Essential things you should know about contracts
Even if you engage lawyers to draft or review your contracts, there are some essential things you should know.
1. The contract document does not necessarily reflect the whole agreement
Even if its heading includes the word “contract” or “agreement”, the document is merely evidence of the existence of a contract between two (or more) parties. It is not itself the contract. Other terms of your contract or agreement may be found in other places.
Some terms may not be expressly stated but rather implied. They may be implied by Courts or by statutory regimes. For example, the Fair Work Act 2009 implies terms in some contracts. Industry standards, customs or norms may also form implied terms in a contract.
Conversely, some statutory regimes may render terms in your document void and unenforceable. An example of this is the regime applicable to unfair terms in consumer contracts, which stems from the Competition and Consumer Act 2010 and, in the case of financial services, from the ASIC Act 2001. Similarly, under common law principles courts may not enforce lengthy restraints of trade or penalty clauses because they are contrary to public policy.
Other terms of the contract may be reflected in communications between the parties such as letters, emails, telephone conversations and meetings.
That said, the written contract is presumed to reflect the agreement reached between the parties and it can be very difficult to prove that it contains a mistake or omission.
A comprehensive written agreement prepared by lawyers is always a good idea to document commercial arrangements.
2. The contract document can expressly state that it reflects the whole agreement
Sometimes, a contract document will contain a clause stating that the document reflects all the terms of the agreement between the parties (an “entire agreement” clause). It is tempting to use such a clause for the sake of certainty – although it, obviously, will not help with statutory inclusions or exclusions.
But be wary. You might want the other party to be bound by representations it has made during negotiations or as part of a tender process. If you use an entire agreement clause, they won’t be.
As a corollary to this, be mindful of the representations you make during negotiations, particularly if the contract document is not going to include an entire agreement clause. You may be held to them.
3. The contract document should reflect the parties to the contract
Make sure that your document shows the names of the legal entities which are making the agreement – not just their business names.
If a party is contracting in its capacity as trustee of a trust, the contract may reflect that but it doesn’t have to. It is also possible (providing the parties agree) for the trustee to limit its contractual liabilities to recourse against the trust.
4. The contract document should readily identify the essence of the contract
Often, your contract document will contain a preliminary section called “Recitals” outlining the key purpose of the contract.
With a well drafted contract it should be possible to identify the essence of the contract relatively easily from the first few clauses. This key purpose or essence will consist of a combination of obligations and entitlements for each party. Be aware that an agreement may have more than one aspect to it. For example, a lease agreement may also contain a personal guarantee from the lessee’s directors.
Many of the terms in a contract document (for example, dispute resolution clauses and governing law clauses) are important to the legality and functionality of the contract but extraneous to its key purpose.
5. The contract will impose obligations on you (or your organisation)
A contract usually contains a mixture of rights and obligations for each party.
Before you finalise the contract, check what the contract is requiring you to do.
There will be some key and obvious obligations that form the crux of the agreement. For example, if it is a service agreement, these might be services that you have undertaken to provide to the other party.
But there could be tens or hundreds of other obligations scattered throughout the agreement. They might appear minor but may, in practice, be onerous. Depending on the wording of the agreement, your failure to meet them may give the other party rights such as the right to terminate the agreement, the right to withhold payment from you or the right to claim damages to compensate it for loss..
For example, is there an obligation to comply with a particular statute? Is there an obligation to destroy all confidential information at the close of the contract?
Is it manageable for you to meet these obligations? If not, you should negotiate (with the help of your lawyers) their removal from, or modification in, the agreement.
6. Look out for the economic effects of the contract
In particular, a contract may have a number of economic effects and the potential to impact your cash flows.
If it is a lease, what does it have to say about outgoings?
If it is an employment contract, what does it have to say about salary, superannuation, travel expenses and telephone bills?
Are there economic considerations which you would expect to see in the contract but which are missing? If so, and the contract is still being negotiated, it may be possible to insert these. If the contract is already finalised, evidence of agreement on these matters may be found elsewhere such as a letter accompanying the contract or a policies manual to which reference is made in the contract.
7. Know the mechanisms by which the contract can be terminated
Your lawyer will probably have you turn your mind to this during the drafting and negotiation stage.
There are a myriad of possible termination provisions. One party may have the ability to terminate the contract unilaterally with no notice – although the ability to include provisions for unilateral powers is limited by statute, particularly where consumers or small businesses are concerned.
There may be a fixed term of notice that may be given by one party to the other in order to terminate the contract.
Other termination events may include the failure of one party to comply with particular requirements, giving the other a right of termination. For example, if an AFSL holder is appointing an authorised representative, it may reserve the right to terminate the representative’s appointment if the representative breaches provisions in the licensee’s compliance manual and fails to rectify this to the satisfaction of the licensee within, say, two weeks.
Legislation now limits the enforcement of rights against a company (including the right to terminate a contract) where such enforcement is triggered by reason of a relevant insolvency event. This legislative regime applies to contracts entered into after 1 July 2018. However, there are several exclusions to this regime. Your lawyer can tell you more.
While termination generally means the agreement is finished, a contract may be drafted in a way that specifies that particular clauses survive termination. This is common. Topics generally addressed by such clauses are confidentiality and restraint of trade.
8. Beware of provisions in the contract allowing variation by one party
Look carefully where variation to the contract is possible unilaterally. Sometimes such powers can be well hidden in the contract.
Again, the ability unilaterally to vary a contract is generally not permitted in consumer contracts or contracts with small businesses but may occur in commercial contracts between some business entities.
For example, if the contract enables the other party to vary unilaterally fees payable by you, this may result in a fee increase so great you may be unable to meet your obligations under the contract.
The notice period required for the other party to vary the contract should be longer than the notice period required for you to terminate the contract – so that if the other party varies the contract in a manner not your liking, you have the ability to exit the agreement.
9. Liability and indemnity clauses
Liability and indemnity clauses are used in contracts to:
- allocate risk between the parties
- limit or even exclude liability on the part of a party.
These issues are invariably not addressed when the contract is being negotiated and they are often only considered later when negotiating the wording of the contract.
Sometimes they are unnecessary – for example, if your only obligation under the contract is to pay for services provided by the other party, then the risk of incurring liability to the other party beyond that fee is not great and can be easily managed.
In recent times it has become increasingly difficult for parties to limit their liability due to the existence of statutory causes of action for misleading and deceptive conduct – against which they are ineffective.
One particular clause of limited use is a “party/party indemnity”. Under this kind of clause, one party agrees to indemnify the other party against a particular loss. Often, this kind of indemnity is not necessary because, in the event of loss, the party suffering the loss can sue the other party anyway – seeking remedies through contract law, negligence or statutory avenues such as misleading and deceptive conduct. Having said that, the provision of an indemnity is effectively a promise that the innocent party will suffer no loss at all. This may go beyond the amount of damages that would be payable under the normal tests that apply to breaches of contract or negligence.
Because of that, agreeing to indemnify the other party under this kind of clause can also negate your insurance cover. This is because you are putting your insurer (which stands in your shoes) in a worse position than the law would otherwise provide.
A contract may also include a clause for liquidated damages. This is a predetermined amount payable upon a particular breach of the contract by the party which breaches the contract. Sometimes this kind of clause is drafted in a manner which seeks to punish the breaching party for its wrongdoing, in which case it is a penalty clause. Penalty clauses are generally not enforceable for the reason stated earlier.
Many lawyers assisting with the negotiation and drafting of commercial contracts do not provide tax advice. When it comes to the tax effects of a particular contract, you may wish to involve a specialist tax adviser, particularly during the negotiation stage.
Issues that frequently affect commercial contracts are GST-based. The parties and their lawyers need to be aware whether a supply of goods or services is:
- taxable – the supply is taxed but the payer can claim input tax credits
- exempt – for example, charities do not pay GST but can still claim input tax credits
- input taxed – where the supply is not taxed and the organisation cannot claim input tax credits (or, for some financial products, is limited to claiming 75% of input tax credits) – for example, managed investment scheme fees or interest on mortgages.
Prices are taken to be GST inclusive unless the contract specifies otherwise. Your contract must make it clear if GST is not to be included in the quoted price. In the case of Cityrose Trading Pty Ltd v. Booth & anor, the Court found that a contract which had a clause which equated consideration with value was ambiguous. The Court effectively removed the clause from the contract. This resulted in the purchaser not having to pay GST.
To ensure internal consistency in your contract, make sure the fees listed (sometimes they are listed in a Schedule to the contract) match any clauses in the contract which provide for the treatment of GST generally.
If you are negotiating a contract for a sale of business, there is no GST payable on the sale, provided the sale is of a going concern. However, there must be written agreement between the parties that the sale is of a going concern and everything necessary to run the business as a going concern must pass. Generally, this would appear in the contract itself.
Sometimes your lawyer will advise you that your “contract” should in fact be executed as a deed. This is because, if it is not clear that a party giving something up under the agreement is obtaining something in return, you may not have what is known as “consideration” and the contract may not be enforceable at law.
A deed means that the contract should be enforceable regardless of whether there is consideration. Your lawyer may prefer a deed, for example, if you are drawing up a restraint of trade agreement or a personal guarantee. The only real downside to executing as a deed is that the signing process is slightly more complicated.
If the document is to be a deed, it should be referred to as a deed throughout the document.
If the other party is an individual who has an agent signing on their behalf using a Power of Attorney, your lawyer should ask to see the signed Power of Attorney. Careful wording of the execution provision can attract some useful statutory protections if a Power of Attorney is being used by the other side. You can expect that your lawyer would probably have no issues with a properly executed Power of Attorney from interstate – but that they are likely to be more wary of an overseas one.
Similar protections are also available where a company executes the document (whether an agreement or a deed) in accordance with section 127 of the Corporations Act 2001. The execution provisions will generally refer to this provision.
12. Different drafts
Negotiations between parties often lead to there being multiple drafts or versions of a contract before it is finalised. The “Compare Documents” function in Word allows you to check that nothing has slipped into the latest draft, courtesy of the other party, other than what they have explicitly told you about.
You may want to use Word to track changes and make comments on drafts internally in your organisation or between your organisation and its external lawyer. Be careful of this and of forms of metadata associated with the document which you would prefer the other party not to see. Remember, there is a lot more to an electronic document than what immediately meets the eye and you may, as a result, inadvertently give away your negotiating position.
13. Other common clauses
A contract will often contain a clause stating that the contract is governed by the law of a particular Australian jurisdiction. For most commercial contracts, it is of little consequence which jurisdiction is nominated and it is generally not worth quibbling over.
A contract will also often contain a dispute resolution clause. This sets out in advance the process to be followed should a dispute arise between the parties in relation to the contract. It can be used as an alternative to lengthy and expensive Court cases.
14. Next steps
For practical advice that is easy to understand, contact our lawyers.
Author: Samantha Hills (Special Counsel)