“A contract is only as good as the people who sign it,” was a saying often quoted by an elderly attorney I worked with for the first fifteen years of my practice and I always nodded in his general direction when he said that and smiled as if agreeing. I liked and respected him, he had won more cases than there were months in my life at the time and he had lived in a legal and business world in which the entire community knew one another and knew who to trust.
That world is long gone, with our population quadrupled in terms of business people and multiplied by ten in terms of attorneys practicing. The odds are good you now deal with strangers, know little about them, and simply cannot trust that the influence of the community will direct their actions.
But even in his smaller, kinder, world, I wondered how accurate his quotation was. Why bother with a contract, then, I always thought. Simply rely on people to do “the right thing.” Since that lawyer had written thousands of contracts, his actions belied his words.
When people are angels perhaps contracts will not be needed. That time is not now and any business which does not have its battery of contracts is not long for this world.
But it’s not just the contract that is useful for business-the very process of getting a contract can teach you a great deal about the person who you are thinking about joining in a business venture. Indeed, if done correctly, before you sign on the dotted line, the negotiation itself will tell you what is likely to happen.
As I saw with a doctor who now lives in Tuscany, in part because he and I learned all we needed to know about a man waving a million dollars in his face and begging him to take it.
The doctor turned him down cold and it was “the best deal he never made,” as he told me a year later.
Doctors are notoriously difficult for lawyers to work with…at least according to lawyers…who find that the doctor’s scientific background gives them little patience for the maneuvers and subtleties that mark the usual business negotiation. To many doctors, the answer to a legal or business question should be as straight forward as a simple diagnosis.
And as more and more doctors are forced to become business people, they confront more and more “grey” areas of business and employment law which are imposed upon their consciousness whether they like it or not. That doctor called it being forced to slide into the “…mire of complex chemical bonding of inarticulate and unintelligible legal jargon.” I didn’t argue when he said that because he was a genius and I had learned not to argue with a genius.
He was a research scientist who had invented a device that measured some microscopic part of one’s intestine that somehow was going to make him and his partners rich. At least that’s what he thought and since one of his partners knew a big time venture capitalist (“VC”) with a lot of successes to his name, that might just happen since he would have the capital to bring it to market.
But the problem was we had to negotiate how to get that VC into the company without giving the company away and the VC had a reputation for coming in with lots of money…then suing everyone in sight long enough that, broke and distraught, they threw the asset in his direction and gave up control of the product. One of my law partners called him the “’poison pill” of VCs since once you took him in, it was only a matter of time until your control of your company died. We needed his money and my task was to find a way to have the money but not the turmoil.
“You think he is trying to trap us like he did the others?” asked my doctor client.
“Don’t know. VCs get a bad rap no matter what they do. Inventors like you always blame them for coming in and trying to protect their investment by putting controls into the company. VCs always blame the inventors for thinking that because they can invent something, they can run a business. It’s hard to know what the guy is really all about.”
He was annoyed that I had hinted he was bad at business. He paused, then snapped, “So…test him.”
He had that exasperated look on his face he got whenever he was forced to say something that he considered self evident to us mere mortals. That always annoyed me and since we were old friends I let him see that.
“Right. Good idea. Written or oral?”
“Anything can be tested. That’s the nature of reality. There must be a relatively objective method available.”
Of course he had a point but I was curious to see what he thought would work. “Lie detector test? Perhaps we can torture him to get him to admit his motivations? I’m sure…”
“Not scientific,” broke in the doctor, not smiling. “Polygraphs seldom are reliable and torture is useless to find the truth. The subject merely tells you whatever you want to hear to stop the torture. No, use a scientific test for good faith. After. what, a thousand, five thousand contracts, you must have one. Use it.”
I stared at him and he stared right back. A long moment of silence. “You still don’t get that law is not medical research. There are no sure fire tests…No patented devices for honesty and integrity. Perhaps that could be your next invention…”
He pressed. “I do not believe that you have not developed a series of questions or methods by which to accurately gauge the good faith of a prospective investor and I suspect you are teasing me because you are annoyed with me.” He would talk like that, you see. Then he grinned. “I am told you are brilliant at this. This should give you an excellent opportunity to demonstrate it.”
Anyone calling me brilliant can mollify me so I explained, “There are some methods, some pretty good ones. But they are not objective, I suppose. We don’t put it into a test matrix, doctor. Besides, we have little bargaining position you tell me. We need his money. You only have one source now available. What do you do if he fails my test?”
He stood up, all five feet six of him, one finger in the air. “You find out if he is interested in working in good faith as a team or not. If the latter, the money I lose in rejecting him is trivial compared to the trouble I would have in accepting him. There are other sources of money out there…” He paused for effect “…but only one product that can do what this does.”
Of course he was wrong in that, several other competing products came out a few years later….but he was dead right in that there are some pretty good tests that anyone can use to determine if a potential business partner is more interested in seizing power than sharing profits, as can be seen by what happened in this negotiation.
The VC never used a lawyer for the initial negotiations, only when it was time to close the deal and after ten minutes in the room, I could see why. This was during the High Tech boom times when wearing a suit and tie was considered an antique fashion and most of the young brilliants wore “Banana Republican” Khakis and pastel shirts, no tie, loafers. That is what I expected but he appeared in a conservative three piece business suit, horn rimmed glasses and reminded me of Clark Kent on a mission. Soft spoken, almost shy but clearly with an agenda.
And he knew his stuff. He had a scientific background, a sharp mind, and had done his homework. He had signed all the confidentiality agreements I had insisted upon without demur, without change, even agreeing to clauses prohibiting him from entering the particular medical field we were servicing if our deal did not go through. That surprised me. VCs don’t like to be restricted in such a broad fashion. But as I watched him work the doctor, I realized why. He had no intention of not buying the product and was convinced we would sell it to him since he was the only game in town.
The doctor liked him. They were both tech nerds, both loved the elegant simplicity of the device, both were happy it was going to make a huge difference in medicine, and neither was only in it for the money. I might as well have been in another building as they poured over the specs and discussed the European market. I let it go on for an hour then threw my monkey wrench into the love fest with my first question.
“How much will you put in for how much interest, Mr. Oswald (not his real name)?”
They both looked at me as if I had uttered a profanity. I smiled. “Sorry, but that’s what my job is, you know. Money and power. Unpleasant things but necessary to consider.”
Oswald paused a moment, then opened another file. “Our firm has standard criteria for determining how much to invest and when.”
“And those criteria indicate that you will put in a little money now, and only be obligated to invest more if certain milestones are met in a timely manner and if they are not met, you gain control of the company?”
He looked at me a moment, then smiled. “Of course. We do not write blank checks. But we are reasonable in those criteria. I can see your client owns a very valuable product and has done a great deal by taking it this far on the business plan. I am very impressed.” He looked at the doctor to show him he was impressed. The doctor looked back to show him he liked that.
“We are delighted you agree that we are well along in our plan,” I said, fiddling with my own papers, “and, of course, we need to know specific amounts and specific criteria in some detail. We are not interested in losing control because we are a few weeks late in the implementation of the business plan.”
“Of course not. You will find we are reasonable and I am talking about a million dollars upfront money right now…within two days of our execution of the documents…with an additional two million upon prototype being finished within six months and a final three million upon approval by governmental authorities. For twenty percent. That is quite reasonable, I believe. One seat on the board unless criteria are not met. Three seats on the board if criteria is not met after ninety additional days. And you will find our timelines are more conservative than yours. And the doctor remains CEO.”
I nodded but thought, “Until we blow a deadline. Which we will, business being what it is…and you get the control of the company ninety one days after that happens.” But what I said was, “That seems something we can use to start our discussions, certainly.” He nodded, realizing that the Dance of Negotiations had begun and waited for our counter. Instead, I used my first test.
“It is unusual to begin at the enforcement of contracts end of our discussions, I realize, but it is important for us to know if the document we eventually create is practical from our point of view.” He was a bit surprised and raised his eyebrows. I went on. “The best contract in the world is of no use to us if the expense to enforce it is beyond our capacity. And dangerous to us if our adversary has funds to enforce it and we do not. We like efficient and inexpensive methods for enforcement.”
He leaned back in his chair, considering. “You are speaking of arbitration, perhaps? Avoiding formal court and discovery and all that for a private judge?”
“Smart boy, “ I thought, and wondered how he would turn it down. I nodded.
He shook his head sadly. “We once thought that would be an excellent alternative to the law courts. It certainly had its advantages. Without depositions, without the need for long court law and motion matters, we did save tens of thousands.” He looked at the doctor, very sincere. “But we discovered why discovery and those formal court procedures exist. They exist for a reason, you know. That’s how you discover the truth.”
The doctor had immediately understood that he was witnessing the “test” he had asked for and, like any good scientist, did not interfere with the test in progress. He merely looked back, interested but noncommittal. Oswald saw that and turned back to me.
“We like to know what the other side is going to present and not be surprised at the hearing.”
“Perhaps I could agree with you…but that is a moot point. We can always agree in our arbitration agreement to allow depositions or other forms of discovery. Limit them to save expense, but allow critical discovery. So that’s no real problem, is it?”
He tried another approach. “No appeal. And the arbitrator is not even bound to follow the law. Is that not true?”
“Somewhat true. The Courts are lenient in overturning their decisions. Give the arbitrators great latitude.”
“Yes. Such laxity that in our case, despite the appellate court knowing that the arbitrator was wrong on the law, he still upheld the award. We were outraged.”
I bet you were, I thought. “That seems most unfortunate. But I have been in hundreds of arbitrations and that has never happened. Most arbitrators do their best to follow the law and apply it. I know of no exceptions. You must have been very unlucky.”
He said nothing, just watched me do my stuff.
I went on. “It’s simple, really, A small contract case will take two to three years and cost at least a hundred thousand dollars to try and there can be two more years of appeal. That same matter in arbitration would cost half as much and take six months. The odds of a bad arbitrator are really not much worse than the odds of a bad judge or jury, are they?”
“Perhaps not, but we get full appeal rights in court. Almost none in arbitration. We just won’t go along with taking that chance again. That is a deal killer.” He watched me to see what I would do.
I paused and did nothing waiting to see if he was firm. He said nothing, I still said nothing and the doctor looked at me to see if this test was enough to kill the deal.
It was not. Oswald had a good point and I knew plenty of very good attorneys and business people who hated arbitration, figuring that arbitrators, largely unafraid of the appellate courts, could be tyrants and dangerous and who wanted unlimited discovery so they would not be surprised by evidence at the arbitration.
But one could always put discovery into the arbitration clause if that was important and most arbitrators, including myself, were pretty good at following the law. Arbitration is not perfect. Neither are the courts. But we could afford arbitration and it was a real question if we could afford a real fight against such a well funded opponent if push came to shove. A contract without power to enforce it…is not worth the paper it is written on. I smiled as I thought that and the VC wondered what was going through my head.
What was going through my head was the real test I was planning to use now. And this test was the important one, the “acid test” and I went to it immediately. “Well, if we cannot use relatively inexpensive methods of enforcement, we can still avoid some of the problem by simply providing that the winning party in any dispute gets attorney fees from the losing party. Simple as that. It stops fights before they begin since both sides only go to court if they are convinced they will win. No insincere fights since if you lose you pay for your opponent’s attorney fees as well.”
And was the great equalizer as well. To win a fight and get a million dollars but spend two million to get it means you lost even if you won. A big budget opponent knows that and can destroy your case by simply forcing you to spend money. But if the winning side can get attorney fees from the other side…well, the cost benefit ratio then allows even the party with less money to take on a giant…if they are convinced they will win.
He tapped his fingers, face blank. I went on. “That’s the law in Germany and in quite a few European nations, you know. That’s one reason they have so little litigation. No nuisance suits. Here, as I am sure you know, in most cases you don’t get awarded attorneys fees if you win unless you put it in the contract. We almost always do that in our contracts.”
He sighed, glanced at the doctor, then answered, eyes on his file. “Well, that has not been our experience at all. Indeed, not. Indeed, attorney’s fees being awarded to the winning party encourages litigation in our experience.”
I leaned back in the chair. “Really? We seem to have a very different history. What would be the rationale for people starting nuisance actions if they knew they would not only pay their attorney but yours as well? One would expect that to be…a disincentive, no?” I wondered what nonsense he would develop.
“One would think so, but people are irrational. They think it will give them more when they win.”
“As it would. And if both sides think they will win, that is a fight that should go forward and the one that is right will be made whole. That seems only right to us.”
Another silence. In reality, we both knew what the real issue was. If he had a lot of money and our client did not, an attorneys fees clause such as we proposed would allow us to fight him if he started a suit just to force us to capitulate because the fees were so high. Any party really intending to work in good faith should have no hesitation in such an obviously useful clause-a clause that truly makes the wronged party whole if there is litigation.
“Anything that makes it easier to go to court hurts business relationships, “ he said to the doctor, “and this clause encourages people to take their chance in court rather than work out their differences.”
The doctor looked at me, saw my expression, and turned back to the VC. “Utter nonsense, Mr. Oswald, and I am upset that you think such weak arguments would sway me. Of course we must have an attorney fee shifting clause or I could never approach your litigation budget and you could use your in house staff of attack dogs to force me to accept any position you take.”
“Attack dogs? “ I asked, a little upset.
“Attack dogs?” Oswald said, equally upset.
“Present company excepted, of course,” went on the doctor, not even looking at me. “Mr. Oswald, I am not a nincompoop. I am aware that if you have a hand gun with bullets and I have a hand gun without bullets, that all your expressions of good will and interest in my project mean little for if we have a falling out, you will win. I see this clause as loading my gun…which neither will hopefully ever use. Please do not insult me by pretending otherwise.”
The doctor was outwardly calm but I could see he was inwardly furious. He felt he was being played for a fool, had been set up by the interest in his project shown by Oswald who was simply pulling a con job on him. I was not upset…this is all part of the game and any VC who did not bargain in this manner was not much of a VC. The doctor was new to this and still emotionally involved.
Oswald also saw the dynamics and tried to save the day. “Doctor we have a difference of opinion. This is not an insult, merely what allows fruitful negotiations.”
“Again, nonsense. If you treat me as a man of above average intelligence, you would have honestly stated that you, with more funds, wish to be able to bludgeon me into submission if we have a legal fight, knowing that I will never get back the fees I spend for my own legal counsel and that my only hope is to meet all criteria religiously. That is your actual position, is it not?”
Oswald was getting angry and I was seeing this negotiation collapse and was looking for a way to break into their argument. Oswald leaned forward. “Doctor, you invented a fine device. You know I like it. It is not proof of business acumen or negotiation skill.”
“That is certainly true, “I interjected, and gave the doctor a look telling him to shut up before Oswald walked.
The doctor leaned back in his chair, seeing that I wanted him to calm down, but before I could say something, looked at me and simply asked, “That is your test, correct?”
Silence in the room. Oswald, looking confused, was staring at me.
“Well…yes.”
“Then this is a waste of time since he has failed it. Let us end this now.”
Oswald could not believe it. He held up his file. “I have a million dollars in an account ready to be deposited into your company the moment we agree. Our terms are certainly within the range of your thinking are they not?
The doctor was already packing his briefcase. “Yes, they are. Not where we want them, but close enough.” Then he looked hard at Oswald. “But you are not, Mr. Oswald. In two ways. Counsel had one test to see if you wished power rather than cooperation and you failed that. But I had my own test. Would you equivocate why? I perhaps could work with a man of power interested in power if he was honest with me and we set the rules up clearly. But a man of power who does not tell me his true motivations? That is too much.”
And he left the room.
Oswald shook his head at me, slowly. “Your client is being very foolish, you know. I see it all the time. These scientists…”
Was he? Well, Oswald crushed the next two inventors he worked with…tossing them some money after he had pushed them out the door of their own companies. The doctor…well, he’s in Tuscany, though it took him an extra two years to raise the money. Two years in which his competitors almost beat him out.
And during that time I often asked him if he had second thoughts. He did not. “I may fail, but I will fail because my product or my business thinking is not good enough. I will not fail because my own backer stabs me in the back. I have no regrets.”
Well, he’s in Tuscany. I’m still here.
Doing my acid tests…