Use Escape Clauses For Tech Contracts

Lawyers and businesspeople are like most people who read things they must or are interested in: They read the exciting parts first ' and that includes contracts. Everyone is interested in the money, and what they will get from the deal.

But what about what might be considered the marginalia, the add-ons ' or what some people might think of as those categories ' the escape clauses of the contract? Well, you can bet that no one reads the term and termination sections first. These “quiet” clauses are usually hidden, well in the back of a contract, with the boilerplate and signatures.

A Precisely Important Thing

But the thing is ' and it's an important thing ' that precisely because of the volatility of the tech and e-commerce sectors, these back-of-the-contract elements can be the most important terms of the contract. No one who wants to be successful wants to be locked in for years to expensive but outdated intellectual property, or to a business model that has become irrelevant.

To put the matter into some perspective, and to hit a familiar memory with which you can work and not have to feel embarrassed, consider the plight of those who invested heavily in videotape rental stores, or dial-up Internet service. The fact that DVDs by mail and broadband service destroyed their businesses doesn't eliminate their contractual obligations.

Today, everyone knows in advance that tech contracts must be written and agreed to in such a way that they're able to be adapted to changing technology. The traditional negotiation tactics of locking in multiyear pricing or rights for the long term ignores today's reality that online, the “long term” may be measured in mere months. It's one of many ways that technology in general, and the Internet in particular, has changed not only the way business is done, but also how people engaged in business view what they do. Instead, negotiators must plan to fashion a contract that preserves business and tech-need flexibility, and at a reasonable cost. Every tech contract should, if possible, have the legal equivalent of the “Get Out of Jail Free” card ' but unlike in the popular board game that features that coveted and hoarded card, the equivalent in a business-contract clause won't be “free.”

Another Way Out

One contract exit strategy is the right to terminate early. An online firm must be free to move nimbly to a new deal, for example, if technology improves, or a better contract comes along ' even if getting that freedom to break the contract comes at the cost of a buyout fee. On the other hand, e-commerce counsel and those who advise regularly or periodically businesses that do a significant amount of e-commerce or invest in and update technology should remember that contract provisions generally work both ways: An early out intended to protect you can hurt if it exposes your firm to opportunistic gamesmanship.

For example, an early termination right in a profitable contract can become just another way for a seller to impose unplanned price increases. Although a vendor generally never wants to lose a customer, it could try to negotiate more favorable pricing by terminating a customer that doesn't have a practical alternative available. Of course, vendors who are willing to do that also ignore the value of building business and partnership relationships by crafting flexible contracts. And so, when the market next shifts to the customer's benefit, the vendor shouldn't be surprised to receive the same treatment.

In fact, the right to keep the contract in force can often be crucial. A firm that has invested heavily in goodwill ' a location, or advertising that has created name recognition, for instance ' certainly doesn't want to lose that investment. When the term has expired, that company wants the contract to renew automatically, unless a default has occurred, without any right for the other party to terminate (and renegotiate).

But What If?

If a termination right, or expiration of the original term, can't be avoided, then a long notice period will still be able to cushion the blow. A firm that leaves itself enough time to provide transition for the business to the new environment should at least be able to try to stay alive. Unfortunately, having time to prepare doesn't remove the cost of the transition.

Tech contracts don't stop there, however. They must also cover ownership of the remains of the ongoing business. The contract should specify who will own any jointly developed intellectual property, and how each party can license it for use. Taking such a step will help to avoid unpleasant entanglements later.

Another issue is which party will bear the risk of obsolete or unsold inventory ' an issue that can be significant, depending on a variety of factors ranging from the type of business to the efficiency of the firm in question. Preferably, the contract should, if possible, adopt a “just-in-time” model under which inventory is procured or stocked on a limited basis when needed or very close to the time when those involved know it will be needed, and that results in little inventory buildup. This precaution, long used in the distribution and warehousing industries, helps prevent excess inventory when a firm is purchased, merges or terminates, and helps lower the costs of storing, maintaining and continuously moving inventory – from a supply source or within storage facilities.

Remember: Tech is Special

But perhaps most important for entrepreneurs, noncompetition covenants that are “normal” in other sectors should not be accepted casually in tech businesses. No one wants to be put out of work by a failed business model, but remain bound by a noncompete covenant with a third party. Of course, good employment litigators can often break covenants when changes in the market or business remove the economic interests to be protected by keeping a person out of competition. But that requires legal fees, and creates uncertainty that could deter investors or future business partners.

Naturally, as with so many situations in business and the world in general, there are two sides to every contract. One firm's protection on each of these points can be the other party's nightmare. And no one knows which side of these termination issues one will prefer in the (perhaps not so distant) future.

One possible solution is to negotiate mutual buyout rights. While fixing the terms of a buyout doesn't avoid all the risks of termination, at least it sets the rules in advance, and has the potential to control legal fees.

Breaking up is hard to do, in affairs of the heart and of the dollar, but it shouldn't bankrupt a firm as well.

Lawyers and businesspeople are like most people who read things they must or are interested in: They read the exciting parts first ' and that includes contracts. Everyone is interested in the money, and what they will get from the deal.

But what about what might be considered the marginalia, the add-ons ' or what some people might think of as those categories ' the escape clauses of the contract? Well, you can bet that no one reads the term and termination sections first. These “quiet” clauses are usually hidden, well in the back of a contract, with the boilerplate and signatures.

A Precisely Important Thing

But the thing is ' and it's an important thing ' that precisely because of the volatility of the tech and e-commerce sectors, these back-of-the-contract elements can be the most important terms of the contract. No one who wants to be successful wants to be locked in for years to expensive but outdated intellectual property, or to a business model that has become irrelevant.

To put the matter into some perspective, and to hit a familiar memory with which you can work and not have to feel embarrassed, consider the plight of those who invested heavily in videotape rental stores, or dial-up Internet service. The fact that DVDs by mail and broadband service destroyed their businesses doesn't eliminate their contractual obligations.

Today, everyone knows in advance that tech contracts must be written and agreed to in such a way that they're able to be adapted to changing technology. The traditional negotiation tactics of locking in multiyear pricing or rights for the long term ignores today's reality that online, the “long term” may be measured in mere months. It's one of many ways that technology in general, and the Internet in particular, has changed not only the way business is done, but also how people engaged in business view what they do. Instead, negotiators must plan to fashion a contract that preserves business and tech-need flexibility, and at a reasonable cost. Every tech contract should, if possible, have the legal equivalent of the “Get Out of Jail Free” card ' but unlike in the popular board game that features that coveted and hoarded card, the equivalent in a business-contract clause won't be “free.”

Another Way Out

One contract exit strategy is the right to terminate early. An online firm must be free to move nimbly to a new deal, for example, if technology improves, or a better contract comes along ' even if getting that freedom to break the contract comes at the cost of a buyout fee. On the other hand, e-commerce counsel and those who advise regularly or periodically businesses that do a significant amount of e-commerce or invest in and update technology should remember that contract provisions generally work both ways: An early out intended to protect you can hurt if it exposes your firm to opportunistic gamesmanship.

For example, an early termination right in a profitable contract can become just another way for a seller to impose unplanned price increases. Although a vendor generally never wants to lose a customer, it could try to negotiate more favorable pricing by terminating a customer that doesn't have a practical alternative available. Of course, vendors who are willing to do that also ignore the value of building business and partnership relationships by crafting flexible contracts. And so, when the market next shifts to the customer's benefit, the vendor shouldn't be surprised to receive the same treatment.

In fact, the right to keep the contract in force can often be crucial. A firm that has invested heavily in goodwill ' a location, or advertising that has created name recognition, for instance ' certainly doesn't want to lose that investment. When the term has expired, that company wants the contract to renew automatically, unless a default has occurred, without any right for the other party to terminate (and renegotiate).

But What If?

If a termination right, or expiration of the original term, can't be avoided, then a long notice period will still be able to cushion the blow. A firm that leaves itself enough time to provide transition for the business to the new environment should at least be able to try to stay alive. Unfortunately, having time to prepare doesn't remove the cost of the transition.

Tech contracts don't stop there, however. They must also cover ownership of the remains of the ongoing business. The contract should specify who will own any jointly developed intellectual property, and how each party can license it for use. Taking such a step will help to avoid unpleasant entanglements later.

Another issue is which party will bear the risk of obsolete or unsold inventory ' an issue that can be significant, depending on a variety of factors ranging from the type of business to the efficiency of the firm in question. Preferably, the contract should, if possible, adopt a “just-in-time” model under which inventory is procured or stocked on a limited basis when needed or very close to the time when those involved know it will be needed, and that results in little inventory buildup. This precaution, long used in the distribution and warehousing industries, helps prevent excess inventory when a firm is purchased, merges or terminates, and helps lower the costs of storing, maintaining and continuously moving inventory – from a supply source or within storage facilities.

Remember: Tech is Special

But perhaps most important for entrepreneurs, noncompetition covenants that are “normal” in other sectors should not be accepted casually in tech businesses. No one wants to be put out of work by a failed business model, but remain bound by a noncompete covenant with a third party. Of course, good employment litigators can often break covenants when changes in the market or business remove the economic interests to be protected by keeping a person out of competition. But that requires legal fees, and creates uncertainty that could deter investors or future business partners.

Naturally, as with so many situations in business and the world in general, there are two sides to every contract. One firm's protection on each of these points can be the other party's nightmare. And no one knows which side of these termination issues one will prefer in the (perhaps not so distant) future.

One possible solution is to negotiate mutual buyout rights. While fixing the terms of a buyout doesn't avoid all the risks of termination, at least it sets the rules in advance, and has the potential to control legal fees.

Breaking up is hard to do, in affairs of the heart and of the dollar, but it shouldn't bankrupt a firm as well.