Virginia Contract Interpretation: Defined Terms

Whether lengthy and extremely sophisticated or short and straightforward, contracts are simply the expression of two or more parties.  In many cases, a skilled contract drafter can make even the most complex provisions of a contract understandable.  However, some contracts can seem daunting and complex to parties that are not exposed to them regularly.  In fact, if drafted poorly, even for attorneys some contract language is archaic and difficult to understand; assuming it makes enough sense to even be understood at all.   Generally, however, many people who are unfamiliar with reading or interpreting contracts struggle and find them difficult to understand.  Oftentimes this comes from basic misunderstandings about the way that contracts are intended to be read, which can often lead to poorly drafted agreements by inexperienced parties or attorneys who do not fully understand what the parties are trying to express in writing.

The first thing to understand is that in a contract defined terms reduce length and ambiguity in a contract by replacing lengthy language or an explanation, usually a definition, with a single term or short phrase.  Defined terms should be capitalized and should remain capitalized in a contract when used in that context.  For example, if “Services” are defined to mean and refer to something specifically, such as ‘computer programming and IT support,’ then for the duration of the contract, in place of ‘computer programming and IT support,’ “Services” should be used with a capitalized “S.”  Without such capitalization, ‘services’ could be read ambiguously or with plain meaning and may not capture the expression of the parties. Therefore, it is important to know what the definitions are in a contract, so that you can understand the meaning of the provisions and how that particular definition or similar language is being used.   It is equally important for a contract drafter to use appropriate definitions where applicable and to use the language consistently.  A skilled drafter or contract attorney will use these definitions as a tool to tell the contract’s story and to keep everything clear.  However, contract drafters can quickly make a contract provision complex with many defined terms used in a single expression.  For example, “only Sales made in the Territory by Builder or Sub-Contractor for Services or Goods Delivered will Costs be deducted.”  With so many defined terms used at once the sentence could easily have complex results and restrictions based on the structural combination and use of those particular terms.  Therefore, it is incumbent on the drafter or contract attorney to fully understand the implications of defined terms and how they are being used, especially if combined with other defined terms.

The second important thing to understand is that if the term is not specifically defined, then, pursuant to Virginia contract law, “words that the parties used are normally given their, usual, ordinary, and popular meaning.”  Preferred Sys. Solutions, Inc. v. GP Consulting, LLC, 284 Va. 382, 732 S.E.2d 676 (2012).  Consequently, if the word is not defined within the agreement, you can read the contract to understand it exactly as the word would normally be used.  Many people are worried that the language or the words themselves contain pitfalls or traps outside of their normal understanding in a contract.  This is generally not the case when there are no specifically defined terms in the agreement.   Conversely, this means that the words will not take on specific meaning if you do not define them to mean that.  Great care must be taken by contract drafters to be certain that they are fully capturing the understanding of the parties or their client’s wishes.  If the parties are using the words in an unusual way, then it may be best to specifically define them.  It is also important to understand that under Virginia contract law, typically the contract is bound by the four corners of the document, meaning, no outside language or other documents, including email exchanges, will be used to interpret or explain the parties’ intentions, especially if the document contains a superseding clause.  This is why it is so important that the contract capture the parties’ understandings fully.  However, the ‘four corner’ approach along with the superseding clause is a lengthy topic with some exceptions that we will address in a future blog post when discussing Virginia’s ‘parol evidence rule.’

A third important issue to understand about reading or drafting a contract is that pursuant to Virginia contract law, “[n]o word or clause in a contract will be treated as meaningless if a reasonable meaning can be given to it, and there is a presumption that the parties have not used words needlessly.” Id.  This means that not understanding a clause does not necessarily render it meaningless.  Therefore, it is extremely important to understand the provision, because there is a presumption that those words were not needlessly added to the contract and will be interpreted to have significance and meaning as a result.  Additionally, it highlights the dangers of inexperienced drafters using duplicative language and provisions.  Such inexperienced drafters may attempt to provide a “concrete” expression or be “extra cautious,’ but they may inadvertently provide added significance or meaning to the provision or clause unnecessarily, which could ultimately change the parties’ intentions.

Attention Investors, Individuals, and Small Business Lenders: Protecting and Enforcing Personal Loan Agreements

A loan agreement, or “note”, is a simple and common contract that typical identifies the lender or creditor, a borrower or debtor, the principal amount being lent, an interest rate, the repayment terms, and in some cases, a trustee, which is often dependent on if the loan agreement has a certain type of collateralization.  A loan agreement does not have to involve a bank or other financial institution, such as a mortgage loan.  In fact, many loan agreements are between two individuals, two businesses, or combination of the two.  It is routine for banks and other financial institutions to perform both background and credit checks as well as to take collateral on any note or loan agreement they issue.  However, this is not always common practice between individuals and/or businesses.  Unfortunately, failure to follow these common practices can result in a business or individual lender having difficulty recovering funds on a note or loan agreement in an event of an incurable default of payment.

The question then becomes how can an individual or business lender protect itself in a loan agreement?  

In an individual or small business setting, it is more common to see notes or loan agreements between family members, neighbors, or close friends.  There is nothing inherently wrong with such a transaction, but it is important for the parties to treat it as a standard business transaction and to take the appropriate precautions.  A credit and/or background check, although recommended, may not be practical in this type of social dynamic.  Consequently, it is more important in such setting to be sure that as a lender you understand fully what the money is being used for and how the borrower is planning to generate the funds to pay you back.  If this is for a business venture or investment, you should evaluate the business plan to ensure that it makes sense to you before you agree to anything.  If you believe the borrower has the means to pay you back and you wish to create a loan agreement, be sure that all of the terms agreed to by the parties are laid out in a clear and easy to understand contract or agreement which is executed by both parties, preferably in front of a notary public.

Some of the key terms that a loan agreement should identify in detail include how interest is calculated, repayments dates, and what occurs in the event of a default.  It may also be worth putting in collection or prevailing party attorney fee language into the loan agreement to deter the borrower from defaulting on payment.  Another consideration is to have other family members or individuals sign the loan agreement as well to guaranty payment in the event of a default by the borrower. This addition can be in the form of a surety or guarantee agreement, as we have discussed in more detail in a previous post.

One of the most important considerations in any loan agreement is collateral.  It is amazing the number of times individual and small business lenders get into trouble for failing to collateralize a loan, which can be a tremendous financial burden on a lender who did not get repaid.  In some extreme cases, it can even force the lender to seek relief through bankruptcy.  Typically, collateral is some form of property that will be transferred to the lender in the event of an incurable default by the borrower.   Common examples of collateral include a house or a car.  Ideally, you would want the collateral to be valuable enough to cover the entirety of the amount owed or outstanding on the note.   Further compounding the importance is that without collateral, you are likely to be deemed an unsecured creditor and as such, any amount owed to you could be at risk of being discharged in the event that the borrower or debtor went into bankruptcy.  As a result of the dangers and considerations involved, it is extremely important to work with someone experienced in contracts and loan agreements. You do not want to find yourself struggling financially, especially to the point of filing for bankruptcy protection, because you did not take the time to ensure that your loan had adequate repayment assurances.

Cost of Employee Turnover: Non-Compete Agreements and Non-Solicitation Clauses

 

In November 2012, the Center for American Progress, a Washington D.C. based independent nonpartisan educational institute, published a study which observed the cost of employee turnover to a business, which is the rate at which an employer gains and loses employees. The results were significant. According to the study, on average, companies pay roughly one-fifth (1/5) of an employee’s salary to replace that employee. Such costs consist of separation expenses, temporary staffing, advertising for the vacated position, and training.

 

With its close proximity to Washington D.C. and the federal government, including the United States Patent and Trademark Office (“USPTO”) in Alexandria, Virginia, as well as multiple, high quality universities,  Virginia is an extremely competitive marketplace for businesses.  Virginia is one of the most favorable states to start a business, with Fairfax County being one of the largest and highly employed counties in the Commonwealth.  With such a competitive marketplace, especially with some industry areas being overly saturated, comes the struggle of retaining quality employees and reducing employee turnover, particularly with those employees who the business has trained for a particular skillset.  

 

Employers may ask themselves, “can I keep my employee from going to a competitor?” or “can my employee start a competing company? What happens in these cases is often that an employee leaves a particular organization to go to work for a competitor who is willing to provide a larger salary and compensation package. In other cases, an employee starts his or her own business similar that of the previous employer and attempts to bring prior co-workers to the newly formed organization. Consequently, as a business owner, in order to maintain a competitive edge and reduce expense it is important to take precautionary measures to account for such a competitive environment and employee loss.

 

One of the most important contractual, precautionary measures that an employer can take is to require all employees to execute a written contract prior to employment that contains (a) a covenant not to compete, also known as a non-compete agreement or clause, and (b) a covenant not to solicit, also known as a non-solicitation agreement or clause.  The Non-Compete Agreement (NCA) essentially restricts the employee both during and after leaving his or her current employment from starting a competing company or leaving the employer to work for a competing company, and if drafted well, includes a well detailed scope for a limited duration and in a limited geographical area.  The Non-Solicitation Agreement (NSA) essentially restricts the employee both during and after leaving his or her employment from soliciting business from the employer’s customers and soliciting the employers other employees, and if drafted well, includes a well detailed scope for a limited duration and in a limited geographical area.

 

Does my business need non-compete agreements or non-solicitation clauses?  ABSOLUTELY

 

As a practical matter these agreements or clauses are by no means absolute veils of protection.  They are not perfect defenses and are the subject of constant judicial scrutiny.  In fact, very many of them are found to be unenforceable entirely or to have unenforceable terms, which in the circumstance of a severability clause, are stricken from an otherwise enforceable contract.  This requires the drafters of such contract language to be extremely careful in understanding what the current judicial trends are so that they can be certain the language will be enforceable.  As the study at the beginning of this article suggests, an ounce of prevention today may save you over a fifth of an employee’s salary tomorrow.

 

Personally Guarantying Payment on Behalf of Your Company or Another Third Party

Sometimes the only way to persuade another party to enter into a contract is too guaranty that the amount owed will be paid by a third party in the event that you cannot completely pay the amount owed. This provides an extra layer of protection to the non-guarantying party as the guarantying party becomes responsible for any amount owed that is not satisfied. The Personal Guaranty / Guarantee Agreement and its language in the agreement will determine the terms of this deal and when the guaranty to pay by the third party will activate.

A Guarantor, is the party guarantying that the consideration or amount owed will be satisfied; a Guarantee is the party to whom such guaranty is made. For example, with respect to student loans, parents may act as a Guarantor and guaranty that the student loans their child is borrowing will be repaid to the Guarantee organization, such as Sallie Mae, whom loaned the money to their child.

In many business, financial, and commercial contracts, you many times run into guaranty language, either embedded within a contract or as a wholly separate contract attached as an exhibit or addendum that guaranties part or all of a larger agreement.  In a typical business contract, two businesses will contract in a way that Business A agrees to pay Business B an agreed upon amount for the agreed upon good(s) or service(s).  However, in some transactions, such as a commercial lease, commercial loan agreement, or other payment overtime agreement, one of the businesses may want the other business’ owner(s) to sign a guaranty.  Ultimately, this guaranty requires payment by the individual(s) who made the guaranty in the event of a default of payment by the business.

Guaranty clauses or agreements can be drafted very conservatively or extremely aggressively.  For example, many business guaranty agreements have language that in the event of default of payment do not require the Guarantee to exhaust all remedies against a business Guarantor, including even filing a lawsuit against the business Guarantor, before enforcing the guaranty and demanding payment from the individual(s) who executed the guaranty.   As a result, in a breach of contract case, it is common practice for attorneys representing a business Guarantee to sue both the other business and the individual Guarantor(s) who signed the guaranty at the same time as opposed to separate or subsequent lawsuits.  This is why it is extremely important that the drafter or the reviewer or negotiator of a guaranty provision or agreement understand when the obligations of a Guarantor are triggered. A poorly negotiated guaranty provision or agreement could put individual third parties at unnecessary or excessive risk.

As noted above, guaranty language can either be embedded within an overall contract as one or more provisions or clauses, or rather such language can be drafted into its own, wholly separate contract attached as an exhibit or addendum to a larger agreement. In Virginia, as in many jurisdictions, a guaranty is often considered a separate agreement between two or more parties.  A very simple and well-articulated opinion outlining this concept, written  by Judge James Chamblin, can be found in the 1989 Loudon County case Snyder v. Keller, 12132., 1989 WL 646376 (Va. Cir. Ct. Sept. 13, 1989).  As this opinion explains, Virginia guaranty agreements must be in writing and signed by the guarantor.  This opinion is also the likely result of why many organizations use a separate document, or contract, for the guaranty as opposed to simply including guaranty language in a single overall document.

As a result of the common practice of using separate documents, it is that much more important for drafters and reviewers / negotiators to ensure that the language in both documents is consistent.  There have been interesting Virginia Supreme Court cases that highlight the pitfalls of document inconsistency and its unintended consequences. Such unintended consequences give way to exploitation by clever litigators, which only heightens the need for quality contract drafting. Use of separate documents also gives way to the importance of proper use of specific terminology and contract language, such as “attached hereto, incorporated herein, and made a part hereof” language, but that is the topic of another day and another article.

Contracts Are Everywhere

McClanahan Powers is proud to unveil its contract law blog!  Whether it is for drafting or reviewing an agreement they wish to reduce down to writing or whether it is enforcing and protecting their rights in a contract that already exists, our clients routinely ask us questions about contracts.  In some cases, clients do not even realize that their questions relate to contracts.  Contracts affect so many different areas of law and are fundamental fixtures in our society.  We want our clients and anyone reading this blog to have a more complete understanding of this fundamental concept.

Contracts are the building blocks and framework for virtually all fields of law.  For example, businesses are built and managed using both simple and complex contracts.  The operating agreement of a limited liability company (LLC) or the bylaws of a corporation are contracts between the members or shareholders about how the company will run, and in the case of an LLC, what the individual members’ roles and contributions will be.  Other common business contracts include employee agreements, vendor agreements, service agreements, client or patient contracts, commercial leases, warranties and any other business arrangement.

Intellectual property licenses, assignments, sub-licenses, and partnerships, as well as collaboration agreements for patents, trademarks, copyrights, or trade secrets, are all contracts between two or more parties. Attorneys who work in a particular field of law may have an understanding of that particular practice area (i.e. intellectual property), but that specific knowledge must work in conjunction with and have its foundation in an advanced understanding of contract law generally. No matter what you call these agreements, at the end of the day, they are all simply contracts.

Contracts are not only found in the business world.  For example, they can play a crucial role in estate planning as well.  Spouses may wish to have their wills or trust instruments treated as a contract between them, so that spouse cannot change the terms when the other spouse passes away.  In addition, health insurance and other payable on death accounts, such as certificates of deposits, are based in contracts between the individual and the health insurance company or banks.

Contracts find themselves in all types of situations.  The number of contracts we encounter daily and the way these contracts impact us could span forever, but here are some additional examples that you may see or be affected by every so often or even every day, a list in which could go on forever:

  • prenuptial agreements before marriage;
  • divorce settlement agreements;
  • child custody agreements;
  • the agreement between buyer or seller when buying a good or service from a store;
  • the agreement between a gym and a new member when joining a gym;
  • the agreement between a business or individual and a homeowner when hiring a repairman;
  • the agreement between the seller and buyer, as well as their agents, when selling or buying your home;
  • the agreement between a university and student when going to a new school;
  • the agreement between the city and library patron when getting a library card; the agreement between the company or individual and user of a website when accessing a website;
  • the license between a company and consumer when putting a program on your computer;
  • the agreement between a web host and website creator when buying a domain name; and
  • the agreement between a business and individual when taking your car to a mechanic.

Contracts are essential parts of our everyday life and affect us in ways we may not even realize.  It is important that you have an understanding of how they work, so that you know when your rights are being violated or when you may need an attorney who is experienced in dealing with contracts to enforce or protect your legal rights. We hope that in the years to come that you find this blog helpful with respect to both big decisions and everyday life.