Legal three

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Introduction

Contracts impact every person in society on a daily basis. In fact, the only way to avoid them is to live completely outside society. If a person takes a hard look at their activities on any given day, it’s fairly certain they’ve entered into a small handful of contracts without even thinking about it. Daily purchases of food, gasoline and similar items represent agreements with the previous owners of those goods, and if purchased on a credit card represent small loans. All of these things are governed by contracts. The simple task of eating eggs for breakfast may be the result of numerous contracts with such diverse parties as the supermarket, the manufacturers of plates and silverware, and perhaps even a Tabasco sauce bottler. If the morning breakfast goes horribly wrong, you may be dealing with homeowners insurance for the fire you started, or perhaps a local farmer regarding salmonella poisoning. And in the worst of circumstances, you may even need to deal with an attorney or two.

While these examples show how prevalent contracts are, a true grasp of their importance is better understood through the story of a lawsuit. Only in the depths of a lawsuit can you see the importance of a well structured and thought-out contract, or the perils of a bad contract. This story is about one such lawsuit of which I was a party.

Definition of a Contract

A contract is an agreement that the law will enforce. While this seems simple enough, a huge amount of money is spent by parties arguing over whether a contract has been formed. Eight years ago, I was involved in a two-year lawsuit, and while the case concerned many issues, I would soon find out that contract formation was going to make a difference on whether I was jointly liable for a $2,000,000 obligation.

Brief Background on Case

I was a 12-year employee of a 120-person accounting firm when I was offered a promotion to a position of “probationary partner,” to which I verbally agreed. I signed a “probationary partner” agreement shortly thereafter. I was informed the probationary partner position was temporary, with an implicit understanding that an equity position would be available one year later. The probationary partner agreement referred to my position at the firm as that of an at-will employee.

Four days before my one-year anniversary of becoming a probationary partner, I was informed of a firm restructuring and that the partners would vote at the partner retreat on my promotion to equity partner. At the retreat six months later, the equity partners unanimously “voted me in” as an equity partner. My reaction to this news was a combination of relief and concern, as I had become very disillusioned with the firm during the prior two years. I smiled but remained silent. Later testimony was inconsistent on whether I said “thanks”, or said nothing and the meeting just

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moved on to other subjects. This reaction would later become relevant as to whether I had accepted an offer of partnership from the firm.

All of the current 19 equity partners had signed a 38 page written partnership agreement created 10 years earlier (there had been no other promotions to equity partner in the past 11 years). I was expected to sign this agreement also upon my promotion, but was informed it was being revised due to the restructuring. As a result, the old agreement was not provided to me to review or sign.

One year later, I gave notice that I was leaving the firm. The new “restructured” partnership agreement was still not completed. I agreed with the firm to stay through year end (several more months) to work on and transition clients. Earlier that same year but prior to my resignation notice, two other partners had given notice that they were leaving to form their own firm, also agreeing to stay on until the end of the year. Their reason was in part to work on and transition clients, but also to continue the negotiation of the terms of their departures under the partnership agreement, which had thus far proved unsuccessful. One month after my resignation I informed the managing partner that I would be joining these two partners in their new firm. Within a couple days of further failed negotiations on the terms of the departure, and with animosity building, the firm asked the three of us to leave immediately rather than wait until the end of the year. They did this by voting to implement a provision in the partnership agreement to enact a “for cause” termination for the two other partners, and exercising their “at will” power to terminate me under my probationary partnership agreement.

Lawsuit and Governing Law

A two year lawsuit ensued based on the terms of the old partnership agreement, with myself and my two new partners individually named as defendants (our new firm was not named). The suit was subject to binding arbitration under both the partnership agreement and my old probationary partner agreement. My old firm sought to hold me jointly liable with my two new partners under the terms of the 38 page partnership agreement for various causes of action. Because I had never seen or reviewed the partnership agreement until commencement of the lawsuit several months after I had left the firm, I had little idea of what it said. My contention was that I could not be held liable under it because I was not a party to it, since I had never signed it. Clearly the common law was going to govern this contract as it was based on employment and there were no goods involved.

Offer

An offer is the manifestation of present contractual intent, with definite and certain terms, communicated to the offeree. When the firm partners approved my entry into the firm as an equity partner, they would have had present contractual intent because they knew they were voting on whether or not I would become “one of them,” subject to the same terms and

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conditions that every other equity partner had agreed to (i.e. the terms of the partnership agreement). The offer was communicated to me when I entered the room at the partner retreat. However, the terms of the offer were not clear because the firm was restructuring the partnership agreement, and I was not provided a copy of any new agreement, nor provided a copy of the old agreement. Further, because the written partnership agreement contained 38 pages, and many of the details would have been material to me, the offer should have failed for lack of definiteness. This issue, however, was never raised by my counsel, nor did I have any understanding at the time of its potential relevance. Instead, the validity of the offer was presumed and the focus was on whether or not my actions at the meeting represented acceptance.

In hindsight, I should have argued that because the terms of the offer were not clear to either party at the time of the offer, the offer was not valid. Under California Civil Code Section 1550, essential terms of a contract include that the parties be capable of contracting, the parties have consented, there was a lawful object, and there was sufficient cause or consideration.1 The argument should have been presented that there was no consent because I could not have consented to terms of which I was unaware and which would be material. There were numerous terms within the partnership agreement that were material to a reasonable person, such as deferred compensation, a mandatory arbitration clause, and the repercussions of departing the firm, just to name a few.

Acceptance

Acceptance is the unequivocal assent to the terms of an offer. California Civil Code section 1585 provides: “An acceptance must be absolute and unqualified, or must include in itself an acceptance of that character which the proposer can separate from the rest, and which will conclude the person accepting. A qualified acceptance is a new proposal.”2 Presuming that the communication of the partner vote to me was a valid offer, did my silence, perhaps followed by a grumbling “thanks”, represent acceptance? The general rule is that the silence of an offeree does not constitute acceptance.3 There are a number of exceptions to this rule, but none appear pertinent to this situation. My potential comment when pressed of “thanks” did not represent an unequivocal assent to the terms of an offer, nor was it absolute and unqualified. However, several partners during deposition testimony indicated that “I seemed happy” or “thrilled” with the offer. Their position was that my outward manifestation of “feelings” represented acceptance, and one partner stated in deposition that my smile indicated acceptance. My view was that although acceptance by conduct is appropriate in some circumstances, it was not appropriate here, and that

1 California Civil Code Section 1550

2 California Civil Code Section 1585

3 McGlone v. Lacey, 288 F. Supp. 662 (D.S.D. 1968)

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only a much more unequivocal form of acceptance should suffice.

I also argued no agreement had been formed because if the partners felt I was subject to the main partnership agreement rather than the probationary partnership agreement, I should have been terminated through the “for cause” provision of that agreement rather than being terminated as an at-will employee based on the probationary partner agreement. To terminate me through an email stating I was terminated as an “at-will employee under the terms of the probationary partner agreement” was inconsistent with the position that I was an equity partner to be held liable under the main partnership agreement. The probationary partnership agreement made clear that a person was a probationary partner only until they became an equity partner, and at no times was both. Therefore, I argued, the firm itself clearly viewed me at the time of my termination as an employee (i.e. non-equity partner), and was only later trying to argue otherwise.

The firm also argued that because I continued to accept the “benefits of being a partner” for a year after the vote, I effectively had accepted the offer. My counter to this argument, after having learned the details of the partnership agreement, was that the functions I performed and the benefits I received after the partnership vote on my status did not materially change from what the situation that had existed under my probationary partnership agreement, and therefore should not be construed as acceptance. The resolution of this issue was never addressed in the final answer by the arbitrator.

Rejection

A rejection is a statement by an offeree that he does not intend to accept the offer nor give it further consideration, and such a communication cuts off the power of acceptance.4 I argued that the offer, if one ever existed, may have remained open to acceptance for a reasonable period. However, the period between the time of the purported offer and the date of my resignation was over a year, and the offer should have expired due to lapse of time during that period. Further, even if somehow the offer had remained alive during that time, my resignation was an unequivocal rejection of any such offer that may have been outstanding.

Consideration

Consideration is that which is bargained for and given in exchange for a promise. The question of consideration was not directly raised during the suit, but presumably would have been supported by my promise to work for the company and their promise to compensate me.

4 Goodwin v. Hidalgo County Water Control & Improvement District No. 1, 58 S.W.2d 1902 (Tax 1933).

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Formation

Whether or not I was bound to the main partnership agreement was a significant issue for me, and I spent a substantial amount of time arguing that I should not be bound. However, because I was uncertain of the resolution of that issue, and the partners in my old firm pushed heavily to bind me to that agreement, I also argued on behalf of my two new partners trying to lower any potential liability they would incur to which I may be held jointly liable. Thus, while the contract formation issue as it pertained to me was tentative and its resolution discussed further below, there was no doubt an agreement existed between my two new partners and our old firm. Much of the costs and time of the lawsuit was spent trying to understand the complicated language used in that contract.

Parole Evidence

The parol evidence rule provides that prior or contemporaneous evidence will not be admitted to vary, add to or contradict a written contract that constitutes an integration. An integration is a contract in which the parties intended the writing to be the final and complete expression of their agreement. Often, contracts include a merger clause expressly stating that the written contract expresses the entire agreement and understanding of the parties concerning its subject, and that any and all prior agreements or understandings pertaining to the same subject matters are effectively null and void. The partnership agreement of the prior firm included such a provision.

However, the parol evidence is subject to a substantial number of exceptions. One such exception is to provide evidence of what the parties mean by words used in the written agreement. The rationale for allowing this exception is that explaining the terms that are actually in the agreement does not vary, add to or contradict the written terms. This type of evidence usually includes such things as background discussions and surrounding circumstances regarding how certain terms were arrived at to help better explain the meaning of those terms when the language in the agreement is ambiguous.

Ambiguity

To determine the meaning of the difficult language in the partnership agreement on numerous issues, some of which are discussed next, numerous partners testified as to what they thought a term meant at the time it was written. Not surprisingly, as both of my new partners were there at the time and involved in writing the agreement, their interpretation differed from that of the other partners. It was clear that the relevant facts were based on what the parties intended at the time, but the “four corners” of the agreement provided little help on many issues and often created additional confusion.

One major issue of contention discussed in more detail below was whether the two departing

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partners were entitled to any deferred compensation when they left the firm. One the one hand, the partnership agreement included a “partner vesting” schedule that made it reasonably clear that a partner of a certain number of years was entitled to a certain and stated percentage of his deferred revenue, to be paid out over a period of 10 years upon leaving the firm. The term “vesting” normally means in laymen terms that once the criteria have been met (years of service in this case), those dollars are secured. The language in this section seemed to support this view. However, another section of the agreement required the loss of all deferred compensation if a former partner competed with the firm anywhere in southern California, or if a partner took partnership assets (i.e. partnership clients). Yet a different section allowed for the former partner to take such partnership clients if they were to pay a certain sum based on past revenue generated by that client, with no mention of deferred compensation.

The partnership agreement was unclear in this area and in many others, and required a person to reference numerous sections of the agreement to try to gain an understanding of what was intended, and even then the intention of the parties was questionable. The language was so ambiguous that during arbitration each party spent considerable time trying to understand what the agreement actually said before they could analyze the legal ramifications to their clients. Because the party drafting the agreement was going to be held more accountable than the party not drafting it, there was also a substantial amount of time spent determining who among the partners was involved in the drafting.

Law vs. Reality

Throughout the lawsuit, there were numerous terms in the partnership agreement in which the true meaning was disputed by the parties. These disputes did not impact contract formation but were very relevant to determining the meaning of certain terms that had a significant financial impact.

One key issue was the validity of the vote to terminate my two new partners for cause. The “for cause” termination in turn impacted whether or not they would be paid deferred compensation. The resolution of this issue shows how convenience and administration of justice sometimes take priority over enforcing an agreement based on original intent of the parties.

Per the partnership agreement, the vote to terminate an equity partner required a simple majority vote of equity partners to prevail, and allowed all equity partners to be part of the “required meeting” to discuss the issue and vote. In fact, the language in the partnership agreement specifically allowed an equity partner to vote on his own termination of his partnership status. We argued that because my two new partners were not invited to vote, nor partake in the discussion leading to the vote, they were not given the opportunity to defend themselves or sway the vote, in addition to their two votes not counting.

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While those two votes alone would not have changed the result, the firm also allowed two nonequity partners to vote on the termination, contrary to the language in the partnership agreement. Further, with the firm arguing to hold me liable as an equity partner in accordance with the partnership agreement, we argued that I should have been allowed a vote based on the firm’s inconsistent stance. Finally, we argued that as all three partners had resigned well in advance of the vote to terminate, and remained working at the firm “as employees” at the bequest of the other partners to help transition clients, there could be no termination for cause as the partners at that time were effectively at-will employees.

With certain partners voting not to terminate for cause, and others partners out of the country and unavailable to vote, adherence to the partnership agreement rules on termination may well have changed the result. However, by the time the arbitration took place two years after the departures, the arbitrator was unwilling to undo the entire termination because it would have been administratively prohibitive. Effectively, while the vote to terminate was clearly not done in accordance with the partnership agreement, and that fact had a material impact on whether a “for cause” termination took place (as opposed to another form of termination having less adverse consequences), the arbitrator seemed to be satisfied that the terminations for cause should stand in part due to the time that had passed.

Result

The “result” of the lawsuit is a loose term as there are really numerous results. The arbitrator relieved me of liability because he noted that I could not be held accountable to a contract that I had not signed, as I had argued all along. However, he held my two partners liable for the majority of damages requested by the other side. They were not to be paid any deferred compensation based on the “for cause” termination, and were required to pay for the clients and staff taken, plus substantial legal fees of the other side. When these legal fees were added to the legal fees billed by our own attorneys, the total legal fees represented approximately 40% of total costs. Worse, because my two partners were generally willing to pay for the clients and staff based on the general understanding of the agreement, they effectively were fighting the case because they thought they were entitled to the deferred compensation, and could not go along with the “for cause” termination. In reality, the maximum dollars they could have obtained from that would be $400,000 paid over 10 years, even if they won that issue. They ended up paying twice that amount just in legal fees, plus full cost for clients and staff rather than the discounted amount discussed during initial negotiations with the old firm. As is often the case in litigation, personalities rather than reason drove many of the decisions to proceed.

Fortunately for myself, because the arbitrator agreed that I could not be held liable for an agreement that I never signed or saw, he completely released me from liability. I could only be held liable under my original probationary partner contract, not jointly liable under the main partnership agreement of the firm. Because there was no “prevailing party” in regard to the case

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against me, I was not liable for the other side’s attorney fees either. Effectively, this meant I was not liable for virtually any costs based on the arbitrator’s decision.

While this result was certainly a huge relief to me personally, I hesitate to consider a two year struggle just to end up in roughly the same place as a victory. While the attorney would consider the case resolved in my favor, there are numerous issues that I would have handled differently in hindsight. The biggest flaw was in accepting the same attorney as my two new partners in hopes of keeping the new partnership together and to share the legal costs, even though my interests clearly varied from theirs.

There were a couple upsides to the case as well from a personal perspective. The experience led me into the field of forensic accounting and expert witness testimony, which I had not done before the lawsuit, and reignited my interest in becoming an attorney. Overall, I learned a lot from the experience but hope never to repeat it.

Conclusion

Contract law has many aspects to it, and a thorough study requires a review of more material at a far more detailed level. While the above lawsuit mostly pertained to issues of formation and breach of contract, the exact nature of the contract and material contract terms were significantly disputed by the parties. If everything had worked out initially and the parties had come to a reasonable negotiated settlement prior to litigation, the various aspects of the partnership agreement that were vague or badly written would not have come to light nor been tested. It’s only when something goes wrong that the benefits of a well written agreement with clear and certain terms shows it’s true value. As is often the case, a little extra work on the front end can save a huge amount of time and headache on the back end.