Over time you tend to notice trends when things go wrong with business contracts.
All sorts of things can go wrong. Wrong wording, mix-ups in the effect of clauses, missing clauses, and unguarded interests.
Usually when you're under pressure and in too much of a hurry. You get to the point where you need to decide whether it's worth the risk.
We've noticed that the problems are more fatal more often than others. They're often the biggest cause of the biggest problems. Often insurmountable.
You're left with legal claims so fraught with risk that the risk is not commercially justifiable. You have problems with no realistic way of fixing them.
These are the 4 horsemen of business contracts. The frequent cause of the fallout. Avoiding the mistakes below go some way to avoiding them.
The four horsemen of business contracts are:
- Oral Agreements
- Not reading the contract before signing
- Not specifying deliverables clearly
- Exclusion and limitation of liability clauses
Save yourself from having problems that you really don't want to have to think about.
The first is not having a written contract…
Mistake #1: Not recording agreements in writing
No-one needs a written contract until something unexpected happens or something goes wrong.
It is harder to back away from contractual commitments which are recorded in writing.
You’ve heard of the "he said, she said" battles. There's also the chant, "I have a witness".
Judges are confronted with situations where two people have opposed accounts of the turn of events. If there are no documents to support either account, odds on the judge will decide the case another way. They'll decide it without resort to what the witnesses say.
Documents win cases.
Written records showing what was agreed almost always prevail.
Confirming what has been agreed in writing by email or other application is better than having nothing at all in writing.
Properly drafted agreements are better still. They create far greater certainty of what has been agreed.
Mistake #2: Contract snowblindnessYou’re confronted with a large contract for the first time.
You read it.
It is hard to process all of the text. You make sense of them from your own background. You gloss over what the words actually mean.
Contracts are technical documents. Specific words mean special things. They import a world of case law and court decisions. They have words with well-defined meanings.
It's fair to say that every clause in a professionally drafted contract has a purpose. A specific purpose.
If you do not get it, you may have real trouble understanding what you are actually signing up to.
What is Contract Snowblindness?
This happens when you don’t understand the terms of contacts. Glossing over the bits that are unclear.
You can get overwhelmed by the volume of words. And then you have limited time to read and absorb it.
Unless you read contracts every day, you can’t read a long contract in one go.
Interruptions make it even harder to understand the detail.
You can lose attention span in big chunky long paragraphs.
Understanding the Detail of Contracts
Reading contracts is not like reading a novel.
It is more like reading a technical manual. You should be flipping back and forth through the contract as you read. From the schedules, to the definitions, to the operative provisions of the contract.
There are common mistakes when reading a contract that lead to errors. Here are some of the more important ones.
- Capitalisation: Capitalised terms take their capitalised meaning. So, if the contract says, "The products delivered shall be White", and there is a definition that says "White means black", the products delivered might need to be black.
- Incorporation of Terms: Watch out to references to documents which are not in the contract. You need to read these too. If they are not provided, ask for a copy.
The contract terms can change over time. Like this:
"In accordance with the customer’s expenses policy (a copy of which will be provided by the customer from time to time) the customer shall reimburse all reasonable travelling, subsistence and accommodation expenses actually incurred and approved by the customer in advance".
The policy could change without your consent.
More on how Incorporation of Terms at Mistake #12.
- Boilerplate clauses: Sometimes trivialised. They are not minor or trivial. They usually affect how the document is interpreted. They alter how the law applies to your contract.
- Agreements to agree: Watch out for clauses that say (or have the effect) of agreeing to agree something in the future, like this:
"The charges payable by the customer for services shall be mutually agreed".
They’re not legally binding.
- Performance: When it comes to performance obligations, look out for abstract contractual obligations. By abstract, you can’t tell what you are meant to do to perform the obligation.
At best it is difficult to work out what is actually intended to be done by the statement. At worst, they lack contractual force.
If it reads like a policy statement, edit it so that it is not, or delete it.
- Payment clauses: What is the process for payment? Is there a curious process with steps that are outside your control? Do you have all the information you need to calculate the invoiced sum or audit invoices?
- Overlooking clauses & Ambiguity: Every clause in a contract will be given legal effect, where at all possible. Courts will bend over backwards to prevent one clause from "cancelling out the other".
You can't just ignore the legal effect of any particular clause within the context of the contract.
Courts presume that all clauses are in the contract for a reason. You need to work out that meaning. Edit the ambiguity or consistency out of the contract.
- Internal Conflicts and Inconsistencies: Where an agreement contains internal inconsistencies, it still needs to be read in such a way to make sense of all of the provisions of contract.
If there are clauses that deal with the same subject matter (and there should not be any to start with…) in a different way, edit it out of the contract so it doesn’t.
This is known as an internal conflict.
These conflicts make it uncertain what the contract actually requires the parties to do.
They weaken your position if you want to enforce the contract. That is because the contract might mean that you lose good arguments after you sign it.
You don’t want to be left in a position where only a judge can resolve the consistencies. But that’s the worst case.
You get the first go to resolve it. Write the ambiguity out of the contract before you sign.
In part of the contract it says, "The services shall be performed with reasonable skill and care".
In another part of the contract, it says, "The services will be performed in accordance with good industry practice.".
The two clauses conflict. They contradict one another.
If you're ready to up your game on reading contracts, keep reading.
Mistake #3: Not knowing the magic words to avoid a legally binding contract
You receive a friendly email or letter that says something along the lines "excellent, we are agreed in principle".
You think a legally binding contract has been formed, right?
These words "in principle" prevent a legally binding agreement coming into force.
Depending on your current expectations, this might be good, or might be bad.
Forming the Contract
If you want to progress the negotiations, the sensible reply is to make the position clear. Something like this might make it clear that you don't have a concluded contract:
"Thanks for your [letter/email]. Let me know what further is required before we are agreed and can proceed. We will not be [supplying any products | performing any services | paying any money] until we have a contract with you."
There are several magic words you can use to prevent a legally binding contract being formed.
Useful when your offsider is trying to make you agree to something.
You could say:
- "Yes, we are agreed in principle";
- "I will [get our solicitors/somebody else to] send through our written terms. After that, we will be all set";
- "That’s great. Let’s work out the details later."
Do not succumb to the pressure and say, words to the effect of "yes, we’re all agreed, aren’t we?" unless you want to be legally bound.
A legally binding contract is only formed when the parties agree to something then and there. Or here and now.
If there is anything further to be agreed or some further step to be taken, then there is no legally binding agreement. These are known as "agreements to agree" something in the future. Other than in the rarest of cases, they're not legally binding.
A note for the cautious.
If the two contacting parties end up doing the very things "agreed in principle" after the conversation which suggest that what was (only) agreed in principle, then the chances of legally binding contract being made are increased significantly.
Mistake #4: Not recording the content of conversations and negotiations in writing
This might sound the same as Mistake #1, but it isn’t.
Sometimes when you put down the telephone with someone. A feeling washes over you that it was an important conversation.
It might come back to haunt you. Time to lay down a marker.
Some conversations should make alarm bells ring loudly. Things like:
- Threats to delay performance pending some event
- Promises not to exercise legal rights
- Conversations about indemnities and limitations of liability
- Discussions about infringement of intellectual property rights
Confirm in writing – email will do – what you took away from the conversation. The next steps which are agreed or not be taken, the timing of events or payments to be made.
Subject to Contract
If you are still in the pre-contractual phases and negotiating, you can use the phase "subject to contract". It means that you don't have an intention to form a legal relationship, pending completion of some further step.
Loud sirens should start sounding when your offsider starts talking about terminating a contract before its time.
Mistake #5: Template contracts
Template contracts are like stock photography. They are prepared to appeal to the widest possible range of business audience. If they are inexpensive, the seller wants – or needs - to sell a lot of them just to cover their costs of doing business.
Every business has its own particular risk profile. It’s exposed to it's own particular types of risks.
The template might look pretty when you receive it, but will it do the job you need it to do?
Exclusion Clauses and Limitation of Liability
One of the problems is that exclusion clauses and limitations of liability clauses get special treatment by courts.
Courts are hostile to parties avoiding liability for their own breaches of contract. That’s because one of the parties that suffer at the hands of another by not performing or performing badly gets off scot-free.
It doesn’t make sense either. Why have a contract that will struggle to the job you need it to, when it really matters?
If you have no choice, get your template contract checked by a subject matter expert.
Tell the expert how – in the unlikely event it might happen - if something is to go wrong, how it will go wrong.
Mistake #6: Relying on Email for Contracts
As they say, an oral agreement is as good as the paper it is written on. But then we have email.
Try to avoid agreements in threads of emails.
Because in the luckless event that a dispute arises, it is a real mess to work out what the agreement reached actually was.
It makes it more difficult to enforce. There is so much uncertainty surrounding what was actually agreed and on what terms.
That makes it more expensive to sort out – if it can be sorted out.
Have a separate document that consolidates everything that has been agreed. Exchange it with your offsider.
That way, you have the agreement all in one place.
Better still, include what some refer to as boilerplate provisions.
They are common. When they are done properly, they really do make a difference to what has been agreed. It is because they make a difference in the way the law applies to the contract. Some boilerplate clauses to makes the interpretation of written agreements more predictable and more reliable.
Mistake #7: Not signing contracts properly
Suppose you own a company.
You sign documents for that company or a limited liability partnership.
Not using the "Limited" or "LLP" suffix when you sign, may cause you problems you don’t need. One day, you could lose your shirt.
The "limited" extension to company names was first required so that businesses dealing with the company knew it had "limited liability".
That still stands true today.
Why might this cause the problem?
When you form a company, you are creating a separate legal person.
It has its own independent legal existence, separate to the directors and shareholders.
The company can buy, sell and own property.
It can be sued by another person recognised by law.
Using the "Limited" or "Ltd" suffix:
- distinguishes the company from a business name, and even you.
- communicates to the reader of legal documents that it is a company is entering into a contract – and not you.
The Companies Acts require companies to use its full company name on all of its paperwork. This includes business cards, letter head and emails. That’s any paperwork.
By using the "Limited"/ "Ltd" / "LLP" extension, you make it clear that it is the company is the legal person that others are dealing with. Not you personally.
When the "Limited" or "Ltd" extension is not used, it exposes the individual signing the contract to personal liability, and not the company.
This is because the application of the law means that it was you signing the document for yourself. You are the party to the contract. Not the company. That makes you personally liable on the contract.
That would defeat the purpose of having a company in the first place.
Mistake #8: Getting yourself into a "Battle of the Forms"
It happens when you can’t tell whose contract applies to govern your legal relationship.
It comes up at the worst time. When you have a dispute.
How does it arise?
The Classic Case
You receive standard terms of contract to sign.
They are the proposed terms of contract. This will be an offer capable of acceptance.
You propose some changes and send it back. This is a counter-offer. It rejects the original party’s offer.
Neither are signed.
This cycle can happen one or more times.
Then the contract works start, before any contract is finalised and signed.
Then the negotiations break down.
Whose terms of contract apply?
This is the battle of the forms.
How it Works
Say you’re an intellectual property rights owner. You run a SaaS platform and own the source code in the platform.
A purchase order you receive contains generic intellectual property provisions which say something, "The Customer will own all intellectual property rights in the deliverables".
If the purchase is legally binding, the customer could well own all of the intellectual property rights in your SaaS solution.
The starting point is that the clauses in the purchase order have legal effect.
You could end up in a situation where you do not own your own intellectual property rights for your own solution. You no longer own your own assets that you were going to use to deliver the SaaS services.
Also, there could be clauses that say things like:
- "You agree to hold harmless and to indemnify us against all or any costs, claims, damages, expenses, fines, penalties, legal expenses incurred by the Company, or for which the Company may become liable, with respect to any claim for infringement of intellectual property rights or failures to comply with the service levels".
You just indemnified your customer with eye-watering exposure to liability.
- "The services shall include the production of source code materials."
Your confidential source code, that is.
- "In the event of non-compliance, the Supplier shall take such steps as the Company requests to remedy and rectify the non-compliance."
If you breach the contract, the customer effectively has you on a leash to do whatever it is they think needs to be done to fix the problem.
- "The Supplier shall reimburse the Company for the costs and expenses incurred by the Company in connection with any inspection, test or audit undertaken by the Company which identified the non-compliance."
This would mean that you would be liable for the costs for inspections, tests or audits - for any non-compliance, no matter how trivial.
- "The Supplier will take out professional indemnity insurance in the amount of at least £10,000,000 for any one default at its own cost."
Whether or not you were planning for the costs of insurance, you're legally bound to obtain it.
There are dragons in those hills.
Avoiding a Battle of the Forms
Even if you have solicitors helping you out with the initial contract, they cannot be with you on every call, before you send any email and visit every website. And you would not want them to be either.
You need to learn for yourself.
Assume that anything you sign or agree to will be legally binding. You will not be able to back away from it later.
That also means understanding – really understanding – the legal effect of the documents you sign, and the context within which you sign them.
Don’t think it happens? Think again.
Whether the end result of a battle of the forms depends upon exactly what happened – the facts of the case. That's what the emails exchanged say, what the documents exchanged say, who did what at the different points in time.
The point is to avoid problems you do not need.
Be alive to what you sign. In the context which you sign it.
Mistake #9: Being in business with others without a Shareholders’ Agreement
When businesses are being step up, you’re in a positive phase.
You are bringing ideas together with your partners, formulating plans, building relationships, all on the same track.
You’re doing what you want to do to get the business up and running.
Moving towards sales and profit.
You’re all headed in the same direction.
The business starts and it’s a success.
During these stages it’s hard to see how tensions could possibly arise. It happens when there is something to fight over.
It happens often.
Shareholders Agreements are ordinarily negotiated at the best time of the relationship. At the beginning during the positive stages, when everyone is cooperating.
Negotiating the terms of a shareholders’ agreement prompts discussions you probably should have early on. It doesn't need to be a long document.
But it should deal with important administrative matters that can affect your rights, such as:
- Voting rights and casting votes in board meetings
- Can decisions be made without you?
- What decisions can only be made with everyone’s consent?
- The matters should reserved exclusively to shareholders for decisions
- Spending without your approval
- Limits on borrowing money by directors
- How are director’s salaries fixed and changed?
- Can directors set up competing businesses?
- Assets of the company be used for other business interests of shareholders or directors
Commitment of Shareholders and Directors
- Is active involvement required by all of the directors or shareholders?
- Do they have designated roles and tasks to perform?
- How can directors be removed?
Exiting Shareholders and Share Value
- Whether your shareholding can be diluted
- How shares are valued when a shareholder leaves
- Whether shareholders can sell shares to anyone or only approved persons
- Can shareholders buy share of leaving shareholders
- process for shareholders to exit the business and obtain value for shares
- How decision deadlocks are resolved
- How can profits be distributed
- How the business can sell its assets
- Removal of directors.
Behaviour which is outside the allowances in the shareholder’s agreement becomes clearer, because it is not in writing.
Handling and agreeing these sorts of matters upfront:
- reduces the scope for disputes
- makes disputes more manageable
- narrows disputes that might arise later.
It’s good insurance for people going into business together.
Mistake #10: Not including an alternative dispute resolution clause
Courts aren’t the only place to resolve business disputes.
More and more, alternative dispute resolution centres are available. Formal processes can be agreed in business contracts. These start with formal negotiation between stakeholders.
They move on to mediation and if the dispute is not resolved mediation.
Then and only then is court-based dispute resolution permitted. The usual exception is for interim relief.
Interim relief is about allowing parties to go to court to prevent continuation of some wrongful behaviour that if allowed to continue will cause serious irreparable damage.
If you're in the kind of business where confidential information might be misappropriated, an arbitration clause will not do, because arbitrators do not have power to order injunctions.
Mistake #11: Not checking your contracts for assignment clauses and pre-agreed novation
The default rule is that contracting parties are not allowed to assign their contractual obligations to another person, without the permission of the other contracting party.
Assignment clauses displace this rule.
They permit a party to assign their obligations to perform for you to someone else. It could be anyone. Including someone that you can't work with.
Novation is the legal term which means transferring the legal obligations under a contract to a new contracting party. So if you have a contract between two parties, and one of them wants to transfer their obligations to a new person, all 3 parties (the outgoing party, the remaining party and the incoming party) can agree that will happen.
Novation can be "pre-agreed" in a contract. We think pre-agreement should be avoided.
You want to be sure who your contracting party is, and control who you have your contracts with.
Mistake #12: Incorporation of Terms
This happens when a contract refers to some external document is incorporated into a contract by reference.
It could be someone’s else’s security policy that you are undertaking to adhere to. It could be their employment policies. You need to ask to see a copy to assess whether you agree to it or not.
Incorporating contract terms by reference usually sucks.
When are included in the contract, everyone knows what is going on. You know what you are agreeing to.
You want some control over the terms of your contracts. If the documents can change, you want a say in how they are changed. Your contractual obligations should not be moving targets.
Well, there is usually inherent uncertainty as to what those terms are. Many businesses signing documents sometimes do not take the time to read them.
So what do you do? For our few clients who incorporated terms by reference, we got good results by suggesting that they be removed, and substituting contractual terms for the documents.
Alternatively, attach a copy of the document to the contract.
Mistake #13: Not having your own terms of contract
If you're a service provider, or procure the same type of services regularly, get your own contract terms. Be master of your own destiny.
It actually saves you time and money. You do not need to get your head around each and every draft contract that comes across your desk. If you’re a supplier, you’re usually expected to have your own terms.
Having your own terms also means that your position is the starting position for negotiations. This is a far better situation than having to push back on your counterpart's terms.
It will probably save you effort in the long run to set up your contracts. It means that you will not need to:
- Think through and scope out your licensing model, pricing and structure, and related services. For example:
- perpetual non-exclusive licence with annual maintenance charges?
- annual licence, which renews automatically, with no maintenance?
- will you provide consultancy services on top of the licence and maintenance
- If you licence intellectual property rights as part of your business, at least get the template contract(s) to licence your own products.
- Tell someone who knows what they are talking about what your commercial objectives are. Ask them to check over the terms. Odds on, the template contract(s) will need to be changed to suit your business model and requirements.
- This way, you will avoid lawyers’ fees to check over a contracts which are not made specifically for your business and its risk profile.
No deal is worth any price. Contracts are a bit like loaded guns. Very useful to those who know how to handle them… quite dangerous for those who don't.
Templates contracts are drafted generically, similar to stock imagery. They are broadly drafted to cover most types of business needs. Not necessarily yours.
It has to be said. If you go into a high-value business relationship without getting them checked that they are fit for purpose and do what you intend them to do, you may need professional help.
Mistake #14: Not focusing on the important parts
It’s one thing to read over a contract. It’s another to understand what you’re looking for. Here’s one way to get into the detail and reduce chances of missing something important.
- If there are Schedules, read them first. They set the context for what is said in the body of the contract.
- If you’re not flipping back and forth between pages as you read the contract, you’re probably not reading it properly.
- You can’t expect to take it all in and understand the finesses and interrelationships in one reading. Plan to read it at least twice and probably 3 times.
If you’ve got legal help, you can fast-track the process. Get told what to focus your attention on.
- Usually, your hit list of clauses to read first will be:
- Term of the contract: This is how long the contract will run for. Are there automatically renewals?
- Warranties: What are you – and they – required to do? is it clear what is being promised?
- Intellectual Property Rights: Who owns intellectual property rights created before the contract is signed? What about during the contract?
- Termination: How can the contract be terminated? Can only one party terminate the contract or can both? What are the preconditions or circumstances in which you can terminate?
- Indemnities: Are the indemnified events within your control? If not, think twice or three times before accepting them.
- Limitations of Liability: While difficult to enforce work out how recovery for breach of contract is limited.
- Restrictive Covenants: Who can’t you do business with, and for how long after the contract terminates?
- Other things to look for:
- Choice of Law clause: If the law governing the contract is not where your business is based, you might have a problem enforcing it.
- Jurisdiction clause: This is where disputes are resolved. There should be a good reason if it is not the country where your business is based.
Mistake #15: Not reading contracts the way courts read them
The rules of interpretation of contracts are about predictability of outcome.
Application of rules of interpretation sometimes conflict and lead to different results. The predominate objective is to give effect to what the parties agreed.
The emphasis on commercial common sense, natural and ordinary meaning, and purpose of the agreement are all directed to the same end. Giving effect to what the parties agreed.
Interpretation of Contracts
Entire books are written on interpretation of contracts. This art-form can’t be communicated in a few short sentences.
But here’s a process to get you on the road.
When courts decide contractual disputes, they need to decide what the contract means and its legal effect.
This is done by ascertaining what happened in the lead up to signing the contract. The written contract is read with the context of that factual background – the surrounding circumstances at the date of the contract – in mind. This is usually referred to as the "matrix of fact" in cases.
The contract is interpreted or "construed" against that background to arrive at its meaning and legal effect. This is the process of "interpretation" or "construction" of the contract.
When interpreting a contract, the intention of clauses is decided by what a reasonable person would have understood the contract to mean. The intentions of what the parties thought or intended by the contract are set to one side. It is said that contracts are interpreted objectively.
The factual background sets the context for interpretation of the contract. It is the contract document itself that determines the contractual obligations. Not the factual background. It is the factual background that colours the interpretation of the agreement, and what a reasonable person would understand by the words used.
More problems with business contracts
There are other causes of problems which come up too.
- Contracts which are so complicated for small businesses that no-one who needs to understand them has time to get a proper handle on them
- Oversized contracts for the job it needs to do. Too long, too involved for relatively small jobs
- Ridiculously complex agreements which require sophisticated legal advice to decide what action is needed when something unexpected happens
- Contracts that are so one sided that it costs a fortune to get it into a state where is it palatable, before you sign.
Drawing out negotiations with small companies to deplete resources so that you can’t properly protect your business interests is a common theme. It usually comes with the attitude, "if it's legal, it's OK". Not really the way you want to do business.
Contract Checklist: avoid problems with Business Contracts
Check can get a contract review checklist here, and help you minimise the prospects of running into these mistakes.
Or you can retain us to so that your business gets the benefit of expert legal advice, to avoid these sorts of problems hurting your business. Keep the genies you don't want in the bottle.