The purpose of a contract is to set out the intention of the parties. Sometimes, though, it seems that drafters go out of their way to make that intent as unclear as possible. In the context of a dispute, this is a big problem because a finding that the contract is ambiguous increases litigation cost significantly. With an ambiguous contract, parol evidence is admissible—which means it is fair game in discovery (the costliest phase of most cases) and at trial. In addition, with an ambiguous contract it’s the jury, not the judge, who decides what it means. So say what you mean and try to avoid these traps.
Requiring cross-referencing when you can easily define a term.
Yes, contracts executed together will be construed together. And, yes, it is easier to refer to terms defined in another document rather than repeat the definition. But if it is possible to simplify the document by saying what you mean, and the undefined term is part of a waiver or other litigation-critical provision, do so.
Consider this case:
- A Guaranty contained a choice of law provision calling for application of the laws of the jurisdiction in which the “Land” is located.
- The Guaranty did not define “Land,” but it did define “Property” as “the real property described in the Security Instrument.”
- The Guaranty also noted that undefined capitalized terms have the meanings ascribed to them in the Security Instrument.
- The Security Instrument defined “Land” as the land described on Exhibit A, which was the real property description of the land securing the loan. So “Land” and “Property” meant the same thing, with only “Property” defined in the Guaranty, but “Land” used to define the applicable law.
In response to a motion for summary judgment, the guarantors claimed the choice of law provision was ambiguous because the term “Land” was not defined in the Guaranty itself and presumably there was some reason to use “Land” instead of “Property” in the choice of law provision. This argument could have been avoided by either
(a) using the term that was defined in the Guaranty;
(b) using only one defined term for the real property described in the Security Instrument; or
(c) just saying Texas law applied.
Option (c) would have been the best in this case, because the guarantors also alleged they had been duped into agreeing to Texas law. Although the property was located in Texas, both the guarantors and the lender were based in California. The Guarantors claimed that it never occurred to them that the law of the jurisdiction where the property was located would control the Guaranty.
Although this is an issue the lender would be very likely to win at trial, the court in this case found there was a fact issue that precluded summary judgment (remember, fraud almost always guarantees you won’t win on a motion). So in a case where all the essential facts establishing liability were uncontested, the lender still could not obtain a ruling on liability in advance of trial.
Failing to define the critical term.
The example above showed how using two terms to define the same thing complicates a case. The mirror-image problem is when a contract uses an undefined term in a critical place, which calls into question whether a defined term controls. Here’s an example:
- A guarantor agrees to pay the “Guaranteed Principal” in the event of a default.
- “Guaranteed Principal” is defined as the principal sum evidenced by the Note, plus interest and all other sums that may or shall become due and payable under the terms of the Note or the other Loan Documents, including but not limited to prepayment premiums, expenses and attorneys fees.
- The guaranty further provides that the guarantor’s obligation is “limited to 50% of the principal balance of the Note.
In this circumstance, what is due? Is it 50% of the Guaranteed Principal, or is it 50% of the outstanding principal balance (i.e., not including interest, fees, prepayment premiums, etc.)? For that matter, is the Guaranteed Principal the same as the amount due under the Note or something else? In this case, the lender meant for the guaranty to be of all amounts due under the note, which includes collection costs, interest, prepayment premiums, etc. This contract uses three terms to describe the same exact thing— only now a defense lawyer can argue that each term is intended to have a distinct meaning, and that the amount his client is liable for is the smallest amount.
Choose one set of defined terms and stick with it. And if a contract calls for a complex calculation, include an example as an addendum to the agreement.© 2013 Andrews Kurth LLP