When documenting a potential deal, attorneys and clients tend to focus on the "deal terms," like the sales price, and overlook seemingly innocuous boilerplate provisions. Failure to watch out for the potential pitfalls associated with typical boilerplate provisions can result in problematic litigation when the deal falls apart or a dispute arises. Transactional attorneys should avoid the false sense of security in boilerplate provisions, and consider such provisions with an eye toward future litigation.

The efficacy of any agreement remains unknown until the agreement comes under scrutiny in litigation. Once under a microscope, conflicting choice of law, forum selection, dispute resolution or arbitration provisions, unintelligible variable interest rate provisions, insufficient merger or entirety clauses, or incomplete force majeure clauses can create costly and unnecessary litigation headaches. This article considers the litigation pitfalls that arise when transactional attorneys fail to watch the pot, and offers potential solutions to keep the pot from boiling over.

A. Watch for Consistency: Conflicting Provisions in Separate Agreements
In any given deal, there can be myriad separate, but related agreements: purchase agreements, guaranties, financing agreements, indemnity agreements, pledge agreements, and security agreements. Although separate agreements executed at the same time as part of the same transaction are construed as a single transaction, problems arise when the separate agreements contain conflicting provisions regarding the same topics. A claim arising from one document may be subject to arbitration while a claim arising under a separate document may be subject to litigation in a particular forum. Construction of one agreement may require application of Texas law, but construction of a related agreement may require application of Louisiana law. There may be instances where separate agreements both provide for arbitration, but the procedure set forth for initiating the arbitration process or the selection of an arbitrator or arbitrators differs.

When such provisions clash, litigators face the unpleasant task of navigating through unnecessarily complex procedural hoops. Such navigation requires litigating gateway issues before getting to the merits of the dispute. These threshold issues often relate to how to initiate litigation or arbitration, where the dispute will be heard, what law applies, or what procedural rules apply. The end result can be expensive piecemeal litigation in separate forums applying different law with the very real risk of conflicting rulings or judgments.

Conflicting provisions generally arise from the use of forms from prior transactions, combining standard forms with a unique document, or mixing and matching forms from separate parties. From the outset, parties involved in a transaction comprised of separate agreements should consciously decide on a particular forum, arbitration procedure, and the applicable law. As forms to be used in the transaction come into play, attorneys should carefully proofread the forms to make sure that the provisions related to dispute resolution accurately reflect the parties' agreement for future resolution of any disputes, and that they do not inadvertently conflict with one another.

B. Watch the Forum: Crafting an Arbitration Agreement
Many clients include boilerplate arbitration agreements in their forms based on a perception that arbitration is more efficient, less costly, more predictable, confidential, more final, and generally better for complicated fact situations that require expertise to understand. In reality, arbitration often does not cost less than a trip to the courthouse, and may not result in a "quick" or more predictable resolution. In the event the arbitrator issues a clearly erroneous award against your client, your client has little-to-no right to appeal the award. The realities of arbitration often conflict with a client's perception of the process.

Instead of automatically assuming arbitration is the preferable form of dispute resolution, attorneys should first consider the inclusion of a jury waiver provision in lieu of an arbitration agreement.[1] In arbitration, parties typically share the cost for the arbitrator or arbitrators—costs that can quickly skyrocket. The courthouse down the street is a free forum. A jury waiver allows the judge to act as the finder of fact and avoids the uncertainty inherent in any jury pool. If the judge makes the wrong call, then a party has the right to appeal, a right essentially forsaken in binding arbitration.

If, after dismissing the virtues of the courthouse, the parties remain committed to arbitration, careful attention should be paid to the drafting of the arbitration clause. Too often such clauses appear to be drafted by attorneys who may have never actively participated in an arbitration. Without knowledge of the arbitration process, the arbitration clause may contain gaps that can cause costly litigation of gateway issues related to arbitrability, e.g. whether an arbitration agreement exists, or whether certain claims fall within the scope of the arbitration provision.

To dodge troublesome and costly gateway issues, the drafting attorney should consider the following checklist when constructing a custom arbitration agreement:

1. carefully define the scope of the clause to include the claims subject to arbitration, and specifically exclude those claims (or third parties) that will not be subject to arbitration;
   
   
2. specify whether the arbitration agreement is subject to application of the Federal Arbitration Act or the Texas Arbitration Act, and when the Texas Arbitration Act applies determine whether to specifically and expressly exclude application of the Federal Arbitration Act;
   
   
3. detail the steps necessary to initiate the arbitration process, which may include written notice, followed by an attempt at resolution by senior management representatives from the parties or mediation;
   
   
4. specify the locale for the hearing, the governing law, and the applicable arbitration rules;[2]
   
   
5. specify the number of arbitrators and the process for selecting the arbitrators;[3]
   
   
6. set forth the requirements for the arbitrators, such as years of experience in a specific industry, and any other considerations for ensuring the neutrality and independence of potential arbitrators;
   
   
7. set forth the parameters of discovery, depositions (if any), the exchange of documents, initial disclosures, interrogatories, or other custom discovery tools;
   
   
8. consider whether to allow parties to the arbitration to file dispositive motions or prohibit such motions in arbitration;
   
   
9. include any limitation on any future award by the arbitrator, whether the exclusion of consequential damages or limiting the amount of any single award;
   
   
10. consider defining the form of the award, e.g., requiring findings of fact and conclusions of law, a reasoned award, or a simple monetary award; and
    
    
11. determine whether the prevailing party will be entitled to attorneys' fees or costs of arbitration.

Last but not least, ask an attorney experienced in arbitration to review the clause.

C. Watch for Cracks: Making a Merger Clause Count
Merger or entirety clauses purport to tie the deal up in a neat little bow. They allegedly prevent future oral amendments or modifications to the agreement and future claims of fraud based on representations outside the agreement. A typical merger clause contains language similar to the following:

This Agreement, together with all Exhibits referenced herein, constitutes the entire agreement between the Parties in relation to the Subject Matter of this Agreement and supersedes all prior agreements, understandings and commitments, whether oral or in writing, between the Parties. This Agreement may not be amended or modified in any manner except by a written document signed by both Parties that expressly amends this Agreement.

Despite a transactional attorney's best intention to tie a bow around the deal, cracks in the clause may allow room for oral amendments or modification of the agreements, and claims of fraudulent inducement.

The statute of frauds requires certain types of agreements to be in writing.[4] Where an underlying agreement is not subject to the statute of frauds, it is likely that any amendment or modification will likewise not be subject to the statute of frauds. Thus, if the alleged amendment or modification does not fall within the statute of frauds, it may be enforceable, despite the contrary working of the merger clause.

A merger clause does not shield a deal from future claims of fraudulent inducement. Although the typical merger clause purports to define the entire agreement within the four corners of the agreement and specifically excludes any prior agreements between the parties, a party to an agreement may nevertheless assert claims of fraud based on oral or written representations that occurred outside the four corners of the document.[5] To ward off the threat of future claims of fraudulent inducement, the merger clause should knock out the reliance element necessary to establish a claim of fraudulent inducement by including an express waiver of any reliance on any representation made outside the four corners of the agreement. Consideration should also be given to expressly waiving reliance on specific representations that naturally flow from the subject matter of the transaction, such as the value or condition of the subject matter. The merger clause may also include an affirmative statement of exclusive reliance on each individual party's own due diligence, evaluation or investigation of the subject matter of the agreement.

D. Watch the Unforeseen: Defining Force Majeure
Often considered the ultimate boilerplate provision, the force majeure clause can excuse a party's performance when certain unexpected events occur. Recent events have brought overlooked force majeure provisions to the forefront, including the government's drilling moratorium in response to the Deepwater Horizon oil spill. Hurricanes in the Gulf of Mexico have shut down refineries and manufacturing plants, raised the price of commodities and restricted transportation access and routes. China's massive construction programs have caused a rapid rise in commodity prices. When these types of purportedly unexpected events occur, parties may look to the force majeure clause to justify non-performance, late delivery or an increase in price. Clients seeking relief or receiving a force majeure notice may be disappointed to learn that the force majeure clause was nothing but an afterthought.

Transactional attorneys should bring the force majeure clause into focus by clearly defining what constitutes a force majeure event, and what happens when such an event occurs. For example, if a hurricane constitutes a force majeure event, the agreement should identify the parties' remedies, whether performance delay, cancellation of the contract, an increase in price, or a duty to cover. The duration of those remedies should likewise be defined to alleviate uncertainty as to how long deliveries can be delayed, performance excused, or prices elevated. The force majeure provisions should not only describe what constitutes a force majeure event and what remedies are available, but also how to proceed after such an event. For example, the provision should detail how to provide notice of a force majeure event, and when any response to such notice may be due. Consideration should be given to whether the responding party has an option to cancel the contract altogether or delay performance. Contractual force majeure terms control over common law rules that can fill gaps.[6] To eliminate future reliance on the common law gap fillers, the parties may detail their rights, remedies, and the procedure in the force majeure clause.

E. Watch for Clarity: Keep Variable Interest Simple
Variable interest rate provisions often complicate the litigation process and impede enforcement of a judgment at the conclusion of the dispute resolution process. The law allows recovery of pre- and post-judgment interest, but exactly what that amounts to may be in jeopardy when neither the jury, nor the court, nor the sheriff can make heads or tails of the provision on which an award of interest is based. Variable interest rate provisions can include definitions that go on for pages and pages amounting to an unintelligible mess that only the drafting attorneys can decipher.

Confusion arising from variable interest rate provisions can be caused by a number of situations. Many variable interest rate provisions rely on sources outside the agreement to determine the applicable rate. Those sources may include various financial publications or pronouncements by other large financial institutions. Complications also arise when different rates may apply to different tranches or levels of funding. To further obscure the applicable interest rate, calculation of the rate may be based on subjective conditions or events occurring outside the agreement.

The litigator faces the challenge of offering specific proof of the applicable interest rate and interest calculation at trial. A judgment must be complete on its face, and cannot change based on future fluctuations in the market. If the applicable interest rate is based on a third-party publication, the litigator can acquire proof of the interest rate during discovery through a deposition on written questions. However, at trial, the applicable rates determined during discovery may have changed due to more recent publications by third parties, or the occurrence of certain events or subjective conditions. Without a crystal ball, future fluctuations in the applicable rate are simply indeterminable. The inability to determine a future interest rate throws a wrench in the path to achieving a judgment that is complete on its face. To establish a future interest rate, there must be a quantitative formula for doing so on the face of the note or applicable agreement. In the absence of such a provision, there is no way to prove the future rate. The litigator must then attempt to convert the variable interest rate into a fixed rate.

The uncertainty of future interest rates generates risks beyond the court room. The judgment, if uncertain or incomplete, can hinder a party's ability to recover on the judgment. The sheriff responsible for executing a judgment must also be able to calculate the amount of the judgment, including interest to enforce it against a judgment debtor. If unable to do so, the sheriff cannot enforce the judgment. Moreover, a client may be subject to liability for any miscalculation that leads to an event of default and premature acceleration of any underlying note.

To avoid the pitfalls associated with complex variable interest rates, transactional attorneys should keep it simple. Consider the inclusion of a provision that applies "the highest rate allowed by law" upon an event of default or post-maturity. Prior to reaching maturity or default the variable interest applies, but upon maturity or an event of default the applicable interest rate defaults to the highest rate allowed by law. Where an outside source is the basis for the rate, such as LIBOR or the prime commercial rate of a large bank, such as Citibank, consider a provision that makes the current lender's records prima facie evidence of the applicable interest rate. Both of these solutions curb the challenge of proving the uncertain, and provide a sound basis for an enforceable award of pre- and post-judgment interest without subjecting the client to potential liability.

F. Watch the Note: Who's got it?
Lenders today frequently fail to confirm prior to initiating litigation or foreclosure proceedings that they hold the underlying note. To prevail in a suit upon a promissory note, the lender must establish standing to bring the suit. To establish standing, the lender must prove that it is the owner and holder of the promissory note. Because lenders today slice, dice, sell and flip loans, the original note can get lost in the transfers, and with it, the ability to establish standing in a subsequent foreclosure action. If the note is not lost, then it may be improperly pledged to another lender.[7] For example, A borrows money from B to loan to C, and gives B the original note with an absolute endorsement as security. In such a situation, the agreements between A and B may reflect that the absolute endorsement is only for security purposes, but the effect is nevertheless the same—B is the owner and holder of the note. Thus, when A seeks to foreclose on a loan to C, A lacks standing because B owns and holds the note through the absolute endorsement.

To avoid this problem, lenders should keep track of the underlying note during any slicing and dicing of the loan. In the above example, A should only collaterally endorse the note to B, and B should give A the note in trust when A seeks to foreclose on the loan with C. To avoid any owner and holder debacles, drafters of loan agreements should consider structuring the loan strictly in the form of a contract rather than as a negotiable instrument.

G. Conclusion
Preventing the pot from boiling over requires nothing more than careful drafting of traditional boilerplate provisions with an eye toward future litigation of the agreement

Liz Klingensmith, a University of Houston Law Center graduate, practices in the business litigation section of Haynes and Boone, LLP. She primarily focuses her practice on disputes arising from oil and gas-related projects.
Larry Huelbig, a partner at Haynes and Boone, LLP, has more than 40 years in business related litigation with a primary focus on litigation involving financial institutions and post-judgment remedies.

Endnotes
1. Parties may contractually agree to waive their rights to a trial by jury. In re Prudential Ins. Co., 148 S.W.3d 124, 132 (Tex. 2004) 2. The American Arbitration Association ("AAA") rules for various industries can be found at http://www.adr.org/arb_med (last visited April 23, 2010). 3. The AAA rules set forth a procedure for the selection of an arbitrator or arbitrators, but the parties may agree on a different selection process independent from the AAA. See, e.g., AAA, Commercial Arbitration Rules, R-11 – R-19. Where the parties agree on such a process, and exclude the AAA's involvement in that process, the parties may receive a 50 percent reduction in proceed fee in the Pilot Flexible Fee Schedule. See id. at Administrative Fees. 4. See TEX. BUS. & COM. CODE § 26.01, et. seq. (2010) (Statute of Frauds). 5. See Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 179 (Tex. 1997) (emphasizing that a merger clause will not always bar a claim of fraudulent inducement); Desert Palm Props., N.V. v. Macfarlane, No. 01-09-00967-CV, 1994 Tex. App. LEXIS 2951 (Tex. App.—Houston [1st Dist.] Dec. 8, 1994, writ denied) (observing that the merger clause "does not preclude liability for, or provide grounds for summary judgment on, plaintiffs' claims for fraud, conspiracy, and negligent misrepresentations because it contemplates only contractual obligations, and would not obviate tort liability."); Burleson State Bank v. Plunkett, 27 S.W.3d 605, 616 (Tex. App.—Waco 2000, pet. denied) (concluding that a merger clause in the form of a "notice of final agreement" is not binding and neither prevents nor limits the right to pursue tort claims). The parol evidence rule will not bar proof of fraudulent inducement claims. See Desert Palm Props., 1994 Tex. App. LEXIS 2951 at *27 (noting that the parol evidence rule does not bar proof of claims for fraud, conspiracy or negligent misrepresentation). 6. R & B Falcon Corp. v. Am. Exploration Co., 154 F. Supp. 969, 973 (S.D. Tex. 2001) (citing Sun Operating Ltd. v. Holt, 984 S.W.2d 277, 283 (Tex. App. –Amarillo 1998, no pet.)); see also TEX. BUS. & COM CODE § 2.616 (providing procedure upon receipt of a notice claiming force majeure). 7. See Vestal v. Conner, No. 14-96-00576-CV, 1997 Tex. App. LEXIS 4244 (Tex. App.—Houston [14th Dist.] Aug. 14, 1997, pet. denied) (granting summary judgment based on lender's failure to establish lender's status as the owner and holder of the underlying promissory note when lender collaterally assigned note to a bank for a loan); Lawson v. Gibbs, 591 S.W.2d 292 (Tex. App.—Houston [14th Dist.] 1979, no writ) (superceded by statute on other grounds) (upholding substitute trustee's sale authorized by bank after determining that bank despite having been collaterally assigned the underlying note by the payee was also the owner and holder of the note when the payee also endorsed and delivered the underlying note to the bank).