In this Q&A series, business litigator Shepard Davidson, a partner at Burns & Levinson in Boston, shares his knowledge on what companies need to know about business disputes to try to avoid litigation and/or end up on the winning side, if they can’t. In this first installment, he talks about the key components of strong business contracts.
Q1: In your experience, what parts of a contract or business relationship are most likely to lead to a dispute?
Davidson: While it should go without saying that all parts of a contract can end up being critical, the vast majority of disputes emanate from those portions setting forth the deal terms. Thus, it is of paramount importance that in-house counsel review the deal terms with the relevant business people to be sure that what the contract says matches what the business people intended.
Q2: Does a “choice of law” provision guarantee litigation will be conducted in the agreed upon state stipulated in the contract?
Davidson: When two parties reside and/or conduct business in different states, agreements often include a choice of law provision. A typical such provision is: “The Parties agree that this Contract shall be governed and construed in accordance with the laws of the Commonwealth of Massachusetts.” While simple and straightforward, such a provision may not get you what you want. Suppose, for instance, a dispute between the parties includes a claim that does not arise directly out of the contract. In that situation, the choice of law provision above likely will not control. Thus, a better provision would be: “This Contract, and any disputes between the Parties, shall be governed and construed in accordance with the laws of the Commonwealth of Massachusetts.”
Q3: Are signatures on a contract binding even if the person who signs it doesn’t fully understand the contract and/or is not formally authorized to sign?
Davidson: The general rule is that, as long as a person is not defrauded, they will be bound by a contract they sign, whether they read and understand it or not. Further, an entity is not likely to avoid a contractual obligation by arguing that the signatory was not authorized to sign the contract if that person has what is called “apparent authority.” Apparent authority arises when an entity, for instance, does something to cause another to reasonably believe that an individual has actual authority to bind the entity, even if the person does not. Thus, if someone with the title VP of Sales signs a contract for $100,000, his company is going to be hard-pressed to avoid that contract even if they have an express internal policy saying that no VP is authorized to sign contracts over $75,000.
These rules rests upon the fundamental need for people in business to be able to rely on written documents and without which there would be too much uncertainty. Accordingly, if you don’t fully understand a contract, don’t sign it. And if you have a policy about who can sign a contract, be sure you enforce it internally because you may not get a chance later to say that the person signing it lacked authority to do so.
Q4: Liquidated damages provision in contracts can be confusing. Can you explain how those work and what makes them enforceable or unenforceable?
Davidson: A liquidated damages provision in a contract specifies the amount of damages one party will pay another as compensation for breaching a contract. Having said that, a provision saying: “If X breaches the contract, it will pay Y $10,000 in liquidated damages” may very well not be enforceable. Under Massachusetts law, for instance, a liquidated damages provisions only is enforceable if at the time the contract is executed it would be difficult to determine the damages that would accrue from the contemplated breach and if the designated damages is a reasonable estimate of the actual damages that a party would suffer if the breach were to occur. If either of these conditions is not met (again, based on what the parties know at the time they sign the contract), the liquidated damages provision will not be enforceable.
In light of this, here are two things to keep in mind if you are considering using a liquidated damages provision. First, if the damages that would accrue from the breach would be obvious or easily ascertainable, a liquidated damages clause will not be enforceable. Second, don’t get greedy when negotiating the amount to be included as the liquidated damages. If you have too high a number, a court may later rule that it was an unreasonable estimate of the actual damages and refuse to enforce the provision.
Q5: What are my rights in choosing outside counsel when a dispute is covered by my insurance company?
Davidson: The best thing about business insurance is that it gives companies peace of mind that the insurer will be responsible for some or all of the damages, and will foot the bill for legal fees and defense costs, when a covered event occurs. On the other hand, the insurance company may have the ability to select the attorney who will represent you in the litigation, and insurance carriers usually are incentivized to engage inexpensive attorneys who may not have the industry, business or other expertise that a company desires. Further, even when insurance carriers allow the insured to select defense counsel, the carriers often only agree to reimburse the insured at insurance defense rates – not the actual legal fees paid.
The good news for Massachusetts companies, however, is that if an insurance company tenders a “reservation of rights” letter, i.e., a letter in which the insurer reserves its right to assert that some or all of the claims may not be covered, the insurer gives up all control of the defense – including the selection of defense counsel. Massachusetts courts also have ruled that under such circumstances an insured is not limited to attorneys who charge insurance defense rates, but is only limited by “what a reasonable person in the insured’s position would pay for capable attorneys it chose to retain.”
So, if you have a covered claim and your insurer sends you a reservation of rights letter, do not be shy about demanding to select your own defense counsel and asking your carrier to reimburse you company for the actual legal fees it incurs.
Shepard Davidson is a partner and former co-chair of Burns & Levinson’s Business Litigation Group and a MCLE-certified mediator. His practice spans all manner of business disputes, including complex business torts, contract claims, non-compete litigation, and issues involving closely held businesses. He can be reached at sdavidson@burnslev.com.
