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A well-written contract is a useful tool in many business relationships. Some commonly used commercial contracts include shareholder agreements, commercial leases, supply contracts, indemnity agreements, security agreements, asset or share purchase agreements, confidentiality or nondisclosure agreements and partnership agreements, amongst others.
While a contract does not always need to be in writing to be enforceable, this is a good practice for business relationships to ensure there is a clear understanding between the parties.
Here are a few tips to keep in mind when entering into a commercial contract:
1. Don’t Forget the Basics
For any contract to be binding, the following three elements must be present:
- Consideration: Each party to the contract must give and receive something. The consideration can be something given in the present or the future. It cannot be something that was previously given.
- Capacity: Each party to the contract needs to have capacity to enter the contract. Minors or persons with certain types of mental disability may not be able to enter into the contract. This principle helps to ensure that there is equality in bargaining power between the parties.
- Compliance: Legal formality requirements need to be met. Certain types of agreements need to be in writing and signed by the persons to be bound – this is a good practice to do regardless.
2. Negotiate Clear Terms
The fundamental terms of the contract should be negotiated with the other side before the formal contract drafting begins. These terms can then be used as a guide for drafting.
Ensure that all of these terms are included in the final draft as terms can be intentionally or unintentionally excluded throughout the drafting process. Many contracts contain a clause that voids any previous agreements as to terms in favour of the final contract terms. This is usually covered by an “Entire Agreement” clause.
3. Use Unambiguous Language
It is best to use plain language wherever possible and avoid the use of legal jargon.
Ambiguous language in the contract will usually be interpreted by the courts in favour of the party who did not draft the agreement pursuant to the contra proferentem rule. However, this may not necessarily be true where both parties are sophisticated and are of equal bargaining power.
4. Clearly Define Terminology
All unclear terminology used in the agreement should be defined in a schedule to the contract or at the beginning of the contract.
For example, the term “sole discretion” has resulted in unfavourable court decisions because it is too broad. In Data & Scientific Inc. v Oracle Corp, the Court looked at the interpretation of a business agreement which stated that the agreement could be renewed annually at the “sole discretion” of one of the parties. The Court determined that discretionary contractual power must be exercised reasonably.
It is better to clearly define the situations were a party may choose not to renew the agreement rather than leave it up to the Court to decide if the party acted reasonably in their decision.
5. Draft the Contract at the Outset of a New Business Relationship
While verbal agreements are still common in business arrangements, putting the agreement in writing at the beginning of a new venture helps to ensure there is no miscommunication or misunderstanding between the parties.
Additionally, it is better to negotiate terms while the parties are on good standing than to wait until a dispute arises.
6. Ensure Restrictive Covenants are Reasonable
Restrictive covenants that prohibit certain activities, such as non-competition clauses or non-solicitation clauses, are commonly used in commercial contracts. However, these clauses are not always enforced by the Courts.
Typically, restrictive covenants that are limited to a reasonable time period and geographical location will be upheld by the Courts, whereas overly broad or lengthy restrictive covenants that constitute restraint of trade may be considered void by the Courts.
7. Plan for Dispute Resolution
Creating a plan for dispute resolution can save contractual parties considerable time and legal fees if a dispute arises. Contracts can stipulate speedy and cost-effective alternative dispute resolution procedures, such as mediation or arbitration, to avoid commencing formal litigation. Dispute resolution clauses must be carefully drafted to ensure enforceability, especially if the parties are located in different jurisdictions. The clause must be explicit about what types of disputes are or are not captured by the dispute resolution clause.
These alternative dispute resolution methods are often better for preserving business relationships.
8. Include a Termination Clause
It is best to include a clear termination clause that states when the contractual agreement ends. You may want the agreement to last for a specified term, such as a 5-year agreement, or until one of the parties terminates the agreement by written notice, amongst other types of arrangements. The contract could also provide for various actions or inactions that trigger termination of the agreement.
9. Proofread for Grammar and Clarity
It doesn’t hurt to read through the final agreement one more time to scan for grammar and clarity and it can save a lot of headache down the road. Small drafting errors such as a typo or incorrect punctuation can change the interpretation of the agreement.
For example, in Rogers Cable Communications Inc. v Aliant Telecom, the placement of a comma was significant to the interpretation of a multi-million dollar contract.
10. Seek Legal Advice
Contracts are complex and often lengthy documents. Even if you have negotiated clear terms with the other side, it is best to have your own lawyer review any formal contract before you sign it to ensure:
- That the contract is consistent with the negotiated terms;
- That there are no new terms added that you did not agree to;
- That you understand the terms of the contract; and
- That you are aware of potential risks.
Please contact Michael Paiva for more information, or if you require assistance with negotiating, drafting or reviewing a commercial contract.