Tricky Terms In Commercial Contracts For All Directors To Consider
Article by Caveat Legal
An essential element of making the right strategic decisions on behalf of a company can be ensuring that the commercial contracts which the company enters into are properly negotiated and drafted. Whatever the type of commercial contract, it will in all likelihood contain certain key terms which can significantly shift where the risks between the parties lie, and as a result, these terms are almost always heavily negotiated. The following are a few of these terms which directors should carefully consider on their own and in conjunction with each other:
Term and Termination
The term of a contact and how the parties may exit it are crucial. With regard to the term, directors should consider how long the contractual relationship with the counterparty should endure for and whether it would be beneficial to enter into a contract which automatically renews on the expiry of an initial or preceding term. With regard to termination, most contracts allow a party to terminate the contract at any stage during the term and for any reason whatsoever, simply by giving the other party a number of months’ written notice of termination. In addition to this, contracts will usually allow a party to terminate the contract immediately on the occurrence of certain events, which, at a minimum, should include one party committing an irremediable breach of the contract or going insolvent. However, directors should also consider whether additional termination events should be included, such as the counterparty committing persistent breaches (even if later remedied) or losing a key employee who may be integral to the performance of the contract. Further, directors should consider whether any terms in the contract should survive its termination, for example indemnities, which are discussed in more detail below.
Warranties are statements of truth made at the time that the contract is entered into and can either be expressly included into the contract or implied by law. On the one hand, warranties can be a useful tool in eliciting disclosures from a counterparty but on the other hand, when being asked to provide warranties, the directors must be absolutely certain that the company can, in fact, give each warranty being requested. In the event that a warranty later proves to be untrue, the aggrieved party will have a contractual claim for damages to recover any loss it suffered as a result of that untruthfulness. In principle, the amount of damages would aim to put the aggrieved party in the position it would have been in had the warranty been true, however, in practice, the amount of damages may be limited or capped in the contract, as further discussed below.
Indemnities can be a powerful tool to protect a party from the risks that may arise from a commercial arrangement. In essence, they are promises by one party to provide monetary compensation to another party if certain specified circumstances arise. Importantly, the obligation on the party providing the indemnity arises automatically upon the occurrence of the specified circumstance, without the need for the other party (the “indemnified party”) to go to court to determine the loss, or even the need to mitigate the loss. If the company is to provide an indemnity, the directors will need to carefully consider whether they are comfortable with the specified circumstances which would trigger the indemnity and, where possible, seek to limit such circumstances, for example by including wording to ensure that the indemnity would not be triggered if the specified circumstance arose as a result of in or in connection with the indemnified party’s actions or omissions. Further, directors will need to determine whether any indemnities should be caught by caps on liability elsewhere in the contract and if not, should ensure that wording is specifically included to exclude the indemnities from the caps on liability.
Limitations of Liability
A party can limit its liability in both quantum (by including a monetary cap on liability) and nature (by expressly excluding liability for indirect, special or consequential losses, which are losses that are generally considered to be unforeseeable or too remote to be recoverable). Limiting liability in nature is commonplace, therefore the focus in contract negotiations tends to be on limiting liability through a monetary cap. This will be specific to each contract, but as a general rule, directors should take the company’s financial position, the value of the contract and whether the company has any insurance policies which would cover all or a portion of their liability under the contract into account.
When negotiating the key terms discussed above, directors will need to have a practical approach to each term, always bearing in mind how the terms can be drafted to reduce the company’s risk as much as possible and best protect the company’s position.
Article by Sarah van Zyl – Caveat Legal
Sarah has a BA (Law and Psychology) and LLB (cum laude) from Wits. She was admitted as an attorney in 2010 after having completed her articles at ENS. Sarah practiced as an associate in ENS’ corporate commercial department before going in-house at Investec Bank plc in London and qualifying as a solicitor in England and Wales. She joined Caveat in 2018.