Commercial litigation often occurs as a result of common and recurring mistakes that are made during the drafting and negotiation of contracts. Businesses that are conscious of these can significantly reduce their risk of litigation. While a good lawyer should be doing all this for you in the background, as a business owner or manager it is worth understanding the importance of, and expertise involved in sound contract preparation.
1. Investigation and Due Diligence
While most companies carefully evaluate the financial part of the deal, a surprising number fail to adequately study their prospective business partners. A credit search should indicate their financial viability, and importantly a litigation search may alert you to companies with a high likelihood of contractual disputes. More important than the number of suits involving them, is the nature and type of conduct that led to the litigation.
Due Diligence should be thorough no matter how hasty businesses are to sign the contract. Where it is impractical to perform a complete investigation, a risk benefit analysis should be performed to decide the scope, and parties could consider including provisions if representations or other contractual assumptions turn out to be incorrect.
2. Legal Review and Approval of Contract
The temptation to enter into contracts without having them reviewed by a lawyer can be particularly strong when contracts appear simple and straight forward. In most instances paying a lawyer to briefly review a contract is an investment that pays for itself. It can be the ambiguity in “simple” contracts which leads to disputes down the track.
3. Define Terms Well
Contracts should contain well-defined terms and clear provisions. Whenever a party seeks to avoid contractual obligations, their first approach will be to find contractual ambiguities. While it is impossible to entirely eliminate that risk, careful drafting avoids creating loopholes and increases the likelihood that contracts will be fulfilled as intended.
4. Include a Choice of Law Provision
Where contracts involve parties or operations from different states, it is important to note within the contract which state law will be used to govern the contract.
5. The Written Contract is the Final Expression of the Agreement
Typically a provision stating that the written contract is a final expression of the parties and that the agreement supersedes all other prior communications should be included. This makes it more difficult to argue that there were side agreements or other understandings.
6. Executing the Contract Correctly
Correctly signing a contract on behalf of a company is more than a formality. If done incorrectly, for example if signed by someone without the correct authority to do so, the contract becomes unenforceable. There are risks for the signatory too. If an individual signs a contract on behalf of a company without required authority, but represents that they do have that authority, the signatory may be personally liable for fulfilling the contract.
7. Ensure Contractual Compliance
The final and often most serious mistake that businesses make is that they merely file a contract away and go on with business as usual. Executed contracts should be forwarded to the managers and employees responsible. Companies should verify that its managers and employees are fulfilling the requirements of the contract.
We strongly suggest using an experienced commercial lawyer to at least review even simple contracts before they are executed, to avoid very costly litigation in future. For advice contact myself or Angela Boyd.