Often entering into general business commercial contracts (distribution contracts, supply contracts, vendor contracts, consultant contracts, etc.) is not seen as all that complicated, and so businesses without ready access to in-house or outside counsel do not seek a lawyer’s advice. As a lawyer who handles a lot of contract review and negotiation, I think this is frequently a mistake.
This article outlines five areas where I think non-lawyers (or at least those persons not experienced with contract terms and review) may make mistakes in signing general business contracts. While I’ve focused this article on five common pitfalls, there are more — and that’s why I suggest that businesses with a significant flow of contracts establish a relationship with an experienced attorney to assist with review and negotiation. An experienced lawyer won’t focus only on the legal issues, but will also help make sure the business issues are aligned with the expectations of the client. Addressing issues at the outset is far more preferable than having to call a lawyer after a significant issue has arisen with a signed contract.
Five Common Pitfalls
#1 Did anyone consider insurance?
Often overlooked is the topic of insurance. If your business is receiving services or products, and especially if you have a service provider that will be onsite, insurance is a critical provision. Ensuring that the other party carries general business liability at appropriate levels, as well as workers’ compensation insurance, is important because that insurance will help back-stop any claim that your business may have (or any claims of the other party’s employees or contractors). Further, service provider’s should be asked to have appropriate levels of professional liability or errors and omissions coverage, which is the insurance that responds in cases of wrongful acts from professional services and unauthorized access or use of confidential information. If insurance is not addressed, your business may be relying only on the general credit of the other party in the case of claims – and as noted in #4 below, this itself could be a concern.
#2 Does this contract last forever?
The parties often don’t consider the term of the contract and related termination rights. I counsel my clients to look closely at the proposed business relationship to determine how long it should last initially, whether it should renew, and when either party (or both) should have rights to terminate. This is going to vary contract by contract, so there is no “one size fits all”. But it is important that the parties carefully think about this up-front and make an informed decision. Otherwise, a contract may have a term that lasts only 1 year when the parties wanted it to auto-renew, or it may last indefinitely and the parties may not come back to the contract to formally terminate it when the business relationship ends. One further point is that, although the contract and relationship may generally terminate, certain provisions probably should survive termination for some period (examples would be confidentiality, indemnification, governing law and dispute provisions). Many contracts fail to address this point about surviving provisions.
#3 Do I have unlimited liability? Does the other party?
Liability provisions are often the most heavily negotiated and focused on provisions in the contract. Not surprisingly, this is because most parties want to limit their liability under the contract. Extra special attention should be paid to these provisions if your business is receiving services or products. For example, what if your business purchased faulty services or products? You don’t want to realize after the fact that the provider of those faulty services or products limited its liability to almost zero or another inadequate dollar amount, leaving your business unable to recover enough damages to be made whole. In the contracting process, one should look closely at the limits of liability suggested for both parties, as well as whether any provisions should be “carved out” of those limits (examples might include indemnification or breach of confidentiality). A contract liability limit can be appropriate if it (i) is reasonable in amount given the circumstances, (ii) applies to both parties (if appropriate) and (iii) accounts for any specific provisions that should not be limited (or should have a separate or higher limit).
#4 Is the other party financially sound?
I have found that parties forget to focus on the financial status and viability of the other party to the contract. Whether the other party is an individual or a seemingly stable company, it is prudent to fully understand the other party’s financial position. This is relevant for a number of reasons: it affects the other party’s wherewithal to perform its, his or her contractual obligations; it affects the other party’s ability to satisfy any claim for damages or indemnification; and it is a good general due diligence marker that you are going into business with a sound business partner. If the proposed other party does not have a strong enough financial position to stand behind the contract, there are strategies to address this – these include parent guarantees, owner personal guarantees and commercial insurance. A seasoned lawyer can help your business navigate this issue.
#5 Can the other party change without my approval?
Assignment clauses vary widely by contract. It is prudent to understand whether either party can assign the contract or delegate its rights to another party (with or without consent). Many times, it is appropriate to allow for assignment or delegation – examples could be to an affiliate or in the case of an acquisition of one party or its business. But it may not be appropriate to allow either party to simply assign freely to any other person. Careful review of the assignment provision in any contract is important in order to make sure that the other party to your contract is who you would expect.
General commercial business contracts may not seem overly complicated. However, a proper review before signing can often help businesses avoid significant legal and business issues on the back-end. Furthermore, a well-constructed contract can facilitate a strong business relationship and help both sides achieve their goals from the transaction, even when circumstances may change or issues arise. Legal review can help to spot the issues I’ve identified in this article, and probably more!
This article has been prepared for informational purposes and is not legal advice. This article is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. This article should not be interpreted to indicate a certain result will occur in your specific legal situation. You should not act upon this information without seeking advice from a lawyer familiar with your specific situation.
© 2015 Fairchild Law Offices, LLC