Avoiding Disputes: Keep the Litigants Out of it

D. Benjamin Borson, M.A., J.D., Ph.D.

The current under-funding of our courts can produce substantial disadvantages for parties wishing to assert their legal rights against those that violate them- and it looks like it is only going to get worse, with  increasing delays in obtaining court dates, more issues that are resolved on the pleadings, and increased reliance upon Alternative Dispute Resolutions (ADR) methods, such as mediation and arbitration. Even though ADR methods have helped parties resolve disputes without long and costly litigation, costs associated with conventional ADR approaches can still inhibit parties from asserting their rights.

In reality, the roles that courts, arbitrators and mediators fulfill are to help principals better define their respective roles and responsibilities.  Instead of relying upon outsiders to decide the important issues in relationships, I believe that clients’ interests are better served by having the principals decide between themselves what the key issues are and what provisions are needed for the collaboration to be successful for both parties.  It is the role of a counselor to provide insight into the legal issues, to educate the principals and to help craft a valid, enforceable agreement that minimizes the likelihood for later litigation, arbitration or mediation.  Of course, there is no way of preventing all disputes from arising, but to the degree that attorneys can work with the parties to produce good working relationships, with open lines of communication, we can help avoid unneeded, costly and time-consuming formal proceedings.

The purpose of this article is to provide an alternative to “after the fact” resolution of disputes and to provide “front end” approaches that may reduce the need for litigation or even ADR.  In its most general terms, the concept is for principals of each party to reach an agreement about a subject in clear, well-defined terms, so that “after-the-fact” disputes may not arise at all.  To this end, I suggest that counsel work in cooperative fashions with not only the principals of their client, but also with the “opponent’s” counsel, and, with permission, with the opponent’s principals.

The rationale underlying this approach is that at the beginning of a relationship, both parties are interested in creating a “win-win” situation.  However, as “zealous advocates,” counsel may be tempted to promote their own client’s interests to produce an agreement that intentionally favors their client’s apparent interests over the common interests of the parties.  This article is intended to provide a framework for attorneys to consider how to reach a “win-win” situation. By creating a win-win situation, neither party is as likely to feel disadvantaged, and will therefore be less likely to put the issues “in dispute.”  By decreasing the tendency to dispute, the parties can avoid the costs, time and lost opportunities that characterized traditional litigation or, to a lesser degree, ADR.  Although the discussion that follows will be more specific for a business context, the principles are applicable to many other disciplines.

We will use a hypothetical contract situation, in which parties A-CO and B-CO desire to enter into a business relationship.  Under basic legal principles, a contract requires: (1) offer, (2) acceptance, (3) consideration.  A cause of action for breach of contract requires all three of these elements as well as:   (4) identification of breach and (5) remedies.  Although discussion of basic contract law is beyond the scope of this article, many disputes arise under provisions relating to breach and remedies.

Hypothetical

A-CO is in the business of developing and manufacturing new products to serve a known market, and identifies B-CO, that may be a prospective client or competitor.  B-CO is a well-known distributor of products in the same field as A-CO.  Both A-CO and B-CO could benefit from a productive relationship.  A-CO’s counsel is asked to prepare an agreement defining the terms under which the parties will do business.  A-CO’s counsel, being a “zealous advocate” retrieves a “standard agreement” (used before) that is heavily weighted in A-CO’s favor.  A-CO sends to proposed agreement to B-CO, whose counsel sees that the proposal is heavily weighted in A-CO’s favor, and advises B-CO’s principals to reject the proposal.  Thus, counsel for A-CO and B-CO are already in an adversarial relationship.

Under this hypothetical, counsel for A-CO and B-CO are likely to trade revisions of the agreement and spend precious resources pressing for their individual positions.  Although this approach is characteristic of an adversarial system, it is unlikely to produce the “win-win” solution that the principals of A-CO and B-CO would desire.

Dispute Avoidance

We will address some of the common areas that give rise to “after the fact” disputes, and some ways of avoiding them.

Principal’s Conversation and Initial Term Sheet

To produce a “win-win” solution, we suggest that the first step not be to provide a “standard agreement,” but rather to identify the true common interests of A-CO and B-CO.  This can be best done through a conversation between the principals (e.g., CEOs or VPs for Business Development)  of A-CO and B-CO.  The goal of the conversation is to determine the overall scope of a possible relationship.  During the conversation, each principal ideally would state their respective company’s genuine interests, including both their desired terms, as well as those things that would be detrimental to the win-win solution.   These discussions would result in the first document, or “Term Sheet” that spells out in general terms, the aims of the relationship.  Once agreed upon, the Term Sheet would be the guide for further discussions and preparation of documents memorializing the relationship.

Confidentiality

Under the hypothetical above, A-CO’s proprietary interest (e.g., trade secret, design, patent, copyright, trademark, source of goods, or other valuable asset) in the technology underlies their proposed product.  Therefore A-CO may wish B-CO to avoid unauthorized disclosure of the proprietary interest.  B-CO’s proprietary interest may be in channels of trade, customer information and the like. Both parties desire protection of their own proprietary information.  The parties then would craft a Non-Disclosure Agreement (NDA) that spells out the terms under which further conversations would be carried out.

Negotiating a Non-Disclosure Agreement may include “non-use” provisions, and generally follows the Uniform Trade Secret Act (UTSA), a standard that many States have implemented.  Although beyond the scope of this article, the UTSA provides that a party asserting trade secret misappropriation prove that the alleged mis-appropriator:  (1) had access to the secret, and (2) used it without permission of the owner.  Trade secret cases are often difficult to litigate, due in part to the possible loss of the trade secret in discovery.  There are many arguments over protective orders, “Attorneys Eyes Only” or other matters the can jeopardize the trade secret holder’s rights to maintain secrecy.

One way to avoid such disputes is for each party to avoid disclosing highly sensitive information early in discussions.  Here, the principals of A-CO and B-CO should be clear about their positions, and should use restraint, and disclose sensitive information until and only if disclosure of such information is required to provide the win-win solution.

Obligations of the Parties and Breach

Once the principals have agreed on principle to the Term Sheet, details of the provisions should be addressed.  Generally, principals try to envision the agreement in positive terms, and may be reluctant to clearly define what obligations they will incur and what acts by themselves or others would constitute a breach of the agreement.  It is important for each principal to understand their obligations undertaken (consideration) in exchange for the benefit of the bargain.  Each principal should represent that they can fulfill the obligations taken on, and warrant that they can execute on them.

A-CO and B-CO should agree upon the key terms of delivery and payment.  For example, if A-CO agrees to provide a certain number of products per period of time, A-CO should ensure that there are suppliers sufficient to meet their manufacturing needs. A-CO may benefit from having alternative sources of components or raw materials needed to ensure sufficient product delivery.  Similarly, B-CO should ensure that they have the channels of trade needed to successfully market the products.  The principals should clearly define how payment is to be accomplished.  For example, B-CO may wish delivery at B-CO’s warehouse before incurring the obligation to pay.  Thus, A-CO would be responsible for loss of products in transit.  If there is a delay in shipping, A-CO could be responsible for B-CO’s anticipated loss of revenue.  In such a situation, A-CO could benefit from provisions requiring either some “down payment” from B-CO to partially cover manufacturing and shipping costs.  Regardless of where the principals’ negotiations lead, both parties should be clear at the outset, instead of leaving this matter to the drafting attorneys.

In the situation where A-CO agrees to payment only after B-CO receives payment for product sold, A-CO may require “audit rights” of B-CO’s books to be able to validate B-CO’s claim that B-CO has paid the proper amount.  Disputes arise here if A-CO simply trusts B-CO to keep accurate sales records including the number of products sold, the selling price, and the times of sales.  Alternatively, A-CO may have other agreements with other distributors outside the US.  Such audit provisions may be difficult to implement, especially if the languages of A-CO and B-CO are different.

Real-Life Example

The dangers of relying on “standard agreements” instead of negotiating terms relevant and important to each company are not just hypothetical.  In one real-life example, A-CO (a foreign company) manufactured product for sale world-wide, and B-CO was a US distributor of the product with exclusive rights to sell product in the US.  The agreement provided a compulsory arbitration provision, whereby any dispute “arising under the agreement” would be arbitrated in the US under certain arbitration rules.

B-CO became concerned that A-CO might be using a different US distributor in violation of the agreement, and sued A-CO in State court in the US.  B-CO’s attorney alleged that the arbitration provision was voidable (at B-CO’s option) because there were no provisions governing discovery and audit rights.  A-CO’s attorney filed an arbitration request, asserting that the dispute should go directly to arbitration.  During the court proceeding, many hundreds of thousands of dollars were expended litigating the validity of the arbitration provision, and finally, B-CO’s attorney justified B-CO’s position arguing that without discovery under State law, B-CO would not be able to determine if there was any breach.  A-CO’s attorney agreed that B-CO had audit rights, but only in A-CO’s country in A-CO’s language, a position rejected by B-CO.  Ultimately, the court held that the arbitration provision was valid, and sent the dispute to the arbitrator, who held for B-CO in an amount of less than 2 % of the litigation costs then expended by A-CO and B-CO together.

This example points out deficiencies of relying upon “standard agreements,” and the need for principals to understand each other and reach genuine agreement about key provisions.  Here, all of this could have been avoided if the parties had talked to each other ahead of time and identified (and agreed upon) their true interests:  A-Co’s interest in_manufacturing products and B-Co’s interest in selling such products in a geographically defined jurisdiction.

Indemnification

To control risk, both A-CO and B-CO benefit from indemnification provisions.  Such provisions are often asserted in litigation to obtain the benefit of the bargain if there has been a failure in performance by one of the parties.  One party (e.g., B-CO) may wish indemnification for breach of a provision to supply a certain number of products, and A-CO may wish indemnification for failure of B-CO to promptly pay for A-COs products or lack of diligent marketing.  If one party (e.g., B-CO) has greater bargaining power,  it may urge indemnification for simple negligence, gross-negligence, or willful breach.  Indemnification for simple negligence may expose A-CO to potentially complete loss, in part because proving simple negligence is a lower standard, and a small company may not have the resources to avoid all potential simple negligent acts, or accidental omissions.

To address potential differences in indemnification provisions, the principals should be clear about the standard to be met.  A “balanced” or “reciprocal” approach may be good in many situations in which both parties want reassurances that their risk is appropriately managed.  In particular, indemnification against each party’s own gross-negligence or willful misconduct can save losses compared to indemnification for simple negligence.  If the principals are clear about the implications of the different standards, then such disputes can be avoided.

Avoid “Agreements to Agree”

There are often situations in which principals don’t have the confidence to tackle potential future disputes, even if they can be reasonably anticipated.  For example, should A-CO develop a new product based in part on one covered by an agreement with B-CO, A-CO may wish to keep it out of B-CO’s agreement.  B-CO may wish the new product to be covered, and therefore take advantage of potential new sales.  Because the new product may not exist (yet), the parties may be tempted to provide an “agreement to agree” to cover future innovations.   Such provisions are common in technology development agreements and even in relatively simple manufacture and distribution agreements like the hypothetical.

The major problem with agreements to agree is that the terms are not likely to be clear at the time the agreement is entered into.  Without the terms being clear, their enforcement is problematic.  Thus, at a later date, A-CO may assert one position and B-CO could assert an opposing position, and the court, mediator, or arbitrator may have insufficient support for rendering a particular decision.  Under general contract law, the meaning of the agreement is defined at the time the agreement is entered into.  If the principals are unclear at the time the agreement is entered into, there will be little but resort to “he (she) said, he (she) said” and the dispute is not likely to be properly resolved in the best interests of both parties.

Additionally, if there is such a provision, the agreement should specify the consideration given for such a provision.  Agreement to agree provisions may be stricken from the agreement as being unenforceably vague or for failure of consideration.  Without a “savings” or “severability” provision in the agreement, the entire agreement may be vulnerable to challenge.

We recommend avoiding such agreements to agree, and instead, working through the key issues in advance of execution of the agreement.  Under the hypothetical, although A-CO is a design and manufacturing company, B-CO may identify a need in the market that could justify producing a derivative (or follow-on) product based on both the original innovation by A-CO, but with input from B-CO.  In such a situation, B-CO could assert ownership over the improved product.  If B-CO has an ownership in the improved product, B-CO could demand a “set off” of the agreed revenue to A-CO, or could even strike out on its own, to develop and market such an improved product without A-CO at all. In cases in which such decisions cannot be made in advance, it may be more desirable to leave those issues for another agreement or amendment to be made in the future, and to rely upon provisions of statutory or case law to guide the next agreement.

Summary: Roles of Counsel in Negotiating Win-Win Agreements

Attorneys can provide guidance to their clients by understanding that the attorney’s role may not simply to be zealous advocates of a narrow, short-term interest of their client (i.,e., to win on one provision), but to promote their long-term interests and act as counselors in the best sense.  The counselor’s roles are to become educated about their clients’ short and long term interests, in which both their client and another party have valid common interests.  By supporting the common interests of the putative collaboration, counsel can educate the principals in ways by which they can reach agreements in which the key terms are clear and generate confidence by both parties.  When guided by the best interests of their clients and their collaborators, counsel can help avoid the parties becoming adversaries, and thereby help avoid long, costly litigation, arbitration, and mediation.

Although contract issues are common, they may have many twists and turns.  Similarly, other areas of the law have their own features.  However, by becoming a true counselor, an attorney can serve the best long-term interests of their clients without compromising our ethical obligation to be zealous advocates of our clients.

D. Benjamin (Ben) Borson is an attorney in private practice with the Borson Law Group, PC (www.borsonlaw.com), with offices in Lafayette California.  Ben counsels clients on intellectual property (IP), high technology, and business law.    He is the Chair of the Business Law Corporate Counsel (BLCC) Section of the Contra Costa County Bar Association, and is Adjunct Professor at Golden Gate University School of Law, where he teaches patent and biotechnology law.  He is Chair of the Legislation Interest Group of the IP Section of the State Bar of California, and is a member of the United States Patent and Trademark Office’s Patent Public Advisory Committee.  Prior to entering the law, Ben was a member of the faculty in the Department of Physiology and Cardiovascular Research institute at the University of California, San Francisco, where he carried out basic biomedical research.  He holds a MA degree in biology from UC Riverside, a Ph.D. in physiology from UCSF, and a JD degree from the University of San Francisco School of Law.  He can be reached at bborson@borsonlaw.com or (925) 310-2060.