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Story #2: THE ACID
TEST CLAUSE
“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… |
