Focus on ‘Formation of the Contract’

July 1, 2011
SDI_0711_LEGAL WATCH_Focus on ‘Formation of the Contract’

We spend a lot of time in the industry focusing on contracts. That makes sense given the risks in designing, installing, monitoring and servicing electronic security and life safety systems. The liability could be catastrophic. 

 In my opinion, however, we don’t spend enough time talking about the circumstances surrounding a subscriber’s decision to enter into a contract or what lawyers call “formation of the contract.” That’s a mistake because one way a good plaintiff’s lawyer gets around a contract is to find something in formation that, if proven in court, voids the contract. A void contract means no limitation of liability, indemnity or other risk allocation clauses that providers rely on for protection. There needs to be a more candid and complete conversation and a better understanding of what’s required to make your contract enforceable.  Let’s get that conversation started here.  We can then continue the conversation on my new Legal Watch blog hosted by at

 First, recognize what’s at stake. An enforceable, well-written contract provides significant protections in a loss. I’ve had plenty conversations with insurance company lawyers who focus on recovering money for losses paid to insureds following fires or intrusions. In private, these lawyers acknowledge that they and their clients often will not pursue claims against security providers because they don’t want to test the insured’s security contract.  (Risk allocation clauses are often enforceable, especially in the commercial context and are the basis on which the provider’s lawyers are likely to obtain an effective result prior to trial.)  

 Second, plan for the future. You are likely to sell your business or borrow money to expand your business. As part of due diligence, a buyer or lender will review your forms of agreement to determine if the forms are enforceable and include appropriate terms and conditions among other things. Due diligence is not the time for a seller or borrower to focus on enforceability and substance of subscriber contracts for the first time.  (I’ve been there when the deal died because of a contract issue. It ain’t pretty for either side but certainly not for the seller or borrower.) 

 Third, deal with the present. You want an enforceable contract to assure you get paid by your subscriber. After all, that’s the primary reason you sold the system and services, isn’t it? 

 Key issues not to be ignored

 With this background in mind, let’s focus on some contract formation specifics.  The point is to make sure your contract is enforceable.  Here are some key issues:

 The three-day right of rescission is specific and you must comply with the laws or your residential contracts won’t be enforceable. The Federal Trade Commission (FTC) adopted the three day right of rescission in the late 60s in response to door to door salesmen selling vacuums or aluminum siding (Think Richard Dreyfus in “Tin Men”) or even security systems. The act applies to transactions where any portion of the sale takes place at a location other than the seller’s place of business. 

 The regulations are quite specific. Among other things, a seller must give the customer a copy of the contract and the contract must inform the customer of their right to cancel the contract. A specific notice must be displayed prominently near the customer’s signature block. The regulations require the seller to provide a separate, pre-printed form advising the customer of their right to cancel the contract under federal law and the form must be signed by the customer acknowledging receipt. There are other requirements and I will post a link to the federal regulations on my LegalWatch blog. 

 In my experience, providers often skip the separate pre-printed acknowledgement form, relying solely on the contract’s notice provision. Is this adequate? It depends.   Certainly if there’s never an issue.  It may not be adequate however, if the buyer or lender decide they no longer want to move forward with the transaction or if the subscriber sustains a catastrophic loss and plaintiff’s counsel wants to set the contract aside. 

 The three-day right of rescission isn’t the only possible basis to invalidate a contract. Many states have similar laws that apply to residential transactions. These include language and print size requirements. Many states have adopted plain language laws. (Despite this, many industry lawyers still use a lot of “therewiths” and “heretos” in their standard industry contracts. I say enough already.) The consumer protection right to cancel law in at least one state (Pennsylvania) applies to sales that are solicited over the telephone.  Other states have similar laws that apply to transactions solicited by mail.  You must know what laws apply to your transactions and then comply with those laws.  (Ignorance of the law is never a defense.) 

 Another example is where a provider provides services in states where it is licensed and in states where it is not licensed.  Following a catastrophic loss, can the provider enforce their contract in the states in which the provider is unlicensed?  Highly unlikely.  Can the unlicensed out-of-state provider enforce the contract if it relies solely on subcontractors licensed in the state to provide the contracted services?  Likely to, depending on resolution of factual and legal issues.      

 Be careful when making promises in the sale of an alarm system, especially to a consumer.  Misleading statements may void the contract.  Most states have laws that make certain practices in the sale of goods or services to consumer an unfair or deceptive trade practice. These laws impose significant liabilities, including treble damages and attorneys’ fees. These laws also often permit an aggrieved party to void a contract. 

 The common-law provides similar remedies in some states. I’ve been involved in litigation where the subscriber alleged the alarm provider made false representations to convince the subscriber to purchase an intrusion system. The subscriber sustained a significant fire loss and claimed the provider told the subscriber the intrusion system would detect fire. The subscriber sought to set the contract (and its limitation of liability and related risk allocation clauses) aside, claiming the alarm provider fraudulently induced the subscriber to purchase the system. The results can be disastrous. 

 These are just a few of the issues you should consider when making sure your subscriber contracts are enforceable. Make sure you follow the law when selling to subscribers.  In the meantime, let’s continue the discussion on the LegalWatch blog.