This article has been written by Arshdeep Singh Bhullar pursuing Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution and has been edited by Oishika Banerji (Team Lawsikho).
This article has been published by Sneha Mahawar.
Table of Contents
In today’s fast-growing world from the moment we wake up to the moment we go to sleep our lives are governed by the set of expectations we have as a result of the explicit and implicit agreements between us and others. When a business is entering into a commercial contract often, it is considered a sign of success, but on the other side, it is significant to understand that if we/business enter into agreements with another individual/business we/it will have important obligations to fulfil in return for any rewards that we/it might receive. So before any commercial agreement is finally signed all the parties involved should invest a considerable amount of time and effort in the process of contract drafting. Drafting a contract or an agreement may be defined as the combination of facts and law in a language form. It is a known fact that perfection in legal drafting cannot be achieved unless the nexus between law, facts and language is fully understood. In simple words, drafting can be described as the practice, technique or skill involved in preparing legal documents that set forth the right of the parties. In this article, we will discuss the importance of clauses in a contract as well as the most important clauses to be kept in mind while drafting a commercial agreement.
Importance of clauses in any contract
Before we engage in the importance of clauses in contracts and agreements it is necessary to clarify the meaning of clauses in relevance to contracts and agreements. So a clause is a particular provision in a legal agreement that relates to an important point of understanding between the parties engaged in the contract. Clause dictates certain conditions under which the parties agree to act during the course of the contract.
Clauses in contracts play a major role in laying out certain conditions under which parties agree to the terms of the contract. Directions are also provided in the enforcement of contracts under different events and conditions. Other major purposes served by the clauses are:
- They provide structure much like the outline in a textbook and thus promote understanding of the contract’s purpose.
- They assist with navigation as some business contracts are extremely lengthy, with the help of clauses one can locate a specific provision buried deep within the agreement.
- They promote Ease of Use and simplify drafting as there are many common contract provisions in an agreement, the use of separate clauses makes it easier to locate and reuse the provisions.
- They provide severability as sometimes parties to a contract agree that even if one or more provisions fail, the remainder of the contract will be honoured. The cautionary use of clauses serves the purpose of separating out provisions about which the parties have any concerns.
Clauses to be kept in mind while drafting any commercial agreement
Contracts and Agreements are used in almost every industry and field, and many of the contract provisions are common to all industries. There are many clauses in a contract that are almost certain to appear in every contract which is drafted and the same is true in commercial contracts and agreements.
Before we get into the most important clauses one thing that needs to be clearly stated is the identification of all the parties. The names of individuals/businesses and their contact information must be included within the contract/agreement. There should never be any ambiguity as to who is subject to the contract/agreement. Below we will discuss some clauses that are very essential to form a sound contract/agreement and they must be kept in mind while drafting various commercial contracts/agreements:
A definition clause as the name suggests is used to define terms used in the legal agreement in plain language to avoid any confusion between the parties as it reduces the chances of misinterpreting any part of the contract. A well-drafted definition clause contains as many or as few contract definitions as necessary as they can affect the outcome of the relationship and any potential disputes that may arise between the parties.
The purpose of a definition clause is to clearly define contract-specific terms as it provides aid in future risk mitigation. When all parties understand expectations clearly, it’s easier to meet them.
Confidentiality clauses prevent the signing parties from disclosing any sensitive information, personally identifiable information, or trade secrets. As when two or more firms enter into a contract, there will almost be a considerable amount of details exchanged to fulfil contractual obligations. To safeguard the interests of all the parties, the contract must have a strict confidentiality clause. These protections are for documents and can be as well as for verbal communications as negotiated by the parties depending upon the scope and obligations of an agreement.
The purpose of a confidentiality clause is to protect the trade secrets and sensitive information of a company. In the event of a breach of this clause, the company may file a damage claim against someone who disclosed critical details to someone, whether they planned to exploit the information or not. The need for confidentiality clauses has arisen much more due to the cut-throat competition among businesses regardless of industry. The Confidentiality clause can be created in two ways which are as follows:
- The one-sided confidentiality clause limits only one party from disclosing any information about the other party.
- The mutual confidentiality clause limits both or all the parties involved in the agreement from disclosing specific information about other parties.
A jurisdiction clause is a very common clause in business agreements as it basically states that the parties involved in a contract have the right to settle legal disputes through adjudication. When the parties to a contract are from different nations or even states, it can be difficult to determine a specific court to resolve disputes if any arise.
When the parties involved in a contract wish to have any disputes that may arise concerning their agreement to be adjudicated by a specific court, the need for a jurisdiction clause arises. A major benefit of the jurisdiction clause is when a party submits to the authority of a court in a specific jurisdiction, the argument that the venue of adjudication is not appropriate is out of the question.
It is to be noted that inconvenience and uncertainty is the possible consequence of a jurisdiction clause not being present. This consequence can lead to delays and higher costs involved in the court proceedings. Jurisdiction is generally categorised in the following ways:
- Exclusive Jurisdiction: Under this type of jurisdiction, it is only the specified courts who have the authority to adjudicate a dispute.
- Non-Exclusive Jurisdiction: Non-exclusive jurisdiction means that a case may be decided by courts which are not specifically mentioned in the jurisdiction clause.
Governing law clause
As clear by the name itself, the governing law clause declares the laws that govern the transaction in case a dispute arises. They are standard clauses found in business contracts and transactions specifically when the parties involved belong to two different nations. The governing law clauses are also commonly known as choice of law clauses.
A governing law clause can be found consistently in contracts and legal agreements between companies and their users. We can typically find these clauses in Standard Terms and Conditions agreements for websites or mobile applications. This clause is significant as when there is no governing law clause in a contract, then the court will decide and it may result in a catastrophic outcome for the parties.
Dispute resolution clause
A dispute resolution clause clearly lays out how the parties intend to resolve any disputes that may arise from their business contract. Even the most carefully written contracts are prone to disagreement, hence it is of utmost importance to clarify parties’ plans for dispute resolution in the event that an issue arises. A dispute resolution clause is important in every contract as with its help the issue at hand is resolved quickly, inexpensively and off the public record as opposed to conventional ways of legal redressal. In a dispute resolution clause, the parties put down strategies for resolving disputes with mutual consent before the contract or agreement is signed.
Methods of Dispute Resolution are as follows:
- Negotiation: This is the least formal type of dispute resolution. With the help of the neutral third party, negotiation allows the parties in dispute to come to a consensus on their own.
- Mediation: This is the second least formal type of dispute resolution. The main difference between negotiation and mediation is that the latter involves a professional mediator as the neutral third party.
- Arbitration: This is the most formal and most famous type of dispute resolution. It is conducted by professional arbitrators and the parties must follow the rules in their arbitration agreement. The outcome of an arbitration is usually binding, meaning the parties generally can’t initiate litigation after arbitration and they must follow the directions given by the arbitrators.
The phrase Force Majeure literally translates into “greater force”. This clause should always be included in all commercial contracts because it shields parties from events that are beyond their control such as earthquakes or hurricanes, etc. A force majeure clause triggers when extraordinary circumstances take place. The Force Majeure clause allows a party to leave a contract temporarily or permanently, in whole or in part, for catastrophes that were not foreseeable. If the catastrophic event meets the terms of the force majeure clause, both parties can end the agreement.
The major purpose of the force majeure class is to release a party when they can no longer fulfil the obligations, usually due to a severe, unforeseen event. Without a force majeure clause, parties would have to turn to common law doctrines to protect themselves but that would amount to a waste of time, energy and money. In general, the term “force majeure” is very broad, and may cover various events but the most common ones are as follows:
- Acts of God: hurricanes, tornadoes, tsunamis, typhoons, pandemics and earthquakes, etc.
- War, explosions, strikes, lockdowns, lockups, or a prolonged shortage of energy supplies, etc.
- Government action limiting or prohibiting any party from performing its contractual obligations.
Limitation on liability clause
In simple words, the limitation on liability clause limits the amount a party has to pay to the other party if the latter suffers losses due to breaches or performance failures in a business contract. It puts a cap on the number and types of compensation one party can recover from the other. The limitation of liability clause may apply to the entire business arrangement or may be limited to only certain breaches or failures, depending on the parties’ agreement.
This clause typically covers losses caused by the following:
- Negligence: One of the parties fails to meet a reasonable duty of care and causes harm to someone.
- Breach of contract: A party fails to fulfil its contractual obligation.
- Infringement of intellectual property rights: One of the parties infringes on the others’ intellectual property rights (i.e., patent, copyright, design right, or trademark).
- Misrepresentation: A party makes a false statement that misrepresents an aspect of the contract, such as the quality of the products they’re selling.
Synonymous terms for the severability clause are salvatorious, severability and survival clause. This clause allows the remaining terms of a contract or piece of legislation to continue in effect even if one or more of its other terms or provisions are judged to be unenforceable or unlawful.
The severability clause keeps the contract intact, as the parties continue to meet the terms outlined in the enforceable section rather than ending an agreement based on single actions. In the absence of a severability clause, a judge or jury has the right to void the agreement. Otherwise, they enforce the remainder.
A severability clause in a contract states that its terms are independent of one another so that the rest of the contract will remain in force, should a court declare one or more of its provisions void or unenforceable. Preserving the remaining valid parts of a contract is the main purpose of a severability clause when a part or parts of an agreement becomes unenforceable or illegal.
Termination clauses, commonly referred to as severance clauses, permit parties to end an agreement early or mutually without violating the terms of the contract. Similar to in business, things frequently do not go as expected, thus parties must be able to separate themselves whenever the need arises.
The termination clause specifically states the circumstances under which one or all the parties may terminate the contract, irrespective of the time left under the agreement. The purpose of the termination clause is to provide guidance and set the terms and conditions surrounding a contract cancellation that doesn’t result in penalties. Incorrect use of termination clauses may result in a legal conflict as general contract principles still apply regardless of the terms and conditions.
Above we have discussed the most important clauses that must be kept in mind while drafting various commercial agreements. These clauses act as the backbone of any commercial agreement and protect all the parties by providing clarity and eliminating vagueness in the contracts and agreements, hence, finishing off any misunderstandings that may arise between them.
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