relevant and reasonable rights when preparing the contract.

While the parties obviously anticipate, and hope, that the exchange of performance between the parties will flow smoothly, counsel does a disservice by not anticipating potential problems and crafting remedies in the contract before it is signed. For example, a default in payment obligations will certain trigger collection rights in

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4 favor of the party expecting payment; however, consideration should be given to charging interest and allocating collection costs to the defaulting party.

Counsel should be able to provide reasonable assurances to the company that the contract will be enforced and interpreted in the manner described by counsel before the contract is signed. In order to provide effective counsel in this area, it may be necessary to engage experts to review particular provisions and provide an opinion regarding the enforceability of a particular right or remedy included in the contract.

Counsel should also understand and acknowledge that a contract may other purposes for a particular transaction. For example, in complex transactions a master contract, which incorporates a number of other contracts by reference, may serve primarily as a way to organize the transaction and identify the conditions that will need to be satisfied in order for all of the contracts to be executed and delivered. Other agreements, such as a letter of intent, may have limited legal effect; however, they can have great symbolic value to the parties as evidence of a willingness to devote further resources to negotiating and consummating a definitive agreement. A security agreement or guarantee is rarely the primary contract in a transaction and is most typically used to provide additional collateral to induce a lender to provide financing or a vendor to offer goods on credit. Finally, companies may require contracts, such as a non-competition agreement, that may not be enforced in their entirety by a court but which may deter the party subject to the covenant from engaging in certain acts thought to be harmful to the company.

Counsel must recognize the modern reality that, in the eyes of the company, effectiveness is also measured by the “cost” of the representation and the amount of time that it takes to complete the contract and the related transaction. When in-house attorneys are involved the costs can be measured by the direct and indirect expenses relating to such attorney. When outside counsel is involved the principal cost is the legal fees incurred by the company; however, ancillary expenses such as travel must also be factored into the analysis. In many cases, counsel will not have the time, or the benefits of a sufficient budget, to negotiate and draft all of the provisions that should go into the contract in the absence of any constraints. If counsel believes that his or her representation is being compromised by the limitations imposed by the company, consideration should be given to memorializing any potential issues in a memorandum to the company. This creates a record of the risks assumed by the company in opting for a less detailed contract provision on an area that might ultimately pose a problem in the relationship between the parties. Outside counsel may direct such a memorandum to the general counsel and other appropriate senior managers. In-house attorneys should direct their memorandum to appropriate senior managers and ensure that the points in the memorandum are part of the record on any internal contract review process. Information in the memorandum should be memorialized in ways the preserve confidentiality and attorney-client privilege.

§3 Law of contracts The law of contracts is a mix of private law, principally the terms of the agreement between the parties, common law and state statutory provisions. The main principles of the common law have been outlined in the Restatement Second of The Law of Contracts

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5 (“Restatement (2d), Contracts”) developed and published by the American Law Institute. State statutory law sets out certain formal requirements for contracts, including the need for certain contracts to be put in writing, and also provides guidelines for construction of various provisions included in a contract by the parties. In addition, preparation of certain types of contracts requires consideration of specific laws and regulations that may, among other things, impose requirements that must be satisfied in order for counsel to be confident that the contract will be enforced. Examples include the following:

Contracts relating to certain commercial transactions, such as sales of goods, secured transactions and leases of goods, will typically be governed by the applicable article of the Uniform Commercial Code (“UCC”).

Consumer transactions, notably consumer sales contracts, consumer warranties and consumer credit arrangements, will be subject to a plethora of federal and state laws and regulations which often dictate in some detail the form of the contract (including type size).

Transfers and licenses of intellectual property rights, such as patents, trademarks and copyrights, may be subject to specific statutes and procedural requirements.

Contracts relating to employment, including covenants not to compete and agreements pertaining to ownership and assignment of intellectual property rights by employees, must be reviewed against specific requirements included in state law and employment laws and federal statutes such as the Americans with Disabilities Act and the Employees Retirement Income Security Act.

Contracts that are entered into online will be subject to the relatively new laws and regulations pertaining to electronic signatures and amendments to such contracts must conform to the guidelines that are being established in court decisions.

Other domestic laws and regulations that may apply depending on the circumstances include federal and state securities laws, insurance laws, franchise laws and federal and state laws and regulations pertaining to procure (i.e., government contracting rules). As companies begin to engage in cross-border transactions they need to understand that such transactions not only trigger the applicability of various domestic laws, such as export controls, but also require consideration of the laws relating to contract formation and enforceability in the foreign party’s home country. Almost all foreign jurisdictions acknowledge the rights of private parties to enter into contracts and create enforceable obligations against one another under local contract law. Depending on the dominant legal tradition within the jurisdiction, contract rules may be established by the common law and/or expressly stated in civil law codes. Each jurisdiction will have its own rules with respect to the issues covered in the Restatement (2d) of Contracts, especially with respect to steps that need to be taken to form a contract that is valid and enforceable. Certain types of contracts (e.g., technology transfer and joint venture agreements) may be subject to special laws and regulations and sometimes may require review and approval by governmental agencies depending upon the subject matter and the obligations to be performed by the local party. Efforts have been made to harmonize international law in certain areas, notably through the development and promotion of “universal” codes and

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6 principles such as the UN Convention on Contracts for the International Sales of Goods and the UNIDROIT Principle of International Commercial Law. The following sections are a brief summary of some of the essential principals of US contract law and are not intended to be a comprehensive guide to all of the exceptions that might apply in a given instance. Reference should always be made to the detailed treatises that are available on the law of contracts. §4 --Contract formation and enforceability

Under the Restatement (2d) of Contracts, a contract is a "promise or set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty."2 Generally, a promise is "a manifestation of intention to act or refrain from acting in a specified way, so made as to justify a promisee in understanding that a commitment has been made."3 In order for a contract to exist there must be an agreement which is basically a manifestation of mutual assent.4 §5 ----Elements of a contract

The key requirements for a valid contract are an “offer,” an “acceptance,” and lawful “consideration.” An offer "is a manifestation of willingness to enter into a bargain, so made as to justify another person in understanding that his or her assent to that bargain is invited and will conclude it."5 In order to constitute a valid offer, a promise must contain sufficiently certain terms so as to allow the court to understand just what act the promisor will perform or forbear from performing. The offer must also state sufficiently just what act or promise is demanded in return if the offeree accepts.6 An offer "may invite or require acceptance to be made by an affirmative answer in words or by performing or refraining from performing a specified act, or may empower the offeree to make a selection of terms in his acceptance . . . Unless otherwise indicated by the language or the circumstances, an offer invites acceptance in any manner and by any medium reasonable in the circumstances."7 An offer creates in the offeree a power of acceptance and this power of acceptance continues until the offeree accepts or the offer is terminated.8 If the offeror has not communicated a definite and specific time limit to the offeree relevant to acceptance, the general rule is that the power of acceptance continues for a reasonable time. An offeree may have the power of acceptance terminated by

2 Restatement (2d), Contracts, § 1; Stentor Elec. Mfg. Co., Inc. v. Klaxon Co., 115 F2d 268, 271 (CA3 1941), rev’d 313 US 487, 85 L Ed 1477, 61 S Ct 1020 (1941); Friedman v. Jackson, 266 Cal App 2d 517 172 CalRptr129, 132 (1968). 3 Restatement (2d), Contracts, § 2; United States v. Kemmel, 188 F Supp 736, 741 (MD Pa 1960), affd 295 F2d 712 (1961), cert den 368 US 988 (1962). 4 Restatement (2d), Contracts, § 3. 5 Restatement (2d), Contracts, § 24; Saske v. Barwick, 404 F2d 495, 499 (CA2 1968), cert den 394 US 921 (1969). 6 Williston on Contracts, § 4.18. 7 Restatement (2d), Contracts, § 30. 8 Restatement (2d), Contracts, § 35.

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7 rejection or counteroffer by the offeree, lapse of time, revocation by the offeror or death or incapacity of the offeror.9

“Consideration” has traditionally been defined as a benefit received by the promisor or a detriment incurred by the promisee. Section 71 of the Restatement (2d), Contracts discusses the requirement of consideration as follows: "§ 71 Requirement of Exchange, Types of Exchange. (1) To constitute consideration, a performance or a return promise must be bargained for. (2) A performance or return promise is bargained for if it is sought by the promisor in exchange for his or her promise and is given by the promisee in exchange for that promise. (3) The performance may consist of an act other than a promise, or a forbearance, or the creation, modification or destruction of a legitimate legal relation. (4) The performance or return promise may be given to the promisor or to some other person. It may be given by the promisee or by some other person." There are some contracts and situations which are viewed as falling outside the general rule requiring consideration for valid formation. Some of these situations are as follows: (1) A promise to pay all or part of an antecedent contractual debt owed by the promisor where the debt is enforceable10; (2) A promise to pay all or part of indebtedness discharged in bankruptcy11; (3) In some situations a promise to perform a duty under an antecedent contract12; (4) A promise to perform part of an antecedent, voidable contract13; (5) Option contracts14; (6) Modification of executory contracts15; (7) Contracts under seal16; and (8) Certain situations involving reliance. §6 ----Contract terms

The terms of a contract can be expressed in language or implied from conduct. If a promise is binding, so too are the terms of the promise; it becomes binding within the "square corners" of the contract unless a rule of law prevents that. "A term of a promise or agreement is that portion of the intention or assent which relates to a particular

9 Restatement (2d), Contracts, § 36. 10 Restatement (2d), Contracts, § 82. 11 Restatement (2d), Contracts, § 83. 12 Restatement (2d), Contracts, § 85. 13 Restatement (2d), Contracts, § 87. 14 Restatement (2d), Contracts, § 87. 15 Restatement (2d), Contracts, § 89. 16 Restatement (2d), Contracts, § 95.

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8 matter."17 A "term of a contract is that portion of the legal relations resulting from the promise or set of promises which relates to a particular matter, whether or not the parties manifest an intention to create those relations."18 A term can also be supplied by law as a matter of public policy, or required by statute. Often, for example, a contract for the sale of land may require certain statutory terms which the state mandates. An insurance policy is also an example of a contract which may require specific terms as delineated by statute. Other than statutory terms, however, the choice of terms is up to the contracting parties, limited by public policy, conscionability and fairness. §7 ----Defenses

Even if it appears that the necessary elements of mutual assent and consideration are present, various defenses to contract formation and enforceability may be available including duress19; undue influence20; mistake21; fraud and misrepresentation22; and illegality and violation of public policy23. Other defenses include lack of capacity24, indefiniteness of contract terms and failure to satisfy the requirements of the Statute of Frauds when applicable25. §8 --Breach of contract

A breach of contract is the "non-performance of any contractual duty of immediate performance."26 In evaluating a breach in light of the available remedies, a court will look at the extent and effect of the breach in relationship to the performance required to determine the appropriate remedy.

17 Restatement (2d), Contracts, § 5. 18 Restatement (2d), Contracts, § 5. 19 Restatement (2d), Contracts, §§ 174-176. 20 Restatement (2d), Contracts, § 177. 21 Restatement (2d), Contracts, §§ 152-154. 22 Restatement (2d), Contracts, § 164. 23 Restatement (2d), Contracts, § 178. 24 Restatement (2d), Contracts, § 12 provides that “[n]o one can be bound by contract who has not legal capacity to incur at least voidable contractual duties. Capacity to contract may be partial and its existence in respect of a particular transaction may depend upon the nature of the transaction or upon other circumstances.” The principal list of those with no capacity or limited capacity to contract includes infants, mentally ill, intoxicated persons and persons under guardianship. 25 The Statute of Frauds, while arising from the common law, is presently codified in forty-eight state statutes and the District of Columbia with Maryland and New Mexico enacting the Statute of Frauds by judicial decision. It provides that for certain contracts to be enforceable, they must be memorialized by a written agreement. This includes land contracts; contracts that cannot be performed within one year; suretyship contracts; contracts by executors and administrators on behalf of a decedent; contracts in consideration of marriage, and in certain states, contracts to make a will; and real estate broker contracts. See Restatement (2d), Contracts, § 110. In addition, certain areas traditionally governed by the Statute of Frauds, such as the sale of goods in excess of $500, are now governed by the UCC § 2-201. 26 Stanley v. Chris-Craft Corp., 21 NYS2d 898, 899 (1939). See also In re Spagnol Enterprises, Inc., 81 BR 337, 353 (WD Pa 1987) ("Breach of contract is the non-performance of a contractual duty or violation of such obligation."); Clevert v. Jeff W. Soden, Inc., 241 Va 108, 400 SE2d 181, 183 (1991) ("Breach of contract is the failure, without legal excuse, to perform any promise which forms the whole or part of a contract.").

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9 §9 ----Doctrine of substantial performance

The duty to perform is not excused by the failure of the nonbreaching party to completely perform all of its obligations. Under the doctrine of substantial performance, the substantial performance by the obligor of its duties obviates the obligee's ability to terminate the contract; the obligee cannot avoid fulfilling its obligations as a result of the obligor's failure to complete all of its obligations.27 The doctrine does not, however, apply to the sale of goods.28 The doctrine does not excuse less than full performance, as the injured party is still entitled to recover damages for its injury based on breach of contract.29 Damages would be based on the cost of bringing the delivered goods into full compliance with the contract price.30 Substantial performance is typically treated as a minor breach.31 A willful action, however, will be treated as a material breach to which the doctrine of substantial performance will not apply.32 §10 ----Nonperformance as minor breach

A minor breach occurs if there is an immaterial effect upon the benefit the obligee is receiving under a contract.33 The effect of a minor breach is that the injured party is not excused from its contractual obligations but is entitled to receive damages for the breaching party's immaterial breach.34 Examples of a minor breach would include the substantial performance of a construction contract or a slight delay in the timeliness of the completion of a contract. A breach for nonperformance in conjunction with an anticipatory repudiation, however, constitutes a material breach, enabling the injured party to immediately terminate the contract and bring a claim for damages.35 §11 ----Nonperformance as material breach

A material breach is one which "touches the fundamental purpose of the contract and defeats the object of the parties in making the contract."36 With a material breach, the obligee may terminate the contract without penalty and has the immediate right to all existing remedies as a result of the obligor's breach.37 Under Restatement (2d) § 241,

27 Matador Drilling Co., Inc. v. Post, 662 F2d 1190, 1195 (CA5 1981); Watson Lumber Co. v. Mouser, 30 III App 3d 100,333 NE2d 19, 23 (1975); Alliance Tractor & Implement Co. v. Lukens Tool & Die Co., 194 Neb 473, 233 NW2d 299, 301 (1975); State v. Brand, 2 Ohio App 2d 460, 442 NE2d805 (1981); Cranetex, Inc. v. Precision Crane & Rigging of Houston, Inc., 760 SW2d 298, 302 (Tex App 1988). 28 See Calamari & Perillo, Contracts § 11-16 (3d ed 1987). 29 Cox v. Freemont County Public Bldg. Authority, 415 F2d 882 (CA10 1969). 30 Mirisis v. Renda, 83 AD2d 572, 441 NYS2d 138 (1981). 31 Master Palletizer Systems, Inc. v. T.S. Ragsdale Co., Inc., 725 F Supp 1525, 1532 (D Colo 1989). 32 In re Carson's Estate, 349 Pa 529, 37 A2d 488, 491 (1944); Mort Co. v. Paul, 167 Pa Super 532, 76 A2d 445, 447 (1950). 33 Gulick v. A. Robert Strawn & Associates, Inc., 477 P2d 489, 492 (Colo 1970). 34 477 P2d at 489, 492. 35 Restatement (2d), Contracts, §§ 243, 250, Comment (a). 36 Rogers v. Relyea, 184 Mont 1, 601 P2d 37, 41 (1979). 37 Wolff & Munier, Inc. v. Whiting-Turner Contracting Co., 946 F2d 1003, 1009 (CA2 1991).

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10 several criteria will be used to determine whether a breach is material: the extent of the benefit received by the injured party; the adequacy of available damages (i.e., if damages cannot adequately compensate the injured party, the breach will be viewed as material); the extent of part performance by the obligor (i.e., a failure will be less likely to be material if it occurs after substantial performance or preparation and more likely to be material if it occurs prior to reliance on behalf of the breaching party); the likelihood of curing performance (i.e., if the party in breach will be able to cure, its breach is less likely to be material); and the extent of good faith and fair dealing (i.e., if the breaching party has been acting in good faith, the breach is less likely to be material). §12 ----Remedies

Remedies for breach of contract can be divided into two general categories: monetary damages and equitable remedies. Monetary damages are those damages for which the aggrieved party is compensated monetarily (i.e., in the form of a cash payment). Monetary means are used because the injury is easy to quantify and because the monetary damages are considered to be a satisfactory means of compensation. Monetary damages are classified as either compensatory, including actual, consequential and incidental damages, or noncompensatory, including punitive, nominal and stipulative (“liquidated”) damages. The recovery of damages is limited by the requirement of “foreseeability,” which means that in order to recover for damages the damages must be foreseeable to the parties when entering into the contract.38 Equitable remedies are awarded when monetary damages are inadequate and may be awarded in addition to other damages.39 The principal equitable remedies are specific performance, injunctive relief and restitution. In general, specific performance and injunctive relief will not be imposed if damages are an adequate means to protect the expectation interest of the aggrieved party.40 Each party must seek to mitigate its damages without undue risk, burden or humiliation, and damages are not recoverable by a party that makes no attempt to mitigate its damages.41 §13 --Contract interpretation

In interpreting the construction of a contract, the courts will apply a number of rules: (1) The courts will look at the four corners of the document and construe the document as a whole.42 Specific or individual clauses contained in the agreement will be subordinated to the overall intent of the parties in entering into the agreement, as determined by a reading of the contract as a whole.43

38 Restatement (2d), Contracts, § 351(1). 39 Restatement (2d), of Contracts, §§ 358 (3), 361. 40 Restatement (2d), Contracts, § 359(1). 41 Restatement (2d), Contracts, § 350(1). 42 Restatement (2d), Contracts, § 202(2). 43 Restatement (2d), Contracts, §§ 230, 233.

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11 (2) Unless a different intention is manifested by the parties, the courts will apply the ordinary meaning of the words "contained therein."44 Technical terms and words of art will be given the meaning when used in a transaction within their technical field.45 If the parties attach different meanings to a word, the court will interpret the meaning attached by one of them. If that party did not know or have reason to know of the meaning attached by the other party, and the other party knew or had reason to know the first party attached a different meaning, the court will enforce the meaning attached by the party without knowledge.46 (3) If inconsistent provisions are contained within the document, the courts will look to the nature of such provisions. Courts will seek an interpretation that gives a lawful, reasonable and effective meaning to all terms rather than one that makes part of the agreement unlawful, unreasonable, or of no affect.47 (4) Specific terms and exact language will be given preference over general language.48 Express terms will be given greater weight than course of performance, course of dealing, and usage in trade; course of performance will be given greater preference than usage in trade and course of dealing will be given greater weight than usage of trade.49 Typed or written provisions will prevail over preprinted or boilerplate language attached to such documents, especially if such provisions appear on the back of a preprinted form.50 (5) The courts will look to general customs in the usage for particular businesses for the particular account where the contract is made or to be performed unless the context or a usage which is applicable indicates a different meaning.51 (6) Any inconsistency in an agreement that cannot be resolved will be interpreted against the draftsman of the contract52 or the person who supplies the words and the meaning that serves the public interest53. The use of intrinsic evidence in contract interpretation is regulated by the Parole Evidence Rule, which provides that where the parties to an agreement have produced a writing which reflects the agreement of the parties, no evidence, oral or otherwise, may be admitted to vary, contradict or add to the obligations of the parties set forth in such writings.54 This rule arose to prevent potential fraud by the inclusion of additional claims or counterclaims. To invoke the rule, however, there must be a final writing between the

44 Restatement (2d), Contracts, § 202(3)(a). 45 Restatement (2d), Contracts, § 202(3)(b). 46 Restatement (2d), Contracts, § 201(2). 47 Restatement (2d), Contracts, § 203(a). 48 Restatement (2d), Contracts, § 203(c). 49 Restatement (2d), Contracts, § 203(b). 50 Restatement (2d), Contracts, § 203(d). 51 Restatement (2d), Contracts, §§ 230, 233. 52 Restatement (2d), Contracts, §§ 206, 261. 53 Restatement (2d), Contracts, § 207. 54 Restatement (2d), Contracts, § 213.

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12 parties which sets forth their intent.55 The Parole Evidence Rule does not prevent a party from using additional intrinsic evidence to show that a writing is or is not integrated, or if integrated, that it is a partial or full integration.56 In addition, intrinsic evidence can be used to determine the meaning of a writing when the intent of the parties is unclear and the court is attempting to interpret the contract.57

§14 --Laws and rules applicable to specific contracts

While it is important to understand general principles of contract law, many commercial agreements will be governed by topic specific laws, regulations and cases. Perhaps the most common example of this is contracts for the sale and purchase of goods. Parties to a domestic sale of goods contract in the United States will be governed by the provisions of Article 2 of the Uniform Commercial Code (“UCC”), which is a model act that has been adopted, with certain variations, in all of the states except Louisiana.58 Article 2 of the UCC deals with all of the fundamental issues which arise in a “sale of goods”59 transaction including the following:

Formation of the sales agreement;

The time or event when the risk of loss or destruction of the goods passes from the seller to buyer;

The general obligations of the seller under the contract of sale, including the seller's obligations to tender the goods in the manner provided in the contract and to provide goods which conform to specifications set out in the contract.

55 McCormick, Evidence § 213. 56 Restatement (2d), Contracts, § 214(a), (b). 57 Restatement (2d), Contracts, § 214(c). 58 Parties relying on UCC Article 2 should be mindful that some states have modified the model provisions relating to certain subjects, particularly limitations on remedies, and that reference should always be made to the applicable state version of Article 2 covering the specific contract. Also, while this publication assumes that the sale of goods transaction occurs between merchants, a large number of states have adopted legislation relating to sales transactions involving consumer products. Not surprisingly, the states have shown the greatest interest in disclaimers of warranties provided to consumers and in limitations of remedies in sales of consumer goods. See generally Clark and Smith, The Law of Product Warranties ¶ 8.05[2]; Clark & Davis, Beefing Up Product Warranties: A New Dimension in Consumer Protection, 23 U. Kan. L. Rev. 567 (1975); Clifford, Non-UCC Statutory Provisions Affecting Warranty Disclaimers and Remedies in Sales of Goods, 71 N.C. L. Rev. 1011 (1993). Most states have achieved this result by amending their versions of UCC §§ 2-316 and/or 2-719; however, other states, including California (Cal. Civ. Code §§ 1790 et seq. (Song-Beverly Consumer Warranty Act)), Kansas (Kan. Stat. Ann. §§ 50-623 et seq. (Kansas Consumer Protection Act)) and West Virginia (W. Va. Code §§ 46A-1-101 et seq. (West Virginia Consumer Credit and Protection Act)) have special warranty protection legislation outside the commercial code that offers consumers broad protection in sales transactions, and specifically curtails the ability of a product seller to disclaim implied warranties. 59 A sale occurs whenever title to goods passes from the seller to the buyer for a price. See UCC § 2-106(1). Goods are defined as "all things" movable at the time the contract is formed and is broad enough to include transactions involving all tangible objects and chattels, including raw materials, work-in-process, building materials, standard as well as specially manufactured goods, farm products, inventory items, consumer goods and equipment. See UCC § 2-105(1).

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13 The warranty obligations of the seller, including the warranties of title, non-

infringement, merchantability and fitness for a particular use, and the disclaimer of warranties under the UCC.

The general obligations of the buyer under the contract of sale, including the obligations to tender payment when it becomes due and to accept goods which conform to the specifications in the contract and which are tendered in the manner agreed upon by the parties.

The remedies for breach of the contract of sale for the seller and the buyer. Sales contracts with foreign parties may also be governed by the rules of UCC Article 2 when the foreign party consents and this is increasingly likely as the foreigners become more familiar with the way the rules operate. Another alternative that might be selected is the United Nations Convention for the International Sale of Goods (“CISG”), to which the US is a party, and some cross-border sales contracts incorporate provisions from the UNIDROIT Principles of International Commercial Contracts.

§15 Collecting information for contract negotiations

Whenever possible, counsel and the manager or other authorized person within the company who is responsible for the particular contract should meet in advance of contract negotiations in order to discuss the background for the contract and the relationship between the prospective parties to the contract. The meeting serves not only as a valuable source of information for counsel in preparing the contract, it also provides a good opportunity for counsel and the company representative to brainstorm about negotiating strategies and the strategic impact of the contract and business relationship on the company’s activities. Among the questions and issues that should be considered at this point are the following:

Does the company have any past or current relationship with the other party? Obviously, past or current contracts can be important indicators of how negotiations will play out with respect to any new contractual arrangement. Also, if the other party is already a significant business partner of the company, this may impact the approach that is taken with regard to accommodating certain requests or pressing various issues.

What role does the company see for the other party in the company’s future business strategies? If the other party is not considered to be a major business partner, counsel and the company may be willing to take a tougher approach on certain issues, particularly if alternatives exist for the particular type of business arrangement.

Is the subject matter of the contract material to the company’s business? For example, if the contract pertains to a procurement arrangement from a key supplier for goods or services that are material to the company’s business, negotiations will focus on performance requirements and the sanctions that may be imposed in the event of a default by the other party. On the other hand, if the contract is routine and the company will not be materially impacted by a default by the other party, counsel and the company may decide not to press on certain issues.

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14 What is the proposed term of the contractual arrangement? A contract may cover a

“one time” exchange of actions, such as an isolated sale and purchase of goods, or it may be designed to govern the relationship of the parties over an extended period of time and multiple episodes of mutual performance (e.g., a long-term distribution agreement). Long term contracts require more consideration of events that may impact the ability or willingness of both parties to perform at the originally agreed levels as time goes by. In many cases, difficult legal and business risks may be mitigated to some extent if the company has the ability to terminate the contract without the penalty on relatively short notice.

How aggressive can the company be in negotiating the terms of the contract? Counsel should determine what the company believes it has sufficient leverage to engage in hard bargaining on the terms of the contract. This requires inquiry into the bargaining power of the other party and whether or not the company has viable alternatives in the event that negotiations break off. Aggressive bargaining may also be necessary when the subject matter of the contract is material to the company since it cannot afford problems once the contract is in place and the parties are expected to perform in a timely manner without delays caused by the failure to resolve all issues in the negotiation period.

How important is the contract to the other party? This is the inverse of the similar inquiry above regarding materiality to the company. If the arrangement is important to the other party, it can be expected that the other party will either drive a hard bargain on certain issues or be willing to concede various points to the company in order to get the deal done quickly.

While each of these questions should be asked and evaluated separately, there obviously will be important overlaps that must be considered. For example, while the company may feel that it has significant leverage over the other party at the current time, it may be imprudent to take too much advantage if there is a possibility of expanding the business relationship in the future. Also, consideration should always be given to the availability of alternatives for both parties when developing a negotiating strategy. If counsel pushes too hard in negotiations and the other party decides to seek a different contracting partner, the company will have expended time and resources that led to nothing, a situation that may lead to finger pointing and an unnecessary deterioration in the attorney-client relationship.

As counsel begins discussions regarding the scope of the assignment, he or she should be given the opportunity to review all of the documents and communications that the company has relating to the transaction, including letters and e-mail communications, internal memoranda and reports, charts, term sheets and any personal notes that might be useful in gaining a better understanding about the business background for the transaction. If the businesspeople have collected information typically requested at the due diligence stage, such as the other party’s financial statements, copies of that information should also be perused by counsel. This type of review will give counsel a good idea about the ground that has already been covered and the tone of communications between the parties. Counsel should also be able to gain a better understanding of the company’s business objectives. In addition, the review allows

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15 counsel to identify gaps in information about the proposed relationship and the legal and business condition of the other party that should be addressed—generally through additional due diligence—before the contract is finalized.

§16 Impact of proposed contract on existing obligations and relationships

In most cases, it is important to consider how a proposed transaction may impact certain existing obligations and business relationships of the company. Obviously, reference should be made to other contracts between the company and the opposite party in the transaction. In addition, however, it is important to contracts between the company and other parties in order to determine whether the new contract under consideration will conflict with the terms of any other agreements. For example, the company may have a distribution or license agreement with another party that restricts the ability of the company to appoint additional distributors or licensees for a particular market without the consent of the original party. In that situation, which is very common, counsel will need to assist the company by determining whether the proposed contract would, in fact, conflict with the prior agreement or whether it might be possible to structure the new contract to avoid the existing restrictions. In any event, once the general business terms of the proposed transaction are settled, or the main issues have at least been identified, counsel should collect copies of any existing contracts to which the company is a party that might be impacted by the subject matter of the new transaction. The main purpose of this review is to identify any potential violations of covenants already made by the company in other contracts and any approvals or consents of third parties that might be necessary in order for the new contract to be signed. In addition to the possibility that the new contract may conflict with existing distribution or license rights, counsel should focus on the impact that the transaction might have on affirmative and negative covenants included in financing agreements with investors and commercial lenders. Counsel should also review any internal policies and procedures of the company with respect to signature authority for a particular contract (see discussion of such policies and procedures below) to determine whether who has the authority to enter into the contract on behalf of the company. For example, the company’s policies and procedures may preclude a manager from executing a contract that creates a financial commitment for the company in excess of a specified amount without the consent of the chief executive officer or even the board of directors of the company.

The review of existing contracts also has other benefits to counsel in the documentation process. For example, contracts that have been negotiated with the opposite party can be used to gain a greater understanding of the pattern of dealing with the other party and the way in which the parties have addressed certain issues in the past. Obviously there is a risk that the company may be locked into accepting various positions because of the precedents in existing contracts, if for no other reason than the company does not want to expend time and resources on issues that have already been “settled” at the same time that discussions are going on with respect to new areas. On the other hand, if rules and

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16 procedures in existing contracts have created problems for the company, it may well be appropriate to take those up in the context of discussing a new deal. Another thing to consider at this stage is the impact that the proposed transaction might have on the company’s ability to enter into other contracts and business relationships in the future. Counsel should discuss the strategic importance of the new contract with the company and the possibility that the contract might somehow limit the company’s ability to launch certain initiatives at a later date as opportunities become available. The most common example of this type of problem is some sort of exclusive distribution or licensing arrangement which would prevent the company from appointing other distributors or licensees for a particular product and/or in a specific market as long as the contract is in place. While the grant of “exclusivity” may be necessary in order to induce the opposite party to take on the responsibility of distributing the company’s products or technology, it obviously makes it more difficult for the company to develop relationships with other parties if the original contract partner’s performance does not meet expectations. Counsel should assist the company in these situations by developing reasonable conditions that must be satisfied by the opposite party to retain exclusivity. In addition, the scope of the contract can be limited to specifically defined markets and/or products, thereby giving the company an opportunity to “grow out of the contract” and thus reduce the potentially adverse impact of exclusivity.

§17 Role of counsel in contracting process

It is absolutely essential that counsel and the company establish well in advance their mutual expectations regarding the role that counsel is expected to play in the negotiation, drafting, finalization and monitoring of a particular contact. In most cases, counsel should be responsible for drafting the contract and all related documents, including certificates and other documents that may need to be delivered at the time that the main contract is executed and the deal is “closed,” and for spotting and resolving specific legal issues. The company typically will be responsible for identifying and resolving all business issues associated with the contract and the underlying relationship; however, depending on the situation and the relationship between counsel and company it is not unheard of for counsel to become heavily involved in negotiation of business issues. In fact, senior in-house counsel (i.e., the general counsel) will often be considered to be a key member of the management team and thus will have a great deal of input into the strategy goals and objectives of a particular contract arrangement. Counsel’s role determines the level of active involvement that counsel may have in negotiations relating to the contract. In some cases, counsel may be present and active in almost all negotiating sessions; however, some companies prefer to take the opposite approach and limit the role of counsel to that of a scrivener working off of notes from periodic conversations with the company. In all situations where counsel is empowered to take some actions without the company being present, counsel should make sure that procedures are in place to promptly communicate any new development to the appropriate persons within the company. Absent this type of communication, and a clear delineation of responsibility between counsel and other company participants, counsel

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17 may find that responsible managers within the company are unhappy with the way the company is being represented. Moreover, lack of coordination increases the risk of embarrassing conflicts and misunderstanding that send the wrong message to the parties on the other side of the transaction.

Even if counsel is not expected to play a primary role in negotiating the terms of the contract, every effort should be made to notify counsel as soon as possible that the transaction is contemplated. Even if the key business terms of the contract have already been settled, early notification provides counsel with an opportunity to collect all necessary details in advance and make preparations for preparing or reviewing the contract on a timely basis. While businesspersons do not always do the best job of informing counsel in advance, even in the best of circumstances, counsel should always attempt to sensitize managers and other involved parties within the company to the possibility that unforeseen legal issues may emerge from a particular business decision. With that knowledge and understanding, businesspersons can be trained to always discuss business points with the caveat that a final decision will ultimately depend on review by counsel. For example, it is important to reserve the right to modify or re-address the agreed business terms in transactions that are based on certain assumptions regarding the anticipated tax consequences to one or both of the parties; transactions subject to complex regulatory schemes, such as securities, environmental or labor laws; and transactions as to which the underlying legal principles and case law are rapidly changing, such intellectual property or Internet law. As mentioned above, companies take different approaches to staffing the legal team for negotiating and documenting contractual relationships. For example, when the company has inside counsel, one or more members of the in-house legal team may be given primary responsibility for working on particular types of transactions. Depending on the size of the company, there may be in-house attorneys in companies with global operations that specialize in specific regions or countries as well as lawyers with expertise in particular compliance areas. However, even when the company has in-house counsel, outside counsel can effectively supplement their work. If the company does not have a large enough group of in-house lawyers to designate a specialist in a particular area, it will need to rely on its regular outside law firm to provide the necessary expertise from its own staff or through referrals. As companies grow and become involved in more and more transactions the role of the in-house legal department, particularly the general counsel or other senior manager of the legal function, becomes even more challenging. Certainly the primary duty of in-house counsel is to advise non-legal members of the business team about specific laws, regulations and cases that will impact how contracts are interpreted and enforced. However, the lead in-house attorney can offer significant value to the business by creating a new, albeit informal, position of “Chief Contractual Relations Officer” to fulfill the following duties and responsibilities:

Understanding and managing the company’s network of contractual relationships;

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18 Establishing and administering the company’s procedures for review and approval of

contractual relationships;

Establishing and administering the company’s procedures for execution of contracts;

Establishing and administering the company’s procedures for retention of records relating to its contractual relationships;

Establishing and administering compliance programs that ensure that the company is able to perform the legal and regulatory obligations assumed under its contracts;

Designing and implementing formal programs for educating managers and employees about reviewing and negotiating the terms of contractual relationships;

Developing procedures for continuously informing members of the senior management team about the alignment between the company’s strategic business plan and its network of contractual relationships;

Creating and continuously updating tools and procedures for making the contracting process more efficient and comfortable for internal clients;

Creating and administering formal processes for efficiently conducting and completing due diligence investigations required in connection with new contracts;

Establishing strong relationships with departments and business units to ensure that information regarding contract matters flows to and from the legal department;

Establishing credentials among other members of the management team—particularly the CEO, CFO and Senior Vice President of Sales—as to counsel’s knowledge of the business activities of the company;

Building reasonable expectations within the company regarding the time required to review proposed contracts and then, hopefully, meeting or exceeding those expectations without fail; and

Continuously striving to maintain an understanding of the larger environment within which the company operates and establishing and maintaining open communications with key players throughout the company.

§18 --Ethical considerations

Any attorney involved in the preparation of contracts and related documents, whether in-house or in private practice, must be mindful of various ethical issues and requirements established under state and national professional rules of conduct. First of all, counsel must act competently during the drafting process, which means that counsel must be knowledgeable in each of the legal subject matters pertaining to the contract or, if not, ensure that he or she associates with counsel that has the requisite qualifications. Second, counsel must determine with whom he or she has the attorney-client relationship and ensure that all actual or potential conflicts of interest are disclosed and waived. This issue is specifically relevant to outside attorneys and should be addressed at the time an engagement letter is signed for representation in a particular contracting matter. Third, while counsel owes a duty of loyalty to his or her client and generally is required to follow the wishes of the client in preparing the contract, counsel should avoid advocating provisions that are fraudulent, unfair, unconscionable or that would otherwise jeopardize the enforceability of the entire contract. Finally, counsel should be mindful of the requirements that must be satisfied in order to assert the attorney-client privilege with

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19 respect to sensitive communications that may have occurred during course of negotiating and drafting the contract. §19 ----Competency

As mentioned above, many contracts and transactions turn on how they will be evaluated under specialized laws and regulations, particularly in the tax and securities area. While counsel may be competent to understand and record the desired business outcome of the transaction, he or she may lack the expertise to fully understand the often detailed regulations that may apply when the arrangement is ultimately scrutinized by the Internal Revenue Service or the Securities and Exchange Commission. Accordingly, counsel should advise the company in advance that the contract, or at least certain provisions included therein, will need to be reviewed by a tax or securities expert. In many cases, specific contractual language may be suggested to ensure that the contract fits within precedents established by earlier regulatory agency opinions or applicable case law. §20 ----Identifying the client and resolving conflicts of interest

While it may be self-evident, counsel should always make it clear at the outset who he or she views as the client with respect to a particular contract and counsel should determine from whom he or she will expect and take direction in the negotiation and drafting process. In most cases, it will be clear that counsel is representing a particular business entity, such as a corporation, when the contract is with another unrelated entity. In that situation, counsel must simply be sure that the instructions he or she is receiving are those of the key decision maker at the company and that the signatory is in fact authorized to bind the company to the terms of the contract. When outside counsel is involved, these matters should be addressed in the engagement letter. When counsel is an in-house attorney the communications channels should be documented in an internal memorandum, which can be a simple e-mail message, and signature authority should be verified by referring to the appropriate policies and procedures. The more complicated situation is when counsel has been asked to prepare a contract for the benefit of multiple parties related to the company, such as a buy-sell, partnership or shareholders’ agreement. In most cases, the sensitivity of the issues and the specialized legal questions dictate that outside counsel should be engaged. In that case, counsel must carefully explain the conflicts of interest that might arise, advise the parties about their right to obtain independent counsel, obtain written waivers of any actual or potential conflicts and make sure that the parties understand that counsel may withdraw altogether in the event a dispute arises among the parties. Finally, as necessary, counsel must provide advance written notice if he or she has an interest in the subject matter of the transaction or has a relationship with another party to the transaction or with a party that has an interest in the subject matter of the transaction. This includes, for example, disclosure of the fact that counsel (or any attorney practicing in the same law firm) may have represented the opposite party on another matter, even though unrelated to the contract at hand. In such cases the company may be more

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20 comfortable using another outside lawyer for the particular contract even though that choice may be more expensive given the need to educate the new lawyer about aspects of the company’s business that are already known to the attorney with the prior relationship to the other party in the transaction. If the company decides to move forward regardless of the attorney’s interest in the subject matter or relationship with another party to the transaction a written record should be made of the attorney’s disclosures and informed decision by the company regarding choice of counsel. §21 ----Use of fraudulent and unfair contractual provisions

Counsel must obviously avoid inserting contractual provisions that are patently illegal or unconstitutional. In addition, however, counsel must take care not to insert provisions that a court is likely to find to be egregiously unfair or unconscionable. Failure to draft a contract that is fair, albeit tough if dictated by the relative leverage of the parties, may have several dire consequences to the contract and on drafting counsel. First and foremost, counsel runs the risk that a court may decline to enforce the entire contract, thereby depriving the company of one of the key goals and purposes of the contracting process. Second, “tough knuckles” drafting and negotiation, while often an attractive strategy for a particular client at a given time, may undermine the collegiality and professionalism necessary to complete the contracting process and usually will cause opposing counsel to request additional protections or contest other provisions in the contract. Finally, insistence on unreasonable and overreaching contract provisions can establish the wrong tone for the business relationship described in the contract and undermine the spirit of mutual trust necessary for the relationship to succeed. In fact, by pushing too hard during negotiations, counsel may ultimately drive such a wedge between the parties that it becomes impossible for the contract to be completed. If, despite all of the foregoing, a businessperson insists on a particular provision, counsel should make a written record of his or her attempts to explain the risks associated with inserting the clause in the document. §22 --Preserving the attorney-client privilege

The attorney-client privilege is generally an important and crucial issue in the context of litigation.60 However, the privilege may also be applicable to communications that occur

60 Common law principles will govern the rules of privilege when the Federal Rules of Evidence are applicable and federal courts have been able to develop privilege rules on a case-by-case basis. See Trammel v. United States, 445 U.S. 40 (1980). In the federal courts the following conditions must be satisfied in order for the attorney-client privilege to be applicable: (1) the asserted holder of the privilege is or sought to become a company; (2) the person to whom the communication was made (a) is a member of the bar of a court, or his subordinate and (b) in connection with this communication is acting as a lawyer; (3) the communication relates to a fact of which the attorney was informed (a) by his company (b) without the presence of strangers (c) for the purpose of securing primarily either (i) an opinion on law or (ii) legal services or (iii) assistance in some legal proceeding, and not (d) for the purpose of committing a crime or tort; and (4) the privilege has been (a) claimed and (b) not waived by the company. See United States v. United Shoe Machinery Co., 89 F. Supp. 357, 358-59 (D. Mass. 1950). State law approaches to the attorney-client privilege vary and reference should be made to specific state laws. For example, the attorney-client privilege in state courts in California is dictated by statutory provisions and courts are not allowed to add to the statutory privileges except as required by state or federal constitutional law and

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21 between attorney and client with respect to a business transaction, but companies and their lawyers should not assume that attorney involvement in a transaction will in and of itself be sufficient to assure that a privilege can be asserted to preserve the confidentiality of all communications relating to the transaction. In general, the value and availability of the attorney-client privilege in the transactional context will depend on the degree to which the attorney’s role expanded beyond that of a legal advisor to include negotiation of the actual business terms and conditions of the deal. Since it is quite common for lawyers to provide their clients with both legal and business advice, often as part of the same communication (i.e., telephone call, e-mail message or written memorandum), it is essential for transactional lawyers to thoroughly understand the potential restrictions on the applicability of the privilege and explain the guidelines in advance to clients so that they are not surprised to later learn that communications they believed would be secret are instead subject to discovery if litigation regarding the transaction commences. The general test as to whether or not a communication involving a transactional lawyer will be eligible for protection under the attorney-client privilege is whether or not the pre-dominant purpose of the communication is to convey non-legal advice from the lawyer to the company. If the dominant purpose of a conference call or written communication is for the lawyer to provide input on business terms and conditions or negotiation strategies the communication will likely not be eligible for protection under the privilege. Certainly many transactional lawyers are engaged, at least in part, for their skills and experience in negotiating and completing specific types of deals and this inevitably leads to attorney input on business matters. The difficult issue that arises in that situation is how to handle “dual purpose” communications (e.g., single documents or other communications that include both legal and business advice). The basic rule seems to be that courts will likely permit assertion of the privilege for this type of communication if advice provided by the lawyer therein is based predominantly on the attorney’s evaluation of legal issues.61 It will be more difficult, if not impossible, to assert privilege in situations where the attorney serves solely as a negotiator in the course of a particular transaction or engages in other activities that would typically be carried out by a businessperson rather than an attorney.62 Whether or not the services provided by the attorney are primarily legal in nature will also determine if notes, mental impressions and legal analyses and conclusions prepared by the attorney during the course of a transaction can protected from disclosure through the assertion of the work product doctrine. For example, where an attorney acting on behalf of a client in a commercial transaction merely conveys the client's position to a contracting party there is no justification for protecting the attorney's notes concerning the conversation and applying the privilege in such a situation would

cannot imply unwritten exceptions to existing statutory privileges. See Roberts v. City of Palmdale, 5 Cal. 4th 363 (1993). The general statutory rule regarding attorney-client privilege in California is laid out in Ca Evid C § 954, which states that the client, whether or not a party, has a privilege to refuse to disclose, and to prevent another from disclosing, a confidential communication between client and lawyer. Confidential communication for purposes of the privilege includes "a legal opinion formed and the advice given by the lawyer in the course of that [attorney-client] relationship." See 2002 Ranch v. Superior Court, 113 Cal. App. 4th 1377 (2004). 61 See, e.g., Note Funding Corp. v. Bobian Investment Co., No. 93 Civ. 7427, 1995 WL 662402. 62 See, e.g., Georgia-Pacific Corp. v. GAF Roofing Mfg. Corp., 1995 WL 378532 (S.D.N.Y. 1995); MSF Holdings, Ltd. v. Fiduciary Trust Co. Int’l, No. 03 Civ. 1818, 2005 WL 3338510 (S.D.N.Y. Dec. 7, 2005).

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22 have the effect of placing a premium upon use of attorneys as business agents, non-attorneys or clients acting for themselves having no such right to protect their notes.63 Obviously in-house counsel are subject to special challenges with respect to any attempt that might be made to assert the attorney-client privilege with respect to communications between counsel and executives and managers within the organizational client relating to a proposed business transaction. Courts have recognized that in-house counsel often serve a very different role from transactional attorneys with outside law firms that may be engaged for the sole purpose of provide legal support for a specific transaction and that in-house counsel often serve also as corporate officers and engage in day-to-day activities within the company that necessarily cross the boundary that separates law and business. Given the permanency of the relationship between in-house counsel and his or her employer and the exposure to and participation in business activities in-house counsel should expect that a much more stringent standard will be applied by the courts before protecting communications by counsel during a transaction under the attorney-client privilege.64 Another issue that often arises when the attorney-client privilege is asserted with respect to sensitive information that has been shared with the other party to a prospective business transaction is whether or not the disclosure to the other party destroys the disclosing party’s right to later assert the privilege with respect to such information in a litigation setting. The potential dilemma for the disclosing party is deciding whether to disclose the information, and possibly lose the privilege, in order to pursue the potential business transaction or refusing the disclose the information to preserve the privilege and risking that the other party to the transaction will refuse to proceed since it cannot access valuable information that it deems necessary to make a decision about the proposed transaction. The law of each state should be evaluated; however, much of the uncertainty in this area under California law was resolved in STI Outdoor v. Superior Court65 where the court of appeal made it clear that the attorney-client privilege associated with confidential communications was not automatically waived by disclosure of the communications during business negotiations and that the privilege would be available provided that the disclosing party could demonstrate that the communications were otherwise eligible for the privilege, there was a reasonable expectation that the communications would be maintained in confidence, and it was reasonably necessary to disclose the communications in order to accomplish the purpose for which the lawyer was consulted. Given the inevitable dual role that transactional attorneys, both in-house and from outside law firms, generally play in assisting with negotiating and documenting a deal it is essential to understand and follow certain basic guidelines so that there is a greater likelihood that privilege can be successfully asserted if desired and that companies fully understand the risk and likelihood that sensitive communications may ultimately be disclosed in future litigation. Suggestions include the following:

63 See, e.g., Watts Industries, Inc. v. Superior Court, 171 Cal. Rptr. 503 (Cal. Ct. App. 1981). 64 See, e.g., Rossi v. Blue Cross and Blue Shield of Greater New York, 73 N.Y.2d 588 (N.Y. 1989). 65 91 Cal. App. 4th 334 (2001).

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23

Determine which state law regarding attorney-client privilege is likely to apply to the particular transaction and analyze the applicable case law to identify the likely boundaries of the privilege and the work product doctrine that will be established by the courts in that state. The choices made in the transaction documentation with respect to governing law and forum selection will likely have a significant impact on defining the relevant legal landscape.

Communicate with the company before the transactional engagement begins regarding the scope of advice that the company is seeking and the purposes for which the company intends to use that advice. Once these communications are completed ensure that any engagement letters are carefully prepared to emphasize (if true) that the primary purpose of the engagement is to provide the company with legal advice.

During the preliminary communications and prior to execution of the engagement letter ensure that the company has been formally advised and warned about the possibility that the attorney-client privilege may not be available to protect sensitive communications in the event that litigation regarding the transactions arises at some point in the future. This is particularly important when the company has asked the attorney to actively participate in business negotiations during the course of the transaction.

Attempt to carefully plan every communication with the company to avoid unnecessary mixing of legal and business advice that might adversely impact the availability of the attorney-client privilege for the communication in the future.

Avoid inadvertent or simply clumsy use of the assertion of privilege that may later be used to deny the privilege to all communications including those that might otherwise qualify for protection. For example, the common practice of affixing “attorney-client privileged” legends on all communications should be avoided and this practice should be limited to truly sensitive communications that include content that would clearly fall within the permitted scope of the privilege (i.e., legal advice).

Carefully monitor participation in meetings and other streams of communication in which both business and legal matters are discussed and consider breaking those discussions out separately so that a clearer line can be drawn between privileged and unprivileged communications.

Before disclosing confidential communications to other parties make absolutely sure that the recipients have signing a confidentiality, nondisclosure, or joint defense agreement that includes specific and comprehensive restrictions on disclosure and use of the information in the communications. Whenever possible, disclosure should be limited to those with a real “need-to-know” and a record of how the information was used by the receiving party should be created and maintained.

Information disclosed to other parties involved in a proposed transaction should be strictly limited to that which is reasonably necessary for the attorney to accomplish the purpose for which he or she was retained. All such information should be prominently marked with legends that make it clear that the disclosing party intends to assert that it is confidential, attorney-client privileged, or joint-defense privileged. A privilege log should be created for the communications for which protection will be asserted and declarations should also be prepared to demonstrate that the disclosures

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24 were reasonably necessary in order to accomplish the purpose for which counsel was consulted.

§23 Contract review and signature authority procedures One of the most important elements of the control environment is any business is the establishment and use of formal policies and procedures for reviewing and approving contractual arrangements with third parties that will create legal rights and obligations for the company.66 Ideally some sort of contract review and signature authority policy will be put in place very early in the company’s existence since contracts of various types will be needed from the time that the company first opens its doors. Many times all of the contracts under consideration during the start-up phase will be discussed by all of the founders because it easy to do so in light of their close proximity and the absence of layers of management personnel when the company is still small. The problems begin to arise, however, when founders and other senior managers start to assume more responsibility for particular areas of the business and the input from other founders and managers becomes more limited due to the lack of time, problems with communication and the fact that the other persons are themselves preoccupied with their own projects. At that point, some degree of delegation for decisions regarding contracts is necessary; however, delegation must be accompanied by reasonable reporting and review procedures that ensure that the company’s contracts are aligned with its business strategy. While the senior managers in a particular functional or business area presumably have the most skill and experience with respect to contracts that they initiate it is nonetheless important to have some independent review of the business case for the contract and the potential risks to the company of assuming the legal and operational obligations included in the contract. For example, all functional areas that might be involved in fulfilling the company’s duties under the contract should be consulted in advance to verify that they will be able to perform as anticipated. Contract review is also necessary to avoid conflicts with commitments that someone else in the company may have already made with other parties. In addition, contract review is needed to be sure that independent parties are reviewing the terms of each proposed transaction and that persons within the company that may be initiating a contract do not have some “vested interest” in the selection and use of the contract partner. Finally, the company’s ability to establish and maintain an effective records retention program obviously requires formal rules and processes for the creation and administration of contracts that include guidelines for collection and categorization of records that memorialize the duties and rights of the company under contracts to which it is a party. §24 --Purposes

Procedures for contract review and signature authority should accomplish at least two main purposes—establish the process for the review and approval of proposed contracts

66 For further discussion of the control environment, see “Elements of Effective Compliance Programs” in “Compliance: A Library of Resources for Sustainable Entrepreneurs” prepared and distributed by the Sustainable Entrepreneurship Project (www.seproject.org).

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25 by various departments (e.g., legal, finance and other departments involved in the fulfillment of obligations created under the contract) and identifying which persons within the company have the authority to approved specified transactions or activities and thus execute a proposed contract on behalf of the company. Ideally the contract review process will also provide an opportunity for evaluating the proposed contract in the context of the company’s overall business strategy. This can and should occur through the creation of a business case for each proposed contractual arrangement (or at least those contracts that are “material” in light of the company’s business) that describes the key rewards and risks associated with the contract, explains why the contract is important to the company’s business plan, establishes performance milestones, and suggests procedures for monitoring performance under the contract after it is executed. The business case process forces the initiating party to think through each proposed contract and become an informed internal champion for the relationship and also serves as an important information and communication tool for senior management to the extent that they are being kept in the loop as to the specific activities and tactics that are being used to further the company strategy that has been established at the top of the hierarchy. Creating signature authority, including delegation of authority downward in the organizational structure of the company, is particularly important as the business grows and the company adds management layers and the number of employees multiplies. When the company is small almost all new contracts should be signed only by the president or chief executive officer of the company after review by the senior managers responsible for the departments that will be involved in fulfilling the company’s obligations under the contract. As time goes by, however, authority to sign contracts can and should be formally delegated by the president and chief executive officer to competent officers and managers within the company subject to specific conditions and limitations defined in the delegation instructions. In all cases, for example, authority to sign contracts should be conditioned upon creation of a written record that all steps in the review process have been completed (e.g., review and approval by other interested departments). Delegation of authority is generally limited to contracts that do not create a financial exposure for the company that exceeds specified amounts. For example, a department manager may be allowed to commit the company to provide cash or services up to $50,000; however, any commitment above that amount would need to be reviewed and executed by someone more senior in the hierarchy. Business relationships with third parties based on “standard contracts” that have been drafted by the company’s legal department may also get “fast track” treatment and not require separate review by the legal department. Managers may also be given more leeway to enter contracts that have been previously anticipated in the business plan and budget for their particular department provided that the managers have complied with other requirements with respect to solicitation of bids and proposals for contracting. §25 --Administrative responsibility

Assuming that the company is large enough to have formed an in-house legal team it is recommended that the legal department be given the primary responsibility for preparing and administering the policies and procedures for review and execution of contracts. In-

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26 house lawyers are generally in the best position to communicate with other departments that will be involved in the performance of the contract and, of course, they can readily provide the legal expertise necessary to prepare binding and enforceable contracts and advise the other internal stakeholders of the legal risks associated with particular provisions. While in-house lawyers may outsource some of the legal work to attorneys in private practice those outside attorneys should not be directly involved in the flow of a contract through the mandated review and approval processes. If the company does not have an in-house lawyer contract review should be assigned to one of the members of the senior executive team, such as the chief financial or operating officer, and the executive may recruit a contract administrator to keep track of all the approvals and other requirements described below. §26 --Scope of contracts covered by procedures

While lawyers should be quite familiar with the requirements for formation of an enforceable contract they should not overlook the fact that the concept of a “contract” is not all that well known to the other non-lawyer parties subject to the contract review and approval policies and procedures—the officers, managers and other employees of the company. Accordingly, the policy itself, as well as training sessions presented to introduce the policy and educate everyone how it should be used, must include a description of what a “contract” is and how it can be created. A short primer on capacity to contract, consideration and lawful subject matter can be presented; however, the most important thing to emphasize to non-lawyers is that representatives of the company that have “apparent authority” in the eyes of outsiders can bind the company to legally enforceable duties and obligations even though they have not complied with the internal procedures for review and approval of a contractual obligation. For example, if a senior sales manager with the title of “branch manager” or “regional vice president” signs and delivers a document to a customer that describes the terms upon which certain goods will be sold and delivered to the customer the recipient of the document would be entitled as a matter of law to assume that it is in possession of a legally binding contract even if the sales manager failed to comply with the company’s own internal contract review and signature authority procedures. The bottom line is that officers, managers and other employees need to exercise extreme caution not to take any action that might create a reasonable expectation in the mind of another party that the company is willing to be legally bound to perform specified obligations. When preparing the policy it is important to identify the contractual obligations commonly encountered in the course of the regular business activities of the company and consider what specific steps should be taken to review and approve those types of contracts. This generally means thinking about the best way to deal with all or most of the following general categories of contracts:

Agreements for the purchase or sale of goods;

Agreements to provide or obtain services;

Nondisclosure agreements;

Leases of personal property, including equipment, furniture and vehicles;

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27 Leases, deeds, and other conveyances affecting interests in real property;

Promissory notes and other instruments relating to the payment of money, including security agreements and guarantees;

Liability waivers and releases;

Settlements of disputes;

Software licenses;

Maintenance agreements;

Memoranda or letters of understanding or cooperation;

Contracts with facilities that require a written agreement; and

Employment contracts. §27 --Forms of policies and procedures

As companies get larger and the scope of possible contracts expands they opt for a fairly comprehensive form of contract review and signature authority policy. Such a policy might cover the following areas:

Overview of the contracting procedures;

Responsibilities of parties initiating contracts;

Requirements regarding formal bidding procedures (i.e., requests for proposals);

Subject matter and funding approvals;

Legal department approval;

Risk management issues including use of insurance and indemnification provisions;

Time frames for review and approval process;

Contracting authority;

Board of directors’ actions and documents evidencing board actions;

Processing of funding requirements for contracts;

Retention of contracts and recordkeeping requirements; and

Contract administration and performance review. Companies and non-profit organizations may choose from a variety of other alternatives when creating and implementing policies and procedures relating to contract review. For example, a university or hospital may emphasize the use of standardized contracts and create escalating approval requirements based on the dollar amount of the commitment created by a particular contract. While standardized contracts prepared by the university or hospital legal and business affairs departments are strongly recommended, non-standardized contracts (i.e., contracts prepared and submitted by potential vendors and other business partners) may be used if they are amended to include certain “required” contract provisions and have been thoroughly reviewed and analyzed using a detailed contract review checklist. For-profit companies may use a policy that focuses on providing readers with a clear flow of the steps that need to be taken in order to complete the appropriate level of review for a proposed contract and the procedures for having the contract executed and delivered for safekeeping as required under the terms of the company’s records retention policies and

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28 procedures. In general, any person needing a contract should first determine who has the authority to sign the particular type of contract by referring to the then-current delegation of authority promulgated by the president and chief executive officer of the company. Once the person needing a contract has determined who has the authority to sign the particular type of contract a determination should be made as to whether the signing party has his or her own requirements with respect to contracts that are to be entered into by a specific department or unit of the company. These requirements would be in addition to requirements that are established in any delegation of authority and would typically be designed to ensure that a contract fulfills the goals and objectives of the department or unit, that funds are available and have been properly encumbered, and that other resources necessary for the completion of the contract will be available. Among other things, a determination should be made as to whether or not the subject matter of the contract requires completion of any company requirements relating to use of a formal bidding process. In the event that bidding is required, the person needing a contract should work with all the departments involved in implementation of the proposed to contract to develop a comprehensive request-for-proposal. §28 --Responsibilities of sponsoring parties

The person needing a contract and the person who has the authority to sign the particular type of contract, referred to in this discussion as the “sponsoring parties”, should determine what, if any, additional approvals may be required before the signing party is permitted to execute the contract. Depending on the circumstances, a particular contract may require as many as three separate types of approval, including subject matter approval (i.e., approvals must be obtained from all departments that will be involved in the fulfillment of the obligations of the company under a particular contract), funding approval (i.e., approvals from senior management and finance department because of the amount of money involved in fulfilling the company’s obligations under the contract) and legal approval. The sponsoring parties should prepare a business case relating to the proposed contract and present it to the president, chief executive officer or any officer who has been delegated authority to review and approve a business case. Among other things the process of review and approval of the business case should include identification of required subject matter, funding and legal approvals. The sponsoring parties should consult with all departments that would be involved in the fulfillment of obligations under any contract covered by the business case to identify material issues and concerns that should be addressed during the contract negotiation and drafting process. Once the business case has been approved a copy should be submitted to the legal department along a list of departments from which approvals of the contract will be sought. As a general rule, approvals must be obtained from all departments that will be involved in the fulfillment of the obligations of the company under a particular contract (i.e., the “subject matter approvals” referred to above). The policy should emphasize that contract review is much more than simply following a series of formal steps and procedures and it is essential that all officers, managers and employees initiating a contract be held personally responsible for reviewing and understanding the proposed terms of the contract and ensuring that appropriate insurance

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29 requirements and indemnification provisions are included therein. In addition, every effort should be made to remove undue pressure from the review process and persons initiating a new contract should allow sufficient lead time to allow for completion of any required review and approval process described in the policy. In many cases a complex contract may require several months of negotiation and preparation and departments that may be impacted by a contract should be notified well in advance of the expected start date for the contract. As a general rule, six to eight weeks should be set aside for legal review and review by other departments. Once the sponsoring parties have received an initial draft of the contract they should review the contract to determine whether it conforms to any specific requirements included in the approved business case. If there is a conflict between the contract terms and the business case the sponsoring parties should attempt to resolve those conflicts with the other party before a draft of the contract is circulated to other departments for subject matter approval. Once the sponsoring parties have a draft of the contract that they wish to circulate for subject matter approval it should be submitted to the legal department for review and circulation. The legal department should circulate the contract to all involved departments for subject matter review and approval and will collect comments from all departments; however, the sponsoring parties remain primarily responsible for ensuring that all departments respond on a timely basis. The legal department should collect and consolidate all comments and transmit them to the sponsoring parties for review and further action. The sponsoring parties should be primarily responsible for reviewing and clearing all comments received from other departments through consultation with those departments and with the other party. The sponsoring parties should arrange for a revised contract and will provide an explanation in writing to the legal department of how each of the comments has been cleared. The legal department should circulate the revised contract and explanation to all departments and request their review and approval. In the event that comments remain outstanding after the process described above has been completed the sponsoring parties and the parties responsible for the outstanding comments should meet with the president and chief executive officer (or the officer to whom they have delegated authority with respect to such contract) to determine what action the company should take with respect to the contract on the terms offered and a written record of the decision should be prepared and transmitted to the legal department. §29 --Execution and retention of contracts

If, after following the procedures described above, the person authorized to sign the contract has determined that company should enter into the contract the sponsoring parties should transmit a final version of the contract to the legal department. The legal department will review the document and if it fulfills the requirements of these procedures will arrange for the contract to be signed and transmitted to the other party. As a general rule, prior to the execution of any contract by any manager, employee or other agent of company, there should be approval as to legal form and validity by the legal department. When the approval of the legal department is required, it must

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30 determine that: the contract does not violate any law, regulation or company policy, or conflict with any other contractual obligation of company; the individual signing it has the authority to do so; and any risk management concerns associated with the proposed contract have been considered by the signing party. When required, the approval of the legal department should be endorsed on the contract. All signed contracts should be maintained and managed in accordance with the company’s contract retention and administration requirements which should include maintenance of a contract log and regular reports to the senior executives of the company regarding contracts completed and signed since the date of the last prior report. Arrangements should also be made for storage or disposal of supporting and background materials relating to the contract including interim drafts and e-mail and other written communications that include information on the negotiation of the terms of the contract. In addition, the person signing the contract should maintain a copy of the contract for consultation during the contract term and a copy of the signed contract should also be disseminated to authorized persons in each department responsible for performing activities on behalf of the company under the terms of the contract.67 §30 --Training and education

The written contract review policy and procedures should be supplemented by training and educational programs that actively impress upon officers, managers and employees the importance of the procedures and provide those persons with the information necessary to easily and efficiently complete the process so as to not unduly slow the pace of business. Among other things the legal department can draft and disseminate a short memorandum that highlights the basic steps that a person initiating a new contract would need to take in order to obtain approval. In addition, annotated copies of commonly used contracts can be prepared and circulated to provide non-lawyers with a reference point to understanding the business and legal issues involved with particular provisions in the contract and these written tools can be used as a foundation for “live” training. In order for the contract review policy and procedures to become truly effective the legal department must be prepared to invest time and effort at the very beginning to sit down with businesspersons and walk them through the contractual language.

§31 Time and responsibility schedule

While usually not necessary when the transaction involves a single contract, a relatively straightforward schedule and deadline, complex transactions in which multiple documents must be prepared and several parties and their counsel are involved in the review process generally will proceed more smoothly if a time and responsibility schedule is put in place at an early stage. In general, this type of schedule identified all the documents necessary to complete the transaction and establishes the most efficient path for making sure that the documents are drafted, reviewed and finalized in advance of

67 For further discussion of contract retention and disposal, see “Records Retention” in “Compliance: A Library of Resources for Sustainable Entrepreneurs” prepared and distributed by the Sustainable Entrepreneurship Project (www.seproject.org).

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31 the desired closing date. In many cases, the schedule is mapped out by first identifying the closing date and then working backward to the point where the schedule is being prepared; however, the parties may obviously take the opposite approach, particularly when some mandatory period of regulatory review must be factored into the schedule. For example, if for business reasons the parties would like to close a transaction by the end of the year and it is known that regulatory review will likely require 75 to 90 days, a five month schedule should probably be used with document preparation occurring before regulatory review and a certain amount of time left for closing preparation after regulatory approval is obtained. The time and responsibility schedule should list every contract that will be required to complete the transaction, as well as every other document that will need to be prepared or procured (e.g., certification of governmental approval, closing certificates, and reports or opinions from third parties). With respect to each contract and other document, the following information should also be included:

The person responsible for preparation of the document or obtaining the document third parties (e.g., governmental agencies);

The parties who must have an opportunity to review and approve the document, including identification of all parties required to execute the document;

The target date for completion and circulation of the initial draft of the document for review and comment;

The target date for receipt of all comments on the initial draft of the document; and

The target date for finalization of the document incorporate all comments received during the review process.

The parties may, if necessary, schedule “all hands” meetings in person or via conference call to exchange comments, negotiate differences and resolve all open items at various points in the process and the dates, times and locations of such meetings or conferences should be included in the time and responsibility schedule. Other key processes, notably the due diligence investigation, should also be integrated into the schedule. While the Internet, and e-mail distribution of documents has essentially revolutionized the contracting process in the last decade, it is nonetheless useful to include contact information for all parties as part of the schedule. Required information includes the names of all parties to the transaction; mailing address; e-mail address; telephone numbers; fax numbers; and home addresses for use when delivery of hard copies in time-sensitive matters might be required outside of normal business days. When preparing the time and responsibility schedule, consideration should be given to the need to include comments and opinions from other professional advisors, such as accountants, financial advisors and attorneys providing limited advice in specialized areas (e.g., tax). Since the parties may not be involved in all aspects of the transaction, it is important to contact them in advance to determine their availability during the drafting period and avoid the possibility that they may not be able to respond as quickly as the principals to the transaction and their respective counsel.

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32

§32 Due diligence As some point during the contract preparation process, generally after the completion of preliminary negotiations and agreement on the basic terms of the transaction, the parties will conduct an appropriate investigation of the other party's business and legal affairs. Referred to as a due diligence investigation, this exercise allows the parties and their respective legal teams to independently verify the information about the other party's business that has been provided to them and confirm that the other party has the legal right and authority to perform its projected obligations under the proposed contract. In many cases, satisfactory completion of the due diligence investigation is made an explicit condition to the closing of the transaction. The concept of due diligence is a creation of law and common sense. There really is no good or authoritative definition of the term, and the appropriate scope of the due diligence investigation will vary from transaction to transaction based on various factors such as the subject matter, the level of risk and uncertainty and the strategic importance of the contract to the party conducting the investigation. For example, when the transaction is a purchase and sale of a business the due diligence investigation will focus on evaluating the accuracy and sufficiency of the representations and warranties made by the other party to the transaction. From the buyer's perspective, emphasis will be placed on those factors which are relevant to determining the appropriate purchase price to be paid in the transaction; however, other benefits to the buyer from conducting the investigation include:

Assisting the buyer in evaluating its obligations under the acquisition agreement by identifying and assessing the obligations, liabilities, and risks it is assuming;

Developing the buyer's understanding of the seller's business and helping the buyer determine the appropriateness and necessity for the representations and warranties from the seller in the definitive purchase agreement, as well as the necessity for certain closing conditions and indemnification;

Confirming that the buyer will be acquiring a business in the form represented by the seller;

Identifying any unusual business problems that need to be dealt with specifically in the transactional documents, in addition to those that need to be addressed prior to closing;

Identifying potential contractual and other legal obstacles to closing the transaction;

Providing a factual basis for the legal opinions from seller's counsel; and

Identifying housekeeping items for the seller that need to be attended to prior to offering the seller's company for sale (i.e., updating corporate minute books and attending to any stock issuance problems with employees).

As for the seller, one of the key objectives of its due diligence investigation will be to validate the intrinsic value of the business for purposes of evaluating the offer which might be made by the buyer. In addition, the seller will have an interest in examining the business practices and creditworthiness of the buyer, particularly when managers and/or

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33 employees of the seller will be employed by the buyer following the transaction and/or when the consideration to be paid consists of ownership interests in the buyer. Particularly in transactions involving sophisticated business partners, it is generally assumed that the participants will rigorously test each factual assumption deemed material to the ultimate success of the transaction. The time for that investigation is prior to the completion of the transaction, even though post-closing remedies are available as a matter of law and are often included as part of the transactional documents. The scope and timing of the due diligence investigation should be mutually agreed upon by the parties as early as possible and counsel should be involved in that process by providing the businesspersons with an assessment of what information will be required from a legal perspective. Additional non-legal information, such as financial statements and detailed historical data on key items such as sales and expenses, will also be collected and representatives of all departments with an interest in the transaction should advise the company managers responsible for the contract as to what information should be requested in order for those departments to fully analyze the terms and conditions and the proposed contractual language. A due diligence investigation involves several methods for collecting and analyzing information. Typically the investigation includes a request for documents; the completion of one or more reports relating to the business areas which are most relevant to the legal issues under investigation; a search of the other party's files; and interviews with officers, employees, professional advisors, and business partners. The backbone of every due diligence investigation is a set of lists and forms that can be used to collect the necessary information. The lists and forms should be designed to obtain comprehensive legal and business information about the business units of the party being reviewed; gather information as quickly as possible; and maintain the attorney-client privilege with respect to the information obtained or generated. The lists and forms are generally divided into the various functional topics which will be covered in the investigation. Each list or form should be accompanied by instructions that guide the investigator, respondent, or reviewer. Each of the parties should also develop their own formal written investigation plan for completion of their due diligence review. A written plan can expedite the review by setting deadlines for collecting the necessary information. While the original investigation plan should be set out in writing, it should be flexible enough for further revisions once the investigation has begun. Among the items that might be covered in the plan are a definition of the areas of inquiry, as well as the scope of the investigation; a schedule to be followed for completion of the investigation; the persons who will assume responsibility for each area of the investigation; the documents to be collected and reviewed; the persons who will be interviewed; and the form of any report which will be rendered on the results of the investigation. The conduct of the due diligence investigation requires a good deal of patience and coordination among the various participants. Any areas of concern should be highlighted early in the process, and the participants should each clearly understand the goals of the investigation, as well as the time and expenditures involved.

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34 Companies have several options when they put together a due diligence investigation team. In certain circumstances, the company will turn to an outside law firm for assistance. But, as the company grows and builds its own in-house legal staff, investigation responsibility may be turned over to the general counsel's office, with help from various operational and financial managers within the company. Regardless of how the investigation team is staffed it is important to make sure that persons serving on the team have substantial familiarity with the legal areas involved so that the investigation can be conducted efficiently and legal strategy decisions can be made quickly as they arise during the course of the investigation so that the timetable for the entire transaction is not adversely impacted. Communication between the members of the investigation team and the relevant businesspeople within the company is also an important consideration and procedures should be established to ensure that businesspeople are promptly advised of unforeseen issues and problems that may arise as the investigation proceeds. When staffing the investigation team members should be chosen for their ability to interact comfortably with the managers and employees of the other party. In many cases the interviews done during the due diligence investigation provide valuable insights into the skills and level of integrity of those persons working for the other party who will be most responsible for administering the contract after it is signed. Assuming that the due diligence investigation is conducted in-house the due diligence team might include a lead attorney reporting directly to senior managers within the company; topic managers; and a document manager. The lead attorney would be responsible for coordinating the investigation and should be available to provide guidance to each topic manager and the document manager. The lead attorney will be the principle liaison with senior managers of the company and should be able to provide managers with daily reports regarding the progress of the investigation and special issues uncovered during the course of collecting and reviewing the information. Each topic manager will be assigned one or more of the functional topics to be covered as part of the investigation. Topic managers may be in-house attorneys, corporate managers, or other agents of the company. Each topic manager will report directly to the lead attorney heading the due diligence team. Each topic manager is responsible for collecting and reviewing all information from the other party on the assigned topic(s). Finally, the document manager, who reports to the lead attorney is responsible for collecting, organizing, maintaining, and controlling access to the documents collected and generated in the course of the due diligence investigation. §33 Contract drafting

Once counsel has had an opportunity to collect and review all the information relating to the business background for the proposed contract or transaction and the parties have agreed on a reasonable timetable for completing all of the work necessary for the transaction to be completed, it is time to turn to the difficult task of actually preparing the initial draft of the contract and any related documents necessary to consummate the transaction. The challenges associated with this activity will depend on a variety of factors, including counsel’s experience with the type of contract or transaction, counsel’s

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35 familiarity with the goals and objectives of the company, prior business dealings between the parties on the subject matter of the contract, and the extent of counsel’s direct involvement in the negotiation process. Any “industry norms” must also be taken into account in the drafting process since there may be advantages to simply incorporating contract language that has been vetted by comparable firms and the counsel in the course of preparing standard agreements. For example, venture capital attorneys have been working with industry groups to develop “model documents” for investment transactions that can serve as a universally accepted template for drafting and negotiation.

§34 --Forms and sources of contracts

A “contract” may come in a variety of different forms and may range from a simple sentence to a comprehensive document that extends for hundreds of pages and incorporates multiple appendices. Many simple contracts are based on standardized printed forms that may be available from stationery stores or libraries. While these forms are adequate for many situations, such as leases or transfers of personal property, they often require supplementation to take into account changes in law and practice and the unique circumstances of the particular deal. A customized contract, which is the focus of the discussion in this Guide, generally involves the most “up front” expense; however, the investment is usually warranted in cases where the contract will govern a long-term relationship and it is necessary to specify in detail the rules and procedures applicable to each party. Finally, contract form and content for certain transactions, such as in the consumer sales area, may be impacted by specific laws and regulations.

Effective contract drafting generally involves several deliberate steps and counsel should allow ample time to complete preparation of the initial draft in advance of any deadline provided for in the time and responsibility schedule. Probably the most important decision to ensure that the drafting process goes smoothly is the selection of the contract template to be used to record the agreement of the parties with respect to all the terms and conditions. Counsel may choose from a variety of sources for contract templates, including the following:

Form files maintained by the specific attorney or one of the attorney’s colleagues within the same law firm (or within the company’s legal department when an in-house attorney is responsible for drafting);

Form files maintained by the company, including standard contracts and internal guidelines developed by the company as part of its contract review and execution policy for use by officers and managers in negotiating particular terms;

Model forms published by continuing education providers, including bar associations, that provide examples of forms and provisions suitable for use in comparable transactions;

Form books published by various legal publishers that provide examples of basic contracts, alternative and optional provisions and samples of comprehensive agreements that have been donated by practicing attorneys in the field; and

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36 Forms located through searches of documents filed to fulfill the requirements of

federal securities laws and available for viewing and downloading on the EDGAR system maintained by the federal Securities and Exchange Commission.

Each of these sources has a distinctive set of advantages and disadvantages. For example, using forms found in counsel’s form files or provided by the company has the advantage of familiarity to the drafter and/or the company; however, counsel must always guard against the tendency to forget that each new transaction should be evaluated on its own merits and that terms used in other contracts may not be appropriate in this situation. Model forms can be extremely valuable in identifying the provisions that normally should be included in a particular contract and often have the additional advantage of commentaries that alert the drafter to specific legal and negotiation points that are relevant to selection of the proper language for the contract. In contrast, form books generally have limited value and probably only should be relied on for very simple contracts that must be drafted quickly and efficiently. In many cases, form books contain materials that are outdated and most form books do not include the detailed commentaries found with the model forms referred to above. Forms found on the EDGAR system can be extremely useful; however, the drafter should carefully check the date of the agreement and remain mindful of the fact that such forms generally include numerous examples of contract language drafted to accommodate the specific circumstance of the relationship. In other words, EDGAR system documents, while loaded with interesting provisions, are far from “standard documents” that can be used “as is” without substantial review and revision. §35 --Preparation of master contract document

Any of the prototype documents described above should be viewed as a source of ideas for the drafter in preparing the contract or other document required for the specific transaction. If possible, counsel should review several examples to get a good feel for the full range of issues that need to be covered in the contract. The goal of this review is to create an initial outline of the contract or document and settle on the preferred format for organizing the specific provisions. Once the outline has been created, the drafter may begin to “cut-and-paste,” hopefully electronically assuming that all the prototype documents are available in a common word processing format, the master document that will be used to prepare the contract. At this point, the drafter may pay little attention to whether the chosen language for a specific provision is favorable or unfavorable to the company since the key is to simply make sure that the issue is adequately covered in the final contract. For example, the drafter may decide that it will be necessary to select a comprehensive clause setting out duties and procedures with respect to protection of confidential information exchanged during the course of contract performance and that each of the parties must be required to protect confidential information provided by the other party. At the preliminary stage, the drafter should concentrate on locating exemplar language that adequately describes the desired duties and procedures even if the language is drafted so that it only applies to one of the contracting parties. Once the language has been inserted into the template, it is

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37 a relatively easy matter for the drafter to edit the provision by reference to other examples to accommodate the need for mutuality in this area. The master document should also include alternative and optional provisions that the drafter might elect to use as more is learned about the parameters of the transaction. Once the initial version of the master document is created, the drafter should refer once again to any specific guidelines or checklists prepared by the company to determine whether there are any mandatory provisions and/or contract language that must be included in the contract. If actual contract language is not part of the guidelines, a search of other contracts should be done to identify examples of how the issue has been handled in the past so that the drafter can prepare the appropriate language for the master document and note the need for complying with the guidelines as negotiations continue. While in most cases the language should be treated as mandatory, exceptions may be permitted as long as the drafter seeks and obtains the necessary approvals from the responsible parties identified in the contract review and approval policy. Once counsel has experience with preparation of commonly used contracts, or the negotiation and drafting of provisions used in most contracts by the company, counsel can prepare a contract template that includes the company’s preferred initial bargaining and drafting position. By creating such a template, counsel can streamline the contracting process by allowing in-house contract managers to approve and process contracts that include the pre-approved language. Of course, if modifications have been requested, further review by counsel will be necessary. When appropriate, schedules and addenda should be prepared for use with the template to incorporate information that will usually vary with each contract (e.g., quantity and description of goods and pricing). §36 --Preparation and use of drafting checklists

The master document should be used as a resource for preparing a checklist of the questions that need to be answered by the appropriate persons within the company with respect to use and tone of specific provisions. By including alternative and optional provisions, including language that if used would clearly be favorable to the opposite party, the drafter is able to frame the issues and provide the respondents with an idea of where the opposite party might be coming from when negotiations take place. Preparation of a checklist is important even when the contract pertains to a transaction that is similar in form and scope to a prior deal between the same parties since it is important to make sure that changes have not occurred in the underlying business relationship or legal context. For example, when preparing a contract for the sale of goods, the drafter for the seller should check to see if the arrangement now pertains to an updated version of the goods which may require modified procedures with respect to delivery, installation, training and support. Also, adoption of new federal and state regulations pertaining to the goods since the last time that a contract was negotiated may require the use of new warranties or covenants from the seller. This is not to mean, however, the prior contracts can be ignored since they are a good indicator of historical patterns of dealing between the parties and provide the drafter with insight as to how key issues have ultimately been resolved in the past.

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§37 --Preparation and use of term sheets

While many companies prefer to move from oral discussions and negotiations directly to preparation of the actual contract, consideration should be given to drafting a term sheet or other outline of material terms as an interim step before time and resources are invested in full contracting. A term sheet or outline should describe the material business terms and conditions discussed by the principals and should also indicate, in a general way, some of the other provisions to be covered in the long-form contract. For example, a term sheet or outline for a sale of goods contract should identify the goods, the purchase price, delivery terms and payment terms in detail and then may also refer briefly to the fact that the contract will include “standard” representations, warranties and indemnities. Counsel should consider developing a template for a term sheet or outline that can be used for all similar contracts and transactions. While an inordinate amount of time should not be spent on drafting the term sheet or outline, areas that might become contentious when the actual contract language is rolled out should probably be addressed at this stage. One strategy that can be used is for counsel to prepare the desired language for a particular provision, such as product warranties, and append it to the term sheet or outline when it is first circulated.

§38 --Drafting the contract

Once the term sheet or outline has been completed and approved by the parties, attention turns to the actual drafting of the contract. Whenever possible, companies should volunteer to have their counsel prepare the initial draft of the contracts and documents required for a specific transaction. While the drafting phase can be time consuming, the company will be better served in the long run if its counsel has the opportunity to seize the initiative by crafting language that is best suited to advancing the company’s interests. In fact, the contract may be billed as the company’s “standard form” for the particular transaction, which may give the opposite party pause before suggesting changes to any language other than text that is materially important to the opposite party. Moreover, it may actually take much longer to revise the initial draft proposed by the opposite party than to simply prepare the document in the first place. Counsel should carefully take into account the ultimate consumers for the contract—the parties that will review, modify, execute and ultimately live by the terms that counsel puts into the document. Every effort should be made to make the contract readable and understandable and the terms should be meticulously edited to ensure that they are consistent and complete. Following the outline derived from reviewing various sources, counsel should prepare an initial draft that is comprehensive and requires little or no modification to add a lot of additional terms and provisions. This will allow the parties to focus on the most important issues from the moment that draft is circulated. When organizing the provisions included in a particular contract, drafting counsel should be mindful of the precedents used in various sample agreements that may have been reviewed in the course of preparing the master document. By organizing the provisions

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39 correctly, counsel can effectively guide the parties through the document in much the same way as a good storyteller. In many cases, the contract will begin with recitals that describe the background for the transaction and the major goals and objectives of the parties. Defined terms may then be introduced for ease of reference throughout the body of the contract. Thereafter, the drafter typically attempts to prepare the language in line with the following general organizational principles:

General provisions should be set out before more specific provisions are introduced.

Major provisions should come before minor provisions. Similarly, provisions that will often be referred to by the parties should come before provisions that will seldom come into play.

Rules should be stated in detail before any exceptions thereto are described.

Technical and housekeeping terms and provisions should normally be placed at the end of the document; however, they should not be taken for granted (e.g., dispute resolution clauses).

The entire should be carefully reviewed in light of the potential applicability of the relevant statutory principles of contract construction to ensure that the company’s intent will be clear in the event a court is asked to construe the contract at a later date.

The form and organization of a particular contract can be positively impacted by the judicious use of “dividers,” including “articles,” “sections” and “paragraphs” that are consistently identified and ordered using a hierarchy of numbers and letters that follow an outline format. The overriding purposes of the organizational scheme should be to allow the parties to place each provision in its proper context and to allow for easy navigation of the document, particularly when cross-references are made between provisions in different parts of the contract. Concerns about headings being used unexpectedly to interpret the substance of the contract can be alleviated through the use of appropriate disclaimers in the body of the agreement. Once counsel has prepared the initial draft, an effort should be made to review the draft with the businesspersons within company who are responsible for the transaction (e.g., the “sponsoring parties” referred to above in the discussion of the contract review and approval policy) before it is circulated to the opposite party and its counsel. The review process is an opportunity for counsel to explain some of the assumptions that may have been made in drafting provisions relating to terms that may not have been discussed or fully evaluated during the preliminary negotiations. Another important reason for a pre-circulation review is to make sure that counsel has not misunderstood the instructions provided by the businesspersons. Finally, counsel should once again explain any legal risks that may be associated with the proposed transaction. If a pre-circulation review is not possible, perhaps due to the press of time and the unavailability of the necessary persons, counsel should obtain appropriate authorization to circulate the initial draft with a clear caveat that the draft has not been completely reviewed inside the company and that the company reserves the right to make further changes to the document before it can be considered to be an accurate record of the company’s position on relevant issues.

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40 The initial draft of the contract and other important documents is normally accompanied by a cover letter or a detailed email message from counsel that provides background information and various instructions to the recipients. Counsel should identify the documents that have been included and remind all parties of the target date for delivery of all comments, which should be the date previously agreed upon in the time and responsibility schedule. In some cases, counsel may also include a brief summary of the contents of the most important documents included in the package; however, if a term sheet or outline has been prepared it is usually sufficient to include a copy of that document to remind the parties of the areas that warrant the closest review in the actual contract form. Circulation of the initial draft is followed by systematic collection and evaluation of comments provided by the opposite party, either directly or through its counsel. Counsel should strive to retain control over the comment process by identifying the preferred method for delivery of comments and making sure that all parties keep to the agreed schedule. In some cases, this means that counsel will need to call or otherwise communicate with some of the parties to make sure that they received the draft and that their comments will be forthcoming. Counsel may choose from among several strategies for collecting comments, including collecting comments individually from each party, assembling all parties together in an “all hands” meeting or simply asking all parties to delivery their requested changes electronically so that the drafter can review all the comments and create a revised draft and a list of comments that have not been accepted. Comments that have not been accepted may need to be discussed by the principals and resolved before the transaction can proceed. §39 --Commenting on draft agreements

While the focus of this Guide is on the process of drafting contracts and related documents for business transactions, there inevitably will be situations where counsel will be responding to a draft prepared by the attorney for the opposite party. Accordingly, it is important for counsel to approach this activity with a specific plan so that the company can be well represented and the transaction can move forward on a timely and efficient basis. Preparing an effective response requires the same type of information that is necessary to draft a contract. First of all, counsel must understand the goals and objectives of the company in entering into the contract so that he or she can identify the issues raised by the draft that are of greatest importance to its company. If the parties have prepared and mutually approved a term sheet or outline, counsel should compare the draft against that document to be sure that the drafter has adequately incorporated the form and substance. Other questions that typically need to be raised by counsel when commenting on a draft contract include the following:

Are the duties and responsibilities of the other party fully and adequately described and are they, taken together, sufficient to ensure that the company obtains the expected performance and benefits?

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41 Does the draft include all of the necessary representations and warranties from the

other party?

Can the company comfortably make all of the representations and warranties required of it as set forth in the draft?

Is the draft consistent with all other documents being prepared in connection with the specific transaction?

The method of conveying suggested revisions will depend on the procedure implemented by the drafting attorney; however, in almost all cases it is best for responding counsel to be prepared to briefly explain the reason for any suggested change and actually propose the contract language that would be acceptable. §40 --Circulating revised drafts and finalizing the contract

Once the attorney responsible for drafting the contract has collected all of the comments and the parties have engaged in all communications necessary to resolve any open issues, a revised draft should be circulated among all of the parties with a deadline for raising any remaining objections or pointing out inadvertent errors made in the revision process. Revised drafts should be clearly marked to indicate all changes made since the prior version. While software programs have made the marking process much easier, drafting counsel must still check the output from the electronic comparison to make sure that it makes sense and that all changes have been identified. This is particularly important when drafting counsel has prepared an interim marked copy solely for review by the company and subsequent changes were made based on the company’s comments before a full revision is sent to the opposite party. When circulating the marked copy, drafting counsel will often include a brief summary of the most important changes in a cover letter and a reminder about the target date for finalizing the contract agreed upon in the time and responsibility schedule. In most cases, one revision will be sufficient to push the process toward finalization of the contract. However, there may be cases where additional work will be needed among the drafting group. For example, some of the changes may not adequately address the concerns of the opposite party or there may be issues that simply cannot be resolved in the drafting process until the principals have had an opportunity to discuss the matter. In addition, there is always the possibility that the passage of time or the results of due diligence conducted by the parties may cause new issues to arise before the projected closing date arrives. In those situations, further work may be needed and it may even be necessary for the parties to reconsider the schedule for completing the transaction. §41 Closing preparations The attorney in charge of drafting the contract is also is typically responsible for closing preparations, including arranging for the venue agreed upon by the parties, working with counsel for the opposite party to finalize pre-closing arrangements, preparing and distributing a closing checklist and memoranda and orchestrating the actual closing. In addition, drafting counsel should normally be prepared to organize all the closing

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42 documents and make sure that they are delivered to all of the parties involved in the transaction once the closing completed. §42 --Pre-closing meeting

Regardless of whether or not counsel for the various parties decide to have a formal closing, it often makes sense to conduct a pre-closing meeting, either in person or via teleconference, to make sure that all documents have been finalized and that the actual closing process will go smoothly. The closing checklists and memoranda serve as the guide for the pre-closing meeting and counsel for each party should carefully review all of the documents to be sure that they conform to the understanding of their clients and include all last minute changes and additions. Once the documents have been approved as to form, they are ready to be circulated among the principals for signature and return. Actual delivery of the documents will depend upon whether all conditions to closing have been satisfied or waived. Counsel may wish to initial the bottom corner of each page of those documents that have been approved at the pre-closing before the documents are copied and circulated for execution purposes. §43 --Closing checklists and memoranda

When a transaction involves most than a handful of documents, it is recommended that drafting counsel prepare and distribute a closing checklist that lists all of the documents that are to be executed or otherwise delivered for the closing to occur and the following information for each such document: the party responsible for making the document available at the closing; the number of copies of each document that must be executed or delivered; the required signatories of each document that must be executed in order for the closing to occur; and the parties who should receive original copies of signed documents or officially certified copies of documents to be obtained from governmental authorities. In cases where a formal closing occurs, as might be the case with the consummation of an acquisition or a securities offering, drafting counsel should consider preparing a detailed closing memorandum which identifies all of the parties involved in the transaction (including their counsel and other professional advisors) and indicating all activities that have been completed prior to the closing and the tasks that will still need to be done after the closing. Some examples of pre-closing activities that might be described include filings with governmental agencies and receipt of reports or opinions from outside experts. As for post-closing matters, the closing memorandum might list documents that will need to be filed or recorded with a governmental agency. Obviously, simply listing post-closing activities is no substitute for making sure that they are actually completed and someone needs to create and monitor all follow-up matters. §44 --Closing

Hopefully the actual closing of the transaction, which is the point in time where all parties release the executed contracts and other documents for delivery as required under

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43 their terms, will be uneventful from the perspective of the attorneys involved. With proper advance planning, the attorneys for each party can meet briefly, check to see that the requisite number of copies have been signed and delivered, and then make the necessary exchange of documents. In many cases, drafting counsel may collect all the documents and advise all the parties that everything has been received and solicit confirmation from the parties that the transaction may be considered to be “closed.” If, however, the closing involves a substantial transfer of funds or title to properties, both of which would be difficult to unwind if problems with the closing documents are discovered, a face-to-face meeting and final review of documents by the attorneys for all parties is highly recommended. Once the closing is completed, all of the attorneys should discuss organization and distribution of closing documents and any other follow-up matters that need to be tended to after the closing. §45 Post-closing follow-up matters

The attorneys for all parties to the transaction should retain copies of all documents executed or otherwise delivered in connection with the transaction for future reference. The documents should be indexed, typically following the organization of the closing memorandum, and placed into a binder or a file drawer in proper order. If outside counsel is involved, the original copies may be given to the company and outside counsel may retain a copy; however, outside counsel may want to request that a sufficient number of copies be signed by all parties so that counsel can have its own set of original documents. The documents should be retained for as long as they may have legal effect, a period that certainly includes the duration of the relationship covered by the contracts as well as any additional statute of limitations period. To the extent that counsel may be subject to professional liability in connection with work performed on the transaction, reference should be made to the applicable insurance policy to make sure that the documents are still available at the time that a valid claim is made under the policy. When organizing the closing documents, counsel should also take the time to conduct a final review of the various files generated during the negotiation of the transaction and make sure that the documents included therein are put into good order and can be readily accessed if necessary at a later date. Failure to organize the files when the transaction is still fresh means that it is highly likely that counsel will be unable to find documents in the future and that details of the negotiations, particularly any due diligence investigation, will be difficult or often impossible to recall. Documents collected during the due diligence investigation should be organized by reference to any due diligence checklist or questionnaire and drafts of key contracts prepared for the transaction can be organized in date order. Notes relating to changes made in a particular draft should be filed with the draft so that counsel has a record of why a particular change was made. When organizing drafts and notes, notice should be taken of the utility of the drafts in interpreting the intent of the parties and the steps that should be taken to preserve the attorney-client privilege or the protections of the work product doctrine in the event that counsel does not want the documents to the be subject to discover in the event that litigation later arises with respect to the transaction.

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44 Immediately after the closing is also the best time for counsel to consider whether any of the contracts, or specific provisions discussed during the negotiations, should be incorporated into his or her own form files for reference and use in future transactions. More often than not, counsel will determine that there are provisions that have been included in the contract that should not be used in a form intended to be a “standard” because the provisions have been drafted solely to conform to the unique requirements of a particular transaction. In that situation, counsel should include a note in the file and/or in the electronic version of the contract so that others do not inadvertently incorporate the provisions into their documents. The last thing that counsel should do when organizing the documents for a transaction is conduct one final review to identify any key dates that should be calendared for further action. For example, if one or both of the parties has been granted an option to terminate the relationship prior to the end of the agreed term, or automatically extend the original term by providing notice to the other party on or before a specific date, counsel should calendar the date upon which the extension option first becomes exercisable or the date upon which automatic extension must be elected in order for it to be effective. It is generally a good idea to calendar another date in advance of the date(s) described above so that counsel and the company have an opportunity to deliberate over the best course of action well in advance of the time when a move must be made. For example, if the date for delivery of a notice to automatically extend an agreement is December 1st for a one-year contract ending on December 31st, counsel should make a note to contact the company on November 1st (or even earlier) so that the company can evaluate how the arrangement has been going to determine if the contract should be extended on the same terms, whether modifications in the contract are necessary as a condition of extension, or whether the contract should simply be allowed to lapse at the end of the year. A similar calendaring system should be used for key performance dates included in the contract.

§46 Renegotiating non-performable contractual obligations

No contract should be signed unless and until each of the parties is comfortable with their ability to perform all of the obligations imposed on them for the entire term of the contract. However, in spite of the safeguards built into the negotiation and internal approval process, companies often find themselves in a bind with regard to performing their obligations under a contract with a vendor, customer or other business partner. For example, a company may have agreed to sell raw materials to a customer over a two-year period at a fixed price only to find that the deal suddenly became unprofitable because of an unforeseen rise in the company’s costs of procuring the raw materials that it was obligated to sell. At that point the company can continue to try and perform under the contract, and risk significant financial damage to its business, or can simply cease deliveries and hope for the best when the customer begins threatening litigation. A strategy of stopping deliveries is often accompanied by any attempt to find fault on the customer side that would allow the company to claim that the customer has breached its duties under the contract thus relieving the company from its obligations. Unfortunately, arguing over the words of the contract at that point will only benefit the outside lawyers involved and the better course for the senior management of the company is to attempt to

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45 sit down with the customer and try and work out a restructuring of the contract that makes sense for all parties. When attempting to restructure a problematic contract an attempt should be made to align the interests of both sides and offer the other party, the customer in this case, an incentive to cooperate other than the prospect of costly litigation. In the illustration above the company might offer to substitute a new pricing formula for the fixed price arrangement which offers the customer reasonable pricing under all market conditions plus assurances that the company will not seek and obtain unfair profits from the restructured relationship. For example, assume the fixed price was $1.00 per unit and at the time the contract was first entered into the company’s cost was $0.85 per unit. At that time the company’s profit was $0.15 per unit. If the market price went down to $0.50 per unit the company’s profit would increase to $0.50; however, the contract became unprofitable for the company—and advantageous for the customer—when market prices rose to $1.50 and looked like they were going to stay there for the balance of the contract term. In that situation the company might suggest that contract price be set at the market price plus 10% which means that the customer would enjoy a price that is in line with the market and the company is entitled to a modest profit at all times during the contract term. The customer waives the right to the attractive pricing in relation to the market that it would have received under the initial contract but is spared the costs of litigating the breach and finding a new vendor. The company gets to keep the customer, and stay in business, but the days of 50% profit margins are gone. The company may throw in other incentives, such as more robust customer service plans, to sweeten the deal. Obviously there are risks in attempting to informally renegotiate a contract. The major concern is that if discussions are not successful the non-defaulting party, the customer in this case, has been given a substantial amount of information that can be used in subsequent litigation and information provided in good faith as a basis for striking a new deal can be turned into a harmful weapon in the hands of the party’s attorneys. In many cases, however, the rewards exceed the risks and companies can resolve problems by providing the other side with sufficient information to allow them to make an informed decision and understand the benefits of a proposed compromise. Several safeguards should be used when entering into negotiations to restructure a troubled contract:

Any documents provided to the non-defaulting party that contain sensitive information should be marked “confidential” and only disclosed after the other party has agreed to sign and return a confidentiality and non-disclosure agreement.

While it is usually obvious that the reasons for the discussion are that the terms of the initial contract have become significantly unfavorable an effort should be made to avoid using language that the other party might reasonably interpret as being an admission of impending non-performance such that the other party might claim anticipatory breach.

Try to continue complying with the terms of the contract as they stand during a limited negotiation period even if this means incurring modest losses on the contract

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46 during that time. If possible, start talking about restructuring a contract as soon as it appears that problems are on the horizon but before they reach a crisis level.

Try and determine if the other party has specific problems of its own that might be solved or managed in some way during the negotiation process. For example, the other party might have an immediate need for cash that might open the door to discussing a buyout of the contract with an immediate lump sum payment that represents a substantial discount from the costs of performing for the entire term.

If litigation is a real possibility and there are legitimate concerns about misuse of information disclosed in good faith consider holding the discussions through a mediator. A mediator is not only trained to get both parties to find common grown, and ignore emotions and anxieties, but it is also possible to have discussions with a mediator protected as confidential and privileged so that they do not later come back to cause harm in the event of litigation. §47 Renegotiating and managing contracts in turbulent markets

When markets turn downward and the level of risk in the company’s business environment begins to increase substantially it is a good time to revisit the specific terms and conditions that have been included in the company’s material contracts. Turbulence in business and financial markets causes companies to re-evaluate their priorities and they may suddenly find that their need for the projected benefits of a particular contract has changed and/or that the resources needed for them to perform under a particular contract are suddenly unavailable or available at a cost that is much higher than anticipated at the time the contract was signed. Among the steps that should be taken to identify contract-related issues and problems are the following: • Review representations, warranties and covenants in major agreements to ensure that

the company remains in compliance at the current time and that anticipated changes in business and financial condition of the company will not trigger a default in the foreseeable future. If a potential issue is identified pro-active steps should be taken to contact the other party to the agreement before a crisis emerges in order to arrange for a modification to the terms or a waiver. Remember, however, that the other party may be seeking a way to exit the contract due to changes in its own situation and any communications should include a potential solution to the issue and acceptance of the fact that it may just be the first step in restructuring the entire arrangement. Dispute resolution provisions in the contract should be reviewed and preliminary litigation plans should be prepared in the event that less formal discussions are not successful. By the way, representations, warranties and covenants provided by other parties should also be reviewed to determine whether they might be heading toward a default of their own.

• If the company’s performance under a major agreement turns on the ability of another business partner, such as a supplier, to fulfill its promises it is important to take a hard look at the contract with that business partner and conduct some basic business and financial due diligence to ensure that market problems will not cause the partner to declare a default. Hopefully the contract with the business partner calls for delivery

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47 of regular financial information. If it does and reports are delayed this may be a “red flag” of potential problems.

• Some of the company’s customers may seek to get out from under payment obligations by making warranty claims based on purported defects in the company’s products. If elements of the company’s products are provided by third party vendors the contracts with those vendors should be checked to ensure that indemnification provisions are adequate and that the vendors are obligated to provide necessary support so that customers are not able to back away from their obligation to pay for the products.

• Many contracts include obligations on the company to obtain and maintain various types of commercial liability insurance. Given the issues that have arisen with many major insurance carriers attention should be paid to the company’s insurance portfolio and communications should be made to the company’s insurance broker to verify that all coverage remains in effect and that the chosen carriers are financially able to meet their obligations. If required insurance is coming up for renewal it may make sense to begin shopping around well in advance of the policy expiration date. If a change is made make sure that the contract partner is given appropriate notice.

• Review the entire roster of parties to major contracts with the company to identify any business partners that are known to be experiencing financial difficulties and make sure that any potential contract claims against them are documented and asserted as quickly as possible. One of the goals is certainly to perfect any legal rights against the partner in the event that it goes into bankruptcy; however, every effort should be made to have the complaint accompanied by ideas to resolve the problem without forcing the partner into bankruptcy where the company may find that its rights are diluted or completed overwhelmed by the claims of other parties. Even if the company cannot assert any contract claims it may be a good time to use a bit of leverage to force the other party to negotiate pricing and other terms in a way that is more favorable to the company.

• If the company itself is having business or financial difficulties make sure that there is an effective communications policy for sharing information with contract partners to minimize the risk that customer, suppliers and other strategic alliance partners do not begin looking for ways to void their contractual obligations to the company. Major contracts should be carefully scrutinized to identify all important ongoing obligations to make sure the company does not inadvertently let something slip that can be used as an excuse to trigger a relationship crisis around the contract.

References and Resources

The Sustainable Entrepreneurship Project’s Library of Resources for Sustainable Entrepreneurs relating to Entrepreneurship is available at https://seproject.org/compliance/ and includes materials relating to the subject matters of this Guide including various Project publications such as handbooks, guides, briefings, articles, checklists, forms, forms, videos and audio works and other resources; management tools such as checklists and questionnaires, forms and training materials; books; chapters or articles in books; articles in journals, newspapers and magazines; theses and dissertations; papers; government and other public domain publications; online articles and databases; blogs; websites; and webinars and podcasts. Changes to the Library are made on a continuous basis and notifications of changes, as well as new versions of this Guide, will be provided to readers that enter their names on the Project mailing list by following the procedures on the Project’s website.

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