No matter what type of business you run, contracts are essential. They not only provide a North Star to guide your business toward success, and establish expectations between parties, but they protect you and provide a roadmap of next steps in case things don’t go quite according to plan.
So it’s worth spending the time to implement contracts and understand how they work. But for most business owners, this can be overwhelming — and rightfully so, if you’re not a lawyer. So be proactive and find a lawyer you trust to help you with your contracts. Remember: an ounce of prevention = a pound of cure.
Common Contract Provisions
This first installment on contracts will cover some of the fundamental provisions and considerations common to most contracts. Keep in mind that, although these provisions may be common among contracts, how each provision is written can (and often should) vary significantly between contracts.
Correctly Defining the Parties to the Agreement
- Make sure the correct parties are responsible for what’s in the contract, so that if there’s a breach, you have the right to enforce the contract against the correct entity.
- Make sure the correct parties have the privileges outlined in the contract so those parties can avail themselves of the benefit of their bargain, respectively.
Effective Date
- This is when the agreement takes effect, and it need not be the date the agreement is signed.
- Keep in mind that you can also backdate an agreement if you want to document an existing or de facto relationship between the parties prior to the date of signature.
Term of the Agreement
- Establishing when the agreement ends is important because it sets in writing the expectation of how long the parties will be involved with one another.
- You have wide latitude for setting the term. For instance, you:
- Can set a fixed term.
- Can set a fixed term that renews either automatically or upon the written consent of the parties.
- Can leave the contract in effect in perpetuity until either or both of the parties decide to terminate it.
Dispute Resolution
- Here, you get to set the rules for how to resolve a dispute. Like with a prenuptial agreement, this gives the parties the chance to avail themselves of a calm moment to determine how to handle a potentially heated future conflict. Some common options here include:
- Resolving the dispute amicably without any legal proceedings.
- Using mediation, which means bringing in a third party to resolve the dispute amicably between the parties.
- Arbitrating the dispute, which is more like a classic litigation except that it’s almost always cheaper and faster because you’re not subject to the lengthy court procedures.A classic litigation in court.
- Keep in mind that you’re free to use any combination of these, and most contracts often do layer these so the parties must first try to resolve the dispute amicably. If that’s not possible within a specific agreed-upon time span, they then agree to go to arbitration, litigation, etc.
Choice of Law & Venue
- This is very intricately involved with dispute resolution. In a choice of law and venue clause, the parties prospectively determine which body of law will apply to the dispute and where the dispute must be physically adjudicated.
Choice of Law: Usually, the party with the most leverage gets the ability to select its home state’s law as the applicable law. If both parties are from the same state, then this is not often contentious. If this decision proves too contentious, pick a neutral state. Delaware is a common neutral state, chosen for its robust body of corporate law and expert courts of chancery.
- Venue: Much like with choice of law, the party with the most leverage often gets to set the venue for a dispute. Venue is important because:
- It can give the in-state party a logistical and financial advantage, eliminating travel to attend the proceedings or the need to hire an out-of-state attorney with whom they’re not familiar.
- The courts in a particular state often have an interest in protecting the rights of their citizens (a sort of “home turf advantage”).
- Note that the choice of the substantive law that applies in a dispute and the venue for that dispute do not need to be the same, i.e., an Arizona court could use Delaware law to resolve a dispute. The risk with this dislocation is that the Arizona court may not be as adept at interpreting and applying Delaware law as the Delaware courts.
Integration Clause
- The integration clause does one CRITICAL thing in every contract – it says that what’s written in the contract is the sum total of the agreement between the parties with regards to that topic (the governance of an LLC, the lease of a piece of property, etc.).
- This means that neither party can produce some other document or interaction (like a conversation, text, or email) as proof that what’s written in the contract is somehow NOT what they agreed to. This keeps everyone playing by the same rules, and it makes it especially important to spend the time getting the contract just right before execution.
Assignment of Rights
This provision typically prevents the parties to the contract from assigning their rights or obligations in the contract to someone else. As a party to an agreement, this is a great clause because it guarantees that the entity you’re signing with will be the entity that has to honor the contract.
Nonetheless, you’ll also want to consider building an exception into this provision (or “carve-out”) if either party sells all or substantially all of its assets. That way, if you want to bring on investors or sell your business, you don’t need approval to transfer your active contracts. Having to get this approval could be a big deterrent for a potential acquirer or investor.
Those are the key contractual terms common to most, if not all, contracts your business will encounter.
In our next installment, we’ll dive into a few specific types of contracts, their provisions, and some common potholes to avoid.
ABOUT THE AUTHOR
Michele Leonelli is a CA-licensed, Austin-based lawyer that loves working with entrepreneurs, startups, and small-medium sized businesses with Phocus Law. His specialties are corporate M&A (including entity formation and structuring) and drafting, reviewing, and negotiating all manner of contracts. As outside general counsel to a variety of companies, he also handles a range of other legal needs for his clients and their businesses. Michele is also one of the vetted partners for the Legal Hotline available to our members. Reach out to Pavilion Career Services to connect.
Check out Michele’s post on how to pick the right legal entity for your business.
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