Part 1: Important Terms Common To All Contracts by Michele Leonelli, Esq. of Phocus Law
No matter what type of business you run, contracts are essential. If you’re reading this and thinking to yourself, “they aren’t essential to my business”, or, “I hardly use any contracts at all”, then YOU ESPECIALLY need to read on.
When used properly, contracts help to accomplish several vital objectives:
– Set expectations between the parties
– Allow businesses to take advantage of opportunities
– Protect against risk and exposure
So, it’s worth spending the time to implement them and understand how they work. But, for most business owners this can be overwhelming, and rightfully so because you’re not a lawyer. So be proactive and find a lawyer you trust to help you with this: an ounce of prevention = a pound of cure.
It’s important to remember that contracts can vary quite substantially from one to another. Nonetheless, many of them share several common features and require that the parties pay attention to a number of common provisions. In this first installment on contracts, we will cover some of the most common fundamental provisions and considerations. Keep in mind that, although these provisions may be common among contracts, how each provision is written can (and often should) vary greatly between contracts.
a. Correctly Defining the Parties to the Agreement: (i) Make sure the correct parties are listed in the contract so that, if there’s a breach, you have the right to enforce the contract against the correct entity or individual; (ii) Make sure the correct parties have the privileges outlined in the contract so those parties can receive the benefit of their bargain, respectively.
b. Effective Date: This is when the agreement takes effect, but it does not have to be the date the agreement is signed. Keep in mind that you can also backdate an agreement so that it, by the agreement of the parties, it is effective on some date prior to the date it was actually signed. This is useful to keep in mind if you want to document an existing or de facto relationship between the parties that existed prior to the date of signature.
c. Term of the Agreement: Establishing when the agreement ends is important because it sets in writing the expectation of how long the parties will be involved with one another. You have wide latitude for setting the term. For instance, you can: (i) set a fixed term; (ii) set a fixed term that renews either automatically or upon the written consent of the parties; or (iii) leave the contract in effect in perpetuity until either or both of the parties decide to terminate it.
d. Dispute Resolution: In the ‘dispute resolution’ clause of the contract, you get to set the rules for how to resolve a dispute. Just like with a prenuptial agreement, this gives the parties the chance to take advantage of a calm moment to determine how to handle a potentially heated future conflict. Some common options here include: (i) Resolving the dispute amicably without any legal proceedings; (ii) Using mediation, which means bringing in a third-party to resolve the dispute amicably between the parties; (iii) Arbitrating the dispute, which is more like a classic litigation except that it’s almost always cheaper and faster because you’re not subject to the lengthy court procedures; or (iv) A classic litigation in court. Keep in mind that you’re free to use any combination of these, and most contracts often do layer these in so that, for instance, first the parties must try to resolve the dispute amicably, but if that’s not possible within a certain agreed upon timespan, they then agree to go to arbitration.
e. Choice of Law & Venue: These terms are very intricately involved with dispute resolution because in a choice of law and venue clause, the parties prospectively determine which body of law will apply to the dispute, and where, physically, the dispute must be adjudicated. Choice of Law: Usually the party with the most leverage gets the ability to select its home state’s law as the applicable law. If both parties are from the same state, then this is not often contentious. If this decision proves too contentious, a neutral state can be selected. A common neutral state is Delaware, chosen for its robust body of corporate law and expert courts of chancery. Venue: Much like with choice of law, the party with the most leverage often gets to set the venue for a dispute. Venue is important because: (i) It can give the in-state party a logistical and financial advantage because they don’t need to travel to attend the proceedings or hire an out-of-state attorney with whom they’re not familiar; and (ii) The courts in a particular state often have an interest in protecting the rights of their citizens (a sort of “home turf advantage”). Note that the choice of the substantive law that applies in a dispute and the venue for that dispute do not need to be the same: an Arizona court could use Delaware law to resolve a dispute. The risk with this dislocation is that the Arizona court may not be as adept at interpreting and applying Delaware law as the Delaware courts.
f. Integration Clause: The integration clause does one CRITICAL thing in every contract – it says that what’s written in the contract is the sum total of the agreement between the parties with regards to that topic (the governance of an LLC, the lease of a piece of property, etc.). This means that neither party can produce some other document or interaction (like a conversation, text, or email) as proof that what’s written in the contract, is somehow NOT what they agreed to. This keeps everyone playing by the same rules, and it makes it especially important to spend the time getting the contract just right before execution.
g. Assignment of Rights: This provision typically prevents the parties to the contract from assigning their rights or obligations in the contract to someone else. As a party to an agreement, this is a great clause because it guarantees that the entity you think you’re signing the contract with, will be the entity that has to honor it. Nonetheless, you’ll also want to consider building into this provision an exception (or “carve-out”) in the event that either party sells all or substantially all of its assets. That way, if you want to bring on investors or sell your business, you don’t need approval to transfer your active contracts from the other parties with whom you’ve contracted over the years. Having to go get this approval could be a big deterrent for a potential acquirer or investor.
In this first part of our series on Key Contracts & Contract Terms For Any Business, we’ve highlighted and explained some of the key contractual terms common to most, if not all, contracts a business will encounter. In our next installment, we’ll dive into a few specific types of contracts in order to explain some of the provisions that are key to each, individually, and some common potholes to avoid.
If you need assistance drafting, reviewing, or negotiating a contract or if you wish to consult with an attorney to take proactive steps to avoid potential contractual pitfalls, please feel free to reach out to Phocus Law by phone at (602)457-2191 or by email at email@example.com.