Even with our gentle experience in last 5-10 years, one thing we can vouch is that contracts have become increasingly complex from a legal, compliance and performance perspective. Drafting/reviewing contracts is an art of memorializing the contracting parties’ intent in a sufficient and unambiguous manner in an effort to resolve today, any dispute that could arise tomorrow. Just like people, no two contracts are the same. Perhaps, it is fair to state that there is rarely such a thing called ‘standard contract’ or standard ways to review them. Yet, in an attempt to make an all-inclusive perfect standard template, in-house lawyers like us have ended-up in facing so many standard templates and formats. At times it is so perplexing even to do a limited review as it is a herculean task to identify which clauses to look at in such lengthy set of terms and conditions. Especially, for seasoned project businesses, contract review turns more commercial in nature from the contractor’s point of view. Off late, organizations in project business are reviewing commercial contracts not in an elaborate way but in an effective way as they started placing more reliance on learnings from the previous experiences than on legal theories of liabilities.
In this article, our intent is to highlight the concept of ‘Spotlight Six’ – an effective mechanism to review the commercial sales contracts. The Spotlight Six are the contract terms which are found to be most critical in managing risks in such contracts. There is no second thought on importance of the legalities involved in other contractual concepts and provisions in a sales contract. But our experience is also that a selective contract review clubbed with value thresholds as realistic to concerned business, has been effective in two-fold: time-saving and emphasis focus on critical clauses.
The basic step of any type of contract review is always to ask the fundamental questions as relevant to purpose of the contract. Some ready-made questions as shown in the pictorial representation given here, will be handy when we use such a basis for contract review. Even a legal professional with hands-on experience will love to have such a framework so that at least important points are not missed even in a heavy work pressure environment.
Now that these basic simple questions will give us a fair idea on the areas to be focused with respect to these terms, let us look a little deeper in to the contractual terms for ‘Spotlight Six’ – Clear Contract Scope, Defined Payment Terms, Fault-Based Indemnity, Limitation of Liability, Warranty and Insurance.
Let us be candid here – if we mess up this clause, the whole contract can turn out to be a nightmare. We all agree to the fact that there is no point in binding yourselves to a contract unless you are crystal clear on what you are supposed to deliver. Hence, make sure that your scope of work or services is clearly set forth in the signed contract to reflect the parties’ expectations/intent and that it references any necessary exclusions/ carve-outs. Exclusions from your scope that are mentioned in preliminary quotations or during negotiations will not be considered part of the contract unless written into/explicitly referenced in the final contract. You should get compensated for additional work outside of the contract’s scope. Remember – the customer may be passive to bring in clarity to scope thinking that he will be benefitted later, but actually it is in the interests of both parties to have the scope clear as much as possible to avoid a future difference or dispute.
All commercial contracts will have payments to be made – mostly by the customer to the contractor. Well defined payments terms will keep the cash-flow of a project positive, which is one of the critical parameter of project management. You should clearly define when payment is due to you. Do include an unambiguous schedule of values, stick to it and obtain copies of payment bonds. Customer shall be liable for interest on overdue payments. Don’t agree (i) to contingent payment terms (i.e., pay if paid) (ii) to overly onerous invoicing requirements (iii) deviate from the agreed-upon payment schedule (iv) waive lien rights by failing to observe time requirements. A successfully delivered project in terms of its scope can still be an internal failure, if the payments are not collected timely from the customer.
This liability is always derived out of express clauses in the contract and so, it can be well managed at the time of contract formation. Indemnity provisions allocate risk between two parties by obligating one party to pay for any loss or damage incurred by the other party. To indemnify a customer means to protect them by promising to pay the cost of possible future damage, loss, or injury. When a customer asks you to indemnify them, you should narrow your indemnity obligations to losses caused by your own negligence. Simply stated, you shall be clear on what causes such liability, whether such causes are in your control and how it can be mitigated. It is also important to have robust risk mitigation plans for indemnities before the contract is executed, which helps the business in intelligent risk taking.
As you may know, the range of liabilities in a contract impacts its commercial factors a lot. Fair and reasonable limits of liabilities in a contract helps the parties to agree competitive commercial terms. A limitation of liability clause limits the amount of exposure you may face in the event a lawsuit is filed or another claim is made against you. A limitation of liability clause can “cap” the amount of potential damages you have to pay. You should attempt to limit your liability to: (a) the compensation and fees paid under the contract; or (b) a reasonable cap. A consequential damages waiver is also important because it limits your liability by excluding, or waiving, recovery for certain kinds of damages that can involve big money. These damages are the “pain and suffering” of a breach of contract claim. The limitation of liability and consequential waiver actually reduces the uncertainty of potential liabilities to a large extend which makes the cost estimation beneficial to both parties.
This is a liability connected more to the products or systems delivered and kick-starts in by the time the major obligations of delivery or handing-over are completed. Your contract should expressly limit all warranties to your standard warranty periods. You can negotiate longer warranty periods provided that the contract price reflects the assumption of the additional risk. You should not agree to an unlimited warranty period. You should disclaim all warranties except those explicitly set forth in the contract and you should specifically disclaim the implied warranties of merchantability and fitness for a particular purpose. If taken care of properly, this clause will help to retrieve your contingent provisions and thereby improve the executed margin of the project.
For an organization of any size, it is not always possible to take all the risks in a contract. There will be situations where we can cover the risks through appropriate insurances. Organizations with businesses globally mostly keep many insurance policies as relevant to their transactions, which can also be leveraged for covering the project risks. Always ensure that the requested insurance coverage is appropriate for the scope of work and reflects the risks associated with the project. It is also prudent to have a look at the deductibles and the coverage amount so as to ensure that the insurance policies are apt. Any waivers of subrogation should be limited to your negligence. Any project specific insurance requirements shall be properly estimated as part of the cost.
We strongly believe that there is nothing wrong in adopting new modalities in contract review different from the conventional ones. However, the same shall be finalized after assessing the risk profile and adaptability of the concerned business segment. The ‘Spot-light Six’ terms provide basis of a contract review for a business which believes in the rationale of focusing on the real relevant issues than working on indefinite number of terms. Without question, it is unfair to judge some of these provisions in a vacuum and without additional context. Admittedly, some things are worth including in a contract to simply to see what you can get away with (assuming that the minimal elements of a contract are otherwise achieved). That said, if at any time a party comments that “we agree to that, but won’t agree to it in writing” then they #ProbablyDoNotAgree.
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