Habit #2: Give Important Contracts Special Attention

I sometimes give a presentation on simple contracting practices that businesses can adopt to reduce their risk. I’ve posted a cliff notes version in Contract Hygiene: Five Healthy Contracting Habits (Part 1) and (Part 2). Without spending a dime on lawyers, a lot of businesses can significantly reduce the number and size of the time bombs that are sitting in their file cabinets cleverly disguised as contracts.

Habit #2 is Give important contracts special attention.

Not all contracts are created equal. A copier lease isn’t as important as a supply agreement for Coke’s super-secret ingredient. If the business relationship is critical to your operations, if there is a lot of money involved, or if your business would be exposed to out-sized litigation risk if something went wrong, you should invest more effort into ensuring that the contract terms are acceptable. You don’t necessarily have to hire a lawyer, but you should escalate contract review to higher executive levels and consider whether the risks the contract terms impose on your company are worth the benefits of the business relationship.

It’s Important to Think Through the Whole Deal

Business relationships are often complicated and involve parties that are not bound to each other by contract. That was the case in Lakeside Feeders, Inc. v. Producers Livestock Marketing Assoc., an Eighth Circuit case whose opinion was filed yesterday. The case involved tort-based claims of fraudulent misrepresentation and negligent misrepresentation, as well as unjust enrichment (all of which can be difficult to prove), rather than breach of contract. The reason is that the plaintiff trade creditor sued its customer’s lender, rather than the customer itself, possibly because the customer wouldn’t have had the funds to pay a judgment.

The defendants, Producers Livestock Marketing Association and Producers Livestock Credit Corporation, which the court’s opinion refers to as “Producers,” entered into a financing arrangement with Prairie Pork, Inc., which the opinion refers to by the name of the company’s owners “Gayer.” Under the agreement Gayer would acquire hogs and raise them and Producers would provide financing. Lakeside agreed to provide feed and care for the hogs and appears to have dealt directly with Producers rather than Gayer. Lakeside operated by way of a “handshake agreement” and “there was no written contract memorializing any agreement between Lakeside and Gayer, or between Lakeside and Producers.”

Gayer’s financing agreement with Producers required Gayer to provide 30% of the funds necessary for its operation. When Gayer failed to provide the funds required under the arrangement during an industry-wide slow-down, Producers refused to pay Lakeside because it didn’t have the funds from Gayer.

What Will You Do When Things Go South?

An important part of thinking through a business deal is considering what you will do if the deal falls apart. From an arm-chair quarterback position, Lakeside’s mistake was that it failed to require security for the trade credit it extended. In addition, Lakeside seems to have been unclear whether its customer was Gayer or Producers and whether one party or the other — or both — had a binding obligation to pay Lakeside. The Eighth Circuit stated, “We do not attempt to surmise as to why Lakeside failed to take steps to legally protect its interest by way of a lien or at the very least a contract, but ultimately it is these failings that paved the way for the instant circumstance.”

Maybe I should revise Habit #2 to be “Give important business relationships special attention” instead of focusing just on the contract. If a business relationship is important, you should make sure that your rights and responsibilities are well defined and documented and that you think through the contractual relationships and what position you’ll be in if the deal goes bad.