Commercial agreements: Key provisions to pay attention
- 2017-08-07
- 637
Definitions
Commercial agreements have Definitions section which is an essential part of such an agreement. The reason is that the interpretation of an agreement is the first step when Parties to the agreement are in dispute and there is a need to understand their rights and obligations. There are occasions where the Definitions of contract terms differ from those Parties assumed.
Defined terms are for clarity and normally written in ‘capital letters’. They intend to ensure that there is ‘no ambiguity’ in the meaning of ‘special’ words or terms used in the agreement and those occurring more than once. They also ensure ‘consistency’ in the usage of terms. Definitions do not, however, mean that words written in ‘small letters’ have no meaning. It is, nonetheless, important to know that Defined terms are intended to prevent a dispute, a variety of interpretations, and make sure that the Parties are on the same page in respect of understanding ‘important terms’ used or repeatedly used in the agreement. It, therefore, saves time and effort to spend to comprehend terms and conditions of the agreement. In addition to the Definitions, it is important to appreciate legal principles and interpretation methods such as ‘understanding direct meaning of a word’, making comparisons between contractual terms and conditions, and comparing a specific condition of an agreement with the overall content of an agreement. They assist with understanding terms that are undefined but are used together with or in the context of significant terms and conditions.
Schedule
This is a project plan for work or service to be performed. It is an essential tool for the Parties to effectively manage the critical steps and paths, and most importantly it allocates resources, and identifies milestones and deliverables. It is, normally, a time sensitive project plan. Many contracts have a clause that “time is of the essence” or time for a particular service/delivery is of the essence. The implication of such clause is that “a delay in service or deliverable” is a material breach. Therefore, it is advised that contracting parties ensure that the schedule is a practical document in view of industry practice, contractor profile and experience, and factors such as weather conditions and supply chain. In other words, flexibility in scheduling should be provided in the agreement so that any deviation from the schedule does not trigger an additional cost, penalty, or increases a liability. Under the Civil Code of Mongolia, ‘standard conditions’ of an agreement are interpreted in favor of a party which accepts those conditions’.
Indemnity
Indemnity is an important provision in a commercial agreement. By indemnity agreement, a contracting party undertakes to hold harmless, defend, or release from liability the other party in connection with future claims for loss. Broad undertaking of liabilities under the indemnity provision is not recommended as one cannot possibly take insurances for all risks and potential liabilities or you may not become liable for other’s negligence under relevant laws. Therefore, limiting liabilities or undertaking indemnity obligations on specific matters are most desirable. It is also wise if an indemnity is provided for third party claims and negligence for which a Contractor is liable. In addition, contracting parties are advised to seek mutual indemnity for the sake of equity and legality.
Limitation of Liability
Limitation of liability clauses serve to establish a contractual ceiling (a cap) on the amount of damages to be awarded if a plaintiff prevails in the litigation. This is not an indemnity clause or an exculpatory clause. It is widely used for professional service agreements, for instance, not to open up to an unlimited liability given the amount of fees paid for the professional service or profit margin is marginal. Judges tend to interpret the limitation of liability clause in view of the bargaining powers of the contracting parties and whether the contract is a consumer contract or it is entered into by sophisticated commercial parties. When using the limitation of liability clause, you must remember that it cannot apply to any and all causes of action. Therefore it is prudent to list out the causes of action (for instance, negligence, breach of contract or breach of warranty). You should also tie this clause with the contracting party against which you take a claim for liabilities.
Warranty
Warranty obligations are limited to the responsibility for warrant provider’s own work and continue for set period of time. They warrant, for instance, quality of materials and equipment, or the work will be free from defects or materials defects.
‘Warranty exclusions’ are used where alterations to the work are not performed by a contractor, abuse or damage to the work is caused by third parties, material or equipment are used for unintended purpose, or an owner fails to properly operate or maintain the work.
A counsel who drafts a warranty clause should be aware that ‘warranty period is not extended by any remedial work’. It is also important to make clear that ‘any extension of the warranty’ is only for the work first performed following the substantial completion (which usually triggers the start of the warranty period).
A contractor should avoid being a guarantor of warranties supplied by sub-contractors and manufacturers of specific systems or pieces of equipment. The Uniform Commercial Code (UCC) or common law principles recognize ‘implied warranties’. Therefore, while drafting the warranty clause a counsel must consider if implied warranties apply to a particular agreement or if they can be waived.
Defects liability period
Most construction contracts contain ‘Defects liability period’ which ranges from one to two years. Such period normally starts from a practical completion (say, in a construction agreement). A defects liability period is beneficial to both the principal and the contractor. The principal does not have a burden to manage and spend a cost on a third party. A new contractor will be unfamiliar with the original work and will need to devote time and resources to understand and rectify the defect. From the contractor’s perspective a defects liability means that payment for the final milestone is not held up by minor defects in the works as it has the ability to rectify these defects after practical completion. A contractor also takes a comfort that the integrity of warranties it has given are maintained. ‘Defects liability period’ creates a contractual obligation under which the construction contractor is required to return to the site and rectify any defect identified in the work/s it has performed. However, it is useful to understand that the principal still have a right to pursue construction contractor for breach of contract, apply a legal warranty, other entitlements or remedies arising under laws if defects in the works transpire.
Payment dispute
Payment disputes are very common. As payments are normally related to performance of your service or ‘both your service and your client’s provisions’ (undertaken by an agreement) you need to be highly diligent in drafting payment terms. No payment or less payment may be caused by a delay or defect in the service. Therefore, it is important to fully understand conditions precedent of your service, in particular, if your service requires any up-front payment or provision of supply to be made by an owner (which you cannot possibly control) in a timely manner.
It is also important to understand the criticality of your service in the context of an entire project. For instance, it may be the case that others cannot work or deliver services without you performing your service firstly and on time. This situation will trigger a delay in the entire project timetable, and under-performance on your part, and moreover holds a project manager liable. Resulting scenario may make you liable before the owner and you may not get fully paid. To prevent from such situation, you need to be clear on sequence and connection of your service and client obligations, and commit yourself to clearly agreed and well advised obligations. An owner’s failure to provide things or monies on time and as agreed should not make you liable. To this end, an agreement language needs to be crystal clear to safeguard you from any expense, loss and additional liability for delay or underperformance. You must not take the blame for others’ breach of agreement or negligence.
Material breach
This is a serious breach of an agreement which entitles a contracting party to relieve itself from a contractual obligation or walk away from the contract. For instance, a material breach could make a party to the contract economically unviable, or eliminate the whole purpose of the agreement. It is important that the agreement defines a material breach. Otherwise, it is up to a judge or an arbitrator to decide if a specific breach or some breaches were a material breach. A material breach may result in suspension of service, and trigger the highest possible monetary penalty or termination of the agreement.
Governing Law
Governing law is a significant provision in a commercial agreement. It is a guide for or used in the interpretation of an agreement. Although parties may choose the governing law on the basis of an agreement it is important to consider a place of contract performance, laws and jurisdiction you are familiar with or the laws which provide more remedies, certainty, and clarity.
Dispute resolution
You could choose either court or arbitration for dispute resolution. Or you may choose negotiation and/or mediation first, and if differences are not resolved through such avenues, the dispute may go to a court or arbitration. What you need to consider is the cost, time, specialty and capacity of the institution and the nature of your dispute (for instance, if it is an Intellectual Property dispute and you require an injunction). Powers and rules of arbitral bodies and courts may differ in respect of evidence collection. Procedural rules they apply may differ to make the actions necessary for case resolution more costly, time-consuming, or less effective. Neutrality of the institutions is an important factor to consider as well.