by Chris SwiecickiWhen is the Right Time to Bring in an Attorney for a Business Contract?
Every business, no matter how small, will eventually need to enter into some type of transaction that requires a formal contract. Small business owners may be tempted to draft a contract themselves or choose from online sources that promise easy-to-use contract templates. They may not feel the need to involve an attorney unless something goes wrong.
While we understand the desire to save time and money with a DIY approach, a one-size-fits-all solution can not possibly capture the nuances of every unique business transaction. There are very good reasons for contacting an attorney early in the process rather than waiting until there is a dispute, even if only for a quick review. Understanding when it’s best to involve a professional will help prevent errors, misunderstandings, or omissions that can lead to costly outcomes.
Four Key Times to Involve an Attorney
Unless a business is big enough to have its own legal department or a corporate attorney on retainer, the question of when to bring in an attorney for a business contract is bound to come up eventually. Even in-house counsel sometimes brings in an outside specialist. Some contracts might need the expertise of a patent lawyer or tax attorney, for example.
While having a lawyer draft or review every single contract might mitigate the majority of risk for a company, it isn’t always feasible—or necessary. Executing simple contracts like a bill of sale or a standard lease agreement may not require a professional’s help.
In general, a more realistic answer of when to call an attorney is whenever a contract involves complex ideas or when the terms of the agreement have high stakes. For example, ironing out the complicated details of a merger or acquisition is something that definitely needs an attorney’s expertise. So does something like negotiating the terms of a licensing agreement for an invention. In both examples, a mistake in the contract could cost millions of dollars, lock one or both parties into an unfavorable situation, or put the company’s future at risk.
We have identified four times when it is in a business owner’s best interest to get professional contract help.
1. When Asked to Sign a Contract
When presented with a contract, the need to have a lawyer review it increases along with the stakes or dollar amounts involved. For example, a multi-year service level agreement with a retailer for your company’s product merits an experienced lawyer’s opinion. On the other hand, an agreement with an independent contractor for a single project in exchange for a set fee is fairly cut and dried.
Still, there is value in having an attorney review a contract to make sure there are no surprises. They can explain the terms so their client completely understands their rights and obligations as well as what will happen if one party does not meet their part of the bargain. If a business owner foregoes the help of a professional, there could be unanswered questions. For example, can the independent contractor in the above example be compelled to complete the work? When is payment due and what type of penalty or interest will be charged if it is not paid on time?
2. When You Want to Formalize an Agreement
An oral agreement can be legally binding. But you’ve probably heard the saying “A verbal contract is not worth the paper it’s written on.” Written contracts lay out the details of an agreement to avoid confusion and safeguard the interests of both parties in a court of law. As soon as it is evident that an agreement with another party needs more than a handshake and a promise, it is time to draft a formal contract.
As with #1 above, the need for an attorney will depend on the importance and complexity of the transaction. Hiring an attorney to draft the document will ensure that nothing is missed and that the terms have the intended results for both parties. As an alternative, a business owner could ask a lawyer to review and recommend changes to a document the business owner drafted.
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3. When a Business Changes
The two previous examples involve new contracts. Existing contracts should be reviewed periodically, especially when either party undergoes a major change. For example, a company expanding its services to include delivery might consider tweaking the terms spelled out in its client contracts. Will they promise delivery in a certain time frame? Will there be an additional fee? What recourse does a customer have if they do not receive their items? A contract attorney can make sure the wording still represents the company’s best interests while covering all new considerations.
4. When a Market or Industry Changes
Just as with company changes, similar adjustments should be made to contracts when a business owner anticipates industry changes. Consider 2023’s labor dispute between the Writers Guild of America and Hollywood studios. The increased use of Artificial Intelligence in the industry triggered the WGA to demand changes in how their work was represented and compensated.
Similarly, any company might see changes ahead for the type of work it does. An experienced contract attorney can structure a contract and adjust its language to accommodate changes when necessary.
Pitfalls of a Poorly Drafted Contract
A good contract safeguards the rights and clarifies the obligations of both parties. A poorly drafted one, however, could result in a number of unpleasant outcomes. There could be few options in the case of a breach. A business might not get paid, may be forced to provide unanticipated products or services, or could end up in litigation.
All of these situations could end up more expensive and disruptive than hiring an attorney to draft or review the contract in question. By bringing in an attorney for a business contract—and bringing them in early in the process, business owners can rest assured that their contracts won’t have the following issues:
- Ambiguity. Every contract can be subject to interpretation, but clear, concise professional language will eliminate confusion.
- Not enforceable. Contracts must follow the laws of the jurisdiction to which they apply. For example, requiring a non-disclosure agreement from an employee in a state where NDAs are not legal, would not hold up in court.
- Omitting key points. Attorneys know how to close loopholes and will think of issues their clients might not anticipate. For example, adding an arbitration clause to a contract allows disputes to be handled out of court. And a termination clause gives parties a way out in certain situations.
- Unforeseen risks. Not considering a variety of eventualities can increase risk exposure. That said, a written contract naturally includes an Implied Covenant of Good Faith and Fair Dealing for both parties’ protection.
While any contract can suffer from issues that could lead to litigation, a professional contract attorney is less likely to make a mistake than a layman. Lawyers understand the meaning and implications of contract language and how the document should be structured.
What a Contract Lawyer Brings to the Table
Hiring a contract attorney puts business owners at an advantage over those trying to draft a document themselves. An experienced lawyer will take the time to understand their client’s goals and the purpose of the contract. They can prevent a business owner from entering into an agreement that does not serve the interests of the company, or worse, harms it.
It is important to find an attorney familiar with the local jurisdiction and who has participated in litigation when contracts are breached. This experience gives them the ability to craft a strong document that provides the assurances and protections the company needs.
A Contract Attorney Can Safeguard Your Business Interests
Whether a business contract is an occasional necessity or part of day-to-day operations, these documents and their contents should not be taken lightly. Errors, vagueness, or the exclusion of important points can lead to costly mistakes and even litigation. Often the expense and inconvenience are much greater for a company than hiring a lawyer from the start.
For all but the simplest agreements, contact an attorney who specializes in contract law like Swiecicki & Muskett. The higher the stakes of a transaction, the more important it is to get professional advice. The future of your business could depend on it.
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by Chris SwiecickiUnderstanding Sandbagging in M&A Transactions
In the context of buying a business, a “sandbagging” Buyer is one who is (or becomes) aware that a specific representation or warranty made by the Seller is false—but instead of telling the Seller this fact, the Buyer completes the transaction. The Buyer then seeks post-closing damages against the Seller for the breach.
Sandbagging is a frequent occurrence in acquisitions. It happens so often that transactional planners have made a “sandbagging playbook” that tells people how to handle the issue, depending on which side of the deal they’re on and whether the state law governing the agreement is “pro-sandbagging” or “anti-sandbagging.”
Competing Interests When it Comes to Sandbagging Clauses
More importantly, the Buyer and Seller in a deal have different competing interests, and so each has their ideas on handling the sandbagging clause.
So, while there are many different ways to prepare for sandbagging, most strategies boil down to three essential elements:
- Including a clause in the acquisition agreement that says the Buyer can seek a claim even if the Buyer knew ahead of time that the Seller’s representations and warranties were false (i.e., sandbagging is permitted)..
- Including a clause in the acquisition agreement that says the Buyer can’t seek compensation for a breach of the Seller’s representations and warranties if the Buyer knew the representations and warranties were false ahead of time (i.e., sandbagging is explicitly forbidden).
- Saying nothing about the issue. In this case, the contract defaults to whatever state law says.
When the Buyer wants a sandbagging clause, and the Seller wants an anti-sanding clause, a typical compromise is to leave both clauses out of the purchase agreement. However, in certain states, if the agreement makes no mention of a sandbagging clause, sandbagging is permitted. So from the Seller’s perspective, mentioning the clause is only sometimes considered an equal compromise.
As seen in Arwood v. AW Site Services, LLC In the Court of Chancery of Delaware, the state respects contracting parties’ right to enter into good and bad contracts. The Delaware Supreme Court has yet to decide if a party can win a settlement for a broken promise if both parties knew some of the promises weren’t true at the time of signing.
Sandbagging in the Context of Due Diligence
Due diligence is expensive, so parties to contracts in mergers and acquisitions often try to ensure a Buyer doesn’t have to check every detail of a Seller’s business.
Pro-Sandbagging
A pro-sandbagging clause enables a buyer to pursue compensation for a violation of a representation or warranty even if the Buyer had previous knowledge that the statement was untrue. The right to a remedy, for instance, is not affected by any knowledge acquired (or capable of being acquired) before or after the execution and delivery of the agreement or the closing date with respect to the accuracy or inaccuracy of such representation [or] warranty.
In the Buyer’s eyes, a pro-sandbagging clause helps assure that it will benefit from its bargain. Based on the Seller’s promises and warranties, the Buyer assumed that its target had a particular worth. Buyers claim that if the statements are untrue, they overpaid and should receive compensation. Additionally, buyers contend that pro-sandbagging agreements give the parties more assurance. They eliminate obstacles to recovery, for instance, a protracted and expensive argument over the Buyer’s prior knowledge during the indemnification process.
Anti-Sandbagging
An anti-sandbagging clause would prevent a buyer from pursuing reimbursement in cases where the Buyer knew (or, depending on the clause’s scope, had cause to know) that a representation was untrue before closing. The contract can provide, for instance, that the Seller is not responsible for “any Losses originating from or attributable to any inaccuracy in or warranty in this agreement if the party claiming indemnification for such Losses had Knowledge of such breach before Closing.”
The parties may restrict the scope of the agreement to knowledge received by a particular group of people or to knowledge obtained before a particular date.
These days, anti-sandbagging clauses are rare. However, sellers contend that these clauses may encourage collaboration between the sale parties in specific situations. If, for instance, an executive or owner plans to stay with the acquiring company after the acquisition, the persistent danger that the Buyer may sandbag the Seller may result in conflict and distraction. Sellers might also contend that they should be allowed to fix any problems the Buyer learns about before closing.
Key Takeaways
By getting the Seller’s promises, the Buyer puts some risks on the Seller. As a practical matter of business, a Buyer doesn’t have to check and make a provision for every aspect of the company’s finances because it knows it can take legal action against the Seller if the claims turn out to be false. For example, false or misleading statements about the company’s financial health or expectations of future performance.
A Seller can’t go back on the promises it made because the Buyer’s due diligence didn’t find out they were false. Since the Seller promised in the contract that the Buyer could depend on certain statements, the Seller can’t say that the Buyer was wrong to trust the Seller’s own binding words.
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Two General Rules Governing Sandbagging
In general, courts have established two separate rules—the so-called “Modern Rule” and the “Traditional Rule”— In the absence of a sandbagging clause in the M&A agreement, parties to M&A transactions and their counsel should be aware of how various states handle a buyer’s indemnity rights.
The Modern Rule
The modern rule refers to a legal principle that guides the interpretation and application of law in contemporary society. It is based on the principle that laws should evolve and adapt to changing circumstances and new situations. In other words, the modern rule emphasizes the need for a flexible and dynamic approach to law rather than a strict and rigid interpretation of outdated legal principles.
According to “Modern Rule” courts, the Buyer had the right to rely on the representations and warranties because they were negotiated contractual duties. Delaware and, generally speaking, New York are two states that adhere to the Modern Rule (as well as Illinois, Florida, Connecticut, and Indiana).
The Modern Rule is a “pro-sandbagging” rule and is thus in the best interest of the Buyer. Because purchasers are typically not required to demonstrate reliance in those jurisdictions to pursue an indemnity claim for a seller’s breach of a representation or warranty, buyers are likely to prefer the controlling law of an M&A agreement to be a state that adheres to the Modern Rule.
The Traditional Rule
According to the Traditional Rule, a buyer’s indemnification claim requires that it be proven that they relied on the representation or warranty in some way.
Most states have adopted this approach, which calls on purchasers to demonstrate that they relied on the representation or warranty that the Seller broke.
The Traditional Rule is seller-friendly since it prohibits “sandbagging.” Because a buyer would have to demonstrate that they relied on the Seller’s false representation or warranty to succeed in a claim for breach of representation or warranty against the Seller, a seller will likely prefer that a state that adheres to the Traditional Rule serve as the governing law of an M&A agreement.
The Bottom Line
Some people who disagree with modern rules think sandbagging is bad economics because it makes bargaining more like a punishment. Others believe that sandbagging is unfair or questionable from an ethical point of view. Even though it might be unsettling to let a Buyer wait until after closing to bring a breach claim against the Seller that it knew about before closing, the risk of this kind of litigation can be managed just like any other risk in the deal that the parties make.
A rule that supports sandbagging backs up the idea that representations and warranties are an essential way to share risks.
When the parties to a contract choose not to (or don’t) divide the risk of sandbagging, the Buyer can rest assured that, as part of the deal, the Seller has implicitly promised to be honest in what it says. This view of “reliance”—that is, it requires nothing more than relying on the express warranty as part of the deal between the parties—reflects the common belief that an action for breach of an express warranty is no longer based on tort but mainly on the contract.
In other words, the fact that the Buyer questioned whether the Seller would honor their promises should not free the Seller from his obligations when it agrees to do what it said it would do. Reliance, whether a good idea or not, is not a part of breaking a contract.
Practice Pointer
During the due diligence, you should keep in mind the Seller’s promises and any facts you find that goes against the promises. It is best to seek legal advice before entering into any contract.
Contact Swiecicki & Muskett, LLC for practical solutions to your business and legal issues.
by Chris SwiecickiUnderstanding Contract Law: The Implied Covenant of Good Faith and Fair Dealing
A legal contract’s basic function is to state the rights and obligations of each party. In addition, the document typically covers what will happen under a variety of possible scenarios. This list of stipulations can be quite lengthy, especially in contracts between corporate entities.