Top Five Things to Watch Out For in a Business Contract
By signing a contract, a business creates a legally enforceable set of rights and obligations. Therefore, when a business chooses to enter into a contract, it is imperative that it fully understands the terms of the agreement and their consequences. Usually draped in confusing and complex legal terminology, any business contract should be reviewed by a competent and knowledgeable business transactions attorney. There are, however, a few parts that anyone entering into a business contract should look out for.
TERMS OF THE BUSINESS CONTRACT
Perhaps the most basic of advice, both parties to the contract should fully read and understand the terms of any contract. After a good faith negotiation, the parties to the contract should clearly write the terms of the agreement in the most descriptive and concise manner possible. The more complete the terms of the agreement, the less likely there will be a misunderstanding in the future. At the bare minimum, a business contract should always include the names of the parties, the subject of the contract, payment terms, and any relevant dates.
Further, while legal jargon can be cumbersome to understand, words in a contract have meaning and were inserted by a party to the contract for a reason. A knowledgeable and competent contract attorney should be able to review any contract and explain what each party’s rights and obligations would be under the agreement. With rare exceptions, the law will hold a party responsible for an agreement that he or she signed – regardless of whether he or she understood the provision at the time the contract was signed.
The parties will also need to agree on the allocation of risk. The “risk” in each contract varies depending on the agreement, and typically the party in the best position to mitigate risk is the one held contractually liable. There are several other popular provisions that can affect how risk is allocated in a contract:
Representations and warranties
Representations and warranties are a common way to allocate risk in a contract. If a contract states that a vehicle will run for five years, or if it warranties that the motor will last at least 30,000 miles, then the buyer will not be responsible if the vehicle does not work properly – at least for the first five years of ownership and 30,000 miles.
Indemnification is a legal term where an at-fault party in a contract agrees to compensate the other party for any harm or loss. The best way to understand indemnification is through an example. Suppose an airplane manufacturer entered into a contract with an airline to supply wings, the manufacturer mistakenly provided a disfigured wing to the airline which caused a very bumpy landing and consequently injured many passengers. The passengers would naturally sue the airline for the damages and the airline would likely be responsible for the harm. However, if the contract clause contained an indemnification provision, then the manufacturer would “indemnify” the airline and compensate it for the loss caused by its faulty manufacturing.
Transfer of Risk
The “Transfer of Risk” provision in a contract defines the exact event or time when the risk-of-loss will pass from one party to another. Particularly relevant to contracts concerning the sale of goods, the timing of when the “risk of loss” transfers from the seller to the buyer can be very consequential. Especially in international transactions, where shipped products are liable to run into delays or go missing altogether, the transfer of risk determines what party will be responsible for the resulting damages.
In the unfortunate event that there is a dispute regarding the contract, it's important for both parties to have a clear understanding of how the dispute will be resolved and what remedies may be available to the aggrieved party.
Forum for Dispute Resolution
Absent an agreement otherwise, contractual disputes will be litigated in the court system. Unfortunately, this is a slow and cumbersome process, which has led many businesses to forgo the court system in favor of alternative dispute resolution, such as arbitration. Arbitration is basically a “privatized” court system, where the rights of the parties are more limited, but the disputes are resolved faster. While there are situations where arbitration can be beneficial, the limited rights in arbitration can sometimes hamper a party from effectively seeking justice.
Another important provision in any business contract includes the remedies available for any breach of the contract.
Typically, this involves financial compensation. A contract can include a clause for compensatory damages, which awards the wronged party the amount he or she lost or was required to pay to receive the same product or services originally promised in the contract. The contract can also include provisions for “liquidated damages” – which require a breaching party to pay a stipulated amount projected to equal the anticipated harm to the non-breaching party.
While financial compensation for the breach is the most obvious solution, for some agreements it may not be the best approach. Specific performance, where the only remedy is the actual performance of the contract, is an especially popular remedy in service or real estate agreements.
Because a contract incurs a legal obligation for your business, it is always a good idea to make sure you understand every provision. The terms and dates should always be clear, and each party should know what risks they are taking on, as well as how any potential dispute may be resolved. If there are any clauses or provisions that are difficult to understand in a business contract, it is always best to contact a knowledgeable business attorney.
If you have questions about business contracts, schedule a consult with business taxation attorney Stephen Thienel today. Mr. Thienel has decades of experience assisting clients with business transactions throughout, Maryland, Virginia, and the District of Columbia.
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