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Break The Code

Learn the fine art of deciphering the fine print.
January 1, 1999
URL: http://www.entrepreneur.com/article/17086

W e lawyers have a saying: "The big print giveth, and the fine print taketh away." If there's one thing formal legal documents are known for, it's fine print, or "boilerplate," those interminable, impenetrable and incomprehensible paragraphs of legalese that seem to be designed to vex and befuddle the layperson.

What follows is an overview of the most common boilerplate provisions. Although it'll help you better understand contracts and what they can do, this series is not a recipe for the do-it-yourselfer. These clauses won't work unless they're worded just right. Get help from an experienced lawyer.

Party Hopping

When your attorney pontificates, saying "The law favors the assignability of contracts," he or she just means your deals can be bought or sold, or, in legal jargon, "assigned." Thus, you could shake hands on a deal with one person and end up doing business with another. Like all things legal, the general rule has many exceptions. For example, the term "assignment" really means two things: the sale to a third party of one side's right to receive something from the other and/or the delegation to a third party of one side's duty to do something for the other.

If you don't want the other side to be able to sell your deal, say so in your contract: "Any assignment of this agreement by [the other side] is void." Conversely, if you want the unrestricted right to sell the deal, spell that out. Or consider a compromise: List which assignments are OK and whether they require any notification or approval.

Key Man Out

If you ink a deal with a gigantic company because of your relationship with one people in it, what are you going to do if he or she leaves? A key-man clause can protect you, giving you the option to walk away from the deal if that person quits or is fired. Change-of-control provisions involving partnerships or corporations are similar. They allow for buyout, termination or dissolution rights if the people you originally dealt with no longer control the entity.

Make It Complete

An integration or merger clause protects you from claims that there are other parts to your deal that weren't written down or that somewhere along the line there was an oral agreement to change the contract from the way it was written. It's usually the last clause in a contract. A simple version of it may read: "This agreement contains our entire understanding and cannot be changed orally."

Checks And Balances

If your deal entitles you to ongoing profit or royalty payments, an audit clause gives you the right to check their accuracy. Without it, bringing a lawsuit may be the only way to get a look at the applicable books and records. If you're the one doing the auditing, get frequent accountings, as well as the right to see whatever specific records you'll need to verify that you've been paid correctly. On the other hand, if you're the one who may be audited, make sure you're entitled to adequate notice, that the audits remain confidential and that you aren't required in turn to audit any third party on whom you rely for issuing statements or payments.

Trust Me

If prevarication is the disease, representations and warranties are the cure. Make the other side reduce to black and white what it promises to be true. These types of warranties are a second cousin to familiar consumer warranties for parts and labor, only here, the stakes are higher. Anyone who makes a phony representation or warranty may get nailed for fraud, as well as the losses suffered by the other side.

Reps and warranties (R&Ws) must be custom-designed for each deal. The more complex the transaction, the more exhaustive the R&Ws and extensive the negotiations. For example, even your garden-variety corporate deal will include a rather comprehensive list of R&Ws: accuracy of financial statements, title to assets, insurance policies, customer lists, payment of taxes, proper corporate formation and operation, stock and good standing of each party, zoning, inventory, patents, accounts receivable, lawsuits, trademarks.

But don't let your guard down just because you have R&Ws swearing everything's OK. In the real world, the other side's dishonesty or negligence will become your problem . . . and a lawsuit is a time-consuming, aggravating and expensive last resort. Even the tightest R&Ws don't replace checking out who you're doing business with, buying appropriate insurance policies and structuring your exchanges to minimize your downside.

It Ain't My Fault

As a general rule, when it comes to making deals, the less you're legally responsible for, the better. Thus, if the other party has leverage, he or she will sell you goods "as is," have you enter the premises "at your own risk," and saturate contracts with disclaimers.

The most celebrated of exculpatory clauses is the indemnity. Among other things, it offers protection from third-party lawsuits. In other words, if you've agreed to indemnify me and I'm sued by someone else because of the deal I just cut with you, you must pay a lawyer to defend me, as well as pay any judgment should I lose. Lawyers love to negotiate indemnity clauses. Who controls the lawsuit? What if you want to settle and I don't? Despite all the haggling, an insurance policy often takes care of the problem. Courts like the idea of contribution--each party bears a proportionate share based on relative fault.

A notice clause lays out exactly how the parties will exchange formal communications, including where, when and how to send them, when they're effective, who gets copies, which ones can be verbal, and so on. Although notice clauses are not intended to be exculpatory, they can be used that way. Send a notice without scrupulously following the letter of the contract, and the other party may scream, "Foul!" Sound crazy? Maybe. But the other side may blow enough smoke to get themselves off the hook, especially if they can argue that your improper notice put them at some disadvantage.

In our next issue, find out about specific clauses that give you the upper hand if your deal goes bad.

Glossary Of Legal Terms

Assignment: the transfer of one party's rights to another

Contribution: the proportional sharing of a loss

Disclaimer: the denial of a claim and the refusal to accept responsibility for it

Exculpatory clauses: provisions that clear a party of fault

Indemnity: one person's agreement to protect another against loss

Integration (or merger): a contractual clause stating that the written agreement contains the complete understanding of the parties

Representation: a party's statement of fact which is influential in bringing about an agreement

Warranty: a promise that a fact is true

Marc Diener is an attorney and author of Deal Power: 6 Foolproof Steps to Making Deals of Any Size (Owl Books/Henry Holt). This article contains general information only. If you are concerned about how these issues might affect you, seek independent counsel.