What Is a Contract Attack?
Contract attacks are an effective and systematic method of determining the financial and business impact of misaligned contract language. When two parties enter into a contract, their obligations and commitments are intended to be met on the terms the parties agreed to and that was envisioned when the deal was struck. Contract attacks simulate likely performance under that agreement, taking into account the current commercial climate. The purpose of contract attacks is to provide point-in-time metrics to the parties, or third party interest holders (like lenders or investors) analyzing the current value and business risks of the agreement.
Contract attacks clarify how the details of the agreement align with actual performance, business realities, and existing commercial terms that holders in similar positions would be willing to accept, giving the parties critical information regarding the economic health of the contract. Through the simulated analyses, a counterparty’s risks and potential rewards, as well as the strength of their position in negotiations, become clear.
Contract attacks provide measures for the value of the contract asserted by one or both parties. For example, if a contract attacking party has made a $100,000 assertion – materially less than what the counterparty claims – it may be easy to defend against, but while defending an assertion that deals with millions, or even billions, of dollars, how do you make sure that what you are doing is supported by an empirical analysis, rather than guesswork?
Particularly during disputes, it may be difficult for parties to agree on the technical merits of their positions . When a grand total value is placed on a claim, assertion, or demand, the parties often have a hard time deciding whether the price difference is material. Contract attacks provide the value metric needed to understand the expected commercial performance, and can help you strategically negotiate with the other side to achieve the best results.
Contract attacks allow companies to see the commercial impact of proactive changes to the agreements they are signing. In negotiating a new contract, one side may be offering a term for the first time, and it may not be very clear what the impact of that term will be post-implementation. A contract attacker can demonstrate with data whether the proposed term is too aggressive, and it allows the target to ask for a different term more in line with commercial realities.
When entities are merger partners or otherwise have a long-term, close relationship, negotiating clauses may seem like an exercise in semantic gymnastics and sword fights. To avoid ruffling feathers, parties may simply agree to language with an understanding that neither party will enforce it, or that the parties will so narrowly interpret it that it is virtually meaningless. However, many of these terms have a very real financial impact if enforced, and choosing an aggressive or passive approach will likely have significant financial implications. A contract attacker can illuminate whether there is a strong case for enforcing the language in question.
Essential Components of a Contract Attack
There are three basic building blocks to a contract attack. They are ambiguities, failure of consideration, and misrepresentation by an offeror. An important thing to remember is that presumption is always in favor of the contract, unless the other party demonstrates, and then proves, prima facie evidence that all of the elements of a contract attack are present.
Essential ingredients of a successful contract attack:
- There must be a binding contract between the attacking party and the other party;
- That contract must be in place for both parties benefit; and
- There should be some degree of detriment to the owner (or other party), who is now attacking the contract.
Ambiguities may be an argument made to make a contract attack stick. The ambiguity argued must be a "critical" element of the contract. This means that if you argue ambiguity and win, it does not void the entire contract (such as an ambiguity in a description of price or quantity of items) but it does address the ambiguity at issue and might render that particular provision of the contract voided.
The failure of consideration argument also makes a contract attack stick in order to attempt to "blow up" the contract. This argument is typically used if the other party did not hold up their end of the bargain under the contract; so even though you received the items of the contract the other party still did not do its end of the bargain.
Misrepresentation by an offeror creates misrepresentation entrapment for the offeror. For example, if the unilateral offer or the offer itself contains untruths or other factors of a no-deal scenario, the offeror may have made a misrepresentation.
Legal Approaches for Contract Attacks
Once an outline is drafted and it’s clear what the attack is going to be, the next step is determining a strategy for the legal arguments that can be made to best support the outline’s attack. For example, the outline should clearly identify a contract term that is problematic in some way (e.g., unreasonable price increase, failure to give a notice when the contract being terminated, unwillingness to continue the contract if there is a change in ownership). One key for the legal strategy to be effective is to determine whether a contract term is too vague, ambiguous or indefinite—if so, the better outline will make clear that an argument can be made by the other side that the contract is not enforceable due to its vagueness or indefiniteness.
Another strategy is to find out if a contract term is unreasonable (e.g., the party being charged a fee is not likely to make a profit after paying the fee that was imposed or is not likely to recoup its costs). A good outline usually articulates which provision(s) of the contract is or are unreasonable and why. Another strategy is to state that the contract is unconscionable (e.g., the person who negotiated for the contract was not represented by an attorney, the terms of the contract are difficult to understand, the provision was imposed on the person who did not have any bargaining power and the provision is detrimental to the person). Among other things, a good outline will cite to the caselaw generally explaining unconscionability.
Other legal strategies can include an assertion that the contract is economically impractical (e.g., the provision is or was without consideration, the term imposes a cost that was not contemplated, the risk of the situation was not foreseen or could not have been foreseen). A good outline will usually describe why the provision is economically impractical and how it is or was without consideration (e.g., when the contract was signed, was the price fair to both parties and were both parties making a profit).
Case Law and Precedents
Knowing the history of contract attacks is critical to understanding how a contract may be attacked or defended after the contract has been entered into. It is also critical to understand what makes an attack successful or not when viewing a contract attack from the other side.
Contract attacks often occur in the context of real estate development. For example, in Saville Hoop Co. v. Pacific Real Estate Finance Services, 208 Cal. App. 3d 852 (1989) a landlord filed suit for damages after a tenant vacated the property. The tenant sought a declaration that the landlord had breached the lease and that the tenant had no further obligations under the lease.
The real estate lease contained a relocation provision providing for a three month period of free rent if a new building was not completed for occupation by a certain date, with the option to give tenant one year free rent if the new building was unavailable by one year afterwards. The new building was completed but at a later date than anticipated. When the tenant vacated the premises the landlord filed suit arguing that it spent more than $400,000 in tenant improvements and the tenant owed it over $800,000 in lease rent. The tenant took the position that it did not owe any more lease rent as the landlord had materialized breached the lease.
The court pointed out that "in order ‘to recover damages for breach and rescission of an agreement to agree, a plaintiff must show that the agreement is one which, if performed, would result in a contract.’" Id. at 859, see also Kreling v. Cansler, 33 Cal. App. 3d 515, 515-16 (1973) ("[T]here can be no cause of action for breach of a contract to enter into a contract." 羅 (citations omitted). Under California law, "an agreement must be sufficiently complete in all its material particulars to be enforceable." Id. (citations omitted). When a contract is incomplete then it falls under the statute of frauds which provides that a lease for longer than a year must be in writing (Cal. Code Civ. Proc. § 1971). Id. at 860. The tenant was pursuing the relocation provision prior to the new building being completed. Since that provision was never finalized it was not enforceable at the time the tenant left the property, despite the fact that the new building would be completed shortly thereafter. The court held that because the tenant sued for breach of the relocation provision, it could not simultaneously claim the landlord had failed to follow the relocation provision. The court held that the provision should not be taken literally to mean that the landlord was required to terminate the original lease when the new building was completed. The court pointed out that "[e]nforcement of a lease is a two-way street; both parties have duties to perform." Id. at 861. The court held that there was no breach of contract since no reasonable jury could find that the parties had a final agreement on the terms of the relocation provision. Id. at 862.
In Weiss v. Marcus 51 Cal. App. 3d 590 (1975) the defendant won an action for breach of contract because the statute of frauds prevented the plaintiffs from successfully enforcing an oral lease agreement. The plaintiffs had paid two months’ rent in advance and signed the lease prior to moving into the apartment, but they did not express their desire to rent the apartment until after the lease period had expired. The plaintiffs argued that the statute of frauds only applies to a lease agreement for one year or longer. The court stated that even though "an oral lease agreement for less than one year need not comply with the statute of frauds" (code civil procedure § 1971) it does not mean that the oral agreement is enforceable. Id. at 597. Even with that exception, however, the plaintiff could not prevail against the defendant. The court stated that the plaintiff had to first take action to affirmatively show a commitment to the rental of the subject property in order to be protected under the statute of frauds. Id. at 598. The plaintiffs in this case were not able to take affirmative action to show a commitment to the rental of the property, so the statute of frauds prevented them from recovering in their action for breach of contract. Id. at 599. The Weiss court affirmed the lower court decision denying the plaintiffs damages.
In these two cases, the court found that the defendant would win on contract attacks because the statute of frauds applied. These cases are illustrative of the importance of minimizing future litigation by entering into contracts correctly at the time the contract is created.
Avoiding Weaknesses in Contracts
Understanding and preventing vulnerabilities in relationships, including business agreements and contracts, is essential when doing business or resolving disputes. Contract attacks can come from one or more of several types of vulnerabilities, including poor drafting, lack of sufficient knowledge of the parties as to their intentions and weaknesses in performance.
The easiest vulnerability that businesses and individuals can avoid is a poorly drafted contract. Properly drafting a contract may involve more than simply writing the deal. It includes ensuring that the terms are clear and fully reflect the parties’ intent, the formality with which the parties intend to conduct themselves and any other particulars or details.
While the contract in and of itself is not necessarily the vulnerability, the manner in which contract terms tie to business, legal and even tax-related considerations could create a vulnerability. In mergers and acquisitions, business logic problems in a contract can result in an attacking business taking advantage of a poorly drafted post-closing adjustment attempt. For instance, if a buyer is required to pay a purchase price based on adjusted net working capital and a seller attempts to define "net working capital" inconsistently with the buyer’s particular form of accounting, the buyer may be unsuccessful in enforcing its rights in the absence of a contractual definition that is technically correct or if the buyer failed to consider business logic problems in a contract.
A lack of sufficient knowledge of the parties as to their intentions could also create a vulnerability. When parties are not on the same page, weaknesses in the contract result . There is always court involvement to determine which party actually won if there is a dispute and it is important that the court have the correct deal. The more formal or sophisticated the transaction, the more important this consideration is.
There are strategies a party can adopt in order to protect itself from a contract attack. One of these strategies is with legal counsel. Counsel is a valuable resource because they speak the language of a contract and can help to protect you from vulnerabilities in your documents by making sure that the intentions of the parties have been properly reflected. Charlie’s advice to clients would be to wait until they have the final draft before executing the agreement, even if it is literally the final draft. A litigator may be thinking about how the contract will hold up under different circumstances presented by future disputes and will make sure that a contract has sufficient detail to support an argument if necessary. An attorney will also make sure that the proper contract is executed by the proper party. Especially in the context of corporate law, such articles as the organizational document or the bylaws may dictate who may enter into a contract on behalf of a company.
In business, one of the best defenses is to enter into good agreements with customers or vendors. This involves reviewing the business relationship beforehand and determining the best contract strategy depending on the type of relationship. The most important thing is to make sure the other party is on the same level as you are and has the capacity to enter into the contract and perform appropriately.
Technology and Contract Attacks
Automation and smart contracts will continue to pose challenges to the regulation of contract attacks given their use of self-executing codes. Similarly, blockchain technology presents new avenues for the creation, use, transfer and registration of rights in asset classes. While some of these developments may lead to more efficient transactions, they also present opportunities for those seeking to take advantage of automated systems or to manipulate them. For example, the risk of hacking may increase as smart contracts are connected to other information systems. Automated systems prepared by third parties (i.e., self-driving cars or an energy power grid) could be rendering new types of service offerings subject to contract attacks. The use of a smart contract, however, does not eliminate contract attacks. For example, it will depend on the code of the smart contract that is complied with. Also, the malicious actions of the account administrator could still trigger a contract attack regardless of whether the underlying contract is a smart contract or not. One development that could help mitigate the risk of contract attacks is cybersecurity insurance. Depending on the risk of a contract attack taking place, some contracts may very well be uninsurable, whereas others may be uninsurable in regards to certain types of contract attacks.
Summary: Risk Minimization and Contract Enhancement
The risk of contract attack is ever-present in any commercial relationship. The best mitigation strategy is to understand the different types of attacks and potential defenses, and to build contractual stipulations or provisions into your contracts if possible, to the extent this is permissible in your jurisdiction. The parties can often do so in a process by which each drafts their own set of terms, and these sets are then used as the basis for negotiations toward a final contract with a proper give-and-take toward each position. Generally speaking, one should limit the scope of all contractual provisions to exclude truly personal information from the general commercial relationship and to safeguard against unfair unilaterally preferred contract provisions.
Such mitigation strategies are effective only in the context of a thorough due diligence review prior to entering into a commercial relationship of any kind, but particularly when including the delegation of responsibilities among services providers and establishing robust cybersecurity and privacy protections, which must be updated regularly. When assessing vulnerabilities during a due diligence review, particular focus should be placed on the use of terms in agreements with employees, vendors, and with standards organizations if applicable . If properly constructed, many of the contractual and organizational risks associated with personal data can be avoided or significantly reduced, though none can be entirely eliminated.
In addition to due diligence and contractual mitigation, firms should also participate in an early discussion and point-of-view exchange with legal counsel concerning the legal context, established case law, legal trends, and the likelihood of success in case of an attack and/or legal action.
Why is all of this important? The answer is simple: proper review of contracts and related documents, specific emphasis on the treatment of personal information under the scope of a particular agreement, and having a conversation with an attorney about the legal context are effective mitigation strategies toward minimizing the risk and cost of dealing with a contract attack. Really, there is no substitute, because the cost of not doing so may very well consist of a significant likelihood of suffering from such a forced loss and the associated costs, including indemnification, defense costs, as well as the overall risk to your business reputation.