Ethical Considerations When Drafting and Negotiating Contracts

Corporate Counsel’s Perspective

When discussing contract negotiations for corporate counsel, ethical considerations and potential conflicts must always be considered. This is the first of a three-part series discussing the ethical factors and conflicts for corporate counsel when negotiating contracts. This week, the MSBA will concentrate on contract negotiations. Next week, the MSBA will focus on parent and affiliation negotiations and conflicts. In the final week, the MSBA will discuss company and key employee negotiations and conflicts. 

Two critical issues to address in every contract negotiation are what duties do you, as corporate counsel, owe to the other party and what duties do you owe to your client?  Typically, when two parties are negotiating a contract, the contract goes through several rounds of drafts and each draft goes through several rounds with the parties with redlines and highlights, track changes, etc. Hopefully, a final draft will be agreed upon.  What if one of the attorney’s involved in negotiating makes changes to the draft, but did not inform opposing counsel? What if the president of one of the companies involved in the negotiations made a change to the draft, but did not tell their corporate counsel?  Later, that company’s corporate counsel discovers the change the president made.  What are corporate counsel’s next steps? Our analysis will discuss what the ABA Model Rules for Professional Conduct have to say about this very common scenario and the unique twist that the Maryland Attorneys’ Rules of Professional Conduct require regarding disclosure.        

Relevant ABA Model Rules for Professional Conduct 

The relevant ABA Model Rules of Professional Conduct regarding this issue are listed below:

• Rule 1.2(d) – A lawyer shall not counsel or assist a client in conduct that the lawyer knows or reasonably should know is criminal or fraudulent. . .
• Rule 4.1 – In the course of representing a client a lawyer shall not knowingly: (a) make a false statement of material fact or law to a third person; or (b) fail to disclose a material fact to a third person when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client, unless disclosure is prohibited by Rule 1.6.
• Rule 1.6 – (a) A lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent, the disclosure is impliedly authorized in order to carry out the representation, or the disclosure is permitted by paragraph (b). (b) A lawyer may reveal information relating to the representation of a client to the extent the lawyer reasonably believes necessary: (3) to prevent the client from committing a fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer’s services. 
• Rule 8.4 – It is professional misconduct for an attorney to: . . (c) engage in conduct involving dishonesty, fraud, deceit, or misrepresentation.”

Relevant Maryland Attorneys’ Rules of Professional Conduct

The relevant Maryland rule is 19-304.1, TRUTHFULNESS IN STATEMENTS TO OTHERS, which provides: 

     (a) In the course of representing a client an attorney shall not knowingly: (1) make a false statement of material fact or law to a third person; or (2) fail to disclose a material fact when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client.

     (b) The duties stated in this Rule apply even if compliance requires disclosure of information otherwise protected by Rule 19-301.6 (emphasis added)

Maryland Rule 19-304.1, is superior to the ABA Rule for Maryland attorneys and requires disclosure of confidential information to “avoid assisting a criminal or fraudulent act by a client.” Id.

Relevant case law  

     Undisclosed changes equal fraud

In the case of Hand v. Dayton-Hudson, 775 F.2d 757 (6th Cir. 1985), Hand was terminated and Dayton-Hudson offered him a settlement payment of $30,000, if he signed a full release. Hand delivered a signed release to a representative of the company accepting the offer, but he made a change to the release by inserting the typed words, “except as to claims of age discrimination and breach of contract.” He did not notify Dayton-Hudson that he made this change to the full release. A couple years later, Hand filed suit against Dayton-Hudson for age discrimination and breach of contract. The trial court granted Dayton-Hudson’s motion for summary judgment and reformed the release omitting Hand’s exclusion because he did not notify Dayton-Hudson of the change. The Sixth Circuit affirmed stating, “Hand committed fraud by not informing Dayton-Hudson of the changes he made to the original release.” The Court also stated that Dayton-Hudson’s signature had been induced by fraud, and therefore the agreement would be reformed to conform to its original understanding and meaning. 

     Must a lawyer read every word of every draft of the contract being negotiated?

In the case of Hennig v. Ahern, 601 N.W.2d 14 (Wisc. App. 1999) a company was getting ready to spinoff a division so it offered the head of the division a percentage of the net equity realized from the sale. The percentages were negotiated, but what was not negotiated was the definition of “net equity.”  The definition in the contract defined “net equity” as the gross sale price reduced by certain expenses.  The definition was never changed during the five rounds of drafts that went back and forth between the parties except for the last version.  The President, Mr. Ahern, without his lawyer’s knowledge, changed the definition of “net equity” to the final draft that had never been discussed or highlighted and to the detriment of Hennig.  No one noticed the change and when the contract was executed Hening received less money than he expected, so he sued. The trial court dismissed the case at the end of claimant’s case basically holding that Hennig did not read the final draft so too bad.  However, the appellate court took a different view by reversing and stating, “ [w]e conclude that Hennig has presented sufficient evidence from which a jury could infer that Ahern’s nondisclosure of the change [to the contract] was knowing and done with the intent to deceive Hennig, for the purpose of inducing him to enter into a contract that he would not knowingly have signed. Thus, Hennig has established prima facie claim for intentional misrepresentation.”  Id. at 29.  “We are thus unwilling to hold, as a matter of law, that notwithstanding a pattern or practice of the parties or their counsel of highlighting and discussing all modifications in previous drafts, a party must read each and every word of successive drafts of a complex commercial document in order to ensure that another party has not surreptitiously inserted a significant last-minute change.” Id. at 28. (emphasis added)

Takeaways 

1. Conduct a Compare Analysis of Every Draft. According to Hand and Hennig, an attorney is not required to read every word of every document, but the better practice is to read a document front to back before you sign off on the final draft.  Many firms as a matter of course conduct a compare/contrast analysis before signing off. Microsoft has a “Compare Documents” feature that allows you to compare documents to determine if any changes were made. There are other softwares in the market that you may wish to consider to compare different types of files (XML, Word, text, and pdf files), e.g. Adobe Acrobat Pro DC, ABBYY FineReader, Workshare Compare, Docu-Proof Enterprise. 
2. Omissions are misstatements. Pursuant to ABA Rule 4.1 and the comments to Maryland Rule 19-304.1, misleading statements and “omissions” are the equivalent of affirmative false statements.  See Rule 19-304.1, Comment[1], Misrepresentation.  
3. Duty to disclose. The materiality of the change in any contract is important in the analysis, but it is a good practice to highlight or redline all your changes.  It is also a good practice to be honest and forthcoming with your opposing counsel during negotiations. 

You may watch the presentation on these ethical considerations in contract negotiation and drafting here.  Join us next week when we discuss ethical considerations and conflicts when corporate counsel negotiates parent and affiliation agreements.  

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Materials for this article were taken from “Ethical Considerations for Corporate Counsel for Contract Negotiation & Drafting”, presented by I. DeAndrei (Dee) Drummond, Esquire, General Counsel with MarketSource, Inc. and Andrew Lapayowker, General Counsel of Rosemore, Inc., during the MSBA’s Legal Excellence Week on February 23, 2022.