This blog post is an overview of some common contract clauses that one should consider as part of any agreement between two small businesses. This information is only an overview. You should consult with an experienced attorney to assist you with your specific contract needs.
A basic agreement should contain the following elements at a minimum:
- Identify the parties to the agreement
- Detail the Goods/Service provided
- Detail the compensation given for the Goods/Services and how it is to be paid
- Dated signature from at least the party who is being presented with the agreement, preferably both parties though.
However, an effective agreement will require more things be considered and possibly addressed in an agreement. Here is a small list of some common clauses that may helpful in drafting an effective agreement. The text of each clause should be customized for your individual needs (There is no signal paragraph that works for all agreements).
An integration clause basically states that no matter what the two parties have discussed verbally or through other means prior to enacting this written agreement, the entirety of each party’s understanding of the agreement is within the agreement itself. By signing the agreement with such a clause, any prior considerations not mentioned in the agreement no longer exist: The document stands by itself as the whole agreement.
When contemplating whether to sign an agreement with such a clause, make sure that everything you are expecting to see in the agreement is there: an offline promise from the other party will not suffice. When drafting an agreement, this clause is helpful to make sure that the other party doesn’t try to hold you to something that you may have agreed to before the final agreement was reached. Promises are made in negotiations that may no longer be applicable when a final agreement is drafted. Also, it’s generally a good idea to state that the agreement may be amended if you are open to both parties agreeing to modification downstream. After the agreement is enacted, you are never obligated to accept suggested changes if you do not want them. However, you do have to the option to accept them if you’d like.
LIMITATIONS OF LIABILITY CLAUSE
A limitation of liability clause will do as the name suggests: it will limit your exposure to liability. When agreements cannot be met, at least one of the parties is harmed by it. How much harm they may endure is not always limited to what was discussed in the agreement. There are numerous types of damages that the harmed party may pursue (direct, indirect, consequential, special, etc.). Defining each type of damage is complex and outside the scope of this pamphlet, so let me give you a simple example:
Supplier is delayed in its delivery to Buyer of 1000 widgets at $5/widget for a total cost of $5000. These components are critical to the Buyer in building their device for another company that will bring the Buyer $100,000 in revenue. The Buyer’s agreement with that company includes having to deliver the completed devices by a certain date. When the Supplier cannot meet the delivery date, the Buyer looks for another vendor who can, but the Buyer can’t find replacement widgets in time. As a result, the Buyer cannot deliver the devices per the terms of their agreement with the company and the Buyer loses out on $100,000 of revenue. The $100,000 is an example of consequential damages. If the Supplier did not have a limitation of liability clause on their agreement with the Buyer that limits their exposure to consequential damages, the Supplier may end up paying far more in damages than they ever would have received on the original agreement.
When entering into an agreement, think about all of the possible ways that a breach of this agreement could harm you. These need to be considered in either drafting the agreement or agreeing whether to sign the other party’s agreement. Drawing the line on how to share that risk between each party is never an easy task. If you were in the position of the Supplier, you’d appreciate knowing what you’re getting into beforehand and not want to be responsible for anything other than the $5000 agreement you committed to. If you were in the position of the Buyer, you’d want assurances that the Supplier could deliver as promised, so as not to cost you $100,000.
NON-SOLICITATION VS. NON-COMPETITION VS. NON-DISCLOSURE CLAUSES
It is common for people to confuse these three clauses. However, each clause is very different from the others. Here’s a brief definition of each one:
Non-solicitation clause – restricts individuals and organizations from soliciting employees, customers, or business opportunities from another company or organization for a period of time. When sending your employees onsite to service another business, it’s probably best to have such a clause in place beforehand.
Non-competition clause – restricts individuals and organizations from providing services or engaging in businesses in certain markets and geographies for a period of time. The clause protects businesses from the potential that knowledge gained by an employee or business partner will be used in the future to compete against the business.
Non-disclosure clause – Commonly called a “confidentiality” clause, this clause acknowledges that the parties may have to share some information that may be confidential and restricts the other party in what they can do with that information. It may also address any damages associated with a breach of confidentiality. Imagine a disgruntled Coca Cola employee publicly disclosing the “secret formula.” The damages to the Coca Cola would be significant.
Sometimes, these clauses are added to an agreement as amendments after the agreement has been enacted, or they are enacted as separate agreements altogether. Since these clauses restrict the other party in some additional way, some form of compensation must be given in order to get the restricted party to accept these clauses when they were not part of the original agreement. If they are part of the original agreement, no additional compensation is necessary.
DISPUTE RESOLUTION CLAUSE
Litigation can be very expensive, and for many business-to-business agreements, the cost of litigation could be far more than the original agreement was worth. Providing for alternative dispute resolution (ADR) processes can be an affordable way to resolve any disputes. A dispute resolution clause often states that arbitration or mediation will be the avenue for resolving disputes.
Arbitration is similar to litigation in that the arbitration panel (often more than 1 person) will listen to both sides and make a ruling one way or the other. Mediation is generally conducted by a single mediator who does not judge the matter, but rather looks for ways at facilitating a compromised resolution to the situation. Sometimes, mediation is used first as a non-binding process, and if no resolution can be agreed upon through mediation, then arbitration is used as the binding process to resolve the dispute.
INTELLECTUAL PROPERTY CLAUSE
Often a business is sharing its intellectual property (copyrights, trademarks, trade secrets, or patents) with another company when there is a contractual agreement. How each party handles the other party’s intellectual property should be addressed in any agreement between them. A simple example may be hiring a web developer to create your website. You may provide them your trademarked logo and some copyrighted content, but you should make it clear that you own this material, not them (got that, Facebook). You may give them a license to use your material for the very specific purposes of the agreement, but nothing more. The web developer may have good reason to include your logo on their web page listing their past and current clients. This use of intellectual property should be negotiated up front and added to the agreement or as an addendum later, but the parameters of that use should be explicit.
FORCE MAJEURE CLAUSE
This clause allows a party to suspend or terminate the performance of its obligations when certain circumstances beyond their control arise, making performance inadvisable, commercially impracticable, illegal, or impossible. Typically, those circumstances are considered “acts of God,” but you may negotiate just about anything for an event triggering this clause (i.e., war, riots, strikes or lockouts, etc.). A force majeure clause should be explicit by defining the events, what happens when the event occurs, which party can suspend or terminate performance, and what happens if the even continues for a longer than anticipated time. For example, you may foresee a strike and suspend performance for 6 months until the strike has settled, but what if the strike lasts longer than 6 months?
A severability clause ensures that if a court or arbitrator strikes down a statement or clause in the agreement, the remainder of the agreement is still enforceable.
GOVERNING LAW, JURISDICTION, OR VENUE CLAUSES
These are all very similar clauses. It basically states that the agreement will be construed under the laws of a certain state, jurisdiction, or venue (i.e., state is Minnesota, jurisdiction is federal court, and venue is Hennepin County). This clause often includes a statement that the prevailing party shall be awarded all reasonable attorney fees from the non-prevailing party. Although the likelihood of a court making such an award is low, you cannot get this award unless you have asked for it, so this text is often added when drafting an agreement.
There are many factors to consider when drafting or consenting to an agreement. It is important to consult with an experienced attorney to assist you before enacting any agreement.