A Legal spring clean of your business contracts

It is vital for any business to have effective, binding, and enforceable contracts in place to ensure its business and therefore its shareholders and employees’ rights are secure.

A company will typically have contracts, which govern their internal relationships (employment contracts and shareholder agreements being the obvious ones) and contracts governing their external relationships with suppliers and customers.

The content of employment contracts is largely governed by the provisions of the employment law applicable to the company and its employees. A company therefore needs to keep abreast of changes to the employment law. This can be the function of the human resources officer of the company or in a small company it is advisable to have the employment contracts reviewed annually by a legal professional. Shareholder agreements likewise should also be reviewed periodically, at least by the shareholders, to ensure that their dealings with each other are in accordance with their agreement. It may be that certain practices have evolved, or circumstances have changed, which require their written agreement (shareholders agreement) be amended accordingly.

When establishing a company or there is a requirement for a new contract with a supplier or customer, there may be the temptation to use a standard contract format found on the internet, without considering the application to the company’s position and specific requirements. This is never advisable and not best practice. Having a legal professional draft the required contracts will give the company a secure footing on which its business can be developed.

All contracts need to be clear, unambiguous, legally effective, and very importantly, work for both contracting parties. Too often parties do not ensure that the terms of the contract reflect how they wish their relationship to operate.

Here are a few key clauses to consider in any commercial contract, to ensure that the company’s position and rights are secure.

Description of the Parties

It is a cornerstone of any contract to correctly set out the counterparties to the contract. If an individual shareholder is cited as the contracting party, when it is the company/entity itself, or if a loosely described reference to the trading name is used, enforcement of any rights under the contract will likely be problematic and the company’s position severely compromised.

Conditions Precedent

Very often the execution of a contract is dependent on certain conditions being fulfilled (conditions precedent), failing which one of the contracting parties would not proceed with the transaction. It is therefore very important to accurately set out all the conditions precedent which must be fulfilled. To be effective and enforceable a time limit should be placed on the fulfilment of a condition precedent. The fulfilment cannot be left open ended.

Reference to Rules of Trade or Specific Organizations

Contracts, specifically for international trade, often refer to industry or internationally accepted rules of practice. These rules are amended periodically, so it is important for a company to ensure that it is aware of the changes and that the correct rules are referred to and followed.

Liability and Limitations

Contracting parties always need to ensure that they are aware of the potential financial risk in the contract and that the extent of their liability is clearly set out. Conversely, each party needs to be clear on what they may recover from the other party in the case of a claim. Limitation clauses are important and need to accurately set out the extent of any claim. Typically, a supplier of goods or services tries to limit any claim against them to the amount received from their customer, so irrespective of what damage their customer may suffer, the maximum the supplier would be liable to compensate them is equal to that which the company was paid. While these clauses are important, it must be noted that they are not full proof as the law applicable to the contract may determine or give a Court a certain discretion to determine what damage can be recovered, to avoid grossly unfair consequences flowing from a party’s breach of contract.

Warranties

Care needs to be taken that the warranties are accurate and for the party giving such warranties, they are limited to that which the party can comply with.

Applicable Law

If Parties are from different jurisdictions or a transaction involves performance in more than one jurisdiction it is important to set out the law which will apply to the interpretation and execution of the terms of the contract.

Term

Setting out the term of a contract is naturally also vital. If it is a fixed term contract it will come to an end (without any further action required) at the end of the term, subject to any provisions for an automatic renewal.

An unlimited term contract on the other hand will require a positive action of termination by one of the parties.

Termination

If a party needs to terminate the contract, the grounds of termination and the process to be followed must be clear and unambiguous. If it is intended that a party has the right to terminate without cause (simply by giving notice without any need for a default by any other party), this must be clearly and properly stated as it is an exception rather than the rule.

Dispute Resolution Forum

It has become common for Parties to agree that any future disputes between them is to be resolved through mediation and failing resolution then by arbitration. It is important that a clause nominating arbitration as the preferred dispute resolution mechanism properly identifies the applicable rules and jurisdiction under which the arbitration shall be held. The first task of an arbitration institution is to determine whether it has jurisdiction to hear the dispute. Too many arbitration clauses are not clear, which leaves room for a party wanting to escape liability to raise jurisdiction objections, which can cause significant delays and incur unnecessary costs.

That said, arbitration should not be simply included as the dispute resolution mechanism by default. Arbitration is expensive and is simply not applicable to all types of disputes, especially if the likely claim amount is relatively low.

Best Practice

While a company’s management can, by actively keeping up to date with industry developments and regularly reviewing the effectiveness of the company’s contracts, ensure that the company is on a sound contractual footing, it is advisable to have a legal professional review such contracts periodically. When a contract is up for renewal it would be a perfect time to check that all is in order and the terms thereof are still relevant and effective.