Start From a Winning Position

July 31, 2013

Virtually every sentence in a contract can be drafted so it favors one party or the other.  Most provisions can also be drafted more neutrally, so the right or obligation is reciprocal.  The objective here may be better stated in a negative manner:  don’t start from a losing position.  An astonishing number of “standard forms” commonly used in day-to-day business contain contractual provisions that actually favor the other party.  For example, purchase agreements for goods and services routinely exclude the warranty of fitness for particular purpose, yet this UCC warranty only comes into effect when the seller is aware of the buyer’s intended use, and the buyer relies on the seller’s recommendation to purchase it.  Why would a buyer who has relied on the seller’s advice that the product is appropriate for buyer’s purposes automatically exclude this warranty?[1]  Similarly, the warranty of merchantability merely warrants goods of average quality.  Why would a buyer knowingly enter into a contract expecting below average quality goods?  Sometimes, the parties negotiate to exclude these warranties, but often they are excluded simply because the drafter inserted familiar language from another form without considering its effect.

According to Model Rule of Professional Ethics 1.2, a lawyer is required to abide by the client’s decisions regarding the objectives of representation.  Some clients prefer that contracts be drafted so their interests are aggressively protected; other clients adopt a more egalitarian view and prefer contracts that are more balanced.  Although lawyers are ethically required to draft contracts according to the client’s objectives, the starting position should never be detrimental to the client’s interests.  Where the client adopts a more egalitarian approach, contractual provisions should be drafted more neutrally, but not in a manner that favors the other party.  Some clients might take a different approach with different types of contracts, or when dealing with different kinds of business partners.  For example, a company might adopt a more aggressive approach to protect its intellectual property, but the same company might adopt a more paternalistic approach when its business partners are small businesses.  Although a lawyer can certainly offer advice and make recommendations, it is not ethically appropriate to ignore the client’s preferences and to substitute the lawyer’s own.

Contracts serve to allocate risk among the parties to a transaction.  For most contract provisions, there is an approach that allocates more risk to the buyer; an approach that allocates more risk to the seller; and a range of possibilities between the extremes.  The way a provision is drafted affects the level of risk and responsibility each party undertakes in the contract.  Sometimes a single word or phrase can have an enormous impact.  Consider how the risk progressively shifts from one party to the other in these warranty provisions:

Warranties: 

1. Warranty. Vendor warrants that the goods will conform to Buyer’s specifications.

1. Limited Warranty.  Vendor warrants that the goods are merchantable. Vendor specifically disclaims the warranty of fitness for a particular purpose.

1. Limited Warranty. Vendor warrants that it will use commercially reasonable efforts to comply with the terms of this Agreement. Vendor specifically disclaims all other warranties, including the warranty of merchantability and the warranty of fitness for a particular purpose.

1. No Warranty. THE GOODS ARE PROVIDED “AS IS” AND WITHOUT ANY EXPRESS OR IMPLIED WARRANTIES, INCLUDING, WITHOUT LIMITATION, THE IMPLIED WARRANTIES OF MERCHANTABLITY AND FITNESS FOR A PARTICULAR PURPOSE.

1. No Warranty. There are no warranties of any kind in this contract.

In the first version of the provision, Vendor has assumed a large risk for three reasons:  first, this is a full warranty with no limitations, so UCC warranties of merchantability and fitness for particular purpose apply; second, there is no materiality limitation, so the goods must conform in every detail, not just in every material way; and third, because the Buyer’s specifications are not defined and limited in the agreement. Presumably, the Buyer may change its specifications from time to time during the term of the agreement, and the Vendor has absorbed the risk of conforming, no matter what those specifications may be.   Vendor’s risk is reduced and Buyer’s risk is increased in the second version because this is no longer a full warranty and the UCC warranty of fitness for particular purpose is disclaimed.  Vendor’s risk is further reduced in the third version because Vendor warrants only to use commercially reasonable efforts (as opposed to any possible effort) to comply with the terms of the Agreement and disclaims all other warranties.  In the fourth version, the risk has shifted entirely to the Buyer because Vendor has disclaimed all warranties.    Ironically, although the language appears to be strong and simple in the fifth version, the risk actually shifts back to the Vendor, because this provision is not enforceable in most jurisdictions and may fail to exclude UCC warranties in some jurisdictions because the warranties of merchantability and fitness for a particular purpose are not named and specifically excluded.

The drafter’s responsibility is to ensure that the client assumes the correct level of risk.  While a Buyer client may ultimately wind up accepting goods “as is” as a result of negotiations, by no means should the negotiation process start at this position.  This is a losing position because the Buyer has absorbed all risks if the goods fail to perform or cause damage.

The biggest challenge for new drafters is to determine the range of risk for each provision, especially given that the language in the template contract may be flawed.  In other words, when “marking up” a template contract to fit the current transaction, how does a new drafter determine whether a provision is neutral or whether it favors one of the parties over the other?  Where does the particular provision fall in the overall range of risk?  Does it advance the client’s interests, or is it more favorable to the other party?  If the client prefers a more aggressive approach, how does the new drafter determine whether the provision is one-sided enough or whether it needs to be tightened up?

To some extent, this knowledge is gained through experience, which is why it is called the “practice” of law, and why partners’ billing rates are substantially higher than new associates’ rates.   The best source for identifying the range of risk for a particular provision is an experienced mentor.  If a reliable mentor is not available, the next best source is the law firm’s or law department’s form files; comparing a contract where the firm represented the buyer to a contract where the firm represented the seller.  The final forms most likely have been heavily negotiated, so the best source is the first draft submitted to opposing counsel, if the firm drafted the contract, or the first revision, if the firm reviewed an initial draft prepared by opposing counsel.  The revisions requested by counsel for each party reveal how experienced lawyers have fine-tuned the language to shift risk from one party to the other.  If a mentor and form files are not available, industry specific form books may be helpful to identify provisions that favor one party versus the other.



[1] A buyer client may have made the decision that it would rather give up its UCC warranty rights in every purchase than to have to negotiate the provision on a case by case, but this should be based on an intentional decision of someone having appropriate authority, not on happenstance or ignorance.