Introduction
Contracts form the backbone of all commercial transactions, defining the rights, responsibilities, and obligations of the parties involved. However, many individuals and businesses sign agreements without fully understanding the terms, leaving themselves exposed to unnecessary risks. Whether dealing with construction, procurement, or professional services, a poorly reviewed contract can result in financial loss, project delays, disputes, and even legal action. This article explores why it is crucial to scrutinise contractual terms before signing, the key elements to look out for, and how ensuring risks are fairly distributed benefits both parties.
Why You Must Understand Your Contract
Once signed, a contract becomes legally binding. Courts will generally enforce the agreed terms, even if one party later finds them unfair or impractical. This principle was reinforced in Rock Advertising Ltd v MWB Business Exchange Centres Ltd [2018] UKSC 24, where the Supreme Court held that contractual terms specifying formal variation requirements must be followed, regardless of subsequent verbal agreements.
To avoid unforeseen liabilities, it is vital to understand:
- The scope of work and deliverables
- Payment terms and pricing mechanisms
- Liability, indemnities, and limitations of liability
- Termination clauses and the consequences of breach
- Dispute resolution mechanisms
- Change control provisions
- Force majeure clauses and their implications
Failure to grasp these elements can lead to costly consequences, affecting the financial and operational viability of a business.
Key Considerations Before Signing a Contract
- Scope of Work and Deliverables
The contract should clearly define the scope of work, deliverables, and performance requirements. Any ambiguity can lead to disputes, as seen in MT Højgaard A/S v E.ON Climate & Renewables UK Robin Rigg East Ltd [2017] UKSC 59, where conflicting contractual obligations regarding quality standards led to costly litigation. A well-defined scope prevents scope creep and unnecessary costs.
- Payment Terms and Pricing Mechanisms
Understanding payment structures, milestone payments, and retention sums is crucial. The Supreme Court, in Triple Point Technology Inc v PTT Public Company Ltd [2021] UKSC 29, clarified the enforceability of liquidated damages provisions, ruling that such clauses continue to apply even if the contract is terminated before completion. Ensuring clarity in pricing mechanisms reduces financial exposure and cash flow issues.
- Liability, Indemnities, and Limitations
A contract should fairly allocate liability between parties. If one party accepts unlimited liability, it could face catastrophic financial exposure. The case of BAE Systems v Northrop Grumman Mission Systems Europe Ltd [2014] EWHC 3544 (TCC) reinforced that exclusion clauses must be carefully drafted, as the courts will enforce them provided they are clear and reasonable. Indemnities should be carefully structured to avoid disproportionate risk allocation.
- Termination and Breach Provisions
Contracts should specify termination rights and outline the consequences of a breach. In Ziggurat LLP v Daejan Investments Ltd [2020] EWHC 2017 (TCC), the court ruled that termination for convenience clauses must be adhered to strictly, as failing to follow the contractually agreed process can result in wrongful termination claims. Termination clauses should provide clear exit strategies for all parties.
- Dispute Resolution Mechanisms
A contract should include a dispute resolution clause specifying adjudication, arbitration, or litigation procedures. In Enka Insaat Ve Sanayi AS v OOO Insurance Company Chubb [2020] UKSC 38, the Supreme Court provided clarity on governing law for arbitration clauses, ruling that unless otherwise stated, the governing law of the main contract does not automatically apply to the arbitration agreement. Understanding dispute resolution procedures can save time and costs in the event of disagreements.
- Risk Allocation and Change Control
Risk should be assigned to the party best equipped to manage it. The case of BDW Trading Ltd v Integral Geotechnique (Wales) Ltd [2018] EWHC 1915 (TCC) highlighted the importance of clearly defining risk in professional service contracts to avoid liability disputes. Change control procedures should be well-defined to prevent uncontrolled amendments that can disrupt project execution.
- Force Majeure Clauses and Unforeseen Events
Recent events, such as the COVID-19 pandemic, have emphasised the importance of force majeure clauses. In TKC London Ltd v Allianz Insurance PLC [2020] EWHC 2710 (Comm), the court ruled on the enforceability of force majeure clauses in light of pandemic-related disruptions. Ensuring that contracts contain well-drafted force majeure provisions can protect businesses from liabilities due to events beyond their control.
Ensuring a Fair and Effective Contractual Process
It is essential to be familiar with the terms of a contract before signing. If any aspect of the contract appears unclear or overly complex, seeking expert advice can prevent potential disputes and financial exposure. Efforts are often made to avoid unnecessary amendments to contract terms, as doing so can prolong negotiations and increase the involvement of legal teams, making the process unnecessarily drawn out. However, if both parties act reasonably and with mutual understanding, the contract can be structured to reflect the true intent of the agreement. When risks are appropriately allocated, each party assumes only the responsibilities they are capable of managing. This fosters a balanced and transparent contractual relationship, ensuring fairness and commercial efficiency.
Conclusion
Signing a contract without fully understanding its terms can have serious financial and operational repercussions. By paying attention to key clauses and ensuring risks are fairly allocated, businesses can safeguard their interests and enhance project success. A well-drafted contract is not just paperwork. It is the foundation of a successful business relationship. Investing in expert contract management can prevent disputes and improve commercial efficiency.
