Contracts 101 for Small Business Owners: Vol. 3 (Math in Contracts)

Judge Richard Posner of the 7th Circuit Court of Appeals wrote in a 2013 opinion that “[i]nnumerable are the lawyers who explain that they picked law over a technical field because they have a ‘math block’”. The number of lawyers who self-identified as being bad at math concerned Judge Posner because of the rate at which science and technology are factors in litigation. For the small business owner, this should be of concern where your commercial contracts are concerned.

It is hard to imagine a commercial contract that doesn’t incorporate, in its terms, some combination of numbers, dates, dollar amounts, and even the occasional formula or two. Such mathematical elements are the building blocks of the business arrangement that will be memorialized in a typical commercial contract. These elements will usually determine when and how much one party will be required to pay the other. They may also define when work must be completed, periods when particular covenants (or promises one party makes to the other) in the contract must be performed, when restrictions placed on a party will expire, or when parties can exit the contract. For lawyers asked to review or draft a commercial contract (particularly those who might profess a ‘math block’ of their own), understanding and synthesizing such mathematical components of the client’s business arrangement into the contract draft or review can be a difficult task. Elements of the deal may be ‘lost in translation,’ either due to a lack of understanding of the desired business arrangement or imprecision in how those elements are put into words in the contract itself. The same is true when non-attorneys are preparing or reviewing contracts. Translating mathematical concepts into a form proper for inclusion in a commercial contract can be difficult for anyone, and given their importance, such elements should be heavily scrutinized to be sure they match the intent of the parties.

As an example of how things can go wrong where math in contracts is involved, last year I was asked by a client to review a set of investment documents for an opportunity involving a private equity fund. My client was thinking about investing in the fund, and wanted me to review the documents to alert him of any ‘gotchas’. The documents included a definitive agreement pursuant to which my client would ultimately be required to invest (if he decided to do so), along with a separate summary of the material economic terms of the opportunity (and that were supposed to be incorporated in the definitive investment agreement). Both documents were prepared by legal counsel for the fund (a large firm based in a major city). I was surprised to find that in the definitive agreement a particular section dealing with a formula for calculating amounts that would be paid to one of the parties involved was inconsistent with the separate summary document. A few words out of place resulted in a serious error in the formula in the definitive agreement (to the potential tune of over a hundred million dollars in total if the fund was fully subscribed). In this case, the error was in my client’s (and his co-investors’) favor, because it would have reduced the amounts payable to the fund’s manager. But it serves as an example of how important it can be to review and confirm that your deal has been accurately translated in any contract, regardless of the sophistication of the legal counsel that has prepared or reviewed it.

When reviewing a commercial contract, always double check the math involved. Confirm that rates are accurately described (both in terms of amount and frequency). Also, double check the dates and make sure those reflect your deal as well. Finally, where a formula is involved, scrutinize the language carefully (and even work through a few examples applying the language) to be sure it accurately reflects your intent. Even a few words out of place can have dramatic consequences.

*Photo Credit: zaveqna on Foter.com / CC BY-NC-SA

*NOTE: This is one of a series of blog entries on the subject of contracts directed principally at small business owners. The primary purpose of this blog is to identify areas of concern in typical contracts so that small business owners can be on the lookout for issues that may adversely affect them. However, this series is not intended as a replacement for obtaining the advice of a good contracts or business attorney, ideally before signing a contract. Every situation is unique, and the preceding is very general advice and is not intended nor should it be received as legal advice or creating an attorney-client relationship between the reader and Klein Bussell, PLLC.

**Klein Bussell attorneys do not blog about pending matters handled on behalf of our clients and will never disclose client confidences.