What is the Point of a Contract?
Contract Law is a foundational first year course in any law school. As fledgling lawyers everywhere know, when they come out of law school and prepare for the bar exam, contracts form a critical component of our global commercial system. When two or more parties are considering whether to work together, they come to the table with the understanding that the agreement they ultimately strike will be reduced to writing, and that writing, once signed, becomes a legal instrument that a court will enforce. As transactional attorneys, we are drafting, reviewing and negotiating all manner of contracts all day long.
Most sophisticated businesspeople would never buy or sell real property, sign a multi-year lease, borrow money from a bank, merge with another company, or issue equity to investors without first consulting an attorney. With that in mind, why is it that when it comes to day-to-day business operations, it remains relatively unusual for a company to consult with an attorney prior to entering into a contract with a vendor or customer? The company’s business and operations teams decide to purchase or sell a service or product, and too often the procurement lead or sales lead simply signs the vendor’s order form or online terms of service or issues the customer an invoice without considering the risks and responsibilities underpinning the deal. In most cases, the person signing the agreement has no legal training and may not even realize that by clicking “accept” or responding “sounds good” to an email, that they are creating a legally binding contract. The reverse is also true: sometimes businesspeople fail to realize that the oral agreement, handshake deal, or imprecise business terms they thought they agreed upon may not actually be enforceable, leaving them relying on a contract that does not actually exist.
Just as with sales of real property, equity or debt financing rounds, mergers and acquisitions, and other material milestones in a company’s lifecycle, a contract is a critical aspect of any commercial relationship. Savvy businesspeople understand that the upfront cost associated with engaging a transactional attorney to review a commercial agreement on the front end can save thousands, if not millions, of dollars down the line.
Contracts, put simply, establish what each party is going to do. A contract prompts the parties to define expectations and guidelines by spelling out details that perhaps they would not otherwise consider, such as how long a project is expected to take, how regularly the parties agree to meet, and who should be contacted if something goes wrong. Sometimes there is a disconnect between the parties, where they think they are aligned but actually are miles apart, such as when a marketing agency offers “advertising services” and a customer interprets this to mean that the agency will create ads, when in fact the agency is merely placing the ads.
A contract is a stand-in for trust. Warren Buffett is famous for his “handshake” deals, where the exchange of millions or even billions of dollars is decided over a dinner discussion capped with a handshake. Buffett takes pride in his keen ability to identify honest business partners. I take a more practical view—Buffett’s status as the “Oracle of Omaha” means no one dares cross him. His reputation and power acts as a stand-in for trust and replaces the need for a contract. Two friends deciding to go into business with each other might also trust each other at the outset and overlook the need for a detailed contract because the idea of suing each other, or even disagreeing with one another, is unthinkable—until it isn’t. As my litigation partners will attest, the most contentious disputes are often between former friends or classmates who started the relationship from a place of trust without ever ironing out the specific terms of the deal.
Finally, a contract is the backbone of a business transaction, supported by the promise that if something goes wrong, a court will enforce what the parties formally agreed to. In this sense, it is more the promise of legal enforceability than the actual litigation that holds the system together. Americans have a reputation for being litigious, but in my decades of practice drafting, reviewing, and negotiating all flavors of commercial contracts, I have rarely seen my clients actually bring a commercial dispute to court. It is much more practical and efficient to react predictively, based on what the parties expect a court would do or say about a particular contract term. If a contract says, for example, that a vendor may suspend services if a customer fails to pay its bills on time, then there is no point filing a lawsuit to terminate the contract. The parties understand that the vendor can suspend services, and the customer can then decide whether to pay its bill or lose its vendor. And when things actually do go wrong, a solid contract can really pull its weight. For example, if a contract specifies that the prevailing party in a dispute is entitled to recover legal fees and court costs, attorneys in a close-call case will push harder to reach an out-of-court settlement than risk losing on both the merits and on fees. If every contract were suddenly tested out in a court of law, the courts would be flooded and our commercial system would collapse. Put another way, a well-written contract allocates risk between the parties so that when the unthinkable data breach, network crash, or other “bad thing” occurs, the parties know who pays what. Litigation is what ensues when there is no contract, or when a contract is vague or silent on the matter in dispute.
What is a “Tech Contract”?
What do I mean by “tech contract?” Technology is a loose umbrella term encompassing all manner of computing, telecommunications, electronics, software, and internet-related services. Most readers know that the largest and most powerful companies in the world in our times are technology companies, offering computing software (Microsoft), web services (Amazon), search engines (Alphabet), social media (Meta), or digital media (Netflix). But even the most old-fashioned brick and mortar corner store uses technology in its daily operations. Any business in today’s economy needs basic technology like a website, email server, data storage, and IT systems to function. These software and technology services are usually hosted by the provider (rather than by the customer) in a manner that requires an ongoing, subscription-type service agreement. As you can imagine, these types of agreements come in many flavors. The most common is the all-encompassing “master services agreement” that covers everything and typically includes some form of statement of work or order form. Other common names for these types of agreements are software as a service (SaaS) agreements, cloud computing agreements, outsourcing agreements, or any software licensing agreements. Tech contracts also include consumer or end-user facing agreements like end-user license agreements (EULAs) or terms of use.
What Makes Tech Contracts Unique?
By their nature, tech contracts cover the processing of vast amounts of data, usually over an extended period of time. With data comes the need for expanded security and privacy protections, especially where the data in question involves personal information. As a result, in addition to covering the basic terms needed in any commercial agreement, a tech contract must also address support terms and service levels if something goes wrong, adequate limitations on data processing and use, and appropriate information security practices, including a plan for what happens if there is a breach.
Intellectual property and trade secret protection is also a critical component to any tech contract, and these are included in clauses that many template service contracts get wrong. The customary approach in a services arrangement is that the customer owns the work product developed by the service provider, without restriction. By contrast, in a SaaS arrangement where the service provider has invested time and money into the platform and technology that it is providing to its customers “as a service,” it is absolutely critical that the service provider retain ownership of that platform and technology. Further, most service providers want to impose contractual restrictions on what their customers may or may not do with the platform and technology, which is a concept foreign to most traditional service contracts. Another distinguishing aspect of many tech contracts is that the customer must provide certain input or material if the platform and technology are to function properly. A diligent service provider will want representations, warranties, and potentially even indemnity from the customer around the quality of this information or material.
Adding to these considerations is the practical reality that often the riskiest tech contracts are for services provided in exchange for low dollar amounts or even free of charge. A common and well understood example of this is the “freemium” model of a consumer app, where the services are provided without charge, but in exchange for the collection and onward sharing of vast amounts of user data. Service providers who receive no monetary consideration in exchange for their services are often reluctant to provide expansive representations, warranties, and support levels for these services, and will often limit their liability entirely and will sometimes even require that the customer indemnify them for any claims arising as a result of the customer’s use of the platform. An unsuspecting customer can find itself holding a large claim of unwanted liability.
Finally, I would be remiss if I failed to mention the imbalance of power at play in most tech relationships. This is certainly not unique to tech, but due in part to the unique aspects of tech contracts, it can matter significantly if a customer or a service provider presents “take it or leave it” terms that it claims it will not negotiate. A tech startup will be thrilled to land a deal with a bigger company but may sour when it realizes that it now must spend thousands of dollars obtaining impossibly high insurance coverage or investing in a security compliance program ill-suited for its size or risk exposure. The reverse is also true: there are a lot of opportunities to make money quickly as a tech startup, and the space is crowded with opportunists looking to make a quick buck. Fraud and deception are rife, and companies looking to invest in new tech offerings that will allegedly fix all their problems are wise to pause, do their diligence, and spend the time and effort negotiating legal terms that will protect them from bad apples.
Pay Attention to Tech Contracts
Whether you are a solo founder launching a new startup, a sales or procurement lead at an emerging company, or a contract manager of a Fortune 500 company, you are advised to pay close attention to your tech contracts! Take time to read them carefully and understand what they say. When questions arise, don’t hesitate to consult your Miller Nash legal team for guidance and support.
This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.
