Understanding the basics of a contract is important for anyone in company, or self-employed, dealing with sales, procurement or any legal matters.
We all come across a contract from time to time and it’s quite useful to understand the most important legal contractual clauses and equip yourself to deal with them.
There are many different types of contract out there and in this article we will address the seven important legal contractual clauses.
In short, we will cover:
- Determine the purpose of the contract
- Identify parties involved for the contract
- Establish the consideration of the contract
- Determine the contractual term
- Assess the important legal clauses
- Identify in what ways the contract may be terminated
- Determine the governing law
Are you ready?
Let’s get it.
Determine the purpose of the contract
The purpose of the contract is essentially the reason why you are entering into the contract.
Are you selling a product, a service? Are you entering into a partnership? A joint venture?
Depending on the purpose of the contract, you will typically have contractual clauses governing the specific purpose of your contract.
For example, if you are selling a service, you will have clauses governing the service such as how the service is rendered, the quality of the service, who will render the service and so on.
Considering this article is to discuss the most recurring general contractual clauses, we assume that you have properly identified the special clauses applicable to the purpose of the contract.
Identify parties involved for the contract
Once you have identified the right contractual template or framework to use depending on the purpose, you must identify the parties to the contract.
A physical person
If the party to the contract is a physical person, you must make sure that the person is of legal age and can legally enter into a contract and has the legal capacity to do so.
Ordinarily, you are unable to enter into a contract with a minor unless the tutor is signs the contract and authorizes it.
If the person is a minor, you must make sure that the minor can enter into a contract with you. This is possible in many jurisdictions for very specific purposes.
In Quebec for example, a minor can directly enter into a contract without the presence of a tutor in some legally specified cases.
Article 156 of the Civil Code of Quebec states that:
A minor 14 years of age or over is deemed to be of full age for all acts pertaining to his employment or to the practice of his craft or profession.
Thus, a minor over the age of fourteen can enter into a legally binding contract in regards to his employment or the practice of a craft or a profession.
If your contracting party is a company, you want to make sure that the company is legally constituted and in good standing.
Also, you want to ensure that the company’s representative is duly authorized and has sufficient authority to bind the company in the contract.
Establish the consideration of the contract
Establishing the consideration of the contract is essentially your agreement on the price or what is being exchanged.
If you are buying a service, the consideration is the rendering of services in exchange for some monetary payment.
In our example of a service contract, you should see details relating to the services expected by one party and the payment expected in return for rendering those services. This is the mutual consideration of the contract.
The consideration is an essential component for the validity of a contract without which your contract may not produce legal effects.
Determine the contractual term
Your contract should also call out the contractual term.
The term is how long you want the contract to produce legal effects if both parties act in good faith during the entire life of the contract.
The term is the desired end of your contractual relationship.
For instance, in our service contract, if I am entering into professional services for the implementation of a software product, then, I will assess how long it may take for the service company to complete the project.
If the services can be rendered in a month or two, then, a term of six months to a year could be seen as reasonable.
If the services could take two to three years, then we may consider a term of four or five years.
You want to make sure that the contractual term covers you for the entire duration of the service project so you keep the service company under contractual obligations.
Assess the important legal clauses
All contracts will foundationally have some contractual clauses.
For example, a general clause could be the governing law clause. In every contract, it is best practice to specifically call out the governing law so that there is no dispute on what statutory regime is applicable to the contract.
The following represent some legal clauses that you will see very often in many contracts:
Liability cap clause
The warranty clause is the promises you make to the other party based on which that party has agreed to enter into a contract with you.
In our example, a company offering professional services will warrant that its personnel are highly trained and qualified to render the specified services for the implementation of a software product.
Without this promise, the client may not feel comfortable that the service company has sufficient experience to render the services.
If you warranted that you have qualified personnel but in reality your staff do not have the ability to render the services, this can lead to the cancellation of the contract of misrepresentation or perhaps a termination for breach of warranty.
The confidentiality clause is a pillar legal clause in most contracts.
You want to make sure that any information, content or material exchanged with your contracting party remains confidential.
Coming back to our example, if you hire a service company to implement a software solution, they may come across confidential business related information by accessing your internal network and systems.
You want to make sure that your service provider does not access your internal and confidential business information and use it to your detriment or leak it out to the market.
When reading the confidentiality clause, make sure you are comfortable with the scope and it protects your trade secrets and material sufficiently enough and for a sufficient amount of time.
The indemnification clause is one that will usually be negotiated on either side.
This clause stipulates that if an event of liability occurs, or if you are pursued because of the actions of your contracting party, then, your contracting party will cover the costs associated with the liability you have or will incur along with any associated attorney fees.
For example, say you are a representative of a public company and you have hired a service company to implement an accounting software solution for your company’s stock exchange compliance purposes.
If the service company breaches the terms of your contract and does not deliver the project on time subsequent to which you are unable to produce your financial statement, are fined and legally pursued, then that’s an event of liability that can be covered by your indemnification clause.
In this case, you will invoke your indemnification clause requiring that the service company pay your fine and assume your legal fees or even court condemnation resulting from the lawsuit.
Make sure you carefully review what are the events that can trigger the indemnification clause and assess the scope and extent of the indemnification.
The liability cap is an amount that you both mutually agree to cap the liability of one party or both.
Typically, the liability cap clause will attempt to limit liability, to the extent permitted by law, to the value of the consideration received.
In our service contract example, if you paid $500,000 to the service organization to implement a software for you, the service company will ask that the liability cap be limited to $500,000.
In other words, if an event of liability were to occur, the service company does not want to be held liable for more money than the money it made under the service contract.
This cap is also usually negotiated in a commercial contract and so you must assess what is the cap value that will make sense for you.
Disclaimers are standard clauses that you may see in most commercial contracts.
The disclaimer is you making a statement warning the other party what your contract is not intended for or what you do not mean to do.
For instance, if you are asking a service company to implement a software for you, the service company will usually want to disclaim against the suitability or merchantability of the software being implemented.
The software company will want to only implement the software based on your assessment and will not want to be held responsible for any other factors other than the actual implementation project.
Identify in what ways the contract may be terminated
The termination clause is also important.
While the term defines the natural expiration of the contractual term, the termination clause allows for an “exit” strategy during the term of the contract.
The termination clause can be for “convenience”. In other words, without a material breach or cause, a party could send a notice to the other and terminate the contract without having to wait for the term to expire.
The termination can also be for cause or breach. In this case, in the event of a breach of contractual terms, the termination clause will establish the logistics and possible remedies.
Typically, the termination for cause will state that the party suffering a damage should send a notice to the other who will have a certain number of days to cure the breach. In cases where the breach is so significant, then the termination could be with immediate effect.
Have a close look at this clause to ensure that you are comfortable with what can potentially allow for a termination for breach, how the breach can be remedied and what remedies the contract will grant the party who has suffered a prejudice.
Determine the governing law
Finally, another important component of a contract is the governing law.
Most commercial contracts will clearly stipulate the governing law. This way, both parties agree on the rules of the game.
The governing clause is important especially when both contracting parties are not located in the same jurisdiction. One may be in one country while the other party may be in another country.
To avoid a conflict of laws, you want to ensure that your contract clearly sets out the laws you want to apply to the contract.
We hope that this article was useful in giving you some ammunition in dealing with a contract so you can better assess the main clauses.
A contract is a powerful tool as it can help protect your business transaction and dealings.
If done properly, you can mitigate risk and give yourself legal ammunition depending on the nature of your contract.
Having the basic understanding of a contract can help you navigate these clauses when you are running your own business or dealing with a supplier, vendor or client.
You can also consider hiring the services of a contract lawyer who masters contract laws and can guide and advise you during your contracting process.
Contract lawyers are professionals specializing in contract drafting and negotiations and understand the intricacies of different types of contracts no matter the purpose.
Good luck with your contract!