SLG's 50 State Survey Part Two: California

This is the second installment of a nationwide survey report we’re working on here at SLG, which will ask the questions listed below of each of the fifty U.S. states. Here’s our New York coverage. Next up:

CALIFORNIA

I. LIMITS OF LIABILITY

Are contractual caps, ceilings, or limits on direct damages enforceable?

Yes.  Courts in California uphold contractual provisions that limit liability for contract breach damages, including for ordinary negligence.  Health Net of California, Inc. v. Department of Health Services, 113 Cal.App.4th 224, 243 (2003).  Except, that is, when (i) the applicable provision affects the public interest, or (ii) another statute expressly prohibits it.  For example, per the California Civil Code, a contractual limit of liability for fraud, willful injury, or violation of law would be unenforceable, Civ. C. § 1668, as may deals struck between parties of unequal bargaining power (more on this below).  Also, California courts may kill limits of liability that are unconscionable.  Civ. C. § 1670.5(a).

Are agreements that exclude all indirect (i.e. consequential, incidental) damages enforceable?

Yes.  Under the California Commercial Code, consequential damages may be “limited or excluded unless the limitation or exclusion is unconscionable.”  Cal. Com. Code § 2719(3).  However, where consequential damages are limited “for injury to the person in the case of consumer goods,” such limitation is invalid unless proved not unconscionable.  Id.

Can remedies be limited to those express remedies solely and exclusively provided for in a contract?

Yes.  For example, a sales contract may limit liability to the “return of the goods and repayment of the price or to repair and replacement of nonconforming goods or parts.”  Cal. Com. Code § 2719(1)(a).  Also, for a stated remedy to be exclusive and mandatory, its exclusivity must be expressly agreed—otherwise, it’s only “optional.”  Cal. Com. Code § 2719(1)(b).

II. DAMAGES

Does California mandate any blanket limits on the amount of (a) consequential damages, or (b) punitive damages that a party may recover in commercial contracts?

(a) No.  However, recovering consequential (or “special”) damages requires that those damages were “foreseeable by the parties at the time of contracting.”  Martin v. U-Haul Co. of Fresno (1988) 204 Cal. App. 3d 396, 409.  Meaning, the breaching party (i) knew, or (ii) should’ve known his/her breach may instigate these damages.

(b) No.  However, punitive damages must stem from a tort, not a contract breach alone.  Civ. C. § 3294(a).

Are punitive damages recoverable in contract matters? If so, when?

No.  Punitive damages are generally unavailable for breach of contract, even where the defendant was malicious, willful, or fraudulent.  However, if a tort (i.e. fraud) independent to a breach of contract is pled and proven, punitive damages may be available.  Cates Construction, Inc. v. Talbot Partners (1999) 21 C4th 28.

 III. DISCLAIMERS/LIMITATIONS OF WARRANTY

Are disclaimers of any and all implied warranties enforceable in California?

Yes.  To disclaim the implied warranty of merchantability, a disclaimer must: (i) mention merchantability, and (ii) when written, be written conspicuously.  Cal. Com. Code § 2316(2).  To disclaim the implied warranty of fitness, a disclaimer must be written conspicuously.  Id.  The following also eliminate or modify implied warranties:

-          Expressions like “as is” or “with all faults,” which spotlight the exclusion of implied warranties.  Cal. Com. Code § 2316(3)(a).

-          The buyer examining the subject goods/sample/model “as fully as he desired,” or refusing to examine the goods—but only regarding defects an examination ought to have “revealed to him.”  Cal. Com. Code § 2316(3)(b).

-          A course of dealing, course of performance, or usage of trade that is counter to the implied warranties.  Cal. Com. Code § 2316(3)(c).

-          Liquidated damages or limits of liability provisions.  Cal. Com. Code § 2316(4).

IV. DISPUTE RESOLUTION

When the State of California is sued over a contract dispute, are there any mandatory dispute resolution procedures such as venue requirements or jury trial requirements?

No, generally.  In most scenarios, when suing a California agency for breach of contract, plaintiff must file an administrative claim within one year of the date of the alleged breach.  The government has 45 days to respond.  If the government agency denies the claim during the 45 days, plaintiff has 6 months to file a lawsuit in court from date the agency mailed the denial or personally delivered this “right to sue letter” to plaintiff.  California Government Code § 945.6.  If Plaintiff does not receive this letter (i.e. the government takes no responsive action to plaintiff’s claim) within 45 days, plaintiff has two years to file a lawsuit from the date of the alleged breach.

Exception: as of late 2016, many California public entities and contractors involved in public works construction must adhere to specific dispute resolution processes, both informal (“meet and confer”) and formal (mediation, an alternative non-binding process, civil action, or arbitration), for disputed claims of payment.  Assembly Bill No. 626.

V. ADDITIONAL NOTES

1. Pertaining to liability caps: A liability cap provision affects the public interest if it exhibits “some or all of the following characteristics.” Tunkl v. Regents of University of California, 60 Cal.2d 92 (1963).  (i) It concerns a business of a type generally thought suitable for public regulation.  (ii) The breaching party performs a service of great importance to the public, which is often a matter of practical necessity for some members of the public.  (iii) The breaching party holds itself out as willing to perform this service for any member of the public who seeks it, or at least for any member coming within certain established standards.  (iv) Due to the essential nature of the service, in the economic setting of the transaction, the breaching party possesses a decisive advantage of bargaining strength against any member of the public who seeks its services.  (v) In exercising a superior bargaining power, the breaching party confronts the public with a standardized adhesion contract of exculpation, and makes no provision whereby a purchaser may pay additional reasonable fees and obtain protection against negligence.  (vi) As a result of the transaction, the person or property of the purchaser is placed under the control of the seller subject to the risk of carelessness by the seller or his agents. So: the less equal the bargaining power, and/or the more publicly important the contract’s subject (i.e. health care services), the less enforceable the applicable limitation clause.

2. Pertaining to liability caps: Regarding contracts for goods (i.e. manufactured goods), the California Commercial Code adds another exception to the enforceability of limits of liability provisions, providing that where “circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this code [i.e. via restitution under Cal. Com. Code § 2718].”  Cal. Com. Code § 2105(2).

3. Pertaining to unconscionability overall: “Unconscionability has generally been recognized to include an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.”  A & M Produce Co. v. FMC Corp., 135 Cal.App.3d 473 (1982).  Both the substantive and procedural elements inherent to this analysis are necessary for a court to rule a contract unconscionable and so, unenforceable.  Little v. Auto Stiegler, Inc. (2003) 29 Cal.4th 1064.

SLG's 50 State Survey Part One: New York

This post is a preview of a nationwide survey report we’re working on here at SLG, which will ask the questions listed below of each of the fifty U.S. states. Our preview, like the coming survey, discusses the keys to contract disputes: (i) limits of liability, (ii) damages, (iii) warranty disclaimers, and (iv) dispute resolution—and the parameters of each within the subject State.

For now, New York seemed a fine place to start.

 

NEW YORK

I. LIMITS OF LIABILITY

Are contractual caps, ceilings, or limits on direct damages enforceable?

Yes. Unless the damages stem from gross negligence or willful misconduct, as discussed below.

Are agreements that exclude all indirect (i.e. consequential, incidental) damages enforceable?

No. New York courts insert an implicit exception to these blanket caps, even if the applicable agreements explicitly don’t. Where the damages at play arise from gross negligence or willful misconduct, public policy dictates the offenders are limitlessly liable, and the cap fails. So, no matter what, liability for such egregious behavior is unlimited.

Despite this exception, caps on indirect damages are enforceable against other (less egregious) claims.

Additional Notes on Gross Negligence in New York:

1.       Drafters should note that evidencing gross negligence or willful misconduct can be difficult, these standards high. Parties must show that a breaching party’s “egregious intentional misbehavior evince[s] some extreme culpability.” Otherwise, no gross negligence or willful misconduct is present, and the relevant liability remains limited under the contract. Metropolitan Life Ins. Co. v. Noble Lowndes Int'l, Inc., 643 N.E.2d 504, 506-07 (N.Y. 1994) (defendant’s “voluntary and intentional … refusal to perform a contract [to develop and install software] for economic reasons,” without plaintiff proving fraud or other willful intent, fell short of gross negligence and willful misconduct and the limit of liability survived; also, entering a contract intending never to perform is not in itself gross negligence or willful misconduct).

Can remedies be limited to the express remedies solely and exclusively provided for in a contract?

Yes.  Per New York’s adoption of the Uniform Commercial Code ("UCC") § 2-316 (more on this below), remedies for breach of warranty may be limited to liquidation or limitations of damages as captured by a contract, or via a contractual modification of the subject remedies.  However, these routes carry their own rules and limitations.  For example, per UCC § 2-718, liquidated damages must represent “an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy.”  An unreasonably large liquidation of damages is, therefore, void.

II. DAMAGES

Does New York law mandate any blanket limits on the amount of (a) consequential damages, or (b) punitive damages that a party may recover?

(a)       No. Unlimited consequential damages resulting from a breach of contract are generally available to parties under traditional contract principles. That is, so long as these damages were (i) a foreseeable result of the breach; (ii) “within the contemplation of the parties” when contracted; and (iii) not unconscionable. The UCC adds that consequential damages may be limited or excluded—except where those limits or exclusions are unconscionable themselves. UCC § 2-719 (3).

(b)       No.

Additional notes:

1.       Similarly, courts will generally enforce a contractual cap on consequential damages unless the cap is unconscionable, violates public policy, or enforcement causes the contract to fail of its essential purpose. Taylor Inv. Corp. v. Weil, 169 F. Supp. 2d 1046, 1058-59 (D. Minn. 2001).  If the provision was reasonable and negotiated as part of an arms-length agreement, however, proving unconscionability may be difficult. Finally, New York does not allow a manufacturer to disclaim liability borne of its own gross negligence, willful, wanton or intentional conduct. Kalisch-Jarcho Inc. v. New York, 58 N.Y.2d 377, 448 N.E.2d 413 (N.Y. 1983).

2.       In recent years New York made it possible for policyholders to squeeze insurers for unlimited consequential damages for breach of policy. This remedy is available where the insurer’s denial of policy benefits (i) breaches the covenant of good faith and fair dealing; and (ii) the applicable damages were foreseeable at the contracting time.

Are punitive damages recoverable in contract matters? If so, when?

Generally, no. Even if a breach is willful and without justification. Campo v. 1st Nationwide Bank, 857 F.Supp. 264, 273 (EDNY 1994).

Additional Notes:

1.       Contract claims fused with tort claims may earn punitive damages. Meaning, where a tort claim stems from a contractual relationship. There a plaintiff must show: (i) the defendant’s conduct is actionable as an independent tort; (ii) the tortious conduct is egregious; (iii) the egregious conduct is directed at the plaintiff; and (iv) the defendant’s conduct is part of a pattern directed at the public generally. Conocophillips v. 261 E. Merrick Rd. Corp., 428 F.Supp.2d 111, 129 (EDNY 2006).

2.       In New York, certain fraudulent conduct may also earn punitive damages, i.e. fraud with “evil and reprehensible motives.” Solutia Inc. v. FMC Corp., 456 F.Supp.2d 429, 453 reconsideration denied (SDNY 2006).

3.       Contracts commonly exclude all incidental, indirect, and consequential damages subject to certain exceptions; punitive damages may be expressly excluded.

III. DISCLAIMERS/LIMITATIONS OF WARRANTY

Are disclaimers of any and all implied warranties enforceable in New York?

Yes. Regarding all issues concerning implied warranties, New York adopted UCC § 2-316, which states that all implied warranties may be disclaimed.  However, such disclaimers must use contract language that is commonly understood to call a buyer's attention to the exclusion of warranties.  Expressions like "as is" or "with all faults" suffice, per the UCC, to adequately warn buyers and, thus, establish warranties.

For the two most prevalent implied warranties—those of merchantability and fitness—New York and the UCC permit sellers to disclaim:

(A) the implied warranty of merchantability, as long as the disclaimer is:

(i) conspicuous, and

(ii) explicitly includes the word “merchantability.”

(B) the implied warranty of fitness as long as such disclaimer is

(i) "affected by a writing," and

(ii) "conspicuous.”

Drafters should note, however, that the UCC places a limitation on these disclaimers: they’re valid “unless the circumstances indicate otherwise.”  Meaning, if the facts indicate that a warranty did exist—perhaps as a deciding factor in the subject sale of goods—regardless of what the contract purports to disclaim, a warranty may exist.  Also noteworthy is the UCC § 2-316’s dictate that “an implied warranty can also be excluded or modified by course of dealing or course of performance or usage of trade.” Although these are likely tougher to prove than black and white ink on a contract is to read.

IV. DISPUTE RESOLUTION

When the State of New York is sued over a contract dispute, does New York mandate any dispute resolution procedures such as venue requirements or jury trial requirements?

No.  The Court of Claims has jurisdiction over contract dispute claims brought against the State of New York and certain State-related authorities.  Rather, to serve New York with a suit for breach of contract, a claim must be delivered to a New York Assistant Attorney General at an office of the Attorney General within six months after the claim’s accrual.  The claim's venue is determined by the county where the claim accrued.

When Assignment Bars & Termination Rights Fail: Bankruptcy Code §365(f)

Intro

Certain of your termination and anti-assignment clauses might be unenforceable.  Here’s why, when and how, and what you can do about it.

The Scenario

You’re shopping to license hardware or software from a reliable company. Maybe the company you settle on is a household name—let’s call it Tech Company—an industry leader in the service you’re seeking.  After some fruitful internal discussions, you reach out to Tech Company’s sales squad and within a matter of days or weeks money changes hands, new products are installed, and your organization is changed for the better.  Soon your employees learn to deftly handle the upgrade and before you know it, you and your customers rely on its speed and interface.  

A month later a notice arrives in the mail.  It’s from your new partners at Tech Company, but they’re not inviting you to the corporate Labor Day BBQ.  This letter is terser than the communications they’ve sent in the past.  You don’t understand its jargon, but you catch the gist.  Tech Company has filed for Chapter 11 bankruptcy.  Now it is assigning your contract to another company you’ve never heard of, called New Entity.  It seems Tech Company has suddenly washed its hands of you and introduced New Entity in its place without your knowledge—certainly without your consent.

The Roller Coaster

Here’s when you might scramble to your agreement with Tech Company.  Your review of the PDF begets more questions than answers, though; it’s practically a rollercoaster of positive and negative results. 

First, in the assignment section, you see something like this:

“Neither Party may assign this Agreement nor any rights or obligations hereunder...”

Point for the home team.

Then, a couple lines later, you read:

“…except to any entity that acquires the applicable assets of Tech Company as a result of a bankruptcy proceeding…”

Point for the away team.

You lighten back up as you come across a backdoor to the exception:

“…provided that You may, in such an instance, terminate this Agreement for convenience under Section…”

You flip to the termination section, and it’s all there, in slightly pixilated black and white.

“You may terminate this Agreement at any time upon sixty (60) days written notice to Tech Company…”

You breathe a little easier.  You still control some measure of your fate.  Tech Company cannot unilaterally unload you onto one of its competitors that you’ve never so much as spoken to.  If you don’t like what New Entity is selling, you can terminate the agreement for convenience based on Tech Company’s bankruptcy-fueled assignment.  Reassured, having disembarked the rollercoaster with your lunch intact, you ring your attorney to talk it over.

And she straps you right back in.

Apparently, there’s something called the Bankruptcy Code, Ms. Attorney says, and it rejiggers your agreement.  Per the Code’s §365, not only is Tech Company’s assignment permitted, but your right to terminate as a result of this assignment is void.

What?

Via §365(f), anti-assignment clauses are often useless in the face of bankruptcy.  Regardless of any provision that “prohibits, restricts, or conditions [an] assignment,” the Bankruptcy Code permits an assignment by the trustee of a bankrupt entity.  The only prerequisites, per the same section, are that:

(A) the trustee assumes such contract or lease in accordance with the provisions of this section; and

(B) adequate assurance of future performance by the assignee of such contract or lease is provided, whether or not there has been a default in such contract or lease.

Since the Bankruptcy Court has already approved the assignment—a.k.a. sale—of your contract to New Entity, these prerequisites have already been met; otherwise the Court wouldn’t have let the process go this far.  According to the Court Order referenced in the letter you received, Ms. Attorney continues, Tech Company’s trustee took control of the contract along with the rest of Tech Company in line with the Code.  Thus, (A) above has been met.  In terms of (B), whether or not Tech Company provided you with “adequate assurance” of New Entity’s ability to future perform your contract, Tech Company has assured the Court that it can and will “promptly take any actions reasonably required to obtain a Bankruptcy Court finding that there has been sufficient evidence of adequate assurance of future performance,” per the Order.  Satisfied with this promise and that New Entity’s performance of your contract wouldn’t result in material, economically significant detriment to you, the Court moved forward, and blessed the assignment.

But don’t I have a right to be notified at least? To object to the assignment? you ask.

Ms. Attorney reads from the Court Order: “If any consent is not obtained or notice is not given prior to the assignment’s closing, the closing shall nonetheless take place subject to the terms and conditions herein…”

And what about my termination rights? you follow up.  These rights were expressly provided for in your contract’s assignment section.

§365(f)(3) erases those, Ms. Attorney replies.

Under this subsection of the Code: “Notwithstanding a provision in an executory contract” that grants a termination right “on account of an assignment of such contract,” the subject contract “may not be terminated or modified under such provision because of the assumption or assignment of such contract or lease by the trustee.”

So, bankruptcy and its ensuing assignment cannot be the root of a termination right.  If it is, that right is itself terminated. 

Keep the Code in Mind

§365 intends to help trustees elicit the max value from debtors’ estates.  To do so it allows trustees to assign executory contracts that benefit the estate—no matter what the contract itself might prohibit or permit.  As long as the trustee assures the Bankruptcy Court that the assignee’s future performance will be adequate as compared to the performance promised under the contract, then the non-debtor (in this case, your company) is in a position level to the one it bargained for with the debtor in the first place, business can proceed, and everyone wins.  Though, as here, it might not feel that way. 

This scenario begs the question: Why do anti-assignment and termination rights hinging on bankruptcy persist if they’re rendered meaningless by the Bankruptcy Code?  Why include them at all?

The prevailing guess is that sometimes, folks don’t know the law.

Whatever side of the table a party and its attorney may occupy, anti-assignment and termination rights—along with an unfamiliarity with §365—can underpin a party’s confidence in their agreement.  However, this confidence could be false.  Through §365, the Bankruptcy Code seeks to right the ship when one entity to an executory contract is sinking.  Bankruptcy can be tricky, and a working knowledge of the Bankruptcy Code at the negotiation stage is key.  When negotiating technology agreements in general—and their assignment and termination clauses in particular—parties and attorneys must keep §365 in mind, or certain rights might be unenforceable after all.

 

New York May Change a Pivotal Arbitration Confidentiality Rule: 3 Impetuses & a First Amendment Drawback

Introduction

An approaching New York rule decision may transform the confidentiality of arbitration, with international ramifications.

Sometime in 2017, the Chief Administrative Judge of the Courts of New York State and the Commercial Division Advisory Counsel is expected to decide whether to expand the confidentiality of the Commercial Division, making it easier for adversaries to keep their arbitration's sensitive business matters sealed--even in court.  

The following addresses the impetuses for this potential change, its projected drawbacks, and scenarios in which the Commercial Division’s decision may severely shift the risks of arbitration.

Arbitration’s Popularity

Arbitration is an attractive choice to parties for several reasons.  Most notably: it’s fast, it’s cheap, and it’s foreign relations friendly.  According to PricewaterhouseCoopers, 88% of corporate counsel have arbitrated at least once, mostly because of its quick resolution relative to litigation.  Since arbitrators are subject matter experts and discovery is limited, arbitration routinely laps litigation.  Also, arbitration is markedly cheaper than litigation; less time spent means less billing.  The 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, which smooths the jurisdictional thorns of international conflicts, further renders arbitration an attractive local avenue, specifically for resolving global contract disputes.  

Finally, according to the American Arbitration Association, 54% of parties choose to handle disputes via arbitration because the process “preserves confidentiality.”  Per explicit binding rules, arbitrators place a heavy premium on maintaining the confidentiality of their parties.

Impetus for Change Part 1: Enforcement via Confirmation

If arbitration is such a slam dunk, why is New York proposing to change it? 

Because arbitration can be toothless.  Unlike litigation and the courts that adjudicate it, arbitration lacks enforcement.  

Arbitration is rooted in a contractual agreement between parties: a compact that should a dispute arise under the agreement they’ve executed, the parties will (neatly) arbitrate instead of (messily) litigate.  As such, post-arbitration, the losing party pays the winner voluntarily.  Meaning no court, state, sheriff or marshal compels the losing party’s compliance with the arbitration award.  The whole proceeding, and its resolution, is a private matter.

So: what happens when a party who lost in arbitration refuses to pay up?  While arbitration itself lacks enforcement, parties to arbitration may turn to the courts to get their awards enforced.

Via confirmation (a.k.a. validation) a party seeking the enforcement powers of the court (likely the arbitration’s prevailing party) presents to the court the relevant arbitration agreement, the award the arbitrator declared, and the award’s record.

A special or summary proceeding follows, where the court reviews and confirms the arbitrator’s award.  The court thereby attaches judicial clout to the arbitrator’s ruling, infusing it with enforceability.  Now the party that lost in arbitration is compellable by the many enforcement tools of the state, and the arbitrator’s award is within reach, regardless of the voluntary proclivities of the losing party.

While many parties who lose in arbitration voluntarily comply with their arbitration’s awards (somewhere between 49% and 90%), when voluntary compliance falls flat, confirmation proceedings to enforce arbitration awards may be necessary.

Impetus for Change Part 2: Confidentiality

Confirmation is litigation, which many parties flock to arbitration to avoid.  Besides for the relative expenses and time-suck of litigation, confirmation has another downside, too. 

By producing an arbitration agreement, record, and award in court a party may expose its secrets, since unlike arbitration proceedings, court proceedings are public.  This publicity guts arbitration’s confidentiality.

Parties facing noncompliance with arbitration awards therefore face a problematic impasse.  On the one hand, a party may prevail in arbitration, maintain its confidentiality, yet receive no award from its opposition.  On the other hand, a party may enter court to enforce its arbitration award, but only by relinquishing its confidentiality as the price of admission.  Indeed, this relinquishment may expose a party’s prized, even proprietary information.

While a party that prevails in arbitration is likely to win confirmation in court (about 90% of arbitration awards are confirmed) the toll in confidentiality lost in exchange for this victory can be severe, even prohibitive.

Impetus for Change Part 3: Tough Sealing

A party may address this impasse by sealing its court record.  This way, a party can get confirmation from the court, while keeping its arbitration docs confidential.  However, sealing a court record isn’t easy.

To maintain judicial integrity, courts strongly prefer keeping their records open to the public.  This aligns with the First Amendment, which protects the public’s (and the press’s) right to access court records. 

New York’s current record sealing rule, 22 NYCRR §216.1, is carefully construed to avoid upsetting this preference.  §216.1 states:

Except where otherwise provided by statute or rule, a court shall not enter an order in any action or proceeding sealing the court records, whether in whole or in part, except upon a written finding of good cause, which shall specify the grounds thereof.  In determining whether good cause has been shown, the court shall consider the interests of the public as well as of the parties.

Courts’ preference for open records and New York’s opaque sealing rule may therefore combine to evaporate confidentiality for parties seeking arbitration enforcement through confirmation.

New Rule to the Rescue?

To stem the flow of confidential info, the New York State Courts Administrative Board for the N.Y. Supreme Court’s Commercial Division drew up Proposed Rule 11-h, 22 NYCRR Sec. 202.70(g)—or Rule 11-h for short.  Rule 11-h clarifies what constitutes “good cause” for sealing court records.  This makes it easier for petitioners to flesh out their arguments for sealing confirmation proceedings, and perhaps, for courts to rule in these petitioners’ favor.  

Rule 11-h, with its revision of §216.1 emphasized, reads:

Except where otherwise provided by statute or rule, a court shall not enter an order in any action or proceeding sealing the court records, whether in whole or in part, except upon a written finding of good cause, which shall specify the grounds thereof. Good cause may include the protection of proprietary or commercially sensitive information, including without limitation, (i) trade secrets, (ii) current or future business strategies, or (iii) other information that, if disclosed, is likely to cause economic injury or would otherwise be detrimental to the business of a party or third-party.

By explicitly stating that protecting “proprietary or commercially sensitive information” (and specific subsections!) is “good cause” for sealing court records, Rule 11-h guides petitioners, providing touchstones for their pro-sealing arguments.  Where petitioners convince the court that their businesses stand to suffer in these particular ways if their arbitration materials are published, sealing is achievable.

Combine Rule 11-h’s specificity with the relative speed of confirmation proceedings, and seeking enforcement of arbitration awards, where necessary, may suddenly present a more palatable recourse against arbitration delinquency.

The Opposition

The possibility of Proposed Rule 11-h has compelled bodies such as the New York State Bar Association’s Committee on Media Law to argue the dangers of shrinking court transparency.  The Committee’s Report points to legitimate alternatives to outright sealing of court records (i.e. redaction) and substantial case law on the “stringent requirements” that litigants must currently meet in order to seal records in New York.  Per the Committee, law and precedent dictate practices such as “document-by-document” analyses to ascertain whether an open record would cause a “clearly defined and serious injury” to a petitioner; only then may “narrow” sealing occur. 

Rule 11-h, which opens the door to “conclusory” statements of business harm, would represent a perilous departure from established, constitutional court standards, presses the Committee.  What if the sealing in question is not petitioned to protect lawfully guarded business secrets, but “dubious management decisions, embarrassing or unlawful business practices, and corporate misconduct or transgressions”?  Often, the Committee stresses, the more a private company wants to keep a matter secret, the more interest the public has in accessing that record.

In this vein, the Committee’s Report on Rule 11-h points to the parties’ choice to appear in court to begin with.  The Report argues that “where the parties have availed themselves of New York State’s court system in order to resolve their dispute, ‘the public’s right to know both the process and outcome of litigation outweighs the parties’ desire to keep their business secret.’”

“[I]f the parties to a commercial dispute want to preserve the confidentiality of their business dealings in all circumstances,” the Report continues, “they can easily resort to confidential private arbitration of their disputes.”

Which lands parties back in square one.  What if, due to arbitration’s lack of enforcement, a party must appear in court? 

Conclusion

Whether or not 11-h modifies §216.1, arbitration is the preferred method of resolution for many global entities looking to quickly, cost-effectively solve contract disputes in New York.  Buttressing this preference is the current §216.1 and established case law protecting current or future business strategies and trade secrets whose exposure would competitively disadvantage the party petitioning for sealed records. 

Yet sometimes, despite the current protections and even when parties elect to arbitrate instead of litigating, enforcement of arbitration awards is necessary, and litigation looms.  It is in such cases, however rare, that the Commercial Division’s upcoming decision on Proposed Rule 11-h may be most impactful.

The Flexibility of Click to Accept Terms: the Individual Consumer vs. the Enterprise

Every day we click away our rights to our favorite apps and social media platforms.  It happens again when you get that shiny new update to the most recent IOS or Android software.  There is a little blurb about what the software update fixes, but what else is buried in those pages and pages of words that we scroll past and accept?  We are all guilty of it, many lawyers included, because the truth is, we don’t have too much control over what we agree to. You have two options: scroll down and accept or be stuck in the past.  The world of technology is fast paced and an operating system that is a month old could leave you with poor call quality, missed emails or worse, question marks in place of the newly diversified emojis.  Your option is accept or be left.  So that leaves us with the lingering question: what are we agreeing to and are our private pictures, text messages, direct messages, and inbox protected?  The software updates aren’t the only form of technology that makes us question what we are signing. 

Every few months, there is a status message posted all over Facebook.  This post announces to the social media conglomerate that the user does not authorize Facebook to use any of its content in any manner.  The hopeless user dates and time stamps the post, making it look tremendously official, and in less than four hours, it goes viral.  We have all seen this post, some of us have laughed immediately, while others run to google to see if there is any validity to this post and then you have a large group who have re-posted the status message.  Well, let’s give this viral post some context.  Have you ever desperately wanted to get out of a lease you signed?  The once charming New York City five hundred square foot $3000.00 per month apartment in Chelsea that you share with a roommate just no longer looks appealing to you or your bank account.  Ok, so here’s how you get out of that lease, place a sticky note on your landlord’s door with the following verbiage:  Dear Landlord, from this day forward I hereby return my apartment to you and will no longer be paying rent.  Do you see how ridiculous and ineffective that is?

Reposting your “copyrights” on Facebook is the equivalent of your sticky note to your landlord.  The status message is like telling your mortgage company via email that you will no longer be bound by the terms of your mortgage.  It is comparable to taking your car back to the lot and telling the bank that holds your car note, you are going to Uber going forward.  Your post means nothing, and here is why: the day you signed up for Facebook, you clicked a little green button that read “Sign Up.”  By clicking that button, you agreed to their Terms and even certified that you read their Terms and Policies.  That click is no different from signing your well-practiced signature on any contract or lease.  That one click of your mouse binds you and a post cannot get you out of a contract. So, what exactly did you click and agree to?  You have agreed to let Facebook and anyone they are affiliated with, or any company or person that pays Facebook, to share any and everything that you post.  That’s it, in a nutshell. 

Individuals using their smartphones or social networks aren’t the only people who face click to accept terms.  These terms are often seen on an enterprise level as well.  For example, a national radio station might purchase a text message providing service so that their listeners can text in when the station is running certain contests.  Before the radio station can use the service, they will be asked to agree to terms referred to as “click-to-accept” or “shrink wrap.”  

As IT attorneys, we are tasked to negotiate our clients out of “click-to-accept” terms.  Vendors often push back and will tell the client that everyone using their service is bound to these same terms, but of course, when there are hundreds of thousands or millions of dollars at stake, no is just not an option.  Recently, our client was asked to accept the terms of a Vendors standard End User Licensing Agreement (“EULA”).  The EULA had several terms that, because of the nature of our clients business, could not be agreed to.  Initially, we sent the Vendor our standard terms that we use when dealing with the type of services that they offered.  The response was an immediate no, everyone likes to use their own paper negotiated by their attorneys, understandable.  Instead of redrafting the entire EULA, we reviewed the terms of their EULA, and the areas that we could not agree to.  Taking some of our standard terms, along with the language in their EULA, after several negotiations, we were able to enter into a letter agreement with the Vendor.  After successful negotiations, the client was not bound by the click to accept terms, or any shrink wrap terms that may have been contained in the service that was being purchased. 

So, what do you do if you’re not an enterprise with millions of dollars and amazing attorneys to negotiate your rights? How do you protect your content or what you are clicking to accept?  Here is the secret: If you don’t agree with the terms, don’t use the service and if you want to keep it private, don’t post it! 

 

Who is not in the Berne Convention?

I was negotiating an intellectual property indemnity clause, and we agreed that the scope would be limited to members of the Berne Convention.  Basically, I wanted a global scope and they were worried about "oddball" countries.  Before settling on the point, I did a little research to see just what the gap would be.   Below are lists of Berne Convention signatories and UN members as of October 15, 2015.  Note that Taiwan is not in either.

Berne Convention Signatories                        UN Members 

                                                                                                          

                                                                    Afghanistan

Albania                                                         Albania

Algeria                                                         Algeria

Andorra                                                        Andorra

                                                                    Angola

Antigua and Barbuda                                    Antigua and Barbuda

Argentina                                                     Argentina

Armenia                                                        Armenia

Australia                                                       Australia

Austria                                                          Austria

Azerbaijan                                                    Azerbaijan

Bahamas                                                       Bahamas

Bahrain                                                         Bahrain

Bangladesh                                                   Bangladesh

Barbados                                                      Barbados

Belarus                                                         Belarus

Belgium                                                        Belgium

Belize                                                           Belize

Benin                                                            Benin

Bhutan                                                         Bhutan

Bolivia (Plurinational State of)                       Bolivia (Plurinational State of) 

Bosnia and Herzegovina                               Bosnia and Herzegovina

Botswana                                                     Botswana

Brazil                                                           Brazil

Brunei Darussalam                                        Brunei Darussalam

Bulgaria                                                        Bulgaria

Burkina Faso                                                 Burkina Faso

                                                                    Burundi

Cabo Verde                                                 Cabo Verde

                                                                   Cambodia

Cameroon                                                    Cameroon 

Canada                                                       Canada

Central African Republic                              Central African Republic

Chad                                                           Chad

Chile                                                           Chile

China                                                          China

Colombia                                                    Colombia

Comoros                                                     Comoros

Congo                                                        Congo 

Costa Rica                                                  Costa Rica

Côte d'Ivoire                                               Côte d'Ivoire

Croatia                                                       Croatia

Cuba                                                           Cuba

Cyprus                                                        Cyprus

Czech Republic                                            Czech Republic

Democratic People's Republic of Korea         Democratic People's Republic of Korea

Democratic Republic of the Congo               Democratic Republic of the Congo

Denmark                                                      Denmark

Djibouti                                                       Djibouti

Dominica                                                      Dominica

Dominican Republic                                      Dominican Republic

Ecuador                                                       Ecuador

Egypt                                                          Egypt

El Salvador                                                  El Salvador

Equatorial Guinea                                        Equatorial Guinea

                                                                   Eritrea

Estonia                                                        Estonia

                                                                   Ethiopia

Fiji                                                               Fiji

Finland                                                         Finland

France                                                         France

Gabon                                                          Gabon

Gambia                                                        Gambia 

Georgia                                                        Georgia

Germany                                                      Germany

Ghana                                                          Ghana

Greece                                                         Greece

Grenada                                                       Grenada

Guatemala                                                   Guatemala

Guinea                                                         Guinea

Guinea-Bissau                                              Guinea-Bissau

Guyana                                                        Guyana

Haiti                                                             Haiti

Holy See                                                                                           

Honduras                                                      Honduras

Hungary                                                        Hungary

Iceland                                                          Iceland

India                                                             India

Indonesia                                                       Indonesia

                                                                     Iran (Islamic Republic of)

                                                                     Iraq

Ireland                                                          Ireland

Israel                                                            Israel

Italy                                                             Italy

Jamaica                                                       Jamaica

Japan                                                           Japan

Jordan                                                          Jordan

Kazakhstan                                                   Kazakhstan

Kenya                                                           Kenya

                                                                    Kiribati

Kuwait                                                          Kuwait

Kyrgyzstan                                                    Kyrgyzstan

Lao People's Democratic Republic                  Lao People's Democratic Republic 

Latvia                                                           Latvia

Lebanon                                                       Lebanon

Lesotho                                                        Lesotho

Liberia                                                          Liberia

Libya                                                             Libya

Liechtenstein                                                 Liechtenstein

Lithuania                                                        Lithuania

Luxembourg                                                    Luxembourg

Madagascar                                                    Madagascar

Malawi                                                           Malawi

Malaysia                                                         Malaysia

                                                                      Maldives

Mali                                                                Mali

Malta                                                              Malta

                                                                      Marshall Islands

Mauritania                                                      Mauritania

Mauritius                                                        Mauritius

Mexico                                                           Mexico

Micronesia (Federated States of)                    Micronesia (Federated States of)

Monaco                                                          Monaco

Mongolia                                                        Mongolia

Montenegro                                                    Montenegro

Morocco                                                         Morocco

Mozambique                                                   Mozambique

                                                                      Myanmar 

Namibia                                                          Namibia

                                                                       Nauru

Nepal                                                              Nepal

Netherlands                                                    Netherlands

New Zealand                                                  New Zealand

Nicaragua                                                      Nicaragua

Niger                                                             Niger

Nigeria                                                          Nigeria

Norway                                                         Norway

Oman                                                           Oman

Pakistan                                                        Pakistan

                                                                     Palau

Panama                                                          Panama

                                                                     Papua New Guinea

Paraguay                                                       Paraguay

Peru                                                              Peru

Philippines                                                     Philippines

Poland                                                           Poland

Portugal                                                        Portugal

Qatar                                                            Qatar

Republic of Korea                                          Republic of Korea

Republic of Moldova                                      Republic of Moldova

Romania                                                        Romania

Russian Federation                                        Russian Federation

Rwanda                                                         Rwanda

Saint Kitts and Nevis                                     Saint Kitts and Nevis

Saint Lucia                                                    Saint Lucia

Saint Vincent and the Grenadines                  Saint Vincent and the Grenadines

Samoa                                                           Samoa

                                                                     San Marino

                                                                     Sao Tome and Principe

Saudi Arabia                                                  Saudi Arabia

Senegal                                                         Senegal

Serbia                                                            Serbia

                                                                     Seychelles

                                                                     Sierra Leone

Singapore                                                      Singapore

Slovakia                                                        Slovakia

Slovenia                                                        Slovenia

                                                                    Solomon Islands

                                                                    Somalia

South Africa                                                 South Africa

                                                                    South Sudan

Spain                                                            Spain

Sri Lanka                                                       Sri Lanka 

Sudan                                                           Sudan

Suriname                                                      Suriname

Swaziland                                                     Swaziland

Sweden                                                        Sweden

Switzerland                                                  Switzerland

Syrian Arab Republic                                     Syrian Arab Republic

Tajikistan                                                      Tajikistan

Thailand                                                       Thailand 

the former Yugoslav Republic of Macedonia  The former Yugoslav Republic of Macedonia

                                                                    Timor-Leste

Togo                                                            Togo

Tonga                                                          Tonga

Trinidad and Tobago                                      Trinidad and Tobago

Tunisia                                                          Tunisia

Turkey                                                          Turkey

                                                                    Turkmenistan

                                                                    Tuvalu

                                                                    Uganda

Ukraine                                                         Ukraine

United Arab Emirates                                    United Arab Emirates

United Kingdom                                            United Kingdom of Gr.Britain and N. Ireland

United Republic of Tanzania                          United Republic of Tanzania

United States of America                              United States of America

Uruguay                                                       Uruguay

Uzbekistan                                                   Uzbekistan

Vanuatu                                                       Vanuatu

Venezuela (Bolivarian Republic of)                Venezuela (Bolivarian Republic of)

Viet Nam                                                     Viet Nam

Yemen                                                         Yemen

Zambia                                                        Zambia

Zimbabwe                                                   Zimbabwe

Service Level for Open Source Policy Compliance?

In “Managing software legal compliance” in the February 22, 2010 edition of Network World, Sorin Cohn-Sfetcu and Kamal Hassin write that “ascertaining the legal compliance of software is just as important as assuring the quality before pressing it into production”.  This assertion raised some interesting questions in my mind about the contractual provisions that should be incorporated in outsourcing contracts, and in particular application development and maintenance (ADM) agreements.

I think it has become pretty common practice in well written, customer-friendly outsourcing agreements to include provisions either forbidding the use of open source code and other third party materials or, more realistically, requiring the vendor to obtain the customer’s consent before using them.  Also, it is common to include robust audit provisions that would allow auditing of the vendor’s code, as the authors of the article cited above suggest.  Both requirements provide the basic tools allowing the customer to have an open source usage policy while requiring the vendor to comply and audit compliance.

Of course, when the relationship is based upon the vendor’s form, the vendor probably has not given the customer any meaningful audit rights.  In addition, the vendor may have included language that gives it the right to use open source wherever it sees fit.  In a transaction I recently negotiated, the vendor proposed language giving it the right to incorporate open source at any time without providing notice.  Clearly, we pushed back on that idea.  Even worse, some vendors will just incorporate open source without letting the customer know that they are going to do so.

Even where customers have a contractual right to impose an open source policy and to audit compliance, one has to remember that having a contractual right to do something and actually seeing it happen are two entirely different animals.  Provisions buried in the boilerplate are often forgotten and worse, ignored from the outset.  The concept of service levels and service level credits (the penalties the vendor pays when it fails to meet service levels) came into being as a way of keeping the focus on issues that are fundamental to service quality.  Service levels are frequently used to measure and maintain many kinds of metrics measuring productivity and performance.

If compliance with an open source policy is important to the customer (and it should be), shouldn’t compliance with the open source policy be something that is addressed as a service level?  The value of a service level measuring compliance with the customer’s open source policy is that it would shine attention on this issue on a monthly basis, and require monthly measurement of compliance.  If any issues are found, correction of any non-compliance at no charge should be a required part of the service level response, as well as a service level credit for missing the service level.  What will constitute correction will, of course, depend upon the type of open source that was used.  In some cases, correction might even mean rolling back to a previous version of the code and making the changes again from scratch (without using open source this time, of course).  Also, what will constitute correction may be impacted by whether the program in question is used internally or distributed.  Keep in mind that using the code as part of a website may constitute distribution. The reporting requirements, obligation to correct improper usage at no charge and the potential service level credits would elevate the importance of the issue in the vendor’s eyes, making compliance arguably more likely and achievable.  Depending upon the contract terms, repeatedly missing the service level might also be grounds for termination.

In a subsequent post, we will discuss the way a service level for open source policy compliance might be drafted, what the appropriate service level metric might be, and what behaviors this service level might drive.

Drafting and Negotiating Teams

I had lunch with a client and friend recently, and we had an interesting (to us at least) conversation about what are the parts of an outsourcing or technology services contract that are likely to be the sources of conflict as opposed to the ones that are likely to be used in a conflict.  Both of us were of the view that the terms that some lawyers may not want to focus on – or that the business people think the lawyers should stay out of – are the ones where the conflicts arise.  The true “legal” terms often end up mattering often only if there is a problem that the business people cannot resolve.

The parties enter into a contract so that the customer can get the services and the vendor can get paid.  So, it really should not be surprising that the scope of services and the pricing are the places where most disputes arise.  Over the years, I have worked with clients (both vendors and customers) on a number of disputes, and the issues have always fallen into one or more of the following categories:  (i) whether certain services were in scope and so included in the price; (ii) whether the deliverables met the specifications, and so whether changes and/or corrections are included in the amounts already paid (or if a holdback must be released); (iii) whether the customer and its other suppliers have met their responsibilities and as a result whether the supplier is entitled to additional charges for working around a failure of the customer to meet those responsibilities or is excused from its failure to perform; (iv) whether the supplier’s performance meets the required service levels; (v) what the schedule for performance was and whether or how far behind the supplier is in performance; (vi) whether milestones have been met for payment; (vii) whether the customer or the supplier can assign the contract and their rights/obligations to a subcontractor, the purchaser of their company or some other party; and (viii) general disputes about what the pricing schedule means and what amounts the supplier is allowed to charge.  My lunch partner had very similar experiences.

You can argue that perhaps some of the categories I listed above should be broken out, or combined with each other.  Perhaps you have seen some other permutations on the fact patterns of the disputes.  That is really beside the point.  The point is that the vast majority of disputes in contract matters (including outsourcing arrangements) arise out of who, what, when and where.  However, unlike many contracts where the who, what, when and where may be quite clear (Wally will provide a bushel of grade one wheat to Wendy in Wichita on Wednesday), the scope of services in an outsourcing arrangement may be very sketchy and too often, will not have been carefully written and reviewed by the relevant stakeholders so that it lines up with what is actually needed or what is actually being provided or reviewed by the lawyers and contract wonks to make sure that it is clear.

Ironically, too many lawyers and other professional negotiators focus their time on reviewing and polishing the terms and conditions.  We will have many posts in the future on topics related to issues in the limitations of liability, the indemnifications, dispute resolution provisions and other legal terms.  However important those provisions are, they come into play rarely, and only when something else has already gone wrong.  I am always shocked in those instances in which the lawyer (or other custodian of contractual tightness) for the other side of the deal is completely absent from the drafting, review and negotiations of the parts of the contract that matter the most, the scope of work, the service levels and the pricing.  While I freely admit that lawyers and other contracts wonks should not be deciding the business terms, and that many lawyers are focused on eliminating risk rather than identifying and managing it, I am still puzzled why the people who are the most critical readers of a document and who are trained in finding the holes and the gaps are ever left out of preparing the provisions that actually give rise to disputes.

So, what is the right way to work on the scope, service levels and pricing?  Of course the level of effort and the team participants should vary depending upon the size of the transaction, the risk and the complexity.  For example, for a time and materials project to provide consulting, the definition of the scope is less critical and requires less precision in drafting from the vendor’s perspective than does a large fixed-price project.  For anything more than the smallest, simplest deals, it seems to me that the correct team (from the vendor perspective) includes at a minimum: (i) the project manager who will have to deliver, (ii) a person with a strong technical understanding of what needs to be delivered, and (iii) a person whose job is writing tight, clear contractual language.  Ideally, the person who sold the deal should be involved too, so that the team knows what expectations were set with the customer.  On the customer side, I think you need: (i) the business person (or a senior representative if there are many) who is supposed to benefit from the services, (ii) a person with a strong technical understanding of what is being delivered and how it will fit into the overall environment and (iii) a person whose job is writing tight, clear contractual language.

The pushback I have received on these views normally can be summarized as one (or both) of two responses.  One response is that there is no time to pull these resources together or that these people are not available.  The fallacy of this argument is that there is no time to do the job right, but apparently there is the available time to deal with the inevitable delays that arise from the customer and supplier having misunderstood each other.  The other response is that one person (i.e., the one giving the response) has it under control and does not need some or all of these other participants.  I hope Superman remembered to bring his cape.

Why Service Levels?

We have mentioned service levels in prior posts and lightly touched on how service levels, among other issues, can give rise to disputes.  This post will cover what a service level is and what it is designed to achieve; we plan to follow up with additional posts that will address other fundamental aspects of an outsourcing contract, such as the scope of services pricing schedule.

So let’s start with the basics.  What is a service level?  A service level is a contractual measure of the service the vendor must achieve.  As we noted in a prior post, “[t]he concept of service levels and service level credits (the penalties the vendor pays when it fails to meet service levels) came into being as a way of keeping the focus on issues that are fundamental to service quality.  Service levels are frequently used to measure and maintain many kinds of metrics measuring productivity and performance.”  Service levels should be SMART: specific, measurable, achievable, relevant and timely.  The purpose of a service level is to lay out a quantitative and qualitative measurement of the service that the vendor agrees to deliver.

What is a service level designed to achieve?  A well-balanced and effective service level is tailored to focus on issues fundamental to service quality.  It is important to strike the right balance between too many services levels (the customer’s desire) that detract from the fundamental service issues, and too few service levels (the vendor’s strategy) that do not effectively make the vendor responsible for fundamental service issues.  When you think of a spectrum, the service levels (in the aggregate) should fall around the midpoint – robust enough to measure the fundamental aspects of the service and but not so comprehensive as to make it difficult or impossible for a vendor to meet them.  This concept is one that mirrors our philosophy regarding contracting – when the contract is generally fair and balanced, it helps promote a mutually beneficial long-term relationship between the parties.

Why would you include service levels in a particular deal?  Perhaps most importantly, it is the opportunity for the vendor and customer to have the proverbial meeting of the minds before contract execution.  The customer can articulate the parts of the service it deems critical or fundamental and which require measurement; the customer’s ability and opportunity to convey these requirements can translate to specific, measurable, achievable, relevant and timely services levels…and a happy client.  Conversely, the vendor has a chance to determine not only if it can meet the customer’s expectations, but earns an opportunity to have a meaningful dialogue, and promote a positive relationship, with the customer.  Furthermore, well-drafted service levels may help drive out unnecessary costs by giving the vendor an opportunity to articulate the quality/cost tradeoffs in a quantitative way.  Finally, with the appropriate thought and planning, service levels can be used to protect the customer from degraded performance during predictable periods of peak demand.

So what does it means to have fair and balanced service levels?  As in-house counsel for a management and technology consulting services vendor, I had the opportunity to work alongside the business people who were responsible for selling and delivering the deals.  Over the course of watching the team win and deliver deals, I had some interesting conversations with those business partners.  In deals where the team held its margin and generally met a set of tailored service levels, the customers were satisfied with the services in particular and the vendor overall.  This satisfaction often led to a better relationship between the parties, one where the customer rewarded the vendor with additional work.  In deals where the service levels were either loosely defined (which may have occurred for a number of reasons) or overly prescriptive and/or comprehensive for the deal, the customer experienced a high level of dissatisfaction.  It often felt that the vendor had sold it a bill of goods, and that the service offering did not meet the customer’s expectations.  The interesting take-away from this is that the outcome is not one party’s fault, but rather a missed opportunity for the parties to tightly define a specific set of service levels at the outset to achieve that (sometimes elusive) fair and balanced contract.

I would argue that every outsourcing deal should consider including service levels, regardless of how small.  It gives the parties an opportunity to set expectations regarding fundamental aspects of the service and its delivery (delivery of it?).  If the parties can agree upon fair and balanced service levels (and resist the temptation to “win” by getting lopsided service levels), they’ve just taken a big step toward a productive long-term relationship.  We will discuss other ways to further that type of relationship in future posts.

One note of caution: Customers should approach the development and negotiation of services levels with an approach that uses logical analysis and a pragmatic view of human nature.  Service levels will drive the vendor’s behavior – that is their purpose.  But the customer needs to think “several moves ahead on the chess board” to make certain that the behavior it is driving is the desired behavior.  For example, if the outsourcing is for a help desk, a service level measuring the average call length and penalizing the vendor if the average call length for a month exceeds some metric will encourage the vendor to bring calls to a close within that time.  That outcome is great if the customer wants to drive out costs, but very bad if its goal is to maximize problem resolution and user satisfaction.

Termination Provisions

Glance through the termination provisions of an outsourcing or technology services contract and you’ll quickly notice a one-sidedness to the terms.  Termination provisions provide terms and conditions under which the relationship between a vendor and a customer may be dissolved.  As this post will discuss, the risks involved with the contract are different for the customer and the vendor – which means each side has a different stake in the performance of the contract.  The risk plays out slightly differently whether the contract is terminated for cause or whether it’s terminated for convenience, but both instances illustrate why the contract may often include terms that, on first blush, favor the customer heavily over the vendor.

Generally speaking, termination provisions aren’t mutual between the vendor and the customer because the risk each side bears is substantially different.  If the relationship between the vendor and the customer is terminated, it’s likely that the vendor’s largest loss will be revenue.  The customer, on the other hand, is in a position to lose a service that could bring day-to-day business to a standstill.  For example, if the service that vendor is providing is IT help desk support, a sudden loss of service may be enough to render the whole company’s IT useless or at least less useful.  While, understandably, no company wants to lose a customer or revenue, the vendor’s entire operation isn’t shut down if one contract ends.   The customer, then, has to be much more protective of the instances which would result in the termination of the contract simply because it has more at risk than the vendor.

The difference in risk between the customer and the vendor affects termination for cause and termination for convenience in different ways.  No one – not the vendor and certainly not the customer – wants to be terminated for cause.  In contrast to a termination for convenience, termination for cause arises when one of the parties is not performing an essential function of the contract.  Perhaps the vendor is routinely late in providing the service and has not satisfactorily addressed and fixed the problem after a given period of time.  Termination for cause means not only lost revenue for a vendor but may also impact the ability to acquire new contracts.  New clients will want to know why and under what conditions a former client terminated the contract and terminations for cause will be viewed with great concern.

Even with these downsides to the vendor, the customer is still in an even more vulnerable position of losing a chunk of operational time.  Given the need for the vendor’s uninterrupted service, a customer should very rarely allow the termination of a contract for cause.  This might happen, for example, if the customer is persistently and severely late with payment to the point of non-payment or if the vendor’s intellectual property is breached by a practice adopted by the customer.  It should be noted, though, that there are few instances where a problem that might result in termination for cause couldn’t be remedied through monetary damages (other than non-payment).  As the instances where this could happen are so rare and the customer’s stake in the contract so great, it is mystifying that a customer would allow a termination for cause to happen.

Termination provisions for terminations for convenience, on the other hand, really should be so restrictive that vendors aren’t even permitted to exercise the option.  Termination for convenience occurs when the vendor’s service or the customer’s needs are no longer aligned with the best interests of the business and, as a purely commercial decision, the customer terminates the contract.  Here again, the customer has much more at stake from termination for convenience than the vendor.  As with termination for cause, if the vendor decides to terminate for convenience, the customer is left with the sudden absence of the vendor’s service that, as discussed earlier, could bring business as usual to a halt.  The added disruption that a termination for convenience causes is the unanticipated search for and transition to a new vendor.  This process can be lengthy (possibly reaching up to six months) and highly disruptive.  To ensure a smooth and orderly transition to a new vendor, then, the current vendor really shouldn’t be able to terminate for convenience for the term of the contract.  At the very least, the notice provisions which give the customer fair warning of a possible termination of the vendor’s services need to be far enough in advance to ensure a smooth and (hopefully) seamless transition to a new vendor.

While there is an absence of mutuality here between when the customer and the vendor can terminate for convenience, the restriction is understandable.  Let’s say, for example, the customer and the vendor have entered into an agreement which ultimately turns out to be a losing contract for the vendor.  Knowing that that customer is dependent on the vendor to keep business running smoothly, the vendor could terminate for convenience and then extort a more favorable and lucrative contract from the customer – all because the customer is so reliant on the vendor’s service.  Ultimately, the vendor, not the customer, must take the risk that the price is correct.  Of course, the vendor may protect itself to an extent through cover.  And this is not to say the vendor is left without options.  The vendor can simply choose to not renew the contract at the end of its term.  Or, if it’s a losing contract, it may simply choose to not renew unless the customer agrees to a higher price.

Whether for cause or for convenience, the unexpected end of a contract will likely leave one party at a loss.  The smart contract will have prepared for this and, through adequate termination provisions, will keep the customer’s business up and running.