Avoiding Common Contract Drafting Mistakes
by Yvette Ostolaza
Litigators spend much of their time trying to preserve economic bargains that contract drafters have worked hard to strike. Unfortunately, contract drafters sometimes make the litigators’ task more difficult than necessary by failing to include procedural protections designed to facilitate enforcement of those economic bargains in litigation.
Drafting an effective contract requires a drafter to remember that the contract will be “Exhibit A” to every dispute—both substantive andprocedural—that arises between the contracting parties. Below are some clauses a contract drafter should consider including to ensure that a litigator has the tools necessary to protect the deal.
1. Where Will the Dispute Occur?
One question a contract drafter should consider addressing is where any resulting dispute will be heard. A forum-selection clause can be used to ensure that future litigation takes place in a favorable or convenient location and, more generally, to increase predictability about future disputes. Alternatively, a forum-selection clause can be used to deter litigation and encourage settlement if parties agree in advance on a forum where litigation is inconvenient or difficult.
A forum selection clause is generally enforceable unless it is unconscionable. Notably, by signing a forum-selection clause, a party typically waives any objection to personal jurisdiction. However, parties cannot create subject-matter jurisdiction by consent. So a court will disregard a forum-selection clause that would put non-diverse parties in federal court on a state law claim.
A specific type of forum-selection clause worth considering is an arbitration clause. Mandatory arbitration clauses are typically enforceable in commercial contracts and, in some jurisdictions, are also enforceable in consumer contracts. To maximize predictability, an arbitration clause should be specific. It should settle in advance the location of arbitration, the panel size and composition, the location, and the rules to be applied to the proceeding.
2. What Law Will Apply?
A contract should also state what law should apply to disputes between contracting parties. Special care should be used in designing the scope of the clause—specifying whether or not the court should apply the conflicts provisions of the applicable law and whether the chosen law should apply to all issues arising between the parties (e.g., tort as well as contract disputes). Choice of law clauses are generally enforceable unless there is a serious conflict with the public policy of the forum state or, in some forums, if the chosen law does not bear a relationship to the dispute. To maximize predictability, contract drafters should consider including both a forum-selection clause and a choice-of-law clause and selecting a forum that liberally enforces choice of law clauses.
3. What is at Stake?
The contract drafter should also consider what the possible damages are and what, if any, procedural mechanisms should be used to determine or limit those damages in advance. One option is to draft a clause limiting the type of damages that a party may recover in the event of a breach. Consequential damages, for example, may be difficult to predict, and proving them may result in expensive litigation. Therefore, in some situations, a drafter may want to include a clause limiting recovery for consequential damages. Because limitations on liability are disfavored, clauses limiting damages should be spelled out in clear and unequivocal language, and state law should be reviewed.
Another way to increase the predictability of risk is to include a liquidated-damages clause. A liquidated damages clause allows parties to look to the future, anticipate breach and agree to settlement in advance. These clauses generally are enforceable as long as they attempt to predict actual damages. If a liquidated damages clause does not appear to be a reasonable attempt to predict actual damages, a court may deem it an invalid penalty clause and disregard it. Thus, when drafting a liquidated damages clause, a party should state the rationale or criteria for the amount chosen and be as specific as possible.
One final way to control what is at stake in future litigation is to include an attorney’s fees shifting provision. Including an attorney’s fee provision provides a disincentive to litigate and increases settlement prospects. However, it also raises the potential cost of vindicating your client’s rights.
A litigator cannot offer a contract drafter a checklist of clauses that should be included in every contract—each agreement must be tailored to its goals and circumstances. However, from a litigator’s perspective, what is important is for the drafter to keep in mind that a contract should not only memorialize a current agreement, but must also adopt a game plan for enforcing that agreement in future litigation.
Yvette Ostolaza is a partner at Weil, Gotshal & Manges LLP. She can be reached at email@example.com.