The 3 Contract Clauses You Need to Review Before the End of the Year

Being a small business owner means taking on several jobs at once by being your own chief executive, accountant, human resources manager and even lawyer. 

That can lead to shortcuts, as entrepreneurs focus on their strengths and make do in the areas where they aren’t as knowledgeable.

As a business contract lawyer, I’ve seen the results of some of these quick fixes, as small business owners reuse boilerplate contracts year after year, even as their business grows and legal precedents change.

Contracts are vital assets for every business because they lay out the “rules of engagement” or expectations for each party. Whether its employment contracts, independent contractor agreements, service agreements, leases, or any other agreement that spells out the parties’ understanding and expectations, these documents act as bodyguards for the small business owner. 

Many contracts renew automatically at the beginning of the year, therefore year end is the perfect time to carve out a small chunk of time to review these documents in order to significantly improve your chance of avoiding costly mistakes in 2021.  

Below is a closer look at three potential problem areas.

Arbitration Clauses

No business owner wants to end up in court, so many contracts include an arbitration clause in which the parties agree to settle any legal dispute outside of a courtroom through a private process that is typically binding and hard to overturn.

Most attorneys agree that arbitration is extremely advantageous to big business. As a good example, consider Amazon and Grubhub, both of which are currently fighting in court to uphold their mandatory arbitration provisions in contracts with their delivery drivers. In recent decisions, federal courts held that certain delivery drivers’ arbitration agreements were unenforceable. 

It is unlikely that big businesses such as these will let go of their preference for arbitration without a fight, and Amazon has teed this issue up for review by the Supreme Court. So, we will have to stay tuned in 2021 to see if the high court agrees to hear and provide guidance on this issue. 

But this doesn’t mean that arbitration is equally good for small businesses. In fact, it’s probably not good for yours. Unlike in court where parties have no say in picking the judge that oversees the case and may ultimately decide the issues, in arbitration the parties get to select the arbitrator or arbitrators that will decide the case. 

The reason that big businesses, like economic powerhouse Amazon, always favor arbitration is because they are sued frequently, and arbitrators who make the ultimate decision have a direct economic incentive to favor defendants that routinely appear before them. 

Even assuming the arbitrator selected has no favor or bias towards one party over the other, big businesses still have strategic advantages in arbitration because they can keep a tally of decisions made by specific arbitrators and collect data that will forecast which arbitrators are most likely to render decisions in their favor. 

Unlike court proceedings, arbitration is usually confidential so there is no public record or transcripts available. Thus, small businesses that are not frequently sued and routinely involved in the arbitration process do not reap many of the benefits of arbitration that make it preferable and a valuable competitive advantage for big businesses.

Arbitration is also generally believed to a faster and more cost-effective alternative to litigating cases in the court system. 

However, small business owners may be unaware that time savings likely comes at a significant cost for two reasons. First, the filing fee in court is a one-time cost that is typically $500 or less depending on the court and locale. After the filing fee is paid in court, the costs incurred stem from third parties assisting with the case, not the court personnel or judge who are paid by tax dollars. 

For example, litigants usually pay attorneys’ fees and fees for expert witnesses to write reports and/or appear at trial. Although the need to hire an attorney or expert witness may exist in both court and arbitration, arbitration has significantly higher filing fees which are calculated on a sliding scale based upon the amount in dispute. 

Filing fees for arbitration can be double or triple that of court filing fees. Then, after arbitration is commenced parties have to pay both administrative fees to the arbitration body, such as American Arbitration Association or JAMS, and fees to the arbitrator, or panel of arbitrators, who decide the case. 

Second, although the arbitration rules pare down the amount of discovery, or investigation, that a party can conduct to obtain information about the strengths or weaknesses of the opposing side’s position, lack of investigation into the facts can be a double edged sword. As matters become complex, the need for more discovery is paramount. This is especially true when arbitrators are not bound to strictly follow the letter of the law but can make rulings based upon the arbitrator’s gut intuition of what they believe is “fair.”  

If you have an arbitration clause in your contract because you think it’s going to be faster, cheaper and better than going to court, you may want to consider taking it out. 

Non-Compete Clauses

Another standard clause used by small business owners in contracts, mainly with their employees, are non-compete clauses. 

These clauses bar an employee from working for or starting a business that directly competes with your business for a period of time following termination of their employment. 

These types of clauses are usually disfavored but are upheld by courts when they are narrowly tailored so as not to restrict free trade by eliminating a former employee’s ability to earn a living at his trade. 

The COVID-19 pandemic, however, may make it easier for employees to skirt non-compete clauses no matter how ironclad they seem. 

Although the enforceability of non-compete clauses varies from state to state, the underlying principal that remains constant is that non-competes must be reasonable in terms of scope, duration, and locality. In sum, they cannot result in undue hardship to the employee. 

In the current economic crisis — where our country is facing the highest unemployment rates in more than seven decades, with millions furloughed and laid off — it’s a given that the labor market will take some time to rebound even if a vaccine is released in the near future. 

An employer’s inability to hire qualified candidates due to restrictive non-competes may only exacerbate the current crisis and delay economic recovery efforts. This will likely result in many court’s inclination to hold unenforceable such provisions even when they are narrowly tailored due to public policy concerns involving the limited employment opportunities that exist as a result of the pandemic. 

There will always be a public interest in upholding enforceable contracts, allowing parties to freely contract with one another, preventing unfair competition, and protecting trade secrets, however, countervailing interests which have arisen due to the devastation caused by the pandemic make these clauses more susceptible to challenge and at risk of being struck down.  

So what should small business owners do? 

First, you should ensure that your non-compete clause contains language that any delay in seeking to enforce the non-compete provisions, or obtain injunction relief, shall not operate as a waiver of such right. Your agreement should take into account that you may make a business decision not to go after a competing employee in the midst of the pandemic, but at the same time provide you with the flexibility to change that business decision as circumstances develop without negative consequences. 

Second, you should review your non-compete provision to ensure that it accurately reflects the needs of the business, specifically with respect to location, duration, and scope. If for example, Covid-19 has impacted your business’ ability to maintain operations in certain areas for the indefinite future, your non-compete should be reviewed to determine if its scope should be narrowed. 

Force Majeure

Force majeure clauses excuse a party from performing their obligations under a contract when they are prevented from performing due to an extraordinary event. 

Force majeure, which in French means “superior force,” only refers to events that are outside of the reasonable control of a party and allows a party to forgo performance and in some cases still receive compensation. 

Contracts usually list specific force majeure events such as acts of God, fires, floods, riots, earthquakes, or strikes. A party’s ability to invoke a force majeure clause is largely dependent on the specific wording of this clause in their contract.

Small business owners should first make sure their contracts include a force majeure clause or similar language to address situations that prevent performance and are beyond the control of the parties to the agreement.

If such clause is present, the next step is to review what events are specifically listed in the force majeure clause and to make sure that “pandemic” is listed. If pandemic is listed then it will obviate the need for business owners to establish that the event was unforeseeable. If “pandemic” isn’t listed it is possible for a Court to determine that the doctrine of force majeure, or impossibility, still applies it will likely just be more costly and time consuming and a step that can be avoided by a proactive review and update to your contracts. 

Winter is knocking on our door and its likely many of us will be staying put instead of making travel plans to visit family or friends or flock to warmer weather, so now is a great time to go over these contracts. 

The routines we have been following for years might have work previously, but chances are very high that outdated contracts can handicap a business if a business dispute arises. This is especially true during the midst of a pandemic, when courts are backlogged and the likelihood of swift justice illusory. 

So take the first step to reaping rewards in 2021 by reviewing and analyzing the contracts you already have in place in order to avoid any unforeseen surprises.

D. Margeaux Thomas will appear on Law Insider’s “Contract Teardown” on Tuesday, December 1 talking about this and more.

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