Contracts, In-House Counsel, Practice Pointers

House Rules: Termination Clauses, Remedies, and Other Things to Argue About Before Christmas

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Admittedly, I take on some large issues in this column. But this is neither a treatise on contract law, nor the forum to attempt one. I am simply attempting to give some pointers for negotiating commercial contracts. I do very much appreciate the emails that I receive that suggest where I missed some salient information, or that offer critiques to some of my strategies. I’ve even used some of them and credited the authors, to the extent they’d allow. Funny thing about this site, most people don’t want to be identified. It’s almost end of year, so here goes:

Let’s say you’re in the heat of a commercial lease negotiation and the customer says to you: “What are these payments in the event of default? Why should I be penalized if your product doesn’t work as it should? Are you telling me that I have no remedies? Don’t you stand behind your products?”

I admit that the first time I heard this argument, or some iteration thereof, I got a bit of a pit in my stomach. Stammering some sort of coherent answer, I was able to move to another topic and table the discussion until I could get my rebuttal ducks in a row. That’s the “fun” of being in-house, you are expected to know everything rather quickly (read: immediately), when in reality, it takes a good long time to master even a small raft of issues.

As I’ve preached time and again, preparation is everything, and when faced with a difficult series of questions, always hit the easiest ones first. First, repeat after me: “Those are liquidated damages, not penalties.” Courts look unfavorably upon remedial “penalties,” and you should take care that your agreements call these remedies for what they are — “liquidated damages.” The theory behind the liquidated damages is that they allow you, in the event of a breach by termination, to recoup at least some of your anticipated benefit of the bargain. The customer can terminate the agreement, but you won’t be left holding the bag completely.

The second answer? Of course we stand behind our products, that’s why there’s a general indemnity section, as well as an intellectual property indemnity section. Oh, and those warranties, yeah, those cover you as well. (BTW, companies always try to waive the warranty of merchantability, but such waiver is generally unenforceable — try instead to have the customer waive fitness for a particular purpose, which is generally enforceable.) And that insurance clause you demanded? Yep, that covers you if stuff goes really badly.

Finally, talk the customer through the true-lease as defined by the UCC. Under 2A, a true lease by definition cannot be terminated. But remember, procurement attorney, a contract can always be terminated. Of course the customer can walk away from a finance lease early, but the problem for them will be the expectation of paying the early termination charges (“ETCs”). No one ever wants to pay ETCs. I didn’t want to pay them when I changed from satellite to cable, nor does a business customer want to pay them when they terminate a finance lease early, but pay they must. Or, at least, we’ll try to collect them, and the customer can sue if they claim we breached the agreement somehow, and they won’t end up paying, and a judge will likely cut the mustard anyway, and sheesh… did that sentence run on or what?

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My point here is that wasting time negotiating over ETCs and the required payment of such shouldn’t really give either side much agita. If we breach, you can sue. Of course, you don’t want the time and expense of a suit, but we also don’t want to breach. And in this economy, we’re going to do our damndest not to breach. And you are the one that wants the lowest pricing and has therefore opted to enter into a true (finance) lease. We have put the remedies language there on paper for you to review. You obviously want the technology and the pricing, so the factoring you have to do is whether down the road, when a competitor tries to knock us out, you want the risk of paying the ETCs — simple as that.

Generally speaking, when a customer begins to understand their choices, and can take the best option while still seeming risk averse, they’ll take the choice given. Understanding the offering is key. Better yet, understanding the business decisions behind the offering is even more key. Knowledge is power, leverage, and a prime factor in negotiating. But it isn’t everything. The truth can also sell. I try to be as truthful as possible when I am working a deal. I cannot give away the store by releasing confidential information, but where there is no harm in being truthful (or open, if you will), the negotiation is likely to go smoother. And your credibility with the customer can increase, which can result in a closed deal that much sooner.

After two federal clerkships and several years as a litigator in law firms, David Mowry is happily ensconced as an in-house lawyer at a major technology company. He specializes in commercial leasing transactions, only sometimes misses litigation, and never regrets leaving firm life. You can reach him by email at dmowry00@gmail.com.

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