The Elements of a Contract

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In my last post, I described a scenario where an entrepreneur drafted his own contract, because he was just concerned with establishing a meeting of the minds between the parties, and not with creating legal rights.  So what are the sections of a contract that an attorney would have added, and what are their functions?

You may recall that the entrepreneur drafted language describing the TRANSACTION, RESPONSIBILITIES OF THE PARTIES, COMPENSATION, and TERM AND TERMINATION.  A more comprehensive contract would also have contained some combination of the following:

1.  RECITALS (or “Whereas” clauses): These are statements that give the reader some background re: what the parties are trying to accomplish.

2.  REPRESENTATIONS AND WARRANTIES: These are factual assurances that the other party needs in order to do the deal.  Representations are statements regarding the present.  For example, a software licensee needs the licensor to represent that it has the right to license the software.  And an investor needs representations regarding a company’s capitalization before deciding to invest.  Warranties, on the other hand, speak to the future.  A company may warrant, for example, that its product will meet certain performance requirements.

3.  COVENANTS: These are promises that a party will do certain things in the future.  For example, a private company may promise to provide investors with financial statements on a periodic basis.  Or a borrower may promise to maintain certain financial ratios while a loan or line of credit is outstanding.

4.  CONDITIONS: In some deals, an obligation of a party is conditional upon something happening first.  For example, a typical acquisition agreement will have numerous “conditions to closing.”  The agreement provides for a closing at a future date, but the acquiror’s obligation to purchase may be conditional upon, for example, certain key employees signing employment agreements, the deal being approved by certain regulatory authorities, etc.

5.  CONFIDENTIALITY: These are typical NDA terms that state that neither party will disclose the other party’s confidential information or use it to the detriment of the other party.

6.  INTELLECTUAL PROPERTY: If the parties are collaborating to create IP, the agreement will need to address who owns it and what rights, if any, the other party has to it.  Or if a party needs rights to the other party’s existing IP, the agreement will need to contain a license to that IP.

7.  LIMITATION OF LIABILITY: The parties may seek to limit their liability under the contract to a specific dollar amount.  They also seek to eliminate their liability for certain categories of damages, such as “consequential damages” (i.e. damages which don’t directly flow from the breach, but are a consequence of the breach—a typical example is lost profits).  Dollar limits are often heavily negotiated, while exclusion of consequential damages is usually reasonable and not negotiated.

8.  INDEMNIFICATION:  If the contract results in one of the parties being sued by a third party, under what circumstances must the other party provide the defense and pick up the tab?  This is often a negotiated provision.

9.  WARRANTIES AND WARRANTY DISCLAIMERS:  What kinds of promises are made by the seller re: product performance?  Contracts often contain “express warranties” made by the seller, and a “disclaimer” of all “implied warranties.”  This means that the seller is giving only those warranties contained in the contract, and not the warranties that, absent a disclaimer, the law applies to most deals (e.g. implied warranties of merchantability and fitness for a particular purpose).

10.  BOILERPLATE: Contracts usually have a section at the end that has a title like “Miscellaneous” or “General.”  This is the “boilerplate,” so named because, like the steel sheets used in the early 20th Century for printing text that would be widely reproduced without changing, these provisions are thought to be pretty standard and unchanging.  There’s some truth to this, but it’s dangerous to ignore the boilerplate.  While some boilerplate provisions (such as “Entire Agreement,” “Modification,” “Counterparts,” “Waiver,” “Severability,” and “Force Majeure”) often vary little from contract to contract, others (such as “Assignment,” “Survival” and, to some degree, “Dispute Resolution”) are very deal-dependent and important.

This overview was intended to give you a “big picture” view of the elements of a contract, so that you can more effectively review contracts that land on your desk.  Future posts will deal with some of these elements in more detail.

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