Every small business will need to enter into a contract at some point, whether it be with customers/clients, software providers, suppliers, distributors, manufacturers, partnering with another company or engaging a service provider. The contract you sign will set the terms of your business relationship.
Never sign a contract without reviewing it!
They are legally binding documents that can have huge impacts on your business – not only financially, but can also affect your ability to sell the business, continue your operations and restructure.
This is why it is essential to know the basics of what to look out for when signing a contract. Keep in mind that this is not a definitive list – every contract is different and contain different risks. However, if you understand and identify what to look out for, you can avoid potential pitfalls and protect your business interests.
Here are a few things to look out for:
1. Clear and Precise Terms
Ensure that the contract’s terms are clear and unambiguous. Vague language can lead to misunderstandings and disputes. Ensure obligations are stated explicitly to avoid any room for misinterpretation.
There are many cases where a term can be ambiguous – sometimes you might think the intention is obvious, but if an unrelated person were to read the document, would they understand and know what it means? Ideally, the document on its own should be clear for anyone that reads it to ensure that it is interpreted correctly.
For example, a supply contract might say: “The supplier is responsible for arranging shipping”. This might mean that they are responsible for the shipping itself, but it doesn’t clearly specify who is responsible for paying for the shipping. It could be interpreted to mean the supplier is responsible for shipping, but then what happens if they bill you for the shipping? It then becomes an argument about the meaning and interpretation of the term.
Read through the contract and see if there is anything that might be unclear or uncertain. If there is a term in the contract that says a party needs to do something, always query: “Who is paying for the costs of doing this?” and “Whose responsibility is it?”.
If you can, preparing a checklist of obligations that you have and obligations the other side has under the contract can help paint a picture of what exactly is happening in the contract, so you can ensure it reflects your understanding of the arrangement.
Check all party details are correct, including all ACN and ABNs. A wrong party reference can mean the contract is unenforceable or a party is wrongfully liable. For example, if your personal name is listed instead of the company, this could mean you are personally liable and your assets such as family home or car can be accessed. A wrong party can also mean tax or other financial consequences.
2. Scope of Work
One of the biggest areas of contract dispute is the scope of work. Often, due to technical language or lack of understanding, the scope of work does not adequately cover off different possible circumstances. This is common in IT contracts, where one party has a stronger technical understanding than the other.
To lower the risk, start by listing out the overall objective of the contract, what you are expecting to receive, by what date, and what you are expecting to pay for it. Try to make it as clear as possible, with discrete targets. Once you have an overall objective, break it down into different parts and work together with the other party to create a scope of work that makes sense from both sides. Consider what happens if a problem arises or if timelines blow out: What is the impact on your business? What would help alleviate your losses?
Clearly define the scope of work or services to be provided. This includes detailed descriptions of deliverables, timelines, milestones, and any specific requirements. Ambiguities in the scope of work can lead to disputes over what was agreed upon.
3. Payment Terms
Review the payment terms carefully. This includes the total amount, payment schedule, due dates, and acceptable methods of payment.
Consider your overall budget for the entire contract, what you are expecting to pay, and highlight any points in the contract where you might become liable for surprise costs, such as penalties for late payments or additional services you might need that increase costs.There are some circumstances where penalties are illegal under Australian law, so if there is any payment term that seems unusual or unfair, have this reviewed by an experienced lawyer.
4. Termination Clauses
One of the most important clauses in the whole contract will be the termination clause. This is because once you sign a contract, they can be lock-in contracts without a way out. You could be bound by a contract indefinitely.
Understand the circumstances under which the contract can be terminated by either party. Is there a clause that lets you terminate without a reason in case you need to get out? This includes notice periods, any penalties for early termination, and what happens to any work or payments made up to that point. Clear termination clauses can protect your business if things don’t go as planned.
5. Confidentiality and Non-Disclosure
If the contract involves sharing sensitive business information, ensure there are confidentiality and non-disclosure clauses to protect your proprietary information. This helps prevent the misuse of your business’s intellectual property and trade secrets.
6. Liability and Indemnity
It is standard for contracts to contain a liability and indemnity clause, however they are often difficult to understand without legal advice. Usually, these clauses limit the liability of one party to another, and place liability on a party in specific circumstances. Consider your risk under the contract – if the other party does not do what they say they would do, what is the impact on your business? Is it severe (e.g. stopping your operations entirely?) or is it a minor impact? (e.g. you can easily find a substitute or suspend that part of the business?)
If it is a severe impact, then review the limitation of liability clause carefully to broaden the other party’s potential liability to you. If it will have minor impact, then it still needs to be sufficient to cover your potential losses.
Additionally, review indemnity clauses where you have to pay for the other party’s losses carefully to ensure that you are only liable for reasonable risks, as this can have large financial consequences on you.
It is highly recommended to have a lawyer review the liability and indemnity clauses as they can be complex and have a significant financial impact on your business.
7. Compliance with Australian Law
Ensure that the contract complies with relevant Australian laws and regulations. This includes consumer protection laws, employment laws, and industry-specific regulations. A contract that doesn’t comply with the law could be unenforceable and lead to legal issues, including penalties under Australian Consumer Law.
One of the most common issues I have seen with small business contracts is breach of Australian Consumer Law, for example, excluding returns for faulty goods if they are on sale or providing a manufacturer’s warranty that does not comply with the ‘shopping list’ of requirements under Australian Consumer Law. There are serious penalties for non-compliance, including both fines and negative goodwill.
9. Assignment Clauses
The assignment or transfer clause is one of the most overlooked clauses in a contract. It is usually at the very end of the contract, buried next to other standard ‘boilerplate’ contract clauses.
This clause specifies whether the rights and obligations under the contract can be transferred to another party. It usually requires you to obtain consent of the other party to transfer, novate, deal with, or assign the contract. Usually business owners will simply agree to this, however the impact of having hundreds of contracts with a clause requiring consent to transfer can be significant.
Firstly, if you want to sell your business, this clause means you need to seek consent of each of the parties that you have a contract with. Any one of these contract holders could say ‘no’ to the transfer (especially if they have no obligation to not to unreasonably withhold consent), or simply not reply if you have not reviewed and amended the clause. If you do not have a termination clause that allows you to terminate immediately, you may be stuck and unable to sell your business, or stuck waiting until the termination notice period ends. Even if you have no immediate plans to sell your business, you are limiting your exit strategies by not considering the impact of assignment clauses early.
The impact of an assignment clause is especially the case where your business has a company structure. Usually, an assignment clause will specify that a ‘change of control’ of your company is considered an ‘assignment’ which requires consent. This can mean that if you change shareholding of your company by more than 50%, you must seek consent of the contract party to change your shareholding structure. Again, this could severely limit you if you are seeking investment.
10. Future Amendments
Consider how future changes to the contract will be handled. An amendment clause can outline the process for making modifications to the agreement, ensuring that any changes are documented and agreed upon by both parties.
Conclusion
Signing a business contract is a significant step that can have long-term implications for your small business. By carefully reviewing the contract and seeking legal advice, you can ensure that your business interests are safeguarded. Remember – this guide is very general and does not cover every potential risk in a contract. Every contract is different, so ensure to get tailored and specialised advice for your specific contract.
The Legal Shop specialises in helping Australian small businesses navigate the complexities of business contracts. Contact or call us today for a free consultation for expert advice and support in protecting your business.
