The title says it all: “Litigators Losing Love of Arbitration Argue for Trials.” But what caught my eye was the suggestions made by those interviewed for the article regarding how you can attempt to limit any downside to arbitration by addressing certain issues in the arbitration provisions:

• require a nonjury trial in the event of a dispute, or at least specify a certain jurisdiction, preferably in federal court
• specify the number of hours or days each side will get to present their case
• limit the number of depositions each side is allowed, when documents should be turned over, and how many days of testimony there should be
• specify that the losing party pays for the other side’s costs

These suggestions serve as a reminder that whatever arbitration clause you use—the AAA standard arbitration clause, my redraft of it (see this PDF of my article on the subject), or something else—commentators on arbitration generally recommend that you supplement it.

But don’t expect unanimity on that score. One of those interviewed for Passarella’s article said that he doesn’t think it’s a good idea for clients to tailor their arbitration clauses to set some ground rules.

And don’t expect consensus on the pros and cons of arbitration. I’ve seen other articles suggesting that arbitration is becoming more trouble than it’s worth; see for example this 2007 New York Law Journal article.  But I also recall seeing this more-upbeat 2006 article from the Daily Business Review.

Here, culled from the SEC’s EDGAR system, are some unprettied-up examples of this phenomenon (the redundant language is in italics):

In the event of force majeure, the affected party shall keep the other party fully informed and shall use its best efforts to comply to the fullest extent possible with its obligations pursuant to this Agreement … .

Make every reasonable effort to cause as little interference with and inconvenience to the business of the other Party as is reasonably possible [read not to interfere with or inconvenience the business of the other Party], subject to such Party’s other obligations under this Agreement and each SOW; 

… then the non-performing, hindered or delayed party will be excused for such non-performance, hindrance or delay, as applicable, of those obligations affected by the Force Majeure Event for as long as such Force Majeure Event continues and such party continues to use its best efforts to recommence performance whenever and to whatever extent possible without delay,

the Borrower shall use its best efforts and good faith to provide the Agent with as accurate information as possible [read accurate information] for such weekly Borrowing Base Certificates.

Motricity will make their best effort to address as many of these bugs as possible [read these bugs] during the 3.0.1 release cycle: …

NPM shall use reasonable efforts to mitigate and cancel, to the extent possible, all obligations that would incur expense … .

But in this context other flavors of possible are unobjectionable if what’s at issue isn’t just whether the task can be accomplished at all; instead, an additional parameter is factored in.

For example, for purposes of an obligation to reduce taxes, it’s not surprising that it isn’t enough that any reduction, no matter how minimal, be achieved—instead, the taxes have to be reduced as much as possible:

The Parties shall exercise their best efforts to ensure that any withholding taxes imposed are reduced as far as possible under the provisions of any relevant tax treaty.

And of course, often a party will want the obligation performed as promptly as possible:

Each of the parties hereto will use its commercially reasonable efforts to satisfy or cause to be satisfied all the conditions precedent which are set forth in Article VII as promptly as reasonably possible … .

The parties shall make a good faith effort to bring the Dispute to an arbitration hearing as expeditiously as possible … .

By the way, if you’re wondering about the distinction between efforts standards, I suggest you consult MSCD or use the search function to search for efforts. In these parts, it’s settled that using anything other than reasonable efforts is counterproductive.

At some point down the road, can you do a blog posting on Most Favored Nation clauses? 

My feeling is that within the last 2-3 decades, some professor in some business school somewhere wrote an article on how important these clauses are. Current CEOs, CFOs, and procurement leaders must have read that article, or must have friends who read that article, because I see these kinds of provisions in agreements to purchase goods or services or both.

I view these clauses as “trophies”. If a supplier readily assents to such a clause, then you don’t need to secure it. If a supplier refuses to accept the clause, then either: (a) you really need it from that supplier, or (b) the supplier is concerned about setting up the mechanism to comply with the clause. Oddly enough, again in my humble view, you may be better off with the supplier who rejects the provision …

Most-favored-nation (MFN) provisions are a feature of international economic relations. If one country grants another country MFN status and thereafter offers to one or more additional countries trade terms that are more favorable than those offered to the MFN country, the granting country must offer the MFN country too those more favorable terms.

The MFN concept has migrated into all kinds of commercial contracts—patent licenses, employment agreements, what have you. (The terminology might be adjusted to, for example, “most favored licensee.”)

But I have no first-hand experience with such provisions. I do know that MFN provisions make it easier for parties to strike a bargain, but they also act as a straitjacket on the granting party.

And MFN provisions are conducive to dispute. For example, when an MFN grantor subsequently enters into a contract granting rights more favorable than those granted the MFN beneficiary, the MFN grantor might be tempted simply not to inform the MFN beneficiary.

And it can be far from clear that terms granted subsequently are more favorable than those granted the MFN beneficiary. Here’s what Raymond T. Nimmer, Jeff Dodd, Modern Licensing Law § 7:15 has to say on that subject:

If one assumed that all licenses granted by the licensor were for a similar duration and differed only in the percentage running royalty rate charged, this formulation would present few difficulties. Thus, a subsequent license at a 2% royalty would clearly be more favorable than the prior license at 7% assuming that all other license terms are identical. However, all other terms are seldom identical or, at least, the parties should assume that they may not be. The issue in this framework thus becomes one of determining what combination of terms is or is not more or less beneficial than another. Making a determination on that issue may present a formidable, if not an impossible, task.

Beyond that, I leave it to you to comment on your experience with MFN provisions

This article on Lexology by Doug Batey of Stoel Rives LLP considers a recent Idaho Supreme Court opinion addressing a dispute over a fee-shifting provision in a limited-liability-company operating agreement. Here’s the contract provision at issue:

In any action or proceeding brought to enforce any provision of this Agreement, or where any provision is validly asserted as a defense, the successful party is entitled to recover reasonable attorneys’ fees in addition to any other available remedy.

The Idaho Supreme Court reversed the trial court’s award of $21,552 in attorneys’ fees because it found that the plaintiff did not seek “to enforce any provision of the Agreement,” as required by the provision in question. The plaintiff instead sought dissolution, which is a statutory remedy.

In his article, Doug explores alternative ways of phrasing the provision. This relates to something I explored in my recent article in the AAA standard arbitration clause (click here to go to a pdf copy). Certain provisions refer to disputes among the parties—arbitration provisions, jurisdiction provisions, and, yes, fee-shifting provisions. In each case, you’d be best off wording the provision so that it encompasses all disputes that the parties might get into as a result of their having entered into the contract. In that regard, whoever drafted the provision at issue in the Idaho litigation suffered from a failure of imagination.

The mainstream-drafting solution would be to throw in arising out of and relating to. But that just piles vagueness upon vagueness. Instead, in this case I might have said something along the following lines: “any dispute arising out of this agreement, ownership of [defined term for ownership interest in the LLC], or management or operations of the Company.” Refer broadly to the activities that the contract is meant to govern, so that the provision in question applies not just to contract claims but also other kinds of claims, including tort claims and, as in this case, statutory claims.

The case is D.B. Zwirn & Co. v. Dittman, No. 09 Civ. 10498 (S.D.N.Y. filed Mar. 23, 2010) (click here to go to a pdf copy). At issue was the following language:

The Company may bring an action or special proceeding in a state or federal court of competent jurisdiction sitting in the City of New York, for the purpose of temporarily, preliminarily or permanently enforcing the provisions of this Agreement or seeking any other remedy, and the Employee consents to and hereby submits to the exclusive jurisdiction of any state or federal court located in the City of New York for the purpose of any disputes arising hereunder or any equitable relief arising out of or relating to this Agreement.

The question was whether this language provided for mandatory or permissive jurisdiction. The court held that the provision was ambiguous:

The first part of the sentence, standing alone, is obviously permissive: That DBZ may sue in New York City expressly leaves open the possibility that either party could file suit elsewhere, including Texas. However, the use of the word “exclusive” in the second part of the sentence indicates that the parties meant for New York City to be the sole forum for a suit arising under the Confidentiality Agreement. But if, as DBZ argues, New York City is the exclusive forum, then use of the word “may” makes little sense.

I’d have analyzed it differently. For one thing, this provision isn’t ambiguous. Instead, the question is whether the first part of the sentence is inconsistent with the second part. (See chapter 6 of MSCD, or this March 2008 blog post, for more on the different kinds of uncertainty that afflict contract language.)

And it’s not that use of “may” makes little sense for purposes of mandatory jurisdiction; the “may” is fine. Instead, the problem is absence of the word only, as in “The Company may bring an action or special proceeding [insert only] in a state or federal court of competent jurisdiction … .”

Because the first part of the sentence appropriately grants discretion but doesn’t specify that the discretion is limited, I don’t think that saying the two parts of the sentence are inconsistent quite captures it. Instead, it’s more that the first part is overly broad, with the second part providing greater specificity. Given the lack of conflict, I think the court could just as easily have held that the contract provides for mandatory jurisdiction.

Here’s the bit that caught my eye:

On the key issue in the appeal, the court found that Cussler had a contractual right to review and reject proposed changes to the original Approved Screenplay “for unreasonable reasons … or for no reason at all.” The court rejected Crusader’s argument that granting Cussler such broad discretion rendered the agreement illusory, since Crusader retained the right to produce the film using the Approved Screenplay. In short, because the contract did not require Cussler to act either reasonably or in good faith, he could not be held liable for having failed to do so.

So if a contract governed by California law explicitly grants you the right to behave utterly unreasonably, the other party can’t complain if you take the opportunity to do just that.

How does this play out in other jurisdictions, in the U.S. and elsewhere?

When you issue a stand-alone purchase order (in other words, one not issued under a master contract), you could incorporate the general terms (in other words, everything that doesn’t relate to deal-specific matters such as product and price) in different ways. You could include them with the purchase order, you could park them on a website, or every year you could send your suppliers the general terms that apply to all purchase orders until the next set of general terms you issue. In the case of options two and three, the purchase order would contain a notation regarding which general terms apply.

Options two and three would have economy in their favor—you wouldn’t have to weigh each purchase order down with a set of general terms. That would speed transmission of POs by EDI (electronic data interchange) and by fax. On the other hand, if the recipient of a given PO isn’t familiar with the general terms, not including the general terms would give the recipient an extra hoop to jump through. It’s a tradeoff.

If you’re going to put the general terms on a website, bear in mind two issues that I’ve written about. Drafters sometimes fail to properly make a “virtual attachment” part of a contract; see this October 2007 blog post. You’d want to make sure that an analogous problem doesn’t arise with respect to having a set of general terms apply to a given PO.

And you’d be faced with the issue of whether you could unilaterally amend your general terms; see this July 2007 blog post. The conservative approach, by far, would be not to unilaterally amend your general terms. Instead, you’d put up a new web page for your revised terms, and they’d apply only to POs issued thereafter.

Otherwise, I’d be interested in your thoughts as to when it’s appropriate, or not, to use each of the different methods.

As you know, goods or services can be purchased by means of purchase orders issued under a master contract or by POs that aren’t issued under a master contract—I’ll refer to the latter as “stand-alone” POs. They can be issued for one-off purchases or on a regular basis as part of an ongoing relationship.

When you have a master contract, the general terms—in other words, everything that doesn’t relate to deal-specific matters such as product and price—are contained in the contract; the purchase orders issued under the contract contain just the deal terms. Furthermore, the general terms in a master contract are negotiated. By contrast, when you buy something using a stand-alone purchase order, the general terms are contained in the PO along with the deal terms, and those general terms are determined unilaterally by the purchaser rather than negotiated.

So what’s your take on the general terms in a stand-alone PO as compared to those in a master contract? Should they be equally comprehensive, or should those in a stand-alone PO address fewer topics more concisely and more evenhandedly?

Currently, the general terms in my company’s master contracts aim to be comprehensive, but those in our stand-alone purchase orders are shorter. One big reason for that is that including general terms in a PO makes demands on the supplier. Because the general terms in our stand-alone POs won’t have been negotiated beforehand with the supplier, they’re a source of delay, in that the supplier has to read through them and, after having done so, may balk at one or more of the general terms. And the longer the general terms are, they greater the likelihood of delay, and the greater the risk that the supplier will decide that given the extra one-sided verbiage, they’d rather not do the deal. Sometimes we end up having to negotiate; other times we agree with the supplier that if any conflicts arise, we’ll resolve them according to the Uniform Commercial Code.

This is of great interest to me because our legal department has prepared a new set of general terms for our stand-alone PO that essentially mirrors the general terms in our template master contract. That means the new set of general terms is comprehensive and one-sided in our favor. It’s also three times longer than the general terms we currently use for stand-alone POs. I’m torn between wanting to protect our company by using a comprehensive set of general terms for all our transactions versus wanting to use a shorter set of general terms so as to expedite our stand-alone PO transactions, most of which are low-risk. I’d be interested to hear what you think.

I don’t have direct experience with this issue, but here’s my first-principles take on it:

I can understand wanting to have the same general terms apply to purchases under a master contract and purchases under stand-alone purchase orders: your concerns as a purchaser are the same in both contexts.

But you have to consider the transaction costs. With a master contract, the parties have decided that they’ll be doing enough business together to warrant incurring up-front the transaction costs involved in negotiating a master contract. By contrast, with a stand-alone PO, you’re dealing with a single transaction—it would presumably not support the same level of transaction costs.

For purposes of illustration, here are a couple of hypothetical scenarios with make-believe numbers:

Acme and AlphaCo negotiate a master contract for Acme’s purchase of widgets from AlphaCo. In negotiating the general terms they incur $10,000 of transaction costs. They anticipate that Acme will purchase $1 million of widgets over the life of the contract.

By contrast Acme and BetaCo elect to have Acme purchase widgets from BetaCo using stand-alone POs. Acme orders 1,000 widgets for $10,000, using a purchase order that contains the same general terms as it used in the master contract with AlphaCo. The order placed with BetaCo is worth 1% of the expected value of purchases under the master contract with AlphaCo.

BetaCo’s transaction costs could well be less than Alphaco’s: with a one-off transaction, not as much would be at stake, so BetaCo might well be willing to accept some general terms without any haggling. But it wouldn’t be reasonable to expect the transaction costs incurred by Betaco to be 1% of the transaction costs incurred by Alphaco—the time it takes to read and understand the general terms would be the same for both transactions.

And it wouldn’t be realistic to expect that just because it’s a one-off transaction, BetaCo will accept all the general terms without negotiation. After all, a supplier that’s willing to give concessions in each one-off transaction could soon find itself with a portfolio of unfavorable contracts.

And it pretty much follows that if a comprehensive set of general terms in a stand-alone PO causes BetaCo to incur disproportionate transaction costs, closing the deal would cause Acme, too, to incur additional transaction costs as it engages in discussions with BetaCo.

So it may be that for the deal to make sense, the general terms in any stand-alone PO issued to BetaCo would have to be significantly shortened and made less one-sided so as to reduce BetaCo’s and Acme’s transaction costs.

Of course, BetaCo’s transaction costs could well be reduced drastically the next time Acme submits a stand-alone purchase order. But that assumes that the same BetaCo personnel are handling the second PO as handled the first. And more to the point, in handling the first PO, it would be risky for BetaCo to assume that it would in effect be able to amortize its transaction costs over the course of future purchases: for all it knows, Acme’s first PO could be its last.

So I’m sympathetic to the notion that for purposes of stand-alone purchase orders, it make sense to cut back a set of general terms used in a master contract and make them less one-sided, even though they reflect legitimate concerns.

I’m sure readers will have their own practical—as opposed to theoretical!—take on this.

• I remain of the view that putting a cap on damages is the simplest and least contentious way to limit damages. And it can make excluding certain kinds of damages less relevant, or even entirely irrelevant. Whether a cap makes sense would depend on the transaction, but it’s the first thing I’d explore when it comes to limiting damages.
• But if you also want to limit kinds of damages, consider that when describing something, it’s generally clearer to say what it is rather than what it isn’t. So instead of saying what damages the buyer isn’t entitled to, it might be simpler to specify the only damages that the buyer is entitled to. In the case of sale of goods, presumably you’d articulate, without using jargon, expectancy damages (the value of the thing promised less the value of the thing delivered) and cover (the cost of causing the thing delivered to conform to the promise), with perhaps some cap built in.
• If you also, or instead, want to exclude certain kinds of damages, I recommend that you not use the phrase consequential damages, as there’s widespread confusion as to what it actually means. From the seller’s perspective, it’s risky to rely on an exclusion of consequential damages, as courts are prone to holding that elements of damages that the seller might have intended to exclude are in fact direct rather than consequential. See, for example, this Bird & Bird analysis of a recent English case. (Thanks to reader Robin for sending me the link.)
• Instead, be specific as to what you’re excluding. Don’t use legal terms of art; instead, refer to “lost profits” or whatever else is on your mind. But whatever elements you include, think them through! Glenn West’s article—the one I linked to in my original post—explores two hypothecal situations and the different kinds of damages involved. I recommend that you consult those hypotheticals and for any given transaction devise comparable hypotheticals of your own, so that what you end up asking for actually makes sense in the context of your transaction.
• A buyer might be more willing to live with a limited range of damages if it’s entitled to liquidated damages in certain contexts.
• In my original post I proposed, as a baseline, language that simply tells the seller that they won’t be liable for damages that weren’t foreseeable when the contract was signed. Of course, in a large organization you face the question, foreseeable by whom—the CEO or the person further down the food chain who’s negotiating the deal, or someone in between? But presumably whatever cap or other limits to damages are built into the contract would render that pretty much irrelevant as an issue.

You’ll see in these thoughts the influence of some of the comments to my original post. My thanks to everyone who waded in.

I have in front of me a contract—it’s for the sale of goods—that contains the following provision excluding certain kinds of damages:

Neither party will be responsible or held liable for any consequential, special, or incidental losses or damages.

You can rely on sellers asking for this kind of provision, and buyers routinely accept it. But I suspect that many lawyers and their clients have an uncertain grasp of what such provisions are meant to accomplish. A rationale you’ll hear is that they prevent a party from seeking damages that are remote, in other words damages that the parties couldn’t have contemplated while they were doing the deal.

But you may be surprised if you take a closer look at these provisions. That’s what I did, with an article that I mentioned in this July 2008 blog post as my trusty guide: “Reassessing the ‘Consequences’ of Consequential Damage Waivers in Acquisition Agreements,” 63 Business Lawyer 777 (2008). (Click here for a copy.) It’s by Glenn D. West, a Weil Gotshal partner whose name has cropped up on this blog a few times, and Sara G. Duran, but in the interest of brevity I’ll be referring to it as “Glenn’s article.” It focuses on waivers of consequential damages in the context of M&A, but the analysis applies more broadly.

Let’s start by considering what damages a party is entitled to in the absence of any limitation. For a nonbreaching party to be awarded damages for losses caused by breach of a contract, generally those losses must be a reasonably foreseeable consequence of the breach. So even in the absence of any limitation, contract damages don’t compensate parties for losses that are remote.

So that’s the baseline. To understand the implications of excluding from that baseline certain kinds of damages, you have to understand the doctrinal jargon used. Each term is, to varying degrees, difficult to define clearly, given that it expresses a vague standard and given the inconsistent guidance provided by the wealth of related litigation in different jurisdictions. Here’s my boiled-down version of the analysis in Glenn’s article:

• Direct damages: These are best understood as damages that one would reasonably expect to arise from the breach in question, without taking into account any special circumstances of the nonbreaching party; also referred to as “general” damages.
• Incidental damages: These are expenses incurred by a buyer in connection with rejection of nonconforming goods delivered by the seller in breach of contract, or by a seller in connection with wrongful rejection by a buyer of conforming goods delivered by the seller to the buyer.
• Consequential damages: These are best understood as including all losses sustained by the nonbreaching party that are attributable to any special circumstances of the nonbreaching party that the parties were aware of when they entered into the contract; in other words, consequential damages encompass all contractually recoverable damages that aren’t either direct or incidental damages; also known as “special” damages.

It’s clear what “consequential damages” don’t do: they don’t compensate a buyer for remote or speculative losses, which shouldn’t even constitute losses. But many people are unaware of that. Here’s what Glenn’s article says on that subject:

[T]o define “consequential damages” as those losses that are so remote that they were beyond the contemplation of the parties at the time they entered into the contract is to define consequential damages as losses for which the law does not allow recovery in contract, regardless of any provision excluding such damages. Yet, many sellers purport to require waivers of consequential damages because they believe consequential damages relate to losses beyond those that the breaching party would have ordinarily and reasonably foreseen or contemplated.

The rules limiting all contractual damages to those that are “natural, probably, and reasonably foreseeable” impose a judicially created “rule of reasonableness” that generally limits the extent to which any damages, including consequential damages, may be awarded for breach of contract. As a result, even in the absence of a contractual waiver of consequential damages, this standard of reasonableness creates limits on the extent of the non-breaching party’s recovery for losses that the breaching party did not otherwise specifically agree to bear.

Given that background, here are my problems with excluding certain kinds of damages:

• Many of those asking that certain kinds of damages be excluded assume incorrectly that otherwise the nonbreaching party would be entitled to recover remote damages.
• The jargon used in such exclusion language doesn’t have a clearly established meaning, so is conducive to dispute.
• It seems arbitrary to exclude certain kinds of contractually recoverable damages but not others.

But for me, here’s the clincher, as stated in Glenn’s article: “While sellers have legitimate concerns over their potential liability for breach … , there are other means of addressing those concerns without the use of terms that have such uncertain meanings.”

Consider the contract I mentioned at the top of this post. In addition to excluding certain kinds of damages, it limits the buyer’s recovery in any claim to what the buyer paid for those goods. That by itself rules out the prospect of the buyer’s being awarded damages that far outstrip the purchase price. Why does the seller also need to engage in the messy business of excluding certain kinds of liability? Any buyer would be advised to resist vigorously that sort of overkill.

So here’s what I suggest: I’m proposing to buy some widgets, and it’s likely that the seller will want to limit damages. I’m the one drafting the contract; I could elect to omit from my draft any mention of excluded liabilities, but it would be more constructive to try to head off any debate by attempting to address the seller’s concern using my own language, narrowly tailored to avoid the excesses of the traditional exclusion language. It would just says what the law is [language revised Feb. 16 9:00 a.m. EST in response to comment by Mark Anderson]:

Neither party will be liable for breach-of-contract damages that the breaching party could not reasonably have foreseen on entry into this agreement.

Glenn’s article in effect endorses this approach: “Instead of waiving ‘consequential’ damages, buyers should seek waivers of ‘remote’ or ‘speculative’ damages.”

If that doesn’t satisfy the seller—it wants to exclude some recoverable damages—I’d propose that we instead put an absolute cap on damages rather than engage in the arbitrary and uncertain exercise of excluding certain kinds of damages.

And even if my draft contains an absolute cap from the start, it would be harmless to exclude remote damages, and there might be some benefit to doing so: it could cut short any discussion I might otherwise be forced to have if the seller is one of the many who don’t understand that a buyer is entitled to only those damages that are foreseeable.

Of course, if the seller wants to double dip—wants both an absolute cap and to exclude consequential damages—we’d have to have a different, and more vigorous, discussion.

***

In closing, some stray thoughts:

• This is just one example of an accepted bit of boilerplate that doesn’t make much sense. In this September 2006 blog post I wrote about another favorite waste o’ time, the “successors and assigns” provision.
• Just as Glenn’s article considers U.S. and English law, I suspect that my conclusions in this post would apply in any common-law jurisdiction.
• This post confirms my aversion to using doctrinal terms of art in a contract. That’s something I considered in this recent post in connection with use of the terms fraud and intentional misrepresentation.