The Practical Effects of Unenforceable Terms in Contracts

Imagine this: You enter into a contract with a wedding caterer. One week before the big day, the wedding caterer tells you its staff has all fallen ill with COVID, it will be unable to serve your wedding, and as a result of financial hardships associated with the pandemic, it will not refund your deposit. With no time to panic, you scramble to hire a replacement caterer on short-notice and tell your original caterer that if it does not issue you a refund, you will issue a charge-back on your credit card. The original caterer points to the contract:

“Absolutely no refunds will be issued for any deposits. Furthermore, if the client issues a charge-back on its credit card, the client shall be liable to the caterer for a penalty that is equal to twice the originally charged amount.”

This clause is an egregious example of an unenforceable penalty and yet it is based on a clause which I actually came across in one of my past client’s contracts.

Unfortunately, unenforceable contract terms are common among transactions between small businesses and consumers. Why? Because many small businesses and consumers do everything possible to avoid the expense of hiring a lawyer. A small business will often draft its own contract, perhaps starting with a template it found on the internet and then modifying it with the same degree of knowledge as a lumberjack surgically removing an appendix.

The crazy thing is that the drafting party of an unenforceable contract often gets away with it because most people will not hire a lawyer – and the drafting party knows it. The drafting party will say, “look right here, it’s in the contract!” The average layperson cannot identify contract clauses as unenforceable; he simply reads the contract and assumes the contract is enforceable as-written. Therefore, even though the unenforceable terms would not hold up in court, the unenforceable terms appear powerful to the layperson, and this is often enough to deter the layperson from pursuing his rights.

I have seen unenforceable terms in employee non-compete agreements, too (in one instance, a small business in Georgia used a non-compete agreement taken word-for-word from a Florida employment law practice guide which lacked any limitation on geographic area). Employers know that most employees will not seek legal counsel to determine the enforceability of their non-compete agreements. As a result, even a legally unenforceable non-compete covenant can benefit employers by deterring employees from leaving to work at competing companies; and when employees think they are stuck, employers will be under less pressure to offer competitive wages.

The practical effects of an unenforceable non-compete covenant can even extend beyond the behavior of employees. Imagine an employee who enters into an unenforceable non-compete covenant with his employer, Whip ‘Em Hard, Inc. A few months later, he quits and applies for a job with a new employer, Kind Co., which is a competitor of Whip ‘Em Hard, Inc. The new employer will likely ask the applicant whether he is subject to a non-compete agreement. The applicant is truthful and so answers affirmatively. If Kind Co. wants to make a job offer to the applicant, it would first need to consult with a lawyer to confirm that it is not exposing itself to legal liability related to the non-compete agreement. Kind Co. may decide that the applicant isn’t worth the trouble – its outside counsel is expensive and charges by the hour – and besides, there is another similarly-qualified applicant who didn’t sign a non-compete agreement. If so, the non-compete covenant, despite being unenforceable, effectively serves the goals of Whip ‘Em Hard, Inc. by reducing the employment mobility of its skilled employees and keeping them from working for its competitor, Kind Co.

Of course, lawyers do their best to draft contracts that are enforceable because people can and do sue over contracts. After all, a contract is a legally enforceable promise, and if it is not legally enforceable, it is just a bluff. While some businesses play fast and loose by drafting their own contracts without a lawyer, this is like a game of Russian Roulette: play long enough and eventually it will blow up in your face.