Lost in Interpretation: Why Understanding What You’re Reading Matters

Earlier this year, it was discussed how correctly written contracts can minimize the risk of litigation. Continuing with contract drafting lessons from the Fifth Circuit Court of Appeals, we have another example of how poor drafting can result in the need and expense of a courtroom interpretation. (See also our blog article from June by clicking here).

The concept of a contract is to make sure that all parties are on the same page with one another. A contract lets the parties know what happens when one party breaks its promise, as occurred in this case. A contract also helps the parties understand certain terms, clauses, definitions, or conditions. It should be simple to grasp the meaning of words, but it’s not uncommon to find both parties reading the same words, and often have different interpretations.

Trouble with interpretations can cause big headaches down the road, especially when terms are not clearly explained in the contract. This was found to be true in the case of SCA Promotions, Inc. v. Yahoo!, Inc., decided by the Fifth Circuit U.S. Court of Appeals this past August.

The dispute was over the interpretation of the Cancellation Fees Provision – was it based on fees already paid? Or was it based on the total fee in the agreement? If so, what was the actual fee if the contract did not expressly state it?

Facts of the Case

Yahoo and SCA Promotions entered into a legally binding contract to allow Yahoo to sponsor a contest to a select a winner(s) in the 2014 NCAA Men’s Basketball Tournament, with a $1 billion prize possible. In return for a fee paid by Yahoo, SCA agreed to pay the full prize money if any contestant won the contest, effectively providing a form of insurance against the $1 billion payout.

The fee was to be paid by Yahoo in two separate installments of $1.1 million and $9.9 million, respectively. Each payment was payable on a specific due date.

In case Yahoo cancelled the agreement, a Cancellation Fees Provision was provided within the contract that explained the percentage of fees that Yahoo would still owe SCA.

Yahoo did in fact cancel and instead partnered with another company to co-sponsor a similar contest. SCA sued and was eventually awarded damages in the amount of the unpaid fee called for under the interpretation of the 5th Circuit Court of Appeals.

Analysis

SCA and Yahoo agreed that according to the Cancellation Fees Provision, if Yahoo cancelled, Yahoo would owe SCA “50% of the fee.” Although there was no dispute of the fact that the cancellation fee was owed, SCA and Yahoo disagreed on which fee amount the 50% cancellation fee should be applied; 50% of the total fees or 50% of the unpaid fee?

SCA argued that Yahoo owed cancellation fees based on the total amount of $11 million and Yahoo argued that there was no “total fee” described by the contract, therefore they were responsible for a cancellation fee calculated using the $1.1 million they had already paid. Thus, SCA sued for $4.4 million (50% of $11,000,000 minus the $1.1 million already paid) while Yahoo countersued for $550,000 in damages (50% of the $1.1 million Yahoo already paid).

The 5th Circuit reviewed the facts and determined that when there is an issue with interpretation in a contract, and it causes multiple meanings, then it is important to look at any external evidence – also known as extrinsic evidence – that may correctly interpret the contract.

The court looked at the invoices that were attached to the contract the day it was signed. Although the contract did not “expressly set an $11 million fee,” it did, however, contain two attached invoices that summed to the total fee of $11 million. The contract states, “[t]he contract, including exhibits and attachments, represents the entire final agreement between Sponsor [Yahoo] and SCA, and supersedes any prior agreement, oral or written.”
In other words, any attachments that are included with the contract are not only part of the agreement, but can overrule what is in the contract. Both invoices were attached, and therefore were an extension of the contract language which provided for a total fee. The court concluded that the total fee – as per the invoices attached – was $11 million and Yahoo was to pay 50% of the total fee to SCA according to the Cancellation Fee Provision, reversing the lower court’s decision of dismissing SCA’s summary judgment and awarding Yahoo $550,000.

Some key takeaways from this case are: 1) whenever there is a contract with penalties involved, it is of critical importance to clearly state them in the paper agreement; 2) pay attention to what wording is used in the contract because it only stated 50% of the fee and not “50% of what was already paid;” and 3) find a great transactional (aka contract) lawyer that will not overlook these small but very important details before signing.

Some Thoughts on the Calculations of Damages

The Fifth Circuit determined and discussed the correct interpretation of the SCA contract. What it did not discuss was why SCA’s damages were $4.4 million instead of another possible number. It all has to do with how the math is done. As explained above, 50% of $11,000,000 is $5.5 million: subtracting the $1.1 million results in a fee of $4.4 million. However, 50% of 9.9 million ($11,000,000 minus the $1.1 million already paid) is $4.95 million. The calculations are similar, but the difference is $500,000.

What SCA did was simply follow the order of operations by dividing the $11 million by 50% first and then subtracting the $1.1 million. This seems like a logical way of calculating damages, however what are the parties trying to accomplish? In this contract the parties negotiated an $11 million fee for providing the insurance against the $1 billion payout. The point of the contract was the payment of the fee, NOT payment of the penalty. A contract can include a damages clause that explicitly tells the buyer how fees should be included when calculating damages. SCA’s better argument was that the total amount due was $11 million and the penalty was on the unpaid fees or $9.9 million times 50%, or $4.95 million. That is, why should Yahoo get to apply the payment to the penalty rather than the total due? Applying the amount to the penalty presumes a breach. Obviously the parties didn’t anticipate a breach or the parties would not have signed the agreement. This nuance may merely be a difference of interpretation between a business transaction attorney and a litigator. But these subtle differences picked by a good transactional or contract lawyer can mean a great deal, half a million dollars in this case.

Be sure that your contracts are well written, and your terms, clauses, definitions and conditions clearly defined! Always have your contracts drafted, or at least reviewed, by an experienced business transactions attorney.

Please, do not hesitate to contact us at Walker Law, PC. We will help you with understand and interpret your important contracts before you make an agreement. We will work with you to maximize your opportunities and minimize your risks in your transactions.

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Written by Walker Law PC

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