Reviewing Contracts in Challenging Times

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An interesting lesson from the Covid pandemic was how a sudden crisis could disrupt a relationship which had previously operated happily (and profitably) for years, be it between a tenant and a landlord, a supplier and a retailer or providers of professional services.

Contract lawyers were required to review longstanding commercial contracts which parties had long thought clear and fit for purpose. In some cases, they found that contracts did not mean what the parties thought that they meant or that boilerplate clauses, often overlooked in contractual negotiations and drafting, did not provide adequate protections or were not fit for purpose leading to issues around termination and enforcement.

It was only when parties entered into disputes, caused or exacerbated by wider issues in the economy, that underlying issues, sometimes stemming from poor drafting, came to the surface.

Here we will look at how good contract reviews and the effective use of common contractual clauses can pre-emptively protect contracting parties as we enter what possibly could be more economically uncertain and geopolitically unstable times.

The fence at the top of the cliff is better than the ambulance at the bottom and thorough contract reviews before issues arise are especially important in circumstances where either template contracts or other parties’ styles are being used.

We recently had two cases where clients “hadn’t appreciated” the impact of certain wording in their contracts. The wording of a software licence was far wider than the client had appreciated – even though it was his licence. In the second case, a key definition which tied in directly with the contractually stipulated fees was again broader than the client thought, resulting in less revenue for them. In this case, the contract document was based on the other (much larger) company’s template which had been drafted to their advantage from the outset.

The early identification of contract risks will also assist with any investor or buyer due diligence processes. Connected to this is ensuring that contracts allow for a degree of internal restructuring in order to ensure customer contracts are easily able to be assigned to another group company which may be required if part of a group gets into financial difficulty and a restructuring process is necessary.

If following a review, there are areas which are open to interpretation then ideally you want these to be addressed and this might be easier to do when there isn’t a “live” issue to deal with. However, one party cannot unilaterally change a contract to amend points they have discovered they don’t like. The contract itself will usually contain a clause setting out how amendments should be carried out and the other party should be engaged in negotiations regarding making changes so that amendments can be mutually signed off in writing.

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If this is not possible, at the very least it is better to be aware of issues than have them revealed at a time at which you are trying to impress a buyer/ investor or actively going through a due diligence process.

With regards to anticipating the resolution of future disputes and difficulties special consideration should be given to clauses dealing with disputes, termination and liability caps.

Some contracts have no fault rights of termination. Many will allow for termination on changes of control. Termination for insolvency will allow a party to terminate immediately where the other party enters into an insolvency event. For instance, if a petition is raised for the company’s winding-up or where an application is made for the appointment of an administrator. Where a customer goes into liquidation it may be desirable to terminate contractual relationships with them as soon as possible to prevent any further transfers of funds or goods to them. A carefully worded termination for insolvency clause will allow this to be done at the earliest opportunity hopefully before any further costs are sunk.

Having such clauses in your favour can be useful in terms of allowing for a swift end to the relationship when it is no longer convenient or profitable. However, if the other party to the contract holds such rights, the contract’s value to your business could be diminished in the eyes of an investor or buyer.

Where conflict does arise dispute resolution clauses can assist and come in various forms. Often they will require engagement and negotiation between the parties before they can seek redress via the courts with a degree of “escalation” as the dispute goes on with more senior management becoming involved. Mediation clauses are increasingly common and require the parties to mediate (whereby an in-person negotiation is facilitated by an independent third party) prior to taking the dispute any further.

Where contracts are cross border in nature special consideration should be given to choice of law and jurisdiction clauses. The law of one country might impart certain advantages over the law of another as far as the contract is concerned. For instance, a contract governed by Scottish law could contain a provision allowing for summary enforcement in the event of default. While such a remedy would not be permitted under an English law contract.

Jurisdiction clauses deal with the court in which action pertaining to the contract can be raised and while it is sometimes considered best to litigate on your “home turf” non-exclusive jurisdiction clauses allow for a degree of flexibility in terms allowing proceedings to be raised in other courts.

In cases where parties are located in “difficult” or remote jurisdiction arbitration causes should be considered with proceedings taking place in a neutral location as arbitration awards are often easier to enforce across borders than national court judgments.

Where litigation becomes necessary, be it in the national courts or through an alternative dispute resolution process liability caps can be used to effectively manage financial exposure by limiting the amount of damages one party can claim from the other arising from a breach of the contract.

The consideration of such clauses should form the part of any contract review.

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