When a business gets into trouble over a contract, it is rarely the result of misinterpreting the complicated legal wording. More often, trouble stems from simple errors that you can avoid with a little planning beforehand.
Whether you’re an IT contractor or small business in the IT industry, it’s important to know what the potential risks are, so we’ve set out our top tips for entering into contracts to avoid some common errors.
Identify the other contracting party
Frequently, we see contracts completed by sales representatives that appear to be associated with the name of a pub, shop or restaurant. However, the law does not recognise these as legal personalities. A legal personality is an individual or limited company. Unless you, as a contracting party, correctly identify who you’re dealing with, it greatly reduces your ability to successfully enforce the contract.
Check their creditworthiness
It does not matter how robust your contract is, if you’re dealing with a party that has no proper funding, you won’t be able to recover any damages if the other party defaults. To safeguard against this, always credit check the other party.
Remember that even if the other contracting party is part of a large group of businesses, legally you have no claim against those other companies so you can’t rely on the collective financial strength of the group.
Incorporate your contractual terms
Some businesses spend a great deal of time and money preparing their terms of business but fail to use them in contracts with their customers. As a result, this can be quite expensive.
Terms of business may include things like the ‘retention of title’ clause that allows an unpaid supplier to recover their goods if a customer becomes insolvent. In fact, the majority of retention of title claims fail, not because of an error in the wording of a clause, but because the supplier has failed to include its terms of sale in contracts with its customers.
Referring to your terms on every relevant document (from order forms and quotations to order acknowledgements and even delivery notes) can help, but you should always seek advice on how best to do so.
Spot and win the battle of the forms
Problems can occur when a buyer and a seller both want to contract under their own standard terms. These terms will be almost opposite in every respect. For example, the buyer’s terms will look to impose wide obligations and liabilities on the seller and the seller’s terms will attempt to exclude or limit their liability as much as possible. This conflict as to whose terms apply is known as ‘the battle of the forms’.
The winner is usually the party that’s last to send out its terms before the contract is created. So, if a business sends out its terms with a quotation and the customer then places an order on its terms of purchase, it will be the buyer who wins the battle.
In this situation, one solution could be to negotiate the terms or have the buyer sign a credit application form agreeing the seller’s terms will always apply. However, making sure that your terms appear on all relevant documents is always a good precaution to take from the outset.
Avoid accidental contracts
An urban myth we still hear pretty regularly is “I never signed anything so we don’t have a contract”. Businesses often forget that contracts don’t need to be signed or limited to writing. In most cases, contracts can be created verbally, by telephone or by email so it’s important to be wary of creating them by accident. This can be as simple as having a disclaimer on all emails that no contract will come into place until a formal contract is signed.
Don’t copy someone else’s contract
Just because another business is using a contract in a particular form, there’s no guarantee it’s right for you. Remember that most contracts are drafted, initially at least, to favour one party over the other. Another business’s contract may therefore relate to a similar business scenario, but be written from a different perspective to your own.
On one occasion we came across an IT company which was about to sell for several million pounds. Unfortunately in its first contract with a customer, it had given away its intellectual property to the customer making the company virtually valueless on a sale. It had found that first contract on the internet, which had been drafted from the customer perspective, so, rather than retaining the intellectual property rights for the company as you’d expect, it gave them to its customer.
Authority to sign
If you want to enforce a contract, you’ll need to make sure it’s signed by someone who has the authority to sign. There’s little point in having a robust, expertly drafted contract, if you don’t check that the person who is signing is authorised to do so. If dealing with a company, a contract signed by a director will bind that company.
Likewise, a contract signed by a partner will bind a partnership. On the other hand, a contract signed by the office junior will almost certainly not be binding. The law can be quite complicated in this area. In most organisations there will be a number of other people who have authority to bind the company but following this logic is a good rule of thumb.
Putting it into practice
Creating a successful contract means doing much more than just signing along the dotted line. By completing the proper checks beforehand and taking a careful and conscious approach to building your contract, you can safeguard against errors that may ultimately become very expensive and time consuming legal disputes.
If you’re interested in learning about the problems that can happen during the lifecycle of a contract and how to avoid them – take a look at our next instalment, Tips for contract management and exit.
When contracting, indemnifying yourself for potential future losses is important. Professional indemnity insurance can provide support should you need to correct a mistake or settle legal fees and compensation costs.