Be Careful When Contracting With Related Parties

Ever heard the expression, “Good fences make good neighbors.”?  I have a similar opinion as to contracts between related parties.  I’m talking about business contracts between parties who know and trust each other and may even be in related or competitive businesses.  Even in those circumstances, a clear and specific contract is important to avoid misunderstandings and effectuate the parties’ agreement.

Let me give you a recent real life scenario.  My “Client” is in a competitive and sophisticated commodity based business where a few pennies on the input or output side can mean millions of dollars and the difference between profitability and failure.  The Client is owned by a group of individuals that are also owners and operators of competitive businesses (the “Competitors”) in the same industry – this means the owners are both partners and competitors.  To further complicate things, a subset of the owners has a related company (the “Management Company”) that manages the commodity-based businesses (both the Client and the Competitors) for a fee.

So, the Client wants to enter into a contract under which the Management Company would manage the Client’s facilities – in addition to managing its own facilities and the Competitor’s facilities.  This arrangement is filled with conflicts of interest and competitive risks/concerns – in other words, this is a situation where the contract is critical.

I can’t discuss all of the key issues here, so I’ll focus on just a few.  The parties’ proposed contract said the Management Company:  (i) had complete discretion and authority to make decisions and enter into contracts binding on the Client; (ii) could use and share the Client’s confidential information with and for the Competitors’ and the Management Company’s own purposes; (iii) had no limits on competition, solicitation or the allocation of business opportunities; and (iv) had no stated standard of care.  In other words, the proposed contact was A RECIPE FOR DISASTER FOR THE CLIENT.

Now, as it turns out, none of the above provisions accurately reflected the parties’ intentions.  However, because they know each other well and trust each other, they thought they could cobble together any document labeled “Management Agreement,” and they’d just work things out as they went along.  When presented with a series of “what-if” questions, the parties quickly realized that this contract needed a lot of work, and we included provisions addressing the above issues and several others.  The result is a contract that clearly sets forth the parties’ rights and obligations and anticipates and addresses the circumstances that might otherwise result in disputes.  In other words, a contract that facilitates and builds their business relationship rather than threatening it.

Keep in mind that contracts between related parties often present the same (and sometimes even more) risks as other contracts.  Make sure you take care when entering into them – for everyone’s benefit.

Litigation From the Business/Transactional Perspective

My last blog post discussed the importance of contemplating litigation risk (or at least the likelihood of disagreements arising from time to time) in structuring business entities and relationships and in drafting contracts – in other words, anticipate and draft for the potential downside. By doing so, you can actually reduce the likelihood of disputes, and even if they do arise, they will hopefully be resolved in a quicker, less costly and more predictable manner. All of this allows clients to focus on running their businesses and making money rather than fighting legal battles and spending money.

Of course, not all disputes can be avoided or settled.  Sometimes you’re forced to litigate or arbitrate.  Even in those circumstances, however, my experience shows that substantial time, money, opportunity costs and emotional damage can be saved if those disputes are approached from a business/transactional perspective.  So, here are a few very brief thoughts on litigating “from the business/transactional perspective”:

• Approach every disagreement with a “problem-solver” rather than a “warrior” mentality.
• Try to compartmentalize disputes – disagreement about one issue doesn’t always need to poison the entire relationship.
• Never litigate over “a matter of principle” unless your business is able to afford whatever it may cost – and it always costs more than you expect.  Principles cost money and don’t generally enhance profitability.
• Don’t get hung up on who’s right or wrong – focus on the impact to your bottom line.
• Settling early costs a lot less than settling late.
• Consider mediation – it really does work sometimes.
• Litigating and winning almost always still costs you a LOT in legal fees, opportunity costs, and sometimes even reputational damage.
• Even in litigation, conduct yourself in a professional manner and with integrity – you never know who or what will lead to your next business opportunity.
• Just because you didn’t have an arbitration clause doesn’t mean you can’t agree to arbitration later on – it still may save both parties time and money.
• While in litigation, there’s no need to fight over everything.  Fight only the battles that matter – you look better in the judge’s eyes, and you don’t waste money on meaningless victories (or losses).

The bottom line is disputes cost money and take you away from your business.  Choose and conduct your battles wisely – from a business perspective.

Transactions From the Litigation Perspective

The law, like most disciplines, has very few absolute truths.  However, it is my firm opinion that a good business transaction is always better than a lawsuit.  Therefore, it’s critical that business transactions and the underlying contracts be structured to maximize value, reduce risk and avoid uncertainty.  After all, risk and uncertainty often lead to disagreement and sometimes litigation.  Therefore, I recommend that parties approach business transactions and contracts with the mindset (but not necessarily the goals) of a litigator – and then use that mindset to avoid litigation.

I do not mean that parties should be argumentative or take one-sided positions.  Rather, what I mean is the deals should be structured and contracts should be drafted as simply, clearly, consistently and comprehensively as possible.  And once you’ve done that, they should be re-examined, and the following question should be asked:

• Is this the right deal, at the right time, with the right party?
• Is the deal structured as simply as possible?
• Is the contract drafted as clearly and simply as possible?  Is it consistent?
• Which provisions invite differing interpretations?
• Have you covered as many variables/contingencies as possible (you generally can’t cover them all)?
• Have you allocated between the parties as many of the risks/responsibilities as possible (again, you may not be able to cover them all)?
• Have you included appropriate insurance, indemnity and escrow provisions?
• Have you allowed for termination or some other type of walk-away if the deal doesn’t work out?  If so, have you anticipated the likely issues, disagreements and entanglements that can arise at this stage (they can be much different than those at the outset)?
• Have you considered how disputes will be resolved?  Mediation?  Arbitration?  Litigation?  Appraisal?  By whom?  Where?  Who pays?  What law/rules govern?  Etc.
• In light of all of these questions, and even assuming you’re comfortable with all of the answers, is this a deal that should be done?

Thinking like a litigator may be the best way to avoid litigation over your business deals.

Tight Legal Budget – What Can You Not Afford Not to Do?

Let’s face it, lawyers are expensive, and really good lawyers are even more expensive.  This is my blog, so I can say it – I think I am (and each of the members of my team are) a really good lawyer.  As a result, I help my clients make a lot of money and protect their businesses and assets – but I’m expensive (at least by Iowa standards).  However, no matter how much I talk about adding value, for some people and in some circumstances legal services just feel like a pure expense – kind of like insurance – something you hate to pay for, but you know you need. 

If this is how you generally view your relationship with your lawyer, my first thought is that it’s probably time to change lawyers, or at least change the way you work with your current lawyer.  However, even if you love your lawyer and really value his/her advice, every business has to operate within a budget – which  means making risk/benefit/value decisions in everything you do, including purchasing legal services.

Here’s a different way to view your legal services budget – what can you not afford not to do or protect?  Here are a few examples of what I believe you cannot afford not to do:

• limit your personal liability with a corporation, LLC or other entity;
• protect your intellectual property and other assets;
• enter into clear agreements with your partners/co-owners as to management, buy-sell, authority and other business and strategic issues;
• adopt clear employment policies, enter into clear agreements with employees and comply with employment laws generally;
• pay your taxes and take advantage of every tax incentive and planning opportunity;
• comply with export laws;
• understand your insurance needs and purchase the right insurance; and
• . . . most importantly, fully understand and consider the legal meaning and effect of every business and legal decision you make or transaction/relationship you enter into – some of them may have “bet the company” consequences – make sure you make sure you make the right bet.

Creativity and Problem-Solving Are NOT Optional For Your Lawyer

How do businesses make money?  Typically, they identify a need that is not being satisfied or a problem that needs to be solved, and they satisfy/solve it.  In other words, challenges create opportunities for businesses – something to be overcome, rather than something that prevents you from achieving your objective.  Your business lawyer needs to think this way as well.  Creativity not only solves problems – it makes money.

Very often clients come to me with a specific opportunity they want to capitalize upon, but some sort of roadblock or hurdle that is making this difficult.  That’s both challenging and exciting.  Rather than focus on the problem, I focus on the solution.  That’s what your business lawyer needs to do too.

At the outset, remember that many challenges are simply risks, rather than obstacles.  Some lawyers can’t tell the difference – those are the ones who went to law school because they “love the law” and enjoy analyzing problems rather than identifying solutions.  Before you alter your business course because of an obstacle or problem – make sure that’s what it is rather than merely a business risk that is better evaluated and addressed by you rather than your lawyer.

Assuming there is a real legal challenge, remember that many problems have simple solutions – and it’s the lawyer’s job to find the simplest solution available.  That way, the client can get (back) to making money in business rather than solving problems and spending money working with lawyers.  However, a lawyer really shows/adds value when he/she solves a particularly complicated problem – the kind of problem that, if not solved, kills the deal.

If your business lawyer has never said things to you like –  “What if we did it this way?”  “How about approaching it differently?”  “I think you’d be better off doing this.” Or “We can’t do that, but we can accomplish your goals another way.” – then it may be time for a change.  In other words, if your lawyer is not a creative problem-solver and a calculated risk-taker, then your lawyer is part of the problem itself, rather than part of the solution.  Problems cost money; solutions make money.

Does Your Business Lawyer Know How to Protect Your IP?

Let me start by saying, I’m not a licensed patent lawyer or an IP lawyer by any definition.  No, that ship had sailed by the time I clerked with a major Midwestern law firm and the head of the Intellectual Property Practice Group laughed out loud at my undergraduate double majors in political science and history.  The true practice of intellectual property as a substantive legal area is largely one involving a deep understanding of the sciences (and I don’t mean political science). 

However, the business side of intellectual property (and of course, the business side is what this blog focuses on) requires the ability to identify valuable intellectual property, conduct a risk-benefit analysis, determine what protections are appropriate and affordable under the specific circumstances, and then (and most importantly) work with you to implement and execute a plan to PROTECT and MONETIZE your IP.

So, does your business lawyer need to be a licensed patent lawyer?  No.  What your business lawyer does need are the following skills/abilities:

• Access to a talented licensed patent lawyer in the same firm (and here’s the critical part) who does more than just process and enforce patents and trademarks – one who regularly works on IP matters and understands how they affect your business activities, relationships and agreements.
• A complete understanding of your business and a specific understanding of the types of IP you have or intend to develop.
• The ability to identify risks and opportunities to and for your IP and to inform you when one may outweigh the other.
• Practical experience in structuring and handling mergers, acquisitions, licensing agreements, joint ventures and other transactions involving valuable intellectual property.
• And finally, an open and creative mind to help you to maximize and realize (i.e., monetize) upon the value of your intellectual property.

Whether you are a technology company, a software developer, a manufacturer, an energy company or any other type of business, you likely have valuable IP – make sure you work closely with capable and experienced legal counsel to protect it.

Does Your Lawyer Understand . . .? Part 1 – Manufacturing

This is the first in a series of articles based on my experiences with lawyers who don’t understand various deals, issues, industries etc., and therefore, don’t adequately represent their clients’ interests.  In this post, I’ll discuss the basics of representing manufacturers.

The most basic issues in representing manufacturers surround supply chain contracts – i.e., contracts where one party manufactures and sells products or components to another party.  Although this seems like a simple context, there are an infinite number of issues that arise.  Here, I’m only going to try and scratch the surface by identifying a few of the most important by asking the following questions:

• Is your client the manufacturer/seller or the buyer?
• Is this a wholesale or retail transaction?
• What is the term of the agreement?
• How can it be terminated (e.g., only for cause, with or without cause, upon material breach, etc.)?
• Is the parties’ relationship exclusive in an industry, product line, territory, or otherwise?
• Is the product (or the process by which it is manufactured or sold) subject to governmental regulation?
• Will the product be exported?  If so, by whom; to whom; and is a license required?
• To whose specifications will the product be manufactured?
• Who decides if changes are necessary?
• How will orders be placed/accepted?  What about lead times, custom orders, etc.?
• Is this a requirements contract (i.e., manufacturer has to meet buyers’ requirements), an output contract (i.e., buyer has to accept manufacturer’s entire output), or something else?  If the latter, what happens if the manufacturer can’t meet the buyer’s demand?
• What are the terms of delivery/risk of loss?
• Whose warranty will govern?
• What are the payment terms?  Prepayment?  COD?  Letter of Credit?  U.S. Dollars?  Etc.
• Who is responsible for taxes, insurance, freight, etc.?
• Who owns (or has license rights to) the intellectual property?  Will any IP be developed during the term?  Will any be jointly developed?
• Can the parties use each others’ names, marks and logos?
• What are the indemnification and insurance obligations of the parties?
• Whose law will govern (especially important in international transactions), and equally important, where and how (e.g., litigation versus arbitration) will disputes be resolved?
• Are there any important restrictive covenants (both during and after the term)?  E.g., confidentiality, non-compete, non-solicitation (of empoyees, customers, etc.), non-disparagement?

These are just some of the questions/issues that your lawyer must ask/understand to adequately represent you if you are a manufacturer – make sure he/she does.