Lawyers play a critical role in negotiating and drafting contracts, but when business owners and investors enter into significant agreements regarding or on behalf of their private company, these documents are too important to leave them solely in the lawyer’s hands. The parties to these business agreements need to carefully read and understand their terms if they want to avoid unwelcome surprises when their agreements become the focus in a future legal dispute. There are a number of issues to consider in documenting business agreements, and the elements that go into developing binding business contracts is the subject of this blog post.
The Terms of the Written Agreement Control
The starting point in securing an enforceable agreement is to “get it in writing.” Virtually all business agreements are entered into after the parties have discussed the material terms of the contract, and in some cases, these negotiations may last for weeks or even months. One party to the contract may therefore conclude that assurances it received from the other party during these negotiations should be as binding as the actual terms of the agreement. Unfortunately, a party who seeks to enforce oral promises or assurances outside the contract faces a steep uphill climb under Texas law.
Standard contract terms will likely include both a “merger/integration clause” and “anti-reliance provisions.” These terms exclude from being part of the agreement any offers that were made during the parties’ discussions, as well as any representations the parties made that are not expressly set forth in the contract. Over the past two years, Texas Supreme Court has made clear that the actual terms of the contract control, and it has repeatedly rejected claims that are based on statements made outside the contract. In 2018, in Orca, the Supreme Court denied a fraud claim without requiring a trial on the basis that the reliance element of fraud can be “be negated as a matter of law when circumstances exist under which reliance cannot be justified.” Just last year, the Court overturned large jury verdicts in two separate fraud cases setting aside judgments based on alleged misrepresentations that were not set forth in the contracts at issue.
In IBM v. Lufkin, the Court reversed a jury verdict for more than $25 million because the specific contract terms at issue disclaimed reliance on any statements not set forth in the parties’ agreement. Lufkin was therefore barred from relying on IBM’s alleged misrepresentations regarding its software installation. In the Mercedes case, the Court tossed out a jury verdict for more than $100 million because the Court found that Mercedes’ alleged misrepresentations to a franchisee were contradicted by the actual terms of the parties’ agreement, which was bar to the fraud claim—the Court rendered a take nothing verdict on this basis.
These Supreme Court cases set a high bar for any party to establish fraud based on statements not included in the parties’ contract. The practical advice for contracting parties is not to rely on any statements/promises that are not actually documented in a written contract.
Agreements to Agree In the Future Are Not Enforceable
During contract negotiations, the parties may reach a point of impasse on certain critical issues. Rather than abandoning the contract, however, they may decide to “agree to agree” by including a provision that requires them to bargain in good faith in the future in efforts to resolve the open issue. While this may seem like an effective compromise to resolve the deadlock that is preventing an agreement from being reached, it may actually make things far worse. Texas law is clear that contracts calling for parties to negotiate in the future—to agree to agree to material terms at a later point—are unenforceable. The entire contract may be held to be invalid or a key provision of the contract may be disregarded, which is an unexpected outcome that may be particularly harsh for one of the parties.
The following language from the Supreme Court’s DFW v. Vizant decision last year expresses the state of Texas law on the unenforceability of agreements to agree:
We have held, however, that agreements to negotiate toward a future contract are not legally enforceable [citations omitted]. And Texas courts of appeals have held that this is true even if the party agreed to negotiate in good faith. [citations omitted] Consistent with our precedent, we hold that the contract here does not state the essential terms of a legally enforceable agreement requiring the Board to make a good-faith effort to authorize a higher payment to Vizant.
We have seen a number of contracts entered between private company owners and investors that are missing key terms. Examples include contracts that are designed to transfer an ownership interest to an investor, but the specific number of shares or the percentage of units to be transferred has been omitted, the exact price to be paid for the shares or the units has not been specified or the timing of when the stock transfer will take place has been omitted. In all of these situations, the result may be that the signed agreement is not actually enforceable.
The takeaway here is simple and straightforward. If the parties cannot reach agreement on all of the material terms of their contract, they need to walk away. Putting a provision in the contract that calls for the parties to negotiate the missing term in the future will likely create a legally unenforceable agreement, even if the contract provision calls for the parties to negotiate the missing term in good faith.
Terms Must Be Clear, Plain Language
Every contract requires three key elements to be set forth to be binding: (1) the identity of the parties must be listed, (2) the specific subject matter of the agreement must be described and (3) the consideration to be paid/exchanged must be specified. When all three of these elements are present, the parties have reached a “meeting of the minds,” and the contract will be upheld and enforced. In order for the parties’ agreement to be carried out as they intend, the terms used by the parties must be set forth clearly and understandably, and not just by the parties alone. If the contract later becomes the subject of litigation, the contract terms may also be reviewed and interpreted by a judge and a jury (or arbitration panel).
The following are a drafting tips that may be helpful to consider in preparing contact provisions and the specific language that parties use in their business agreements:
- Use Numbers Not Just Words – in any contracts that rely on a formula for the amounts involved, it is a good idea to provide examples using actual equations. Describing the formula in words is not nearly as effective as putting in the actual calculations in numbers so the parties can confirm that this is how the formula or calculation will work in practice. Some formulas that are often used in contracts and which should be expressed in numbers are: (i) working capital adjustments, (ii) earn out calculations, (iii) bonus projections and (iv) the percentages of stock grants to be issued under certain circumstances.
- Do Not Use Business Jargon – using words that are industry specific, but which are not known or understood by lay people is dangerous, because these terms may be later misinterpreted in court proceedings. Plain English is always better, or if the industry term must be used, explaining it in more common language should be considered. The following phrases are a few examples that may be subject to disagreement if they are used as defining terms in a contract: (i) patentability, (ii) critical mass, (iii) market acceptance, and (iv) cash flow positive.
- Require Reporting – Too often, contracting parties assume that they will receive key information or receive regular financial reports from the other party. But if the contracts do not require any reporting to take place, and if the reporting does not happen, the party seeking additional information will have no contract right to require reports. Parties should therefore address the degree to which reporting will be required as the contract proceeds—monthly, quarterly, annually or on some other basis that is agreed to by the parties.
- Direct Notices to Parties Not Just Counsel – Most contracts include the name of someone to receive notices of any alleged breach of the agreement, and this may be the party’s counsel. It is fine to include counsel as a party receiving notices, but the contract should also require the notice to be issued to the party, as well. If a party changes counsel, or if the lawyer changes firms or becomes disabled, the notice may not be received timely. Therefore, all notices of any alleged breach of contract should be sent to the actual party and not just to counsel.
- All Contract Amendments Signed and in Writing – Contracts can be agreed to via email, which is often prompt and cost-effective. The danger, however, is that one of the parties to the contract may then seek to amend the agreement through a later exchange of emails, which is not intended by the other party. To avoid this problem, the parties’ contract should expressly state that it cannot be changed via email and that an actual signature is required for any amendment.
Business owners and investors who routinely enter into contracts are at risk if they rely solely on their counsel to negotiate and draft agreements without also taking the time themselves to carefully read and understand their contracts. All contracting parties need to ensure that the business deal they believe they secured is actually set forth in their written agreement and that they are not relying on any assurances outside the contract. It will be a source of great frustration, as well as unexpected legal expense, for a business owner or investor to learn for the first time only after a lawsuit has been threatened or actually filed that that the contract does not mean what it is supposed to mean or that a key term is missing from the agreement.
 JPMorgan Chase Bank, N.A. v. Orca Assets G.P., L.L.C., 546 S.W.3d 648 (Tex. 2018); Mercedes-Benz USA, LLC v. Carduco, Inc., 16-0644, 2019 WL 847845, at *1 (Tex. Feb. 22, 2019), and Int’l Bus. Machines Corp. v. Lufkin Indus., LLC, 573 S.W.3d 224 (Tex. 2019), reh’g denied (May 31, 2019).