With so many different sorts of contracts out there, you can expect to be doing contract reviews on whole host of different agreements.
All contracts will have some effect on your business. Some big, some small.
If you haven't read it or don't understand it, you're exposing your business to unknown risks. Missing them means that you are putting your business at risk. Exposure to financially costly events cause unnecessary or fatal strains on your business and your relationships.
Where do you start with your contract review process when you're confronted with a beast of a contract?
Starting from the very beginning and going through it one page after another is a mistake. You'll 10x the time you need to get into it, understand it, find the gaps and fix them so that it works for your business.
There's a better way.
Implement a structured process to do it.
Preliminaries: Starting Up - Reviewing a Contract
Reading contracts isn't like reading a novel. It's more like reading a technical manual.
The problem is, where do you start?
Avoiding Common Mistakes
There are common misunderstandings reading a contract that lead to errors. Here are some of the more important ones:
- Express terms: The starting point is that the contract means what it says. Legal interpretation comes later.
- If it's not stated: If something isn't said in the contract, it doesn't need to be done. There's a possibility that terms may be implied (you don't want to go there unless you need to, really).
That however shouldn't stop you from making sure that the contract says what each party is meant to do as a starting point.
- Capitalisation: Contracts often have a definitions section.
Defined terms are usually (and should be) capitalised throughout the contract.
Capitalised terms take their capitalised meaning. When a defined term is used multiple times, it has the same meaning (strictly speaking, this is only a presumption of contractual interpretation).
If the contract says:
"The products delivered shall be White",
and there's a definition that says,
"White means red",
the products delivered might just need to be red.
Suppose there's a term defined "Services" in your contract. As above, "Services" takes its defined meaning. When lowercase "services" is used in the same document, it will probably mean something different. What it means depends on the context in which it was used.
- Headings: Clause headings, as such "Warranties", "Confidential Information", "Intellectual Property", "Limitations of Liability" (or anything else) are usually used like a street map around a contract. When the contract is prepared properly.
Contractual warranties are usually put under the heading for warranties clauses.
Clauses dealing with intellectual property are under the "Intellectual Property" heading.
Just because a clause has a title, don't assume that that's all it deals with.
For example, we've seen plenty of confidentiality clauses that don't just deal with confidentiality.
You've got to read the entire contract eventually. Closely…
- Long paragraphs and sentences: There‘s rarely a good reason for long paragraphs.
Time honoured traditions don't seem to be a good enough reason these days.
These are the ones that stretch into upwards of say 5 lines and upwards. In a single sentence.
Is it a marker of intellect of the person that wrote it?
We. Think. Not.
Take the view that it's a marker that you are meant to lose concentration when you read it. Just because you're not paranoid, doesn't mean they're not out to get you.
And miss something important. (Just because you've never seen a dragon, doesn't mean they don't exist. Most breathe fire.)
When you're editing, break the paragraph up into shorter paragraphs and maybe shorter sentences. It'll be easier to understand, and edit in negotiations.
You can keep your sanity at the same time.
It's not a matter of style when it comes to your legal obligations. It's a matter of understanding the contract.
Easily. The words used should convey the intention clearly.
It'll also an easier edit. The wording of the contract needs to be clear.
- Incorporation of Terms: Watch out for references to documents which aren't part of the contract. You need to read these too. Before you sign. If they are not provided, ask for a copy.
- Boilerplate clauses: Sometimes trivialised. They are not minor or trivial.
They affect how the document is interpreted:
- how legal rights are applied, and
- alter how the general law applies to your contract.
Don't think that all boilerplate clauses that look the same are the same. They're usually carefully worded. The legal effect depends upon the precise wording used.
- Rights of Suspension: There's no right to suspend performance of a contract, unless the contract says so expressly.
Let's think about this for a moment.
Say you don't get paid. You decide to stop providing the services, or shipping goods.
You'll probably be in breach of contract for doing so, unless you have an express right to suspend work in the agreement.
Say you don't like the services you're receiving under a contract.
You have a role to play to enable the supplier to deliver its services to your business. You don't cooperate any longer. You prevent them or make their job difficult. You may find yourself in repudiatory breach of contract of an implied term.
There's no right to suspend your own performance unless there's an express right in the 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."
"The parties shall agree the service levels to apply to the contract."
They're not legally binding, other than in exceptional circumstances. To find a solution to make agreements to agree enforceable, usually requires some pretty creative legal interpretation of the contract. Even if there are options available. That doesn't happen often.
The wording should be changed so that whatever it is to be agreed is agreed then and there in the contract. Not at some time after the contract is signed.
- Overlooking clauses & ambiguity: Every clause in a contract will be given legal effect, where at all possible.
Courts will work hard to prevent one clause from "cancelling out" another clause.
The starting point is that all clauses were put into the contract for a reason, and have their own distinct purpose.
So you can't just snub or pass over the legal effect of any particular clause within the contract.
Particularly when different clauses conflict with one another. They can say the same thing a different way, or say the complete opposite thing to one another.
Doing that in a contract creates ambiguity. It will hurt you when you need it most: when you need to rely on the contract.
Edit out the ambiguity or inconsistency.
Terms of Contracts: The Important Clauses
Focus your attention on structurally important clauses first.
The important clauses which are in (or should be in) most contracts get a mention below.
Some clauses are common to all contracts. Other clauses are only included in particular types of contracts.
These ones should be in all contracts - unless there is good reason to leave them out. If you're unsure, think seriously about putting them in.
We've put them in order that we most often check them. Doing this gets you into the contract faster to understand what the contract's all about.
You should be flipping back and forth through the contract as you read. From the definitions, to important clauses in the operative provisions, and the schedules.
Choice of law: Which law?
A choice of law clause fixes the system of law which is going to be used to decide the rights under the contract. Each country has its own system of law.
Even in the UK, the laws of England and Wales, Scotland and Northern Ireland are different.
Then you have:
- Each State in the US has its own system of law – that's at least 50 systems of law.
- The European Union is made of 28 countries. Each of them has their own system of law.
- The UK is made up 4 countries.
This also means that there is no law of "the UK", "the United States", "the European Union" or "European Economic Area".
So if you're going to enter a contract and they want the law to be that of New York, you need to decide. What system of law applies? England or the State of New York?
Choice of law clauses usually read something like this:
This agreement is governed by the laws of [England | the State of New York].
Jurisdiction Clauses: Where are disputes decided?
Jurisdiction clauses fix the place or location (ie the courts of the country) which will resolve disputes. You should have a good reason if it is not the country where your business is based. The simple ones usually read something like this:
"The parties irrevocably agree that the courts of [England | California] will determine disputes arising under or connected to this Agreement, including non-contractual disputes or claims."
Why are choice of law and jurisdiction clauses SO important?
They're more important than you may first think. That's because they have a direct effect on enforceability of the contract.
Let me explain.
You're a service provider based in England. You'd usually agree to English law to govern your agreement and English Courts to decide disputes. That makes sense. No argument there.
Say though, that you have a potential customer in another country. They want the laws of California to govern the terms of the contract. They also want the courts of California to decide disputes.
Let's say you agree to that.
If a serious dispute arises that you want to go after, you'd have to (1) engage a lawyer in California, and (2) sue in California.
Some businesses say they don't care. They say that because they say they will never sue.
Ah huh. But it's not that simple.
By agreeing to a foreign system of law, it seriously dents your business's ability to enforce the contract.
Or even defend legal proceedings.
Suppose you haven't been paid.
You may have a really good, solid claim. Making a legal threat to sue to recover what you are owed is more difficult to carry through.
The amount of your claim which is owed needs to be large enough to justify all the additional expense of involving foreign lawyers and the inconvenience of suing abroad.
Make sure you have a solid credit control system. And insurance.
Suppose that something goes wrong with your services.
It is easier for the customer to sue you on their own turf. It's more expensive for you to defend abroad.
But then let's say you won't bother to defend it.
Well, there are well-established routes to getting an adverse judgment from say the Supreme Court of California, and getting it recognised by English Courts.
It can be done say through the Queen's Bench Division of the High Court on Strand in London, at the Royal Courts of Justice. And it's a well-travelled road.
An application is made to a Master of the High Court to have the Californian judgment recognised as a judgment of the High Court of England and Wales.
Once that is done, the Californian company has all the means and methods of enforcement of judgments in England to enforce the judgment against you (at this stage, your business is a "judgment debtor").
- Writs of Control, to seize the goods of your business
- Examination of directors: Orders requiring directors of the judgment debtor to come to court to answer questions about the assets of the business, and
- Third Party Debt Orders: to obtain money owed by the judgment debtor from say its bank account or a company that owes the judgment debtor money.
It's even easier if the judgment comes from another country in the European Union.
There are far more sophisticated choice of law clauses and jurisdiction. They alter the law and the jurisdiction in different circumstances. They can be handy in negotiations. The example above: that's the starting point.
Set the choice of law and jurisdiction up front. It's easier.
Duration of the contract
In legal lingo, this is known as the "term of the contract". It's how long the contract will run (in the future) or ran for (past tense).
The term of a contract is more usually important for contracts for supply of services over an extended period, as opposed than for products. But they can certainly be made to apply to both.
There are so many different ways that the term of the contract can be set. The most basic ones are:
- a fixed term. At the end of the term, it terminates (aka "ends").
So a contract that says, "This contract shall have a term of 3 years" runs from the date that it is signed for 3 years.
- a fixed term with automatic renewals.
At the end of the term, the contract renews itself for the renewal period.
So a contract with a 3-year term could be made to renew for consecutive 1 month periods. If that's want you had in mind, good stuff. If not, it should be changed.
- until completion of the work. This might be done by reference to another document, such as a project plan, with milestones fixed by a project plan or delivery timetable.
And then there are hybrids of these types. One example is contracts that peg the duration of the contract to an event or a contingent event.
Term of Contract
Another word about the term of a contract.
Just because a contract is in force, doesn't necessarily mean that you will be performing services for the entire term of the contract.
You see, the term of the contract can be longer than the period for which you do any work under it.
- We have a 3 year contract with one another.
- It is a time and materials contract. I only get paid for the time that I spend working.
- Let's say under the contract, you have no positive obligation to give me work to do during the 3 year term.
- Let's say that you don't give me any work for the 3 year period.
We have a 3 year contract, but I am not guaranteed any work at all.
These are commonly known as "zero-hours contracts".
Although the contract is in force, I'm not doing any work under it.
There are less extreme versions of this sort of arrangement. It may be that we set up a contract. Let's say it's a 2.5 year term this time. You might have a project that you want me to implement under the contract. I put in a project plan that the work will take 12 months, working every business day of the year. I deliver the project on time. Although the project has finished, my contract with you continues for the remaining 18 months.
So that's the difference between the term of the contract and the work to be performed under it.
Watch out for it.
Now you know the law of the contract, the place where disputes will be decided, and long the contract is to run for.
Let's get to when and how it can end.
Termination clause: End of the Contract
Thinking through to the end of the contract
At the beginning of a contract, it can be really hard to think that the contract may have to end badly. Such as:
- You're not paid. And they're still asking for delivery of more products or services, or
- The services are delayed, not they're not up to scratch or defective
There are times when it'll be in your business's best interests to end the contract.
Termination is when a contract comes to an end. Some call this "cancelling the contract". That usually means terminating the contract for repudiatory breach or under some statutory right.
It's important to know how contracts can come to an end:
- by both parties performing their obligations under the contract
- by effluxion of time (the contract runs its term)
- by agreement, before it has terminated for either of the above reasons
- by breach of contract, after the right to terminate for repudiatory breach has arisen, and
- under the terms of the agreement (say under a force majeure clause, if there is one)
- by frustration of the contract.
Properly drafted contracts usually take a few approaches for termination.
One or both parties can:
- terminate for repudiatory breach: if the breach is able to be fixed or cured after a limited period (ie a "remediable" breach), and it's not cured within the notice period.
A standard notice period is 28 days.
Also, several minor breaches which when combined together, may amount to a repudiatory breach.
Sometimes the sort of breach required is a "fundamental breach", "material breach" or "substantial breach". In the context of the contract, these terms for breach can mean different things.
- Termination without cause: one or more parties terminate for their own convenience (ie without reason) on a set period of notice, such as 28 days or even without any notice
- Termination for insolvency: that is, terminate in the event of the insolvency of the other party. The main purpose of this basis for termination is to avoid the (innocent) solvent party being tied to a contract where it has little prospect of getting paid or getting tied up in a liquidation.
No express right to terminate
It's a good policy to assume that if a right does not appear which allows you to terminate the contract, you can't terminate it. This actually isn't legally correct – it's just more difficult, and risky. That's because you need to set up a repudiatory breach at common law.
Know this: Terminating a contract before the end of its term without the written agreement of the other contracting party is fraught with risk and compounds tension you don't need.
If you get it wrong, you will be in repudiatory breach yourself, and hand your (now former) contracting party a counterclaim for damages against you.
Effect of Termination: Post-Termination Provisions
Often a clause appears after the termination clause which reads, "Effect of Termination", "Consequences of Termination", or something similar.
This clause (if it exists) makes it clear what happens after termination.
- Cumulative Rights
One of the more important clauses are the ones that say something like:
"Termination of this Agreement shall not affect any accrued rights or liabilities of either party".
Clauses like this preserve all of the rights of each of the parties as at termination.
If it's not included, there's an argument that termination was the sole remedy available to the innocent party in the event of a repudiatory breach of contract.
If that argument is successful, damages won't be available as a remedy.
- Continuation Post-termination
When a contract comes to an end, the primary contractual obligations to perform come to an end.
There are other "secondary" obligations that continue, if the parties want them to continue in force.
It reads something like this:
"Upon termination the following clauses will continue in force, in addition to any other clause intended to come into force or continue in force after termination: [list of clauses]"
The usual candidates for inclusion are:
- payment provisions
- confidentiality clauses
- data protection, and return or destruction of personal data
- restrictive covenants
- indemnities, and
- limitations of liability.
These sorts of clauses can also extend the entitlement of the parties of the benefit of the contract. But that's not a good idea in most contracts. That's because it confuses performance obligations during the contract and after the contract "terminates".
Why provide that performance continues after the contract ends?
This is when the rubber hits the road. Reading contracts becomes serious business.
Historically, there are conventions adopted when reading all contracts.
These conventions were applied by courts rigorously. They are known as "canons of construction".
Canons of Construction
These days they're mostly guidelines.
But some of them remain gospels of interpreting contracts.
Others are only applied to resolve ambiguity in contracts: when a clause or part of the contract can be read at least two ways. They're applied as a last resort.
These days they are used when the background to the contract - known as the "matrix of fact" - can't be used to resolve the ambiguity.
Part of the art of interpreting a contract is knowing when these guidelines will be applied.
It can't really be a science, when different judges (at the trial, Appeal Courts and Supreme Court) disagree on when - and how - they should be applied.
All of that said, a word about these types of clauses:
- Interpretation clauses displace the usual operation of these guidelines (ie the canons of construction), if scope arises for rules of construction to apply to the contract.
When they do crop up, you might find that the Latin name is used to refer to them. The most frequent ones are:
"In this Agreement the ejusdem generis rule shall not apply."
"The interpretation rule known as the contra proferentem rule shall not apply, nor shall any similar rule or approach to interpretation."
- Interpretation clauses can also state the order of precedence of documents which making up the contract. That is, when there's an inconsistency – which part of the contract prevails over the other?
For instance, say a contract is made up of (1) an order form, (2) operative provisions (ie the body of the contract) and (3) schedules.
If a conflict or inconsistency arises between the terms in 2 or more of these parts of the contract, which takes precedence?
An interpretation clause resolves the dilemma. It states the order in which the different documents take precedence over one another.
You need to follow the order of precedence if you encounter a conflict or inconsistency between documents. The other parts will (if it's a simple case) be ignored to the extent of the inconsistency.
Specifying the Fundamental Terms of the contract
These terms are really what the contract is all about.
These are the provisions and clauses that require the parties to positively do something to perform the contract.
There could also be clauses that require you not to do something too. That might be not to compete with the contracting party for the term of the contract by not supplying competing services. Or poach their staff.
These are the contract terms that form the core of what supplier must do. Clarity is especially important here. When it is not clear, you can get cascading problems.
You need to work out whether your business can:
- do what the contract says
- to the time frames stated, and
- to the standard required by the contract.
That standard is "reasonable skill and care", unless the contract says otherwise.
When it does, it is almost invariably a higher standard. Such as "best industry practice", or "standards generally accepted in the industry".
Consider that a warning.
There are others.
Schedules and Statements of Work
If there are schedules to the contract, they get into the detail of the contractual obligations, service levels and expectations of your counterpart and/or you.
Schedules can contain anything that doesn't fit neatly or conveniently into the text of the contract or might change from contract to contract, such as:
- detailed specifications of work
- quantities of products to be delivered, and when
- projects plans
- service level agreements, including response times and resolution times
- calculation of service level compensation when service levels are not met, and/or
- the method of calculations for payments, such as rate cards,
Each schedule should be referred to somewhere from the operative provisions of the contract.
Let's break it down:
A few prompts for the sort of things you should be asking yourself:
- Supply of goods:
- what goods, and to what specification or description must be delivered?
- It's not just "the product", but also:
- product number, SKU
- and so on.
Is it to match a description or as sample? Say so. And then document the sample. Take photos if you think it will help.
- Supply of services:
- Precisely what services are being delivered?
- What is the specification of the deliverables?
- By when?
- What service levels apply, or other description of quality of the services is required?
- Intellectual property licence agreement:
- What's the scope?
- What exactly is being licensed? It is a particular version of the intellectual property, or future releases as well?
- How may it be used?
- For how long?
- What's the scope?
- Restrictions and limitations:
- Is it limited by market segment, market location, location, retail outlet?
- Can it be uses, manufactured, sold, sublicensed, or combined with other products? One, some or all of these?
- Geographic scope:
- By country, territory, region or worldwide?
- Time needs special attention when handling intellectual property rights.
The duration of the licence doesn't necessarily need to correspond to the term of the contract.
It's all about precision. What is it that you have to do to perform under the contract?
If you can't work it out by looking at the words used in the contract (and no other document), it's probably not clear.
You're inviting serious problems.
The price of glossing over the detail
Seriously, disputes feed on imprecision and ambiguity in contracts. Specificity reduces legal costs in disputes. You only need a contract when something goes wrong, don't you?
I mean, that's one of the dual purposes of a contract isn't it? The other is to avoid disputes altogether.
Want to increase legal costs in a dispute? Gloss over the detail.
You know it can get complicated. Or more complicated than you'd like it to be.
Break it down into its pieces. It's more manageable that way.
Simplicity is the master of clarity.
Keep it structured.
How Cerberus enters your world
If you don't one problem can lead to another.
- If the services to be provided are not clear:
- no-one can tell clearly whether what has been delivered meets the contractual standard,
- which means that you may be in breach of contract,
- which means:
- you might be liable for damages, and/or
- the other party might be able to terminate the contract,
- you might have problems getting paid, and
- all of your options involve risk that you'd prefer not to have:
- it's unclear whether you have a right to terminate for bad performance and deliveries
- if you terminate when you do not have a right to, it's a repudiatory breach, and
- which means that you lose the ability to rely upon any term of the contract, save for the "secondary obligations" under the contract.
The same concepts in this list apply 1-to-1 to contracts for the sale of goods.
Warranties tend to have the role of supporting the performance of the key performance terms. They support the fundamental, core performance requirements of the contract. But they're not the most important terms of the contract. The conditions of the contract are: they're the fundamental terms.
The party giving the warranty is responsible for performing the obligation. If you don't it's a breach of contract.
Warranties might include promises, such as you:
- have the right to enter into the agreement, and will not be in breach of any other contract by entering into the one being contemplated
- have all the requisite licences and permissions to perform the services and supply the products to be supplied
- own all the rights and property you need to, to perform the contract
- will be responsible for inaccuracies of the information that you provide your contracting partner
- will not infringe the intellectual property rights of any third party, and
- will cooperate with one-another to perform the contract, and not do anything to hamper the performance of the other.
Other types of warranties excuse delays and defective performance. Such as when:
- information, materials or data are defective or not to specification, or are supplied late
- interference is encountered from an associate of one of the contracting parties, and
- a party fails to pay charges on time.
If you have a hard time working out which are warranties and conditions of a contract are, check this out. It also helps to know what an "innominate" or "intermediate" term of a contract is.
Depending of type of contract, other clauses can be important as well. Such as:
- Physical Property: Is there a transfer of property, if so who owns it?
Unless the contract provides otherwise, title (ownership) to property is passed on delivery, the risk in the goods lies with the owner until they are delivered.
- Intellectual Property clauses:
- warranties as to ownership
- transfer intellectual property to the intended party
- grants of licences to use intellectual property
- Assurances: additional promises to do further acts (such as executing documents) to give full effect to the contract. There are tricks in the trade with these clauses. Courts have said that the assurance needs to relate to an obligation set out in the contract.
At this point, you know the term of the contract, the services to be provided, any special rules of interpretation that apply in the contract.
Time to get into the detail of payment provisions.
Payment Provisions of Contracts
When you break it down, from a payment and services perspective, there are 3 basic types of payment models in contracts of supply of goods or services:
- Fixed Price
- Costs plus, or
- Time and materials
Licences, such as intellectual property licences can be different. They are not labour based. In licence agreements you have royalty payments or licence fees. Payments can be fixed by a formula including say, by unit. That brings them into a fixed price model.
Contracts dress them up all sorts of ways.
In each type of contract, relative importance of the terms of the contract vary.
It also depends on whether you are the customer or the service or product supplier.
What are the differences between the different payment models?
What are their priorities? It matters. If you get it wrong, you may not have an appropriate model for your business.
The basic frameworks of the different payment models in the contract should be as follows:
- Fixed price:
- For products or services to be delivered:
- the customer must understand what must be procured
- the service provider should be specific about what's to be supplied
- Ideal when you have clear, specific and known requirements
- The product or service is well established and predictable for the supplier to deliver
- An agreed scope of work should apply
- A defined change management process applies for variations. Documentation is exchanged prior to the changing the legally binding commitments, and
- There could be incentives to meet or exceed service levels, or penalties for missing them.
- For products or services to be delivered:
Variations to the goods or services should mean a variation of the price.
Fixed price contracts usually favour the buyer. The supplier will want clear, known, and specific deliverables, which are predictable for the supplier.
- Costs plus:
- The cost of the work performed by the supplier is paid to the supplier, in addition to a known (and pre-agreed) profit margin. 10% margin is common.
- This model may be convenient when flexibility in project scope is the highest priority.
- When risk of change to project scope is high, can be used to mitigate risk to the customer
- Most frequently used in the construction industry.
- Time and Materials:
- The supplier charges:
- their time plus
- the cost of materials and expenses used on the project. Costs and expenses of materials performing the work are reimbursed.
- Supplier staff rates are fixed for the individual resources or class of resource.
- Should include "not to exceed" terms, subject to a change of scope of work.
- The supplier charges:
There is room for more laxity of time to be spent on the specification of work.
This model increases the need for performance assessment of the supplier to ensure value (and/or value for money) is delivered in a time-efficient manner.
Elements of these types of contracts can live together coherently within the same contract. For instance:
- Cloud based software as a service agreement can be for a fixed price per month or per year. Related services could be supplied on a time and materials basis:
- help desk services;
- maintenance services;
- different standard of service level in an SLA, or
- additional disk space or bandwidth.
Structuring prices like this reflects the commoditisation of services.
- Supply of products are fixed price contracts, unless customisation is required by the customer. Even then the custom changes are likely to make most sense at an additional fixed price.
Timing of Payments
Options for payment clauses include:
- in advance, usually for products and services bought online
- on delivery plus a specified number of days
- on a time schedule
- on a regular schedule with variable payments: the hours spent may vary from period to period. It might be structured with:
- Base fee, per month
- Variable component, based on contingent events, such as the number of calls to a call centre within a month. Payment varies by volume.
- on completion of a milestone, event or project plan.
However it's expressed, the payment provisions should allow for payment within a fixed time or by a fixed date, with a minimum of obstacles.
Look out for:
- Time between services for payment: These are situations where the customer has the data needed to raise an invoice, and the time to deliver the data is long. Combining this with 30 days can result in a payment regime such as this:
- today is the last day of a monthly period to deliver the services
- the customer has 30 days to provide you with the information required to raise an invoice
- let's say you turn the invoice around the same day, and
- the customer has 30 day payment terms.
The customer has in effect a minimum of 60 day payment terms. That's 60 days after they have received the products or services. If the services were delivered at the beginning of the month, they could be getting up to 90 days credit before you're paid.
You would also need to build in time to verify the correctness of the invoice and query the data.
This would obviously add unpredictable time and trouble to when you get paid.
And there's probably nothing you can do about it provided every behaves "reasonably".
If that happens, you have a cash flow problem
- Payment provisions that don't work: Make sure the method of calculation is correct.
You'll do well to "stress test" the calculations with real world situations: and all the unpredictability that the real world brings
- Complicated payment formulae: Preconditions that must be satisfied before you can get paid.
These might include having to issue an invoice in a particular format and give a specific breakdown of information
- Invoice Frequency: The frequency that you can issue invoices: monthly, quarterly, at any time or otherwise as appropriate
- Unusual provisions that don't make commercial sense: These are the weird hurdles, flaming hoops or processes that must be navigated or requires manhandling to issue an invoice.
These will be obstacles to getting paid. Those barriers are usually there for a reason…
Here's a tip. Most often "Purchase Orders" are a mere administrative convenience for the buyer. It assists administration of their business.
Typically debts arise under the contract. Not because a purchase order has or has not been issued (unless it says so in the contract).
If the buyer says that they can't pay because they haven't issued a PO, pull out your rubbish meter and see how high it reads.
- Suspension: whether there's an express right to suspend performance of the contract if payment is late, and
- Exclusion of Set-Offs: Check whether a payment dispute still requires the customer to pay the undisputed amount. Or not.
Allocation of Risk > clauses to look out for
There's a lot to be said about proper allocation of risk in business contracts.
Think about it (fairly).
The party with control over the risk should bear consequences if the risk materialises.
If it's not your fault, you should not be liable for it.
You can manage in a series of ways. One of the main ways are the warranties.
The other ways include indemnities and limitations of liability.
For the reasons set out below, liability for indemnities should always be capped. The usual maximum (commercially speaking) that businesses accepts is the upper limit of your insurance coverage.
I come back to insurance under the limitations of liability section in moment.
People who know what these mean, don't let them fly by in contract reviews.
An indemnity is special type a warranty.
When they bite, my, they can really hurt.
A person who indemnifies another party promises to compensate them if:
- the circumstances caught by the indemnity come to pass, and
- the contracting party suffers loss as a result.
The indemnifier (the business which gives the indemnity) is contractually required compensate the indemnified person: ie the other party for their loss. The indemnifier is primarily liable for the loss.
Types of Indemnities
There are two types of indemnities.
One contracting party agrees to make good losses and liability incurred by their contracting party, which was caused:
- to that contracting party.
You and I have a contract with one another.
I agree to indemnify you for your losses caused by my breach of contract.
If I breach the contract you suffer loss of £10 as a consequence, I need to pay you £10.
And the second type:
- to a third party to the contract.
Let's say I am a software developer and you licence software from me.
As part of the software licence, I give you an indemnity for any loss you incur as a result of infringement of intellectual property rights in the software I develop for you.
But here's the problem.
I don't own all of the intellectual property rights in the software. That means I don't have the right to licence it to you.
The true owner of the intellectual property rights has a claim against you.
They require you to pay £15 for your infringement of their software (that I supplied you, without their permission).
My indemnity to you would require me to pay you £15.
But then you suffer loss, such as having to replace the software, your legal fees, staff administration costs, amongst others.
I'm in the firing line under the indemnity to pay you those amounts as well.
So an indemnity is an express contractual obligation to compensate for any loss suffered (or as fixed or described in the contract).
The obligation is completely independent of what the liability of the party in breach might otherwise be to a third party to the contract.
Why an Indemnity?
Indemnities sidestep the calculation of damages in accordance with the general law. The amount payable under an indemnity is almost invariably higher.
That's because the considerations that reduce the sum of damages payable under well-established rules of law do not apply.
The rules that don't apply include these:
- There is no distinction between direct loss and consequential loss. The rule in Hadley v Baxendale doesn't apply
- Mitigation of loss: Generally speaking, the indemnified party does not have an obligation to act reasonably to minimise their loss.
But then, they take risk by going over the top about it either. That's an application of the canons of construction mentioned earlier.
When is an Indemnity appropriate?
You should not give indemnities unless you completely control the circumstances which liability might arise under the contract – unless you've got a very good reason to do so. That is a matter for you to decide.
In the example above, the contents of the software which was "licensed" to you were completely under my control.
I chose the components of the software to supply to you, even if I used open source software. I was the developer. If there was another software developer supplying the software package that I didn't supervise or control, you wouldn't get the indemnity from me.
Indemnities are often accompanied by a warranty that the party conducts the litigation on behalf of the indemnified party. And pays all of the costs. That's an eye-watering prospect.
Make sure the you control the circumstances which give rise to the indemnity.
If you don't, you may need professional help. Not from a lawyer.
Limitations of Liability and Exclusions of Liability
These are amongst the most important clauses in a contract.
Before we get to them, a bit of background.
When you have a breach of contract legal claim, the law takes a two-step process:
- Step 1 – Establish Liability: The first question is always, "Are you liable for breach of contract?". If so move to
- Step 2 – Calculate Quantum: The second question is, "How much should the innocent party be awarded in damages?" (and is any other remedy appropriate, such as an injunction).
There can be no damages award without a breach of contract.
Types of Limitations of Liability
Therefore, there are 2 types of limitations of liability:
- Limit what can be a breach of contract
This first type aim to prevent liability for breach arising in the first place.
In this way, there is no legal claim to be made, because there is no breach of contract.
Limitations of liability do so in these ways:
- referring to specific events and state that there shall be no liability for the specified events
- excluding all warranties unless they are named in the contract
- excluding legal claims based on misrepresentation.
For instance, over-selling the capabilities of a product or service to get a sale or order would probably be a claim based in misrepresentation.
- Limit the sum awarded, if there is a breach of contract.
In this case, you're not saying that what happened isn't a breach of contract.
You're saying that there is a breach of contract, that the contracting party is liable for damages.
This type of limitation of liability operates to cap the damages to a maximum sum.
Different categories of events can be specified and limited, such as cyber-attacks and breaches of the GDPR.
What's the downside and upside of Limitations of Liability?
Limitations of liability are hotly contested in business contracts because:
- Sometimes they attempt to exclude all liability whatsoever. They try to absolve a party of liability for something your contracting partner did wrong
- They create real barriers to the innocent party making legal claims. As a consequence, they increase the risk of making a legal claim.
- Damages awards in contracts have no theoretical upper limit, without limitations of liability.
Damages can be completely out of all proportion with the value of the contract to you.
Without limiting your liability under the contract, your business is exposed to these risks.
How do they work?
You are a service provider. You host websites. All of your customers' sites go down due to a cyber-attack. The damages claim is £50.
You have the benefit of a specific limitation of liability for breaches caused by cyber-attacks. That limitation is fixed at £10.
If that fails (see below), then an overall cap of liability under the contract is set at a higher sum, say £20.
The idea is that you get 2 bites at the cherry.
If the first limitation of liability is effective, your liability is limited to £10, not £50.
If the first limitation of liability is not effective, and the second is effective, your liability is limited to £20, not £50.
However, if neither of the limitations of liability are effective, you're up for a damages bill of £50.
Limitations of liability can be quite difficult to enforce.
That's primarily because at the time you're agreeing to the limitations of liability, you don't know the circumstances in which the breach will arise (that you want to limit), or how serious the breach of contract might be may be down the line.
There are statutory provisions in the Unfair Contract Terms Act which can help to set aside onerous and unreasonable limitations of liability.
But courts seriously don't like the intrusion of the Unfair Contract Terms Act into the territory of business contracts. It's been said as high up as the Appeal Courts.
Why's that important?
It because the courts expect businesses to fend for themselves. That means not signing agreements which expose them to risks that they are not willing to accept.
The things to do are:
- Express contract terms clearly. If it doesn't say what you need it to clearly, change the wording. Remember that's clear to a judge, reading the contract using well-established rules of interpretation. Not a necessarily a businessperson.
- Understand what the contract means. if you don't quite get what the contract is saying (and guessing is a mistake) take legal advice from a specialist, and
- Assess commercial risk. Don't agree to risk that your business can't handle commercially. Or legally.
If a contract can go seriously wrong for you, it's worthwhile taking other steps to mitigate your risk. Such as insurance.
Insurance and Limitations of Liability
Many – if not all - policies of insurance exclude claims where damages are not limited.
That usually translates to excluding consequential loss. But yours might be different.
When you're working with your contracts and limitations of liability, you should know the exclusions to your policy. Off. By. Heart.
In short, you may need to insist on inclusion of limitations of liability if you believe you might find yourself in a position to have to make a claim.
Difficult Language in Contracts
There are some words to watch out for in contracts. Here are a few, and what they might mean in your contract.
- "Notwithstanding anything contained herein to the contrary, …":
It doesn't matter what else is said in this contract, the text after the comma applies regardless
- "best endeavours":
This may mean having to taking steps which are uncommercial, to avoid a breach of contract claim.
- "for the avoidance of doubt":
This phrase apparently makes it clear to a person interpreting the contract that the specific instance of the obligation (which appears after the phrase) is intended to be included by the parties. It's meant to:
- increase the predictability with which the contract will be interpreted. That's the intention of the person writing the contract anyway. Whether it does so or not is another question.
- ensure that provisions elsewhere in the contract are less likely to create a conflict which would prevail over the specific instance, which the parties have seen fit to include in the contract.
Either way, it needs to be clear to the person with the role of construing the objective intention of the parties in the contract.
The litmus test is ultimately how a judge sitting in court would decide it. Not a lawyer.
Most of the time, the phrase is redundant.
Example: "for the avoidance of doubt":
In the context of intellectual property rights, "for the avoidance of doubt" might be encountered like this:
Each of the parties shall at all times use the intellectual property rights of the other in accordance with the terms of this Agreement.
For the avoidance of doubt, such intellectual property rights shall include the intellectual property not referred to in this Agreement.
First Reading of the Contract
The more times you read a contract, the more your thoughts mature. The longer it is, the more time you need to process it.
Read it again, and you will see things that you missed on the previous readings.
The meaning(s) of the text sinks in properly over time.
Making up the meaning
Don't let yourself be fooled though: you shouldn't "make up the meaning" of the words when you try and make sense of them.
There is a lot to be said for making notes on your first reading of a contract. They can go in one of the margins. The clarity of your first thoughts can be lost on a second and third reading.
You might want to check against your first impressions later. You will end up having a marker to compare your thoughts against when you read it again, and your thoughts mature.
Also, you might find that you take in more of the contract in when you read it… on paper.
After you read it the first time, you'll have a better sense of what the contract is about. It really depends on what the objectives are of the parties signing it.
New Habits to consider
You'll also be able to flick from page to page and section to section. If you're not in the habit of doing it, make a point of printing it (once at least) with contracts that can do real damage to your business if you get it wrong.
You might also notice that if you read the contract away from the usual place that you work, you concentrate better, with greater clarity of thought.
What should you be looking for?
After you've read the contract if it seems like it is all one-way traffic, it probably is.
You have the comments above about the different sorts of provisions.
You should have also spotted:
- provisions that make you feel uneasy
- any references to clause numbers which are wrong,
- missing words or text
- missing dates.
Time to get ready for a discussion with your counterpart. It's your opportunity to check things with your intended contracting partner.
There's a consolidated checklist below to assist your review.
With that you'll find that you'll be able to take a structured approach to your contract review.
There are fixes and then there are amendments to contracts. Let's call fixes "clerical fixes". They both as important as one another.
They all form part of your contract review.
Contract Review Checklist
1. Capitalisation: Are all the terms that are meant to be capitalised, Capitalised?
2. Dates for delivery: Do they make sense, and are they realistic?
3. Prices: Are the prices or their method of calculation clearly expressed
4. Parties: You may think this is obvious. It is.
Minor mistakes can cause major problems.
Check the company exists. Do a company search. These days, there's not many places on earth where you can't get some company details for free.
You want to make sure you are contracting with a business that actually exists. You want the contract to state the full company name.
What's the full company name?
It's the company name with:
- the suffix (Limited, Ltd, LLP, LLC, Pty Ltd, as the case may be)
- its address, and
- its number of incorporation.
Think it's trivial?
I cant tell you how many times I have found mistakes in contracts that specify the wrong company or wrong number. It rules out a whole class of problems arising later (such as: who is this contract actually with?).
5. Referencing: Make sure internal references to clauses are correct. These are clauses that refer to other clauses.
6. Incorporated Documents: You have received (and have you read…) and preferably have attached documents incorporated by reference to the contract?
Ideally, you'll ship the incorporated documents with the signed contract itself.
That way, there's minimal room for argument over which documents were the correct versions after the contract is signed.
7. Catch gaps: All empty spaces in the document are filled in.
BTW, it's good practice to mark items that are not finalised in contracts with "[insert]".
Makes them easy to find with a search for the "[".
Other people prefer colouring the text. It's harder to search for.
Contract Review Pro Tips:
- What are the preconditions to getting things done, if any?
- If there is anything, is there a workaround, or a limitation of liability to forgive breaches caused by failure of the other party to do their bit, so that you can?
9. Tiers of changes: You should know what is important in the contract and what is not.
Split your negotiating points into 3 tiers:
- Tier 1: Deal breakers
- Tier 2: Important to have and worth pressing for, if you can get them. Perhaps worth getting in exchange for something in your favour as part of a concession
- Tier 3: Nice to have. Not essential, but preferable if you do
10. Long paragraphs and sentences: Break them up
11. Negotiations: Rare is the occasion that the terms of a contract can't be negotiated.
Even if you're told to take or leave it. If they refuse to negotiate and you need something changed you might think, "Well, why wouldn't they want to negotiate, if they are fair, reasonable and good people to work with?"
12. Stupid Questions:
The consequences of getting a serious contract wrong are dire.
So there's no such thing.
If you're thinking you might be embarrassed about asking a question, maybe ask it like this:
- "Could you explain how clause [number] is meant to work?"
- "What did you intend by the [restrictive covenants]?"
- "I'm not quite with you on clause . What did you have in mind here?"
- "I'm a bit uncomfortable with [insert]. Can we reword it to say [insert]?"
13. Negotiating excessive risk:
- "We're a small business. We can't expose the business to the sort of risk that you are suggesting we take on by clause [number]. We can't accept it. [Do you have an alternative approach?]"
- "We're a specialised business. We can't give you the kind of support you're asking for at clause [insert]. We're happy to do it (if you are), but we need to raise the pricing. [What do you want to do? / How do you want to approach it?]"
14. Inconsistencies: If there's a big difference between what you're being told and the common sense meaning of the words on the pages of the contract, you shouldn't be hearing alarm bells.
You should be hearing sirens across the city.
If the verbal description of what the contract does differs to what is in writing, why shouldn't the writing be made to match what they say?
15. Time pressure: In some circles it's common practice to apply time pressure in negotiations so that one party get their own way. That's applying time pressure to a fictional deadline.
The objectives seem to be:
- make you gloss over the content of the contract, because you're in a rush, and stressed as a result.
That is, to apply pressure so that you don't have the opportunity to read it closely or with the attention that you should.
You might lose the deal.
- stop you having time to get legal advice to tell you why clauses might not be in your best interests. Gosh that's understated.
- put you under pressure to think "oh, it's not worth it", and just agree.
If it's important enough to them, they'll wait. If not, you might have been a throw away opportunity to them in the first place.
You don't need to put yourself in a position to find out for sure.
16. Exchange final drafts: if at all possible, send contracts in a form ready to sign. Not "drafts" that need further editing. Unless of course, you've got a very good reason not to. But that's rare.
17. Walking Away: Maintain a mindset where you're able to walk away from the deal.
You'll negotiate better.
Just because you've finished your negotiations, doesn't mean that you're committed.
You're committed once you sign.
18. Interpretation clauses: Does an interpretation clause affect the way you should be reading the contract?
19. Services: Are the services to be delivered sufficiently clearly expressed, that you can:
- put your hand on your heart and say with certainty that you
- tell when the criteria will be met or satisfied for delivery?
20. Term of the Contract: Check for automatic renewals: it may not be what you are expecting.
21. Termination: Are you able to get out of the contract if it all goes horribly wrong?
22. Intellectual Property Rights: Do you have the rights to assign, licence or otherwise deal with under the contract (in the way that you intend to)?
23. Indemnities: Are you in control of all of the circumstances where you are giving an indemnity?
24. Data Protection: If you're exchanging data with your contract partner and it contains personal data relating to individuals in Europe, have you thought about the application of Article 28 (and others) of the General Data Protection Regulation?
25. Limitations of Liability:
- If the limitations to liability are disproportionately small to the greatest loss that could be suffered, they may well be unenforceable.
- Have you checked your insurance policies to make sure that it won't be invalid if you make a claim under the contract?
Check whether your policy excludes consequential loss altogether if it's not limited in your contract.
26. Dispute Resolution: If there is any prospect that you may need to obtain an interim injunction to prevent unlawful behaviour with your assets? If so arbitration and other alternative dispute resolution procedures (such as mediation) are not going to make sense for you unless there is an express carve out to apply for interim injunctive relief.
27. Choice of Law: Has the law that is going to govern interpretation of the contract been specified? Is it a valid selection?
28. Jurisdiction clause: This is where disputes (hypothetical or otherwise) will be fought out.
Need some help to work out what a contract means for your business?
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