Drawing Lessons from ICG Link v. Steen

In my Friday post, we looked at the facts and holding of the October 31, 2011 appellate decision in ICG Link v. Steen. Recall that both parties thought they had entered a contract for ICG Link to build Steen’s company, Nashville Sports Leagues (“NSL”), a website. They sued and counter-sued each other for breach of contract: ICG Link to get paid, NSL to get damages for what it regarded as a less-than-useful website.  Only, there was no contract because the court couldn’t determine what it was NSL thought it was buying. As I mentioned in my last post, the contract was the equivalent of a contract for a car with four wheels, an engine and a drive-train, for $12,000. Just as you don’t know what car you’re getting for $12,000 (it could be a Yugo, it could be a Maserati), ICG Link and NSL never had a “meeting of the minds” about the website.

The result was that both parties felt pretty burned. ICG Link recovered only half of the amount it invoiced, and NSL (and Steen) had to pay for a website that it never used. That is because, in the absence of a contract, the appellate court invoked the doctrine of quasi-contract, which substitutes the objective value of the goods or services rendered (set by the court to be $15,000) for the bargained-for contract price (which was about $30,000).

But, as I hinted, the result could have been much, much worse for both sides, with just a slight alteration in the facts.

It Could Have Been Worse

ICG Link could easily have lost the case–and been liable for NSL’s damages–had “Another Guy” (the ICG employee who issued the “Quote”) been slightly more forthcoming to Steen about the details of his work, and Steen been able to point to any contractual term spelling out any utility standards for the new website. Recall that, while Steen had a number of complaints about the website, his main complaint was that it was too hard to add new data to the website, and adding new data was crucial to his business. Luckily for ICG Link, Steen apparently never mentioned this to Another Guy, either in a phone conversation or in writing.

Had the Quote been found definite enough to form a contract, it would have been a mischievous document for ICG Link. Just because a contract has a written document associate with it doesn’t necessarily mean that the written document contains all of the terms. Unless the written document contains a term (known as an “integration clause”) that explicitly limits the contract to the “four corners” of the written document, the court can find additional (or even different) terms based on oral testimony of the parties, whose memories are going to be colored by the current dispute. Even if the Quote had contained one of these “integration clauses,” the Quote would have been so indefinite that the court would have allowed testimony in order to flesh out the contract’s terms, which is almost as bad.

The other risk ICG Link took was assuming that Steen understood the Quote to be an estimate, even though it was called a “quote” and the word estimate wasn’t ever used. The appellate court appeared to assume without deciding that the $12,622.50 set forth in the Quote was the contract price, but that issue wasn’t before the court. But if the court had found that a contract existed, it could easily have decided that $12,622.50 was the contract price, and ICG Link would have received even less than the $15,000 it won (less the deductions I discussed last time).

It Could Have Been a Lot Worse

Steen is the one who really dodged a bullet, though, with the finding of no contract. If Another Guy had described the proposed website with more clarity, Steen could have been on the hook for the full $30,000 in open invoices. While the court appeared to assume without deciding that the $12,622.50 was the contract price (which would have been a good result for Steen), that issue wasn’t before the court. Had the court been forced to decide the issue, it could easily have come out the other way. While the Quote didn’t use the word estimate, it provided time periods associate with each task, which it then added up and multiplied by a billing rate. I think a lot of people would have interpreted that as an estimate because most people know it’s difficult or impossible to state precisely how long a project will take.

In that case, Steen would have ended up with the web equivalent of a $30,000 paper weight (only a real paper weight could at least hold down paper). But it gets worse under this scenario because he wouldn’t have been able to deduct the amount he spent trying to fix the website. Under the quasi-contract theory, the appellate court deducted that amount from the $15,000 because it represented a real reduction in objective value of the website. If you have to pay $1000 on consultants to get your website to function, then logically website’s value is $1000 less.

But if there had been a contract, the court wouldn’t have done that. That’s because under a contract, the you’re stuck with whatever bargain you struck. So, if the court found that Steen agreed to pay $85 an hour (as opposed to $12,622.50 total) for a website with certain features, and no mention were made of the data-entry requirements, Steen would have been forced to accept the imperfect website because that’s what he contracted for. He might have realized later that he needed a better interface for entering data, but by then it would have been too late. ICG Link would have given him what he “wanted.” The time to require standards for data entry would have been during negotiations, before a contract was formed.

Update in Response to a Good Point Someone Raised: There’s probably a limit to how “bad” the contract would have gotten for Steen. Although $12,622.50 probably isn’t the contract price for the website development, it’s still an estimate, at Steen was entitled to rely on it to some extent. It was, after all, provided by one in the business of making such estimates, and Steen could plausibly argue that he wouldn’t have entered into the contract if the “estimate” had been accurate (i.e., much higher). A court wouldn’t have capped the damages at $12,622.50 because Steen should have known it could have been low. But a court would probably cap damages at some amount higher than $12,622.50–how much higher would depend on how what a reasonable person in Steen’s position would have understood the upper limit of the estimate to be.

Both sides would have benefited from a “good” contract–one that actually reflected what each party wanted and expected. Both sides got lucky and avoided accidentally forming a “bad” contract–one whose terms are unstable and full of unpleasant surprises. They ended up with no contract. Thus, in this case, a good contract is better than no contract, and no contract was better than a bad contract.

The Challenge of IT Contracts

The Tennessee Court of Appeals was cognizant of the challenges of technology contracts:

This dispute highlights, as one legal scholar puts it, “the unique characteristics of information technology” and the impact these characteristics can have in an otherwise ordinary dispute over unpaid invoices. Michael D. Scott, Scott on Information Technology Law § 1.01 (2010). Scott writes:

Contracting for computer-related services is theoretically no different from contracting for other types of goods or services. . . . [However,] Computer industry technology can be confusing and often ambiguous. To add to the normal confusion experienced by the neophyte, the computer industry has the . . . habit of using terminology in an ambiguous manner, taking everyday words and giving them entirely new meanings, and inventing words to suit its needs. While this creates problems even for those knowledgeable in the industry, it creates additional problems for inexperienced buyers, their counsel, and the judges who must sort out conflicting claims in any contract litigation. Id. § 7.01.

Problems can be exacerbated by the fact that most businesses heavily rely on information technology to operate, and typically the software developer is the only entity with the knowledge to repair defects, especially in custom-designed software. As Scott observes, “[b]ecause of the potential for confusion, misunderstanding, and dissatisfaction that can result from the development of software that does not meet the expectations of the parties, it is incumbent upon the parties to carefully spell out . . . the procedure by which the final software product will be developed . . . .” Id. § 10.04. Scott emphasizes especially the need to express the parties’ respective obligations when a change to a program is requested, because “[o]ften what appears to the customer to be a minor change necessitates a major rewrite on the part of the [developer].” Id. § 10.05(B). He also suggests a payment schedule based on the completion of defined “modules” of the website. Id. § 10.05(C). Ownership of certain “generic modules,” or modules that can be reused in other websites, as well as ownership of data and both parties’ proprietary information are also likely to be areas of contention if not addressed prior to performance. Id. § 10.05(D).

In some ways, though, ICG Link’s risk wasn’t nearly as big as Steen’s because ICG Link could control whether a dispute arose or not. In other words, for ICG Link, the problem with the NSL website was as much a business (or customer-relations) problem as it was a legal problem. With some better communication on ICG Link’s part, and maybe a bit more work, the whole episode could have been avoided. In that respect, ICG Link’s legal risk is perhaps acceptable. The worst that can happen is it doesn’t get paid, and only then if the customer is unhappy.*

* Unless the technology provider gets itself on the hook for “consequential” (or downstream) damages, in which case it could be in for loads of trouble. If the provider knows how and why the project is important to the customer, the provider could be liable for all foreseeable damages resulting from its breach of contract, such as lost profits. That could be a lot. Fortunately, this is an avoidable problem.

For Steen, though, the problem was 100% legal. He needed a good contract to protect his interests. It was far more important to him than to ICG Link that the contract spell out the minimum requirements and features of the new website. Without out it, he was really as ICG Link’s mercy. Luckily, NSL had enough cash to build a replacement website without missing a beat, but a smaller company might not have been able to. And yet, technology providers are much more likely than technology consumers to insist on written, fully integrated contracts–and guess who is more likely to benefit from those form contracts?

Why Did I Form an LLC, Then?

Why was Steen personally liable for what ended up being an $8842.50 judgment? Given how much the damages had been reduced, this may not make much of a difference if NSL is otherwise solvent–it can always reimburse its CEO. But it still should surprise several of you. Steen had gone to the trouble of forming an LLC. Isn’t the point of forming an LLC to avoid personal liability for contract damages.

Yes, yes it is. But it’s not enough just to form the LLC (or corporation or whatever). You have to act like you’re the manager/CEO/President/whatever of the LLC. Steen didn’t do this. All ICG Link knew was that it was dealing with “Nashville Sports Leagues.” Recall that “Nashville Sports League” wasn’t the name of Steen’s LLC. It was just the name his LLC was doing business as. But for all ICG Link knew, it was just the name of Steen’s personal business. After all, a sole proprietor can do business under any name.

It was up to Steen to make clear that the actual party ICG Link was dealing with was his LLC, TN Sports, LLC. Normally, people in Steen’s situation will fix the problem by putting the LLC name in the written contract. But, here, there wasn’t a written contract (or any contract). Thus, if you are operating a small business, it is up to you to make sure that the people you do business with know (1) the legal name of your business, and (2) that you are acting on its behalf, not on your own behalf. It doesn’t take much…. For example, make a habit of telling potential business contacts what company you’re working for, and talk terms of what your company will do, rather than what “I” will do.

Thanks for reading!