Five things to think about when negotiating commercial contracts

Why are written contracts important?

A contract doesn’t need to be in writing in order to be legally binding, but there are lots of advantages to making sure that you have appropriate written contracts in place as soon as possible: e.g. they get the parties talking openly about the relationship from the start; they are needed to effectively transfer certain property rights (including intellectual property rights); investors or acquirers will want to see the terms of the contracts that a business has signed up to before they invest in or buy the company; and, while you’d hope that a signed contract can sit in your records without ever needing to be looked at again, they provide important evidence of the parties’ obligations, and how disputes should be handled, in case the relationship breaks down.

Here are five things to think about when negotiating commercial contracts:

1. Clarity is key

As the primary purpose of a written contract is to evidence the terms agreed between the parties, it is important to make sure that the terms are clear and unambiguous. Negotiating a contract at the start of the relationship is a very useful way of getting each party to talk about what they want from the relationship, and to set expectations, right from the beginning. While you might not know all of the commercial terms straight away, that can be accounted for, and there’s nothing to stop you from changing the terms of the contract as the relationship develops. If the terms of the contract aren’t clear from the outset, then it will be very difficult to establish what is meant to happen (and whether either party is in the wrong) if the relationship breaks down.

2. Protect your IP

Intellectual property rights (“IP”, such as patents, trade marks, design rights and know-how) are often a business’s most valuable assets. It is essential to make sure that ownership of any IP pre-dating the contract is properly protected and that it is clear who owns any IP that is being created under the contract. While an employer will generally own the IP in anything generated by its employees in the course of their employment (depending on the terms of their employment contract), this is not the case for IP generated by contractors, which will be owned by the contractor unless there is a contract in place that says otherwise. If IP is being transferred, then the transfer needs to be in writing to be valid. Without an appropriate contract in place, there is a significant risk that you might not own the IP that you think you own.

3. Don’t accept any onerous indemnities, and make sure your liability is limited

An indemnity is a contractual obligation to make a payment on the occurrence of a certain event. They are used to ensure that where a party (the “indemnifying party”) does (or doesn’t do) something which results in the other party (the “indemnified party”) suffering a loss, the indemnified party can claim that loss back from the indemnifying party as a ‘debt’ rather than having to claim for breach of contract. Indemnities should only be given for things that are within your control, and should be reasonable in the circumstances.

Even if there are no indemnities in a contract, you should still make sure that your total liability under the contract is reasonable. It is common to agree a cap on liability, and that cap might be the same for both parties or (depending on the level of risk and bargaining power of the parties) it could be different. You should be careful about accepting liability for anything that is out of your control, for any indirect or consequential losses (i.e. losses which aren’t a direct result of your actions or omissions), or for any amounts that exceed your insurance coverage.

Conversely, it is important to ensure that the other party gives you appropriate indemnities for matters that are within their control, and that their maximum liability to you is appropriate in the circumstances.

4. Make sure you have an escape route, if you need one

If the contract you are entering into is long term or onerous, it is important to make sure that you have a way out, if you need one. This can be through the inclusion of “change control” provisions (so that you can change the terms of the contract if the initial expectations can’t be met) or through “termination for convenience” provisions (so that you can terminate the contract early if necessary). These should clearly set out what happens in the event that they are triggered (which often includes a change to the payment obligations), so that the process is decided before you reach what is likely to be a difficult stage of the relationship.

Conversely, you should make sure that if you are engaging the other party to provide services to you that they can’t get out of providing those services to you without appropriate provisions in place for you to ensure that you don’t lose out if they can no longer provide them.

5. Know where to turn if things go wrong

Contracts should contain dispute resolution provisions which confirm what happens if either party wants to make a claim under the contract. These might be a simple as referring to which country’s laws apply and which courts have jurisdiction to hear any claim. They might have ‘escalation’ provisions, requiring any disputes to be escalated internally before being referred to the courts, or more complex ‘alternative dispute resolution’ provisions requiring disputes to be referred to mediation or arbitration (for example). There are pros and cons of each approach, but it’s important to make sure that you understand and are happy with the provisions that apply, so that you are not faced with any additional unwanted surprises should the relationship break down.

This article has been written in the context of business to business contracts. Consumer rights laws require consumers to be given additional protection, which aren’t considered in this article.