Marisa Fong highlights the importance of understanding contract terms – both yours and the other party’s.
As business owners or managers we have a great deal going on each and every day. So it can be tempting to just cast your eye over contracts and trust that the lawyers will identify any issues; or to simply sign a new client contract in your eagerness to do business with them.
But today, in two separate meetings, I heard about two instances where contracts were vital in protecting each person’s position. And it caused me to reflect on whether we, as founders of businesses, truly understand how important it is to know what to put into our contracts. Not to mention understanding the terms of the contracts we sign!
Unless you’re trained in the law, then like me, you don’t know what you don’t know. Even if you try to read up and know your stuff, the Contract and Commercial Law Act 2017 has 347 sections – hardly a light read!
So you’re relying on your lawyer who you hope is commercially smart enough to cover all your bases.
But when you think about where the potential issues could arise, they usually centre on a few key things. In my experience they can be summarised as:
• Pricing and price increases.
• Terms of payment/trade.
• Protection of intellectual property.
• Exclusivity of supply.
• Dispute resolution and mediation.
It can be hard to know whether these clauses protect you like you think they ought to.
Thinking about it, wouldn’t it be better to test them against all the scenarios that could happen, both positive and negative? It can be exhausting to plan for the worst case scenario – but should it happen, you’ll be thanking your lucky stars that you did.
One of the examples that came up in one of the meetings I mentioned earlier concerned a large company (Company A) advising all of its suppliers that they were moving to 60-day payment terms. I’ve heard of this happening a lot. And often, the business owner feels they need to assent or they will lose a significant client.
But one particular small company (Company B) advised that prices would then increase by three percent. Company A said “you can’t do that, and no other company has said no!” – to which Company B responded “read your contract – if the cost of doing business with you increases, so does our price”.
In the other example from my meetings – let’s call the business involved Company C – the issue was share options where ten percent of the Company C shares would be retained as employee share options. If the share capital increased, so did the amount of shares in that ten percent pool. Company C’s investors are now challenging this, but it’s clearly stated in the contracts and agreed to by the board and previous motions.
So, in testing your own contracts, you need to run through the scenarios most likely for your company. Ask yourself some key questions about your non-negotiables, and what you’re actually quite relaxed about. And make sure they’re covered off in the legalese!
Some things to think about could include:
• What happens if a client doesn’t pay? How long do they get before you repossess plant, initiate legal proceedings? Would you really do it, or would it be an empty threat?
• What recognition will you give for payment in seven days, 14 days, 30 days, etc?
• What are the consequences if they share your trade secrets or your propriety documentation?
• They promised to give you exclusivity in return for sharp pricing and/or certain volumes. What happens if this is not upheld? Are you prepared to pull out of supplying them? Or would you just include a price increase?
• What about returns? How do you deal with issues caused by the client’s staff in not following proper process?
Keep in mind that there’s so much more to consider depending on the type of contract being created. Employment agreements, preferred supplier agreements, and shareholder agreements all have different nuances that you should familiarise yourself with.
Invest the time and effort
So next time you have a contract to sign, go through the headings, get your lawyer to spell it out in plain English and then think through what is missing for you or what you can’t accept.
As they say, once it’s in the bottom drawer, you shouldn’t ever need to pull it out again. And if you have to, then that’s when you’ll be mighty pleased you invested the time and effort to create a document that is perfectly fit for purpose.
Of course, you can’t go back in time and change what you may have signed or handed over for the other party to sign in the past. But if you’re wary of something that arises, you don’t have to immediately settle for the status quo and assume that you’ve got no recourse.
Have a chat with your lawyer, and make use of resources like the consumerprotection.govt.nz website, where you can find information that may come in handy.
And you’ll be better prepared to make the right calls with contracts in the future – so if worse comes to worst, it can be chalked up as a learning experience!