Wednesday, April 6, 2011

Contract Construction

In drafting and negotiating contracts its very important to understand how they will be interpreted if the contract were to be interpreted by Courts as part of a law suit. There are some basics rules / standards that apply:
  1. If the parties attach the same meaning to a term, the interpretation will be based on that even if a third party may not interpret it the same way. If the parties have a different understanding of the meaning, a contract may not be enforceable as there was no meeting of the minds.  If you had reason to know what the other party understood the term to mean, it may be interpreted according to their meaning.
  2. If the language is clear and explicit, the court will look no further in interpretation. The exception to that is if the language would lead to an absurd result.
  3. Contracts are construed against the drafter if there are any ambiguities.
  4. Words are given their ordinary meaning unless a special meaning is given to them in a technical sense or by usage such as creating defined terms.
  5. Technical words are interpreted by persons in profession or business they are used in.
  6. If a term is omitted, courts will supply a term that is reasonable.
  7. If there is a written agreement, evidence of a prior or other agreement is inadmissible to vary or contradict the terms of the written agreement.
  8. If the meaning is plain and unambiguous, the meaning will be determined within the document without extrinsic evidence.
  9. Enforcement will be according to the terms or the agreement provided that the agreement is clear and complete.
  10. Terms will be interpreted to be complimentary.

To put this into the perspective of a contract:

To make sure that the parties attach the same meaning to an item, contracts usually have a definitions section and create defined terms and each time the term is used that has that special meaning, it is capitalized to show that it is a defined term

To prevent extrinsic evidence from being introduced, contracts will have what is called a “merger clause” such as “This Agreement replaces any prior oral or written agreements or other communication between the parties with respect to the subject matter of this Agreement” to show the clear intent of the parties that what is within the “four corners” of the agreement is all the parties intend to constitute the Agreement.

To deal with issues where a term may be found by the courts to be unenforceable, most contracts will also contain a severability provision that says that the if the unenforceable term doesn’t materially affect the parties rights under the Agreement, the agreement without that term will remain in effect.

Another key term in interpreting an agreement is making sure that there is a clear understanding between the parties on exactly which terms will survive the termination or expiration of the agreement. That is done in a survival provision.

Another issue in interpretation of an agreement can be the specific actions of the party. For example if you have a specific term within your agreement that you continually do not enforce, in interpreting the agreement a court could determine that by your actions you have “waived” your rights to enforce it. To prevent that, most agreement will normally include a “waiver” provision which both requires that any waivers must be in writing and that a waiver of one instance will not be deemed to be a waiver of future instances. 

As agreements frequently consist of a number of documents that are either attached to or are incorporated by reference into the Agreement, ever good contract will have an “order of precedence” provision that establishes the priorities in the event of a conflict between the documents.  In situations where the parties have agreed to an order of precedence, that will be used to interpret the parties obligations. If there is no order of precedence, or if multiple documents that make up the agreement have the same precedence, they will be interpreted to be complimentary. So if one document called for A to M and another called for N to Z, it would be interpreted to require A to Z. Even when there is an order of precedence, the order of precedence only establishes the priority between conflicting provisions. So if you have A to M required in a document that has priority and you have N to Z required by a document of lesser priority, you could still have A to Z required. However, if something in Section C has priority over anything in sections N to Z and there is a conflict with something in Section P, the contract would be interpreted such that the conflicting language in P would not apply. The more important things are, the more important it is to establish the right order of precedence and that can apply not just between contract documents like an agreement and a statement of work, but also between things like the specifications that are made part of the agreement. For example, you may want a Statement of Work to have precedence over the terms of the agreement, but do you also want all the documents that are incorporated into that statement of work to also have priority over the Agreement? Where this is extremely important is if you will be incorporating any of the other party’s documents into your agreement where if you don’t correctly establish the order of precedence the supplier’s document could have priority over the terms of the agreement negating the term.

In dealing with documents that are executed at different times, unless there is an order of precedence established between those documents, the latest writing in time will always have priority. For example an amendment could potentially change both the agreement it is amending and it could change a prior amendment if it is written at a later date. In writing amendments it’s important that they be drafted in a way where the scope of the change is clear and it identifies whether it applies to only a limited scope or the entire agreement. Remember, as the drafter of the document any ambiguity will be held against you.

As a Buyer, if you are using your own contract form, all this means is that if there are errors, inconsistencies, or if a particular point is vague or ambiguous, that may be construed against you so its better to clearly define exactly what the obligations of the parties are and what they mean. 

The last point I is the combined impact of both #7 and 8.  If the agreement is clear an unambiguous a court will only look at what's contained within the Four Corners of the Agreement. With this an prior 
representations, promises, agreements will not be considered.  If a promise or representation was an important consideration in making the purchase, make sure that its included in the agreement!

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