Contracts

Do your contracts anticipate the risks that are unique to your business?

Many new business owners pull form contracts from online libraries or from other businesses. This can make sense for a new, cash-strapped entity – but leaves your business dangerously exposed as you grow and develop your services. Let us review your agreements to make sure they mitigate the risks that are unique to your business.

Negotiating and drafting customer and vendor agreements is a critical component of running a business. These agreements are the cornerstone of protecting a company’s interests, mitigating risks, and ensuring successful business transactions. A poorly drafted contract can impede your ability to collect payment or enforce important provisions like those relating to confidentiality or ownership of intellectual property. In the worst case, it may expose your company – or even you personally – to significant liability.

Let’s explore the main considerations and risks involved in negotiating these agreements – and how to protect yourself without blowing up an important deal.

Clear and precise language: One of the primary considerations in any agreement is clarity. Contracts should use clear and precise language to avoid misunderstandings and disputes. While an agreement should cover all the relevant aspects of the proposed arrangement, it’s also critical that none of the terms conflict with one another, and that potential pitfalls are clearly and thoroughly addressed beforehand. 

Scope of services and deliverables: Clearly defining the scope of services and deliverables is crucial for vendor agreements. If the scope is not adequately defined, vendors may not deliver what is expected, leading to frustration and, at the extreme, potential legal action. It’s also important to include a clear process for amending the deliverables over time, so that you don’t have to start from scratch. 

Pricing and payment terms: Pricing and payment terms should be well-documented, including the frequency of payments, late fees, and any additional costs. For contracts involving the delivery of physical goods, an additional consideration is defining when the goods have officially been “delivered” and payment becomes due. Disputes can arise when there is ambiguity in pricing and payment terms.

Termination and exit strategy: Every agreement should include a provision regarding termination. Without a clear exit strategy, the parties may disagree about whether the agreement has been properly canceled – and equally importantly, what payment is due and what services remain to be delivered. There are several potential scenarios under which an agreement may terminate:

• Termination on completion: If the defined goods or services have been delivered, and there is no expectation of additional deliverables (and no provision for automatic renewal), the agreement may provide that it will terminate automatically.

• Termination for cause: If a party breaches a provision of the agreement, the other party may be able to terminate the agreement immediately. In many instances, the breaching party will be given a period of time to “cure” (or fix) the breach before the agreement will terminate.

• Termination for convenience: You may want to provide that either party may terminate the agreement before the deliverables have been completed. Typically, the terminating party will need to give written notice a set amount of time (i.e., 30 days) before the agreement terminates. Keep in mind that termination for convenience can affect the amount of money that you collect under the agreement (if you are the vendor), or the deliverables that you’ll have in hand when you part ways (if you’re the customer). For this reason, many companies have a strict policy not to accept termination for convenience provisions in agreements.

Confidentiality: The agreement should use clear and precise language to define the obligations of the parties involved with respect to confidential information. A few particulars to keep in mind:

• Mutual vs. one-sided obligation: If both parties will be disclosing confidential information, the confidentiality obligation should be mutually binding. If only one party will disclose confidential information, a one-sided obligation is likely acceptable.

• Definition of confidential information: It sounds obvious, but it’s crucial to clearly define what constitutes confidential information. This should cover not only existing information but also any future information that may be disclosed.

• Obligations of the parties: Specify the obligations of both the disclosing party and the receiving party. The disclosing party should outline what can and cannot be disclosed, and the receiving party should understand its duty to maintain confidentiality.

• Duration: This is one that parties often overlook. If the duration of the confidentiality obligations is not clear, one party may inadvertently disclose confidential information before the other party had intended. Although many people think that confidentiality obligations always last forever, this isn’t always true – and in some scenarios, it may not be appropriate (or even enforceable!).

• Permitted disclosures: Almost every confidentiality provision includes “exceptions” where a party is permitted to disclose confidential information. This could include permitted disclosures to third parties like employees and advisors, or disclosure in the event of a lawsuit or other legal process. It goes without saying that a lack of clarity on this front can lead to inadvertent breaches.

• Exclusions from confidentiality: The agreement should identify information that is excluded from the confidentiality obligations, such as information already in the public domain or information independently developed by the receiving party.

• Consequences of breach: You should clearly outline the consequences of a breach, which may include monetary damages or injunctive relief to prevent further disclosures.

Intellectual property: Defining ownership of intellectual property (“IP”) created during the course of an agreement is a critical aspect of vendor agreements, especially if either party will share its own IP and/or create IP as part of the agreement. Obviously, unintentionally granting ownership or usage rights in your IP is a nightmare scenario that could have a severe economic impact on your business. Some of the key considerations when addressing this subject matter are:

• Clarity in ownership: Determining who owns the IP created during the agreement is of paramount importance and should be clearly spelled out in the agreement.

• Scope of licensing (if any): When licensing IP, it’s vital to specify the scope of use, duration, and any limitations. For instance, a licensing agreement for a trademark may limit its use to specific products or geographic regions. It’s also important to specify whether the party receiving the license can then sub-license it to other parties.

• Royalties and compensation: If the party receiving the license will pay a royalty, the agreement should clearly set out the royalty calculation, payment schedule, and how any ambiguities will be resolved.

Non-competition or non-solicitation clauses: Some agreements may include “restrictive covenants,” which most often consist of agreements not to compete with the other party, hire away their employees, or solicit their customers. These can be a valuable tool to protect a party’s bottom line, but they must be drafted carefully. To be enforceable, a restrictive covenant must be reasonable in scope. What constitutes “reasonable” depends on a number of factors, including the nature of the relationship between the parties and the governing law of the agreement. Some key considerations when drafting these provisions to be reasonable:

• Duration: The restrictions cannot last for an unreasonable amount of time. Non-compete and non-solicit clauses may last for different amounts of time, depending on the particulars of the situation.

• Geographic scope: You may want to limit the restrictive covenants to a certain radius around the location of the business or where the services are performed.

• Substantive scope: Especially when drafting non-compete clauses, it’s important not to define “competitor” too broadly. Courts don’t look favorably on restricting others from working, so non-competes must be narrowly tailored to be enforceable.

Compliance and regulatory requirements: In many industries, compliance with certain laws and regulations is vital. For example, an agreement involving the sale of food or drugs will likely need to comply with certain FDA requirements; banking agreements may need to comply with certain anti-money laundering laws. Be sure to consult with an attorney about which compliance considerations are most important for your agreement.

Governing law, jurisdiction, and dispute resolution: Of course, all agreements are drafted with an eye toward avoiding conflicts – but if one arises, it’s equally important that the agreement set out clear guidelines for how the dispute gets resolved. The following are critical when drafting this provision:

• Governing law: This specifies which state’s laws will govern any disputes regarding the agreement. Depending on the subject matter of the agreement, certain states’ laws may be more favorable to one party than the other, so it’s important to consult with your attorney regarding this provision.

• Jurisdiction: This section states where any lawsuit or arbitration regarding the agreement will be filed and heard. This may or may not be the same jurisdiction as that specified in the governing law section – for example, many Delaware corporations are based in other states, so their agreements may provide for Delaware governing law but a different jurisdiction.

• Dispute resolution: You may provide for a specific mechanism by which disputes will be heard. For example, although most people think of court trials when they imagine how corporate disputes are resolved, many businesses prefer to have conflicts heard by an arbitrator. This is because arbitration is not governed by the strict rules of evidence and procedure that rule in court, and in some cases arbitration may be faster and less expensive than having a case heard by a judge.

Miscellaneous provisions: Many standard provisions – often called “boilerplate” in the legal industry – are actually critical to ensuring that the agreement can be enforced and interpreted. Things like defining how the parties may give notice to one another, whether electronic signatures are acceptable, and whether an unenforceable clause will doom the entire agreement can make or break an otherwise solid contract.

Next Steps

Negotiating and drafting customer and vendor agreements is paramount for businesses looking to limit their exposure to liability and maximize profits. By carefully considering these key factors and addressing associated risks, businesses can protect their interests, maintain strong relationships with customers and vendors, and avoid costly legal disputes. Book an exploratory call with us to make sure you’re covered.