Building Blocks of a Contract
In this article, we have a look at the main building blocks of a contract
Contracts can be daunting. In fact, a report by World Commerce and Contracting association reveals that almost 90% of businesspeople find contracts hard or impossible to understand.
So, before diving into the world of contracts, it’s important to get one thing straight –
When drafting a contract, your aim must be to create clarity. If your aim is to screw over the other party, the DocNinja guides are not for you.
In an article published in Harvard Business Review written by Shawn Burton, the general counsel for GE Aviation’s Business & General Aviation, Shawn writes –
However, I believe it is indeed possible—as a three-plus-year effort to promote plain-language contracts at GE Aviation’s digital-services business has demonstrated. Since this initiative began, in 2014, that unit has signed more than 100 such contracts. Those agreements took a whopping 60% less time to negotiate than their previous legalese-laden versions did. Some customers have even signed plain-language contracts without a single change. Customer feedback has been universally positive, and there hasn’t been a single customer dispute over the wording of a plain-language contract.
The Agreement specific blocks contain information specific to the transaction, for example, the parties, the background to the transaction, definitions and the scope of the Agreement.
Core legal provisions
The core legal provisions are those where the respective legal teams like flexing their muscles.
These provisions essentially address various risks relating to the transaction.
The core legal provision blocks include limitation of liability, indemnities, term and termination, warranties, intellectual property and confidentiality.
When looking at the WCC data on most negotiated terms, it is clear that these provisions require careful consideration -
|1||Limitation of liabilities block|
|10||Intellectual property block|
|15||Confidentiality and non-disclosure block|
It is often said that the devil is in the details - When you have been working with contracts for a while you will know this idiom rings true when building your boilerplate clause.
Boilerplate provisions are used to regulate various miscellaneous aspects of the transaction.
Often labelled as "just boilerplate" or "less important" clauses, these clauses still requires careful consideration and generally includes clauses dealing with insurance, adherence to policies, regulatory compliance, information access and management, applicable law and jurisdiction, force majeure, entire agreement and dispute resolution.
Contract schedules generally contain information requiring additional input from non-legal business teams within the business.
For example, take a software development agreement; the first schedule may contain technical and functional specifications relating to the development, deliverables, milestones, dependencies etc. These schedules are likely the most important aspect of a contract when considering that the WCC data indicates that Scope and Goals / Specifications are considered the most important terms when negotiating a contract.
Schedules often forming part of an Agreement include schedules relating to the services / products, fees and costs, data, SLAs and change control.
The block containing the Parties to the Agreement needs to detail the registered name of the contracting Parties, registration number, address, and jurisdiction within which the party is registered/incorporated in.
The background block is also sometimes referred to as the recitals.
Background / recitals are not a legal requirement and do have a direct legal effect on the obligations of the Parties under the contract.
Despite the above, the background / recitals may become important when interpreting the the agreement.
The purpose of the definition block is to provide certain assigned meanings to a specific word or phrase.
Whenever the word or phrase is used in the Contract, the first letter of the word is capitalized.
Definitions therefore assist in creating clarity in contracts. That being said, sometimes the "over use" of definitions can cause more ambiguity than clarity. As a rule of thumb, if the ordinary meaning of a word clearly conveys the meaning that you require, don't create a definition for that word.
The scope block contains the nuts and bolds of the specific transactions. Without these provisions, the contract will not make sense.
Each contract will have a different scope. For example, the scope of a Software Development Agreement differs from the scope of Software License Agreement.
More information on the different scopes for different contracts -
- Software Development Agreement
- Software Licence Agreement
- Services Agreement
- Reseller and Distributor Agreements
- Service Level Agreement / Schedule
- Data Privacy and Security Agreement / Schedule
- Cloud Services Agreement
- API Agreement
- Software Escrow Agreement
- Purchasing Agreement
- Non Disclosure Agreement
- Subcontractor Agreement
Core legal provisions
Part of the legal team's responsibilities is to limit the risks of the business.
With contracts, this is done by limiting certain claims or excluding certain claims that may arise that relate to the contract.
The limitation block contains -
- the types of losses and damages that a Party will not be able to claim from the other party; and
- limitations places on certain types of claims.
Clauses relating to the limitation of liability are also some of the most negotiated clauses among legal teams and require careful consideration.
Indemnities are used to ensure a party is not held responsible for something the other party causes.
As an example, if you licence software, you don't want to be sued for copyright infringement when using the software.
To address the concern about being sued for something that is not your problem, you can use an indemnity block, which provides that the other party must indemnify you against claims of a certain nature.
When a Party does not honour the contract terms, you must have a way out of the contract.
On the other hand, you don't want a Party to walk away from a contract if they no longer want to be bound by the contract.
The termination block determines when a Party can terminate a contract.
Generally, if there is a material breach of the contract, the Party who is in default (in other words, the Party who committed the breach) will be provided with a number of days to fix the breach. If the breach is not fixed, the aggrieved Party's right to terminate becomes available.
Then, there are other situations where the right to terminate may become available. For example, the Party files for bankruptcy or fails to meet a certain service level.
It is also possible to terminate a contract where nothing has gone wrong. This type of termination is commonly referred to as termination for convenience.
When you buy a product or ask someone to do something for you, you want to be sure the product meets certain standards or that good and proper service is provided.
In contracts, warranties ensure the product meets the requirements or the service is provided as required.
Intellectual property is not limited to the usual suspects like copyright, patents and designs.
Intellectual property considerations are at play with every product supplied or service rendered.
The intellectual property blok generally comprises provisions relating to who owns which intellectual property.
For some businesses, their intellectual property is the most valuable asset of the business, and for this reason, careful consideration must be given when drafting intellectual property provisions.
For certain types of intellectual property (for example, trade secrets) to enjoy protection under the law, efforts must be made to protect it, for example, by concluding contracts with confidentiality provisions.
The confidentiality block contains various provisions addressing what information constitutes confidential information when it can and cannot such information be disclosed to any other parties, and what happens if someone breaches the confidentiality provisions.
Is the SLA a stand alone agreement?
SLA's will generally be incorporated as Schedule to a Main Agreement (for example, a SaaS Agreement) if the document is negotiated.
It is, however, also possible that a SLA takes the form of a policy that is published on the Provider's website. In such a case, the Customer may likely agree to the SLA by way of clickwrap when subscribing to, for example, the SaaS.
Which styles or fonts must I use?
Well, whatever floats your boat. However, keep in mind that more and more people view and sign contracts on mobile devices.
Articles, sections and subsections, what's the difference?
What’s the difference? Well, it depends on which jurisdiction you are based in. Clauses, articles, sections, and subsections refer to a specific place in an Agreement.
There are various numbering methodologies used in contracts. For example, some Agreements will use numerals, others will use letters, and some will use numerals, roman numerals, and letters. There is no right or wrong.
Martin Kotze is a commercial lawyer with over 10 years of experience. He specialises in transactional work within the Tech, Financial Services and Property industries.
He is also one of the co-founders at DocNinja and regularly advises companies on how to contract better with their customers and vendors.
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