Our small business legal expert, and founder of Grid Law, David Walker, offers company owners a step-by-step contract review checklist to clarify the various clauses and phrases likely to appear.
It seems to have come as quite a shock to people that you don’t have to play fair when negotiating a contract. As explained last week, you have every right to strike a deal that’s entirely in your favour. This is fine when you’re in control, but most small business owners are forced to accept unfavourable terms dictated by much larger companies.
Now, I fully accept that it won’t be cost effective to have a solicitor review every contract for you. But, with business to business contracts in particular, it’s still your responsibility to ensure you understand and accept the terms you’re signing up to.
It’s too late to try to re-negotiate them later or terminate the contract early if the relationship isn’t working out how you planned. If you do, you could find yourself facing a claim for compensation due to your breach of contract.
So, what should you do?
You must read every contract before agreeing to it and look out for the following key terms. If you’re not prepared to accept them and the other party won’t compromise you have to seriously consider not signing up.
As you can appreciate, not all of these provisions will be in all contracts and I can’t possibly cover every eventuality you’re likely to come across. However, the following should give you a better understanding of what various clauses and phrases mean.
You can then assess the potential risks a contract may contain before agreeing to them, or if you feel you need to, you can take professional advice.
Know who you are contracting with
It may sound obvious, but check that the parties to the contract are correct. If the party you’re contracting with is a limited company you can look up their details, for free, at Companies House. Check their name, registered office and company number.
It’s also a good idea to review their last filed accounts. If it looks like they’re in financial trouble, proceed with caution. If they’re a client they may not be able to pay you and if they’re a supplier there’s a risk the company could become insolvent before they have finished delivering their products or services to you.
Who is doing what?
Whether it’s a contract for the sale of products or the delivery of a service, it must be clear what both parties are obliged to do. If the obligations are too vague, the contract may be unenforceable.
Alternatively, if it’s not clear what the other party is legally bound to do, you may never be able to prove they’re in breach of contract if they fail to deliver the service you’re expecting.
In many ways, products are easier to define than services. For example, you might simply be able to refer to the name of a product or a product number in a catalogue. If the product’s specifications are important or it’s being made to order, make sure there’s sufficient details to ensure you get exactly what you are expecting.
Services can be a little trickier to define. Are you engaging someone to complete a task or to generate a particular result? It may be easier to refer to a pitch document or a presentation which contains far more details than could be included within the contract.
This document could be annexed to the contract as a schedule. If it’s not, you may find you can’t rely on important information within it if the contract contains an “entire agreement” clause (see below).
Read back over some of David’s most popular legal articles:
- Does a handshake form a legally binding contract?
- Are statements made during contract negotiations legally binding?
- Standard terms and conditions: Why they’re the unsung saviours of your business
“Best endeavours” or “reasonable endeavours”
In the contract, a service provider may say they will use “best endeavours” or “reasonable endeavours” to achieve a particular result. Both phrases mean they’re working towards a result, rather than saying they will definitely achieve it.
The exact meaning of these phrases is always being debated in the courts, but best endeavours effectively means that the service provider must do everything in their power to achieve the result. Reasonable endeavours is a less onerous obligation. The service provider is only required to do what is commercially reasonable in their attempts to achieve the result.
“Time is of the essence”
When the time for achieving a particular result is important, the contract may say that “time is of the essence.” If time is of the essence and a service provider misses a deadline, this could be considered serious enough for the client to terminate the contract and claim damages.
Targets and guarantees
If a particular result is expected from a service, is it a target or is it guaranteed? This is an important distinction in case the service falls short of expectations. Missing a target is unlikely to be a breach of contract, but failing to achieve a guaranteed result will be.
If a guaranteed result isn’t achieved what happens?
Does the service provider have to keep working towards it until it is finally achieved? Does the customer receive all or some of their money back? Should they be compensated in some other way?
Ideally, the contract will explain the consequences of failing to achieve a guaranteed result. This will help prevent disputes later and allow you to better understand the risks before signing up.
Price and payment
How is the price calculated and when should it be paid? Does the price include or exclude VAT? Are there any additional fees or charges, for example delivery costs?
If this is a long-term service agreement, is there a mechanism for the price to increase over time?
What happens if payment is late? How much interest will be charged? Does the service provider have the right to suspend their services if payment isn’t made on time? At what point can the contract be terminated for non-payment?
If products are being supplied, is there a “retention of title” clause? This means that ownership of the products won’t pass to the purchaser until payment has been made in full.
If you are creating any form of intellectual property for a large business, they will usually insist on owning it. You can use this as a lever to ensure payment. They will likely want all intellectual property rights automatically assigned to them on creation. Instead, try to agree that they will only be assigned when payment has been received in full.
If either party (or perhaps both parties) are disclosing confidential information, there should be an obligation to keep it secret. What is and isn’t considered confidential should be carefully defined in the contract, as should the purpose for which it can be used.
It’s also common to place a time limit on how long the information should be kept confidential. It could be a year, five years or until a project is complete. Sometimes, confidentiality provisions last forever.
Reducing risk and limiting liability
There’s always a risk in any contractual relationship that one party may not fulfil their obligations. The greatest risk is usually on the service provider or the supplier of the products. So, it’s entirely normal for them to limit their potential liability.
There are three contractual clauses that are particularly effective at reducing risk. These are:
- Exclusion clauses
- Limitation of liability clauses
- Entire agreement clauses
I explained more about these in a previous article “Using a contract clause to reduce the risks in commercial transactions”.
Rather than reducing risk, you may find that a business tries to eliminate all of their risk. A client of mine faced this problem recently. Although the other party was clearly in breach of contract, recovering compensation from them would have required a long and drawn out legal battle and the outcome was far from certain.
What seemed to them like a fairly standard clause ended up costing them a huge amount of money because they didn’t understand the implications of accepting it.
Duration and termination
Contracts should have a clear start date. This may be the date that it’s signed by both parties or it could be a specified date.
The contract will then remain in force for a fixed term, after which it will end automatically or it could continue indefinitely until one party gives the other notice that they want to bring the relationship to an end.
Contracts usually contain provisions allowing them to be terminated in other specific situations. For example, if one party commits a material (serious) breach of contract or they become insolvent.
Terminating the contract simply because the relationship isn’t working out as you expected is rarely an option. If you are concerned that it may not work out, you could try to negotiate an initial term – say 6 months or a year, and if it isn’t working out at that point you have the right to terminate.
Consequences of termination
Contracts often contain provisions for what should or shouldn’t happen when the contract comes to an end.
For example, there may be an obligation for an outgoing service provider to ensure a smooth handover with a new service provider. Be wary of this. If you have terminated a contract because you haven’t been paid, the last thing you will want to do is co-operate with someone new coming in.
There may also be restrictions on what you can and cannot do after the contract has ended. For example, a franchise agreement may contain restrictions on you starting a rival business in a particular locality for a specified period of time.
Terminating a contract without the right to do so will usually lead to a compensation claim. In contractual disputes, the amount of compensation the court will award is the amount of money that it will take to put the innocent party in the position they would have been had the contract not been breached.
This is subject to the innocent party taking reasonable steps to mitigate their losses and any limitations of liability that we mentioned above.
You should now have a better understanding of some of the most common provisions you find in business contracts. Understanding these terms will help you assess the potential risks of the contract before you accept them.
If you have any questions about anything I have covered in this article, please feel free to email me at firstname.lastname@example.org and I will happily answer them for you.
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