This article is written by Chetna Agarwal, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here she discusses “Important Clauses for forming a Perfect Contract”.
Table of Contents
Introduction
If a person wants to make another person or body corporate bound by certain terms and conditions, it is preferable to enter into a contract with them. According to section 2(h) of the Indian Contract Act, 1872, ‘An agreement which is enforceable by law is a Contract’.
Contracts can be written by using formal or informal terms, or could be entirely verbal or spoken. There are certain elements that, when fulfilled, would constitute a valid contract and contrary to that it would be considered null and void depending on the circumstances. Section 10 of the Indian Contract Act, 1872 enumerates certain conditions which must be fulfilled in order to constitute a valid contract.
Assuming that you are well-versed with the provisions of Contract Laws, I would like to take a step forward in explaining “How to Draft a Perfect Contract”.
A well drafted contract is easily understood and avoids confusion. However, a badly drafted contract results in ambiguity and wastes a lot of time in understanding the intention of parties.
One of the most important things to be considered while drafting a contract is to make it straightforward and easy to understand. A contract should be able to clearly explain rights and obligations of both the parties.
Have you ever started drafting an agreement but you are clueless as to which clauses should be included so that it is free from loopholes or you are about to execute an agreement with someone and want to be extra sure as to whether all the important clauses have been inserted into your agreement or not?
This article will guide you so that you won’t miss out on any clause which should exist in an agreement to form a perfect contract.
Checklist of Clauses to be included in the contract are mentioned below
- Title of agreement
It is necessary to name the agreement. The title of the agreement denotes nature or type of agreement.
- Names of the parties
The parties are provided with a particular name that is used to refer them in the entire agreement.
- Recitals
This clause gives the background of the parties and the purpose of entering into the agreement. If it is a supplementary (additional) agreement then the reference of the main agreement is provided under this clause.
- Definitions
There are certain terms used in the agreement which have a technical meaning. Such terms should be defined under this clause of the agreement that makes interpretation accurate.
- Representation and Warranties
This clause provides an underlying statement of fact by the parties (for example, Mr. X is sole owner of the property, the property is free from encumbrances). In future, if it is proved that the other party has misrepresented the facts, the party has the right to seek compensation from the guilty party.
- Covenants
Covenant means a promise to do certain acts in future. Unlike representations and warranties, it does not include statements of fact (for example, Mr. X shall make payments to Mr. Y before the 10th day of each month).
- Term
The duration of the agreement should be included in the agreement (in year or months). The term of the agreement shall be in force unless contract is terminated by either parties or on mutual consent of both the parties (term clause is linked to termination clause).
- Consideration
One of the essential elements for a contract to be considered valid is consideration. Consideration can be monetary or it may take the form of a promise to carry out a particular act (such as services, money, etc.).
- Terms of Payment
Duration of Payment:
- Time based payments – every 30 days, 45 days, etc.
- Progressive payments – on completion of first milestone, on receiving results,
- Full payment on the entire work done.
Method of Payment:
- Fixed Based Model – a fixed amount of payment shall be made;
- Revenue Based Model – a percentage of revenue earned shall be paid,
- Profit Based Model – a percentage of profit made shall be paid.
Mode of Payment:
- Cash,
- Cheque,
- Net Banking.
- Indemnification
It is basically about shifting the risk to another party. In case breach of any provision by one party causes loss to another party, the defaulting party has to make good the losses caused to the non-defaulting party. How indemnification will be done should also be mentioned in this clause.
- Termination
Circumstances when the agreement can be brought to an end by either parties shall be mentioned. Also, how many days prior written notice period is mandatory should be specified.
- Invoices (in some contracts)
What all things should be included in an invoice? Date of invoice, name of the parties, name of item/activity/service for which invoice is made, amount of invoice, percentage of taxes, etc.
Note: If you are registered as MSME (Micro, Small or Medium Enterprise), the invoice should specify the same.
- Notices
The address or email-id of the parties should be provided in this clause to deliver notice to the parties.
- Force Majeure
In case any event is beyond the control of parties or unforeseeable, whether the agreement can be terminated due to non-performance by either parties?
- Intellectual Property (in some contracts)
This clause will help to know who shall own the intellectual property (patents, copyright and trademark) that is created out of contract and whether such intellectual property can be assigned or transferred to a third party.
- Confidentiality
Whether the confidential information exchanged between the parties can be shared with a third party. Also provide with the exceptions to it. It is recommended to define “confidential information” in the definition clause.
- Exclusivity (in some contracts)
The parties can be restrained from providing the same kind of services or entering into the same nature of agreement with a third party during the existence of this agreement.
- Severability
In case, some part of contract is declared illegal then other part of contract shall be valid. Such a clause saves the contract from being entirely dysfunctional.
- Amendment
If the Parties wants to make any alteration in the contract, its procedure should be specified in this clause.
- Jurisdiction
In case of any dispute between the parties, which court shall have jurisdiction to handle such matters? The Parties shall use the word ‘exclusive jurisdiction’ to limit the location.
- Governing Law
The laws applicable to the contract are very important (for example, this agreement shall be governed by the laws of India).
- Dispute Resolution
How the dispute shall be resolved? There are different modes of dispute resolution such as mediation, arbitration or conciliation.
- Signature sections
First and last pages need to be signed by the parties along with initials on other pages. Signature is mandatory for validity of the contract. In certain contracts, attestation from witnesses shall also be required.
- Schedules or Annexures (in some contracts)
When the information is too lengthy to be included in the clauses section, such details can be mentioned in tabular or pointer form at the end of the agreement (for example: list of properties sold, services to be provided by event managers).
- Entire Agreement
This clause specifies that the agreement covers all rights and obligations of the parties and supersedes all other agreements whether written or oral between the parties. Such a clause helps to avoid negotiations earlier made which were not finalised later.
- Duplicate Copies
It is recommended that each party should have a copy of the agreement and both the parties have understood and agreed upon terms and conditions of the agreement.
Tips for drafting a perfect contract
- Each clause should be drafted considering the purpose of the contract.
- An agreement should be drafted in active voice for better clarity. A sentence framed in passive voice often creates confusion or becomes ambiguous for the reader to understand. For example, “the amount of fees to be paid to the contractor shall be decided” (written in passive voice). Now if we write the same sentence in an active voice – “Developer shall decide the fees amount to be paid to the contractor”, it creates an instant precision to the reader.
- There are some standard clauses which form part of every agreement. For example, term clause – duration of the agreement. However, there are specific clauses which are particular to certain agreements. For example, non-solicit clauses in the employment agreement.
- Simple language should be used. Avoid use of technical terms unless compulsory.
- Even a person with a non-legal background should be able to understand terms and conditions of the contract while reading it.
- A well drafted contract is self-explanatory and concise.
Case Laws
While drafting a contract, there is always an urge to mitigate risk for ourselves and transfer it to another party. However, you should keep in mind that clauses framed should be reasonable and acceptable in the eyes of law.
In Standard Retail Private Limited v. Gs Global Corp and 3 Others, Bombay High Court recently dismissed a plea invoking the Force Majeure exemption, in a contract involving steel importers. While dismissing, it observed that the distribution of steel has been declared as an essential service, and there have been no significant restrictions on the movement of vehicles and manpower in the context of the steel industry, or operations of container freight stations and warehouses for steel. It further noted that the lockdown would be for a limited period and the lockdown cannot come to the rescue of the petitioners so as to resile from its contractual obligations to the respondent of making payments.
In V. Lakshmanan v. B.R. Mangalagiri and Others, Supreme Court held as follows: The question then is whether the respondents are entitled to forfeit the entire amount. It is seen that a specific covenant under the contract was that respondents are entitled to forfeit the money paid under the contract. So when the contract falls through by the default committed by the appellant, as part of the contract, they are entitled to forfeit the entire amount.
In Diljeet Titus v. Mr. Alfred A. Adebare and Others, the defendant was working as an advocate at the plaintiff’s law firm. On termination of employment, the plaintiff contended that taking away privileged information of the law firm, the use of which other than by plaintiff, can make them liable to their clients. The defendants claim to be the owners of the copyright in what they have created and it is their contention that the creation was independent and the same was so created by advising and counselling the clients and the computer generated data was lying in the computer system of the plaintiff. The Delhi High Court rejected this contention and ruled that defendants are restrained either through themselves or their representative from utilizing the material of the plaintiff forming the subject matter of the suit and from disseminating or otherwise exploiting the same including the data for their own benefit.
In ABC Laminart v A.P Agencies, there was a contract between the parties for the supply of 5000 bobbins of Rulon Metallic yarn. The Appellant had the jurisdiction of Kaira, Gujrat and the respondent functioned his business in Salem, Tamil Nadu. The jurisdiction clause in the contract reads as “Any dispute arising out of this sale shall be subject to Kaira jurisdiction.” The respondent on the arising dispute filed a suit in the court of Salem, Tamil Nadu, the appellant on this filed a case challenging the jurisdiction of the court of Salem, and the dispute was appealed to the Supreme Court.
It was observed by the Supreme Court that it is not explicitly mentioned in the contract clause regarding exclusive jurisdiction. It was held by the court that in the absence of words – “Only”, “alone” and “exclusive”, the maxim of “Expressio unius est exclusio alterius” is to be used which means the explicit mention of one is the exclusion of another. It was stated by the court that “it could not be said that jurisdiction of the Court at Salem which Court otherwise had jurisdiction under law through connecting factor of delivery of goods there at was expressly excluded hence, both the courts had jurisdiction.
Conclusion
If you want to figure out whether your contract is simple and can be easily understandable, you can ask someone to read the document who has no knowledge of the proposed agreement, would they be able to understand it or more changes need to be done?
One thing to be kept in mind is that a contract is much more than a legal document. The contract is mainly tested when differences arise between the parties.
If your contract is enforceable, that’s a great thing. To do that, you need to see every clause inserted makes the agreement more relevant and precise.
Even if you consult a lawyer to draft a contract, you can also suggest to him/her to make the agreement in an understandable and simple way.
There have been cases where courts are unwilling to enforce a clause that takes away the rights of parties hence consulting a good lawyer having in-depth knowledge in drafting contractual agreement will help you save in litigation costs and structure it as per needs of the client.
Considering the above checklist and an overview on important clauses for a perfect contract, you can now be better negotiator to keep your terms in the contract or to make your own contract smoothly and efficiently.
References
- https://indiankanoon.org/doc/53894809/
- https://indiankanoon.org/doc/16443/
- 2006 (32) PTC 609 Del, 130 (2006) DLT 330
- 1989 AIR 1239, 1989 SCR (2) 1
- https://www.business.gov.au/Products-and-services/Contracts-and-tenders/How-to-prepare-a-contract
- https://www.brownejacobson.com/training-and-resources/resources/legal-updates/2019/04/drafting-the-perfect-contract
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