2 Contractual Clauses You May Want to Avoid - Kiplinger's Personal Finance

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“I am selling one of my three lube and tire stores to a large national chain that has similar shops all over my part of the country. Their attorney prepared the sales agreement. Our family’s lawyer pointed out two paragraphs he did not like:

1. Arbitration: Instead of going to court, private arbitration is required in the event of a dispute over anything in connection with the sale or activities of the parties afterward.
2. The loser to pay the other side’s attorney’s fees.

“I thought that having an arbitrator settle a contractual dispute could be much quicker and less expensive than going to court. Also, I have been totally honest in this sale and will honor the terms of the agreement, so if the buyers sue me, I know that I would win and certainly would expect them to reimburse me for my attorney’s fees.

“Why would my lawyer suggest not agreeing to these two clauses in the contract? Thanks for your help, ‘Jeff.’”

A Business Trial Lawyer Gives His Opinion

“Jeff’s family lawyer gave him very good advice,” San Francisco-based business litigation attorney Matt Kenefick says. “There are many good reasons to exclude these clauses from a contract. For a small-business owner selling his company to a large corporation, arbitration can have more cons than pros,” he notes, listing common reasons against agreeing to arbitration:

1. Arbitration can increase litigation costs, since, in addition to paying your lawyer, you are paying for the arbitrator’s fees and the costs of the arbitration service provider. Some arbitrators charge over $800 an hour.
2. Arbitration eliminates the right to a jury trial. In certain circumstances, this can be important as juries can be sympathetic in David and Goliath situations.
3. Arbitration can make provisional remedies difficult to obtain. For example, when a dispute is subject to arbitration, obtaining a restraining or attachment order to preserve the status quo will require a much higher standard of proof.  
4. Arbitration eliminates most appellate rights. Generally speaking, you cannot appeal even if the arbitrator rules contrary to law!
5. Venue: Arbitration clauses can specify an inconvenient location for the arbitration proceedings.

“There are, however, times when arbitration makes sense,” Kenefick underscores. “For example, if you want to eliminate the right to a jury trial, arbitration allows the parties to pick an arbitrator with specific expertise and experience related to their dispute. With some matters, the parties can choose a panel of several arbitrators. Arbitration reduces the risk of relying on just one person — a judge — or an overly sympathetic jury. Also, arbitration could make sense if you want an expedited proceeding. Always keep in mind that the devil is in the details — so you need to be very careful to be sure that what is in your arbitration clause matches your needs and expectations.”

So, the bottom line on arbitration is this: “It is not necessarily an evil — but it can be an evil. Experience has shown that arbitrators are far less apt to be moved by sympathy for the little guy. So, if you are the little guy in a business transaction, arbitration can be an evil and you could very well stand a better chance of a favorable outcome in a courtroom.  But if you are Goliath in a David and Goliath struggle, you probably would be best served by having an arbitration clause.”

Attorney’s Fees Clauses - Watch Out What You Wish For

It often comes as a surprise when a small-business owner is served with a summons and complaint. Often the first reaction is, “When I win this thing, those guys are going to pay for my lawyer!” Well, not so fast.

In the United States, the American Rule of Attorney Fees states that, “Unless provided for by law, without an attorney’s fees clause each party pays its own legal fees and litigation costs, regardless of who wins the lawsuit.”

The American Rule contrasts with the English Rule, which almost every other country on the planet follows, requiring the loser to pay for the winner’s lawyers and costs.

Kenefick lists two situations where this clause can be dangerous:

1. Parties who are emboldened to file a lawsuit because they believe they will recover their attorney’s fees. 
2. An attorney’s fees clause can significantly raise the stakes in litigation, because the amount in controversy will be increased by each party’s respective claim for their fees.  For a party with deeper pockets, they can use this to leverage a settlement against an adverse party who cannot risk being court-ordered to pay the other side’s attorney’s fees.

“So, a party who is more likely to be the defendant in a future dispute will not want to include an attorney’s fees clause in their agreement; whereas, a party who anticipates that they will more likely be the plaintiff in a future dispute will want to include a fees clause.”

Easily Creates Unfairness in Contract Disputes

“Prevailing party attorney’s fee clauses can lead to unfairness in contract disputes, unless the parties are both strong, financially,” he observes. “They can make it difficult for the financially weak to enforce their claims for fear of losing the case and being hit with the winner’s attorney’s fees and court costs.”

Kenefick concluded our discussion with this warning:

“Both arbitration and attorney’s fees clauses can be volatile and therefore should not be taken lightly.”

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Attorney at Law, Author of "You and the Law"

After attending Loyola University School of Law, H. Dennis Beaver joined California's Kern County District Attorney's Office, where he established a Consumer Fraud section. He is in the general practice of law and writes a syndicated newspaper column, "You and the Law." Through his column he offers readers in need of down-to-earth advice his help free of charge. "I know it sounds corny, but I just love to be able to use my education and experience to help, simply to help. When a reader contacts me, it is a gift." 

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