Contract risks: getting it right

It can be tempting to prioritise deal-making over the finer details of the contract. A little extra care at the drafting stage, however, will minimise the risk of expensive headaches later. By Laura Samuel

contract

The most important features of any contract are clarity and certainty. The contract should clearly set out the rights and obligations of each party and have adequate provisions in place for dealing with unlikely events.
There are a number of risks to consider when drafting and negotiating commercial contracts. The single biggest difficulty is lack of certainty, which can result in legal disputes and commercial paralysis. A common cause is the use of standard contracts. These can be problematic for two reasons: first, standard contracts are often written to put one party in a more advantageous position; second, standard contracts may cause uncertainty because they can include terms which are not representative of the parties' intentions.

Commercial contracts often govern relationships spanning several years, and the interests of any business can change over time. Parties sometimes face problems when they are bound into contracts that initially suit them, but have no scope to negotiate if business takes an unforeseen shift or interests change.

In business, reputation is critical to success. Inflexible contract terms in the context of unforeseen events can imperil a company's reputation if the firm cannot extricate itself from obligations it cannot meet.
Market changes can have commercial implications for the contract. For example, the price of an essential commodity may unexpectedly change. Such changes can affect supply chains, which can cause difficulties in fulfilling the obligations of the contract and in allocating the financial loss which may arise. Contracts should take account of such circumstances.
To avoid the risk of disputes, there are a number of areas which merit close attention. As a minimum, the contract should deal with the following issues:

● The parties to the contract should be clearly set out. This may sound obvious, but in addition to the correct company name and number, it is important to clarify whether any third party has rights under the contract. The Contracts (Right of Third Parties) Act 1999 stipulates that, where a contract is made for the benefit of a third party who is not a party to the contract, that third party may sue on it in order to obtain the benefit. When drafting, it is often appropriate to exclude the rights of third parties.

● The parties to the contract should be clear as to start dates, end dates and the events which will automatically end the contract. These should be decided in collaboration with strategic and operational teams, so that the business can be sure that all deadlines are met. Termination clauses are particularly important.

● Recitals, a kind of preamble, can be extremely useful for setting the commercial context in which the contract is formed. Courts and arbitrators will take a purposive approach to contractual interpretation. Setting out the background context by way of recital can help to avoid misunderstandings.

● Definitions in a contract should be clearly set out. Care should be taken to ensure that only relevant definitions are provided.


What happens when a dispute occurs?

The parties should be clear about whether UK law will apply to the contract, or the law of another jurisdiction. There should also be certainty as to the court or arbitration body that will have jurisdiction. This is particularly important if one of the parties has offices outside of the jurisdiction, or if they conduct business abroad.

The risk of unforeseen circumstances is a factor in all industries. The contract should provide for the associated risks for performance, suspension or alteration of the terms, or for termination. It is important that such clauses are tailored carefully to each situation.
Agreeing in advance the remedies for breach can assist in providing certainty if a dispute does arise. Agreements for liquidated damages should reflect genuine estimates of the costs involved, rather than constituting penalty fines within the contract. If agreed damages are excessively large, they will be considered punitive, and will not be enforceable.

The parties should identify in the contract whose insurers are on risk and in what circumstances. Where employees or workers are involved, the parties may need to address issues in the contract. While certainty is important, built-in flexibility can prevent disputes arising. Express clauses should govern in what circumstances the contract may be varied or renegotiated, and by whom.

It is possible to specify that in the event of a dispute, arbitration should take precedence over litigation, which can make disputes faster, cheaper and more confidential to resolve. It can be particularly suitable for disputes that would benefit from a judge with specialist expertise. As not all matters are suitable for arbitration, parties should clarify which kinds of dispute should be referred to arbitration, and which should be heard before the courts.

Where parties begin work based only on correspondence, a court can sometimes deem a contract to have been concluded. Issues of liability for defective goods, or late delivery, are unlikely to have been discussed in such circumstances, and the courts will be left to interpret the parties' intentions.

The resulting uncertainty is extremely unattractive. For this reason, businesses should be careful of doing any work before agreeing a contract. If it is necessary to do so, it can be helpful for parties to stipulate in their communications, that discussions are "subject to contract". By doing so, the parties can reduce the risks whilst moving their business objectives forward.


Laura Samuel is an associate at Berrymans Lace Mawer (laura.samuel@blm-law.com)

 

 

 

 

 

 

 

 

 

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