The Art of Drafting a Commercial Contract
A contract is formed when a party with sufficient legal capacity makes an offer and the other party of sufficient legal capacity accepts the offer with a legal consideration. In order to be a contract, the agreement must include valid consideration. That is, both parties must contribute a Quid pro quo [i] to the agreement such as money, labor, a return promise, etc. To form a valid contract, both parties must have the legal capacity to enter into a contract and the purpose or objective of the contract must be legal [ii]
Competency to Contract
In the Indian Contract Act, 1872 [iii]
Section 11 : Who are competent to contract.- Every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is of sound mind, and is not disqualified from contracting by any law to which he is subject.
A contract is therefore an agreement that is enforceable by law.
Essential aspects of contracts are (a) Parties (b) Obligations of the parties (c) Payment Terms (d) Integration Clause (e) Termination.
(a) Defining the parties
The agreement may be worthless if the other party is unethical, unwilling to keep its commitments, and/or in poor financial health. In addition, the agreement may contain an assignment clause allowing the other party to substitute another party to perform the contract obligations. It requires the assignment to be effective only with other party’s approval, and assuring availability of appropriate recourse against one or both parties for failure to deliver.
(b) Obligations of the parties
Disputes often occur because the contract does not adequately specify the obligation of one of the parties. Think through what one wants to be delivered as a product, and how progress will be measured and tied to the obligation to make payment or deliver product or services.
(c) Payment Terms
When goods or services are being secured, requirement of prepayment, if any is to be clearly brought out. When does the contract require the party to pay? Pay in advance fully or partly or await performance? It is surprising how many times such contracts get disputed. It is advisable to require payment after delivery, or to make payments matching progress of deliveries if the contract calls for performance over a period of time.
(d) Integration clauses
Written contracts often have an integration clause that specifies that the contract represents the whole understanding of the parties, and that no changes are binding unless executed in writing.
Such clauses are acceptable as long as the contract is managed in that manner ensuring adherence to the requirement for documenting by amendment any changes
Termination prior to the end of the term may be for Breach of contract (failure of the other party to meet its commitment), Effect of refusal of party to perform promise wholly ,for occurrence of an event (such as loss of access to key personnel or products) or for convenience of a party (a party no longer wishes to continue the relationship) .
But termination clauses can be problematic in assuring fair treatment of both parties. So they must be clearly stated.
What happens upon death of either party?
Promises bind the representatives of the promisor in case of the death of such promisor before performance, unless a contrary intention appears from the contract.
A promises to deliver goods to B on a certain day on payment of Rs. 1, 000. A dies before that day. A’ s representatives are bound to deliver the goods to B, and B is bound to pay the Rs. 1, 000 to A’ s representatives.
However all such contracts cannot be enforced.
A promises to paint a picture for B by a certain day, at a certain price. A dies before the day. The contract cannot be enforced either by A’ s representatives or by B.
A contract is drafted with following basic sections :
- Subject matter of contract
- Consideration & method of payment
- Scope of Supply & Services
- Indemnity and Risk allocations
- Effective Date & Validity
- Miscellaneous (Boilerplate) Provisions
This section identifies the parties to the agreement, the date of the agreement, the place of formation and the addresses of place of business of the contracting parties. If multiple affiliated parties are involved, the preamble identifies certain parties by their relationship to other parties such as corporate parents, subsidiaries, trustees and guarantor. Preamble shall list all parties intended to be bound, their legal status, place of business, intended degree of liability, change in party ownership and third party beneficiary.
Following is an Illustration –
This Frame Agreement (hereinafter referred to as the “Agreement”) is entered into on this day of . . . . .
BY AND BETWEEN
XYZ Limited, a Company incorporated under the provisions of the Companies Act, …. and having its Registered Office ……, (hereinafter referred to as “XYZ” or “the Buyer” which expressions shall, unless repugnant to the context or meaning hereof, include its successors-in-interest and permitted assigns) of the ONE PART;
………………. a ………………. Firm with its office at ……………… (hereinafter referred to as “the Supplier” which expression shall, unless repugnant to the context or meaning hereof, include its successors-in-interest and permitted assigns) of the OTHER PART.
These set out the stage of the contract, providing the basic text, structure and context of the transaction. Recitals are typically declarative statements of facts and intentions but not generally binding provisions of the contract. In case of a purchase agreement of a product it will give a generic description with more specific information in the body of the contract.
Here it defines terms that appear in different parts of the agreement.
“GCC” means the General Conditions of Contract hereof.
“SCC” means the Special Conditions of Contract.
“Technical Specifications” mean the technical specifications, schedules, detailed designs, statements of technical data, performance characteristics value and all other particulars of the Contract.
“Day” means calendar day of the Gregorian calendar.
“Month” means calendar month of the Gregorian calendar.
“Employer” means XYZ Ltd and includes the legal successors or permitted assigns of the Employer.
“Contractor” means the person(s) whose bid to perform the Contract has been accepted by the Employer and is named as such in the Contract Agreement, and includes the legal successors or permitted assigns of the Contractor. In case Contract is with Consortium of two or more members then the Contractor shall mean one or more members of Consortium as the case may be
- SUBJECT MATTER OF CONTRACT
This section provides for structure of the transaction broadly defining the scope and the method of payment, time of completion and the main matter of the contract.
- Consideration & Terms of Payment
This section provides for amount to be paid, the terms of payment, any financial formulas for post closing adjustments. It also provides for break-up of purchase price. These allocations of contract price have implications on tax matters which may be different for the buyer than the seller. What benefits one party may be detrimental to the other and may have effect on anticipated net consideration.[iv]
- Scope of Supply & Services
Essential part of any contract is description of transferred item and / or services. Based on the nature of items being transferred (product / services / real estate / business / intellectual property) a schedule is to be made. Here is an Illustration –
Scope of Facilities
- The Contractor shall, unless specifically excluded in the Contract, perform all such work and / or supply all such items and materials not specifically mentioned in the Contract but that can be reasonably inferred from the Contract as being required for attaining Completion of the Facilities as if such work and / or items and materials were expressly mentioned in the Contract.
- The Contractor shall furnish the items with its specifications & prices of spare parts required for the operation and maintenance of the Facilities
- Indemnity and Risk Allocations
The most important part is to provide party’s right of indemnification if the party discovers that the other party has breached one or more of its representations. In this way representations serve as a mechanism for allocating economic risks between the parties.
The contracting parties may insist on keeping all information that would be available to the other party during execution of the contract confidential.
- Effective Date, Time of Completion & Validity
The contract or agreement should have a date stated as the contract date or effective date. This date is not necessarily the date when the contract was signed but rather the date from which all the contractual rights and obligations begin and from which point any term of time, usually commences.
The time allowed for completion of all work required by the Contract will be stated in this clause and will be known as the Contract Time.
Validity period of a contract determines time interval over which the terms of a contract apply. Each contract includes a basic validity period. The validity period consists of a start date and an end date.
To reduce ambiguity it is always preferred to have a termination clause in the contract. Typical termination provisions include clauses requiring mutual agreement of the parties before termination and clauses permitting termination due to failure to fulfill closing conditions before specified date.
Contract rights are freely assignable in absence of an express provision to the contrary. This provision describes what constitutes an assignment and certain types of assignments.
However all assignments will not be enforced.
An assignment of a contract will not be enforced in the following situations:
- a. The contract prohibits
Contract language, typically referred to as an anti-assignment clause, can prohibit (and “void”) any assignments.
- The assignment materially alters what’s expected under the contract.
If the assignment affects the performance due under the contract, decreases the value or return anticipated, or increases the risks for the other party to the contract (the party who is not assigning contractual rights), courts are unlikely to enforce the arrangement.
- The assignment violates the law or public policy.
Some laws limit or prohibit assignments. For example, many states prohibit the assignment of future wages by an employee, and the federal government prohibits the assignment of certain claims against the government.
Assignment by Act of parties may cause assignment of rights or of liabilities under a contract. As a rule a party to a contract cannot transfer his liabilities under the contract without consent of the other party. This rule applies both at the Common Law and in Equity[v].
- Miscellaneous (Boilerplate) Provisions
These are normally kept at the end of the contract and become useful in case of disputes.
- Choice of Law – This Agreement, and any dispute arising from the relationship between the parties to this Agreement, shall be governed by [country/court] law, excluding any laws that direct the application of another jurisdiction’s laws.
- Notice –
Any notices required or permitted to be given hereunder shall be given in writing and shall be delivered (a) in person, (b) by certified mail, postage prepaid, return receipt requested, (c) by facsimile, or (d) by a commercial overnight courier that guarantees next day delivery and provides a receipt, and such notices shall be addressed as follows:
If to ______________: Attention :
If to ______________:
Or to such other address as either party may from time to time specify in writing to the other party. Any notice shall be effective only upon delivery, which for any notice given by facsimile shall mean notice which has been received by the party to whom it is sent as evidenced by confirmation slip.
- Modification of Agreement:
This Agreement may be supplemented, amended, or modified only by the mutual agreement of the parties. No supplement, amendment, or modification of this Agreement shall be binding unless it is in writing and signed by all parties.
- Entire Agreement.
This Agreement and all other agreements, exhibits, and schedules referred to in this Agreement constitute(s) the final, complete, and exclusive statement of the terms of the agreement between the parties pertaining to the subject matter of this Agreement and supersede all prior and contemporaneous understandings or agreements of the parties.
- Severability of Agreement.
If any term or provision of this Agreement is determined to be illegal, unenforceable, or invalid in whole or in part for any reason, such illegal, unenforceable, or invalid provisions or part thereof shall be stricken from this Agreement, and such provision shall not affect the legality, enforceability, or validity of the remainder of this Agreement.
- Dispute Resolution –
All disputes arising out of or in connection with this Agreement, including any question regarding its existence, validity or termination, shall, unless amicably settled between the Parties, be finally settled by arbitration in accordance with the Arbitration and Conciliation Act …., and any modifications thereto and re-enactments thereof from time to time, by three arbitrators. Each Party shall appoint one arbitrator and the third arbitrator shall be appointed by the selected two arbitrators. The seat of arbitration shall be ….. The language to be used in the arbitration proceedings shall be English.
- Code of Conduct –
The parties can draft a code of conduct to comply with, setting a set of the principles and requirements for the performance of the contract.
Signatures – IN WITNESS WHEREOF, both the Parties have caused this Agreement to be signed by their respective duly authorized officers identified below on the day, month and year first hereinabove written.
For ABC Ltd. For ______________________
(i) By: ________________ By: ________________
Name: _______________ Name: ________________
Title: _________________ Title: ________________
(ii) By: ________________
Name: _____________ By: ________________
Title: ______________ Name: _____________
Thus drafting of the contract must be done skillfully to prevent disputes. The terms should not be ambiguous so that in case of any dispute the matter can be resolved amicably. This is a standard draft of a commercial contract and the basic principles remain the same in all states.
[i] ) “This for that” in Latin^ Merriam-Webster, the American Heritage Dictionary of the English Language (Fourth Edition), and the New Dictionary of Cultural Literacy (Third Edition)
[ii] ) Drafting Contracts: How & Why Lawyers do What they do.” Aspen Publishers,2007
[iii] ) Indian CONTRACT Act, 1872 , section 11, Henry Cunningham & Horation Shephard, revised by Justice S.Rafat Alam Edition : 12th edition, 2009
[iv] ) Commercial Contracts Rules for Drafting & Negotiation, Aspen Publishers 2001
[v] ) Vide para 337 of Halsburys Laws of England, Fourth Edition, Part 9