Cecily Zamora
Contracts are a common feature of both our personal and professional lives, outlining the parameters of business relationships, including ownership, payment terms, and length of the agreement. However, they are notoriously difficult to read, often filled with legal jargon and complex terminology. To read contract law effectively, it is important to understand the structure and key terms used in contracts. This involves knowing the difference between boilerplate language, which is standard in many contracts, and unique provisions specific to the agreement. Reading a contract thoroughly and carefully is essential to avoid potential pitfalls and legal battles in the future. It is also crucial to consider all potential scenarios and ensure the contract addresses them unambiguously. In this topic, we will explore strategies for reading and understanding contract law, including tips for identifying key clauses, interpreting legal jargon, and recognizing unfair or questionable terms.
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What You'll Learn
Understand risk allocation and indemnification
Understanding risk allocation and indemnification is an essential part of contract law. It allows parties to address potential liabilities and manage their exposure predictably. Risk allocation and indemnification provisions are among the most commonly and heavily negotiated provisions in a contract.
Indemnification refers to the broad concept of one party compensating another for losses, damages, or liabilities, usually due to third-party claims. It is an agreement that safeguards one party from the financial impacts of specific actions or events. An indemnification provision is a distinct clause in a contract specifying how one party will execute indemnification. It outlines the responsibilities of the indemnifying party (the compensator) to cover the indemnified party (the compensated or indemnitee) for particular losses or damages. This clause also defines which claims are covered, the process for claiming compensation, and any liability limits.
Indemnification provisions allow a contracting party to customize the amount of risk it is willing to undertake in each transaction and with every counterparty. For example, in a sale of goods agreement, the risk that a product injures a third party is more efficiently borne by the seller than the buyer. The seller has more control over the goods and is in a better position to mitigate losses and liabilities related to the goods. Indemnification provisions also protect contracting parties from damages and lawsuits that the counterparty can more efficiently bear.
When reading a contract, it is important to carefully read and understand the risk allocation provisions. If something goes wrong, these provisions will limit recovery to some extent. Other ways risk is allocated between the parties include waivers of certain types of damages (e.g. punitive, lost profits, consequential, etc.), limits on liability (e.g. the value of the contract), mandated insurance coverages, and hold harmless clauses (clauses that release and hold harmless one party from liability to the other).
Additionally, watch out for potential pitfalls such as Most Favored Nations (MFN) clauses, which require a party to offer the same services, products, or prices on the same terms and conditions as offered to any other party or category of parties. Exclusivity is another important consideration - does the contract require exclusivity on the part of one or both parties, and is the company prepared to do that? Are there any competition law problems with exclusivity?
To prepare for contract negotiations, it is important to understand that any term in the agreement may be subject to negotiation. It is recommended to have a firm bottom line in mind to know when to walk away from the negotiation and to be clear on the ideal terms that will be agreed to right away, such as the price.
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Read the boilerplate
Reading the boilerplate is a crucial step in understanding a contract. The "boilerplate" refers to standard clauses that usually appear at the end of a contract. These provisions cover the mechanics of how a dispute between the contracting parties will be resolved. While they may be standard, they can have a significant impact on your rights and liabilities under the contract. Therefore, it is important to carefully read and understand these clauses before signing.
- Choice of law and jurisdiction: These clauses determine which state's legal rules will be applied in the event of a lawsuit and where (in which state and county) the lawsuit must be filed. This is especially important if the contracting parties are located in different states, as laws can vary depending on the region.
- Indemnification: This clause addresses the allocation of risk between the contracting parties. It specifies which party will cover the costs of certain disputes related to the contract brought by third parties.
- Warranties: These are promises or assurances made by either or both parties regarding their contract obligations.
- Confidentiality: This clause guarantees that either or both parties will not disclose certain information related to the contract. Breaching a confidentiality clause can have monetary consequences and damage your reputation.
- Arbitration: This clause states that any disputes under the contract will be resolved through arbitration proceedings, rather than a lawsuit. Arbitration refers to settling a legal matter outside of court with a third-party arbitrator.
- Jury trial waiver: The parties agree to give up their right to a jury trial and have any disputes heard by a judge instead.
- Severability: This clause permits a court to sever (remove) an invalid provision from the contract while keeping the rest of the agreement intact.
- Attachments: This clause specifies that attachments and exhibits will be included as part of the agreement.
- Escrow: This provision allows for payments to be placed into a special account that can only be accessed under certain specified conditions.
These are just a few examples of boilerplate clauses that you may encounter in a contract. It is important to carefully review and understand the specific language and implications of each clause before agreeing to a contract.
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Be aware of the Most Favoured Nations clause
A Most Favoured Nation (MFN) clause in a contract gives a party to the contract the legal right to terms and benefits that are as good as or more favourable than those received by anyone else who enters into a similar contract with the other party. These clauses are also known as "most-favoured customer clauses" or "antidiscrimination clauses".
In the context of international trade, a Most Favoured Nation clause is a provision that requires a country to provide the same trading terms to all partners. It is the founding principle of the World Trade Organization. The term has been expanded to apply in commercial contexts as well. For example, if a country belonging to the WTO reduces or eliminates a tariff on a particular product for one trading partner, the treaty's MFN clause obligates it to extend the same treatment to all members.
MFNs are commonly reviewed in contract review situations as they can uncover various risks. Price changes to one customer under a contract can trigger a duty to notify other customers with MFNs of the change and change prices for them as well. They are also used to protect a party from being disadvantaged compared to others, thereby ensuring fairness and competitive parity in contractual relationships.
MFNs can appear in any contract and might not be clearly labelled as "Most Favoured Nation" or any of its synonyms. They can be hard to find, even for experienced lawyers. This is why MFN clauses lend themselves to automated review using AI-based contract review tools.
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Know how to prepare for contract negotiations
Preparing for contract negotiations is a critical element of any business arrangement or agreement. It involves discussing and agreeing upon various terms, conditions, and provisions to establish a mutually beneficial and legally binding relationship. Here are some key strategies to help you effectively prepare for contract negotiations:
Understand the Dynamics and Objectives
Before entering negotiations, it is essential to comprehend the dynamics of the parties involved. Identify the stakeholders and their respective interests, priorities, and negotiation styles. Assess your relationship history with the other party and consider any cultural differences that may impact the process. Determine whether there is a zone of possible agreement (ZOPA) between your reservation point and that of the other party. If there is no room for bargaining, it may not be worthwhile to negotiate. However, consider adding more issues to the discussion to find common ground.
Set Clear Goals and Boundaries
Define your desired business outcomes and specific goals for the negotiation. Adopt a broader perspective to avoid setting goals that are too high or easily achievable. Identify your "lines in the sand," or non-negotiables, which represent your core interests and values. These deal-breakers provide a framework to guide your negotiation strategy while allowing flexibility on non-essential points.
Conduct Thorough Research
Gather all relevant information, including previous contracts, changes in the client's business circumstances, legal and regulatory updates, and key individuals involved. Understand the competitive landscape and the client's financial health. Review the current contract's terms and conditions, and assess the revenue and expense inputs associated with the negotiation. Identify the client's priorities and pain points from past negotiations to anticipate their position better.
Develop a Negotiation Strategy
Break down the negotiation into manageable pieces by focusing on key elements such as pricing, timelines, deliverables, and liabilities. Prepare an agenda for each negotiation session, concentrating on a limited number of key elements to maintain structure and avoid chaos. If working as a team, assign responsibilities based on team members' areas of expertise to enhance productivity and thoroughness.
Anticipate Disputes and Plan Resolutions
Despite efforts to create a comprehensive contract, disputes may arise during its execution. Anticipate potential conflicts by conducting a risk assessment and incorporating dispute-resolution mechanisms into the contract. Include clauses outlining the steps for dispute resolution, such as negotiation, mediation, arbitration, or litigation, and define the involvement of third-party mediators or arbitrators.
Utilize Resources and Tools
Stay organized by using contract management software, which provides a centralized location for contract team members to access relevant information. These tools offer dynamic dashboards, task assignments, and upcoming deadlines, ensuring a structured and efficient negotiation process. Additionally, consider seeking outside expertise or consulting industry peers to gain valuable insights and ensure cost-effective decisions.
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Ensure the contract is complete and addresses worst-case scenarios
When entering into a contract, it is important to consider all potential worst-case scenarios and ensure that the contract addresses these situations unambiguously. For example, what could happen if the client wasn't happy, or if you had to leave the project prematurely? What if you failed to complete a task on time, or if there was non-payment?
To avoid a breach of contract, the language of the contract should be clear and precise, and all parties involved should understand their roles and expectations. It is essential to include explicit obligations, specific deadlines, and clearly defined consequences for non-compliance. For instance, your contract should contain detailed stipulations outlining project expectations, payment amounts, and payment schedules. Furthermore, your contract must protect your right to payment.
If legal jargon is difficult to understand, use resources such as legal dictionaries or online assistance, and consult a legal professional if required. Remember, a contract can be changed even after it has been signed, but any changes must be agreed upon by all parties involved.
To ensure that a contract is legally binding, it must meet certain criteria, including a clear offer and acceptance, consideration (something of value exchanged between the parties), and the intention to create legal relations. Both parties must also have the capacity to enter into the contract. If a contract is breached, the non-breaching party may be entitled to remedies such as damages, specific performance (requiring the breaching party to fulfill their obligations), or termination of the contract.
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Frequently asked questions
The three passes approach is a good way to read a contract. The first pass should be a high-level scan of the document to understand its structure and where key information is located. The second pass can be a closer read, and the third pass should be the most careful read, focusing on important aspects such as payment provisions and ownership.
It is important to watch out for "viper pits", such as Most Favoured Nations clauses, which require a party to offer the same services, products, and prices to another party. Exclusivity requirements and indemnity provisions, which allocate risk between parties, are also important to look out for. In addition, be aware of any vague or ambiguous statements, and ensure that the contract does not give the other party complete control to unilaterally change any referenced external documents.
If there are parts of the contract that are unclear or questionable, it is important to consult a lawyer or legal professional before signing. You can also reach out to the other party for clarification or do a quick online search to clear up any uncertainties.
