Learning e-Commerce Contracts From Sherlock Holmes

Business lawyers ' even tech lawyers ' lead unexciting lives. Reading and writing contracts keeps them stuck in front of a computer or a Blackberry. Even when they work from such “exotic” locations as a coffee shop or an airport lounge, they can't get away from words on a screen.

But sometimes, contract review requires that lawyers have the detective skills of a Sherlock Holmes, when they have to read the parts of a contract that aren't even there. In Arthur Conan Doyle's “Silver Blaze,” the legendary detective solved a crime from the fact that a dog did not bark. The dog's silence was the key clue that it knew the intruder:

“Is there any point to which you would wish to draw my attention?”

“To the curious incident of the dog in the night-time.”

“The dog did nothing in the night-time.”

“That was the curious incident,” remarked Sherlock Holmes.

Beware: Silence Can
Be Less Than Golden

In the same way, lawyers who read tech contracts should think about what is not on the page before them. To satisfy their clients' expectations, they must ask whether anything particular is missing from the document, which the client expects as part of the business deal.

Because tech contracts may require so many critical clauses to describe a deal fully, simply reading the language provided is not enough. Counsel must pay as much attention to what is missing as to what is written, both to protect the client's interests, and to control counsel's own malpractice exposure.

The first step in tech contract review, therefore, is simply verifying that the deal on paper is the same one that the client believes it agreed upon.

At the simplest level, an attorney must ask if all of the key deal points that the client expects have been included.

Executives who negotiate a deal may implicitly understand all its terms ' those specifically negotiated and how it relates to the company's existing business. Because that knowledge has become second nature to them, the dealmakers may not have fully explained that background to the person who must write the first draft of the contract. That draftsman, typically a less-experienced attorney, may not even understand the business well enough to realize how much he doesn't know.

But that process may not be as easy as it sounds. The highlights of a one- or two-page business term sheet can expand to fill many pages of boilerplate, particularly when dealing with large vendors with a vast array of preprinted forms and alternatives.

Break Through The Boilerplate

While tech executives can usually review price, quantity and contract length themselves, without counsel, the rest of the deal can easily be confused or even obscured by page upon page of boilerplate. In fact, sometimes that is all they read before moving on to the next deal.

Business clients who are more familiar with the nuances of their own industry must, then, do the “first reading.” Counsel can then explain any subtleties in the language that may make it mean something different from what it appears to say to a layman. Price-escalation clauses, contingent renewal options, and raw material pass-throughs are just a few examples of how dense legal jargon can muddle even these basic “business points” of an e-commerce agreement.

It is particularly important to keep this focus on basic details in tech contracts. Novel technology may have received the most attention during negotiations – at the expense of getting the basic business deal correct.

Look for What's Not There

In the absence of time-tested, ready-made forms for tech ventures, lawyers must be sure that all contracts have all the “normal” contractual protections, such as warranties and indemnities, or escrows. But they must modify them to fit e-commerce situations unfamiliar to counsel and client. When entrepreneurial clients are willing to take substantial risks in quickly changing markets, counsel must try to parse through all of the possible consequences, be certain that the client understands the stakes beyond the contract under discussion, and then draft around any unacceptable risks.

But these “first reading” questions address only a narrow question: Whether what the contract actually says is accurate. That step, while critical, must be only the start of the contract review. Instead, like Sherlock Holmes, the skilled reviewer must also ask which provisions should be in a contract ' but are not. In “Silver Blaze,” Holmes noted that the watchdog should have barked at an intruder, but didn't because it knew him. In contract negotiations, the quiet absence of key contract clauses, whether legal boilerplate or negotiated business terms, may be the most important clue about the other party's intentions for the business relationship.

Some Scenarios To Snoop Around

Consider, for example, a typical event early in the life of a startup company: the demand for price concessions from a key customer's aggressive procurement department, intent on squeezing every concession possible from vendors. The firm may be willing to do almost whatever may be asked to get that business, both to establish credibility in the industry and with the customer (and others who may have held off buying until the startup had demonstrated its competence), and to secure badly needed cash flow.

The client may therefore be willing to sign the proposed contract as written, unless counsel can ' with as little expense as possible – point out any major problems. But will the startup get anything for its concessions other than low-margin work? Even worse, could it find itself locked into onerous long-term obligations that will burden the company long beyond the customer's initial purchases?

For example, is the contract just an order, or does it have a guaranteed minimum annual purchase volume? If it does not contain the customer's commitment to purchase the startup's product, then the customer could use the low-price concession as a stalking horse to seek low bids from other firms.

The contract's silence on these critical points may reveal an attempt to get short-term benefits from the startup, without the longer-term purchasing commitment that the startup may have anticipated as implicit in the business deal. That quid pro quo for the discount can easily be added before signing ' if the startup folks know to request it. If, on the other hand, the request is refused, then the vendor must determine whether the benefits of an isolated sale, perhaps small, can justify the cost of the concessions demanded. It could be better for the startup to delay the sale temporarily, to negotiate the concessions, than to be locked into a long-term obligation ' a non-competition clause, for example ' in exchange for a one-time benefit.

A similar situation can arise in the sale of surplus assets from a closed manufacturing facility. The buyer may naively assume that it will routinely get the business that those assets serviced ' but the seller may have already shifted it to another location. A typical asset-sale agreement will not include the business, unless the buyer negotiates for it.

A similar situation can arise when a business is sold, and the principals of the seller get employment contracts and equity in the continuing business as part of their package. Such so-called earn-out arrangements are common in the tech sector, because the future appreciation of the purchased business is unknown, and the buyer wants to pay only for performance, rather than for potential.

But if the sellers get a letter confirming only employment compensation and duties, without a definite term, then they will be treated as “employees at will.” The buyer can terminate their employment at any time, for any reason, or for no reason. Losing their job with the buyer isn't the worst of it, however. Typically, non-public firms have the right to buy out shares, at a low price, when employment ends. Not only would the sellers lose the jobs and equity they thought they had, but they would also be unable to manage the firm to increase revenue and their earn-out. The silence of the employment letter on a fixed term of employment is the critical but omitted point that would not be apparent from simply reading the document.

Sort Clues, and Needs, Carefully

In the situation described immediately above, sellers who have never contemplated that their business could operate without them, even after a sale, must instead explicitly protect their future employment if such buyout rights exist. Even though that discussion may seem unusual, when everyone is celebrating the closing of the sale of the firm, something as basic as locking in the term of employment becomes critical to protecting everyone's equity interest in the business, and its future appreciation.

Boilerplate intellectual property licenses are another example of a hidden contract risk. A “standard” license may seem long and complete, yet omit key terms. Simply reading what is on the page will not reveal the missing components of the license, which could greatly affect its value and utility. Consider, for instance:

• May the licensee use the technology in all product markets, or is the license scope restricted to certain applications?
• Is use in e-commerce expressly permitted? Is it prohibited? Some premium brands insist on brick-and-mortar sales support.
• Are there geographic limits on the license? If so, is the license exclusive in the licensed territory? For example, is it worldwide, or can competitors get a license in other territories? In the e-Commerce Age, geographical exclusivity may have little meaning for anything that can be sold online.
• May the owner revoke the license, and on what proof? For example, can the licensor merely claim a default by the licensee, or is a court order required to terminate the rights?
• Is the license perpetual, or automatically renewable, or will the licensee be extorted for a new fee at the end of each license term (which may be higher because of the value added by the licensee)?

The 'Hound' Can Serve Two Masters

Of course, the “Holmes approach” can become an offensive weapon as well. Counsel drafting contracts for tech firms can use silence on key points as part of a negotiating strategy, particularly on the emerging issues for which industry standards have not yet evolved.

For example, a firm may choose not to offer certain points in the first draft. If the other eventually “hears the silence,” a gracious concession may lead to a trade for substantive points at no real cost.

Similarly, if a drafter knows that it must accept a particular issue that is critical to the other side, it doesn't have to do so in the first draft in the form preferred by the other side. For example, the seller of a business eager for equity might receive only non-voting stock, or an employment agreement with incentives, rather than guaranteed compensation.

From the draftsman's perspective, there certainly is no failsafe way to make sure that a contract has everything the business deal needs. No one can cost-effectively consider every possible contract provision in an effort to avoid leaving out necessary clauses. But examining how the draft would resolve problems that have actually occurred in the business provides a good start, and may lead to new issues that may have to be added.

Seasoned executives may think that they could never overlook that a contract lacked critical points. Yet, each of the examples described above came from actual deals for experienced clients who were stunned by what they had missed.

Like the choice of a military battlefield, the drafter can choose what to include or omit in a contract as a conscious strategy to reach the most favorable deal.

Just as Sherlock Holmes discovered clues from what didn't happen, counsel reading a tech contract must be ever alert to what could (or should) have been included, but was not. Perhaps the drafter was careless ' or chose omission as a conscious negotiation strategy.

The process of how to read the “unwritten” tech contract is, to paraphrase the clue hound of 221b Baker Street, not exactly elementary, but fundamentally important.

Business lawyers ' even tech lawyers ' lead unexciting lives. Reading and writing contracts keeps them stuck in front of a computer or a Blackberry. Even when they work from such “exotic” locations as a coffee shop or an airport lounge, they can't get away from words on a screen.

But sometimes, contract review requires that lawyers have the detective skills of a Sherlock Holmes, when they have to read the parts of a contract that aren't even there. In Arthur Conan Doyle's “Silver Blaze,” the legendary detective solved a crime from the fact that a dog did not bark. The dog's silence was the key clue that it knew the intruder:

“Is there any point to which you would wish to draw my attention?”

“To the curious incident of the dog in the night-time.”

“The dog did nothing in the night-time.”

“That was the curious incident,” remarked Sherlock Holmes.

Beware: Silence Can
Be Less Than Golden

In the same way, lawyers who read tech contracts should think about what is not on the page before them. To satisfy their clients' expectations, they must ask whether anything particular is missing from the document, which the client expects as part of the business deal.

Because tech contracts may require so many critical clauses to describe a deal fully, simply reading the language provided is not enough. Counsel must pay as much attention to what is missing as to what is written, both to protect the client's interests, and to control counsel's own malpractice exposure.

The first step in tech contract review, therefore, is simply verifying that the deal on paper is the same one that the client believes it agreed upon.

At the simplest level, an attorney must ask if all of the key deal points that the client expects have been included.

Executives who negotiate a deal may implicitly understand all its terms ' those specifically negotiated and how it relates to the company's existing business. Because that knowledge has become second nature to them, the dealmakers may not have fully explained that background to the person who must write the first draft of the contract. That draftsman, typically a less-experienced attorney, may not even understand the business well enough to realize how much he doesn't know.

But that process may not be as easy as it sounds. The highlights of a one- or two-page business term sheet can expand to fill many pages of boilerplate, particularly when dealing with large vendors with a vast array of preprinted forms and alternatives.

Break Through The Boilerplate

While tech executives can usually review price, quantity and contract length themselves, without counsel, the rest of the deal can easily be confused or even obscured by page upon page of boilerplate. In fact, sometimes that is all they read before moving on to the next deal.

Business clients who are more familiar with the nuances of their own industry must, then, do the “first reading.” Counsel can then explain any subtleties in the language that may make it mean something different from what it appears to say to a layman. Price-escalation clauses, contingent renewal options, and raw material pass-throughs are just a few examples of how dense legal jargon can muddle even these basic “business points” of an e-commerce agreement.

It is particularly important to keep this focus on basic details in tech contracts. Novel technology may have received the most attention during negotiations – at the expense of getting the basic business deal correct.

Look for What's Not There

In the absence of time-tested, ready-made forms for tech ventures, lawyers must be sure that all contracts have all the “normal” contractual protections, such as warranties and indemnities, or escrows. But they must modify them to fit e-commerce situations unfamiliar to counsel and client. When entrepreneurial clients are willing to take substantial risks in quickly changing markets, counsel must try to parse through all of the possible consequences, be certain that the client understands the stakes beyond the contract under discussion, and then draft around any unacceptable risks.

But these “first reading” questions address only a narrow question: Whether what the contract actually says is accurate. That step, while critical, must be only the start of the contract review. Instead, like Sherlock Holmes, the skilled reviewer must also ask which provisions should be in a contract ' but are not. In “Silver Blaze,” Holmes noted that the watchdog should have barked at an intruder, but didn't because it knew him. In contract negotiations, the quiet absence of key contract clauses, whether legal boilerplate or negotiated business terms, may be the most important clue about the other party's intentions for the business relationship.

Some Scenarios To Snoop Around

Consider, for example, a typical event early in the life of a startup company: the demand for price concessions from a key customer's aggressive procurement department, intent on squeezing every concession possible from vendors. The firm may be willing to do almost whatever may be asked to get that business, both to establish credibility in the industry and with the customer (and others who may have held off buying until the startup had demonstrated its competence), and to secure badly needed cash flow.

The client may therefore be willing to sign the proposed contract as written, unless counsel can ' with as little expense as possible – point out any major problems. But will the startup get anything for its concessions other than low-margin work? Even worse, could it find itself locked into onerous long-term obligations that will burden the company long beyond the customer's initial purchases?

For example, is the contract just an order, or does it have a guaranteed minimum annual purchase volume? If it does not contain the customer's commitment to purchase the startup's product, then the customer could use the low-price concession as a stalking horse to seek low bids from other firms.

The contract's silence on these critical points may reveal an attempt to get short-term benefits from the startup, without the longer-term purchasing commitment that the startup may have anticipated as implicit in the business deal. That quid pro quo for the discount can easily be added before signing ' if the startup folks know to request it. If, on the other hand, the request is refused, then the vendor must determine whether the benefits of an isolated sale, perhaps small, can justify the cost of the concessions demanded. It could be better for the startup to delay the sale temporarily, to negotiate the concessions, than to be locked into a long-term obligation ' a non-competition clause, for example ' in exchange for a one-time benefit.

A similar situation can arise in the sale of surplus assets from a closed manufacturing facility. The buyer may naively assume that it will routinely get the business that those assets serviced ' but the seller may have already shifted it to another location. A typical asset-sale agreement will not include the business, unless the buyer negotiates for it.

A similar situation can arise when a business is sold, and the principals of the seller get employment contracts and equity in the continuing business as part of their package. Such so-called earn-out arrangements are common in the tech sector, because the future appreciation of the purchased business is unknown, and the buyer wants to pay only for performance, rather than for potential.

But if the sellers get a letter confirming only employment compensation and duties, without a definite term, then they will be treated as “employees at will.” The buyer can terminate their employment at any time, for any reason, or for no reason. Losing their job with the buyer isn't the worst of it, however. Typically, non-public firms have the right to buy out shares, at a low price, when employment ends. Not only would the sellers lose the jobs and equity they thought they had, but they would also be unable to manage the firm to increase revenue and their earn-out. The silence of the employment letter on a fixed term of employment is the critical but omitted point that would not be apparent from simply reading the document.

Sort Clues, and Needs, Carefully

In the situation described immediately above, sellers who have never contemplated that their business could operate without them, even after a sale, must instead explicitly protect their future employment if such buyout rights exist. Even though that discussion may seem unusual, when everyone is celebrating the closing of the sale of the firm, something as basic as locking in the term of employment becomes critical to protecting everyone's equity interest in the business, and its future appreciation.

Boilerplate intellectual property licenses are another example of a hidden contract risk. A “standard” license may seem long and complete, yet omit key terms. Simply reading what is on the page will not reveal the missing components of the license, which could greatly affect its value and utility. Consider, for instance:

• May the licensee use the technology in all product markets, or is the license scope restricted to certain applications?
• Is use in e-commerce expressly permitted? Is it prohibited? Some premium brands insist on brick-and-mortar sales support.
• Are there geographic limits on the license? If so, is the license exclusive in the licensed territory? For example, is it worldwide, or can competitors get a license in other territories? In the e-Commerce Age, geographical exclusivity may have little meaning for anything that can be sold online.
• May the owner revoke the license, and on what proof? For example, can the licensor merely claim a default by the licensee, or is a court order required to terminate the rights?
• Is the license perpetual, or automatically renewable, or will the licensee be extorted for a new fee at the end of each license term (which may be higher because of the value added by the licensee)?

The 'Hound' Can Serve Two Masters

Of course, the “Holmes approach” can become an offensive weapon as well. Counsel drafting contracts for tech firms can use silence on key points as part of a negotiating strategy, particularly on the emerging issues for which industry standards have not yet evolved.

For example, a firm may choose not to offer certain points in the first draft. If the other eventually “hears the silence,” a gracious concession may lead to a trade for substantive points at no real cost.

Similarly, if a drafter knows that it must accept a particular issue that is critical to the other side, it doesn't have to do so in the first draft in the form preferred by the other side. For example, the seller of a business eager for equity might receive only non-voting stock, or an employment agreement with incentives, rather than guaranteed compensation.

From the draftsman's perspective, there certainly is no failsafe way to make sure that a contract has everything the business deal needs. No one can cost-effectively consider every possible contract provision in an effort to avoid leaving out necessary clauses. But examining how the draft would resolve problems that have actually occurred in the business provides a good start, and may lead to new issues that may have to be added.

Seasoned executives may think that they could never overlook that a contract lacked critical points. Yet, each of the examples described above came from actual deals for experienced clients who were stunned by what they had missed.

Like the choice of a military battlefield, the drafter can choose what to include or omit in a contract as a conscious strategy to reach the most favorable deal.

Just as Sherlock Holmes discovered clues from what didn't happen, counsel reading a tech contract must be ever alert to what could (or should) have been included, but was not. Perhaps the drafter was careless ' or chose omission as a conscious negotiation strategy.

The process of how to read the “unwritten” tech contract is, to paraphrase the clue hound of 221b Baker Street, not exactly elementary, but fundamentally important.