There has never been a more important time for businesses to understand their contracts with suppliers, technology licensors and customers. In this article, Laurie Heizler considers what you need to know about commercial contracts and essential provisions that need special consideration.
A contract is an agreement between two or more parties that the law will enforce. There must be an offer from one party, acceptance from another and the intent to create a legal relationship. There must also be ‘consideration’ (payment or the acceptance of certain obligations) in return for reciprocal obligations. Basically, all parties must get something out of the deal.
The Verbal Contract
“Verbal contracts are not worth the paper they are written on!” - Samuel Goldwyn (attributed)
Contracts may be made verbally or through a course of dealing. This means that there is a risk that binding agreements may arise unintentionally. Businesses should be very aware of the possibility of “accidental” contracts and maintain a strict contracts policy to ensure commercial evaluation, proper drafting and regular review of every important contract. You must know exactly where you stand contractually with their suppliers, customers and other third parties.
The Written Contract
There is more recognition of written contracts. These may be “back of an envelope” efforts or detailed agreements that have been expertly drafted by lawyers. A good contract addresses a specific commercial venture, the risks attached to it, how it is terminated and all-important limitations of liability.
Sales of goods or services to other businesses or to consumers are usually conducted on the basis of contracts that incorporate standard terms and conditions. Contracts of all kinds, especially those made with consumers, incorporate terms implied by law which can only be excluded to a limited extent.
Interpreting a Contract
Disputes may arise over the interpretation and enforceability of any contract. Contractual provisions must not create any commercially unacceptable risks. They must not be ambiguous or create provisions that are not enforceable in law.
The attitude of the courts to contract interpretation used to be more purposive, inferring what the parties must have intended where the plain meaning of the words is not clear. This is still relevant but the language used is of primary importance. They will be analysed in their full context taking account of the natural and ordinary meaning of words together with the purposes, facts and circumstances known to the parties when the contract was drawn up - and also commercial common sense!
Where there is ambiguity, judges will try to construe the contract so that it remains valid and effective. If the issue relates to provisions that aim to limit key rights and remedies (for example, limitations of liability), the provisions in question will be strictly interpreted.
Essential provisions to consider
Key terms which are priorities when contracts are being reviewed, negotiated and drafted will include:
- Warranties: you must ensure that you can meet the warranties you give in terms of performance and delivery. They may create an onerous burden in practice. Failure to comply with any warranties wholly or partially may entitle the other party to damages.
- Limitation of Liability: in a properly drafted contract, each party may limit its liability. It is usual to exclude liability for loss of profits or other consequential losses and limit liability for other things to a reasonable amount taking account of the likely level of loss. The “cap” on liability may be an amount linked to contractual payments due over a reasonable period of time. You should be careful with respect to indemnities involving full compensation for matters such as IP breach.
- Intellectual Property (IP): it is important to ensure that the contract does not oblige you to give away any IP. If the other party can only fulfil its contractual obligations by using your IP, you would only need to grant it a limited licence to do so.
- Force Majeure: a provision allowing for delay or excuse from performance will protect you from being obliged to perform contractual obligations and suffering penalties when it is simply impossible to fulfil the contract due to circumstances beyond anyone’s control.
- Jurisdiction: depending on where the parties are based, issues may arise as to which country’s laws govern the interpretation of the agreement. It is important for an English party to ensure the agreement is made under English law. Jurisdiction should also be by the courts in England and Wales so that local legal advice can take account of issues of interpretation, enforceability of key provisions and litigation procedure if the other party is in breach.
- Termination: problems arise when it is perceived that the contract is not working well enough or it is ceasing to be profitable or advantageous. It is therefore important to consider how easy it might be to get out of the contract. There should always be provisions to terminate for “cause” (such as material breach or insolvency of the other party) or perhaps where one party undergoes a change of control. But you might also consider adding a provision to end the contract for “convenience” on giving reasonable notice but without necessarily giving a reason. This may not always be commercially possible. In any event, the agreement must be very specific as to the circumstances where either party retains the right to terminate.
- Dispute Resolution: in complex contracts where there is always scope for minor breaches which do not merit termination of the contract as a whole. To avoid the expense, time resource expenditure, publicity and other negative consequences of litigation, it is advisable that important contracts contain an alternative dispute resolution (ADR) mechanism (arbitration, expert determination or mediation) that is applied in the event that any dispute arises.
Our advice is to take contracts very seriously. Keep them under regular review and ensure you obtain professional help when the contract is critical to an important or risky commercial relationship.