Tuesday, 27 January 2015


Aspects of a Commercial Contract

Now that we've reviewed the basic aspects of contract drafting with a simple example of contract involving the sale of used car, let’s look at the more complex aspects of understanding a contract.

1. Establishing the law of the contract:
A unique feature of contract law is that it sets out a ‘private law’ between the parties. This means that the parties to a contract can choose which law they wish to be governed by, regardless of the local law of the place where they reside.

For example: in case of a contract regarding the sale of a used car, the buyer and seller could resort to arbitration as a mechanism of dispute resolution instead of approaching the courts.

For example, if an American company wishes to sell a factory that it owns in China, to an Australian company, the parties could choose to have the contract governed by the laws of a California where the Australian company has a local office. This ensures that the governing law and forum are neutral towards both parties, and provides both parties with a certain degree of comfort in structuring the transaction.
2. Establishing complex transaction structures:
Commercial contracts are usually complex documents which lay out the structure and organization of the transaction. Commercial contracts are also often futuristic.

Consider the example of the sale of a business by Sam to Sally. The contract could be signed on Day 1, and then the parties could provide for a 20 day time-period where Sally has the right to inspect the financial and operational documents of the business before they take a decision on finalizing the sale. During this period, the parties will usually negotiate the purchase price, based upon the inspection of the documents and understanding of the business. At the end of this 20 day period, if Sally is not satisfied with the results of the inspection, she would have the right to walk-away. Alternatively, the contract could provide both parties the right to walk-away if they are unable to finalize the purchase price.
3. Reducing risk:
One of the most important jobs of a lawyer is to structure a transaction in a way that minimizes the risk of his client. Lawyers are becoming increasingly creative in drafting clauses that reduce risk and/or transfer the risk from their client to the other party. The most common risk that is encountered in all contracts is the financial risk. This could be mitigated in a number of ways – establishing an escrow account for the funds during the period between signing of the contract and finalizing the sale; ensuring that the buyer provides a guarantee from his bank regarding the availability of funds, providing that a third person would step in to guarantee payment of the purchase price, etc.
4. Providing waiver rights:
Waiver rights are provided to parties to permit them to go ahead with the transaction, even if some of the contract obligations have not been met.

For example, in the used car contract, the parties could include a covenant to say that: "The Seller shall ensure that the car contains a full tank of gas on the day of the sale." However, the closing conditions to the contract could provide the Buyer with the right to waive this obligation and still purchase the car, if he so wishes.

Waiver rights are important because they permit parties to go ahead with transactions, if the party feels that the risk incurred by him because of the other party’s non-fulfillment of a certain obligation is less than the risk that would be incurred if he concluded the transaction.

Contract drafting has traditionally been a lawyer’s domain. However, websites offering customizable forms have become popular, especially for the contracts that we use almost every day. Examples include: lease agreements, agreements for the sale of a used car, etc. A quick read would seem to suggest that the contract contains fairly standard terms, but a single seeminingly unimportant word, phrase, or even punctuation mark could change the meaning of an entire clause. Therefore, each party should have proposed contracts reviewed by a lawyer who understands their company, their goals, and the laws governing the transaction. This ensures that the party receives the benefits they are contracting for and prevents costly future litigation.

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