Provisions in an agreement can wreak havoc on what otherwise looks like a perfect lawsuit between a food producer and its customers, distributors, co-packers, or really anyone with whom you contract. These provisions, along with others, are often buried in fine print in exceedingly long commercial agreements. In other words, the part where you, or your sales department, has grown weary of reading and parsing words and “just wants to get this done.”
But what other kinds of provisions are lurking in the fine print? This post highlights three: provisions limiting a party’s liability (Hold Harmless and Indemnity clauses), the force majeure provision, and the choice of law clause.
Limitations on Liability and Indemnification
As a general rule, recoverable damages for a breach of contract are measured by the amount necessary to place the non-breaching party in the position that it would have been in but for the breach. In the most general, legal terms, contractual damages equal the loss in value of the other party’s performance caused by its failure or deficiency, plus any other loss (including incidental or consequential loss caused by the breach).
Each state defines types of damages slightly differently, so under the chosen law, parties must take notice of what constitutes compensatory, actual, general, special and consequential damages. Lost profits may be recovered if not speculative in some states. For contracts involving the sale of goods, the Uniform Commercial Code (UCC) provides for general, consequential and incidental damages. However, the UCC, or its agricultural cousin the Perishable Agricultural Commodities Act (PACA), do not cover all contracts that persons or entitles may enter into.
Courts will enforce provisions limiting damages provided that they are not overreaching or unconscionable, and that do not violate public policy. These provisions may limit the types and amounts of damages (as opposed to exculpatory clauses that immunize a party as a result of certain conduct). These terms are defined differently in different states. And for those of you familiar with these clauses, you have probably not seen other states’ case law on what may be “overreaching”, “unconscionable” or know the state’s “public policy”, even if you know your own state’s.
Liquidated damages provisions, which will generally be enforced unless deemed to be a penalty or in contravention of a similar public policy, anticipate the amount of any loss ex ante (“Before the event), and set caps on any potential recovery. These provisions should not be confused with clauses limiting available remedies. Liquidated damages provisions need not be reciprocal, and are meant to represent an apportionment of risk determined when contract was entered into.
Force Majeure Provisions
These provisions, which are also known as “acts of God” clauses, operate to suspend performance of a party’s contractual obligations in the event of unforeseen disasters, such as earthquakes, hurricanes, floods and so on (think Hurricane Katrina or Sandy). Force majeure is generally considered to be an event or condition not existing at the time a contract was executed, nor reasonably foreseeable at that time, and not reasonably within the control of either party. This event then prevents the performance of one of the party’s contractual obligations, or renders the performance of such obligations so costly or difficult as to make such performance commercially unreasonable.
To fit within the parameters of such a provision, the unforeseeable event must be the cause of the delay in performing the agreement, as opposed to other business considerations that may exist at the time for performance.
So what may not qualify as a force majeure? Recently, state contractors have attempted to use the fiscal insolvency of various states to argue that a state’s failure to remit timely payments excuses the contractor’s obligation to make its own timely payments to a third party, claiming refuge in a contractual force majeure provision. Although this excuse may technically fit within accepted definitions of force majeure provisions, courts have been slow to excuse performance based on this premise. Nevertheless, as state governments continue to delay paying their bills, this type of argument may gain traction.
Choice of Law
These provisions relate to which law is used to resolve any dispute. As a general rule, parties are free to select which jurisdiction’s laws will apply to their relationship, so long as the chosen jurisdiction bears a “substantial relationship” to either the transaction or the parties, or some other reasonable basis exists justifying the parties’ choice. Contracts for the sale of goods are governed by the UCC or PACA, which have similar rules requiring a “reasonable relationship” to the transaction. The wording of a choice of law provision is important, as courts generally construe such provisions narrowly. In the absence of a choice of law provision, the law of the state with the most significant relationship to the substance of the contract will govern its enforcement.
An often-overlooked but essential consideration is the substance of the applicable law, which can differ from state to state. This is of particular import when a party may seek to limit any future recoverable damages in the event of a breach. Although parties may be generally familiar with the law of a given forum, in all likelihood they do not undertake close examination of every nuance when drafting an agreement.
There is often a perception of wanting the applicable law to be our home state, but looking into the other state’s laws may result in more favorable terms. Sometimes it does not. Indeed, in some contracts, we have heard where the choice of law is made by either flipping a coin, or picking a state in which neither contracting party has a presence. In such circumstances, beware of the unknown when it comes time to address a dispute.
These are just a few of the types of provisions that may be found in the “miscellaneous” section of a contract. Although these provisions may appear standard, they may have profound impact on a business relationship, going so far as to turn a “big deal” into a “big mess”. Ultimately, a contract is about managing and assessing risk. But that includes all of the contractual provisions—not merely the ones defining the basic economic terms.
Simply put, do not accept “boilerplate.” There is no such thing.