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The Importance of Contracts

In today’s complex business environment, having a basic understanding – and appreciation – of contracts is critically important.  Too often, we (attorneys) see a dispute arise because there is no contract between the parties or only a unilateral document governing the parties’ relationship. In other cases, we see that one or both of the parties did not understand their contractual obligations at the time they executed the agreement.

Contracts govern the relationship between the parties – before, during, and after the agreed upon services or transaction.  In the event of a dispute between the parties (or even with a third-party), the contract may govern the parties’ obligations and the dispute resolution process.  The contract may even define the parties’ damages in the event of a breach of the agreement.

Ultimately, the value of contracts is in their ability to specifically define the parties’ rights and remedies.  This allows the parties to determine what their obligations will be and their potential exposure in the event of their own failure to perform, or the other party’s failure to perform.  After all, contracts are the terms agreed upon by both parties.

Although the law will enforce oral and written contracts or agreements, to accomplish the goal of the contracts, for the reasons set forth in this article, the contract should always be in writing

The following is a brief review of some of the most important contractual provisions that should be analyzed in each agreement.

Indemnity is the obligation to secure or protect another against loss or other financial burden. These complicated and lengthy provisions typically obligate you the contracting party to indemnify a second party in the event that a third party makes a claim on the second party. This obligation may be triggered by your negligence or even the allegation of your negligence. The obligation may also be triggered by the negligence or alleged negligence of your subcontractor or consultant.  These provisions may also include your (immediate) duty to defend or hold the second party harmless.2. Attorneys’ Fees

When a dispute does arise between the contracting parties, an attorneys’ fees provision allows the party prevailing in the litigation or arbitration to be awarded its attorneys’ fees.  Notably, under California law, an attorneys’ fees provision in a contract applies to both parties, even if the contract indicates that it only applies to one of the two parties.  Attorneys’ fees provisions can significantly impact the resolution of a dispute: in addition the disputed damages, the parties are at risk of incurring the other party’s attorneys’ fees.

Also, if there is no attorney’s fee provision in the contract, no attorney’s fees are recoverable by the winner from the loser unless there is some statute that allows it. Good examples of this are attorney fees recovery against the surety on a public works payment bond, attorney fees recovery by the prevailing party under the prompt payment statutes and so on.

Also, fees might be recoverable even if there is no fee provision in the contract you signed but there is a fee provision in an incorporated other agreement.

Always make the small investment in having a lawyer review any contract before you sign it.3. Dispute Resolution

Often, contracts will include dispute resolution procedures including mediation and/or arbitration.  In some cases, submission of the dispute to mediation is a prerequisite to the award of attorneys’ fees (i.e., failure to submit to mediation may waive the right to attorneys’ fees) or even to bringing suit.  In other cases, the dispute must be submitted to arbitration instead of litigation (i.e., submitted to a judge or jury).   Mediation is non-binding: the mediator attempts to facilitate an agreement between the parties.  Arbitration, on the other hand, is typically binding: the arbitrator makes a binding decision.4.Limitation of Liability

“Limitation of Liability” provisions typically limit one party’s liability (exposure) to a set amount.  The amount may be an agreed-upon figure, the contract amount (project or transaction), or the limits of the available liability insurance or surety bond

With respect to surety bonds, the limit or penal sum of the bond does not change with the bonded contract amount unless there is a written agreement that does it does. Normally, if a $500,000 contract increases by another $500,000 due to change orders, the penal sum remains at $500,000 but the fee you pay for the bond (the premium) increases because it is based on the contract amount and not the penal sum of the bond.5. Liquidated Damages

Liquidated damages are a specific amount of damages that are to be assessed in the event of a party’s breach of its obligations or late performance of its obligations.  Liquidated damages are not meant to be a penalty, but to allow the parties to specifically determine – and agree upon – their exposure.

The wording of a contract (indeed, a single word) can trigger or negate any of the above contractual provisions. As a result, careful review of the contractual provisions in your own standard contract or any proposed contract is of the utmost importance.

Often, parties do not seek to revise or negotiate a contract out of fear of losing a business opportunity.  However, entering into an unfavorable contract can cost a party more than the lost business opportunity.

To ensure you have the strongest protection available, Lanak & Hanna has experienced attorneys available to review and analyze all of your contract needs. We are also available to give live presentation to your group on this topic or surety bonds or any other topic having to do with construction or insurance.