Reading Agreements Critically with a Contract Playbook

March 1st, 2010

Followers of this blog may be aware that I avoid reading contracts front-to-back as much as possible.  I find that breaking a contract into chunks lets me read more quickly, more effectively and more critically.

To do that, a client and I recently adopted a strategy that I have used informally for a long time, which is to develop a playbook of preferred terms that we incorporate in our form documents so that when I sit down to read a contract I know exactly what I am looking for.

I start my review by comparing the contract against my playbook and making notes on any differences.  After I finish that I usually have a good sense of how the contract is structured, and I can then read through to put the sections together.

On top of the contract-review benefits, having a formal playbook makes it easier to coordinate contract strategy with clients, and also to maintain consistency over time.  When we have a clear sense of what “normal” is, we can develop a set of arguments to support our preferred terms, and also keep track of which deals required us to deviate from our standards.

A contract playbook is a great tool to read difficult contracts quickly, carefully and comprehensively.  I recommend it to anyone who needs to review a lot of documents.

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Making SaaS out of a Services Agreement

February 20th, 2010

Many software companies build products that live on the web and don’t install on local computers at all.  Enterprise-focused companies call this SaaS; everyone else just calls them web-based or hosted services.

Either way, developers of these products sometimes look for customers among big companies.  It is really common then that the customer’s contracts manager doesn’t quite get the nuances and sends over some kind of Master Services Agreement to document the deal.  Those agreements are generally based on the idea that the vendor is providing a specific, custom deliverable and don’t fit the situation very well.  I have been through this drill a lot and have a few observations about some of the important differences between a custom services and a SaaS deal.

1)  Work for hire language.  A Master Services Agreement will almost always say that the customer owns all technology and works created by the SaaS vendor during the course of performance.  This would be true if the vendor was writing custom software, but is the opposite of what the vendor wants in a SaaS situation.  This should be replaced with something that says the vendor owns all the software and anything developed during the term of the contract, and that the customer has a license to use all of it (subject to payment of all fees).

2)  Service levels.  The Master Services Agreement may not have any service level terms, such as an uptime guarantee or detailed procedures for responding to service errors.  This can work out well for the vendor since it allows more flexibility and avoids difficult conversations about discounts if the service goes down.

3)  Source code escrow.  Some companies feel strongly that if an important vendor goes out of business they should be able to take over the source code to preserve continuity.  With SaaS products these terms are especially inappropriate because the service is hosted- a customer would have to take over the entire service rather than just getting the source code to maintain an installation at its own facility.

4) On-site services.  Master Services Agreements can use a lot of ink on issues like vendor behavior on the customer’s premises and the customer’s ability to replace vendor personnel.  This comes out of the idea that vendor personnel will be in the customer’s data center regularly, which is not correct in a SaaS relationship.  I watch out for language that is really egregious here, but mostly try to leave this stuff alone since it just doesn’t apply very often.

The point of this post is that a Master Services Agreement is the wrong tool for the job in a SaaS deal.  From the vendor’s side, some terms definitely need to be changed, while others are not applicable but can be left mostly alone.  I always try to make the minimum set of changes that will let everyone sign the deal and get the relationship underway, while making sure there is nothing in the agreement that can come back to bite my clients later.

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Reading Contracts: What am I Missing?

August 28th, 2009

One of the hardest things to do when reading a new contract is to figure out what is not covered.  It’s relatively easy to review an agreement and pick out things that are completely wrong or run contrary to one’s interests.  On the other hand, the sea of words can prevent readers from noticing, for example, that a license agreement provides a nonexclusive, worldwide, perpetual license, but doesn’t say clearly whether the license fee must be paid and once paid whether it must be periodically renewed.

The best way to be sure a contract contains all the terms one needs is to do the same type of transaction over and over until you know it cold.  Next best is to find someone else who has to rely on.  Those aren’t particularly helpful suggestions to someone in unfamiliar territory with a deal on the line, though, so here are some suggestions to help identify missing terms.

1) Make up a hit list.  Before you start reading, write down list of the important terms.  This step takes a surprising amount of mental discipline but it is incredibly important.  Avoid the temptation to dive straight in and “see what the contract says”.  Even if you think you know what terms you need, write them down before you start reading.

2)  Take the contract in sections.  This goes along with my piece on How to Read a License Agreement.  Instead of reading front-to-back, search the contract to find all the terms on your hit list.  Do they match your requirements?  Is anything from your list missing?  Bonus points for lining up your hit list in one column on a piece of paper and writing down the comparable terms in the contract in the next column.  I have only taken this extra step a handful of times, but found it very helpful when the deal was complex or I was having a hard time getting through the contract language.

3)  Put it Back Together.  Now that you have found the biggest points, you can read through and see how other terms flow around them.  Do all the defined terms match your understanding of what they should be?  Do any subparagraphs under one of the big points limit its applicability?

4)  Try to Break it.  It’s also easy to read a sentence, squint a bit and say “yeah, that basically covers it”.  Instead of trying to read the contract in a way that fits your needs, do the opposite.  How could a paragraph be read against you?  E.g. if you quit vs. being terminated by your employer, will you lose any vesting in your stock?

5)  Read with a Friend.  If the deal is important it merits more than one set of eyes.  I frequently find that useful points come out of discussion with a co-reader.

6)  Search for Exemplars.  I am putting this last because it’s really hard to find good examples of many types of agreements.  The SEC’s EDGAR database is a good source, but search is very limited unless you pay for advanced search capabilities.  Docstoc and Scribd have pretty good libraries but since there is no clear way to judge quality it is best to look for at least 3 samples of the type of agreement you need, then compare terms carefully before relying on any one contract.

I hope these ideas are helpful.  Reading carefully and catching everything is a genuinely hard task.  Practice very much makes perfect and these are some of my favorite practice tools.

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Thinking Out Loud About Contract Survival – Please Contribute

August 12th, 2009

I have recently come across a number of contracts with extensive survival provisions.  For the non lawyer-wonks out there, a survival clause says that when the contract is terminated certain provisions will continue to govern the parties’ behavior toward one another.

There is a part of me that hates the concept of these provisions- they turn the whole deal into a kind of roach motel that the parties can enter, but can’t fully leave for a long time.

The other part of me understands that survival clauses have value, but wants to find the right logic for using them.

Confidentiality – Yes
For example, parties to a deal may well learn a bunch of confidential information about one another.  Terminating the agreement might be used as a way to escape the need to keep that information confidential, so I commonly see language that says the parties will be required to keep information confidential for 3-5 years, and that the confidentiality language will continue to bind the parties after the agreement is terminated.

Indemnification – No
On the other side, I also see language that says one party’s indemnification obligations will continue after the deal ends.  Indemnification means that, in an agreement between A and B, if C sues both A and B because of something A did, then A will take charge of the litigation and cover all of B’s damages and legal costs.

I can certainly see why B might want this, but B is really saying there that it wants the ability to terminate the deal- ending A’s economic advantages- and still keep A on the hook for any downside issues that come up.  As lawyer for A, I push back on this idea.  If B wants out so be it, but B shouldn’t get to keep the economic advantages and push all the risk onto A.

In Search of a Rule
Is there a principle goverining which provisions should survive termination of an agreement?  I’ m not sure and this is the thinking out loud part.  Here are my ideas to date:

-> Leverage wins.  If one side to a deal has significantly greater negotiating leverage then it can probably dictate the type of risk-allocation point above.

-> When the parties are in equal positions, my idea is that “passive” activities can/should survive, but the parties should not be required to affirmatively do anything.  E.g. confidentiality doesn’t require anyone to step forward and take action, so it can survive.  Indemnity is an active obligation by one side to litigate and pay costs.  It should not survive.

Seeing this written down, I am not sure if this is the right way to think about it.  E.g. the parties may negotiate limitations of liability in a deal (e.g. in a dispute damages payable by A are limited to fees paid to A by B during the term of the deal).  Should one side be able to terminate the agreement and dump the liability cap or should both sides be held to the negotiated terms forever?

Comments Requested
Is there a rule here or is every deal a unique set of circumstances?  I’d love to hear your thoughts in the comments.

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On Not Making a Federal Case of Every Transaction

July 21st, 2009

Clients hire me for subject matter expertise and to help negotiate transactions. Having worked through a lot of deals in my 10 years as a lawyer, I have some sense of what works, what doesn’t, how to evaluate risk in a deal and how to draft an agreement that takes on just the right amount of risk.

The other side in the deal has an attorney doing the same thing, and once the deal is done we both step out and let the business principals begin the relationship that the agreement covers. In this process it is really easy for the lawyers to get hung up trying to perfectly craft every term in the agreement. This can drag out the negotiation and run up costs. If the negotiations are especially bruising it can also create a bit of tension for the principals at the start of the relationship.

How, then, can one avoid turning every contract into a major battle? Here are a few ideas:

1) Don’t get personal. Contract negotiation is not a battle of wills. It feels that way sometimes, especially when it seems like the other side is determined to throw out all of my suggestions and force its own terms on my client, but the focus needs to stay on reaching a deal that works, not a document I created.  Egos should be checked at the door so the parties can focus on the facts.

2) Work with those facts. I talk through scenarios with my client and the other side and use concrete examples as much as possible so that everyone can understand why a certain term is important.  Tit-for-tat negotiation where each side can only concede something if the other does can stay in the bazaar as far as I am concerned.  I talk through my client’s economics (without giving up confidential information, of course) so the other side can understand why prices are set where they are, why insurance provisions can’t change for this deal, etc.  When the other side understands the *reasons* they need to work much harder to counter my client’s proposals.

3) Listen actively. Asking questions and making a visible effort to understand the other side’s business requirements pays huge dividends. It might seem counterintuitive based on #2 above (if I ask the other side for its reasoning won’t it be harder for me to say no to them?), but it isn’t.  The acts of listening, acknowledging concerns and finding ways to help the other side cover those concerns encourages them to do the same with us.  When we all understand one another’s needs really well we can jointly work out collaborative solutions.

Every deal is different and some definitely go sideways despite everyone’s best efforts to keep things moving properly. Still, when I am able to approach a negotiation with these best practices in mind I find that the deal moves much more smoothly, quickly and with the best legal fees/contract value ratio.  My clients like that.

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Keeping Things all in Context

July 10th, 2009

[Note: I have taken about a 5 month hiatus from this blog and am suitably refreshed and ready to get back in the habit.  This is a copy of a newsletter I sent recently.  I hope you enjoy it.]

I worked through a complex contract recently where the other side had heavily revised my client’s standard form agreement. A number of terms were extremely important, and others less so.

I got to one paragraph about shipping requirements and rolled my eyes slightly when I saw that the other side had changed our “FOB origin” term to “FOB customer’s facility”, meaning that my client would be on the hook for lost property until the goods reached the customer’s facility.

The same day, I found the amazing photo below on the Web, courtesy of Clay Shirky‘s Twitter page.


It was a timely visual reminder that much as we might like to take things like shipping for granted, we can’t always count on them.

With that in mind, I looked at the full context of the agreement:

*Do we have insurance to cover these kinds of losses? Yes- good.

*Does the agreement have “time of the essence” language, liquidated damages clauses or other penalties that could apply here? No- terrific.

Knowing that, we determined that this point was not likely to have major repercussions and we could focus on other terms in the deal.

The lesson? Context matters, and little points can turn into big ones if we don’t look at everything together. Great photos help.

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Contract Management Strategies

January 6th, 2009

Enterprise software companies sooner or later accumulate a lot of paper governing customer contracts.  Maybe half the time customers accept a company’s standard sales or license agreement without substantive comment, but the other half gets negotiated- sometimes a little, sometimes heavily and sometimes the customer insists that its own paperwork govern.

Managing all these terms is complex and painstaking work.  I know a few large companies that take a draconian approach to the task- they only circulate agreements in pdf form (to prevent changes) and any revised terms go in an amendment instead of the original document.  The theory is that the presence of an amendment flags the fact that there are non-standard terms.

In practice this makes a giant mess.  It should be possible to draft amendments that are very specific and clear about which terms have been changed and how, but it never seems to work that way.  I think the companies that get to the stage of doing this get overly caught up in process, the lawyers making the changes are not connected to the deal being done and the terms end up more confusing than they should be.

You need to be a really big company to take that approach in any case, so what works better for the average company?  As with many other things, the answer is to make sure that the information doesn’t live only in the heads of certain people.  Write it down.  Put someone in charge of collecting signed contracts and tell that person to make up a spreadsheet (for starters, at least) that notes any variations from standard.

As the lawyer I wish I could tell the sales teams they won’t get paid until they tell the contract managers about any wrinkles, but I know I’d get overruled.  Still, collect the info right when the deal closes before everyone forgets about it, then work on keeping it up to date.  It’s an ugly “uh-oh” when you realize you have inadvertently been in breach of a contract’s terms because you didn’t know it was non-standard.

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When Rights of First Refusal Are a Bad Deal — HBS Working Knowledge

June 30th, 2008

HBS Working Knowledge newsletter has a Q&A with a Harvard professor who examined a specific kind of right of first refusal, where one party has the right to buy an asset at a fixed price, but can also swoop in if the asset is offered to a third party at a lower price.

The article explains that this works against the right holder, because it lets the seller tell the third party “buy at this (high) price or not at all.”

When Rights of First Refusal Are a Bad Deal — HBS Working Knowledge

The best part of the whole article is the answer to the question “why do people use these types of rights if they work out so badly for the right holder?”  The answer:

Contracts are big, complicated things with lots of clauses, some of which get exercised rarely if at all.

Words to live by for sure.

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Automatic Contract Renewals: Get Out Your Colored Pens

March 13th, 2008

When your business enters an open-ended relationship with another company, there are two ways to manage the term. First is to provide that the agreement will terminate automatically unless renewed, and second is the opposite- the contract renews automatically unless is it specifically canceled. Each method has its pros and cons. Here are some ideas to consider:

Automatic Termination
All contracts should be periodically reviewed for value to the company. One way to make sure this happens is to provide that the contract must be actively renewed or it is deemed to lapse. The problem here is that it requires memory and attention to manage. I would not recommend this to any but the most detail-oriented of clients who have a great calendar system to track review/renewal dates and a person capable of staying on top of them all.

However, for certain special transactions such as limited-term trials, this can make sense. The risk, of course, is that one forgets to renew, realizes several months later that the company has incorporated someone else’s technology into a product and is then in a poor negotiating position when the time comes to set the general availability pricing.

Automatic Renewal
This is far easier to manage, for obvious reasons, and I recommend it as the default. The trick here is that most automatic renewal contracts allow termination (without cause) only within a set period, such as 60 days prior to the renewal date. Miss the window and you could be stuck with the deal for another year. A calendar of these dates- at least for big-ticket contracts- is still highly recommended.

With automatic renewals, it is also crucial to check the “emergency exits”. What are the grounds for “for cause” termination? Once invoked, can the other side cure the breach? Is that desirable or would it be better just to let everyone walk away?

Good Practices in the Real World
In both cases, the challenge is not get caught by surprise. As a company grows the volume of contracts and renewal dates gets larger as well. Again, I suggest a calendar (or a spreadsheet) of key dates and a person charged with keeping it updated.  In most cases, renewal is a non-issue unless there are problems with the relationship.  An ounce of planning here can avoid a pound of headaches.

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A Letter of Intent Can be a Dangerous Thing

February 14th, 2008

I’ve been reading DC Toedt’s notes on “350 Things I Wish I Knew as a First-Year General Counsel”. He has a number of very good, practical observations about how to be an effective attorney- and not a “Sales Prevention Department”.

One that made me laugh was to remember that “the most useful function of a letter of intent—arguably its only proper function—is to establish that the parties do not intend to enter into a contract at that time.”

In other words, it’s a contract to say that there is no formal contract. The comment is hyperbole, of course- the parties do intend to enter a contract at a future time or they wouldn’t bother with the LOI to begin with, but there is a lot of truth to it at the same time.

I ‘ve definitely seen deals go bad between the LOI and the final agreement. Most LOIs say explicitly that they are non-binding, but having the signed piece of paper can have some kind of placebo effect that gives people undue confidence in the strength of a relationship.

I actually had one client that got a signed LOI, proceeded to hype it for all it was worth and told a bunch of investors that the final agreement was a mere formality. The investors chose to wait for the final agreement before committing, and when the other side backed out it was very embarrassing for everyone. I don’t think the company ever recovered.

So yes, letters of intent are great to have. Just don’t bet the company on one.

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