March 31, 2004

Amazon, Borders Face Market-Division Claims

According to this story at CNet News, last week a federal district judge in San Francisco said that a private antitrust claim against Amazon and Borders, for allegedly divvying up portions of the on-line book market between them, could proceed to trial. (The judge dismissed a companion price-fixing claim as "ludicrous on its face.") The claim related to a teaming agreement that Amazon and Borders signed in 2001. The CNet story reports that:

[Judge] Patel said one section of the contract, which is similar to one Amazon inked for the online store of Toys "R" Us, is "troubling." A restriction prohibiting Borders from competing with Amazon means that "Borders could not even provide overstock books to another online marketer, even if there were no mention online that these books came from Borders," Patel said.

This story illustrates a basic principle of contract drafting: Any clause that even resembles a division of the market among competitors should be closely scrutinized. For even if Amazon and Borders emerge victorious, they still have to go through the hassle and expense of a full-blown antitrust trial. Presumably they have already gone through the hassle and expense of document production and depositions. And they must contend not only with the antitrust laws, but also with California's notorious unfair competition law. All this for a contract clause that undoubtedly seemed like a good idea at the time.

March 31, 2004 in Contracts, Marketing | Permalink | Comments (0) | TrackBack

November 04, 2003

Contract Simplification

I've developed a real thing about contracts with incredibly convoluted language. You've seen plenty of them -- "if X and Y happens, then Z will occur, provided that A is true, and subject to the occurence of B, except that if C is also the case, then D will take place." I confess to having been guilty of such crimes against language myself.

There is, however, a better way -- several of them, actually.

Short Sentences, Plain English

Contracts don't have to be written in legalese. Short, plain statements of the parties' intent will do nicely. If a sentence starts running long, break it up.


Charts and Tables

Instead of long, complex narrative language, use charts and tables. Here's an example of the former:
If it rains less than 6 inches on Sunday, then Party A will pay $3.00 per share, provided that, if it it rains at least 6 inches on Sunday, then Party A will pay $4.00 per share, subject to said rainfall not exceeding 12 inches, [etc., etc.]

Here's the same provision, in table form (apologies for the extra blank space just below; I can't figure out how to make it go away):














AMT OF RAIN ON SUNDAY PAYMENT DUE
FROM PARTY A
Less than 6 inches $3.00 per share
At least 6 inches
but less than 12 inches
$4.00 per share

Which one would you rather read?

Situation Tables

There's no reason that a contract can't provide for Plan A, Plan B, Plan C, etc., when particular things happen. This can often be spelled out in situation tables. Here's a trivial example:
EVENT PLAN A PLAN B PLAN C
Supplier experiences quality problems Supplier will give immediate written notice to Buyer and correct the problem within 24 hours. Buyer may obtain goods from alternative sources and bill Supplier for its expenses, less what Buyer would have paid Supplier under this Agreement. [Be creative!]

Illustrative Examples

Your contract may contain a complex formula or some other particularly tricky provision. If so, consider including a hypothetical example to "talk through" how the formula or provision is intended to work.

Explanatory Footnotes

Suppose that, after intense negotiations, a particular contract clause ends up being written in a very specific way. Consider including a footnote at that point in the contract, explaining the same. Future readers -- your successor, your lawyer, a judge -- might thank you for it.

November 4, 2003 in Contracts | Permalink | Comments (0) | TrackBack

October 11, 2003

Bye-Bye, Carolina; Hello, California

Late last month, a North Carolina customer of Oracle Corporation found itself involuntarily headed for California to pursue its lawsuit against Oracle. This came to pass because the customer -- probably without even knowing it -- agreed to a forum-selection clause when it bought its Oracle software license.

The Forum Selection Clause

The customer apparently signed an order form which stated that its terms were governed by the Oracle License and Services Agreement. That agreement contained a fairly typical choice-of-law and forum-selection clause:

This agreement is governed by the substantive and procedural laws of California and [ACC] and Oracle agree to submit to the exclusive jurisdiction of, and venue in, the courts in California in any dispute relating to this agreement.

The customer, unhappy about something (the court's opinion doesn't say what exactly), sued Oracle in North Carolina despite the forum-selection clause.

The Court's Analysis

The forum-selection clause didn't automatically mean that the case would be transferred to California. The judge still had to go through a detailed, 11-factor analysis to determine whether the interests of justice and the convenience of the parties would be best served by transferring the case or by keeping it in North Carolina.

In the end, the judge concluded that the case should be transferred. He quoted a prior case that said that "once a mandatory choice of forum clause is deemed valid, the burden shifts to the plaintiff to demonstrate exceptional facts explaining why he should be relieved from his contractual duty."

The customer now faces the increased expense and inconvenience of having to litigate its case across the continent from where it originally hoped. That likely will give Oracle some bargaining leverage.

(AC Controls Co. Inc. v. Pomeroy Computer Resources, Inc., No. 3:03CV302 (W.D.N.C. 09/29/2003))

Possible Lessons

1. Read all contracts before you sign them.

2. Know that, if your contract contains a forum-selection clause, you may well have to live with litigating your case in a courtroom far, far away.

October 11, 2003 in Contracts, Litigation, Purchasing, Sales | Permalink | Comments (0) | TrackBack

October 09, 2003

Backdated Sales Contracts Resurface Years Later

The CFO of software giant Computer Associates was forced to resign, along with two other senior financial executives of the company -- and who knows what else now lies in store for those folks -- because several years ago the company "held the books open" to recognize revenue for sales contracts signed after the quarter had ended.

According to CA's press release of yesterday, in the fiscal year ended March 31, 2000, the company took sales into revenue in Quarter X even though the contracts weren't signed until after the end of the quarter. See also these stories from Reuters, the AP, and Dow Jones.

(Continued below)

CA stressed that the sales in question were legitimate and that the cash had been collected; the issue was one of the timing of revenue recognition. The Audit Committee was still looking into whether the company's financial results would need to be restated. In the above-cited news stories, outside observers speculated that the company was attempting to position itself to minimize the SEC penalties that were likely to be imposed.

These revenue-recognition problems came to light during an Audit Committee inquiry triggered by a joint investigation by the U.S. Attorney's office and the SEC. It just goes to show that past sins can come to light years after the fact, possibly as a domino effect of unrelated events.

A May 2001 column, The Fraud Beat, by Joseph T. Wells, in the Journal of Accountancy, has a readable explanation of this so-called "cut-off fraud" and how it can be detected. The column recounts a couple of interesting war stories, including one about a Boca Raton company that programmed its time clocks to stop advancing at 11:45 a.m. on the last day of the quarter. The company would continue making shipments -- with the paperwork time-stamped by a stopped clock -- until sales targets had been met, at which point the time clocks would be restarted.

As I observed in a previous post, backdating a contract can be perfectly legal in some circumstances, but -- as illustrated here -- not when it comes to recognizing sales revenue.

It remains to be seen what else will happen to the three former CA financial executives. It can't be a good thing for their peace of mind that the Justice Department and SEC are already involved.

October 9, 2003 in Accounting, Contracts, Embarrassments / Bad Career Moves, Finances, Sales, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

September 29, 2003

Surreptitious Contract Changes II

This weekend I posted a clause with a representation that no unmarked changes had been made to a contract, to provide a reasonable basis for signing the electronically-negotiated contract without reading the final hard copy. Today, in a very thoughtful commentary on his Corporate Law Blog, Mike O'Sullivan offers a more rigorous clause that contains both a representation and a warranty, "to also cover all redlining failures (intentional or unintentional) and to make it easier to reform the agreement under the doctrines of mutual or unilateral mistake:"

No Unidentified Changes. Each party represents and warrants that each version of this agreement distributed by such party to the other party clearly identifies each change (other than minor non-textual changes in formatting) in the version from the prior version distributed from one party to the other, with the full text of each addition being double-underlined and the full text of each deletion being struck-through. Each party acknowledges that, when such party distributed changes to this agreement, the other party was entitled to rely on the drafting party's identification of changes without further investigation. If the drafting party fails to identify any changes, the drafting party is deemed to have intentionally failed to identify those changes and this agreement shall be reformed, at the non-drafting party's option, to omit any unidentified additions or include any unidentified deletions made by the drafting party. For purposes of this section, any drafting action taken by a party's counsel or other advisors shall be deemed to have been taken by the party

This would be a great clause for deals such as the M&A; work that Mike does, particularly where the parties aren't trying to establish a long-term relationship. (For that kind of contract, however, I think I would probably continue to read carefully the final, hard-copy document, just as he does.)

The clause I posted is designed for higher-volume, long-term-relationship work such as software license agreements. It balances some competing considerations with the intent of trying to get sales deals closed while still providing acceptable legal protection. The clause includes a representation, not a warranty; that was intentional. Let me outline some of the thinking that went into the specific wording of the clause -- please feel free to shoot at it.

  • At the end of a fiscal quarter, when a lot of sales contracts are in negotiation at once, negotiator time is a scarce resource that has to be used economically. You want to provide as much legal protection for your client as practicable, but as the clock runs down on the quarter, you also want to try to timely get the customer's ink on the signature line.
  • The customer's contract negotiator also has limited time, and might not be a lawyer. The last thing your sales people want is for the negotiator to get nervous about your language and, taking the path of least resistance, to put your deal aside until next quarter.
  • In my experience, a representation clause comes across as "softer" than a warranty clause, and is less likely to trigger a visceral objection from the other side.
  • Theoretically, a representation has different legal consequences than a warranty. But in many vendor-customer situations -- particularly longer-term, high-dollar relationships such as some software license agreements -- the differences likely will be academic:
    • In my experience, high-dollar vendors are keenly interested in preserving their customer relationships if at all possible -- they generally don't want to file a lawsuit against a customer except as a last resort.
    • If a customer were unintentionally to make a material change in the contract without marking it, the odds are high that the vendor and customer would try to work things out amicably. In that situation, the mere existence of the representation clause would bestow a fair degree of moral- and bargaining leverage on the vendor. (It's something I could go to my counterpart with and ask, "can't we do something about this?")
    • Whether the change in the contract was truly unintentional might well come down to the credibility of the customer's witnesses -- not a comfortable situation for the customer to be in. As Mike points out, if a jury were to conclude that a customer had deliberately sneaked in a material unmarked change in the contract, that likely would be fraud under my clause, giving rise among other things to the possibility of punitive damages. That likely would give the vendor even more bargaining power in negotiations to fix the contract wording.


So, on balance, for high-volume, high-dollar, long-term agreements, I prefer a simple representation that the customer is likely to accept readily, over a more-complete warranty-and-reformation clause that might require more time for customer legal review. That won't be the case in for all situations -- and for an M&A; deal, a clause like Mike's could well be superior -- but it seems to work well in a lot of cases.

Thanks to Mike for his response.

September 29, 2003 in Contracts | Permalink | Comments (0) | TrackBack

September 27, 2003

Surreptitious Contract Changes

It's the end of the fiscal quarter, and so a lot of contracts are being negotiated. These days, most contract negotiations are done electronically. I email you a Word document. You email me a "redline" with revision marks and maybe some comments. We talk by phone. Repeat as necessary. In the end, however, we're probably going to want a handwritten signature on a hard copy of the final contract.

Suppose I send you a signed original contract and ask you to countersign and return it. Do you do a word-for-word comparison, to make sure the hard copy matches the agreed electronic document? If you do, you're spending time that surely could be put to better use. But if you don't, how do you know I didn't surreptitiously change something before printing the document for signature?

The overwhelming majority of lawyers would never try to pull something so underhanded. It's stupid -- if you were to get caught, your reputation could be severely damaged. Other lawyers might start refusing to deal with you. Your negotiation partner (turned enemy) could well report you to the state bar.

But I know two lawyers who, years ago, unwittingly let their clients sign "bogus" documents that way. Needless to say, their clients weren't pleased.

A few years ago, as I started doing more and more contract negotiations electronically, I drafted a clause to address the surreptitious-changes issue. In recent days I've had several lawyers tell me that they loved the clause and intended to steal it. Here's the latest version:

No Unannounced Modifications to Signature Documents. The parties have reviewed (and, if applicable, negotiated) this Agreement in its electronic form. They desire to be able to sign the hard-copy version without having to re-read it to confirm that no unauthorized changes were made before the final printout. Toward that end, by signing and delivering this Agreement and/or any schedule, exhibit, amendment, or addendum thereto, now or in the future, each party will be deemed to represent to the other that the signing party has not made any material change to such document from the draft(s) originally provided to the other party by the signing party, or vice versa, unless the signing party has expressly called such changes to the other party’s attention in writing (e.g., by “red-lining” the document or by a comment memo or email).

At least with this clause, each side has an indisputably reasonable basis for assuming that the other side isn't playing dirty. They therefore shouldn't have to worry about re-reading the hard-copy document before signing it. (It might still make sense to re-read the hard copy anyway, just to make sure it says what you really want it to say.)

If you've got any suggestions for improving this clause -- or war stories about situations where the clause would have come in handy -- please post them in a comment.

September 27, 2003 in Contracts | Permalink | Comments (1) | TrackBack

September 24, 2003

LOI Disclaimer Clause Rescues Investment Bank

Many letters of intent contain a clause stating that the parties do not intend to enter into a contract at that time and that neither party will be bound except by a final, formal, signed, written agreement. Earlier this month, such a clause rescued an investment bank from a lawsuit over a failed IPO.

The players in this saga were Schneider Securities and its would-be client Café La France, apparently a Starbucks wannabe. In 1996, Schneider and Café La France signed a letter of intent for an IPO. For several months they made extensive preparations for the IPO, but they never signed the final underwriting agreement. For a variety of reasons, the relationship deteriorated, and Schneider began to get uncomfortable with the deal. Eventually another investment bank appeared on the scene, and Schneider withdrew from the deal, saying that it considered itself fired. The new investment bank proceeded with the IPO, which didn't go nearly as well as hoped. Café La France ultimately withdrew its registration statement, returned the money it had raised, and did the all-American thing: it filed a lawsuit against Schneider.

At the conclusion of the trial, the judge made short work of Café's claims against Schneider, primarily because the LOI between Café and Schneider had created only a few binding legal obligations and had expressly disavowed all others:

This document is a statement of intent. Its execution does not, either expressly or by implication constitute a binding agreement by [the parties] to undertake the financing outlined above or an agreement to enter into an underwriting agreement except as set forth in paragraphs 5(d), 8 and 9 hereof. Any legal obligations between the parties shall be only as set forth in a duly negotiated and executed underwriting agreement (the "Underwriting Agreement").

Café tried to claim that Schneider was nevertheless obligated to market the IPO under a combined written and oral contract. The judge would have none of it. He said that "Café may have expected Schneider to [market the IPO], and at some point Schneider may have intended to, but that expectation was not *incorporated into the binding portions of the LOI." (Emphasis added.) He also said that:

[T]he LOI bound the parties . . . only to paragraphs 5(d), 8 and 9, and that in the absence of an underwriting agreement there would be no other legal obligations with respect to the IPO. Schneider has not breached any of those provisions, and in fact, appears to have exercised its right, memorialized in paragraph 8, not to proceed with the offering if "in its sole judgment ... information comes to [Schneider's] attention relating to the Company, its management or its position in the industry which would, in its sole judgment, preclude a successful offering." [Emphasis by the court]

LESSON: Business people like LOIs for various reasons. But from a lawyer's perspective, the real title of such a document should be "letter of non-intent."

(Café La France, Inc. v. Schneider Securities, Inc., D. Rhode Island, Sept. 8, 2003.)

September 24, 2003 in Contracts | Permalink | Comments (0) | TrackBack

September 16, 2003

Side Letter in Sales Deal Leads to SEC Fraud Suit

Last week the SEC announced that it had filed a civil lawsuit against a former Logicon executive who allegedly placed a $7 million order with Legato Systems that included a secret side letter giving Logicon the right to cancel its purchase. According to the SEC, the Logicon executive not only knew that Legato planned to fraudulently misstate its financial results, he even advised Legato's sales people how to conceal the cancellation right from the Legato finance department.

LESSON: The SEC's news release quoted Helane L. Morrison, District Administrator for the Commission's San Francisco District Office, as saying, "Sales executives who book phony deals often rely on assistance from people who work for their customers. Today's action highlights the Commission's resolve to hold such persons responsible when they knowingly assist in fraudulent revenue recognition practices."

September 16, 2003 in Accounting, Contracts, Embarrassments / Bad Career Moves, Purchasing, Sales, Securities law, SEC regs / actions | Permalink | Comments (0) | TrackBack

August 23, 2003

Backdating Contracts Leads to Prison Term --
But It Can Be Entirely Proper

From the notes I took while getting ready to start this blog:

A former public-company CFO was recently sentenced to three and a half years in federal prison. His company, Media Vision Technology, had inflated its reported revenues, in part by backdating sales contracts. Because of the inflated revenue reports, the company’s stock price went up – until the truth came out, which eventually drove the company into bankruptcy. (We've all seen that particular movie in the past couple of years, eh?)

The judge noted that the CFO had an otherwise-exemplary record. If the new, stiffer penalties of the post-Enron sentencing guidelines had applied, however, the CFO likely would have faced more than 10 years in prison. (The Recorder, Apr. 8, 2003; see archived story.)

But backdating a contract is not necessarily illegal, depending on the circumstances.

Let's look at a hypothetical example. Suppose that:

  • Jones is an end-customer from Customer Corporation. Smith is a sales rep from Vendor Corporation.

  • While playing golf together one Saturday, Jones and Smith start talking about a potential sales deal. (That’s why I keep telling myself I should learn to play golf.)

  • During their conversation, sales-rep Smith tells Jones about some features that will be in Vendor Corporation's next product release; he asks Jones to keep the information to himself, because it's still confidential. Jones says "no problem."

  • Monday morning, sales-rep Smith starts getting nervous about having disclosed his company's confidential information to Jones. He calls his company's lawyer. The lawyer drafts a nondisclosure agreement (NDA), which states that it is “executed to be effective as of” the previous Saturday.

  • Smith takes Jones out to lunch. While they're waiting for their food, he and Jones sign the NDA.

    (Whether Smith and Jones had authority to sign contracts under their companies' respective policies is another question -- many companies have internal policies that restrict who is allowed to sign what kind of contracts. But chances are that Smith and Jones each had apparent authority, vis à vis the outside world, and that may well have been enough to create a binding contract.)

So far, so good – the backdated NDA very likely will be deemed to be effective during Jones’s and Smith’s conversation on the golf course. There's no deception involved; the written NDA simply memorializes and fleshes out the oral confidentiality agreement that Smith and Jones entered into. (There's another lesson here, which is that oral agreements can sometimes be entered into very casually.)

Now change the facts a little, and the possibility of jail time looms into view:


  • Customer Jones and sales-rep Smith continue with their discussions. It ends up being a big-dollar deal. Smith, the sales rep, starts shopping for the new car that he intends to buy with his commission check. Jones and Smith work hard to get the sales contract executed by March 31, the last day of the first (calendar) quarter.

  • Unfortunately, however, Customer Corporation’s legal department is too busy to review the contract before March 31. Customer’s purchasing department refuses to sign the contract without the legal department’s blessing. (Damned lawyers, always screwing up deals . . . .)

  • On April 10, Customer’s legal department blesses the sales contract (finally!), without asking for any changes, so the purchasing department signs the contract – without dating it – and FAXes it back to Smith the sales rep.

  • A happy Smith and his sales director fill in “March 31” on the date line. The sales director signs the contract and sends a copy to Accounting. The company's controller calls up the sales director and says, "it's about time!"

If Vendor’s accounting department books the revenue in the first quarter, that might well constitute securities fraud. The Media Vision Technology CFO undoubtedly knew this. Unfortunately for him, he had the lesson reinforced the hard way, with a prison sentence.

August 23, 2003 in Accounting, Contracts, Criminal Penalties, Embarrassments / Bad Career Moves, Sales, Securities law, SEC regs / actions | Permalink | Comments (0)