Contract clauses every business must understand

Contracts between businesses are rightly regarded as a record of expectations: what’s being provided, for how much, and when. As a result, negotiations tend to focus on the headline commercial terms. However, when disagreements arise, it is often the “legalese” that decides who bears the risk. As suppliers often contract under their own standard terms, business customers should understand the significance of key contract clauses to avoid costly surprises later.

LIMITATION OF LIABILITY: WHO CARRIES THE RISK?

Limitation of liability clauses set the maximum amount a breaching party must pay to the other. This cap may be a fixed figure or a multiple of the contract’s annual or total value, and certain types of loss are excluded completely. Often, they only limit the supplier’s losses, leaving the customer fully exposed.

Lawyers often turn to liability clauses first when a project runs into difficulties. A business may expect to recover the full cost of a failed project, only to find that the contract restricts reimbursement to a fraction of the actual loss.

Check:

• Is the allocation of financial risk under the liability cap fair and commercially reasonable?
• Is the liability cap proportionate? It might be too low if important systems or large sums of money are involved.
• The specific risks for your business if the contract fails: are these covered (or excluded) by the proposed liability wording?

RENEWAL AND TERMINATION: PLAN YOUR EXIT

Commercial relationships begin positively, but contracts may remain in place long after circumstances have changed. Issues with performance, changing business priorities, or financial pressures can all affect a long-term arrangement.

Renewal and termination clauses set out when and how a contract can end. Some agreements allow for automatic renewals, which must be managed carefully. Request the right to terminate for convenience, ideally with longer notice periods for suppliers, to ensure there’s enough time for customers to find a replacement provider. Beware of contracts that only permit an exit in cases of very serious breach or insolvency.

Without appropriate termination rights, you could be locked into contracts that no longer meet your needs, even when prices have escalated significantly.

What to do:

• Check for flexible renewal and termination mechanisms.
• Ask for the right to terminate for convenience.
• Avoid contracts with only limited or difficult exit options.

INTELLECTUAL PROPERTY: NEVER ASSUME OWNERSHIP

Businesses often pay third parties to create intellectual property such as software, designs, reports, marketing materials, branding, and other valuable assets.

A common misconception is that paying for the work automatically transfers ownership to the purchaser. That is not the case. Unless the contract clearly says otherwise, ownership remains with the creator, and only limited usage rights may be granted. This can cause problems if the business customer later wants to adapt, commercialise, or transfer the work.

What to do:

• Always check who owns any intellectual property created during the contract. “Assignment” means full ownership transfers, whereas a “licence” is a limited permission to use it for the stated period.
• Make sure the contract matches your commercial expectations and requirements, especially if you still want to use the intellectual property after the contract ends.

SECURITY AND CONFIDENTIALITY: PROTECTING VALUABLE INFORMATION

Most commercial relationships involve exchanging sensitive information, whether about customers, pricing, finances, business plans, or technology. This data can be a company’s most valuable asset.

Data security and confidentiality clauses set out what is protected, for how long, how it is safeguarded, who can access it, and the limited circumstances in which it may be disclosed.

What to do:

• Ensure the contract’s security and confidentiality provisions cover your own specific type of sensitive and confidential data.
• Check that protection lasts long enough to safeguard your interests.
• If third parties are involved, make sure they are included as permitted recipients to avoid accidental breaches.

INDEMNITIES: UNDERSTAND THE REAL EXPOSURE

Indemnities are used to fully compensate an innocent party for specified losses, incurred because of a third-party claim against that innocent party. For example, the customer uses supplier-provided branding and is later sued by a third party for copyright infringement. The supplier indemnifies the customer fully against the costs of defending itself, because the customer could not have known that the supplier copied the brand from someone else.

Increasingly, however, indemnities are (incorrectly) used to protect suppliers against any contractual breach by a customer. Because indemnities can create substantial liabilities, they should never be accepted “as is” without careful consideration.

What to do:

• Understand exactly what indemnity protection you are being asked to give and what you will receive in return.
• Strongly resist sweeping indemnities against any contractual breach.
• Consider financial caps to the indemnity – do they undermine the indemnity’s protection?
• Check your insurance cover if you must indemnify your contractual partner.

PRICE INCREASES: CHECK THE SMALL PRINT

It’s not unusual for suppliers to grant themselves unilateral price increase rights, often hidden in the small print. Combined with automatic renewals, this can result in exponential price rises for business-critical services that are difficult to switch away from.

What to do:

• Limit the increases allowed to inflation.
• Specify the timing of increases and limit their frequency to once per year, as a maximum.
• Require advance notification before renewal, so you have leverage to negotiate or exit.

DISPUTE RESOLUTION AND GOVERNING LAW

Check which country’s laws apply and where and how disputes will be resolved. This can have a major impact on cost, convenience, and strategy in case the case of disagreement.

FINAL THOUGHTS

• Avoid missing contractual terms entirely because they appear in a hyperlinked PDF. Assume they are binding just like a signed contract and file a copy.
• Leave enough time to review key provisions so that issues can be discussed and resolved.
• Don’t worry that raising concerns could jeopardise your new business relationship. Intelligent, pragmatic negotiations can actually increase respect between the parties and foster greater collaboration and stronger relationships – saving management time and money in the long run.

For further advice on drafting, negotiating, or reviewing commercial contracts, please contact Lucy Blick-Jones.