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State of Indiana v. IBM: Test for Determining the Materiality of a Breach of Contract

There is not a significant amount of case law on the topic of how to determine whether a party’s breach of a contract rises to the level of a “material breach.” However, an Indiana court recently provided some direction with its decision in State of Indiana v. IBM.

Facts of the case

The State of Indiana entered into a 10-year, $1.3 billion outsourcing contract with IBM. The contract provided that IBM would overhaul and update the state’s welfare system, including providing the ability for residents of Indiana to apply for welfare benefits online or by calling a call center. However, once the new system was implemented, it caused an increase in error rates and slowed the rate of eligibility determinations. The State of Indiana terminated the contract, claiming that IBM had materially breached the timing and quality requirements under the agreement.

Court decision

The State sued IBM for $1.3 billion for breach of contract and IBM filed a counterclaim to recover the value of the equipment left with the state under the terms of the contract. The trial court determined that both parties were at fault and that neither should prevail. The court used portions of the test set forth in Williston on Contracts in ruling that the evidence presented by the State did not prove a material breach by IBM. The two factors the court focused on were:

  • the extent to which the injured party will be deprived of the benefit which it reasonably expected
  • the likelihood that the party failing to perform or to offer to perform will cure his failure

The court concluded that because the state obtained an improved welfare system from IBM, it was not denied the benefits it reasonably expected. The court also found that just prior to the termination of the contract, IBM was in the process of curing the timeliness problems. Finally, the court discussed whether the breach went “to the heart of the contract” and found that because IBM substantially performed, there wasnt a material breach.

The Aftermath

The court’s decision is troublesome because IBM avoided the material breach claim by only meeting between 50% and 80% of the required service levels. The court did not give much credence to serious breaches in the service levels and instead focused on the disclaimed warranty of “uninterrupted or error-free operation” when analyzing the performance issues.

If you are negotiating an outsourcing agreement, it is important to negotiate and clearly identify the performance standards in the contract. For tips on how to accomplish this in your contracts, please read our next blog titled “Defining ‘Material Breach’ in Your Contract.”

To learn more about how to draft an effective contract or how we can assist you with other business-related matters, contact Leslie S. Marell today.

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Online Contract Formation: Are your “Terms of Use” binding?

Many companies have their “terms of use” posted on their websites, but are they binding? The Ninth Circuit Court of Appeals recently decided a case addressing this specific issue and providing guidance to businesses that use websites and/or mobile applications in transacting with customers.

Facts of the case

In Nguyen v. Barnes & Noble Inc., the plaintiff alleged, among other things, that the operator of the website engaged in deceptive business practices when it cancelled an order he placed and was confirmed by Barnes & Noble, Inc. In response, the website operator filed a motion to compel arbitration as required under the terms of use (TOU) posted on its website. The plaintiff argued that he should not be bound by the arbitration requirement because he did not have notice of, nor did he agree to, the TOU.

The TOU on the website were accessible through underlined, green hyperlinks located in the bottom corner of each page of the website. The hyperlinks were located beside other legal notices and near buttons a user had to click on to complete an online purchase. The website operator claimed this gave the user constructive notice of the TOU and the plaintiff continued to use the website after such notice.

Holding

The Court of Appeals for the Ninth Circuit sided with the plaintiff. The court reasoned that although the hyperlinks to the TOU were conspicuous on every page of the website, the user was never prompted to agree to them. Even having the hyperlinks located close to other buttons the user must click on, without more, is insufficient to give constructive notice. As a result, the plaintiff did not accept the TOU, did not enter into a binding agreement with the website operator, and therefore arbitration was not required to address plaintiff’s claims.

Conclusion

This decision demonstrates that the rules of contract formation still apply to website agreements and terms of use. It also highlights the importance of requiring the user to take an affirmative action to accept the TOU. As Nguyen indicates, you should require the user to click on an “I Agree” box before allowing the user to complete a transaction.

Courts are reluctant to bind individual consumers to agreements or terms of use contained in browsewrap contracts. In fact, the Ninth Circuit commented in a footnote that the standard may be higher where agreements are being enforced against consumers than against business entities. Regardless, this decision should serve as notice to all website operators that browsewrap terms of use have serious limitations.

Remember, you can have the most solid and protective TOU possible, but if they are not enforceable, they do you no good.

If you have questions regarding business law matters, contact us today to schedule an initial consultation. Leslie S. Marell has been practicing business and commercial law for over 25 years. She is established in private practice and has extensive legal experience counseling companies in the areas of business contracts and transactions, purchasing, sales, marketing, computer and technology law, employment law and day to day legal matters. Let us provide your company the advice and guidance you need.

 

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Contract Terms: What does “Prompt” Mean?

The term “prompt” is commonly used in contracts, but what does it mean? According to Judge James T. Vaughn Jr. of the Delaware Supreme Court, it depends.

Facts of the case

In Avaya, Inc. v. Charter Communications Holding Company, LLC, C.A. No. N14C-03-052, Plaintiff Avaya, Inc. (“Avaya”) moved for summary judgment. The parties entered a Master Purchase Service Agreement (“Agreement”) under which the defendants, Charter Communications Holding Company, LLC and Charter Communications, Inc. (together “Charter”), purchased equipment and software from Avaya. The Agreement included a provision requiring Avaya to “defend, or settle, at its own expense”, and “pay all damages and costs” relating to, any claims for infringement of patent, copyright or trade secret brought against Charter related to Charter’s use of Avaya products purchased under the Agreement. However, the Agreement also required, among other things, that “Avaya’s obligation is expressly conditioned upon the following: (1) [Charter] shall promptly notify [emphasis added] Avaya in writing of such claim or suit…”

In its summary judgment motion, Avaya argued that Charter failed to comply with the contractual indemnity requirement to “promptly notify” Avaya of a claim or lawsuit for which indemnity was being requested. The complaint was served on Charter on September 5, 2006, but Charter did not provide a copy of it to Avaya until July 2, 2007.

Ruling

Justice Vaughn denied the summary judgment motion filed by Avaya. He was not prepared to rule that giving notice of the claim ten months after the filing of a lawsuit was not prompt “as a matter of law.” He reasoned that Charter should be given the opportunity to conduct discovery to determine the applicable facts and circumstances that should be considered by the court.

Judge Vaughn stated that he agrees “with Charter that the phrase [prompt] is subject to some interpretation, and that the interpretation may be influenced by attendant facts and circumstances.”

Conclusion

While the use of “prompt” is common in contracts, the Avaya case is just one example of how it may not mean what you think it means. Terms such as “prompt” or “sufficient time” are vague enough that they are open to interpretation. As a result, if you want to avoid confusion, disputes, and even worse, litigation over what these terms mean, it is wise to define them in your contract. For example, language such as “prompt notice is required, but in no event later than 20 days after receipt of a claim.”

If you have questions regarding your company’s contractual needs, contact Leslie S. Marell for help. We serve as general counsel to clients who do not require, or choose not to employ, a full-time lawyer in-house. Call today to schedule your initial consultation.

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IBM’s Legal Department: A New Approach with Contracts

Assistant general counsel at IBM, Neil Abrams, believes that he can better serve clients and customers by simplifying matters. With this strategy in mind, Abrams has led a team in reducing complex and lengthy contracts for cloud services to a straightforward, two-page document.

Abrams explained to CorpCounsel.com that the contracts for a large number of cloud services were causing frustrating obstacles for customers. The contracts would be sent to the customer’s attorney who would begin negotiating the wording and the progress would come to a frustrating standstill.

Abrams’ team took a couple of months to reduce the crucial points of the contract into a two-page document. They even translated it into more than 20 languages, using concise and plain wording. The team did not use cross-referencing, hyperlinking or including other documents into the contract by reference.

Additionally, while many businesses also require a separate contract that outlines what actions the company is going to take or the “professional services” to be provided, the new IBM contract includes services. Abrams’ team even included intellectual property indemnification in the contract, which many cloud providers do not include.

The response to the new, shorter contract has been positive. It is less time-consuming for the customers and the attorneys are able to accomplish any necessary negotiations quicker. In fact, IBM has even been recognized as a finalist for the 2014 Innovation Award for Operational Improvement for “boldly and rapidly transforming its cloud computing contract process.”

As far as Abrams, his work on the cloud services contract has moved him from head attorney for software to serving as an assistant general counsel tasked with looking for ways to improve IBM’s overall client experience, including the simplification of more contracts. In fact, Abrams has already released a four-page contract that covers all of IBM’s products and formerly averaged approximately 30 pages.

Many large companies have template contracts that their internal clients use and over time they get longer and longer. As a result, the contracting process is taking longer. This can take a significant toll on both the buyer and the seller. As IBM is proving, simplifying and shortening contracts (with a focus on making them easier for internal clients to understand) can improve the process for all parties involved.

I have always been an advocate of making contracts clear and concise. I am encouraged by IBM’s advancement in this direction and it is my hope that many other large companies will follow in IBM’s path. It may be a challenge, but it will be worth it when the parties realize they truly understand what their contracts say and disputes are less likely to occur, which save everyone time and money.

To learn more about simplifying your contracts or how we can assist you with other business-related matters, contact Leslie S. Marell today.

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11 Shipment Terms Defined under the Incoterms

Hopefully you have read our blog titled “Shipping Terms in Your Commerce Contracts.” This blog will provide a brief summary of some of the terms defined in Incoterms 2010. Remember, these are summaries of the terms and you should confer with legal counsel before using an Incoterm in your transaction.

Below are Incoterms that apply to all modes of transport:

Ex Works (EXW). The Seller agrees to have the goods at an agreed point (usually the seller’s facility) and provides the Buyer notice to allow the Buyer to take delivery of the goods. The Seller’s only responsibility is to prepare the goods for pick up by the Buyer’s carrier; Buyer assumes the risk of loss of the goods, freight charges, export and import responsibilities and delivery to buyer’s facility. EXW is typically not an ideal option for most importers unless you have a freight forwarder and broker in place and have negotiated preferential shipping rates.

Free Carrier (FCA). The buyer and seller can name a location on the seller’s side (for example, “FCA Seller’s Facility at [address]”). If the parties name the seller’s facility, the seller is responsible for loading the goods onto the initial carrier and the buyer is responsible for transport, freight charges and risk of loss thereafter as well as export and import responsibilities.

Free Alongside Ship (FAS). This term is followed by a named port of shipment and is only applicable for water transport (”FAS Boston.”). The seller is responsible for the cost of transporting and delivering goods to the export point, but the responsibility shifts to the buyer once the goods are unloaded at the export point..

Free on Board (FOB). This term is followed by the named port of shipment, for example FOB New York, and applicable only for waterway transport The goods are place on board the vessel by the seller at a port of shipment at seller’s expense. Seller has responsibility until the goods are loaded on the transport vessel, then all responsibility shifts to the buyer.

Cost and Freight (CFR). This term is followed by the name of the port of destination and applies only to waterway transport. CFR requires the seller to pay the costs and freight necessary to bring the goods to the named destination. Buyer assumes responsibility for loading the goods on the truck at the place of import, transport to the destination and import responsibility.

Cost, Insurance, and Freight (CIF). CIF is similar to CFR (applicable only to waterway transport) with the additional requirement that the seller purchases insurance against the risk of loss or damage to goods.

Carriage Paid To (CPT). The buyer and seller name a location on the buyer’s side to which the freight is prepaid by seller. The wording would be something like “CPT Buyer’s Facility at [address].” The import responsibility is buyer’s only obligation, while the seller is responsible for transport, freight charges, risk of loss and exporting obligations.

Carriage and Insurance Paid (CIP). The parties name the place on the buyer’s side to which the freight is prepaid by seller (“CIP Buyer’s Facility at [address]”).. Seller carries all of the responsibility, including providing insurance against loss of damage, and import responsibility and unloading from the final carrier are buyer’s only obligation.

Delivered at Terminal (DAT). The buyer and seller identify a terminal, or a named point within the terminal, where appropriate, on the buyer’s side to which the goods are delivered. Seller carries all of the responsibility, except import responsibility falls on the buyer as well as obligations to unload at the terminal.

Delivered At Place (DAP). The parties name a stipulated destination on the buyer’s side where the goods are to be delivered. Seller carries all of the responsibility, except import responsibility falls on the buyer as well as the obligation to unload once it reaches the designated destination

Delivered Duty Paid (DDP). The parties name a Buyer’s location to which the goods are delivered (e.g. “DDP Buyer’s Facility at [address]”). All responsibility falls on the seller, except for obligations of unloading once the goods reach the Buyer’s location.

As you can tell, Incoterms can be confusing. The above is only a summary of the terms and there are many other factors to consider.

. I’ve created a graph identifying the buyer’s and seller’s obligations within the 11 Incoterms and will be happy to email it to you if you send me an email to Leslie@marell-lawfirm.com

If you need assistance understanding shipping terms or drafting an effective contract, contact Leslie S. Marell to schedule an appointment.

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Key Terms to Include in a Partnership, Shareholder, or LLC Operating Agreement

If you are entering a partnership, shareholder or Limited Liability Company (LLC) Operating Agreement with another party, it is important to draft a solid contract. Although you may not think it is necessary because the other party is somebody you trust, having an agreement in writing can help avoid legal disputes in the future as well preserve your relationship.

In some jurisdictions (such as New York), it is not a breach of contract for a party to withdraw from a partnership that was created orally. See Gelman v. Buehler. In other words, a partnership may be dissolved unilaterally if there are no particular terms or undertakings specified in the underlying agreement. This, in addition to the important issue of joint liability, is why I typically dissuade people from using straight partnerships.

There are a variety of important terms to include in this type of written contract, but the buyout agreement terms require special attention. The Buy-Sell Agreement is an agreement among business owners to purchase or sell a business interest after a specific event, at a determinable price and on predetermined terms. The purchase or sale may be mandatory or optional and the agreement may give purchase or sale rights to one party, all of the parties, or to the company.

Below are three important purposes of a Buy-Sell Agreement:

  1. The owners of the business may want to place restrictions on who can become a new co-owner. For example, if a co-owner dies or gets divorced, his or her interests could transfer to a spouse or children if a buyout agreement is not in place. The agreement includes a general prohibition on the sale of transfer of ownership interests, except under the circumstances specified in the agreement.
  2. The owners of a business may wish to “create a market” for the sale or transfer of their ownership interests. Owners of a small business typically do not have a ready market to sell all or a portion of the business, so the Buy-Sell Agreement can provide a means for the purchase of it.
  3. The mechanism for determining the purchase price of an owner’s interests can be specified in the Buy-Sell Agreement. In fact, the agreement can set forth how the purchase price will be paid. This can prevent disputes that commonly arise between “selling” owners that typically have a different perspective of fair price or terms of payment than those of the remaining owners.

There are many other factors that should be considered in a Buy-Sell Agreement, which will be covered in future blogs, so please check back for more information. Or, to learn more about buy-sell agreements and how to protect yourself or how we can assist you with other business-related matters, contact Leslie S. Marell today.

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Shipping Terms in Your Commerce Contracts

Shipping terms used in domestic commerce in the United States are defined by the Uniform Commercial Code (UCC), as adopted by each individual state. However, the UCC terms (as they currently stand) are inadequate for international transactions because they do not deal with responsibility for exporting and importing as well as who loads and unloads the goods at the various points throughout delivery and who pays for which points of delivery. . If you are an importer, your shipping terms should be defined by referring to the “Incoterms,” which is a registered trademark of the International Chamber of Commerce (ICC). The ICC drafted the Incoterms and continues to update and revise them every 10 years, with the latest version having been published in 2010.

Incoterms are used by exporters and importers in nearly every trading country worldwide and they define the primary obligations of the exporter and importer in relation to the shipment of goods in international transactions. There are 11 very specific delivery terms in the Incoterms all of which precisely define who is responsible for transporting, loading and unloading from the seller’s facility, the port of export and the port of import, insuring, and complying with exporting and importing regulations..

There is no such detailed definition of the terms of delivery within the UCC  The “F.O.B. term deals with the issue of risk of loss and freight charges. People routinely modify the term to add language such as F.O.B, Origin, Freight Prepaid & Charged Back.” The additional language is not defined in the UCC; rather it is ‘defined” by industry usage.

The 11 Incoterms do not require additional statements. As soon as the seller quotes the buyer “EXW ABC Facility in Houston, TX, USA-Incoterms 2010”, both parties know that the seller is saying that any freight charges, forwarding fees and customs clearance are the Buyer’s responsibility.

It is important that you understand the distinctions between the 11 delivery terms of the Incoterms 2010. It is also important that you have similar discussions with your supplier as to which delivery term will apply and then ensure that this term I’m convinced that you need a “cheat sheet” listing all the responsibilities included as part of your purchase order. I’ve created a graph identifying the buyer’s and seller’s obligations within the 11 Incoterms and will be happy to email it to you if you send me an email to Leslie@marell-lawfirm.com.

Our next blog will provide you a brief summary of some of the Incoterms you will want to be familiar with. However, this can be a very complex area of the law and you should obtain legal counsel when participating in international trade. Contact Leslie S. Marell for assistance in understanding domestic shipment terms under the UCC and international shipment terms under the Incoterms.

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What does “Hold Harmless” Mean?

0Hopefully you have read our blog titled “Indemnification Clauses,” because indemnification is commonly confused with “hold harmless” provisions, and rightfully so. In fact, many argue that the two are one in the same. A hold harmless provision provides that a party is not liable for certain damages under a contract and shifts the responsibility for those damages to the other party. A common example of a hold harmless provision is Party A agrees to hold harmless Party B for its (Party B’s) negligence, intentional acts or omissions.

The courts that find indemnification and hold harmless provisions as being two distinct clauses follow the reasoning that every word of a contract should be given meaning. The indemnification language provides a party “indemnity” (no liability to third parties) while the hold-harmless clause provides the party exculpation (releasing first-party liability or a wrongdoing indemnitee).

An exculpatory clause is a provision which is intended to protect one party from being sued for their wrongdoing or negligence. Many courts find the terms “indemnification” and “hold-harmless” to be synonymous. However, it is important to confer with a business attorney to understand what the applicable state law provides for the type of contract you are entering into. Mistakes involving these types of provisions can be quite costly.

As a practical matter, it may be advisable to include both an indemnification clause and a hold harmless clause in your agreements so you are protected by whatever definition is applied. It is also important to note that a “responsibility clause” is similar to an indemnification or hold harmless clause, but it is typically less protective. Again, you should consult with a lawyer regarding the type of clause being used in the contract, the state law to be applied, and the right strategy for protecting your best interests.

If you have questions regarding indemnification, hold harmless provisions, or other business law matters, contact us today to schedule an initial consultation. Leslie S. Marell has been practicing business and commercial law for over 25 years. She is established in private practice and has extensive legal experience counseling companies in the areas of business contracts and transactions, purchasing, sales, marketing, computer and technology law, employment law and day to day legal matters. Let us provide your company the advice and guidance you need.

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Getting Sales Commission Agreements in Writing Avoids Disputes (and in some states, it’s the law!)

Whether you are an employer or an employee, it is important to have your sales commission agreements in writing. In fact, several states (including California) require any employer that pays commissions to employees providing services in the state to have a written agreement with the employee. The contract must outline how the commissions are computed and how they will be paid.

A sales commission agreement should clearly explain how the commissions are calculated and when they will be paid. The employee should be provided a signed copy of the contract and the employer should retain a signed acknowledgement of receipt of the contract by the employee.

In setting forth the calculation of commissions, the terms “sales” and “profits” must be defined. If returns, refunds, cancelled orders or other such occurrences impact the calculation, this must be clearly stated in the contract. It should also set forth when a commission is earned. Is it earned when an order is placed, when the goods are shipped or when the customer pays?

What about bonuses? You must look at the applicable state law, but in California short-term productivity bonuses are excluded from the definition of “commissions.” This can be a tricky area, however. For example, if the California employer has agreed to pay a fixed percentage of sales or profits as compensation for work, that can be considered a commission. It is common for bonuses to be based on a percentage of sales or profits, so this can create some ambiguity in what constitutes a commission. As a result, the best strategy is to have a clear and concise written agreement that sets forth the bonus plan and/or commission plan in order to avoid any disputes with the employee.

It is important to note that most employers do not have contracts with their at-will employees, so the sales commission agreement should contain a provision stating that the employee’s at-will status is not changed by the existence of the written commission’s agreement.

There are numerous other factors that must be considered when drafting a sales commission agreement. If you need assistance creating this type of contract or you have questions regarding your company’s contractual needs, contact Leslie S. Marell for help. We serve as general counsel to clients who do not require, or choose not to employ, a full-time lawyer in-house. Call today to schedule your initial consultation.

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Resolving the issue of Limitation of Liabilities between Buyer and Seller

When a buyer and seller are negotiating the issue of limitation of liabilities, it can get messy. The goal of your attorney is to eliminate or at least reduce the amount of risk, while a business person’s goal is to get the deal done ( and, of course, all deals have inherent risk). It is important for you to be involved in this part of the transaction. Don’t assume that it is only a legal issue, because this provision determines which party will ultimately be responsible and pay the money if something goes wrong. Thus, you and your counterpart in the transaction should realistically assess the risk and discuss who will take responsibility for what liability.

Below are a few tips for how to resolve the issue of limitation of liabilities between the buyer and the seller:

  • Approach the negotiation with the understanding that every prudent business must make a conscious decision as to which risks it is willing to assume and those it is not. A buyer should not view a seller’s limitation of liability clause as the seller refusing to stand behind its product or services. That is not what this clause means. The seller’s limitation of liability is its attempt to protect itself in our very litigious society.
  • Consider the real world risks and determine what makes sense under the circumstances. This includes talking to your supplier regarding real world examples and concerns. For example, if you are purchasing direct material, you’ll probably want to discuss what the supplier would do in the event of field failures….which will likely require expenses for recall, transportation, etc.
  • When discussing real world contingencies, avoid using legal terms such as limitation of liability or consequential damages. If you use these legal terms, your supplier is likely to turn it over to their attorney to handle those issues.
  • Talk about these concepts before you talk about the contract language. Reaching an agreement with your supplier ahead of time makes writing the contract easier.
  • Keep in mind the likelihood that you will have to go to court in order to recover consequential damages such as loss of business, loss of profit, downtime and other large dollar amounts. One approach is to agree to a swap with your supplier. That is, permit the supplier to limit its liabilities for damages with respect to certain damages (such as loss of business or downtime, for example) for which you’ll probably not pursue recourse from your supplier. In exchange for that agreement to limit the seller’s liabilities, require that the seller be responsible for the costs and expenses that you’re more likely to incur (such as field failures). Another common approach is to create a maximum dollar amount for which the seller will be liable.

Whatever your approach is to resolving disputes over limitation of liabilities, the bottom line is to make sure the upside gain is commensurate with the risk. If you are reasonable, the other party is more likely to be reasonable too.

To ensure that your contract provides you with the most protection from liability available, contact Leslie S. Marell to schedule an appointment. Our office is located in Torrance, California, but we proudly serve businesses of all sizes from all over the country.