Thoughts on Backdating Contracts: Sophisticated Parties
There are some circumstances in which parties to a contract want to use a date on a business contract that is prior to the date that the contract is actually signed. This is the general meaning of “backdating a contract.” As between sophisticated business parties and when the issue of the contract date is fully negotiated, backdating is not illegal. However, there are some potential traps and pitfalls to avoid. In this article, we discuss those issues with respect to sophisticated contracting parties. In the second part of this series, we will discuss consumer contracts. A different set of principles apply to consumer contracts since there is almost never any sort of negotiation involved. If you are considering backdating a contract or if your business is being asked to backdate a contract, it would be wise to seek the advice and counsel of an experienced San Diego corporate attorney.
As between sophisticated contracting parties, backdating might be agreed to under several circumstances. For example, the parties have already begun performance and are just waiting for the written contracts to be finalized. All parties involved understand the “effective date” of the contract is, say, October 1st. However, the final versions of the contracts are not signed until October 9th. Generally speaking, this sort of backdating is not legally problematic.
However, the biggest legal issue with backdating occurs when a contract is expected to be shown to and relied upon by third parties. Now, there are potential issues of fraudulent misstatements, omissions, and failure to disclose. Take an office lease as a simple example. Sometimes leases — and the monthly income that they represent — are used by the landlord to seek financing from a lending institution. Generally, the bank will require copies of the leases and will base certain underwriting decisions on those leases. A sheaf of backdated leases is potentially misleading to the lender. As a matter of practice, it is easy to solve this problem within the four corners of the contract. Instead of indicating that “This Lease is effective on October 1,” you would use language similar to this:
“This LEASE is hereby entered into on November 1st, to be effective as of October 1, with respect to the PREMISES…”
This phrasing makes it clear that the parties have agreed that there is a difference between the date when the contract was signed and its effective date. Using this type of phrasing helps to avoid any potential pitfalls with any third party that may be reviewing or relying on the contract. Another solution here is to ensure that there are filled-in dates next to the signatures. Those dates should be the dates on which the various parties actually signed the contract.
The other important legal issue with backdating involves various governmental authorities such as the IRS, the California taxing bodies, and/or a City permitting/zoning department. Criminal and civil penalties can be assessed if a backdated contract is used for improper purposes. For example, if the contract is used to obtain business tax deductions that would not otherwise be allowed, that could bring unwanted scrutiny. These legal pitfalls become more pronounced as the gap between the effective date and the signature date widens. Short gaps — maybe a month or less — are generally “okay,” but longer gaps become more problematic.
Notice and other deadlines within the contract itself are another area of concern when backdating contracts. If the term of the contract is, say 12 months, and the contract is backdated one month, the parties should understand that, in practice, the term of the contract is 11 months. Clear language should be in the contract showing that the parties understood the legal effect of the backdating with respect to term and notices.
Contact San Diego Corporate Law
For more information, call Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard focuses his practice on business law, transactional, and corporate matters, and he proudly provides legal services to business owners in San Diego and the surrounding communities. Call Mr. Leonard at (858) 483-9200 or contact him via email. Like us on Facebook.