Adam provides seven vital contract clauses every contractor should understand to protect their business from legal disputes, financial losses and unexpected risks in commercial agreements
THE Magnificent Seven is a classic ‘60s American Western about seven rugged gunslingers hired to defend a humble Mexican village from a ruthless band of marauding outlaws. After more than two hours and much shooting the village is saved. It’s well worth a watch for those into westerns.
Given that contractors work – or should work – to signed contracts, Robyn Hey, a senior contracts manager at HCR Law, details that there are seven gunslinging clauses that they need to consider when drawing up or signing agreements with each existing to protect a business.
Of course, not all will be relevant in every case but Hey thinks that understanding them may help save a firm from major legal and financial risks.
Limitation of liability clauses
When contracts go wrong, the knock-on effects can have disastrous consequences from a financial and reputational perspective. This is why Hey says that ‘it is important that liability is appropriately distributed to provide the right mix of protection and pragmatism.’
She notes that ‘the allocation of liability is often a sticking point in contract negotiations,’ adding that ‘the reality is that neither party wants to take on risk unless it must, but factors like negotiating power, who controls the high-risk aspects of a transaction and general commercial experience all play a part in these discussions’.
For the smaller sub-contractor, Hey knows that trying to push back on risk can be very hard and where it feels that it is being forced to take on liability that it just can’t handle, difficult decisions need to be made. But just because a business can enter into an agreement that looks enticing and profitable, doesn’t mean that it should. Hence she says that ‘management needs to assess whether or not its systems, people and cash flow can sustain any agreed obligations under an agreement,’ adding that ‘it may be that with some insurance in place and a proper legal and financial strategy, the risks of entering into a commercial arrangement where the liability provisions are disproportionate are worth it.’
However, these decisions are best made with a cool head and some external input from advisors who have a more detached view and a thorough understanding of how to mitigate risk.
Indemnities
At their core, indemnities safeguard against, or provide compensation for, a loss or liability. In essence, where an agreement provides for an indemnity, one party promises to pay an identified loss to the other if a particular trigger event happens.
Here Hey says there are certain areas of commercial relationships where indemnities may be appropriate such as the duty of confidentiality, data protection breaches, and third-party intellectual property infringement claims against the recipient user of IP licensed by the indemnifying party.
She says that ‘these aspects of the agreement are, broadly speaking, more heavily in the control of the person giving the indemnity than the person receiving it… the consequences of a breach of these kinds of obligations may go far beyond the usual loss or damages which may arise but often go to the heart of a contractor’s operations and reputation’.
Naturally, some seek to extend the application of an indemnity to any breach, including a breach of warranties. Service recipients, from Hey’s perspective, are particularly keen on this, because ‘while the indemnity scope may be expressed in mutual terms, the service provider will inevitably always bear the lion’s share of service and warranty obligations.’
Where possible, Hey advises clients who are providing goods and services not to indemnify the other side for warranty breaches. Why? Because ‘indemnities provide legal cover less onerous for the indemnified party than normal rules applying to contract breach. Indemnities don’t require the usual obligations to prove the loss itself of the amount of this loss, and don’t require the innocent party to take steps to limit the loss it suffers.’ These for her are very powerful differences.
Warranties
To warrant something in a contract means to promise it in a way which Hey says leaves the door open to some remedies but not others. Crucially, she notes that ‘if a warranty is breached, the innocent party can claim damages but cannot necessarily rely on the warranty breach to terminate the contract.’
Experience has told her businesses often don’t understand this and ‘think that, if they receive a host of warranties from the other party, they have better or more extensive protection which is not the case.’
Termination clauses
Termination can be more complex than most would think. Lawyers are frequently instructed by clients to provide for a fixed term and a clause allowing for the termination for convenience without, as Hey comments, ‘realising that these concepts don’t work well together’.
She explains that ‘under standard conditions, termination for convenience allows for a party to terminate for any reason on notice. In contrast, a fixed term ties parties into the agreement for an agreed period during which termination can only be exercised in the case of a breach of the agreement.’ There are pros-and-cons to both constructions and Hey says that ‘it’s important to look at what suits the contract best in the light of the arrangement between the parties’.
What’s more, it may be that the party with more bargaining power expects that it will be able to terminate for convenience where the other, less powerful party, may not. Where one party is insisting on a one-sided right of termination for convenience refuses to budge on this point, Hey advises ‘the other party to consider the impact of this on its planning and revenue forecasting before entering into such an agreement – no contractor wants to scale up for a large contract just to find the rug – pun intended – pulled from under them.’
Payment clauses
Tight and accurate payment terms are foundational to any agreement. When considering the timing of invoicing and payment, matters such as a business’s payment obligations to suppliers must be considered.
A contractor, for example, will not want to be receiving payment on 90 days when its suppliers expect payment within 30 days; that does not make for good cashflow or a sustainable business model.
Beyond this Hey says that ‘negotiating the right to suspend services for non-payment, requiring payment of the non-disputed aspects of an invoice in situations where there are concerns about the payment for services, and ensuring the right of set-off is excluded (or included as the case may be) requires an evaluation of the commercial realities of the relationship between the parties’.
Intellectual property clauses
Another prickly issue for Hey is the protection of intellectual property – especially in software and general services agreements. She warns here that ‘the granting of limited licenses to allow for the performance of services must be accurately drafted’. And in particular, ‘where ownership of intellectual property passes from one party to another, the requirements for this transfer must be carefully set out’.
Data protection clauses
This is one of the most misunderstood aspect of contracts. Where there is a controller-processor relationship, Hey warns that the terms of this arrangement ‘must be clearly set out to protect both parties and comply with the complex legal obligations under data protection legislation’.
The Information Commissioner Office is taking a tougher stance on breaches; any failure to comply with the data protection legislation ‘can,’ says Hey, ‘see not only financial consequences in the form of fines but also reputational damage and, in the worst-case scenario, criminal penalties’.
Conclusion
Properly negotiated and drafted, these seven gunslinging clause can protect a business in the case of a legal dispute arising. Assessing how best to put the appropriate protections in place isn’t purely a legal exercise. It requires a thorough understanding of the commercial and operational aspect of a given business.
No contract can ever protect a business from being unable to fulfil its obligations because it has overestimated its internal business capabilities. Similarly, no contract will ever be able to protect a business from a counterparty unable to fulfil theirs.
Adam Bernstein is an independent columnist
