Contract Drafting Tips and Guidlines

Although contracts vary widely, there are common principles and provisions that arise in almost any situation. Having some familiarity with these can help greatly in negotiating agreements.

GENERAL PRINCIPALS

Probably the two greatest contributors to contract disputes are a) failure to address all possible situations, whether deliberately or not, and b) ambiguity in the provisions that are included. It is well worth reviewing a contract several times to avoid these problems. Leaving key items (for example, price or delivery dates) open for later discussion may well make the contract unenforceable if the two sides cannot reach agreement on them later. Similarly, not addressing all possibilities, even the unlikely ones, can lead to problems if those possibilities occur. (Everyone may believe that a key piece of third-party software will be ready well in advance of when needed, but what happens if it is not?) A provision that is ambiguous can lead to arguments, especially where each side has mentally interpreted the provision in its favor.

These problems are what lead to the adage "get it in writing": although oral contracts ARE valid, there can be immense problems proving their terms. This is also a good reason for using plain English and avoiding legalese: if you aren't sure what a provision means, then you may well have trouble enforcing it. Using someone else's contract can bring its own problems if that contract has provisions that do not apply to your situation or does not address all the issues you face. (Also, any form contract needs to be allowed to evolve over time as business conditions change and you gain additional experience in the sorts of problems that are likely to arise.)

Letters of intent have a special quirk: whether they are binding or not depends on the intent of the parties. As a result, it is best to state in each letter of intent whether it is binding or merely a launching point for further negotiations.

With that background, we can look at some more specific contractual provisions. While there is not space here to delve into particular types of contracts–like those involving licenses, employment, leases, consumers, confidentiality etc.–there are certain clauses that are useful in most contracts.

PERFORMANCE

When it comes to performance, be sure to specify exactly what each party is to do and when. If there is what might be an open-ended commitment (for example, a flat-fee per month consulting arrangement), specify the maximum number of hours that will be provided.

Be sure to state exactly when payment is due and what happens if payment is not made on time. If you are the party receiving payment, you may well want to add a late charge or interest for overdue payments. In situations where you are receiving a percentage, it is generally wise to include a provision allowing an audit of the books. If sales or other taxes are involved, be sure to specify who pays the taxes.

COMPETITION

Where you are concerned about the other side having access to your confidential information, you will likely want to include confidentiality provisions that prohibit the other party not only from transmitting the information to others, but also from using that information for purposes other than those set out in the agreement. Be careful, though, of provisions that prohibit competition: in California many of these are void.

TERMINATION

For the party purchasing goods or services, a termination provision can often be the best protection when a contractual relationship is not working well. Ideally, termination should be allowed at any time upon giving the required notice (e.g., 90 days). Be wary of provisions that allow termination only once a year during a "window" period. Finally, you may well want to state that certain provisions–confidentiality, outstanding payments etc.–remain in effect despite any termination of the main agreement.

EXPOSURE

Any party providing goods or services needs to consider adding provisions that limit warranties. With contracts involving goods, the Uniform Commercial Code automatically creates certain warranties unless there are specific disclaimers of those warranties. Some of these warranties– such as the warranty of fitness for the buyer's purpose–may be difficult for the seller to meet. Warranties can also be a problem for parties providing services. In addition, a party providing services or goods may want to include a provision limiting liability so that there is no exposure for the other side's lost profits etc. in the event of a problem.

CHANGES

Certain provisions limiting changes in an agreement can be extremely useful. For example, unless the contract states otherwise, either side has the right to assign the contract. You may want to prevent assignment to a competitor or prevent all assignment so that you are assured of who you will be dealing with. (On the other hand, it is common to allow assignment to parent or sister companies or to a new version of the same entity, for example when a partnership becomes a corporation.)

Generally, any ambiguity in an agreement is construed against the party drafting it. One possible solution is to add a provision stating that the agreement will be interpreted as if drafted by both parties equally. The recitals at the beginning of an agreement (often the "whereas" clauses), are usually deemed under California law to be correct and binding, so be careful what things are listed there.

Another useful provision is an "integration" clause. This type of clause states that the contract sets out the entire agreement between the parties and that no oral representations or earlier versions of the contract apply. Obviously, this can eliminate a great deal of argument by limiting the agreement to the terms of the contract itself. (Of course, you have to make sure that everything important to you is included in the final contract.) Similarly, you may want to include a provision stating that any modifications of the agreement must be in writing and signed by both parties, to eliminate any future claim that there was an oral modification to the agreement that you dispute.

ENFORCEMENT

If you believe it is more likely that you would sue (rather than be sued) over the contract, you may well want to include a provision allowing recovery of attorneys' fees. (Generally, attorneys' fees cannot be recovered unless the contract specifically provides for them.) Recognize, however, that under California law an attorneys' fees provision running in favor of just one party will be interpreted to award attorneys' fees to whichever party is the "prevailing party" in any litigation. Also, it is unusual to recover ALL of one's attorneys' fees even when one is the prevailing party.

Particularly where the two parties are from different states, it is important to specify which state's law will apply and where any litigation will be held. Smaller parties in particular will want litigation brought where they are located because of the expense of out-of-state litigation. Obviously, this type of provision can generate some argument. One way to resolve disputes over it is to state that the party suing has to sue where the defendant is located. However, this is not appropriate for all agreements.

Arbitration clauses are something else to keep in mind. Arbitration is generally cheaper and faster than litigation. On the other hand, arbitration awards tend to be smaller than jury awards, so one consideration is whether you are more likely to be a plaintiff or defendant. Arbitration is particularly useful in a relatively small industry or where the parties are likely to be doing business again in the future.

Mediation is another option that can be used with or without an arbitration clause. The advantage is that perhaps 75% of all mediated cases settle. The disadvantage is that if the matter does not settle, you still have the cost of arbitration or litigation.

CONCLUSION

Of course, if a contract goes well, you are likely to never need to look at the provisions after it is signed. On the other hand, paying attention to some of the provisions discussed can be a powerful form of insurance if anything goes wrong.