Common Elements of Business Contracts, Part 7: General Terms and Conditions

This is the seventh in a series of articles [1] presenting an overview of various provisions commonly found in business contracts, primarily from the point of view of the drafting attorney. [2]

General Terms and ConditionsChoice of Law

A choice of law provision is an agreement between the parties that the contract will be governed by the law of a particular jurisdiction. It does NOT dictate where the parties will litigate a dispute. A contract governed by the law of one jurisdiction can be litigated in another. If the parties agree to restrict the locations where a lawsuit may be filed, a forum selection clause, discussed below, should be used.

What if there is no choice of law provision?

If the contract does not include a choice of law provision, what law applies? Although that analysis depends somewhat on the state in which the lawsuit is filed, generally courts will apply the law of the state that has the most significant relationship to the transaction and to the parties. [3] In determining which state has the most significant relationship, courts consider factors such as where the contract was signed, where it was negotiated, where performance occurs, where the subject matter of the contract is located, and where the parties are located. [4]

Will a choice of law provision be honored?

On the other hand, if the contract contains a choice of law provision, most courts will, in most circumstances, apply the law that the parties agreed to. [5] There are, however, two exceptions, both of which apply only if the most-significant-relationship test described above would dictate a choice of law different than the one chosen by the parties. For the purpose of explaining those exceptions, “chosen state” means the state designated by the contract’s choice of law provision and “other state” means the state dictated by the most-significant-relationship test. If either exception applies, the court will apply the law of the other state.

The first exception is when the chosen state has no substantial relationship to the parties or to the transaction and there is no reasonable basis for the parties to have selected the chosen state. [6] Accordingly, a lawyer drafting a choice of law provision can avoid this exception simply by choosing a state that has some type of substantial relationship to the transaction or to the parties.

The second exception occurs when applying the law of the chosen state would result in the violation of a fundamental public policy of the other state and the other state has a materially greater interest in the resolution of the particular issue at hand than does the chosen state. As a practical matter, the lawyer drafting a provision need not worry a great deal about the first exception and not at all about the second. The lawyer drafting a choice of law provision can do very little to avoid this exception other than, of course, to select the same state that would be dictated by the most-significant-relationship test.

So what factors affect the decision to select one state’s laws over another?

The main reason to include a choice of law provision in a contract is not for one party to gain an advantage over the other. The primary purpose, which benefits both parties, is to provide more certainty in predicting how a court will interpret or apply a contract in light of a given set of facts. To increase the likelihood that a choice of law provision will be honored, most transactional lawyers try to choose the law of a state that has at least some nexus with either the transaction or the parties.

Beyond that consideration, lawyers generally favor states that have a substantial body of applicable case law, favoring New York or Delaware over, say, South Dakota. For those who wish to go even further, another factor that improves the predictability of results is to select a state, like Indiana, that has a strong parol evidence rule.

Two examples, one broad and one narrow

A frequently discussed question is whether a choice of law clause can apply to non-contractual claims, including torts, that are related in some way to the relationship established by a contract. A complete discussion of that question is beyond the scope of this document, but most drafters probably desire the choice of law clause to be as broad as possible. Here is an example of a clause that is very broad, probably about as broad as it can practically be.

The laws of Indiana govern this Agreement (including its interpretation, construction, performance, and enforcement) and all claims, controversies, and disputes arising from or related to it, the services and transactions it contemplates, or the relationship it establishes between the parties.

At the other extreme is a simple clause that might be sufficient if brevity is more important than covering every conceivable possibility.

The laws of Indiana govern this Agreement.

A good situation in which to use the short example is when the contract designates the same choice of law that would arise from the application of basic choice of law principles. For example, the above example of a simple choice of law clause is entirely adequate if the parties are located in the same state, the contract is negotiated and signed in that state, performance will be entirely within that same state, and the parties are satisfied with that state’s law.

Forum Selection Clause

A contractual designation of forum establishes one or more courts in which the parties will litigate a dispute. Forum selection clauses are generally enforceable if certain conditions are met, but the details vary from state to state and between state courts and federal court. As noted earlier, a forum selection clause and a choice of law clause are two different things; it is perfectly legitimate to select the law of one state to govern the contract and the courts of another as the exclusive venue for litigation. Doing so is a bit unusual and it may increase the cost of litigation because the parties will have to inform the court what the law actually is in the other jurisdiction.

In Indiana, forum selection clauses are enforceable if they are freely negotiated, if they are reasonable and just under the circumstances, and if there is no evidence of fraud or overreaching that would deny a party its day in court. [7]

In federal court, things are a bit different because of course, the court must have subject matter jurisdiction, and it cannot be conferred by a forum selection clause or any other agreement or act of the parties. [8] If that requirement is satisfied, forum selection clauses are presumptively enforceable, [9] at least if the subject matter jurisdiction is based on a federal question. If the court is sitting in diversity jurisdiction, it may follow the presumptively enforceable standard of The Bremen, or, if the court views a forum selection clause as substantive rather than procedural, it may follow the Erie doctrine and apply state law. [10] The applicable rule depends on the particular circuit. [11]

DRAFTING TIP: If the selected forum is in federal court, designate a state court as the alternative selection if the federal court lacks subject matter jurisdiction.

In order to ensure that a forum selection clause is enforced, the forum selection clause should:

  • Provide that the selected forum is the only forum in which a case may be brought and maintained.
  • Provide for all parties a submission to personal jurisdiction in the selected forum.
  • Contain a waiver of objections to the selected forum, including any objections based on forum non conveniens.Track the language in the choice of law clause that designates the types of cases that are covered.
Example:

(a) Any party who brings against any other party a legal action or proceeding arising from or related to this Agreement, the services and transactions it contemplates, or the relationship it establishes between the parties shall bring the legal action or proceeding exclusively in the United States District Court for the Southern District of Indiana or, if that court lacks subject matter jurisdiction, in Marion Superior Court, Marion County, Indiana.

(b) Each party hereby consents to personal jurisdiction of the courts named in paragraph (a) and to any court to which an appeal may be taken from those courts.

(c) Each party hereby waives all objections to venue in the courts named in paragraph (a), including any objection based on forum non conveniens.

Severability

The legal issues associated with a severability clause are discussed elsewhere in these materials. Example:

If a provision of this Agreement is held to be unenforceable, the other provisions will remain in effect. If possible, the offending provision will be modified to the slightest degree necessary to make it enforceable, remaining as close as possible to the parties' original intent for the provision. If not possible, the offending provision will be stricken.

Assignment and Delegation

Example:

Neither party may assign its rights or delegate its obligations under the Agreement except that:

a. Property rights acquired under the Agreement may be freely assigned unless the Agreement expressly prohibits the assignment.

b. Accounts receivable may be assigned in accordance with Applicable Law.

c. Contractor may engage one or more Subcontractors to perform its obligations under the Agreement, but only with Owner’s prior written consent; however, Contract will remain fully responsible to Owner for the performance of all obligations delegated to the Subcontractor.

d. Owner may assign any or all of its rights or delegate any or all of its obligations under the Agreement to any of its Affiliates.

Survival

Some provisions of contracts – confidentiality clauses are a common example – need to remain in effect even after the contract is, for other purposes – no longer in effect. In other words, the provisions need to survive even after the rest of the contract has expired or has been terminated. Hence the survival clause.

There are two different approaches to survival clause. One is to itemize each section of the agreement that remains in effect after termination. The second is to describe those provisions without itemizing them. The following example takes the second approach.

The expiration, termination or cancellation of this Agreement will not extinguish the rights of either party that accrue prior to expiration, termination or cancellation or any obligations that extend beyond termination, expiration or cancellation, either by their inherent nature or by their express terms.

Amendments

Many business contracts, maybe even most, contain a provision that requires any amendments to the contract to be in writing. Such clauses are sometimes called “no oral modification,” or NOM, clauses. Unfortunately, they are generally unenforceable, at least in Indiana. [12] The exception is contracts for the sale of goods governed by Article 2 of the Uniform Commercial Code. [13] Even so, including a NOM clause may be a good idea because it encourages the parties to reduce all amendments to writing.

Example:

No amendment to this Agreement will be binding on either party unless it is in writing and signed by each party or executed in another manner expressly provided by this Agreement. Such an amendment does not require the consent or agreement of any third party, even if the third party is beneficiary of this Agreement.

Waiver

Business contracts often contain two related clauses dealing with waivers – one that requires all (express) waivers to be in writing and another that precludes implied waivers. For example:

No provision of this Agreement is waived unless the waiver is in writing and signed by the party granting the waiver.

No delay in exercising any right, power or privilege under this Agreement will operate to waive completely or partially any present or future exercise of that right, power or privilege.

Although these provisions are similar, they are viewed very differently by courts. Just as a contract may be modified orally even if it contains a NOM clause, a provision of a contract may generally be waived orally even if it prohibits oral waivers. In essence, the no-oral-waiver clause can be waiver orally.

The second type of waiver clause – the one providing that failure to insist on complete performance in one instance does not excuse the same nonperformance in another instance – is more likely to be successful. For a more complete discussion of waiver and modification clauses, see Stark, pp. 505-538.

Integration

An integrated agreement is a writing that is intended by the parties to be the final expression of their agreement as to one or more terms of a contract. A completely integrated agreement is an integrated agreement that the parties have adopted as their complete and exclusive agreement. A completely integrated agreement replaces all prior agreements that are within the same scope. [14]

An integration clause is a provision in a contract that (typically) sets forth the parties understanding that the contract is a completely integrated agreement and, therefore, replaces all prior agreements within its scope.

Example:

This Agreement is the final, complete and exclusive expression of all the statements, promises, terms and conditions within its scope and supersedes any prior written or oral agreements within its scope. In making the Agreement, neither party relies on any promise or statement made by the other party, other than those contained in the Agreement.



[1] These articles are adapted from materials prepared by the author for a continuing legal education seminar, “Business Contracts from A to Z,” sponsored by National Business Institute, and presented by Michael Ray Smith of Smith Rayl Law Office, LLC; and by Trevor J. Belden and Robert K. Stanley of Faegre Baker Daniels, LLP. Used by permission of National Business Institute.

[2] There is no universally accepted structure, format, or style for writing business contracts. In contract drafting, as in computers, “The nice thing about standards is that you have so many to choose from.” Andrew S. Tannenbaum, Computer Networks, 4th ed., quoted at http://en.wikiquote.org/wiki/Andrew_S._Tanenbaum. Two references sometimes used by the author are Kenneth Adams, A Manual of Style for Contract Drafting (2008). Another reference for specific provisions is Tina L. Stark (ed.), Negotiating and Drafting Contract Boilerplate (2003). These two sources are subsequently referred to as “Adams” and “Stark.”

[3] Restatement (2nd) Conflict of Laws, § 188(1). Indiana courts select the law of the state with the “most intimate contacts” with the transaction and the parties. Kentucky Nat. Ins. Co. v. Empire Fire and Marine Ins. Co . , 919 N.E.2d 565, 575 (Ind. Ct. App. 2010). Despite the different name, the test is essentially the same as the most-significant-relationship test of the Restatement. Hartford Acc. & Indem. Co. v. Dana Corp., 690 N.E.2d 285, 291 (Ind. Ct. App. 1997).

[4] Restatement (2nd) Conflict of Laws, § 188(2). The last factor in the list, where the parties are located, is a simplification of the rule. A more detailed statement of the rule is that a court will consider the domicile, residence, nationality, place of incorporation, and place of business of the parties.

[5] Restatement (2nd) Conflict of Laws, § 187(1).

[6] Restatement (2nd) Conflict of Laws, § 187(2).

[7] Adsit Co., Inc. v. Gustin, 874 N.E.2d 1018, 1022 (Ind.Ct.App.2007).

[8] Insurance Corp. of Ireland, Ltd. v. Compagnie de Bauxites de Guinee, 102 S.Ct. 2099, 2104 (1982).

[9] The Bremen v. Zapata Off-Shore Co ., 92 S.Ct. 1907 (1972).

[10] Erie Railroad v. Tompkins, 58 S.Ct. 817 (1938).

[11] See Stark, pp. 132-133, for a more complete discussion of the various approaches of the circuits.

[12] See, e.g., Sees v. Bank One, Indiana, N.A., 839 N.E.2d 154, 161 (Ind.2005) (“Even a contract providing that any modification thereof must be in writing, nevertheless may be modified orally.”)

[13] Ind. Code § 26-1-2-209 .

[14] Restatement (Second) Contracts, §§ 209-213.