Seeing the Forest for the Trees
Don’t Lose Sight of the Single Most Critical Consideration in All Key Business Contracts
Types of Key Business Contracts
Dunham Law attorneys have helped clients for decades with key business contracts, including LLC operating agreements, corporate buy-sell / shareholder agreements, asset and stock purchase agreements, joint venture agreements, and contracts with high-level employees and critical vendors. We also help resolve disputes when those agreements don’t work out, including “business divorces” among co-owners and breach of contract claims.
What Clients Lose Sight Of
Unfortunately, we see that by being too focused on all the individual details (and excitement of the possibilities of the deal), clients sometimes fail to adequately consider the most critical part of the contract: the other party. As I routinely tell clients, if you enter into an agreement with the wrong individual or business, you’ll still have a costly, regrettable mess on your hands. This is true no matter how clearly and well we draft the contract.
As business owners who have been involved in litigation know all too well, it’s not like we get to run down to the courthouse the next day, have a judge read our contract, take 15 or 30 minutes to hear both sides of the story and make a decision, and then the money judgment automatically appears in the winning party’s bank account. Getting to a decision can take years and cost a stomach-churning amount of money. And even then, you have to collect on your judgment, which could be an impossible task if the losing party files bankruptcy or otherwise doesn’t have the money.
That’s why when clients call when a dispute develops to see if their position is “right” based on the contract language, I often have to follow up my answer by saying that it doesn’t really matter if their position is right or not. While it significantly helps matters if you have a clearly, well-considered contract in your favor, that’s only part of the equation. The best way to avoid the problem is to enter into contracts only with the “right” individuals and businesses.
What Makes an Individual or Business the “Wrong” Other Party to Your Contract and How to Discover It Before It’s Too Late
So when considering entering into a key agreement with an individual or business, what makes someone the “wrong” party? We find that there are generally two categories of “wrong” parties to your business agreement. One is obvious and the other not so much. Both can be very costly. This post focuses on the obvious one. Our next post will focus on the less obvious one.
The obviously wrong party is someone who is NOT:
Qualified
Reliable
Ethical
Cooperative
Financially or mentally stable
Generally good working with others
Major (Negative) Bonus Points: They routinely find themselves (voluntarily or involuntarily) in litigation.
We’ve found clients can avoid this type of individual or business by (1) not ignoring red flags already known to them and (2) not taking things at face value and, instead, doing some additional digging into the background of the potential party. This means taking the extra time to:
Ask others in the industry about their experiences with this individual or business
Searching the court, property and lien records for the counties in which the business and its owners currently (and previously) operate and live
Searching regulatory records
Performing credit checks
We routinely help clients with this sort of due diligence, which can be performed fast enough that it won’t slow down a deal.
Sometimes clients are hesitant performing this type of diligence, because they don’t want to offend the other party. Much of this can be performed without the other party even having to know. Also, rather than being offended, the party who has nothing to hide is often impressed the client was sophisticated enough to take this extra step.
While it can be of value in any business arrangement, this process should be standard practice before entering into those contracts that are particularly important to your business.
More Often Than Not, You’ll Be Surprised What You Find (or, You Think You Know Someone)
If you find yourself getting ready to enter into an agreement that is critical to your business and saying that you don’t need to perform this level of diligence because you know the other party, think of this: we find that - more often than not - this process uncovers some information that is a real surprise to our client. This includes tax liens, other financial problems, pending or historical litigation, a track record of unsuccessful projects, criminal charges (including those indicating honesty and/or potential addiction issues), the distraction of a pending divorce, assets are not as represented, etc.
Take, for example, our client who wanted to wire $500,000 to someone he had known for many years in the insurance industry. Our client, who had decades of success operating and investing in insurance businesses, was being asked to invest in a novel insurance product that this out-of-town insurance executive claimed to be developing. The lack of documentation regarding the investment and speed at which the executive needed the funds raised red flags for us. The client wasn’t concerned; he thought the proposed business venture was a good one and knew this individual.
This was on a Friday. We asked him to hold off until Monday. We did some digging and found the executive had been indicted for felony fraud in Michigan about one year earlier and his jury trial was scheduled in about a month. At a minimum, his pending criminal trial would be a significant distraction to getting this new insurance business off the ground. However, the more likely scenario was he needed money to pay his criminal lawyer for the trial and was desperate enough to say and do just about anything.
While this example is extreme, it’s just one of numerous examples where we’ve found facts that were inconsistent with those represented to our client.
Worth the Effort Even if You Proceed With the Deal
Even if your due diligence confirms your belief that this individual or business is the “right” party, it’s not a wasted effort. The comfort and confidence you gain in this other party can help solidify the relationship. And if your investigation raises concerns but not enough to nix the deal, you are at least better able to take steps to mitigate this risk on the front-end. Examples of ways to mitigate the identified risk include:
Easy termination standards
Liquidated damages
Escrows / deposits / reserves / holdbacks / bonds / security interests
Personal guaranties
The ability to use other individuals and businesses as a backup (i.e., non-exclusive)
Change the economics of the deal to justify the increased risk
Next Post: The Less Obviously “Wrong” Other Party to Your Key Business Contracts
Look for our next post where we discuss the less obviously “wrong” party to a key business contract. While less obvious, this can be even more costly to you and your business.
Dunham Law
Dunham Law can help protect you with your key business contracts through practical advice and clear, well-considered drafting. Contact Brian Dunham @ 859.479.3961 to learn more.
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