To: Mary J. Novak

From: ******8848

Date: September 25, 1998

Re: Parlay Contract with Thayser & Associates: Admissibility of Subsequent Conduct of the Parties

For purposes of this memorandum, the following facts are assumed to be true. Sally Tanner has asked for our help in ending a contract between her Silicon Valley venture capital firm, "Parlay" and Dr. Paul Thayser's company, "Thayser & Associates." After finishing a Ph.D. at the Massachusetts Institute of Technology in 1994, which focused on design of lead-acid batteries for use in electric vehicles, Thayser moved to California bringing his lab assistants with him, where he started his own company. The focus of the contract is the development of lead-acid battery technology to be used in electric vehicles.

One of the primary reasons Thayser chose California was the fact that it had the most extensive zero-emission vehicle ("ZEV") program in the country. The ZEV program was part of a plan adopted by the California Air Resources Board ("ARB") in 1991. One of the specific regulations of the plan provided that a certain percentage of automobiles manufactured for sale in California by 2000 would be ZEVs. In May 1998 the ARB amended its regulations such that auto manufacturers would no longer be required to sell a specific percentage of ZEVs by 2000, and instead the market would shape the outcome of the ZEV technology.

The only battery technology that existed in 1994 for use in ZEVs was a lead acid battery, although its use was limited. Thayser hoped to use his expertise to develop the technology of the lead-acid battery so that it would provide a comparable driving range of that of a conventional gas-powered vehicle.

Upon reading about the ARB's regulation regarding ZEVs, Tanner decided to contact Thayser in order to see if Parlay could provide him the resources he needed to develop his battery technology in exchange for his exclusive service. Tanner, acting for Parlay engaged Thayser in a 10 year contract, in which her firm agreed to pay his company $100,000 per month to work exclusively and confidentially for Parlay, in developing and improving the first pilot lead-acid battery for use in ZEVs. The Contract included a purpose section:

Additionally, there was a provision that in the event of a dispute, the parties would submit to mediation prior to taking any other more formal dispute resolution steps.

When Tanner first heard the ARB had amended its regulations she called Thayser and told him to "stop working, the contract is off." A few days later while preparing to respond to a request for mediation from Thayser, Tanner's staff presented evidence to her that the ZEV market was developing rapidly without the ARB regulation. She called Thayser on June 2 and told him to "continue working under the Contract because the market for ZEVs is there, even though the ARB's regulation is not." Work began again, and Parlay continued to pay the company $100,000 in June and July.

In August Tanner discovered that a new battery technology had emerged, which threatened to make the lead-acid battery obsolete. After a month of reflection on this news, and holding the August check, Tanner decided to "cut Parlay's losses" and end the Contract with Thayser. In September she again called Thayser and told him to stop working. She then contacted us for advice in getting out of the Contract.

This memo will only address the following issue: Are actions by Tanner and Thayser subsequent to the formation of the contract admissible for purposes of interpreting the contract?

Tanner will likely be able to show a dispute did arise, thus making acts subsequent to contract formation inadmissible for purposes of interpreting the Contract. When there is a dispute, only the acts and conduct of the parties before the dispute arose can be used for purposes of contract interpretation. Modification of the Contract, a delay in its performance, and a request for mediation by Thayser are evidence of a dispute and therefore actions occurring after the dispute cannot be used for purposes of interpretation.

Because the actions by Tanner and Thayser subsequent to the formation of the contract were a result of a dispute, most likely they will be inadmissible for purposes of interpreting the contract. Courts have consistently held "the construction given by the acts and conduct of the parties with knowledge of its terms, before any controversy as arisen as to its meaning, is entitled to great weight and will, when reasonable, be adopted and enforced by the courts." Warner Constr. Corp. v. Los Angeles, 2 Cal. 3d 285, 296-97, 466 P.2d 996, 1003, 85 Cal. Rptr. 444, 451 (1970). There is no question that both parties did have knowledge of the terms of the contract as Tanner was the one who drafted it and Thayser signed it.

As the Contract stated, once a dispute had arisen, the parties would enter mediation in an effort to resolve the problem. Once an issue is in mediation it is clear that there is a dispute between the parties. Wolsey, Ltd. v. Foodmaker, Inc., 144 F. 3d 1205, 1211 (9th Cir. 1998). In a similar case, the parties were attempting to resolve a dispute over which method would be used to construct a retaining wall. Although the dispute was not resolved, the plaintiff completed the retaining wall and sued for damages upon completion. To determine if the plaintiff was entitled to damages the court held that in order to determine the original intent of the contract "practical construction only applies to acts performed under the contract before any dispute had arisen." Id. at 1211.

In another case, the court held that "the acts of the parties under the contract afford one of the most reliable means of arriving at their intention and . . . the construction thus given to a contract by the parties . . . will . . . be . . . enforced by the courts." Crestview Cemetery Ass'n. v. Dieden, 54 Cal. 2d 744, 754, 356 P. 2d 171, 176, 8 Cal. Rptr. 427, 433 (1960). Crestview Cemetery hired Dieden to assist in attaining a rezoning of some property so that it could be developed as a cemetery. The rezoning was passed, but then later repealed by referendum. The question here was whether Dieden's job was finished after the passage of the rezoning, or did he not do a satisfactory job because the rezoning was repealed? By looking at the actions of the parties before and immediately after the zoning was changed, to help substantiate the intent of the contract, the court found the original intent was for Dieden to only obtain a zoning change. Id. at 754.

Here it is arguable that the dispute arose when Tanner made the first telephone call to Thayser informing him the contract was over. Later, on June 2, when Tanner told Thayser to continue working "under the contract," she noticeably modified the Contract. Had there been no dispute, there would have been no reason for this change in the Contract. The contract in Warner called for modification only through a change order. Although no change order was granted, the court held there was no reason to say no dispute had occurred simply because it had not followed the amendatory procedure as outlined in the contract. Warner, 2 Cal. 3d at 296-297, 466 P.2d at 1003, 85 Cal. Rptr. at 451. In our case it is not an excuse to say no dispute had occurred simply because mediation never began. The court held that a compromise in a contract dispute will often take the form of a modification of the contract. Id. at 297.

In Warner, like in our case, there was a delay while the parties negotiated the terms. Also, similar to our case, the delay was caused by a dispute. In Warner, although work did continue, the court found the parties had reached a "stage of clear disagreement on the crucial question" by the time work was directed to resume. Id. at 297. Just because Tanner directed Thayser to resume working did not mean the disagreement was over and there was no dispute. Instead, it just showed a temporary lapse in the dispute, which resurfaced when Tanner again instructed Thayser to stop working.

A factor that differentiates Crestview from our case is that the dispute arose after Dieden was paid for his work. The court held because "both [parties] acted as if the contract had been fully executed . . . the finding of no mistake is supported." Crestview Cemetery Ass'n, 54 Cal. 2d at 756, 356 P. 2d at 178, 8 Cal. Rptr. at 434. In our case, the rule can be applied in the inverse: when the parties act as if there is a dispute, there is a dispute. The delay, the modification of the Contract, and request for mediation by Thayser all support the claim the parties acted as if there was a dispute.

Dr. Thayser could argue the first phone call requesting work to be stopped was not the beginning of a dispute, but that it served to shift the purpose of the Contract away from making ZEVs because of the ARB requirements, to making them simply for capitalistic purposes. He may claim because the Contract is a ten year contract, it is natural and necessary for modifications to occur in order to keep the Contract healthy. Another issue he may raise, was that this so-called dispute was only one-sided, and that if there really was a dispute it should have been submitted to mediation, pursuant to the provisions of the Contract.

Dr. Thayser's arguments should not prevail. The courts have consistently held that in order to determine the parties' intention in a contract, their actions must be examined before the dispute arose. Warner, 2 Cal. 3d at 296-297, 466 P.2d at 1003, 85 Cal. Rptr. at 451. From the evidence presented, Thayser would have a difficult time claiming there was no dispute. Angrily telling Thayser to stop working and then telling him to start again, is indicative of a dispute. Thayser himself requested mediation which showed he recognized there was a dispute. The Contract stated "in the event of a dispute, 3the parties would submit it to mediation . . . ." When Tanner called back instructing him to continue working, he dropped his request for mediation, thinking the dispute was resolved. The fact he was willing to enter mediation shows he knew a dispute had arisen. Parlay likely will be able to show a dispute arose, and therefore only the actions of the parties before the dispute arose can be considered for purposes of practical construction of the contract.