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Best Practices for IT Agreements:  What Lawyers Can Tell Us

Mark is on a panel of experienced IT lawyers discussing “Best Practices for IT Agreements:   What Lawyers Can Tell Us” on Wednesday, May 29th at the monthly chapter meeting of the New York Chapter of the Society for Information Management (SIM).  The event is at the 21 Club at 21 W 52nd St in Manhattan.

Registration is required.  To register and for more information please visit:  http://www.nysim.org/events/next-event-details

The panel will discuss:

• Traps for the unwary in contract negotiations and what to do about them
• Optimizing the role of the IT staff in creating agreements
• Why owning IP you pay for may create the wrong incentives for the vendor
• Coordinating the work of external counsel, internal counsel and the company’s project owner to save time and speed implantation
• How to structure agreements as an “Early Warning System”

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After almost two decades of practicing law, I’m still amazed at the number of legal fallacies that even sophisticated business people have about doing deals and properly documenting them. It doesn’t matter what kind of deal–software as a service, licensing, cloud deal, or whatever.  I see these fallacies constantly.  One of the most prominent fallacies is that Letters of Intent (LOI) are always nonbinding.

I suppose that the misconception arises because — well — it does say “Letter of Intent” and not “Contract” at the top of the page.

Do yourself a favor and press the “I Believe” button on this one when I tell you that LOIs can be binding agreements.  You need to take them seriously and your lawyer needs to write them.

As a person who does other people’s technology, telecom, and outsourcing negotiations, I understand and still get the adrenaline rush of getting close to wrapping the big deal.  Still, these are the moments where you need to take a deep breath and make sure that you get the documentation right.

LOIs go by many names, such as Memorandum of Understanding, Agreement in Principle, and Term Sheet, among other things. Whatever you call them, they can and will bite you if you’re not properly circumspect about the things you sign.

Yes, it’s exciting when your big deal is making big time progress.  I know that when the other side mentions the LOI, it’s a Right Guard moment.  Just understand that once you sign that LOI, you may be blurring the line between engagement and marriage.

If you never close your deal because you never could work out all the details, you may find that LOI under lots of scrutiny. LOIs can and do find their way into courtrooms. The essence of the lawsuit is often plain ol’ “breach of contract.”

It really comes down to non-lawyers are often under the misconception that the title of the document absolutely governs the situation.

If the language in your LOI reads like a binding contract, it’s probably a binding contract. Don’t make the mistake of thinking that just because not every detail of your deal is in the LOI that this necessarily means you would win if sued.

The starting point in drafting an LOI is to remember its purpose. Usually, parties are looking to summarize their deal as a prelude to negotiating the details. Sometime they want to start a project moving before all the details are fully negotiated. Either way, it’s usually intended to be superseded by a more formal and lengthy document.

Further, the parties don’t intend many of the terms to be binding if they never sign a more formal contract that includes all the details.

However, the parties usually have terms they do expect to be binding even if they never close the deal. Some examples would include the part about starting the project, how much that will cost, a confidentiality provision and a provision that says each party is responsible for their own attorneys’ fees and other expenses in connection with the negotiation of the deal.

If your LOI isn’t specific about whether it’s really a contract or a nonbinding summary of the state of your negotiations, you could be creating an unpredictable mess for yourself. If there’s ever a dispute about the LOI, you’re forcing a court to look at the document as a whole, accept testimony with those who participated in the LOI creation process, and then make an educated guess as to the intent of the parties.

In this situation, the fact that it says, “Letter of Intent” at the top is just a single piece of evidence that a court will use to find the parties’ intent. If everything below the title reads like a binding agreement, the court may find that you have a contract and not just the simple outline of terms to be negotiated that you thought you had.

In some ways, if your lawyer does it right, this can be simple. A well-drawn LOI has a provision that specifically states to what extent the parties intend it to be a binding agreement. A typical provision will say that the LOI in fact has provisions that the parties intend to be binding even if they never sign another document. It will then go on to specify those provisions.

Whatever you do, just remember that an LOI is a legal document that you should have your lawyer write. If you think that you are up to the task, let me give you some perspective: As somebody who mentors young lawyers, I’ve yet to find one who fell out of law school with an innate ability to draft legal documents. It takes years of mentoring and training for a young lawyer to master the art of legal writing. I just ask, “Who mentored you?”

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When clients come to me to consider suing because of a tech deal that has gone bad, the single worst lawsuit killer is often the “standard” limitation of liability clause found in a vendor’s form agreement. It never ceases to amaze me how people don’t pay attention to these clauses as they blithely sign-off on a one-sided agreement. It’s just one little clause and yet it can cause so much damage.

Here’s an example of the type of provision that you’ll see in tech agreements:

“The liability of vendor to customer for any reason and upon any cause of action related to the performance of the work under this agreement whether in tort or in contract or otherwise shall be limited to the amount paid by the customer to the vendor pursuant to this agreement.”

Yes it’s heavily slanted in favor of the vendor—it’s the vendor’s form.  I draft them just as one sided when I’m representing a software vendor so that I protect MY client.  As I always say, he who drafts sets the agenda.

Judges Can Read

Now, if you sign off on a clause like that because you figure that your lawyer will find some technicality to overcome it later when a problem develops then I’d say to you, don’t depend on it. As a generalization, the clause means what it says and says what it means.  Judges can read and will probably enforce it as it’s written. Judges are not in the habit of rewriting commercial contracts.

That’s your job when you’re negotiating your deal.

It’s the Norm

When you negotiate your agreement and tell the vendor that the limit of liability has to go, you’re likely to get a blank look. You know, it’s the same look you get from your kids when you remind them that they haven’t given you your change after you sent them off on an ice cream run.

I know that what I say when I represent a vendor and the other side pushes back on the limitation of liability clause being so slanted in the vendor’s favor. I say things like “Limits of liability are the norm.” “Everybody uses them.” “We’ve never done a deal without one.” “We’d have to increase the price dramatically because of the additional risk we’d be assuming.”

Ironically, all of this is true. So, we’re done, right? Wrong. A skilled and experienced negotiator can make all the difference here.

While it is to some extent the norm to see limits of liability in tech, telecom and outsourcing deals, it’s not necessarily true that they’re all as onerous as my example. While getting the vendor to remove it completely may be like climbing Everest, making it fairer isn’t necessarily as hard if you ask for the right things.

The Negotiation

If your vendor won’t eliminate the limit of liability provision, you start by pecking at it. There are many way to do this, some of which I briefly discuss below.

In my example, the vendor’s liability is “limited to the amount paid by the customer to the vendor pursuant to this agreement.”

Let’s say we have a $5,000,000 deal cooking, which calls for 24 equal payments over 24 months as work progresses. Let’s say that after the first month it becomes clear that the work they’re doing is causing more harm than good, so you rightly refuse to make your second payment. Finally, let’s say that they’ve somehow caused damages worth $1,000,000.

You might think that you could successfully seek damages of $2,000,000. However, you are not likely to prevail because you’re limited to the amount you’ve paid — i.e. a refund. So, as written, no matter what they do and no matter ow bad it is, the most you get is the amount you’ve paid to date. They risked nothing!

My first attempt to chink their armor would be to ask them to limit liability to the total value of the contract to them ($5,000,000), not the amount paid to date. Failing that, I might ask for some multiple of the amount paid to date.

However, these two examples above assume that the vendor’s total liability to you will nicely match the total value of the contract to them.  That’s unlikely, so you should also consider asking for a multiple of the total value to them.  You know the scope of what they’re providing to you, so put some thought into all the ways they could potentially harm your company while providing goods and services to you.  How high does that number go?  Ask for it or something even higher and then negotiate downwards as appropriate.

Another approach is “reciprocity.” In fact, I’d say that no single word is more important in moving a one-sided agreement toward the middle than reciprocity. What’s good for them is good for you. Don’t be embarrassed to ask. They certainly weren’t embarrassed to make it one-sided to their advantage..

The idea is that the most that they can ever recover from you is equal to the most you can recover from them. Why should they have a protective limit, but not you? They won’t like that, but it’s hard to argue against the proposal’s inherent fairness. Still, they are likely to ask for an exception from the liability cap for the fees you owe them. In most cases, that’s fair.

Yet another approach is to create exceptions or “carve outs” for the vendor’s liability on several issues.  The most important is often creating an exception for infringing intellectual property. In the example as written, if they “create” software for you and you are sued for millions for infringing some third party’s copyright, you pay unknown millions. Then when you seek indemnity, you find that your indemnification is limited by the limitation of liability provision to a fraction of what you paid to the third-party. That’s fundamentally not fair..

Another common carve out is an exclusion for any third party’s property damage or bodily injury claim. As with the copyright situation, it seems inherently unfair that you should pay unlimited amounts of money to a third party because of something your vendor did, but then your recovery is limited by your contract.

Yet another common carve out is an exclusion from the limitation of liability relating to your vendor’s breach of their (hopefully heavily negotiated) IT security and privacy obligations in the agreement.  If your vendor suffers a data breach and your customer’s personally identifiable information winds up on the Internet, your vendor should be on the hook for the total amount of damages, not some arbitrarily capped amount.  Cleaning up the situation is going to be hard enough. If you’re also out of pocket for something the vendor did (or didn’t do), it only makes things worse.

There are a lot of other common exceptions to pursue during your negotiations.  Vendor’s breach of confidentiality, indemnity obligations beyond intellectual property infringement, gross negligence, recklessness, willful misconduct, intentional breach of the agreement, violation of law, or obligation to provide you with credits under the agreement. However, you won’t get them if you don’t ask for them.

It’s almost a waste of time to put effort into negotiating a contract to have it emasculated by a one-sided limitation of liability clause. Don’t let that happen to you. While it may be true that these types of clauses are “normal,” don’t assume that the one in their proposed agreement has dropped from the heavens as the only way it can be.

Related articles

• Limitation of Liability Clauses in contracts: Indian Perspective (tkamal20.wordpress.com)
• 12 Steps to Contract Negotiations (thethrivingsmallbusiness.com)

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