Ever read another person's class notes, ones that were written only to themselves? If you have, it probably made you wonder, at least in one place or two, what was meant by the words written there. While the author clearly knew what she was writing, for a third party to get to the meaning behind such words can take some detective work, utilizing both context clues, and your understand of the person behind the words.

While this can be sorted out with personal notes, a contractual agreement is a completely different kettle of fish. Even though extreme care is supposedly taken with such documents, I've run into unclearly written contracts quite often.

Just like in the personal notes, the authors of the contract "knew what they meant to say." Unfortunately, relying on the authors, when it comes to a contractual agreement, is often not practical.

"Institutional Memory" is a term that I'm going to appropriate for this post, applying it in a slightly non-conventional way. Normally, "Institutional Memory" refers to the body of knowledge shared by members of an organization, often knowledge that isn't codified. In my special usage, let's assume that this knowledge extends to the agreements between parties, and what was actually meant by the written agreements they make. The point is, "Institutional Memory" is embedded in people, rather than in the words themselves

Many agreements unintentionally rely on this "Institutional memory," this shared understanding, when the contract is developed. The problem is, the intent of the contract is buried in the heads of the people involved in the negotiations. When those people change or are replaced, the "Institutional Memory" fails. At that point, we often end up with "Institutional Amnesia," which is typically reverts back to a literal interpretation of the contract. Of course, those interpretations are often biased in favor of the interpreting party.

I've most often seen problems occur with long-term contracts between companies. This would mainly be agreements such as: Joint ventures, partnerships, shareholder agreements, technology agreements, licenses, etc. The most vulnerable agreements seem to be ones where there is an imbalance in the timing of when each side of the agreement extracts the value they want from the relationship. For example, in a joint venture agreement, the seller usually gets cash up front, while the buyer is typically relying on longer term benefits. Because of "Institutional Amnesia," there can be a real risk of opportunistic interpretation of the contract down the road by either side of the agreement, particularly when one or both of the primary negotiators of the original agreement move on to other jobs. Issues seem to be smaller when both parties are extracting their value from the agreement over roughly the same timeline (such as with a long-term supply contract).

The devil is in the details. I've seen "Institutional Amnesia" take over primarily with the detailed mechanics of the agreement. How is the share price supposed to be calculated, exactly? How do we draw the line between covered and non-covered latent liabilities? What are the exact steps needed to force a management change? How do we draw the line between an allowable and a disallowed use of the licensed technology? "Institutional Amnesia" is opportunistic. It encourages the "forgetful" entity to re-interpret the agreement so that they maintain technical compliance, but still manage to avoid the intent of what was written. Sometimes the agreements are so poorly written, it is difficult to establish either intent or technical compliance. Under those circumstances, the door is wide open for manipulation.

In a foreign licensee, we were reaching the planned end of the contract and there was a major issue brewing over territory. Getting an extension on the agreement required solving this issue but, unfortunately, the "Institutional Amnesia" surrounding the details of end of license with respect to ownership of the technology created an additional major complication. It seemed the licensee "believed" that the agreement allowed the returning drawings and specifications to us, but did not prevent them from entering the space as a direct competitor. As a result, the other party maintained that they could "create their own drawing and specifications," even though that was clearly not the intent of the original contract. Unfortunately, the wording of the contract wasn't completely clear. Since the agreement didn't specifically forbid them copying and altering drawings and specifications (by replacing our name and logo with theirs), they proceeded to do just that. In the end, we were severely hampered by the poor contractual wording.

In another example, I was forced to remove a partner in a joint venture after he ran the business into the ditch. Such an eventuality was anticipated, but the details of how to do it were never included in the shareholder's agreement. As a result, innumerable hours were spent choreographing the event. Even after all the preparatory work, I made enough mistakes that we were still eventually sued. The whole problem could have been avioded with a contract that carefully enumerated the understanding between the two sides.

I know most managers dislike long, complex contracts. And 80% of the time, 99% of the provisions covered in the contract are never referenced. In those cases where it is needed, however, clarity of intent is absolutely critical. Wording counts. Taking the (often tedious) time needed to make sure everything is clear, correct, and represents the entire understanding between the parties is absolutely critical to protecting you and your employer down the road.

What do you do if you inherit a poorly written contract?

There are two approaches to dealing with this issue. Unfortunately, the first one can only be used prior the commencement of troubled times. You should carefully review any inherited contracts (or, better yet, get an independent attorney to do so), and make sure there is common understanding and interpretation on any unclear or controversial items. This absolutely must be done in writing, and may even require an amendment to the contract, depending on how poorly written the original was to begin with.

Once trouble starts, however, (such as the approach of the end of the license agreement in the first example above) the only thing you can do is renegotiate based on a literal interpretation of the contract. While you might be able to get the partner to agree to some or all of the "intent" of the original agreement, my experience is that rarely happens (worth trying, however). In many cases, what you thought you had locked in will prove to be unenforceable, and you'll end up with a much less favorable agreement.

Of course, you can always agree to disagree, which will most likely result in a legal or market battle of some sort.

Clearly, it pays to get things straight before a rough spot is reached.

The bottom line is you can't rely on "Institutional Memory" when it comes to your long term contracts. Instead, you must plan for "Institutional Amnesia." Your best bet as a manager is to be far out in front of any contractual problems, whether of your own making or inherited. When you make a new contract, take the time necessary to make sure your intent, particularly when it comes to all contingencies, is properly and accurately reflected in the contract. A good strategy is to let a savvy non-participating manager read it without coaching, and have her tell you what she thinks it says. Your successors will thank you, and it might even benefit you if there is a change in personnel on the other side of the agreement. 20.3

Institutional Amnesia

Tom Spears

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