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Cobbling Together ‘Contract Documents’ Beyond the Contract

When Four Corners Become Eight: The Single Instrument Rule

Sometimes lawyers use the term “four corners” when describing a contract. This shorthand simply means that you look at a written contract to determine each party’s rights and obligations. The “four corners” refers to the four corners of a page of paper. The simplest example is a written purchase agreement, such as Bob will pay John $2,500 in exchange for John’s 1993 Ford Tempo. John may include the words “As Is” and disclaim any promise that the car is in fit condition to drive. If the car turns out to be a junker, John will not be liable to Bob.

But appearances can be deceiving. Suppose Bob is short on cash? Suppose Bob wants to pay John $1,000 down and $500 a month for three months to pay the full $2,500? To document that part of their agreement, John may require Bob to execute a promissory note, setting out the promise to pay, the amount of the down payment, and a payment schedule. Thus, there is a written agreement for John to sell Bob the car for $2,500, and Bob’s written promise to pay $500 a month for three months. Two separate documents, two separate contracts, right?

Not so fast. Under Texas law, multiple written agreements executed as part of a single transaction are treated as one instrument. Thus, four corners become, in the above example, eight. The picture becomes more complex when you add layers to a transaction. For example, suppose John knows Bob’s credit isn’t so good, so he asks Bob’s father Dave to guarantee the debt, thereby promising to pay the note if Bob defaults. That can result in a third document, called a guaranty agreement. Again, all three documents are considered to be one instrument for purposes of the transaction. Your four corners are now twelve.

Unless carefully drafted, multiple documents related to a single transaction can have unintended consequences. For example, in loan agreements it is common to define what constitutes an “event of default” which will result in acceleration of the loan so that the full amount becomes immediately payable. Sometimes a contract provides that a default in any single provision results in a default in other provisions. For example, Bob owns three businesses, Acme Appliance, Widget King, and ABC Electric. He decides to obtain a $500,000 line of credit usable by each business from First State Bank (FSB). FSB drafts three separate line of credit agreements and, because it wants to take a lien on each company’s inventory, three security agreements and three UCC financing statements. FSB also wants Bob to provide a personal guaranty on each line of credit, so it drafts a single guaranty agreement that identifies each line of credit by account number. The single guaranty agreement ties all nine other documents together into a single transaction, and provides that a default by one company constitutes a default by the other companies. Thus, if Acme defaults on payment, it triggers a chain reaction resulting in Widget King and ABC Electric also being in default, even though their payments are current.

Another way the multiple instruments rule can cause problems is where one of the agreements contains a binding arbitration clause. In binding arbitration, the parties agree to submit any disputes to a decision by a neutral arbitrator or arbitrators selected by agreement or pursuant to the rules of an organization such as the American Arbitration Association. In cases where multiple documents, such as a sales contract, a promissory note, a guaranty, and a security agreement, an arbitration provision in one of those documents could result in a dispute that arises under one of the other contracts being submitted to arbitration. In the above scenario, where Dave guarantees Bob’s note, if the sales contract between Bob and John contains an arbitration clause and Bob defaults, John can make a demand for payment on Dave, and if Dave refuses Dave could find himself submitting to arbitration, though he did not agree to do that in the guaranty agreement itself.

Finally, contracts often include an integration clause. An integration clause generally says that the contract is the sole source of rights and obligations of the parties to the transaction, and that any prior agreements, oral or written, are no longer binding and do not affect those rights and obligations under the contract. Integration clauses also provide that the written contract cannot be modified except in writing with the consent of all parties. This eliminates verbal side agreements, or misunderstandings under prior, incomplete documents, or statements made during negotiations, from becoming part of the final transaction. But buyer beware, if drafted properly an integration clause can also bar a later lawsuit for fraud based on misrepresentations made prior to the signing of the contract.

When drafting multiple documents related to a transaction, you should always seek the advice of a business law attorney to ensure that the final product clearly defines your rights and obligations in the transaction, and avoids any unexpected pitfalls. You must “mind the gap” or you may find yourself crushed between two documents you thought would protect you.

Vethan Law Firm, P.C.’s business lawyers routinely deal with fixing and finalizing contracts and representing our clients in B2B contract disputes. Our contract attorneys work with our clients to protect their bargained for contract rights.

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