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Announcement: The Common Draft contract clauses and templates, with extensive research notes and commentary, are posted (in draft). If you’d like to be notified of significant developments in the project, please subscribe to updates at right, because I’ll be posting announcements on this blog. See also my first e‑book, Signing a Business Contract? A Quick Final Checklist for Greater Peace of Mind.

You get what you inspect, not what you expect

In working on the Common Draft audit-rights clause, I found a citation for a saying I learned in the nuclear Navy: You get what you inspect, not what you expect.

The source of the citation is certainly authoritative: Admiral Jonathan Greenert, the current Chief of Naval Operations — that is, the top officer in the U.S. Navy* — who came up as a nuclear submariner.

* Unless the Chairman of the Joint Chiefs of Staff is also a Navy officer

Document those oral conversations!

Imagine that "Alice," a lawyer, has a phone conversation with "Bob." During the conversation, Bob says something that's important to a matter that Alice is handling for a client. It'd be wise for Alice to document the conversation promptly — for example, with a confirming email or letter to Bob (for which Alice would want to be able to prove that Bob actually received it), or at the very least, with a memo to file written promptly after the conversation.

Why would Alice want to do this? Because someday in court, she and Bob might get into a "he said / she said" swearing match about what exactly was said during the phone conversation. If Alice can't produce contemporaneous written documentation of the conversation, the judge might find her version less credible than Bob's version.

Something much like that happened in Bell v. Safeco Ins. Co. of Illinois, No. HHDCV126028741S (Conn. Super. Oct. 7, 2014). There, an attorney testified that two insurance adjusters had told her orally that the limitation period for making an underinsured-motorist claim was longer than it actually was under the insurance policy terms. The two adjusters denied having said that; they also produced contemporaneous written summaries of their conversations in question. The attorney produced a memo to file, but it was written long after the fact.

The court sided with the insurance carrier, remarking that:

This finding is based both on [the adjusters'] demeanor while testifying and on the corroborative evidence of the claim activity log.

Attorney Crockett's file notes, by contrast, were created many months after the alleged conversations, at a time when she had to rely on distant recollections and after she had realized that the limitation period might have run. [Emphasis and extra paragraphing added.]

Lesson: After any important oral conversation, it's not a bad idea to promptly send a follow-up email confirming any important points of the conversation.

(Hat tip: Tara Kowalski of the Jones Day law firm.)

When a contract (i) involves a consumer or other sympathetic plaintiff, and (ii) that plaintiff is agreeing to arbitration, it behooves the other party to make sure a complete signed copy of the arbitration agreement is available in the record. Otherwise, the plaintiff might well deny having signed the arbitration agreement.

Exactly that happened in Ashburn v. AIG Financial Advisors, Inc., No. A138620 (Cal. App. Feb. 6, 2015). In that case, five early-retiree employees of Pacific Bell signed on with an investment-advisory firm to help them figure out what to do with their lump-sum payment. Unhappy with their investment results, the retirees sued the investment firm, which moved to compel arbitration.

The investment-advisory firm's files for the retirees were, shall we say, streamlined; the account manager stated in a written declaration:

As part of my practice when working with a client to fill out new account forms and account worksheets, such as those signed by plaintiffs in this matter, I would typically place the client's signature page in in the file, but I would not necessarily place all of the pages with the standard arbitration language in the file. This was because these pages were standard forms that could be reproduced by reprinting the applicable version of the form. [Emphasis added.]

The retirees, of course, denied having signed an arbitration agreement; for example, one of them stated in a declaration:

6. After Ms. Kearney had convinced me to take early retirement, elect the lump sum cash-out, and invest the cash-out with her, Ms. Kearney gave me numerous forms, and instructed me to sign them.

Ms. Kearney did not explain the forms to me.

Ms. Kearney did not tell me anything about arbitration.

Kearney did not tell me what arbitration meant.

Kearney did not tell me that, by signing the forms, I was giving up my right to a jury trial in the event of a dispute, and agreeing to binding arbitration with no right of appeal.

Ms. Kearney did not tell me that, not only was I losing my right to a jury trial, by signing the forms as instructed, but that I would also be forced to arbitrate in a forum where one of the arbitrators is affiliated with the securities industry.

7. I did not read the forms before signing them, because I trusted Ms. Kearney.

Ms. Kearney did not give me sufficient time to read the forms.

My meeting with Ms. Kearney was approximately 30-45 minutes. There were too many forms for me to read in that time.

I relied upon Ms. Kearney's honesty, and signed the forms where she told me to sign.

8. I understand that Ms. Kearney claims that she gave me a Customer Agreement, with language describing arbitration. She did not. I kept all of the paperwork Ms. Kearney gave to me. I do not have a Customer Agreement.

9. I understand that Ms. Kearney claims that I signed an agreement containing an arbitration provision, March 17, 2004, in her presence. That would have been impossible. I did not meet with Ms. Kearney in 2004, let alone sign anything in her presence.

[Extra paragraphing added.]

The district court granted the investment firm's motion to compel arbitration, without holding an evidentiary hearing.

The appellate court reversed and remanded, directing the district court to hold an evidentiary hearing and remarking that "[t]here certainly was abundant evidence that there was no enforceable agreement to arbitrate. Likewise abundant evidence that could support a fiduciary duty." Id. at text accompanying n.4.

[EDIT:] A similar result occurred in Ruiz v. Moss Bros. Auto Group, Inc., No. E057529 (Cal. App. Dec. 23, 2014). There, an employee filed a putative class action complaint alleging that the employer failed to pay overtime (and related claims). The employer moved to compel arbitration; the trial court denied the motion.

The appeals court noted that state law allowed for electronic signature. Nevertheless, implied the appellate court, the employer's litigation counsel simply blew it in attempting to show that the employee had electronically signed the arbitration agreement: "But Main [the employer's business manager] never explained how Ruiz’s printed electronic signature, or the date and time printed next to the signature, came to be placed on the 2011 agreement. More specifically, Main did not explain how she ascertained that the electronic signature on the 2011 agreement was 'the act of' Ruiz." Id., slip op. at 11 (citation omitted).

The appellate court then drew a road map for employers' counsel to use in future cases:

Indeed, Main did not explain[:]

  • that an electronic signature in the name of “Ernesto Zamora Ruiz” could only have been placed on the 2011 agreement (i.e., on the Employee Acknowledgement form) by a person using Ruiz’s “unique login ID and password”;
  • that the date and time printed next to the electronic signature indicated the date and time the electronic signature was made;
  • that all Moss Bros. employees were required to use their unique login ID and password when they logged into the HR system and signed electronic forms and agreements;
  • and the electronic signature on the 2011 agreement was, therefore, apparently made by Ruiz on September 21, 2011, at 11:47 a.m.

Rather than offer this or any other explanation of how she inferred the electronic signature on the 2011 agreement was the act of Ruiz, Main only offered her unsupported assertion that Ruiz was the person who electronically signed the 2011 agreement.

In the face of Ruiz’s failure to recall electronically signing the 2011 agreement, the fact the 2011 agreement had an electronic signature on it in the name of Ruiz, and a date and time stamp for the signature, was insufficient to support a finding that the electronic signature was, in fact, “the act of” Ruiz.

For the same reason, the evidence was insufficient to support a finding that the electronic signature was what Moss Bros. claimed it was: the electronic signature of Ruiz.

This was not a difficult evidentiary burden to meet, but it was not met here.

Id., slip op. at 12 (citations omitted, extra paragraphing and bullets added).

A food-products manufacturer ("customer") hired a painting company to do contract work at the customer's site. The painting company orally agreed to name the customer as an additional insured under the painting company's commercial general liability (CGL) policy.

That oral agreement shouldn't have been a big deal. The painting company's insurance had an automatic additional-insured clause that would have resulted in the customer being an additional insured — if the insurance carrier had issued the additional-insured certificate before a covered "occurrence."

But, before the painting company requested such a certificate, one of its employees was injured in a fall at the customer's site and sued the customer for negligence. (Shortly after the fall, another painting-company employee sent an urgent email to the insurance carrier requesting a certificate, which the insurance carrier issued the next morning.)

The insurance company sought a declaratory judgment that it wasn't obligated to provide a defense for or indemnify the customer because the painting company hadn't timely requested the certificate, as required by the policy terms. A federal court granted summary judgment in favor of the insurance company. Cincinnati Ins. Co. v. Vita Food Prods., Inc., No. 13 C 05181 (N.D. Ill. Jan. 30, 2015).

That likely will result in the painting company being responsible for the defense and indemnity obligation; as an appeals court in another jurisdiction noted last year (but in the end found it unnecessary to decide), "a party who agrees to procure the insurance and fails to do so assumes the position of the insurer and, thus, the risk of loss." Higby Crane Service, LLC v. National Helium, LLC, 751 F.3d 1157, 1161 (10th Cir. 2014) (reversing and remanding summary judgment for plaintiffs) (citation and internal quotation marks omitted).

Lesson for drafters (for either party): It wouldn't hurt to check that someone is making sure the agreed-to insurance is actually obtained.

This post was prompted by a Hacker News discussion.

Is it even worth asking a potential investor for an NDA?

Potential investors in a company might be reluctant to sign an NDA. Venture capitalists in particular often flatly refuse to do so. If you're dealing with folks like that, you might either have to take your chances that they won't "steal" your idea or see them walk away.

As a practical matter, though, going without an NDA with a potential investor might not be a bad bet, because:

  • You can try to be very, very selective about what you disclose without an NDA, so that you're not giving away the "secret sauce" of your idea.
  • Investors and others generally do have one or two other things on their minds. They generally see lots of entrepreneurs who are convinced they've got a world-beating idea. You'll probably be lucky to get these investors to pay attention for two minutes. Ask yourself how likely it is that they'll want to take your particular idea and spend time and money building a business around it without you.
  • Contracts aren't the only thing that discourage bad behavior. If an investor stole someone's idea, and if word got around, then that investor might later find it hard to get other people to talk to him.
  • You have to decide what risks you want to take. Your business might fail because an investor steals your idea and beats you to market. Or it might fail because you can't raise the money you need to get started.

It's sort of like having to take a trip across the country. You have to decide whether to fly or drive. Sure, there's a risk you could die in a plane crash flying from one side of the country to the other. But if you were to drive the same route, your risk of dying in a car crash has been estimated as being something like 65 times greater than flying.

As the old saying goes, you pays your money and you takes your choice.

Potential BigCo "partners" might be a very different story

Suppose that one day you're contacted by a big company. The BigCo people say that they want to "partner" with you, and hint that they might want to acquire you. It might be that their real interest is in finding out your secret sauce. This Hacker News commenter tells of how that happened to his (or her) startup company: A big company reached out to the startup and invited them to do a demo. The BigCo people asked, "how exactly do you do X?" The startup people told them. The BigCo people then showed the startup folks the door, with one of the BigCo higher-ups saying, "the race is on, better hurry!"

That sort of situation can be averted by an NDA — although it might take a long time and a lot of legal fees to enforce the NDA, especially if BigCo is convinced it hasn't done anything wrong. On the other hand, sometimes it can pay off, because a jury might well punish a company that it found violated an NDA. See, e.g., the 1996 case of Celeritas Technologies v. Rockwell International, where a federal-court jury in Los Angeles awarded a startup more than $57 million, and the judge then added $900,000 in attorneys' fees, because the jury found that Rockwell had breached an NDA. (Disclosure: I was on Rockwell's trial team in that case.)

Be sure to comply with marking requirements

Many NDAs include requirements that confidential information must be disclosed or summarized in a writing that's marked "Confidential" or "Subject to Nondisclosure Agreement" or something like that, on pain of losing protection. Disclosing parties will want to be sure to comply with any such requirement, because not doing so could be fatal. For example, in the Convolve v. Compaq case, the computer manufacturer Compaq (now part of Hewlett-Packard) defeated a claim of misappropriation of trade secrets concerning hard-disk technology because the owner of the putative trade-secret information didn't follow up its oral disclosures with written summaries as required by the parties' non-disclosure agreement. See Convolve, Inc. v. Compaq Computer Corp., No. 2012-1074, slip op. at 14, 21 (Fed. Cir. July 1, 2013) (affirming summary judgment).

Include a "show-how fee" in the NDA?

4. Suggestion: Even for non-secret information, an NDA might be negotiated to include the equivalent of a break-up fee. That is, even if it turns out that the secret technology wasn't a secret after all, but the receiving party didn't know the technology, then the receiving party might be required to pay the disclosing party something as payment for "show-how" (as distinct from know-how), in return for having taught the receiving party about the information.

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