Monthly Archives: May 2009

The Most Useful Contract Provision? (Technology Law Letter #6)

The Most Useful Contract Provision?

In my view, the most useful contract provision is the “term” of the contract, in other words, the time period that the contract is legally in force before it expires.

Why?

Because a very short-term contract (such as month-to-month) can eliminate many issues, shorten negotiations and even reduce legal fees.  If the parties don’t like what’s happening under the contract, they can let it expire.

On the other hand, a lengthy contract (five years or more) can become like a ball and chain, even if it was very reasonable when it was signed.  This is because the world changes, and no one can predict the future.  Given enough time and money, lawyers can negotiate every possible contingency and edge-case you can imagine, and give you a contract the size of the Manhattan telephone directory.  You see this for example, in information technology outsourcing agreements, which often last for eight years or more.

It is very easy to overlook this simple and commonplace clause.   And yet this clause can have a profound impact on your deal.

You probably could accept very onerous and heavy-handed deal terms… if they last for only one day.  On the other hand, even the most simple contract terms can become an unbearable burden…  if they run for 20 years.

If you want to reduce the time and expense of negotiating your deals, there is a simple fix.  Make your deals on a month-to-month basis.  If either party objects to the deal in the future, they can exit, clean and simple.

If you want a deal to look longer, for “optical” purposes only, you can sign up to a fixed term (such as two years or five years), but allow either party to terminate “for convenience” on 30 days notice. Termination for convenience is often written as “termination for any reason or no reason at all.”

It will look like a longer deal, but in effect it really is a month-to-month deal.  Watch out, though, for contracts that give this right only to one party, not both.  The contract would then be in essence an option contract, which only one party could exit.

I have seen month-to-month agreements and termination for convenience clauses eliminate many unnecessary negotiations and roadblocks to getting a deal done.

There is less to fight over if either party can leave at will.

This strategy won’t work for every contract relationship, however. First, accountants may require an actual binding long term agreement for accounting and financial purposes. Second, this strategy is less effective when one of the parties has a large fixed investment to protect.  Large outsourcing agreements raise this issue. The outsourcer needs a long-term contract to recoup its investment in setting up the systems and infrastructure to perform the services.  Similarly, lenders and investors may require a true long-term contract to act as collateral for a long-term loan or investment.

Can you imagine that a company would use the term of a contract as a competitive advantage? That’s exactly the approach of America’s Best Value Inn, a new hotel chain, according to The New York Times (http://tinyurl.com/5zgykh). Most hotel chains, such as Wyndham Hotels, require franchisees to sign up to contracts of 15 to 20 years.  By contrast, America’s Best Value offers franchise agreements that are renewable each year.  Many franchisees like this flexibility.

A short contract term isn’t a cure-all, of course, even for hotel franchisees.  One lawyer mentioned in the article, who represents franchisees, says his clients prefer long-term contracts, to protect the franchisee from losing its franchise if it doesn’t pay for expensive upgrades to its facilities every few years.

If your contract needs to protect a large, fixed investment by you or the other party, then a short contract term probably isn’t the answer.  In the future, I’ll discuss how to protect yourself in that situation.