By: Timothy Murray, Murray, Hogue & Lannis.
There are innumerable articles, books, and seminars that offer guidance on contract drafting style. Among many other things, they typically counsel drafters to avoid legalese, redundancy, inconsistency, and ambiguity—all important suggestions.
CLARITY, FOR EXAMPLE, IS PARAMOUNT. I CAN’T EVER recall hearing a judge complain that a contract was “too clear” for him or her. And no attorney wants a court to say about his or her contract what the Second Circuit recently said about a contractual provision central to a dispute: “[W]e have no idea what it meant.”1
But there’s another kind of problem associated with drafting that can’t be cured by a style manual and that is largely ignored in the discourse about writing better contracts: we can’t write effective contracts without a healthy respect for the daunting complexities of contract law.
Judicial decisions are replete with holdings that the contract at issue wasn’t worded correctly to achieve its intended effect. Like it or not, there are rules of substantive contract law that govern the way certain contractual provisions have to be written—rules that vary from jurisdiction to jurisdiction, that often aren’t as well known as they should be, and that sometimes violate the style mavens’ sacred tenets. The sheer number of reported decisions where contracts weren’t worded correctly suggests an unacceptable indifference to the substantive law of contracts among too much of the practicing bar.
Taking the time to consult the case law as we draft is a prudent investment for the client—most lawsuits involving contracts can be won, or better yet, averted, in the drafting stage.
The following are some of the drafting landmines associated with common contractual provisions that every lawyer who deals with contracts ought to know about. Many of these vary from jurisdiction to jurisdiction, of course, and this guide is only intended as a start.
Naming the Parties
Sometimes contracts define an entity by tacking on words to this effect: “. . . including its subsidiaries, divisions, parent, and affiliates.” Broadly defining a business entity party can be problematic. It is well known that a division has no legal identity separate from the corporation in which it is integrated and that subsidiaries and parents are separate legal entities—purporting to contract on behalf of another legal entity poses a host of well-known problems.
A common problem that may not be as well known is the use of the word “affiliates.” This word pops up routinely in contracts, but there is no universally accepted definition for it. Absent a definition for it in the contract, the word has been held to be ambiguous.2
DRAFTING TIP: Either don’t use the word “affiliates,” or define it in the contract.
Contracts frequently include recitals, sometimes called preambles or whereas clauses. Recitals can be useful to spell out the contract’s purpose or to provide context or tell the back story for the transaction. They can be particularly helpful to explain how the contract fits with other transactions between the parties—for example, whether the latest contract is a substitute agreement or a modification of an earlier one.
Courts generally afford recitals less contractual significance than the so-called operative terms of the contract, and this sometimes poses significant problems. Many courts hold that the operative provisions trump the recitals in the event of a conflict. Some courts go so far as to say that recitals are not even part of the contract.3 The case law counsels against including matters of substance in recitals.
DRAFTING TIP: To avoid disputes about recitals, incorporate them into the operative terms of the contact with a specific provision.4 For example: “The above recitals are made a part of this Agreement.”
A written contract is typically formed at the time it is executed (that is, when all the parties have adopted it—usually, but not always, by signing). Often, in the contract’s introductory paragraph, a specific effective date is stated. If that date is not tied to the date the last party signed the contract, and if there is a discrepancy between the effective date written in the introductory paragraph of the contract and the date of actual execution (that is, the date of the last signature to the agreement), courts are permitted to ignore the effective date written in the introductory clause to discover the real date of execution.5
When would a court need to do this? When one party seeks to introduce evidence of a purported oral agreement that would vary the written contract. The parol evidence rule bars the admission of pre-execution, but not post-execution, communications that contradict or add to the terms of the agreement. If, for example, an alleged oral agreement was made after the effective date written in the introductory paragraph of the contract but before the date of actual execution (usually signing) of the contract, such oral agreement would be a preformation understanding barred by the parol evidence rule. As one court stated: “Massachusetts case law consistently refers to the execution of a written agreement, and not to its effective date, as the event that triggers application of the parol evidence rule.”6
DRAFTING TIP: Have the parties date their signatures at the end of the contract. Define the effective date in the introductory paragraph by stating: “The contract will be effective as of the date the last party signs it.”
Time is of the Essence
Clients often don’t understand that even when the contract spells out specific dates for performance, a late performance typically (though not always) is an immaterial breach that will not discharge the non-breaching party’s obligations nor entitle it to more than nominal damages.7
Can the parties turn late performance into material breaches?
Including the words “time is of the essence” in connection with a date for performance is often regarded as an effective means to signal that if a performance is late, it is a material breach.8 Even without using those magic words, sometimes the facts compel the conclusion that time is of the essence.
A drafting landmine arises when “time is of the essence” is either overused or misused. A generalized time is of the essence clause that purports to make every contractual obligation of the essence, especially if such clause appears in a standardized, preprinted form, may be ignored by the courts. Further, some jurisdictions do not give conclusive effect to time is of the essence provisions. In one case, Kodak was late delivering machinery to DuPont, and DuPont relied on the contract’s time is of the essence clause to terminate the contract. The court held that such termination was, itself, a breach because in Illinois, time is of the essence clauses are not determinative of materiality, and a jury ultimately determined that DuPont had no right to terminate the contract.9
DRAFTING TIP: Use “time is of the essence” sparingly—only when time really is of the essence, and spell out the reasons why timely performance is critical. Don’t use generalized time is of the essence clauses intended to apply to every obligation in the contract. Put the magic words in the same paragraph as the specific obligation it references. Finally, before treating your client’s duties under the contract as discharged because the other party was late and the contract had a time is of the essence clause, consult the law of the pertinent jurisdiction to ascertain if it treats such clauses as determinative of materiality.
Negating the Invisible Terms Implied in Every Contract
Certain invisible terms are implied in every contract to cover areas not expressly addressed by the contract’s terms: trade usage, course of dealing, and course of performance. “‘Agreement’ . . . means the bargain of the parties in fact, as found in their language or inferred from other circumstances, including course of performance, course of dealing, or usage of trade . . .” U.C.C. § 1-201. These terms are frequently misused, even by courts. Course of performance refers to repeated conduct by a party after contract formation that the other party acquiesces to without objection. Course of dealing is a sequence of conduct between the parties in prior transactions that establishes a basis for interpreting their expressions and conduct. And trade usage is any practice or method of dealing so common in the trade as to justify an expectation that it will be observed in the present contract. The Restatement(Second) of Contracts makes clear that these concepts are not limited to contracts for the sales of goods but are applicable to contracts in general. (See § 202(4): course of performance; § 222: usage of trade; and § 223: course of dealing.) These invisible terms are not only used to interpret the contract in question, they may actually supplement or qualify it. U.C.C. § 1-303. Evidence of trade usage, course of dealing, and course of performance are admissible even when the words of the agreement are clear and unambiguous. Such evidence has nothing to do with the parol evidence rule.
It is often the case that clients would prefer not to be governed by invisible terms. They, and their counsel, may consider it preferable to have the terms of the contract limited to the written memorial of their agreement. U.C.C. § 2-202 cmt.2, provides that trade usage and course of dealing can be “carefully negated.” This requires words in addition to the standard integration or merger clause.
Can course of performance be negated? Technically, no. See U.C.C.§ 2-202 cmt. 2; K. Rowley, Contract Construction and Interpretation: From the “Four Corners” to Parol Evidence (and Everything in between), 69 Miss. L.J. 73, 331 (1999). See also, 1 William D. Hawkland, Uniform Commercial Code Series § 2-208:3, at 2-306 (1998). Why not? Course of performance constitutes a post-contract formation modification.
DRAFTING TIP: Draft the merger clause to include a negation of course of dealing and trade usage: The parties intend this Agreement to constitute the complete, exclusive, and fully integrated statement of their agreement. As such, it is the sole repository of their agreement and they are not bound by any other agreements, promises, representations, or writings of whatsoever kind or nature. The parties also intend that this complete, exclusive, and fully integrated statement of their agreement may not be supplemented or explained (interpreted) by any evidence of trade usage or course of dealing.
No Oral Modification and Anti-Waiver Clauses
While the law of the particular jurisdiction needs to be consulted, clauses purporting to forbid oral modifications generally can’t be relied upon to preclude oral modifications. Contracts can keep most preformation understandings from having contractual significance (there are some important exceptions, such as understandings induced by fraud), but post-formation understandings are much more difficult to control in the document. “Even where the contract specifically states that no non-written modification will be recognized, the parties may yet alter their agreement. . . . The pen may be more precise in permanently recording what is to be done, but it may not still the tongues which bespeak an improvement in or modification of what has been written.”13
Anti-waiver provisions are subject to the same sorts of considerations. One court explained: “[A]n ‘anti-waiver’ clause, like any other term in the contract, is itself subject to waiver or modification by course of performance.”14
Contracts predominantly for the sale of goods pose their own issues. Many courts hold that pursuant to U.C.C. § 2-209(3), the statute of frauds requires any modification to be in writing, even those that did not need to be in writing at the time of contract formation. Many legal scholars criticize this construction of the UCC.
It is also important to remember that there can be post-formation warranties:
The precise time when words of description or affirmation are made or samples are shown is not material. The sole question is whether the language or samples or models are fairly to be regarded as part of the contract. If language is used after the closing of the deal (as when the buyer when taking delivery asks and receives an additional assurance), the warranty becomes a modification, and need not be supported by consideration if it is otherwise reasonable and in order. (Section 2-209).
U.C.C. § 2-313 cmt. 7.
DRAFTING TIP: While there is no sure-fire way to preclude oral modifications or waivers, if the contract’s no oral modification clause states that certain specified agents shall have no power to vary the contract or to waive the performance of conditions, this will make it much more difficult for oral modifications to be legally operative. Such a provision “is notice that these agents have no such power when the contract is made. Therefore, a party who wishes to rely upon a subsequent waiver by the specified agent must show that in some way he acquired such a power after the contract was made.”15
Landmines Associated with Damages Limitations
The Presumption of Cumulative Remedies
The default contractual remedies provided under the Uniform Commercial Code and the common law generally favor buyers. Sellers routinely seek to limit or exclude remedies in the parties’ contract, but this must be accomplished carefully in order to be effective.
There is “a presumption that clauses prescribing remedies are cumulative rather than exclusive. If the parties intend the term to describe the sole remedy under the contract, this must be clearly expressed.” U.C.C. § 2-719 cmt.2. “[R]esort to a remedy as provided is optional unless the remedy is expressly agreed to be exclusive, in which case it is the sole remedy.” U.C.C. § 2-719(1)(b). (Courts also have applied this principle to contracts governed by common law principles.)16
A drafter should not assume that merely listing specific remedies will be sufficient to prevent the non-breaching party from obtaining other remedies. If the drafters desire for the remedies listed to be the exclusive remedies, the contract should spell out that the remedies listed are the sole and exclusive remedies available for breach.
For example, where a contract provided that in the event of nondelivery of coal, the seller “shall” pay the buyer the difference between the total base price under the contract and the price at which the buyer purchases substitute coal, a court held that the contract did not clearly express an intent that this was to be the exclusive remedy. It did not overcome the “presumption that clauses prescribing remedies are cumulative rather than exclusive.” Consolidation Coal Co. v. Marion Docks, Inc., 2010 U.S. Dist. LEXIS 31365 (W.D. Pa. Mar. 31, 2010). There are many similar examples.
DRAFTING TIP: To insure that a specified remedy is exclusive, the contract needs to say it. Example:
Sole and Exclusive Remedy.
The parties agree that the seller will repair or replace, at the seller’s option, any defective part in the product for a period of 90 days from the date of delivery. This remedy is intended to be the sole and exclusive remedy of the buyer for any breach of this contract.
Drafting a Damages Limitation Too Well May Result in No Limitation at All
Sometimes, parties draft clauses that limit damages too well, and the result is that a court might not honor any limitation at all. “[I]t is of the very essence of a sales contract that at least minimum adequate remedies be available.” U.C.C. § 2-719 cmt.1.
Consider the following case. Plaintiff, a window and door manufacturer, incorporated defendant’s aluminum lineals in the windows and doors it sold. Customers who installed these products started to complain that the lineals were losing their paint adhesion. Plaintiff sued defendant, and defendant countered by citing the terms of the contract between plaintiff and defendant that limited plaintiff’s recovery to the purchase price of the lineals. The court held that the remedy must be greater than the one set forth in the contract. The use of the lineals in finished doors and windows made the total cost to remove, repair, and replace them dramatically higher than the purchase price of the lineals, so limiting the remedy to the purchase price would not provide a minimum adequate remedy under the law.17 A money back guarantee or similar remedy does not always place the aggrieved party in the position it would have occupied had the contract been performed—the essential purpose of contract law.
DRAFTING TIP: Don’t exclude all damages just because the other party will agree to it. Give the other party a remedy that will provide at least a minimal adequate remedy in the event of a breach, or a court might strike the limitation altogether.
If a Remedy Fails of Its Essential Purpose, It Might Eliminate the Exclusion of Consequential Damages
Sellers’ contracts often include clauses providing a limited repair or replacement remedy in lieu of all other buyer remedies. If that sole remedy “fails of its essential purpose”—that is, if the seller does not perform the remedy in a timely fashion or fails in an effort to provide the remedy—the default remedies allowed by the UCC are restored. The UCC provides: “Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this Act.” § 2-719(2). (This concept has been extended to contracts not involving the sale of goods.)18 In effect, the law allows the aggrieved party to pursue the remedies that were surrendered in exchange for the failed substituted remedy.
But what happens when a contract’s substituted remedy—for example, an exclusive repair remedy—fails of its essential purpose and that contract also contains an exclusion of consequential damages? Since failure of essential purpose opens the door to the default remedies as provided by law, should the buyer also be entitled to consequential damages despite the provision excluding consequential damages? The jurisdictions are split.
If the exclusion of consequential damages is viewed as dependent on the validity of the substituted remedy, the failure of that remedy would also remove the exclusion of consequential damages. If, however, the exclusion of consequential damages is viewed as an independent exclusion apart from the substituted remedy, exclusion of consequential damages would be honored. Currently, the independent view is the prevailing view throughout the country, but it would be prudent to draft the contract in a way to negate the minority, dependent view.
DRAFTING TIP: To retain the exclusion of consequential damages even when a remedy fails of its essential purpose, the contract needs to spell this out:
Sole and Exclusive Remedy.
The parties agree that the seller will repair or replace, at the seller’s option, any defective part in the product for a period of 90 days from the date of delivery. This remedy is intended to be the sole and exclusive remedy of the buyer under this contract. Should this sole and exclusive remedy fail of its essential purpose, however, the seller will return the purchase price to the buyer minus the reasonable value of the buyer’s use of the product. The parties also agree that, regardless of the failure of the sole and exclusive remedy, seller will not be liable for any consequential damages of whatsoever kind or nature. The parties intend the exclusion of consequential damages as an independent agreement apart from the sole and exclusive remedy herein.
With respect to a contract for the sale of goods, without a force majeure clause, performance is excused where it “has been made impracticable by the occurrence of a contingency the nonoccurrence of which was a basic assumption on which the contract was made.” (U.C.C. § 2-615(a)). Force majeure provisions have been held to displace the default defenses automatically given by law: impossibility, frustration of purpose, and impracticability.19
The danger in drafting a list of force majeure events is in missing something since no one can list every possible event that might occur—but the canon of interpretation/construction expressio unius est exclusio alterius would exclude any item not specifically listed.
The solution: add a catch-all at the end of the list—but this catch-all needs to deal with another canon of interpretation/construction, ejusdem generis, by referencing dissimilar events or circumstances.
DRAFTING TIP: Draft a clause that deals with expressio unius est exclusio alterius and ejusdem generis: “The parties expressly condition the performance of their duties under this Agreement on the nonoccurrence of [list events], in addition to any and all events, regardless of their dissimilarity to the foregoing, deemed to be impracticable or impossible under the law.”
A breach of contract may be material or immaterial. When a party to a contract materially breaches the contract, the other party is—if it so chooses—discharged and freed of any obligation to perform and may, at that point, sue for damages. When a breach is immaterial, the non-breaching party is not excused from future performance but may sue for the damages caused by the breach.
To determine if a breach is material, courts often look to the factors set forth in Restatement (Second) Contracts, § 241. This is generally an issue of fact, though sometimes it can be so clear that no reasonable trier of fact could disagree about the outcome. The problem is, without a court order, parties can’t know for certain if the breach was material or if the non-breaching party has the right to be discharged from his or her contractual obligations.
The contract can avoid the uncertainty as to what constitutes a material breach by spelling out the events that warrant termination of the contract and discharge from further contractual obligations. “As with other default contract rules, parties to a contract ‘may agree to displace’ the principle of material breach.” Morrison Comprehensive Learning Ctr., LLC v. Va. Dep’t of Med. Assistance Servs., 2016 Va. App. LEXIS 122, at *6 (Va. Ct. App. Apr. 12, 2016). Even otherwise nonmaterial events can be included as events warranting termination and discharge (e.g., “any violation of an employee handbook that is not cured within 10 days following notice”).
Drafting these provisions raises the same sorts of issues that affect force majeure clauses. The canon of construction/interpretation expressio unius est exclusio alterius would exclude any item not specifically listed, and those unlisted items might be deemed breaches that don’t warrant termination or discharge. The problem is that no one can list every situation that might result in material breach. The solution: add a catch-all—but, as is the case with force majeure clauses, the catch-all needs to deal with the canon of construction/interpretation ejusdem generis by referencing dissimilar events or circumstances.
DRAFTING TIP: Draft a clause that deals with expressio unius est exclusio alterius and ejusdem generis and the presumption of cumulative remedies:
The following warrant immediate termination of this Agreement: any violation of this Agreement or the employee handbook that is not cured within 10 days of written notice, [list other events], in addition to any and all other reasons, regardless of their dissimilarity to the foregoing, deemed to constitute material breaches under the law. A termination in accordance with this paragraph shall not be the Employer’s sole and exclusive remedy for any breach of this Agreement.
Indemnity provisions raise a host of potential problems, but one of the more insidious is that if the indemnity provision is drafted broadly, it may be applied to cover any claim at all—not just claims asserted by third parties, but even breach of contract claims between the parties to the contract. While it may seem peculiar—and wrong—to allow an indemnity clause to be used to support a claim for breach of contract, courts in some jurisdictions hold that if the indemnification clause is not expressly limited to claims brought by third parties, claims between the parties themselves are also covered by the indemnity language.
This is important primarily because an indemnity provision is typically the one place in the contract where a party (in this case, the party to be indemnified) is permitted to recover attorney’s fees. Accordingly, if the indemnity clause is used to support a garden variety claim for breach of contract, the winner may recover attorney’s fees.
DRAFTING TIP: If you want your indemnity provision to be limited to third-party claims—define the events triggering indemnity as claims asserted by third parties.
As with most of the other provisions referenced here, drafting express warranties and disclaimers of implied warranties raises a host of issues deserving of their own article. One of the most misunderstood aspects of warranty law concerns the time to bring an action for breach.
Generally, warranties warrant that the goods will do certain things or be a certain way at the time of delivery. Warranties do not extend to future performance unless the contract explicitly says so. Thus, generally, “[a] breach of warranty occurs when tender of delivery is made.” U.C.C. § 2-725(2). The statute of limitations starts to run from the date of delivery, not from the time a problem with the product manifests itself.
But U.C.C. § 2-725(2) provides an exception that allows the warranty to extend to “future performance of the goods” where “discovery of the breach must await the time of such performance.” In that case, “the cause of action accrues when the breach is or should have been discovered.”
So what, you say? The lawyer drafting a warranty can extend the warranty to future performance, which would have the effect of delaying a finding of breach, the accrual of a cause of action, and the running of the statute of limitations to a future time when the buyer discovers or reasonably should discover that the product does not meet warranty.
This is a very powerful tool for purchasers. With just a few words in the express warranty, the drafter can, in effect, extend the statute of limitations out many, many years beyond the norm. Hoctor v Polchinski Mems., Inc., 50 Misc. 3d 65 (N.Y. App. Term 2015) involved a tombstone purchased and installed in 2003. The tombstone seller’s literature stated the tombstones were guaranteed to “last forever” and were “backed by a perpetual warranty.” A problem with the tombstone purportedly was discovered in 2013. The court held: “The foregoing provisions in defendant’s literature constituted an explicit warranty of future performance.” Id. at 67.
DRAFTING TIP: If the warranty mentions a specific time period or that the product will “last forever” or comes with a “perpetual warranty,” the statute of limitations will not even start to run until a problem is, or reasonably should be, discovered within such time period. For purchasers, such a warranty extending to future performance can be a very valuable provision, even if the contract otherwise limits the time to sue after the cause of action accrues.
Landmines Associated with Choice of Law
Clients often assume that the choice of law clause determines the place where lawsuits must be litigated, and they need to be disabused of that assumption.
There are significant differences with respect to the substantive law from one jurisdiction to the next, of course. In negotiating a contract, if you are going to insist on the law of one state or another, it is important to know why. Sometimes, counsel for the other party to the contract will tell me that his or her client will only accept the law of a certain state, but when I inquire why, they usually can’t provide a rational basis. (It is sometimes surprising how little attorneys know about the law of contracts in their own state—for example, ask the lawyer who insists that the law of his or her state apply to the contract whether, under the law of that state, a welldrafted merger clause is conclusive on the question of whether the contract is fully integrated.)
Aside from selecting the state based on the law, as opposed to an arbitrary guess, there are various drafting landmines associated with choice of law. Here are three of the most important:
Scope: If Too Narrow, It May Not Encompass All Claims
When a choice of law provision is included in the contract, generally, the parties want the law they select to govern all claims in the event of a dispute. Commercial litigation often involves claims not only for breach of contract but for extra-contractual claims (e.g., torts or statutory violations) as well. But if the clause is drafted too narrowly, it might be construed to govern only the construction and interpretation of the contract, not extra-contractual claims.
To assure the application of the chosen law to all claims, a broad choice of law clause is needed. See, e.g., Jiffy Lube Int’l, Inc. v. Jiffy Lube of Pa., Inc., 848 F. Supp. 569 (E.D. Pa. 1994) (explaining that “This Agreement shall be construed, interpreted and enforced in accordance with the laws of the State of Maryland” is narrow, not encompassing extra-contractual claims); Lipman Bros. v. Apprise Software, Inc., 2015 U.S. Dist. LEXIS 95301 (E.D. Pa. July 21, 2015) (explaining that “any suit brought to enforce this Agreement or based on this Agreement or the business relationship between the parties” is broad language covering tort claims).
If a choice of law provision is narrow, and if there are extracontractual claims, the court is forced to look beyond the choice of law clause and apply the forum state’s conflicts-of-laws analysis to decide which state’s laws govern the extra-contractual claims. Thus, with narrow language, it is quite possible that a court will hold that one state’s laws govern the contract claims while another state’s laws govern the extra-contractual claims. (The same analysis regarding scope is also applicable to choice of forum and arbitration clauses.)
DRAFTING TIP: Draft a broad choice of law provision. To do this, the law of the applicable jurisdiction needs to be consulted to insure the language selected will be construed as broad language. Here’s a generic broad clause:
Any and all matters of dispute between the parties to this Agreement, whether arising from the Agreement itself or from alleged extra-contractual dealings, interactions, or facts prior to or subsequent to the formation of the Agreement, including, without limitation, fraud, misrepresentation, negligence, or any other alleged tort or violation of the contract, shall be governed by, construed, and enforced in accordance with the laws of the Commonwealth of Pennsylvania, regardless of the legal theory upon which such matter is asserted.
Opting Out of CISG
The United States and more than 80 other nations have ratified the United Nations Convention on Contracts for the International Sale of Goods (CISG), a treaty that governs transactions for the sale of goods (roughly equivalent to the UCC, but with important differences). The CISG is the law in virtually every leading trading nation in the world.
Unless the parties have clearly agreed to opt out of the CISG, any contract for the sale of goods between parties that have their principal places of business in different CISG countries are bound by the articles of the CISG rather than the domestic law of the parties’ countries.
When parties subject to CISG decide to opt out of CISG, it does not occur merely by agreeing on the law of a particular state in the choice of law provision. The Supremacy Clause makes the CISG part of each state’s substantive law. What that means is that for contracts under CISG, generally, if the choice of law provision states, for example, “Pennsylvania law shall apply,” that means that CISG shall apply.
To opt out of CISG, the parties need to expressly state they are opting out of CISG.20 Whether the parties should opt out of CISG is a different question. There are, indeed, significant differences between the contract law of the UCC and the CISG that need to be considered to answer that question—including the fact that CISG has no parol evidence rule.
DRAFTING TIP: If the parties do not want any disputes decided under the CISG, add language indicating that the parties are opting out at the end of the choice of law provision:
The parties hereby agree that the United Nations Convention on Contracts for the International Sale of Goods will not apply to this Agreement.
Determining Whether the Contract Is Governed by Common Law or the UCC
A question that can be of paramount importance is whether the contract will be governed by the UCC or common law. This question is generally not dealt with in the text of the contract, though it should be.
Generally, if the predominant purpose of the contract is for the sale of goods, the UCC applies. Courts consider a variety of factors to determine the predominant purpose of a contract. One court listed several: (1) the contract’s language; (2) the terms of payment—that is, whether the price is primarily calculated based on the costs of the goods or services; (3) the mobility of the goods; (4) the value of both the goods and services; and (5) the business of the seller.21
Generally, a drafter can’t dictate whether the UCC should apply if the nature of the contract clearly suggests it shouldn’t. However, if the issue is close, it can be helpful if the words of the contract characterize it. One court explained: “Though the label that contracting parties affix to an agreement is not necessarily determinative of the agreement’s predominant purpose, it can constitute potent evidence of that purpose.” Ross-Simons of Warwick, Inc. v. Baccarat, Inc., 102 F.3d 12, 17 (1st Cir. 1996). If a party has expressly agreed the contract is predominantly for the sale of goods, a court will likely look askance at that party’s argument that the contract is actually predominantly for services, not goods.
DRAFTING TIP: Spell out in the contract whether it is for the sale of goods or otherwise. For example: “The parties expressly agree that this Agreement is predominantly for the sale of goods.”
Anti-Assignment Clauses Require Magic Words to Prevent Assignments
Contracts routinely include clauses forbidding the assignment of the contract without the approval of the other party. Many courts hold that in order to be effective—that is, in order to remove not just the right but the power to assign—such clauses need to contain magic words, such as the following: “Any attempted assignment in breach of this agreement shall be null, void, and invalid,” or “the nonassigning party shall not recognize any such assignment.” Erection Co. v. Archer W. Contrs., LLC, 2015 U.S. Dist. LEXIS 27294, at 25 (D. Nev. Mar. 4, 2015).
Where such language is not included in the anti-assignment clause, according to courts that follow this rule, any provision limiting or prohibiting assignments will merely remove the right, not the power, to assign. Thus, the assignment will be allowed, and the nonassigning party can sue for damages (but damages would likely be at least difficult, perhaps impossible, to prove in that circumstance).22
DRAFTING TIP: Add language to this effect:
Anti-Assignment: The rights and duties under this contract may neither be assigned nor delegated. The parties further agree to surrender any power to assign their rights or delegate their duties as of the moment of formation of this contract. Any attempt by either party to assign any right or delegate any duty under this contract shall be null and void.
General Clauses Disclaiming Third-Party Beneficiary Are Not Always Effective
It is common to include in contracts a general clause stating that no third-party beneficiaries have rights under the contract. But where it is clear that a purpose of a contract was to benefit certain nonparties (and not merely as an incidental result of the contract), many courts would regard those non-parties as third-party beneficiaries with the right to enforce the contract.
“If the intent of the contract was to directly benefit a third-party, he should not be denied that benefit because of a general disclaimer of intent to benefit third-parties when that benefit is the very object of the agreement.” Doyle v. Jewell, 2015 U.S. Dist. LEXIS 47766, at *15 (D. Utah Apr. 9, 2015).
DRAFTING TIP: If a purpose of the contract is to benefit certain persons, and if the parties to the contract really don’t want to give those persons the right to enforce the contract, the drafters should include a specific clause explaining that those specific persons have no rights to enforce the contract—make it clear the contract is referring to them. Don’t rely on a generalized “no third-party beneficiary” clause.
Pay-when-paid versus Pay-if-paid
In the construction industry, if the owner doesn’t pay the general contractor, the general contractor is still obligated to pay the subcontractor. Subcontract provisions that shift the risk of the owner’s non-payment to the subcontractor, often referred to as pay-if-paid provisions, are common in that industry. Most, but by no means all, courts enforce them.23 These sorts of provisions may also be employed in contexts other than the construction industry.
Sometimes parties think they are drafting pay-if-paid clauses when they are really drafting pay-when-paid clauses—there’s a big difference. Courts do not like pay-if-paid provisions, so they require such clauses to explicitly state that the subcontractor won’t be paid unless the contractor is paid. If a clause merely states that “the subcontractor will be paid within seven days of contractor’s receipt of payment from the owner,” the requisite explicitness to shift the risk of non-payment is not present, and courts construe such a clause to be a pay-when-paid provision, which does not transfer the risk of non-payment to the subcontractor. BMD Contrs., Inc v. Fid. & Deposit Co. of Md., 679 F.3d 643 (7th Cir. 2012). Such a clause “address[es] the timing of payment, not the obligation to pay.” Id. With a pay-when-paid clause, if the owner doesn’t pay, the contractor is not excused from paying the subcontractor—it must pay within a reasonable time.
DRAFTING TIP: To draft an enforceable pay-if-paid provision, make clear that the subcontractor will not be paid unless and until the owner pays. It might state that “the owner’s payment to the contractor is a condition precedent to contractor’s obligation to pay subcontractor.” Sloan & Co. v. Liberty Mut. Ins. Co., 653 F.3d 175 (3d Cir. 2011). “A pay-if-paid condition generally requires words such as ‘condition,’ ‘if and only if,’ or ‘unless and until’ that convey the parties’ intention that a payment to a subcontractor is contingent on the contractor’s receipt of those funds.” LBL Skysystems (USA), Inc. v. APG-America, Inc., 2005 U.S. Dist. LEXIS 19065 (E.D. Pa. Aug. 31, 2005).
Modifying Limitations Periods
Sometimes drafters become too aggressive in their attempts to limit the time to bring a legal action for breach. Generally, parties may contractually shorten the limitations period to not less than one year for contracts predominantly for the sale of goods (U.C.C. § 2-725), and not shorter than a reasonable time for contracts governed by common law. (Some states have statutes governing this.)
Generally, parties are not permitted to enlarge the limitations period beyond the period allowed by law. Tolling agreements are generally not governed by this rule because such agreements are made after the cause of action accrues. After a cause of action accrues, the parties may agree to extend the limitations period beyond the time allowed by statute since the defendant is on notice of the claim and is able to preserve evidence and avoid being prejudiced by an enlarged limitations period.24
DRAFTING TIP: If you desire to shorten the statute of limitations, consult the applicable law of the governing jurisdiction because if you are too aggressive and try to limit it to less time than allowed by law, the provision might be deemed invalid, and your client will be stuck with the period mandated by the applicable statute of limitations.
Headings, of course, don’t capture everything in the paragraphs that follow. They are often tacked onto agreements with little thought or care. That’s one reason drafters add clauses making clear the heading has no effect. Without such a clause, in the case of ambiguity, courts may use headings as guidance to discern the paragraph’s purpose.25
DRAFTING TIP: Add a clause to this effect: “Any headings preceding any of the sections of this Agreement are inserted solely for convenience of reference, shall not constitute a part of the Agreement, and shall not otherwise affect the meanings.”
Timothy Murray is a partner with Murray, Hogue & Lannis. He co-authors the biannual supplements to the landmark contract law treatise Corbin on Contracts. Mr. Murray has represented all manner of business entities in contract law disputes and transactional matters.