Common Mistakes in Small Business Contracting

When a business is served with a lawsuit, the question of “what could we have done differently to avoid this ” is top of mind. There are certain mistakes made frequently by small businesses that are easy to avoid with a little planning ahead.

One common mistake is to operate without written contracts. A handshake or verbal agreement is difficult to enforce in a court of law. The most amicable of relationships can devolve quickly when the parties begin to disagree about the terms of the deal struck. Even an invoice that contains terms and conditions may not be enforced unless it is signed by the customer. For this reason, it is recommended that businesses create standard form contracts for everyday business transactions. It can be as simple as an invoice, with listed terms and conditions, that the customer must sign before work can begin. While this practice will not eliminate legal risks, it can greatly reduce them.

Another common mistake is to relax record keeping mid-project or for long-time customers. If an invoice is signed but then the work order changes, or additional items are purchased, a new or amended invoice should be prepared and signed by the customer. Some contracts contain integration clauses, which essentially state that the entirety of the parties’ deal is included in the pages of the contract. That means side deals, text approvals, emails, subsequent work order changes, etc. might not be enforced by a court. Even without an integration clause, a judge may hold the parties to the signed document and give less weight to unsigned side agreements.

Many people mistakenly believe that if they file a lawsuit, or have one filed against them, and they win (meaning the case is settled in their favor or the judge issues a ruling in their favor) then they are entitled to have all the attorneys’ fees and expenses they spent during the lawsuit reimbursed by the losing side. Under California law, however, this is typically not the case. Particularly with contract disputes, unless the parties’ contract specifically provides for recovery of attorneys’ fees by the prevailing party, each side will be responsible for its own fees.

This means that if you do not have a signed agreement that includes an attorneys’ fee provision, you are likely out of luck when it comes to bringing or defending a lawsuit. You may win the case, but you will likely still be stuck with a large attorneys’ fee bill. It is not uncommon for a simple contract dispute to take one to two years to come to a conclusion in court and for attorneys’ fees (even at reasonable rates) to add up to tens of thousands of dollars in the process.

If you have a customer that owes you $25,000, for example, you may end up winning your lawsuit and recovering a judgment for the $25,000 but owing double or more than that amount to your attorney. If you have an attorneys’ fee provision in place, however, then all your fees will likely be added to the judgment to be paid by your customer.

The same is true in reverse. If a customer feels you performed negligently and sues you for $25,000 you may end up winning the case (meaning, the customer may be awarded $0). But unless you have an attorneys’ fee provision in place you will almost certainly still have to foot the bill for your attorneys’ fees and expenses in the process. And unlike a lawsuit you bring yourself, you cannot simply dismiss or ignore a lawsuit filed against you or you risk having a judgment entered against you by default.

Sometimes businesses attempt to include unilateral attorneys’ fee provisions in their contracts. For example, “If business prevails in a lawsuit then business is entitled to recover its attorneys’ fees.” They believe this gives them leverage, as the provision allows them to recover their attorneys’ fees in a legal dispute but not their customers. However, such unilateral provisions are not allowed in California and will be interpreted by the court to benefit all parties to the lawsuit. This means that even if the fee provision is worded unilaterally, if your customer wins the lawsuit they will nonetheless get to collect their attorneys’ fees and expenses from you.

Finally, businesses often put arbitration clauses in their agreements, requiring that if there is a dispute regarding the agreement then the matter must be arbitrated as opposed to being brough in civil court. While there is nothing inherently wrong with arbitration, a business should understand what such a provision means before flippantly incorporating it into its contracts.

While arbitration typically proceeds more quickly than a civil lawsuit, it is almost always more costly. Unlike a lawsuit in civil court (where there will be a filing fee but no payment due for the court’s time in deciding the case), arbitration is a private dispute resolution process. That means the parties to the arbitration pay for the arbitrator’s time. It is not uncommon for an arbitrator to charge upwards of $500/hour for their time. And just like a lawsuit, parties are encouraged to have attorneys represent them in the arbitration process. All of this adds up to a lot of money.

Arbitration also typically offers fewer chances for discovery (questioning the other side, accessing their documents and evidence, etc. to build your case) than civil court. And arbitration has limited appeal options. If you do not like the ruling of a civil court judge, you have automatic rights to bring an appeal to a higher court. An arbitrator’s ruling, on the other hand, is typically binding and final – even if the arbitrator is unfair or does a poor job.

Some businesses find these factors to be a positive. They may pay more, but the process is fairly short and simple and final. If that is the manner of dispute resolution that works for your business, an arbitration provision may be in your best interest. Otherwise, it is wise to omit any such provision and allow disputes to be brought in civil court.

Note that in contracts without arbitration provisions, there is nothing preventing the parties to a dispute from agreeing to bring their dispute to binding arbitration. So, it is not an “either/or” decision. You are simply deciding whether the dispute has to be brought in arbitration if you choose to include an arbitration provision. It is wise to retain counsel to review your business documents and practices before any problems arise to assess any risk areas. This will give you the opportunity to make editions to documents or practices in an effort to limit or reduce your legal risks.