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Course of Conduct

In our last letter, we discussed the “Battle of the Forms”, where a contract is created through the process of exchanging inconsistent forms. Each party believes their form is controlling but one or both later find that not to be true. However, binding contractual obligations can arise even if no written document is ever drafted, much less signed.

Business often moves at a different pace than the legal world. Through the course of negotiations, phone calls, and general conversations, business decisions are made but the contracts are still to be finalized. Many times, the parties go forward with a deal before they get any document signed. Sometimes, this is simply a case of poor contract maintenance. However, one of the parties may believe (mistakenly) that they have obtained an advantage by being able to terminate the “agreement” at any time; after all, they say, “we do not have a contract.” In other cases, one or both parties simply do not want to address a business issue that may scuttle the whole deal; so they move forward, hoping the matter will never come up. Whatever the reason, the absence of a written contract does not mean there is no enforceable contract. No matter how practical or strategic it may seem, such a situation can create dangerous consequences and is ripe for conflict. It is at this point of conflict that the all-important question is voiced: Is there a contract at all, and if so, what are its terms?

When these problems arise, they often end up in court. One such example involves a distributor for a manufacturer of grain dryers in Indiana. The two parties engaged in negotiations to establish an exclusive distributorship deal. The distributor would sell the manufacturer’s grain dryers in Indiana and the manufacturer would only sell its grain dryers through that particular distributor. After multiple negotiations and legal advisement, the parties prepared written proposals and drafts of the contractual obligations of the parties. However, a final contract was never executed by the parties. Despite this fact, the distributor acted as the manufacturer’s exclusive distributor for the next six years. Then on December 8, the distributor received a letter from the manufacturer stating that the manufacturer would terminate the exclusive relationship 30 days from December 1. On December 23, the distributor ordered 35 grain dryers. The manufacturer refused to supply the grain dryers claiming that no formal contract was ever executed and that it was free to terminate its obligations at-will.

The Court engaged in a very extensive analysis to determine whether a contract existed and to identify the terms of the contract. After thousands of dollars on attorneys’ fees, the Court found that even though the contract was unsigned, the parties’ six (6) year history constituted a “course of conduct” that supported the existence of a contractual relationship. The Court chose to enforce the terms of the last draft of the unsigned contract which included a provision that the contract could only be terminated upon thirty (30) days written notice to the other party. The result was that the manufacturer was liable to the distributor for the lost profits on the re-sale of the grain dryers. In another Indiana case, a 40-year distributor for a producer of snack foods was allowed to force the producer to continue to supply product for a reasonable period of time based solely upon the history of their business dealings.

As an additional example, a customer defaulted on its scheduled payments of $314,000 to its supplier. While the parties had exchanged forms at the beginning of their business dealings, the court could not find that a contract existed because of the differing terms in the documents (no winner in that “battle of the forms!”). However, based upon the parties’ “course of conduct,” the supplier was able to prevail.

It is not the specific outcomes of these cases that are important, but rather it is the fact that a contractual relationship can be created through the “course of conduct” of two parties. In short, if a buyer and a seller conduct business in a manner that recognizes the existence of a contract, a court can find a contract exists even if there is no written and signed contract (or even an exchange of drafts or forms) between the two parties. Ultimately, it is a court that has the final say. Not only does this situation lead to uncertainty and confusion in business transactions, it can be very costly and time consuming to have a contract dispute settled by a court. Each party must go the great lengths to put on the proof of their business dealings, and to refute the other party’s case. Regardless of the different assumptions made by both a buyer and seller, the outcome can be a very real and enforceable contractual relationship.

The bottom line is, YOUR CONDUCT CAN ESTABLISH A BINDING CONTRACT EVEN THOUGH YOU DO NOT HAVE A WRITTEN AGREEMENT. Nothing you or your attorney does can completely eliminate the risk of this “course of conduct” problem and subsequent litigation. However, to minimize this risk, the first step is to look closely at the way your company processes its contracts. Not only should there be a clear policy requiring written contracts, there needs to be a defined set of procedures for filing and maintenance of all company contracts. This system should include a central calendaring of the expiration dates and notice periods for the company’s agreements so that contracts are not allowed to inadvertently expire, leaving the business relationship to potentially be redefined by the parties’ future “course of conduct”. Do not let a judge write your contracts.

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