Chapter 5
Terms of contracts to keep an eye on
If it is in there, it is important
There are no unimportant terms of contracts. Every term has its use and place. If the contract goes well, some of the terms may never be relied upon by either party. An example of this is a clause terminating the agreement.
However, when negotiating and entering into an agreement, it is important to scrutinise all of the terms of the contract. Your vigilance should be heightened when you are provided with a contract already drafted by your counterparty.
In particular, closely review the clauses that are generally towards the end of a written agreement and look like ‘standard terms’. As already stated, there are no standard terms in contracts. There is no term that cannot be negotiated. On this basis there is no term that does not require your full and complete attention as to what it says, does and implies.
Set out below are some terms that look merely technical and logistic, but may in fact be Trojan horses.
This clause provides that some or all of the terms of the agreement will only become operational if an event or act occurs.
Example
A management company provides ‘integration services’. It assists two separate businesses that have merged or when one has acquired the other to integrate their systems, people and operations time and cost effectively. It may be that the services of this company are sought after. One of the parties may seek to enter into an agreement with the management consultant that if the merger or acquisition takes place, they will provide a precise set of professional services to facilitate it. However, the agreement contains a condition precedent. That condition precedent, or necessary event, is that the merger or acquisition actually takes place. If the merger or acquisition does not take place there will be nothing that the management company is obliged to do and nothing that the requesting party needs to pay for. In this context it would be unwise for the management company to spend too much time and money in preparing to meet contractual obligations that may never come to pass.
Contracts will usually include the basis on which they may be varied. Generally speaking, the only means by which a written contract can be varied is by agreement of the parties recorded in writing. This is because the contract sets out the way a variation must take place. Often the agreement is recorded in a formal document entitled something like ‘Variation to contract between X and Y dated 1 January 2007’. However, an exchange of letters may be sufficient to satisfy a variation clause that needs to be in writing. It depends very much on the words used in the clause. If the contract is well prepared it will generally not allow for any variation other than in writing. This is sensible. The primary agreement is in writing. So should the variation be. Also, it promotes certainty and allows the parties to clearly see what they have to do under it.
It is important to acknowledge a clause of this kind as you may not be able to vary the contract other than by written terms.
Example
Say you have a discussion with a representative of your counterparty. You believe you have agreed a variation of the contract. It is never put in writing. You rely on that variation in performing your obligations. It is alleged you have breached the contract even though you did what you thought was agreed.
The variation is unenforceable because it is not in writing. Here the opportunism of your counterparty may cause you to suffer genuine financial damage. While they in principle agreed to the variation, this is not recorded as required by the contract. This leaves it open to them to assert that no variation of the contract occurred given all the rules have not been complied with.
Variations can also be oral depending on what the contract says. But again, my prejudice for written contracts comes to the surface. The problem of uncertainty prevails in oral variations. A fight about the variation is generally the last thing you want.
You may need to make a decision whether the written agreement records the entire agreement between the parties. If you have taken the time and energy to put the agreement in writing, it generally should. This will ordinarily mean that an entire agreement clause should be added to the agreement.
The effect of an entire agreement clause is to ensure the parties acknowledge the agreement records all the rights and obligations that exist between them under the contract and that there is nothing outside the contract or any oral terms not set out in the agreement itself.
Entire agreement clauses can be extremely important if you are the stronger party to the contract or a buyer of a good or service. If you have done a good job in setting out in the contract what you want from the vendor and their obligations under it are clear, an entire agreement clause is a further strong protection for you. If the document has all you want, you are ordinarily best served by this type of clause.
It means it cannot be alleged that there are other terms and conditions that regulate the way the parties deal with each other under the contract. You have certainty. A clause in these terms will generally say there are no express or implied conditions, warranties, promises, representations or obligations in relation to the agreement other than those implied by law.
Example
A company enters into an agreement with a waste services organisation to dispose of its industrial waste. A short-form agreement is entered into. It has an entire agreement clause. The agreement provides for payment by the disposer on a per-tonne removal of waste basis. However during the negotiations a rebate system was discussed: after every 1000 tonnes of waste disposed it was agreed that the waste management company would pay a bonus of a further 10 per cent of the fees earned from that 1000 tonnes of waste. It is not in the agreement. Remember, it was in short form!
The customer makes a claim against the waste management company for the bonus. The waste management company says it was not agreed in the contract and they rely on the entire agreement clause saying the agreement sets out all the rights and obligations of the parties. It has put the provider in an extremely difficult position in seeking to enforce what it considered to be a contractual right. They probably cannot. The entire agreement clause works against them.
While one can never say ‘never’ in this situation, the court will generally say the entire agreed clause is there for a reason and therefore will uphold it. The provider would in all likelihood have to show deceptive practice by the customer. This is hard.
The parties in an agreement will usually decide which legal jurisdiction will govern the contract. If it is a contract between two interstate Australian entities, they may decide on a particular State or Territory. If it is a contract between international parties, it is necessary to decide which country’s jurisdiction will be the relevant one for the determination of disputes. This is a clause that may be critically important in the event of a dispute under the contract. It seems immaterial at the time of entering into it, but legally speaking will be of profound impact if a dispute develops.
Example
An Australian company enters into a contract with a Dutch software company. The Australian company manufactures telecommunications hardware. The Dutch company makes software that is an application on the hardware made by the Australians. They enter into an agreement where the Dutch company is to provide the Australian company with software for a set fee. The Dutch company provides the software. The Australian company then forms the view that the product is not fit for its purpose and the Dutch company has not complied with its contractual obligations. However, the contract has a clause that Holland is the proper jurisdiction of the contract. The Dutch company had delivered to the Australian company its standard terms and conditions which, without a lot of thought and consideration, the Australian company had signed.
The Australian company seeks to assert a dispute in Australia. The Dutch company relies on the governing law clause.
It is necessary for a court to determine whether the governing law clause prevails and whether Holland or Australia is the proper jurisdiction. The court will look closely at the negotiation and the term of the clause itself to decide what the parties had intended. Importantly, the court will seek to give effect to what the parties intended. It will not decide on a parochial or nationalistic basis for the convenience of one party or the other.
Joint and several liability clauses
Often an agreement will have a term that says if there is an obligation that binds one or more people or entities they will be liable for the performance of that obligation jointly and severally. If there is an obligation binding two or more entities under a contract, it is possible that the counterparty can hold one of those people alone liable for the performance of that obligation. They do not have a proportional liability. This means that because there are five people all with ‘one’ liability it does not mean they have a responsibility for 20 per cent each. They may be obliged to perform all of that contractual obligation irrespective of the others.
Example
A retailer contracts with a business owned by three individuals (not a company) for updated sales training for its staff nationwide. The training will be expensive. It will involve the trainers travelling to various stores and retail centres around the country to train staff. As a term of the contract, if there is any breach by the trainers, an agreed amount by way of damage is to be paid by them. Certain types of breaches are set out and the amounts they need to compensate the company for those breaches are express in the agreement. There is a joint and several liability clause. This means that if there is any breach and these damages clauses are aroused, the company can pursue any one of the owners to the exclusion of the others, or all three together. Their liability may be separately or together. It enhances and increases the flexibility of the company in enforcing its rights to specific performance and the damages clause.
Again this is very important when you have a joint venture type of agreement or agreement with counterparties whom you do not control. Breaches of the agreement by them may cause you to assume a much greater obligation and liability than you had intended at the outset.
If you are uncertain about your commercial partners or those on ‘your side’ of the contract and have doubts about their viability and willingness to see the contract through, you should avoid a clause like this.
On the other hand if you are contracting with a number of entities, you should incorporate as far as possible joint and several liability clauses. It means each of the entities will be liable for the entire breach.
Indemnities are safety blankets given by one party to another under a contract. One party says to another that it will ensure the other party suffers no actual loss under the contract arising from its conduct. Generally indemnities set out particular circumstances in which the indemnity applies.
Example
Fast Taxi operates a taxi network in a major metropolitan city. It enters into arrangements with various vendors of goods and services around the city that a 10 per cent reduction will be given on their goods and services for customers of the taxi service. This is regarded as an attractive value-add to encourage more passengers to travel on the service. The vendors of goods and services see it as an important marketing ploy to increases sales. One of the vendors of goods and services is a museum. A passenger of the taxi service relies on their discount to enter the museum. As they enter the museum the passenger slips on a spilled drink and their head collides with the marble floor. They suffer a serious brain injury. They sue the museum and the taxi service for negligence.
However, happily for the taxi company there was an indemnity in the agreement. The vendor agreed to indemnify the taxi company against demands against it arising out of its performance of its obligations under the agreement that are suffered by a third party or another person. It relies on this indemnity. It succeeds and has no actual liability in relation to the claim.
In this example the indemnity serves as an insurance policy for the taxi company. Any damages and liability it suffers shall be met by the museum on the basis of the indemnity.
Indemnities can be extremely useful when there is a risk of a third party liability arising. That is, a liability to someone who is not in the contract. That liability can be by breach of contract, infringement of the Trade Practices Act, personal injury, defamation or any other type of liability that may arise. The key here is to draft the indemnity clause in the broadest possible terms so as to offer the widest protection.
Regularly in contracts involving companies, a party will seek a guarantee from the shareholders, directors or officers of the company entering into the contract. It is possible to trade with companies that have very limited assets and that offer those controlling the company great protection from personal liability.
Example
A large commercial landlord enters into a lease over office premises. The company lessee is without assets. It is not insolvent, however, in the event it is sued and a judgement made, no money could be obtained in satisfaction of the judgement because the company has no assets to be realised. The landlord seeks a guarantee from the directors of that company that if there is any default under the lease they will stand in the shoes of the corporate tenant and make good personally any loss that the company has caused. It places the company’s liabilities in their hands. It protects the landlord if the company does not perform its obligations.
In order to protect their position, a counterparty to a contract with a company may seek guarantees from the individuals standing behind the company so as to make sure they assume liabilities for the company under the contract if they arise. This should focus their minds more on performing the contract to the letter and not breaching it. It will mean they are personally liable for any breaches.
As a matter of law, the company and its officers and directors have separate legal identities. They are not one and the same. A liability against a company is not a liability against its directors and shareholders.
An important part of a clause in these terms is that the counterparty may be in a position to compel the directing officers of the company to give a guarantee where they effectively stand in the shoes of the company in the event of a liability. Because of the fragile commercial situation the company has, they may not be willing to do this. However, if they sign a contract undertaking this obligation, their counterparty may be able to get specific performance of it. That means a court may compel them to execute a simple-form guarantee.
By a failure to closely scrutinise the contract and understand the guarantee clause they may unwittingly enter into an obligation that they do not want to have but cannot get out of. On the other hand no guarantee means great risk for the other party if the company goes under.
One or the other party may seek that the agreement be confidential. Often it is not necessarily in both parties’ interests to maintain that the agreement be confidential. It is important to consider whether confidentiality is something that is in your best interest. Equally, if you would like to shout from the rooftops that you have a contract with a particular entity, do you renege on the deal if they insist that the agreement be confidential?
It is important to look at why you are entering into the contract. If it is a ‘flagship’ contract it may assist you in marketing. If the other party wants to keep the existence of the contract confidential, this may make it less appealing.
Example
Big News PR firm does a deal with a major merchant bank to handle its public information management and corporate reputation. The bank is very image conscious. As a matter of policy it does not like its counterparties publicly stating they have it as a client. The bank insists that the existence of the contract be confidential. That means no disclosure about it. This goes against what Big News wants to do. It sees this contract as marquee business and it wants to provide this relationship as a means of getting bigger and better work. It wants the radiated glory of the success of the bank. The bank makes lots of money and Big News wants to be able to tell people it acts for an entity that makes lots of money. It considers the fact that the bank has chosen it to be a great vote of confidence that others will also give. This was a major part of the benefit Big News thought it would get when entering into the contract. Now it won’t get it. Is the contract still worthwhile? This is the question for Big News. The rates are bad and the bank wants the world for a song.
The other type of confidentiality relates to the terms of the contract only. This may mean a party wants to keep certain confidential terms undisclosed. This may be for a kaleidoscope of good commercial reasons.
Example
Reliable Car Rentals does a deal with Clear Air, a domestic airline. It offers rebates to Clear Air for referrals and enters a marketing joint venture. Reliable wants people to know about the relationship generally. It does not want other businesses to know about the rebates. It has preferred-user deals with a number of large hotel chains without the rebate. It knows they will ask for the same deal if they know about it. Reliable does not want to offer it, so it incorporates a term of the contract that the rebate is confidential and not to be disclosed by Clear Air. The agreement in its other terms must be promoted publicly for its success.
Warranties are an important part of commercial contracts. They generally involve a party giving clear representations as to facts. Generally speaking, those warranties relate to the commercial state of affairs a contracting party has as at the time of entering into the contract.
Example
Big Storage Pty Ltd seeks to buy Little Storage Pty Ltd. In the contract Little Storage warrants that the accounts as at 30 June 2007 are accurate and valid. Further, it warrants there are no liabilities to any director or shareholder of Little Storage.
The sale of the company is completed on 1 August 2007. After getting the books and records, the people behind Big Storage realise there is a great deal more money in the bank accounts as at 30 June 2007 that was not recorded in the accounts. In addition, significant slabs of money have been paid as loans to the shareholders of Little Storage after 30 June 2007. The warranties have been breached. Big Storage makes a claim against Little Storage for breach of those warranties.
It is critical that you ensure that warranties are absolutely factually accurate. It is a high-stakes game to give warranties that are not absolutely and clearly true at the time of entering into the contract. Your counterparty will rely on those warranties on entering into the agreement. Those warranties not being absolutely correct may cause you a significant liability if you are anything but full and frank.
If you cannot give a warranty in the terms requested that is satisfactory, do not give one at all.
There are various ways in which warranties can be crafted so as to ensure they are accurate.
The wording of warranties is often an area of prolonged discussion. This is because the party giving the warranty needs to make sure what it says is precisely and absolutely true and as narrow as possible.
The court will strictly construe the warranties. That is, it will look at what the warranty precisely says and means. On this basis the more precise the warranty, the more limited the fact you are asserting. As a consequence, you are in much better shape in proving that warranty was not false and was at all material times true.
Sometimes in contracts parties will regulate the way in which disputes are to be dealt with. Again, these clauses seem innocuous when negotiating into a contract but may become extremely important when a dispute arises. There are generally three ways disputes are resolved:
1 mediation — a formalised negotiation at which neither party is ordered to do anything but it is hoped that a settlement can be reached
2 arbitration — court-like proceedings where a decision is imposed but not by a judge
3 court proceedings — a judge hears the dispute and determines who is in the right or wrong.
Each of these dispute resolution mechanisms has important benefits and disadvantages. It is important that you closely consider these benefits and disadvantages in deciding which of the dispute resolution mechanisms potentially fits your needs best. I deal with some mechanisms below.
This decision is generally best made with your lawyer who is probably more familiar with these strategic considerations.
A party may waive all or part of its rights under a contract. Waiver of rights means the party does not insist on the strict performance of an obligation in the terms of the contract or it gives up its right to enforcement of that term at all.
Waiver of contractual terms occurs extremely regularly in modern contracts. This is because the party to the contract at the outset cannot contemplate all of the swings and roundabouts that they may be subject to during the contract. Waiver is a flexible way in a good contractual relationship of ensuring the needs of the supply of the good or service can match the wants of the buyer.
Contracts regularly have clauses that either:
- set out that there will be no waiver of any rights under the contract except made in writing — this means that if there is any oral waiver or otherwise it is a matter that needs to be confirmed by a document ordinarily signed by the party waiting
- stipulate that any indulgence granted by one party to the other during the course of the contract does not constitute a waiver of a right or constitute a variation of the contract
- specify that no partial exercise of any power or right stops the party insisting upon the strict terms of the contract in future.
In these contexts the waiver clause has two purposes. They are to ensure:
1 no waiver occurs without writing for the purposes of clarity of communication
2 any indulgence granted by one party to another is not an implied waiver of contractual rights. It may be a one-off instance but not create a new mode of conduct.
While this sounds like a medical term, it can be an important aspect of contracts. The law changes from time to time. What may constitute a valid enforceable contractual term today may not be so tomorrow depending on the decisions of a court or any legislation enacted by Parliament.
On this basis it is important to corral, or sequester, terms of the contract that become unenforceable from the document as a whole. This means any term of the contract that cannot be put into action as a result of changes to the law does not infect the other contractual terms or the whole agreement itself. In this sense, the term that is in breach of the law becomes severed or excluded from the contract.
It can be useful in certain contracts to expressly state that if a term is unenforceable all other provisions that remain valid at law remain of full force and effect. It is only the term of the contract that falls foul of the law that is severed or excluded from its operations.
This can be a useful device to ensure that the rights and obligations you have under the contract remain binding even if one part of it becomes unenforceable.
Fundamental terms are the most important terms in the contract, as the name suggests.
The breach of a fundamental term gives rise to a right to terminate the contract in the hands of the other party. A breach of an ‘inessential’ or non-fundamental term only gives rise to a right to sue for monetary damages.
There is a general guide at law as to what are fundamental terms and what are not; however, the dividing line is never clear. Whether a term is a fundamental term or not depends more broadly on the subject matter of the contract, the contracting parties, their intentions at the time of entering into the contract, what terms are necessary to make the contract work as a commercial instrument and what the term itself does.
In certain circumstances it may be useful to identify the fundamental terms of the agreement to avoid uncertainty. A clause of this type would identify the parts of the agreement that would give rise to a right to terminate the contract if breached. A clause like this would work in tandem with a termination clause.
However, you need to closely consider whether a fundamental terms clause is to be to your benefit or otherwise. It will generally not be to the benefit of the supplier of the goods or services. They will want to maintain some flexibility.
On the other hand, for the purchaser of a good or service predictability as to delivery is essential. In the event of delay or some other quirk in the delivery of the good or service, the purchaser may wish to keep its options open to terminate and the clause should contain broad rights in this service.
This is an example of an innocuous-looking clause in the agreement that may have fairly severe consequences for one or other party depending on whether it is incorporated in the contract and the precise clauses identified as being fundamental terms of the contract.
This clause binds future parties to the contract.
Successors at law are those who buy your company business or take control of it in the future. It also applies to individuals.
Assigns are entities or people to whom you have given your rights and obligations under a contract.
A clause in these terms states the parties agree that the benefit and obligations in the contract bind successors and assigns of both parties.
Example
Speedy Couriers runs a delivery service for parcels and packages. It has developed a reputation for fearless speed and accuracy. It is taken over by National Couriers. National Couriers is the leading courier company across the country.
Speedy has a contract with Grafix — a graphic design company. It delivers plans, diagrams and other work done by Grafix to its clients in the city on a daily basis.
Speedy is to be sold to National Couriers.
There is a general master agreement between Speedy and Grafix. It contains a successors and assigns clause. That means that all of the contractual benefits Grafix gets from Speedy will transfer to National, the new owners of the business.
Variations to agreements are part of commercial life. They need to be agreed by both parties. It is generally not possible for one party to unilaterally vary an agreement — that is, without the agreement of the counterparty.
It is possible to set up in your contract the way in which a variation of the contract may take place. Generally speaking, if the contract has been properly negotiated and is fully set out in writing, the agreement records that any variation to it must also be in writing. The clause may also set out the manner in which the variation is to take place. This can be by a further agreement or deed. Alternatively, it may be merely by exchange of letters. This is an important matter to turn your mind to at the outset. You do not need to mandate or forecast what the variation may be. All you have to do is to make sure there is provision in the agreement for a variation to take place and how you think this should happen.
While it seems a boring and mundane issue, it may also be important for a regime to be constructed where one party is to give the other notices under the contract. This is particularly important when notices of breach are in play. Otherwise, notices as to variation of the contract or for any other purpose are often better delivered by an agreed and structured method. It avoids any dispute down the track based on ‘I told you about that’ by an informal means. It also regulates the flow of information under the contract so that anything important becomes notified in a structured and proper manner.
Generally notice provisions regulate:
- the manner in which notices can be provided (hand-delivered, sent by mail, fax or email)
- that a notice is given if it is delivered in a certain way (by one of the means set out above that can be proved by evidence that dispatch actually sets out the identity of the person to whom the notice should be sent and relevant contact details).
If the contract is one in which there are likely to be notices, it can be really important that the information is delivered strictly within the terms of the contract. On this basis you may have an extra clause saying that a notice not delivered in the approved manner is of itself invalid as a notice to give rise to rights under the contract.
Example
Sure Logistics has a contract with Fresh Food Supermarkets. The contract has an exclusivity term. That is, Sure must only provide logistic services to Fresh Food. Sure wishes to enter into an arrangement with a larger supermarket chain. To do so, it is necessary for it to terminate its contract with Fresh Food. The managing director of Sure sends an informal email from his Blackberry after a meeting with the new contracting party telling Fresh Food that it has ended its relationship.
However, the contract provides that a formal notice of termination must be delivered providing 30 days’ notice of any termination to Fresh Food CEO on Sure letterhead and signed by the MD.
Fresh Food, in its desire to find a replacement logistic service provider in the interim, contests the termination. It says that the termination was not properly executed because a notice was not validly sent. Sure had not honoured the terms of the agreement in the manner in which it sent the notice.
Assignment clause
Broadly defined, an assignment is the transfer of rights or interests in a contract to another party.
There is a significant body of law on rights and entitlements that transfer under an assignment.
There are two ways assignment clauses are used in general commercial contracts:
1 a prohibition on the contract being assigned, attempting to stop this taking place
2 assignment generally being permitted by the party not being able to reasonably refuse consent to the assignment.
Some contracts are not susceptible to being assigned. This is particularly so if there is a service of a quality or character being provided by one entity to another. It may simply not be possible in the market to get someone to replace your service provider at the same level of skill, quality and experience. In this context it may be appropriate to enter into an agreement expressly precluding assignment by either party of the contract. It is, and was always intended to be, a contract between the two parties only. There is no intention for any replacement of either party. If one or the other cannot buy or deliver the service, the contract will be deemed at an end or some other arrangement reached. This is important in the context of drafting your termination clause.
Notwithstanding the above, a halfway house can be reached. It may be that assignment can take place with the written consent of the other party. While this generally conforms to the position at law, it still may be useful so as to be absolutely clear to indicate in the agreement that an assignment of a right cannot take place without the prior written consent of the counterparty. This is the type of clause you would add when you have a good relationship with your counterparty and do not think they will be difficult if you wish to try to assign your rights and obligations under the contract to someone else in due course.
If you anticipate that the relationship may not be eternally harmonious you may wish to have a clause that allows you to assign the rights and obligations on notice. The counterparty will be bound to consent to the assignment acting reasonably. This basically means if a contracting party of a similar size, quality and nature to you can be sourced by you as your replacement, it will ordinarily be difficult for your counterparty to reasonably not consent. The general rule here is, all things being equal, a clause like this facilitates the assignment taking place.
A force majeure clause can be more colloquially referred to as ‘an act of God’.
It generally means that circumstances beyond the reasonable control of a party occur that prevent them from performing their obligations. However, if they have any fault or any negligence in the event occurring, they cannot generally seek the protection of the force majeure clause.
Example
Swift Sneakers are a sneaker manufacturing company. They are riding the crest of a fashion wave and their products are in high and insatiable demand. While their design and marketing takes place in Australia, the manufacturing of the sneakers occurs in a large purpose-built factory in Bangkok.
They have undertaken joint marketing with a number of substantial retail stores and promised a new range for the upcoming spring fashion season. This requires them to have shoes manufactured and delivered by August.
The manufacturing process is well under way in mid May. However, overnight there is an explosion at the factory and it burns down. The factory and everything in it is destroyed. This means that Swift will not be able to honour their contract with retailers. This will be a source of concern for retailers because they have marketed Swift as being one of the up and coming brands and have considered them to be a big attraction for shoppers. Retailers indicate they will lose sales and foreshadow a damages claim.
Swift, very wisely given its business circumstances, incorporated a force majeure clause in its standard terms and conditions with the retailers. It invokes this clause to explain its breach of contract and as a consequence relies on the term that allows for the suspension of its obligations until the circumstances giving rise to the unfortunate event can be resolved.
The elements of a force majeure clause are generally as follows:
1 A definition of what a force majeure event is — generally it is defined in the inclusive way. That is, it can be any event that stops business but includes things like strikes or industrial action, war, governmental legislation or orders, quarantine or customs, a natural disaster or similar calamity outside the control of the parties.
2 Sets out what are the consequences of a force majeure event occurring — this is usually suspension of the contractual obligations or immediate termination of the contract and would depend largely on the parties and subject matter of the contract and the commercial circumstances in which the contract takes place.
3 The procedure a party seeking to invoke a force majeure must employ immediately the event arises — this generally means an agreed form of notification and can also contain an obligation that it must promptly and efficiently and as soon as possible restore itself to a position where it can perform its contractual obligations in the event they are suspended and the contract is not terminated.
Sometimes it may be appropriate to try to tie in a contracting party exclusively. This is particularly so if you think you are given a competitive edge by the sole ability to exploit their resources and skills. While the Trade Practices Act has a lot to say about matters of this kind, there are ways in which this can be done without infringing that statute.
This however is a matter that requires precise legal advice and a detailed consideration of all the facts and circumstances in relation to the proposed deal.
Given the powers of the ACCC a badly worded or ill-devised exclusivity clause may see a dawn raid on your offices seeking to extract information that the ACCC alleges constitutes anticompetitive conduct. This is obviously an event to be avoided. Exclusivity, while it can be extremely useful, needs to be looked at in the context of the relevant law at the time the contract is entered into.
Restraint of trade or competition
As with exclusivity, restraints of trade or competition can be a valuable tool to protect your business and confidential information within it.
It is important to bear in mind there are two levels of restraints in the ordinary course of business. They are:
1 a restraint on the employee or competitor from competing in the same field of business
2 a restraint on the use of confidential information obtained by the employee or counterparty in the course of the contract.
The first of these restraints is very difficult to uphold without compensation. That is, if you wish to take out your counterparty from the market for a period of time, the law generally considers this unfair if you have not paid them for this period of time. You are seeking to deny them their income-earning capacity without making good their loss.
The second form of restraint of confidential information is more readily enforced but relies generally on a precise and appropriate definition of what constitutes the confidential information in the commercial context. This is a matter in relation to which you should pay a huge amount of attention on entering into a contract. Where you think your counterparty will have information in their hands that, if used against you, removes your competitive edge or diminishes your ability to keep your market lead you need to identify it clearly.
I can’t emphasise enough that precision is crucial. The more detail in which you can identify the categories of information and, if possible, the pieces of information themselves, the better position you are in to identify clearly in the contract what the other party cannot use.
Again, restraints require delicate drafting. It is a matter that you should closely consider.
As a rule of thumb, the key is not to be greedy. Seek a restraint that you honestly and genuinely believe you need to protect your business. Do not ask for anything more. If push comes to shove and you are forced to test the restraint in court proceedings it will be necessary for you to, generally on oath, indicate why the restraint is needed. In my experience, courts form an adverse impression of a party if a restraint is drafted high, widely and handsomely where something far more limited and, in all the circumstances, fair is adequate.
Just as it may be important to include warranties in the agreement, you can expressly exclude them.
It is generally not possible to exclude the implied warranties incorporated by law. These are imported into every contract as a matter of law. The Parliaments of the Commonwealth and of all states have decided that contracts should have these terms. It is not possible for you to decide that you don’t like the look or taste of those terms and therefore to exclude them. You may set out in the agreement that nothing in it seeks to restrict, modify or vary any condition, warranty or liability that may be implied by certain acts. However, you don’t have to as the law operates in this case anyway.
Putting aside these legally imposed warranties, it is possible to exclude any warranties to the agreement if they are not given within it. A clause of this kind would say clearly that there are no implied conditions, statements or warranties about the quality or nature of the goods or services supplied. They are intentionally and overtly excluded. As a corollary, it may also be important to say that the party excluding the warranty will not be liable for any claim for a breach of the warranty when in fact it has not been provided. Even better, it has been expressly and deliberately excluded.
Statement of no infringement of third party rights
Sometimes, and depending on the nature of the business conducted by your counterparty, you may want them to expressly state in the agreement, in the nature of a warranty, that they do not infringe any third party rights, be those rights in the nature of intellectual or personal property.
Clauses of this kind are regularly used where your counterparty employs intellectual property or software licence rights in the course of the contract. You may want an express warranty from them that there is no breach of the rights of any third party and that all relevant licences are issued and held by the contracting party so as to ensure:
- they can perform the contract and will not be the subject of any litigation for claims for breach of any rights that will in turn cause them to be unable to perform their obligations under the contract
- avoidance of any allegation that you have been complicit in a breach of intellectual property or other rights with them and therefore yourself open to a claim.
While this clause is not absolutely necessary, it is a failsafe and classic safety net type of provision. It serves as a statement by one party to another of the state of affairs.
This is a highly important clause.
As we discussed in the springboard–safety net distinction, no party enters a contract hoping for the worst. People in business have a degree of confidence about their ability to cut through the stormy waters and make sure the relationship stays strong. However, there are instances where this does not occur. You cannot unscramble an egg.
In this context a termination clause becomes often the focus of great scrutiny for and on behalf of a party seeking to get out of the contractual relationship.
A lot of time and energy needs to be devoted to the terms of this clause prior to entry into the agreement. The ‘get out of jail’ is as important as the steps through the gates of heaven.
There are many ways to draft a termination clause.
The key matters to bear in mind in the process of considering such a clause are:
- What do I need as a matter of commerce in order to get out of the contract?
- What do I need to do to exit this contract?
- What are the business implications for me?
Depending on the answers to each of these questions you will be in a position to decide whether you want a ready ability to terminate the contract or are happier for there to be a longer exit period.
Never assume that the right to terminate in a termination clause is the same for both parties. It is a regular device used by providers of goods or services proffering ‘standard terms and conditions’ that they have a ready and easy right to terminate the contract often on a very short period of notice whereas the purchaser can only terminate for breach of a fundamental term and only after giving the supplier 30 days or more to remedy the breach.
Here is clearly a substantial inequity of termination. On the one hand the supplier can go when it wants. The purchaser, however, must identify a fundamental breach, give the supplier an opportunity to remedy it and if it can’t, only then terminate. This is often in the context of there being a fairly poisonous relationship with the supplier for the period between when the breach is notified and the time when its remedy expired. If the supplier scrapes in and fixes the problem at the last minute, a tense tone in the relationship may prevail.
Looking from a distant and broadly moral perspective, clauses in these terms are unfair. They confer a greater flexibility and dexterity to one party over the other.
There is no necessary reason for this. In most contracts there is no such an apartheid of rights. It is all about the negotiation and bearing in mind the safety net.
Example
EDU is an online education course provider. Wide is an internet bandwidth provider. EDU and Wide enter into a contract for Wide to facilitate EDU in providing online educational services to its customers.
They enter a contract that provides Wide can terminate the contract on 30 days’ notice. EDU must continue to use the services for those 30 days and Wide can invoice up to and including the last day on which the contract is in force. On the other hand EDU can only terminate the contract if there has been a fundamental breach of it by Wide (which specifically arises only through circumstances in the contract itself) and must provide Wide with 60 days to remedy any breach before the termination is triggered. That means from the date of the notice until the period ends there may be conceivably 61 days in which the breach prevails and an inadequate service by Wide is maintained. There are no clear set-off rights in the agreement for EDU not to pay or to pay a lesser amount to Wide.
This contract is all about being one-sided. It is somehow worse that the one-sidedness was supervised and, implicitly, endorsed by EDU! It did not even try to negotiate a better deal. It probably skimmed the termination clause and assumed the same rules applied for either party. It wishes to get out of its contract and has a serious problem.
The court will generally uphold a termination clause like this. It will consider that, if the parties turn their minds to an issue of this kind, what they have said in the agreement reflects the way in which the deal is to be done.
It may be possible for the parties to agree the consequences of the breach or termination. However, legally speaking, you are swimming in possibly troubled waters in this context. It is very important that you precisely identify what the likely or anticipated consequences of the breach will be for you. You should avoid imposing a penalty in the agreement on the other side for breach giving rise to termination. This will not be upheld by the court. A penalty is a failure to pre-estimate the damage you will suffer and merely an attempt to extract a windfall from the other party.
Example
The Sydney Scallops football team hire a pontoon boat for an end-of-season trip. They agree in the hire agreement to a damages clause. If it is necessary for the pontoon owner to fix any damages after the cruise, it can charge the club no less than $15 000 for those repairs, no matter what they are. During the course of the cruise, and notwithstanding the impeccable behaviour by the footballers, a rail is broken.
The pontoon owner sends an invoice to the club for $15 000. The club raises a query about the invoice. The pontoon owner relies on the contract clause. In actual fact the railing cost only $250 to replace.
The pontoon owner in a moment of contractual bravery sues the club for the balance of the money ($14 750).
The general test the courts apply in relation to deciding whether a contractual term is a penalty or otherwise is to:
- consider the damage that the party actually suffered
- look at what the clause says
- decide as to whether the clause, in the context of the damage, is extravagant and unconscionable.
The key in liquidated damages clauses is to do as much research and due diligence as you can to ascertain what your likely damage is to be if there is a breach of the contract. In many forms of contract this is just simply not possible. On that basis it is often unwise to include a liquidated damages clause if you have no reasonable grounds for forecasting either:
- the range of the likely breaches
- what the commercial consequences of those breaches are to be.
Sometimes parties need to do further things and execute further documents in performance of their contractual obligations. The contract should contain a term which is a general undertaking from one party to another saying they will do whatever else is reasonably necessary to put the terms of the contract into place.
Example
John sells a hot dog shop to Jim. As a term of the Council Development Consent, John needs to assign to Jim his rights to run the hot dog shop and his hot dog vendor’s licence. This is not referred to in the sale agreement. Jim realises this one month after he buys the hot dog shop and gets a visit from the council inspector who threatens to close him down.
Jim contacts John and requests he execute an assignment form. He relies on the further assurance clause in the contract in which John agreed to do all things further in order to put the contract into place. Honestly and subject to his contractual obligations John executes the document.
The goods and services tax has been in place since July 2000. Clauses of this kind in contracts appear extremely dry and uninteresting. However, they can have very serious implications. This is a matter you should address with your accountant in detail. It is extremely important that the GST clause reflects the position you wish it to have. The key is ascertaining who has the liability to pay the GST. Secondly, if GST is levied does one party have to account to the other? If so, how? These are all important questions that need to be negotiated and reflected in the agreement clearly and unambiguously.
The above list is not intended to be comprehensive. There is a vast range of contractual clauses that parties may seek to insist upon that are ancillary to or seek to flesh out the rights and obligations of the parties under the contract. The terms of those clauses are highly important.
They have the capacity to be Trojan horses. Look at them closely. Decide whether you are happy with their terms. If you are not, do your best to renegotiate them. On the other hand, can you do a better deal on those clauses even though they are acceptable in principle?
Again, all terms in a contract are up for negotiation. Depending on the goodwill of your counterparty, the possibility for drafting a deal is endless!
What you need to add largely depends on the subject matter of the contract.
You may need to obtain government approvals in order to do the deal. You may need to insert condition precedent clauses. These will need a separate contractual term dealing with the steps the parties undertake.
I have set out the regular and ordinary clauses that a commercial contract may have. However, the more complex the contract, sometimes the more detailed and complex the clauses need to be. In this context you should work closely with your lawyer in order to make sure the contract addresses all relevant matters to keep the equilibrium between the springboard and the safety net!