12
12.1 Writing Contracts
LEARNING OBJECTIVES
- Learn how to write valid contracts.
- Understand strategies for drafting contracts.
Knowing how to write legally enforceable contracts that protect their interests is a vital skill for businesses. In fact, most contracts are not written by attorneys. Individuals and businesses write contracts without legal help because they are trying to save time, money, and tension with others. However, hiring an attorney to write or review a contract to protect personal or business interests is sometimes necessary and worthwhile.
There are no magic words that a contract must have to be enforceable. Some are short and informal, while others are long and formal. No one style, format, or approach will always serve the parties’ needs. The only legal requirement that contracts must have are the elements of a contract: offer, acceptance, and consideration. This chapter offers some guidelines for business people to consider when writing their own contracts.
Counselor’s Corner It has been said that a poorly drafted contract will work if everyone gets the benefit of their bargain. This may be true, but it does not excuse sloppy drafting. Address all essential matters, clearly, succinctly, and at once. Non-essential terms, inconsistent use of defined terms, and repetition create fertile ground for disputes. You cannot control how the other party will perform. However, you put yourself in the best position possible by ensuring that the intent, obligations and rights of all parties are stated clearly and unambiguously. ~Kathy K., attorney
12.2 Structure of Contracts
Written contracts can be organized in many different ways. However, having a structure can help keep information organized, clear, and easy to find. The best contracts have clear headings that accurately describe what is contained in that section. Using emphasis, such as bold and underlining, work better than italics alone for capturing the reader’s eye.
In general, contracts often contain a structure like this:
- Title
- Introduction of Parties and Purpose
- Definitions of Material Terms
- Covenants and Promises of Performance
- Conditions
- Breach and Its Consequences
- Representations and Warranties
- Standard (often called “Boilerplate”) Provisions
- Procedure to Modify Contract
- Rights of Assignment and Delegation
- Alternative Dispute Resolution
- Choice of Law and Forum
- Integration
- Severability
- Exculpatory Clause
- Force Majeure
- Attorney Fees
- Signature Block
Not all contracts will contain all these elements and provisions. The parties’ needs and the purpose of the contract drive the structure of the document.
Title
Contracts have a title, often in bold or CAPITAL letters, at the top of the page. Titles should be as descriptive as possible. “Contract” or “Agreement” are not useful because they require the reader to read through the contract to know what it is about. The best contracts capture the nature of the document in the title. For example, “Employment Agreement Between Jane Doe and Stanford University.”
Introduction of Parties and Purpose
The introduction should name the parties and describe the nature of the contract. If background information is useful in explaining the parties’ interests and objectives, then it should be included here.
Definitions of Material Terms
Most business contracts contain some definitions, unless the subject matter and parties are clear. Definitions are useful because it is an area readers can reference to ensure compliance with the contract. For example, did the seller provide the specific goods as defined by the contract?
Definitions are not necessary for every term, though. If not defined, legal terms are given their legal meaning. And ordinary words are given their common, ordinary meaning. Therefore, businesses should define the material terms of the transaction: goods, services, quantity, quality, price, etc. Definitions that are specific to the industry are also helpful to include.
Covenants and Promises of Performance
A covenant is a formal promise to perform. This is the section of the contract where the parties state exactly how they will perform the contract. Buyer will pay a specific amount for the goods or service. Seller will deliver a specific item at a particular location.
To ensure clarity, the best contracts use active verbs in this section. For example, “Buyer will pay Seller ten dollars.” It is clear who will be paying whom, and how much is owed. Passive voice injects ambiguity, which can be problematic. For example, “Seller shall be paid ten dollars.” Will Buyer pay Seller the money or will someone else tender payment? If payment is not made, is Buyer in breach of contract?
Conditions
As discussed in Chapter 10, conditions are things that must occur before performance is due. Usually conditions must be expressly stated in a contract to be legally enforceable. The best contracts identify any conditions and delineate a timeline for when performance is due after the condition is met. For example, if an inspection of a property is a condition precedent of purchasing it, how long after the inspection is completed must the buyer perform?
Breach and Its Consequences
To constitute a violation of the contract, a breach must be material. A material breach is a substantial breach of contract that excuses aggrieved parties from further performance and affords them the right to sue for damages.
In contracts that require performance over a period of time, or payments in installments, it is helpful to define what constitutes a material breach. This clarifies when the non-breaching party can seek a remedy. The best contracts anticipate reasons for breach and identify consequences for them.
Acceleration Clause
An acceleration clause makes all future payments due immediately under the contract. Acceleration clauses often exists in contracts where periodic payments occur. For example, a contract to purchase a vehicle may require payment of all remaining money owed under the contract if the buyer misses a monthly payment. This allows the business that sold the vehicle or the bank that issued the loan to sue for breach of contract once, rather than filing a new lawsuit for each month.
Liquidated Damages
A liquidated damages clause allows parties to determine the amount of damages in the event of a material breach. Agreeing to the value of the contract before any breach occurs often saves time and money should the case be litigated. To be enforceable, the liquidated damages must apply to all parties equally, and be based on the value of the contract rather than act as a penalty.
Representations and Warranties
Representations are statements of fact made to induce someone to enter into a contract. Common representations by businesses include:
- They are properly licensed;
- They are insured;
- Their financial statements are accurate;
- They own all relevant assets;
- They have legal authority to enter into contracts.
Warranties in a contract are express promises that guarantee something in furtherance of the contract by one of the parties. For example, a seller warrants that the object being sold is as represented or promised.
Warranties differ from representations in four ways:
- A warranty is an essential part of a contract, while a representation is usually only a collateral inducement;
- A warranty is written in a contract; while a representation may be written or oral;
- A warranty is conclusively presumed to be material, while a representation must be proven to be material by the party claiming breach; and
- A warranty must be strictly complied with, while a representation must be substantially true.
Please note that express contract warranties are different from implied warranties under the Uniform Commercial Code (UCC). A party may disavow implied warranties under the UCC through a written contract.
Modification
Often with contracts that require an extended period for performance, modification becomes a concern. What happens if prices or deadlines need to be altered? Does that require a new contract or can the existing contract be modified? Good contracts often include a procedure for how to modify a contract. This may be as informal as writing changes directly on the original contract with the parties’ initials and date. Or it could be through a formal addendum procedure.
Regardless of the chosen procedure, it is a best practice for businesses to discuss modification procedures when entering into a contract. If the procedure is clear, less friction occurs when a party seeks modification.
Assignment and Delegation
In general, parties are free to assign and delegate their rights and duties under a contract. Parties can limit those rights or they can request notice if an assignment or delegation occurs. This is a provision that is often not needed unless a party has a concern about assignment, such as in the insurance industry.
Alternative Dispute Resolution
As discussed in Chapter 4, many businesses want to reduce their risk of litigation by participating in alternative dispute resolution (ADR). Mandatory arbitration clauses are common in consumer and employment contracts. Before including an ADR provision in a contract, parties should be fully comfortable with the option that they choose. If a party agrees to mediation or arbitration, a court will enforce that choice even if the parties change their mind.
Choice of Law and Forum
Choice of law provisions determine which state’s laws will be used to interpret the contract. Choice of forum provisions determine the state in which any litigation will take place.
This provision is often unnecessary for contracts involving individuals and entities in the same state. If the parties do not select that state law or location for litigation, the courts look to:
- Where the contract was signed;
- Where the contract is performed;
- Where the parties are residents; and
- The court’s jurisdictional rules.
Integration
An integration clause is a provision stating that the contract represents the parties’ complete and final agreement and supersedes all informal understandings and oral agreements relating to the subject matter of the contract. In other words, it is the agreement.
The purpose of an integration clause is to prevent the parties from later claiming that they agreed to additional or different terms than what the contract states. This means that any statements made before the parties signed the contract are not part of the contract and they will not be used to interpret the meaning of the contract.
Severability
A severability clause is a provision that keeps the remaining provisions of a contract in force if any portion of the contract is declared unenforceable by the court. It is also known as a savings clause because it “saves” the whole contract from being declared unenforceable.
For example, if a non-compete clause in an employment contract is declared unenforceable by a court, then the rest of the employment contract remains in effect.
Exculpatory Clause
An exculpatory clause is a provision relieving a party from any liability resulting from a negligent or wrongful act. They are often employed when the risk of injury exists. Exculpatory clauses cannot limit liability when a party acts with gross negligence, commits an intentional tort, or when public policy or state laws prohibit them. Exculpatory clauses have been struck down by courts in some cases where parties to a contract have greatly unequal bargaining power, especially when the party with greater power acts unethically or with gross negligence.
Force Majeure
A force majeure clause is a provision allocating risk to a certain party if performance becomes impossible as a result of an event that the parties could not have anticipated or controlled. Force majeure events are big, disruptive events such as natural disasters, war, terrorist attacks, and fires.
For example, if the subject matter of an international sales contract is destroyed by a hurricane, does the buyer or seller lose the money in the sale?
Attorney Fees
Business contracts often have an attorney fees clause that entitles a party successful in litigation over the contract to be reimbursed its attorney fees. This clause often has the effect of limiting frivolous lawsuits because it becomes more expensive for parties to litigate weaker claims. It may also give leverage to a winning party to prevent or end appeals of a court judgment.
Courts will usually enforce an attorney fees provision in a contract. However, courts review attorney fee awards for reasonableness. Therefore, the amount of fees usually must be deemed reasonable by a court or arbitrator before a party can collect under a contract.
12.3 Common Mistakes
Four of the most common mistakes when writing a contract are not understanding the content, vagueness, ambiguity, and typographical errors.
Not Understanding the Content
One common mistake is using free online resources without ensuring that they are appropriate for the circumstances. Just because it sounds official, a document generated by a computer algorithm may not be helpful. Better to read the contract and ensure that it accurately reflects the parties’ agreement.
Courts presume that parties have read a contract before signing it. Any mistakes in drafting go against the party who wrote the contract. In other words, if the contract is unclear, the party who did not write it gets the benefit of the doubt. The idea is that the party who wrote it should have done a better job, and the party who read and signed it should not be penalized as a result of someone else’s error. When writing a contract, better to keep it simple and clear.
It is also important to exclude provisions that are irrelevant to the contract. Contracts that are too long and contain irrelevant and contradictory terms are hard to understand. The best contracts are used as a reference between the parties during the period of performance. If a contract is too broad, too confusing, or contains too much irrelevant information, it hinders the effectiveness of the document.
Vagueness
In the context of contracts, vagueness means the language is imprecise, uncertain, and not clearly expressed. Vagueness is problematic because it could mean that the parties did not have a meeting of the minds because they were not talking about the same things.
Some business people think that keeping the contract “general” will facilitate a business transaction and that the details can be worked out later. However, if the parties are not in agreement up front, it is uncommon that things will work out smoothly later.
Another risk with vagueness is that it is not clear how a court will interpret the contract. If there are two or more reasonable interpretations, it is possible that the court will decide another interpretation is more reasonable. Again, mistakes in drafting are held against the drafter so if a court concludes that the vague term was a mistake, then it is hard to win in litigation.
Ambiguity
In contracts, ambiguity means an uncertainty of meaning or intention. Ambiguities can be either patent or latent. A patent ambiguity is where the language of the contract itself creates uncertainty because it is contradictory. For example, a contract states two different sale prices.
A latent ambiguity exists where the uncertainty arises during the performance of the contract. For example, the contract states that goods will ship via a carrier that has a common name and could be referring to different carriers.
Typographical Errors
Typographical errors are common in contracts. Some are harmless, some are embarrassing, and others are harmful. Although some typos are easy to ignore because they do not carry legal consequences, some can be fatal to the agreement.
Minor errors are called scrivener’s errors. The scrivener’s error doctrine permits typographical errors in a written contract to be corrected when clear and convincing evidence exists that the mistake does not reflect the intent of the parties.
However, errors related to dates, price, quantity, legal names of individuals and entities, and property descriptions (such as addresses and lot numbers) may not qualify as scrivener’s errors. Such errors may be fatal to the contract or may be enforced with adverse consequences against one of the parties.
12.4 Tips for Writing a Contract
Regardless of the purpose of the contract, some tips for writing good contracts include:
Naming the Parties
Be sure to use the correct name of the business entity or individual who is a party to the contract. This may seem obvious, but people often write the name of a representative of the entity rather than the legal name of the entity.
For sole proprietorships, it is appropriate to identify the party as Ling Chen doing business as Chen Bookkeeping. If the business is a Limited Liability Company (LLC), identifying an individual in the contract by name may remove any personal liability protection that a LLC provides. Similar issues may arise with a partnership if each individual is identified as a party to the contract.
Except for sole proprietors who do not have a separate business name, use the business entity’s name and not a personal name as a party to the contract. Otherwise, parties may lose the benefit of limited liability. There may also be tax consequences.
Define the Scope of the Work
Clearly define the scope of work or service being provided, and the proposed timeline to complete the work. Be specific. For example, instead of a broad “renovate the kitchen,” provide details of the cabinet designs, counter tops, and other materials and work to be provided.
If applicable, a time frame for each phase of the project is useful, along with procedures to follow if there are delays. This is especially helpful when delays occur as a result of a supply shortage or a third party. Breach of contract may not always be the fault of the parties. Having procedures in place in the case of delay often saves business relationships when things go wrong.
Specify Time and Amounts of Payments
Entering an hourly rate and projected time for completion, or the total amount of payment for a project, may be insufficient. Depending on the nature of the goods or services, the contract should include:
- Who is paying whom;
- How much is being paid;
- The method of payment (such as check, cashier’s check or bank transfer);
- Any portion of fees to be paid upfront;
- Any fees to be paid at project milestones;
- Payment for work completed if contract is canceled;
- Any late fees; and
- Hourly/per diem rate for time due to delays caused by the other party.
Termination Clause
Few contracts go on forever, so including an end date for the agreement or procedures for a party to cancel the contract are helpful. For example, parties often want to end the agreement if the other party fails to pay or misses too many important deadlines.
Termination procedures should be as specific as possible and include how much notice needs to be given, the type of notice required, and whether there is a time period where the other party may cure the deficiency.
Termination clauses should anticipate termination by all parties and address the parties’ rights based on which party requests termination and why.
Sign and Date the Contract
The signature block should name the business entity, then under the signature, the name and title of the person signing.
Figure 12.1 Signature Block Example
For example, Ahmad’s Construction, LLC By: __________ Khalid Ahmad, President
Each person signing the contract should date it next to his or her signature.
For partnerships, only general partners can sign a contract on the partnership’s behalf. For corporations, the president or chief executive officer is presumed to have authority to sign. For an organization or association, a board president would have authority, but it may require a vote of the governing board to approve the contract.
Minor Changes
Minor changes can be made directly to the contract. Both parties need to initial and date beside the changes to show that both parties agree to the change.
This is common when people buy property and the amount held in escrow changes (usually based on interest accrued) from the time the contract was prepared to the time it was signed.
Legal Terms
Courts interpret legal terms to have their legal meaning, regardless of the parties’ intent. Avoid using legal terminology unless all parties fully understand the legal definition and how it will be applied by the court. Again, simple and clear language is more effective than confusing legal jargon.
Allow for Flexibility
Contracts are usually the result of negotiation and the majority of them never end up in court. Contracts cannot cover every possible future situation but serve as a working document for the parties’ business relationship. When writing contracts, it is best to think of them as an agreement between parties that need some flexibility for the transaction(s) to take place. Life is dynamic and the best contracts give structure without being too rigid.
12.5 Concluding Thoughts
Writing valid contracts is an essential skill to be successful in business. Most contracts are not written by attorneys but they are critical to capturing an agreement between parties. Successful business people see contracts not just as a way to protect their interests, but also as a document that governs their business relationships with others. A well-written contract can be used throughout a transaction to guide the parties in their interactions and responsibilities.