Contracts perform at least two functions:
- Notice and Communication: Contracts are a form of communication in which the parties state their intentions and expectations while also providing each other with notice regarding what they care about and how they are wiling to work together.
- Accountability: Contracts not only provide the parties with information, they also provide an objective standard which third parties can consider and use to evaluate whether the parties to the contract have performed under the contract.
When parties engage in a relationship which constitutes a contract, they are engaging in a bargain where each party gives something in exchange for something else. Presumably, each party is giving something of less value to get something they value more resulting in a net gain by both sides. However, in order for the parties to actually get what they want, while giving away what they can, the parties have to actually understand and know what it is they are giving and getting. There has to be a meeting of the minds between the parties, and this only occurs when each side both effectively communicates with the other side, and understands the other side’s position.
The end goal of any contract is performance. Hopefully, the parties do not have any disputes, but sometimes a party needs to get out of the contract or the parties cannot agree about their rights or responsibilities required by the contract. This is when the contract performs its second function of being the standard a third party will use to hold the parties accountable if they cannot resolve their differences on their own. How disputes will be resolved is not only important at the end of the day, it is important for calculating the value of the bargain at the beginning of the process. A parties’ understanding of how disputes will be resolved, and the risks and costs associated, will affect their choices and behavior long before there is a full breakdown of the deal, and may in fact be essential to whether a deal can be reached in the first place.
Here, I want to address two optional provisions of a contract which are sometimes overlooked, but which can be essential for parties in establishing the right allocation of risks and benefits of a deal. These are provisions on Alternative Dispute Resolution and Attorney Fees.
Alternative Dispute Resolution
By default, if parties are unable to resolve a dispute themselves, the recourse is to go to court. This often means attorney fees, costs, delay, uncertainty, and emotional expense. A party has to consider the costs of this process as a part of determining how they will proceed. Sometimes, this is the best option for parties, but it is not the only option.
In the contract, parties can agree about how they will resolve a dispute. While there are many ways this can be done, a basic first approach is to require the parties to engage in a mediation.
A mediation is essentially a conference where a third party is selected by the parties to work with each of them to see if they can resolve the dispute. While parties may be required to conduct a mediation in good faith, neither party can be required to resolve the dispute at a mediations. Sometimes mediations can take days of back and forth to get to a resolution, and sometimes mediations will be over in only an hour or so without any resolution. The primary value of a mediation is getting a third parties take on the situation, and this is sometimes enough to get the parties to compromise.
A second basic option is for parties to agree to an arbitration. An arbitration is essentially a mini-trial before one or more private decision makers and is usually binding on the parties. It is usually binding because the parties agree that it is binding and the decision can be submitted to a court to be enforced without the court second guessing the decision.
Arbitrations are supposed to be quicker, more efficient, and less expensive than a court trial. This is not always the case, but often can be. One of the advantages of an arbitration is that it is not subject to the procedures and rules associated with trials, and a decision generally cannot be appealed. Arbitrations do have their own rules depending on what arbitration organization is used. Of course, the things that make an arbitration better can also make it worse. The fact that an arbiter might misapply the law or misinterpret the contract is not a basis to overturn an arbitration decision because the parties have agreed to abide by the decision of the third party. Parties generally have to pay for an arbiters time and the cost of the process at an hourly rate while courts do not have such charges. Parties often have legal representation in arbitrations such that the cost of attorney fees may not be less than in court.
An alternative dispute resolution provision can state what organization will conduct a mediation or arbitration, what rules might apply, how costs and fees will be allocated between the parties or awarded in a decision, where the mediation or hearing will take place, what law will be applied, how many mediators or arbiters will be involved, the timing for an arbitration, and how the decision will be enforced. Such provisions may also state whether only one, or both parties, can require a mediation or arbitration. Generally, arbitrations are private and the parties can keep the existence and content of an arbitration confidential.
In general, each party will be required to pay its own attorney fees in any dispute. There are some statutes and situations where a party can recover attorney fees. One of those situations is when the parties agree in a contract about who will be responsible for which attorney fees.
Including an attorney fee provision can be extremely important for a party who is successful in a dispute, whether in court or before a third party. An obligation by a loosing party to pay attorney fees to the prevailing party changes the calculation for what a party may be willing to do both in potential settlement negotiations or in the litigation or arbitration process. In short, when a party is likely to succeed, they have leverage over the other party to require a higher settlement and less incentive to resolve the matter before trial or without a substantial recovery. On the other hand, a party that is likely to loose will be responsible for both their own attorney fees and that of the other party, and the party will have an incentive to resolve the matter for less than the combined liability and to shorten the time in which attorney fees are accruing.
Attorney fees also make a big difference in negotiations of a contract. When a party has the right to recover their attorney fees for enforcement of the contract, it lowers the risk of entering the agreement in the first place because they will have a better chance of recovering not only their damages, but the cost of getting their damages. In many ways, an attorney fee provision increases the pressure on the party that is considering a breach to perform by increasing the cost of a failure to perform.
Both Alternative Dispute Resolution and Attorney Fee provisions are key to properly balancing the give and take of a contract. It is important to realize that the failure to consider such provisions is a decision about the nature of the bargain in question and creates a certain balance or imbalance. It is one thing to consider such provisions and affirmatively decide not to include them, and quit another to never consider them at all.