This article was written by Thanush S, pursuing the Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution Course from LawSikho, and edited by Koushik Chittella.

Introduction

Less than 35% of businesses started in the US in March 2013 and lasted until March 2023. It is very concerning since a lot of these businesses help in building a nation. Small businesses are the backbone of a country. According to the Small Business Administration, they have created around 13 million jobs in the U.S. over the past 25 years. They also contribute to almost half of the GDP in the US. While these businesses play a vital role in building the economy, many struggle due to preventable issues. One such issue is poorly drafted contracts. In this article, let us try to understand how agreements and clauses will help grow and secure small businesses.

Common contractual problems faced by small businesses

The following are the common contractual problems faced by small businesses:

  • Complex legal jargon: There can’t be a proper meeting of minds if they don’t specify what all are included in the term meaning. This can lead to misunderstandings.
  • Inefficient termination clause: Many small businesses focus on growing their business rather than this clause, thinking it to be unnecessary and expensive. So, they neglect this clause or avoid it, thinking that nothing will happen. But in the future, it creates issues within the business when there is a breach of the contract or when unforeseeable events happen.
  • Inadequate confidentiality provisions: A lot of times, small businesses have faced their trade secrets being exploited by their team, and their business has started to fail.
  • Payment disputes: The lack of clear details regarding payment can raise different issues, such as financial instability and cash flow problems. This might cause a delay in the payment process. Also, in case of a default of the payment, they might not know what to do next.
  • Absence clause: In the early stages of a business, the employees may leave their company due to a lack of resources or funds. But they may not stop them from using the confidential information they obtained from this business for their own gains later. They could start another competing business or maybe join another competing business. This may affect the small businesses badly.
  • Inadequate confidentiality provisions: A lot of times, small businesses have faced their trade secrets being exploited by their own team, and their business has started to fail.
  • Unclear ownership and responsibilities among founders or shareholders can lead to conflicts and potential business dissolution.
  • Employee disputes arise due to misunderstandings about job roles, compensation, and expectations.
  • Sharing sensitive information without protection can result in data leaks and loss of competitive advantage.
  • Ambiguities in service terms can lead to disagreements between the business and clients or vendors.
  • Businesses face unexpected rent hikes or evictions without a clear lease agreement.
  • IP theft or misuse occurs without an agreement protecting intellectual property.
  • Payment disputes: The lack of clear details regarding payment can raise different issues, such as financial instability and cash flow problems. This might cause a delay in the payment process. Also, in case of a default of the payment, they may not know what to do next.
  • IPR infringement: Small businesses tend to neglect this clause, which may later affect proprietary information and innovation of theirs.
  • Absence of ADR involvement: Even in small businesses, there can be serious disputes among the parties. Small businesses may avoid this clause thinking that their business won’t be facing any disputes within itself. This will lead to expensive and prolonged litigation, which might not be good for both parties.
  • Lack of clear obligations: In small businesses, they might be having trouble assigning roles. This would create confusion among the parties, which would lead to the breach of the contract.

Strategies for risk mitigation

These issues can be addressed by ensuring that agreements are made between the parties and by incorporating essential and effective clauses.

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Important Clauses

Although it’s difficult to avoid these problems, we can take some measures by including some specific clauses in the contract and also including some essentials of each clause. Here, it is noteworthy to mention some of the clauses with reference to the problems that we have discussed:

  • Be specific about the meaning of a specific term: It is necessary to have definition clauses in every contract, where they should include the definitions of every term that might have more than one meaning and also might confuse one if the term meaning is not specified. They should also interpret the terms for easier understanding. For example, if we mention premises in a contract, the other party may not know which premises the contract is specifying, so they will be confused. The term might also have multiple meanings under them.
  • The small businesses can ensure that they draft a proper termination clause that includes the conditions that can terminate the contract. Special provision to terminate the contract even if there is no reason for doing it. Specify which all breaches of the contract can lead to the termination. Mandatory notice period to terminate the contract.
  • A strong confidentiality clause can ensure the protection of their business. They should include all the information shared between the parties in this clause and the obligations both parties have to protect this information.
  • Specify what will be the remedies for breach of the confidentiality clause, such as specific performance
  • Clearly define payment: It must include how much the amount is, acceptable payment methods, whether it’s a one-time payment or instalments, an annexure giving the complete payment schedule, and which currency will be used if the parties are from different countries.
  • Default charges: They should include how much interest will come if they default on the payment or any other remedies that can compensate for the default of the payments.
  • Non-compete clauses can help small businesses avoid risking their trade secrets to their previous employees against them in the future. This clause includes the time period until which the noncompete clause will exist after the employee leaves their current owner and specifies any areas where they can’t start any business after leaving.
  • By providing an IPR clause in the agreement, they can protect their IPR rights from getting infringed. This clause should include
  1. What all are IP under this contract?
  2. What IPRs are they given license to use during the course of the contract?
  3. What IPRs are they not given?
  4. Remedies if the IPR is infringed.
  • A dispute resolution clause in a contract helps both parties choose a more cost-effective and faster mode to resolve a problem. This clause includes Specifies resolution methods, procedure, the language and place, and the time frame within which the resolution should take place; otherwise, it would terminate the contract and the governing law.
  • A proper and clear obligation clause specifying the roles and responsibilities will definitely help in building the meeting of minds and also avoid the contract from getting breached.
  • The obligation clause must contain what, who is responsible, where, how, and when obligations should be fulfilled.
  • Consulting legal experts may be a good option to ensure that the contract does not have any loopholes by which it might become invalid. There are platforms where contract drafting and reviewing freelancers are available with enough experience. This will help them get their business secure in a more cost-effective manner.
  • Continuously review and monitor contract performance to ensure all parties meet their obligations. This approach helps identify and address issues early.
  • Clear and Specific Titles: It should be specific and reflective of the agreement’s nature and purpose. For instance, using an “exclusive distribution agreement” instead of a generic “service agreement” ensures clarity.
  • Detailed Parties Information: Clearly identify all parties involved in the contract, including their full names, addresses, and legal capacities. This ensures that there is no ambiguity about who the contracting parties are.
  • Representations and warranties: Include representations and warranties to assert the facts on which the agreement is based. This provides a basis for recourse if any party makes false claims.

Agreements as legal protections

  • Partnership or Shareholder Agreement: This agreement outlines roles, responsibilities, and ownership percentages, preventing conflicts. (Key elements: ownership stakes, roles, decision-making, exit strategies)
  • Employment Agreement: This contract defines the employer-employee relationship, detailing job roles, responsibilities, compensation, and terms of employment. (Key elements: job description, salary, benefits, termination conditions)
  • Non-Disclosure Agreement (NDA): An NDA ensures confidential information shared with third parties remains protected. (Key elements: definition of confidential information, obligations of the receiving party, duration of confidentiality)
  • Service Agreement: This agreement sets the terms for services provided by the business or by vendors to the business. (Key elements: scope of services, payment terms, duration, termination conditions)
  • Lease Agreement: A lease agreement outlines the terms for renting commercial property, including rent amount, lease duration, and renewal/termination conditions. (Key elements: rent, lease term, maintenance responsibilities, termination clauses)
  • Intellectual Property (IP) Agreement: This agreement protects the business’s intellectual property, ensuring ownership of creations or inventions. (Key elements: definition of IP, ownership rights, usage terms, protection measures).

Conclusion

Don’t underestimate the power of a good contract for your small business! It’s like having a clear roadmap that prevents misunderstandings and protects your interests. By laying out everyone’s roles, responsibilities, and expectations upfront, you can avoid problems down the road and keep your business running smoothly.

Strong contracts also help ensure you get paid on time and safeguard your valuable ideas. Considering a chat with a lawyer can make your contracts even more bulletproof, giving your small business the best foundation for long-term success.

References

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