20 Golden Rules of Contract

Do you read a business contract before signing or use the fingers crossed approach, or perhaps you are just plain lucky and do not need a contract.

Non Est Factum

In 1869 a frail old man with poor eyesight was fraudulently induced to put his name on the back of a bill of exchange, making himself liable as endorser, on the fraudulent representation of the acceptor that he was signing a guarantee. The bill got into the hands of the bona fide holder who sued the old man as endorser, and the result of the action was that the old man, having signed the document without knowing it was a bill and under the belief that it was a guarantee, and not having been guilty of any negligence in so signing it, was held not liable on the endorsement.   This case Foster v Mackinnon (1869) LR 4 CP 704 led to the evolution of the modern approach to non est factum.

Non est factum (Latin for “it is not [my] deed”) is a defence in contract law that allows a signing party to escape performance of an agreement ‘which is fundamentally different from what he or she intended to execute or sign’

So if you sign a business contract, it will be valid unless you can prove that you did not intend to sign it e.g. you are blind or have been fraudulently forced to sign the contract or had a shotgun pointing to your head.  Not reading the contract is no defence.

Whilst we are not lawyers at Theon, we have a pragmatic and commercial approach to contracts and are often called in to support lawyers in their interpretation of reasonable commercial approach on multimillion dollar legal disputes.

Below are some rules that I suggest you look at to protect your position and think about before signing business contracts.  The list is by no means complete and must not be construed as legal advice. Remember, I am an Engineer and businessman, not a lawyer. You should consult a good lawyer and commercial manager before committing your company to a contract.  That said, the guidelines are based on many years of business experience.

20 Golden Rules of Contract

If you are working in business, you will be signing for property leases, car leases, software, IT, copiers, joint ventures, clients, sub-contractors, contract award letters, banks, employees etc.  Many people just sign contracts because they are desperate for the relationship, unfortunately I can provide a catalogue of colossal mistakes that could have been avoided, and people could have kept their jobs!, by reading and understanding the contract in the first place.  Here are my 20 golden rules of contract:

1) Are the parties involved correctly stated?

Check that your details and the other party’s details are correct.  Also check that the person and party you are dealing with has the authority to enter into contract with you.  Make sure you are speaking to the organ grinder and not the monkey!

2) Is the purpose of the contract properly stated?

The role of the parties and the purpose of the contract should be clearly stated.

3) Have you negotiated the commercial terms and are they correct?

The first draft of a contract is just a starting point and from my experience you can negotiate every agreement usually to your satisfaction or reach good compromise between two reasonable parties.  Even if the other party has more power in the relationship, they will appreciate engaging with a partner that is commercially aware and diligent in their dealings.

As an Engineer, double checking calculations is in my DNA and for commercial terms this is crucial.  Verify the price, rates, margins etc and let someone else check your numbers.  You can get too close to the numbers and not see simple errors.

4) Is the duration of the agreement acceptable?

Check the duration of the agreement and make sure that both parties are able (commercially and legally) to enter into the agreement for the proposed duration.  Check any break clauses in the agreement and make sure the break clauses are equitable to both parties.

Look for automatic renewal in agreements, a common trick by many companies is to automatically renew unless notice is given many months in advance of termination.  Add a date in your diary to consider the contract in line with the termination notice period so you are not forced to enter into an undesirable contract.  Check the terms of any renewals to make sure they are still favourable and any automatic price increases are acceptable.  Its sometimes better to terminate the contract and form a new contract so you receive favourable terms as a new business.

5) How do you or the other party exit the contract?

Check notice period for termination and also consequences of termination.  Check how you are paid on termination and also how impact on any ongoing joint projects is minimised if one party decides to terminate.  Make sure you have ways to terminate the contract if it is not working to your benefit.  Make sure you understand any early termination penalties.

6) Do you understand the Events of Default and Remedies Provisions?

Determine what acts constitute events of default and whether you are able to enter into and perform under the contract without causing a default. Also consider what should be included as events of default by the other party.

Review remedies provisions. Determine the worst that can happen to you if you default. Explore ways to limit your liability. Also determine what types of remedies you need in the event of default by the other party.

7) What are the Warranties and Representations?

Review and understand warranties and representations given by you and the other party. Don’t give any representation if you do not actually know that the representation is true or if the other party is in a better position to know the facts being represented. If you must give warranties, try to limit them as much as possible. Be careful of disclaimers or limitations given by the other party.

8) Are the risks to both parties addressed in a fair way

Determine how risk is to be allocated between the parties. Risk should be typically borne and managed by the party in the best position to prevent loss. Check your mitigations in should a risk event occur and make sure you can control that damage, absorb the damage, pass the damages onto another party or have adequate insurances for the risk.  Check the terms and provisions of insurances of both oarties to cover risks that cannot be controlled.  Make sure you add insurance renewal dates to your calendar and discuss insurance values well in advance of expiry dates.  Check that you are able to obtain the required insurance within your budget.  Check the Force Majeure Clauses and make sure that you have plans in place for unforeseen events that you cannot insure for.

9) Are the Harmless and Indemnification Provisions reciprocal?

Check hold harmless and indemnification provisions. When you agree to hold someone harmless you are agreeing to not hold him responsible for liability that may arise due to certain agreed events.   When you indemnify someone, you are agreeing to protect him from liability or loss that may arise out of these events. Ensure that you have back to back reciprocal provisions where possible so that the contract is fair and both parties protect each other.

10) Is your Limit of Liability defined?

Ensure that any contract you enter into has a limit of liability defined so you are not sued for liabilities that could put you out of business.  It is preferable to define your limit of liability for events that you cannot obtain insurance for or are not within the business’s control.

11) Is ownership of Intellectual Property clear?

If your contract deals with the creation of works protectable by intellectual property laws, be sure to outline which party will be deemed the owner of that intellectual property. And even if such works won’t be created, one party may need to license their intellectual property to the other party to allow it to perform its obligations.

12) Is Confidentiality preserved?

Maintaining the confidentiality of your confidential information should be among your top priorities. So you should include a unilateral or mutual non-disclosure provision that clearly defines what constitutes “confidential information,” exceptions to the definition and to the non-disclosure obligation, and how long the non-disclosure obligation will last (including some period of years after the contract is terminated).

13) Have you minimised or removed any Consequential Damages?

A party that has suffered a breach of contract has the right to claim damages as per the contract.  The remedies for the breach should be clearly defined in the contract.  However the other party may also seek consequential losses such as loss of profit and pollution damage. For an equitable contract it may be better to specify that neither party may seek consequential damages from the other party. There are notable examples of alleged pollution damage by oil companies that have run into several Billion dollars.

14) Are there carve outs?

Any contract clauses should be clear and not include several exceptions that undo the intent of the clause.  This is a common trick in commercial contracts.

15) What’s missing in the contract and what is hidden? 

As important as what is in the contract, ask yourself what is not in the contract, also make sure you read and understand any hidden clauses or ‘small print’.  Most people read contracts in detail but do not look at what is missing.

16)  Does the contract have all referenced documents and attachments?

Check that the contract is complete and that you have reviewed all referenced and attached documents.  Most people assume attachments are fine but this is not always the case.

17) How do you Resolve Disputes?

Determine how you want to deal with resolution of disputes. An arbitration or mediation requirement could ultimately save you lots of time and money. However, there are times when you may need to go to court to resolve the dispute. When appropriate, try to give yourself some flexibility.  Define the arbitration process should both parties not be able to reach an agreement.  Always try to resolve disputes without recourse to courts and arbitration as in the end it does come down to what the two parties are prepared to accept.

18) Can the Contract be Assigned Without Your Written Permission?

People and businesses enter into contracts with other people and businesses because they trust the other party and believe the other party is able to do the job. But if that other party attempts to assign its rights under the contract to a third party, you may find yourself doing business with an entity with which you are not familiar. For this reason, a contract should specify that neither party can assign the contract without the written consent of the other party.

19) Is the contract properly executed and the law for interpretation defined?

The law of the country should be defined.

The contract should also be signed by parties that are authorised to enter into the contract. Check the authority of the other party and make sure you are authorised to enter into the contract.  Each signature should be witnessed by an independent person.  The contract should be signed by both parties and held securely in your filing system for auditing purposes.

20) When should the contract be reviewed?

A periodic review of all your contracts should be conducted including those with clients and suppliers to ensure that they are still appropriate to your business and any changes in the relationship are reflected. Also periodic review of the commercial terms should be conducted to ensure that you have the best deal based on the current market and relationship.

Support and preserve good relationships with a contract

Contract law just formalises good behaviour in contracts. In India, contracts were sealed in a unique manner, akin to the British manner of ‘my word is my bond’. Two parties would exchange a hair from each other’s moustache to seal an agreement.  Certainly a lot cheaper than the modern method and no lawyers were needed either, a problem though if you are clean shaven!

 

Look out for my next blog, where I may look at what to consider in investment appraisal and energy asset valuation during mergers and divestments.

Zulfiqar Hussain
Director

zulfiqar.hussain@theonltd.com