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Business feature (opinion and advice)

Contracts 101

by Scott Fine, Attorney at Law (United States)

image:photo collage of contract signing

Contracts are what run the global economy, not the Internet, e-commerce, wireless communications or the latest new widget. Whether you realize it or not, you enter into contracts every day and each one has the potential for windfall and liability. Sadly, many business people think that written contracts are costly and time consuming. Get an attorney involved and negotiations are certain to collapse.

The opposite, however, is often true. Contracts are the oil that keeps business running smoothly. If you are running your own web design business, you should think of a contract as a business tool that can help you communicate clearly with your clients.

Certain types of contracts must be in writing (such as those involving interests in real estate, or contracts that cannot be performed in less than a year). Still others, such as employment contracts, should be in writing to overcome certain legal obstacles. (Employment is usually considered an "at-will" arrangement; either party can terminate the contract "at will." Oral employment contracts are therefore considered "illusory" and are unenforceable.)

However, generally, oral contracts are valid and enforceable. What people often fail to realize is that they are entering into contracts with or without the paper. Failing to formalize terms and conditions on paper causes several things to occur.

One consequence is that the law will substitute its terms for missing ones. (In fact, this is true even for written contracts; all a court will need to enforce a contract are essential terms -- and price is very often not considered an essential term.) If, in a contract involving the creation of an original work of authorship, the parties fail to specify or transfer ownership in writing, the Copyright Act will dictate who the owner is. With very few exceptions, this is not the person who paid the money.

Another effect of failing to memorialize an agreement is that parole evidence, or evidence "outside the four corners of the contract" will muddy the waters in any dispute. As a general rule, parole evidence is considered in contract disputes only to explain terms, not to contradict them. In today's e-conomy, flurries of e-mail messages can be an evidence nightmare. A formal, written agreement can help you sleep better.

Still another downside experienced by some contract-haters is that they never really experience a meeting of the minds. In its simplest terms, a contract is nothing more than an offer, acceptance of the offer, and consideration. The offer-acceptance thing is just a meeting of the minds, but as to what terms?

Let's use the copyright-ownership example again, where a web designer (the seller) has created a nifty new web graphic for a client (the buyer). The buyer and seller may have two different ideas about who owns the copyright. A web designer who is savvy about copyright law might know that it is the author (creator) of the graphic that owns the copyright by default. Let's say as well that the web designer also intends to retain that ownership. The buyer, on the other hand, may be a small company looking for a web site for the first time, or they are looking to upgrade their current web site. The buyer may think that they own that great new graphic because they paid for the work. With no written agreement, how then can anyone claim that there was a meeting of the minds?

Contract basics

Many business people get by without written agreements and never have a problem. Others experience their first problems only after using written contracts. For others, the costs associated with drafting and negotiating formal contracts are prohibitive. For the rest of you, here are some contract basics.

Negotiate all the terms up front. Get the messy stuff out of the way. Have your disputes before the contract is signed. Very often surprise terms, such as copyright ownership, are either deal killers, or result in the acquiescence of the term. One way to deal with surprise terms is to provide alternatives. For example, offer selling the copyright, but for more money than merely licensing certain rights to the work. (Be aware that assigning copyright rights, or exclusively licensing them, has serious consequences. Always use copyright counsel when dealing with copyright issues.)

Another example of a surprise term is the "venue" for litigating disputes. Given the ease of global business these days, venue choice has become more important in smaller contracts. Each party will want to litigate disputes in their own backyard. One way to handle this potential deal killer is to agree to venue in the defendant's backyard. This can often cause the would-be plaintiff to consider bringing suit more carefully.

Get over "length-prejudice." A short contract is not necessarily a good one. It is short. People who are scared by "long contracts" are probably just trying to leave themselves an out. Include all the terms you want. Remember that leaving them out means that the law will insert its own.

Make sure you include warranty disclaimers and that the disclaimers are adequately drafted. There are certain implied warranties in every contract. Among them are the warranties of merchantability and fitness for a particular purpose. Merchantability mean that the goods (or services) at least pass without objection in the trade and are fit for the ordinary purpose for which they are used. If, at the time of contracting, a seller knows any particular purpose for which the goods or services are going to be used and that the buyer is relying on the seller's skill to provide suitable goods or services, then the warranty of fitness for a particular purpose is implied.

Intellectual property

When your contracts involve intellectual property, there are many things to consider. In contracts where the buyer is providing some content or material to be used in creating the contract property, the seller needs to be certain that use of the provided material does not infringe any third-party's rights.

One way to handle this is to ask for warranties of non-infringement. These warranties are designed to assure that each party has, or obtains all necessary rights in and to original works of authorship that are to be used pursuant to the contract. Such warranties and representations are not, however, guarantees. Since many people misunderstand intellectual property ownership, many make these warranties and representations without thinking, and are very often wrong.

One way of dealing with this problem is to clear the intellectual property yourself. Ask to see what rights were granted. If a license was granted, not merely implied, make certain that sufficient rights were granted. For example, a web development company does not necessarily have the right to digitize a logo created by a third-party graphic design firm.

Indemnification and arbitration

While many contracts have indemnification clauses, indemnification (payment by one party to the other for legal fees and/or judgments as a result of the indemnifying party's acts or omissions) is only as good as the depth of the indemnifier's pockets. Always keep in mind that an ounce of prevention is worth a pound of cure.

Consider whether you really want to arbitrate disputes, rather than litigate them. Many people feel that arbitration is less costly than litigation and in many cases that is true. However, there are drawbacks to arbitration. Arbitrators do not need to know or understand the law nor do they need to follow the rules of evidence. Arbitrators also have a tendency to want to split the baby in half and give everyone something. Most troubling of all is the inability to appeal the arbitrator's decision except in very limited situations.

Online contracts can also be the source of headaches. One electronic issue is whether "click-wrap" licenses are valid and there is little reason to think that they aren't. One party's performance is often the "acceptance" part of the contract. Therefore, a web site- user who gains access to certain areas only after clicking on an "I accept" button cannot rely on the argument that he did not read the contract.

One final warning, beware of forms and contracts that you may find online. Using those contracts can land you in a heap of trouble. Don't rely on the legal advice given to others, get your own. You deserve it.

© 2000 Scott J. Fine

This article is not intended to be legal advice and nothing herein should be construed to create an attorney-client relationship. For questions concerning a specific matter, seek the advice of an attorney duly licensed to practice law in your jurisdiction.

Photo of Scott Fine's feet

Scott Fine practices in the Intellectual Property/Information Technology Group of Fine Hummel, P.C. where he is Managing Partner. He concentrates his practice in intellectual property, trademark, copyright, entertainment and information technology law, representing a diverse clientele in both the old and new economies. Mr. Fine counsels his clients concerning their intellectual property rights and reviews intellectual property portfolios, handles domestic and international trademark and copyright applications and clearance, and drafts and negotiates licenses and trade secret agreements. He is adjunct faculty at Touro College, Jacob D. Fuchsberg Law Center, Huntington, NY, where he teaches Intellectual Property, and is Co-Chair of the Entertainment Law Committee at the Suffolk County Bar Association. Mr. Fine also frequently lectures for the Suffolk Academy of Law which provides continuing education credits to the legal profession.
Fine Hummel, P.C., Attorneys at Law
410 New York Avenue, Huntington, New York 11743
(t)631.351.2100 (f)631.271.4558

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