Quick Contract Tips #5- Five Common Mistakes in Business Contracts
Having to negotiate and formalize a contract is great news for a business. What it means is, you’re in business! But it also means you’ve come to a place where your choices and actions have real consequences down the track for how you grow, on-sell and wind-up your business. All too often, business owners sign a contract only to find out later that the contract had a serious flaw that is costing them time, money, and heaps of frustration to fix. If such a situation sounds familiar, you will know how important it is to scrutinize every detail of a contract. When negotiating the terms of business contracts there are many pitfalls even for people with significant experience in these matters. For this reason, I’ve put together what I consider to be the ‘Top 5 common mistakes” I’ve seen in commercial contracts – and how to avoid them.
1. Bypassing the Contract all together!
If you're going into business with someone whom you have known for a while and you trust that person, you might be tempted to rely on a simple verbal agreement to make your business deal. That is not a wise idea. If disagreements arise later, you'll have nothing to fall back on. Human memory is often faulty, and either you or the other party may eventually (even conveniently) forget what the original agreement was. You can’t sell a verbal agreement. Written contracts are also important if you leave the company, as you want whoever takes over to have a written record of the agreements you made. Also, when an acquirer looks to acquire your business (see below), one of the most important things they will consider is whether you have written contracts in place, how long those business relationships have been in place and if they consider that they would like to retain these relationships
Are you thinking about enacting a business arrangement and creating a contract after the arrangement goes into effect? While creating a contract late is better than having no contract at all, it is still best if the contract is in place before you and your business partner get started on whatever transactions you have in mind.
2. Using a pre-made form from “Google-lawyer”!
It is easy to find some pre-made business contracts on line these days. These can seem like an attractive and low-cost option when you are contemplating entering into common types of business arrangements, but it is better to steer clear of these cookie cutter forms for several reasons: They don’t touch on all applicable business laws relevant in your locality – be that Japan or another country overseas if you are dealing with clients/customers outside of your home country. These google-searched documents may also leave out important details, such as a termination clause or an assignment cause, or guidelines on how to handle breeches and disputes (see below).
3. Not giving thought to disputes before they happen
Disputes commonly arise in business, and it is really important that you think about and be prepared for these disagreements. The contract may state that both parties will make “good-faith attempts to resolve disputes without resorting to legal action” or may also direct the parties to try mediation to avoid the courtroom and preserve the contractual relationship.
4. Not thinking about what constitutes a breach and what has to happen to terminate
The next step is to think about what would make you want to end a business relationship. This is not being pessimistic! It’s being practical with a capital P. I think this is the most important point that I see often not addressed in contracts. What if your counterparty doesn’t pay? What if the company you hired doesn’t deliver the product as expected or is late? What if the quality isn’t what you’d hoped for? What if the person ends up being really hard to get on with? The contract should include detailed information about what constitutes a breach and the consequences for that breach. Will a breach enable the innocent party to get out of the contract? Will there be monetary fines for the person who breached the contract? How serious are various types of breaches? What actions are serious enough to lead to litigation?
In addition to information about breaches, the contract also needs a termination clause, which creates a way for either or both parties to get out of the contract. Some people might hesitate to include a termination clause because they don't want the other person in the contract to have second thoughts about the contract and wriggle out of it but in reality, such a clause helps to avoid costly and lengthy arguments & litigation. Think about these scenarios: What if you learn, six months after you sign a contract, that a competitor is offering a better product at a lower price? What if you learn someone else can do a much better job? What if you decide to change your business strategy or pivot and the company you’re working with is no longer the right fit for you?
Many business contracts only allow for termination only in the event of breach. This is rather shortsighted. Every business contract should have a way for both parties to exit the contract – not just because the counterparty did something “naughty” – but simply because it makes business sense for them to be able to get out if they have to. This is true even if the other party is doing their best to make the business relationship work. Sometimes it’s just time to move on. And in every business relationship, each party should have the opportunity to give their business partners reasonable notice and terminate their relationship, for no other reason than because it makes business sense.
5. Leaving out the Assignment clause
Maybe you are a small or growing business now but even small-ish businesses are bought out by larger companies. This can be a good thing for the seller, giving you access to greater resources and a new pool of talent. However, if your business contracts do not have an assignment clause, this could hinder the business buyout. An assignation clause is basically a provision allowing the transfer a contracts to anyone who buys your business. Anyone interested in buying your business may do so only if your business will retain its contracts in case ownership goes to another party. If an acquisition is one of your future goals for the business, you’ll want to make explicit that every contract you enter into can be assigned in the event of a merger, sale, or purchase of all the assets of the company.
By far the best way to avoid these kinds of common mistakes in business contracts is to have a lawyer look over any contract you're thinking about signing. Look for an experienced lawyer who has real familiarity with your type of business and who can offer you advice that will help you and your business to prosper.
Disclaimer: The contents above are for educational and informational purposes only and do not create an attorney-client relationship. If you have specific questions make sure you contact a lawyer for advice.
To design or review your agreements to avoid these kinds of common mistakes, contact me at firstname.lastname@example.org.