When drafting a contract, it’s common to include provisions for what happens when one party fails to perform what is required of them. This provision is a type of contract clause.
Without specific clauses addressing potential disagreements, more of your contract will be open to interpretation by a court. Often, the court’s decision may not favor either party. It’s far simpler to have an agreement between the parties in advance, as it allows you to avoid this escalation.
In this guide, we’ll look at some common contract clauses, what they mean, and why they deserve attention. First, let’s understand the basics of a contract clause.
What is a contract clause?
Think of a contract as a rulebook for a game. Each rule in that book is like a clause. So, a contract clause is simply a specific rule or section within the contract that clarifies a particular aspect of the agreement. It spells out the details of what each party has agreed to do or not do.
Purpose of contract clauses
Having the right contract clauses in place can offer solutions to problems before they even arise. By being proactive, you can protect both parties and establish clear expectations for the business relationship. Let’s expand more on these vital aspects of contract creation and maintenance.
Management of risks and compliance with the law
Clear contract clauses help prevent disputes by clearly outlining terms and conditions. They serve as an insurance policy against misunderstandings and potential legal problems.
For example, specifying payment schedules and deliverables in detail can reduce disagreements about what’s expected from each party.
Additionally, you can use contract clauses to ensure your agreement complies with any relevant laws and regulations. Certain types of contracts may require particular formalities and clauses in order to be binding.
Read also: Contract management: Tips for legal teams
Clarity of business relationship
A well-written clause sets clear expectations for both parties. It reduces the chances of disputes and strengthens business relationships. It also means parties cannot say they didn’t know possible consequences, as they are stated in the contract and would have been mutually agreed upon.
11 Common contract clauses and their impact on agreements
There are many types of contract clauses — too many to cover in one blog post! However, we’ve pulled together the most common and crucial ones you’ll encounter in business agreements.
1. Confidentiality clause
A confidentiality clause limits the disclosure of sensitive information to the public, market competitors, or other third parties. Confidential information may include trade secrets, inventions, personally identifiable information about employees and clients, and sensitive business data.
Because confidentiality clauses typically define what qualifies as confidential and limit how that information can be used or shared, they help address practical concerns. For instance, if you’re wondering, “How do you record a phone call for record-keeping while aligning with confidentiality and data protection expectations?”, this type of clause can provide important boundaries and protections.
Confidentiality clauses are usually simple, straightforward, and limited in scope. They can be one-sided or mutual.
2. Indemnification clause
An indemnification clause is a provision in a contract whereby one party (the indemnifying party) agrees to compensate the other (the indemnified party) for any losses or damages resulting from a particular event or circumstance.
For example, if a software company hires a third-party developer and the contract includes an indemnification clause, the vendor may be required to cover the legal costs and damages that arise if, say, the mobile app they developed contains security vulnerabilities that lead to data breaches.
Companies that conduct thorough vendor risk assessments can negotiate stronger indemnification clauses. This may reduce their exposure to liability in cases involving third-party actions or breaches.
3. Limitation of liability clause
A limitation of liability clause, as the name implies, ‘limits the liability’ one party can cover from another party for breaches or performance failure. In other words, the clause can create a ceiling for compensation that an organization might be obligated to pay under specific conditions.
This clause can apply to the entire agreement or be limited to certain types of breaches, failures, or damages, depending on the contract.
Consider, for example, a sales software provider’s contract with a company that uses their platform to manage customer leads and track sales performance.
The contract might include a limitation of liability clause—if a temporary system outage causes the company to miss out on a few high-value leads, the clause might limit the software provider’s from being sued for extensive lost revenue, limiting their liability to, for instance, the amount paid for one month of service.
4. Termination clause
If one or both parties want to end a contract before its due date, a termination clause outlines the procedure for termination. It generally describes how a contract may be ended, sometimes without penalties, under specific conditions agreed upon by both parties. A termination clause can be found in various types of contracts, including employment contracts, rental contracts, and vendor agreements.
While specific terms will vary, they typically include the grounds for termination and notice period. For instance, in an employment contract, the grounds for termination might be poor performance after an employee review, or the desire to move to a new company. The notice period outlines how long notice must be given before ending the contract.
5. Payment terms clause
Payment term clauses outline the timelines and obligations for payments between parties. It specifies amounts, accepted payment methods, due dates, and penalties for non-compliance
For example, a supplier may provide materials to a manufacturer under an agreement that includes a payment terms clause. This clause could require a 50% upfront deposit and the remaining balance upon delivery. This ensures the supplier receives partial payment before production begins.
A payment terms clause can help manage cash flow more effectively, support favorable financial planning, and reduce the risk of payment disputes.
6. Intellectual property (IP) rights clause
An intellectual property (IP) clause is a contract clause that oversees the ownership, rights, and protection of intellectual property assets.
IP refers to things like trademarks, trade secrets, and creative works. An intellectual property clause specifies ownership, rights, and responsibilities relating to intellectual property assets. It protects the interests of the parties involved and establishes rules for the management, use, and protection of intellectual property.
This clause aims to prevent disputes and ensure clear ownership and usage rights of intellectual property, allowing both parties to use and protect it effectively. They’re often found in software development agreements, joint venture agreements, and employment contracts.
Read also: Is an email legally binding?
7. Governing law and dispute resolution clause
A governing law clause and a dispute resolution clause are essential components of any contract. The governing law specifies which legal system will be used to interpret and enforce the agreement – for instance, “This agreement shall be governed by and construed in accordance with the laws of the State of California.”
The dispute resolution clause outlines the forum in which parties want to resolve any potential disputes under the agreement. This includes arbitration, mediation, or litigation through the courts.
8. Force Majeure clause
This type of contract clause relieves a party from liability if they cannot meet their contractual obligations due to unavoidable or unforeseen events beyond their control. This often includes:
- War
- Pandemic
- Labor strikes
- Government actions
- Supply chain disruptions.
The American Bar Association reported that Force Majeure clauses were relied upon during the pandemic, showing just how important they can be.
9. Warranties and Representations clause
Warranties and representation clauses contain factual statements and assurances about conditions relevant to the contract.
Representations provide information about the present or past, while warranties guarantee the truthfulness or legality of those facts. This clause outlines the basis for entering the agreement and remedies for breaches.
10. Non-Compete clause
A non-compete clause is often used in a contract with a business partner or employee. It states that the party bound by the agreement is not allowed to open a competing business or work for a competitor for a defined period. These provisions typically specify a geographical region where the party is prohibited from competing, as well as how long it applies.
Non-compete clauses are widespread, with around 30 million employees in the US having one in their contract. However, they often face resistance, so it is crucial to be precise and clear in the wording if you choose to include one.
11. Severability clause
Under a severability clause, any provision in the contract that a court deems invalid will be removed from the contract. However, the remainder of the contract terms will remain in effect.
Key takeaways
Every contract clause can be seen as a chance to protect the interests of the parties involved in an agreement. They provide clarity and solutions to potential misunderstandings, reducing the chances of escalation to legal proceedings should difficulties arise.
By spending extra time perfecting every clause, you can save time, money, and your reputation further down the line.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. Always consult a qualified legal professional for advice tailored to your situation.
