Contract Drafting - Clauses to Keep in Mind

“If you can’t clearly state what you need…how do you ever expect to get it?”

In our daily life, we end up making hundreds of contracts, sometimes even without realizing that we are entering into one. However, in the corporate landscape, such mindless contracts can cost billions of rupees. A person, while entering into a contract or drafting one, must be able to appreciate the intricacies involved in the process.

Boilerplate Clauses: It is quite obvious that there are numerous types of contracts that result in a corporate transaction. Every contract is unique and dedicated to a particular cause. However, one must note that there are always certain general clauses that run like a common thread between all types of contracts. These clauses are known as boilerplate clauses. A badly drafted boilerplate contract which does not serve the purpose of the contract or disregards its uniqueness, can cost the signing parties dearly.

The definition section: All contracts must necessarily include a definitions section. The purpose behind this is to reflect the exact meeting of minds between the parties. There can be certain terms in a contract which can cause confusion in its interpretation. One example of such confusion can be the use of the term “legal entity” in the contract. What exactly is “legal entity”? Does it include Government organizations as well? The Definitions Section is always included in a contract to eliminate the risk of such ambiguity.

Force majeure clause: When two parties enter into a contract, it is impossible for them to foresee all obstructions that might occur during the performance of the said contract. As a result, termination of the contract or immense loss to one of the parties or both the parties can happen, even in cases where the obstruction was way beyond their control. The Act of God Clause or the Force Majeure Clause comes to the rescue of the parties in such situations. They stipulate that if the contract becomes impossible to perform or is rendered meaningless by an incident that was beyond the control of the parties, then they cannot be held liable.

Severability Clause: where one of the terms of the contract is held to be invalid or unenforceable. This can cost both the parties the whole contract. To avoid a situation like this, it is important to include a severability clause in the contract. This stipulates that even if one or more clauses of a contract are held to be unenforceable, the contract, as a whole, will still survive. This severs and protects the whole contract from the invalid clause.

Renewal Clause: A contract can be of two types – one which ends after a stipulated time and the other which can be renewed after a fixed period of time. Every contract must stipulate if it is eligible for renewal after a fixed period of time. This clause, may seem simple but is not. Simply stating that the contract is eligible for renewal does not make the contract precise, rather leaves room for speculation. Every such clause must include the circumstances under which the contract can be renewed and what the consequences of such renewal be (if any).

Termination Clause: Every person who is drafting or reviewing a contract must keep in mind the fact that there will be situations which will call for a complete termination of the contract. Such clause of termination can be contingent on certain events, can be without reason or can be at convenience of one of the parties. It can also be a contract for a fixed period of time, after which the contract may terminate automatically. In this as well, all consequences of termination should be anticipated in advance so that there are no disputes between the parties when the contract ends. So, while drafting a termination clause keep the reasons and the consequences of termination at the forefront.

Time is of essence clause: This is particularly important where the transaction involves goods or services that are time sensitive in nature. For example – there is contract between a construction company and an event manager that the construction company will build a stage for a ballet performance in two weeks. If the contract is not completed on time the performance will not happen and the event manager will suffer. In transactions like these, time is of immense importance and the contract must reflect this. Along with this clause it is always a good idea to include either a positive incentive or a negative consequence for the service provider as it may help in ensuring timely performance.

Indemnity Clause: Indemnity simply means a promise to pay the other party in case a loss or damage occurs in the future. In contract of providing services or goods, indemnity becomes a major advantage. This can be understood with the help of an example – let’s take the previous situation. Imagine that the stage breaks during the ballet performance and the troop leader sues the event managing company who had to pay for the consequences. If there is an indemnity clause in the contract between the construction company and the event management company then they can claim the damages they paid to the performers from the construction company.

Defect removal clause: This is a chance depending upon the need and generosity of the parties. Therefore, it cannot be said to be a compulsory clause. The main purpose of this is to provide the parties a chance to remove a defect in the performance of the contract. The party who has been wronged will be obliged to give them a chance to remove the defect in performance before they are able to initiate litigation against them. Example – the stage in the previous situation is made in a week but lacks structural strength and this is discovered by the event managers before the performance. Now if there is a defect removal clause in the contract between them, they will have to give the remaining one week for default correction instead of making them pay damages.

Confidentiality clause: It is important for every contract to have a confidentiality clause, it obligates both the parties to keep the information shared, to themselves. The drafter or the reviewer cannot afford to go through this clause casually. It should be analysed in detail. To avoid all ambiguities, it is important that the contract clearly stipulates what is confidential and must not be shared with a third party. Other than this, it is important that the contract also clearly lists out the consequences of such breach. It can be as severe as termination.

Limitation of Liability Clause: This is one of the most important clauses. This is an effective way to limit the amount of damages one party may have to pay to the other in the event of a breach. Through this clause a pre-decided amount of damages is fixed for the event of a breach of the contract. This can be made even more detailed by listing out the events that might constitute a breach of contract. Since the amount of damages is fixed, it makes the process of obtaining insurance for the amount, easier.

Amendments Clause: The main question that needs to be answered here is that – Are further amendments to contract allowed? If the answer to the question is no, it must be expressly stated in the contract or else the ambiguity may result in detriment of the client if unfavourable amendments are introduced. If the answer to the above question is affirmative then the drafter must stipulate the procedure through which further amendments can be introduced. They must also mention if there is a specific time limit till which further amendments can be introduced.