Business & Commercial Law
Common Contract Terms Explained
In every contract there are invariably a slew of legal terms and conditions that, regardless of the contract’s purpose, go unchanged and often unchecked by the contracting parties. These terms and conditions are often referred to as the contract’s “boilerplate” language. Most people don’t give these sections a second thought, and it’s typically a non-issue. That is, until they have a dispute and the contract is used as evidence in court. Since these terms can influence the outcome of a lawsuit, it’s worth knowing at least their general meaning, and whether they can be negotiated in your favor.
Indemnification (Hold harmless agreement)
If you agree to an indemnification clause it means you are agreeing to hold another party harmless against future legal claims. It’s easiest to understand indemnification through an example: say you rent a car and sign a contract with the rental agency that you will indemnify them against any future claims. If you were to get into a car accident where another party was injured, they would not be able to sue the rental agency because you have indemnified them against all future claims. If the other party attempted to sue the rental agency, you would be legally obligated to assist in the agency’s legal defense.
Indemnification is a way for people to protect themselves from being financially liable for another’s actions or negligence. These clauses are usually written with great care and precision so it is important to understand the limitations and scope of the indemnity before signing a contract.
Sample indemnification clause:
Widgets, Inc. agrees to indemnify and hold harmless Corp. X against loss or threatened loss or expense by reason of the liability or potential liability of Corp. X for or arising out of any claims for damages.
Time is of the essence
A time is of the essence clause is included in a contract to signal that any delay in performance will amount to a material breach of the agreement. For example, a landlord may insist a remodel of a condo be completed by a certain date because tenants will be moving in shortly thereafter. If the remodel isn’t completed by that date, the consequences for the landlord would be significant in terms of lost rent. Without a time is of the essence clause, a delay might be considered a material breach and the landlord may not be able to successfully sue the contractor for the breach.
In some cases, contracting parties will explicitly agree that time is not of the essence. This is particularly true when there are unknown variables that could influence a person’s ability to perform under the contract within a certain period of time. If the parties want to make it clear that a delay in performance is acceptable they should include a time is not of the essence clause.
Sample time is of the essence clause:
Time is of the essence with respect to all provisions within this Agreement. Any delay in performance by either party shall constitute a material breach of this Agreement.
Choice of Law & Forum Selection Clause
When parties include a forum selection clause they are agreeing that any disputes will be covered by the law of a specific jurisdiction, and/or within a certain forum (court). If the parties elect to choose a specific jurisdiction, it’s typically because they are doing business across states lines and need to know what law to follow in case there are any discrepancies. When dealing with a company or person from different jurisdiction, you should be aware of the applicable law as stated in your contract because it may be different than the state you currently reside.
The contract may also state that any dispute will be handled in a certain forum. This means that a contract signed in California could be litigated in Florida if that’s what the parties agreed. Further, this clause can also limit your ability to litigate a dispute in the courts. Instead, the contract can demand that disputes must be brought to arbitration or mediation only. Arbitration is usually in front of a judge or judge-like decision maker, and mediation is akin to a negotiation before a neutral third party.
Sample choice of law & forum selection clause:
This Agreement shall be interpreted and construed according to, and governed by, the laws of Delaware, excluding any such laws that might direct the application of the laws of another jurisdiction.
In the event that the parties can not by exercise of their best efforts resolve the dispute, they shall submit the dispute to Mediation.
Arbitration clause
See “forum selection clause” above
Severability clause
As seen in other terms on this list like “indemnification,” the language of each legal clause must be properly written for each contract and for each set of parties. Unfortunately, attorneys who write contracts are human and can make mistakes with regard to the language. Language mistakes have the potential of voiding the entire contract. A severability clause will either allow the invalid portion to be modified to reflect the party’s actual intentions, or rescue the other portions of the contract that are written properly and keep them valid and enforceable.
Sample severability clause:
Invalidity or unenforceability of one or more provisions of this Agreement shall not affect any other provision of this Agreement. If possible, any unenforceable provision within this Agreement will be modified to reflect the parties’ original intention.
Attorney fees provision
This provision is common and states simply that if a dispute arises from the contract then the losing party will pay both side’s attorney fees. If you have an issue with this outcome, you may want to negotiate that this provision will only apply to claims brought frivolously.
Sample attorney fees provision:
In any proceeding by which one party either seeks to enforce its rights under this Agreement or seeks a declaration of any rights or obligations under this Agreement, the prevailing party shall be awarded its reasonable attorney fees, and costs and expenses incurred.
Liquidated damages clause
A liquidated damages clause states that if a party fails to live up to the terms of an agreement, that party will be liable for a specific sum of money. These clauses are used when the actual damages resulting from a breach are unascertainable. For example, a developer may hire a builder to construct a new restaurant to be opened on a certain date. When the parties sign the contract there is no way to determine how much revenue and profit the restaurant will make each day after it’s opened. Thus, the parties may agree that if the construction is delayed, the builder will pay liquidated damages amounting to $300 per day the restaurant is delayed.
In order for a liquidated damages clause to be enforceable it must be reasonable as measured at the time of signing. In the example above, it would be unreasonable for the parties to agree to a liquidated damages sum of $50,000 per day because the figure is obviously too high. Usually however, if there is a legitimate question as to whether the liquidated damages amount is unreasonable, the judge will side with the party attempting to enforce the liquidated damages clause. This is why it’s important to read your contract for a liquidated damages clause, and if you’re uncomfortable with the amount, feel free to negotiate.
Sample liquidated damages clause:
If the Contractor fails to complete the work within the contract time, the Contractor agrees to pay the Owner $300 per day as liquidated damages to cover losses, expenses and damages, not to exceed $10,000.
Acceleration Clause
This clause provides that if one party breaches the agreement, the other party can demand full performance immediately. This is important in contracts with installment payments spread over a long period of time, such as in a mortgage arrangement. If an installment plan includes an acceleration clause and one party fails to make a payment, the other party will be able to demand the entire amount outstanding immediately.
For example, say a buyer contracts with a store to purchase a couch for $1000, to be paid in ten monthly installments of $100. If the buyer makes the first three payments, but fails to make the fourth, an acceleration clause would require the buyer to pay the store the entire balance of $700. If the buyer were unable to make the $700 payment, he would not only lose the couch, but all the money he had previously paid.
Sample acceleration clause:
In the event of default in the payment of any of the said installments or said interest when due as herein provided, time being of the essence hereof, the holder of this note may, without notice or demand, declare the entire principal sum then unpaid immediately due and payable.
Merger and integration clause (Entire agreement clause)
This clause basically states the entire agreement between the parties has been completely memorialized in the words of the contract. Thus, if there were ever a dispute as to the purpose of the contract, or the expected performance of the parties, a judge would only look to the language of the contract to decide the case. For example, say you agreed to buy goods from a merchant who would deliver them to you on a certain date. If a contract for this sale of goods included a merger and integration clause, the merchant would be precluded from later claiming you had agreed accept the goods on a different date. The contract language trumps whatever other agreements you may have had.
There is at least one exception worth knowing. In a dispute over a contract that includes a merger and acquisition clause a judge may allow in outside evidence in order to clear up language ambiguities, or to determine whether fraud was committed. However, outside evidence will not be admitted into court to directly contradict the written contract’s terms. For example, if during the signing of a contract one person thought the word “Soda” included fruit juices whereas the other party thought it included only carbonated beverages, outside evidence may be admissible and useful to clear up the initial confusion.
When faced with a contract that includes a merger and integration clause, it may be helpful to have a third party review the contract for ambiguities or missing elements. You may know what soda means, but without a clearly expressed definition the word is open to interpretation.
Sample merger and acquisition clause:
This Agreement and exhibits attached hereto constitute the entire agreement between the contracting parties concerning the subject matter hereof. All prior agreements, discussions, representations, warranties, and covenants are merged herein. There are no warranties, representations, covenants, or agreements, express or implied, between the parties except those expressly set forth in this agreement. This agreement may only be amended by a written document duly executed by all parties.
As a general rule, all contract terms and conditions are negotiable. If you ever have a question regarding what something in the contract means, it would be wise to research its meaning and consequences before signing. Ignorance of the law is not an excuse that will allow you to break a contract after it’s signed.