Dealmaking: Three Deal-Drafting Pitfalls

By Guhan Subramanian on / Dealmaking

Adapted from “From Handshake to Contract: Draft the Right Agreement” by Guhan Subramanian in the October 2006 issue of the Negotiation newsletter.

The transfer of an agreement from negotiators to lawyers or other professional deal drafters can introduce three main types of mistakes. Read on to discover how you can avoid making these same mistakes at the bargaining table during your next dealmaking negotiation session.

1. Contract Terms Do Not Accurately Reflect the Agreement

Recently, the managers of a Boston-area child-care center negotiated with their board of directors for a change in the center’s policy. The center was experiencing high mid-contract turnover, which caused classroom disruptions and significant costs. The center’s policy held parents liable for monthly tuition only until a replacement child was found.

Specifically, the contract read, “Deposit: This amount will be held until the end of the contract period, and may be used toward the final month’s tuition if the child’s enrollment is to be terminated.

Because a replacement was usually found quickly, parents received their deposit ($1,500-$2,000) and exited the contract at no cost.

To compensate for the center’s replacement costs, management and the board agreed to require parents to forfeit their deposit if they left the center midcontract, even if a replacement child was found immediately. The center’s managers asked their lawyers, members of a respected Boston-aread law firm, to implement this policy for the next year’s contract. The lawyers drafted the following, changing only the final words of the clause: “Deposit: This amount will be held until the end of the contract period, and may be used towards the final month’s tuition if the child completes the contract.”

Sure enough, in the next school year, a child left mid-contract, triggering the revised clause. The parents pointed out that the new language said nothing about whether they should get their money back. The center’s managers were puzzled.

Had they not been clear enough with their lawyers? Their intended interpretation required reading the “if” in the clause as “only if.” But this reading couldn’t be correct, either, as it would imply, for example, that parents wouldn’t get their deposit back if the center closed midyear.

The center’s managers returned to the drawing board. With assistance from students at Harvard Law School, they came up with the following: “Deposit: If the family decides to terminate the contract before the end of the contract period, the deposit will not be refunded. If the family successfully completes the contract, the deposit may be used toward the final month’s tuition.”

A year after negotiating the policy change, the center finally got contractual language that reflected its intention. Poor communication between the principle (the day-care center) and its lawyers kept the terms from accurately reflecting the understanding that the center had reached with its board.

2. Critical Deal Terms Are Often Missing or Vague

In 1995, Computer Associates (CA) of Islandia, New York, negotiated pay packages with its top executives that included significant stock grants. However, although the company and its managers clearly intended to include language authorizing the alteration of the number of shares that could be awarded, the contract approved by the company shareholders did not include such terms. In 1996 and again in 1997, CA split its stock. When board assumed an adjusted such an adjustment in making its stock grants, shareholders sued – and won.

A Delaware court ordered CA’s top executives to return $558 million of CA stock to the company. The lawyer’s language was not inaccurate, as in the day-care center case; but rather, they forgot to include supplemental terms to handle a very likely contingency.

3. Deal Terms Contradict Each Other

In complicated deals, lawyers sometimes can help their clients identify contradictions inherent in the agreement. Imagine a contract in which the seller is supposed to make monthly deliveries, but the buyer is supposed to pay weekly. It’s likely that the buyer and the seller intended the buyer to pay in installments, thereby reconciling these potentially conflicting terms. A good lawyer will point out this tension so that clients can clarify their agreement.

In other cases, the lawyers themselves create such contradictions. When Silicon Valley software firm PeopleSoft went public in the mid-1990s, its bylaws said that directors could be removed “with or without cause,” while the charter said directors could be removed only “for cause.”

Which was it?

Fortunately, corporate law dictates that the charter rules in such cases; in other situations, however, such discrepancies are a recipe for headaches or even litigation.

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2 Responses to “Dealmaking: Three Deal-Drafting Pitfalls”

  1. Rory Cleland /

    Great article. just goes to prove the saying: "if you can't construct it, de-construct it", i.e. break the clause down so that it is understandable to the 'idiot in a hurry' and not just the reasonable person. Reply

  2. Val Schabinsky /

    Thanks for emphasising the importance of: 1) Ensuring the contract terms accurately reflect the agreement 2) Making clear the Critical Deal Terms 3) Avoiding deal terms contradicting each other Reply

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