The question of which party to a contract writes the first draft is generally understood among attorneys, but can sometimes be a mystery to clients. This article will present a brief overview of which side usually drafts, the reasons for doing so, the exceptions to the rule, and some discussion about the consequences for not following tradition.
The general rule is that the party that most needs to be protected in a transaction is the party that does the first draft. For example, a landlord needs to be able to control how tenants use the leased property. Lenders want to impose covenants to better ensure their loans will be repaid. A buyer of a business wants assurances as to the assets he is acquiring so as to minimize risk of post-closing liabilities for pre-closing activities. A software licensor wants to make sure that its code is not reverse engineered or used beyond the scope of the license. Employers want to clearly set forth an employee’s duties, the employee’s “at will” status (or, if applicable, a description of the grounds for termination), and post-termination obligations.
The party that doesn’t need the protection would normally draft the shortest document possible. A tenant would prefer a lease that does little more than describe the leased property, the start and end dates of the lease, and the amount of the rent. The tenant isn’t interested in language detailing how it can or can’t use the property, restricting renovations, or prohibiting assignments. A borrower’s ideal loan document would state the amount of the loan, the interest rate and the repayment terms. It’s the lender that wants affirmative and negative covenants, financial covenants, and events of default. Similarly, a seller of a business would be happy to sign a one page bill of sale listing the assets sold, their purchase price, and stating that the sale is as is. The buyer, on the other hand, wants the protection gained by a long list of representations and warranties about the business and the assets it’s purchasing, along with indemnification provisions to address any breach of those representations and from certain pre-closing activities of the seller.
Accordingly, it’s the party that needs the protection of a more fulsome document that is the party that normally does the first draft of the document.
There are however, times where the general rule described above does not apply.
First, when real estate is being sold, the common practice is that the seller drafts the purchase and sale agreement. The reason for this custom is that the buyer is not looking to the contract for its protection when purchasing a property (normally all liability of the seller terminates at the closing of the sale); instead, the buyer obtains title insurance as the source of its protection if there’s an issue with the title to the property. In some transactions, the sale of real property is being made concurrently with the sale of an operating business, in which case, contrary to the rule stated above, the seller’s attorney may also draft the asset purchase agreement. This is more common if the purchase price for the business is a relatively small part of the overall purchase price – if the value of the business is a substantial part of the overall transaction, then the seller may draft the real estate contract and the buyer the asset purchase contract.
Second, a seller of a business may sometimes have a number of interested buyers. In this situation, the seller may elect to send out its version of the purchase agreement in order to be able to gauge the potential buyers’ attitudes on issues such as escrow, scope of representations and warranties, survival of representations and warranties, and indemnification deductibles, baskets and caps. A seller may be willing to sacrifice some purchase price for a reduction in its post-closing exposure, and having potential buyers mark-up a seller prepared purchase agreement is an efficient way of accomplishing this.
Third, while it would be consistent with the general rule for non-disclosure agreements to be drafted by the party making the disclosure, as a matter of practice the rule is not followed here as regularly as it is with the other contracts described above. For one thing, in many deals both parties are making disclosure, in which case both parties are presumably aligned in having a reasonable agreement, such that it doesn’t matter who does the drafting. While this may appear to be the case, other than in a transaction such as a merger or joint venture, disclosure is not equal in terms of the sensitivity or scope of the information being disclosed, so that even a mutual non-disclosure agreement can be revised to provide some better protection for one side or the other. In addition, because non-disclosure agreements are used so often, and usually do not require significant modification, most larger companies have standard forms, meaning that the party who does the first draft is simply the first one that hits the send button on the email sending out the document.
When Not to Make an Exception
Clients sometimes believe that having the other side do the first draft, in a situation where this is not normally done, can result in reduced legal fees. After all, doesn’t it take less time to read a 20 page agreement than to write one? As such clients generally find out, this is a misguided belief.
As discussed above, the party to be protected by a contract is the party the benefits from a lengthier agreement. When the “wrong” side drafts, counsel for the party that should have done the drafting is faced with a twofold concern. First, what provisions of the contract need to be revised? And second, and equally if not more so important, what isn’t in the contract that should be there? This second issue is particularly challenging for attorneys who are less experienced with the subject matter of the contract – it’s hard to know what’s missing if you don’t already know what should be there.
When drafting contracts, attorneys almost always start from an existing contract. They know from experience that the contract contains the terms that are needed to protect their client, and when a new deal comes along, the existing template just needs to be revised to conform to the deal terms. However, when the “wrong” side drafts, the attorney who receives that contact not only needs to review every word of it (even boilerplate provisions can be problematic), he or she also needs to compare that contact against the template in order to determine what the drafting attorney did not include.
One of the issues that we often see arise in this situation is that the revising attorney is accused of going overboard on their revisions – that she or he is looking to cause problems with the deal, or is “over lawyering” the contract – and tries to use this as leverage to keep the number of changes to a minimum. Clients sometimes don’t understand that making changes to proposed text that is not market, or adding text that should have been there to begin with, is not over lawyering but merely an attempt to put the parties in the position they would have been had the “correct” party drafted the agreement in the first place.
Letting the “wrong” side do the first draft rarely saves money and can often put the non-drafting party in a worse negotiating position, and should be avoided whenever possible.
David Paseltiner is chair of the firm’s corporate and commercial transactions practice group and a member of its banking and financial services practice group. He represents businesses in a wide variety of industries, ranging in size from small start-ups to well established firms with national and international operations. He also represents individuals in connection with employment agreements, shareholders agreements and operating agreements. David can be reached at 516-393-8223 or email@example.com.