Properly worded contracts provide certainty and control. They ensure that when parties enter into a commercial arrangement, the rules are clearly set regarding who is responsible for what. They also provide something of an insurance policy, in that they should also set out what happens when problems arise, whether that be performance issues by one of the parties involved, or where something unexpected happens that takes everyone by surprise.
The Problem with Verbal Contracts
Many businesses take unnecessary risks when it comes to documenting their arrangements. Often agreements are done with a handshake, which is all very well when things go as planned. We often see this with start-up businesses – people want to show their trustworthiness by not requiring legal documentation. The problem with verbal agreements is that often when differences of opinion arise later on, people’s recollections of what was agreed to often vary considerably. Having an agreement properly documented avoids legal disputes down the track because, if the document is well prepared, most potential future problems have been identified and provided for in a clear way.
Verbal contracts will not usually contemplate a variety of terms and conditions that will be found in almost every professionally drafted contract. For example:
- While in some cases legislation implies warranties into a contract for the supply of goods and services, these generally only apply if the price is less than a set amount, or the goods are not provided for re-supply. As such if you are buying a large piece of machinery, or equipment to be on-sold you will likely have limited recourse against the supplier unless a properly drafted warranty is in place.
- A well drafted indemnity clause takes into account the ability of each party to control the risk of any loss or damage and apportions the liability for that risk accordingly. If this has not been considered and put into writing you may find yourself open to liability over which you have limited or no control.
- While we all hope that our contractual relations go smoothly, with a satisfactory outcome for everyone, the simple fact is that this does not always happen, just ask our litigation team. In such a case it is advantageous to have in place an agreed process for discussing and resolving any disputes, including requiring mediation. Without such your only option may be costly litigation where you could wind up having little or no say in the outcome.
Understanding the terms of a Contract
It sounds trite, but often we see disputes arise in circumstances where one party failed to fully comprehend the meaning of a contractual term.
When entering into a contract, consider carefully what you are hoping to achieve from it. You will have in mind some specific targets, perhaps regarding time of delivery, or quality of product or work. Be specific about these terms, and satisfy yourself that they are clearly and properly expressed in the contract.
The other party to the contract will also have specific targets in mind when contracting with you. These are the terms you need to be most careful of, as they will inevitably favour the other party, potentially to your detriment. As tedious as it might be, you must discipline yourself to consider these terms carefully and satisfy yourself that you understand the impact and effect of these terms to the same level of clarity and detail that you would insist upon for the terms that favour you.
The only airtight answer to this issue is to seek legal advice on the terms. When presented with a contract, discipline yourself to sit down and read each clause one by one.
Ambiguity in the wording of Contracts
The worst disputes tend to occur in circumstances where a contract has been drafted with such ambiguity that it can be interpreted in two different ways. Where the interpretation results in a significant difference to the rights and liabilities of the parties, one way or another, disputes are likely to arise. Inevitably each party will adopt the interpretation that most favours them. The problem with such a dispute is that where genuine ambiguity exists, until the court makes a ruling on the point, there can be no absolute certainty as to which interpretation is the correct one. The potential for this to lead to wasted legal costs is almost limitless.
We usually see ambiguity arise in contracts drafted by people without legal training (although lawyers have been known to mess this up as well!). We have a range of contracts drafted for all types of commercial transactions which have been ‘battle tested’ (upheld in court), and can provide them for a reasonable cost.
Be aware of the consequences of not properly documenting an agreement
In determining how closely you need to scrutinize a contract before signing it, you need to have an appreciation for the potential consequences if the contract is not drafted correctly. Most serious commercial contracts will cause significant loss to one party if the other does not properly abide by its obligations. For example, if you supply goods to someone who runs a business of selling them to consumers, you can expect any dispute over the contract to include a ‘loss of business’ component, which in the right circumstances can be shockingly high.
Before entering into a contract, consider the worst-case scenario mess-up. If the worst-case scenario is something that your business cannot afford to occur, it is probably worth speaking with lawyers to confirm the terms of the contract, and to ensure that your interests are protected.
In 2010 the Commonwealth Government passed the Competition and Consumer Act, which largely replaced the Trade Practices Act. Amongst other things, this introduced the concept of Unfair Terms in consumer contracts and when these might be found to be void. In 2016 these unfair contract laws extended to many small business contracts.
A small business contract is any contract which satisfies all of the following conditions:
1. The contract is for a financial product, supply of financial services, supply of goods or services, or the sale or grant of an interest in land;
2. At the date of the contract at least one of the parties employed fewer than 20 persons (which, in certain circumstances, may include casual employees); and
3. Either of the following apply:
- The upfront price under the contract is not more than $300,000; or
- If the contract is to last for longer than 12 months, the upfront price payable is not more than $1,000,000.
A term of a contract is unfair if:
1. It would create an imbalance between the parties;
2. It is not reasonably necessary to protect the legitimate interests of the party advantaged by the clause; and
3. It would cause detriment to a party if the clause was relied on.
The legislation also provides some guidance as to what type of terms might be unfair (e.g. granting one party unilateral rights to vary the contract, allowing one party but not the other to cancel the contract).
Of course, just because a clause falls within one of the examples in the legislation does not mean it will be unfair. Conversely, there have been cases where clauses have been found to be unfair, even though they are of a type not described in the legislation.
It is important to note some points regarding unfair terms:
1. A term being found to be unfair does not automatically invalidate a contract. If the contract is capable of being enforced without the clause then the remaining provisions stay in effect.
2. Certain terms are not capable of being unfair, including those which describe the subject matter of the contract (for example the amount being paid, or the goods being bought).
3. It is preferable to have a balanced, fair term in your contract, which can provide you with some protection, rather than a one sided term, which may be completely struck out.
4. The legislation will not apply to contracts entered into prior to the protections coming into effect, however it will apply to any renewal or variations of such contract.
5. Only a small business, or the regulator, can seek to rely on these protections. A “Big Business” party to a small business contract does not gain the protections of the legislation.
Our expertise in this area
We have decades of experience drafting commercial contracts in a range of commercial contexts, for both small and big business. We have developed advanced templates which ensure that all of the key issues ever likely to arise have been taken into account. We make it our business to listen carefully to our clients to understand the nature of the business because without understanding the business and industry in which it will operate, it is impossible for the drafter of the contract to protect against all of the relevant risks.
We often assist clients with the negotiation of contracts. The parties themselves will know the effect of what they hope to achieve in their agreement, but perhaps lack the legal understanding to create and negotiate a contract that achieves those outcomes. We can assist you in negotiating the terms of an agreement with the other party or their lawyers, to ensure a fair agreement that deals reasonably with the circumstances, and which is enforceable in circumstances where the other party is in breach.
We provide comprehensive agreements dealing with:
- Confidentiality, Distribution and Supply
- Partnerships and Joint Ventures
- Shareholders and Unit-Holders
- Building and Major Projects
- Buy/Sell and Exit Agreements
We also have many years’ experience in the litigation of contracts, so that if something goes wrong, and the other party breaches the agreement, we can provide strong representation to ensure that you receive what you are entitled to under the contract.