Negotiating contracts can be tough as such, but the confusing contract language isn’t helpful. There are inherent risks in signing contracts without understanding the consequences.
It is crucial to familiarize yourself with key legal clauses that form a sales contract. At its very core, a sales contract helps record a transaction between a buyer and a seller for record-keeping legal purposes. What is critical is that it should also include acceptable levels of risk and rewards for the parties.
Here is a quick introduction to key clauses of any contract and how to deal with them:
Warranty Clause
A warranty clause is an assurance that the products or services being sold are free of defects and meet the description. They also explain how your product will function and what it will do. Warranties go hand in hand with the remedies clause. Remedies describe what damages or compensation will be applicable if your product does not work as stated in the warranties clause.
The law recognizes some warranties as implied remedies, which do not need to be explicitly described in a contract. However, it is important to review any ‘explicit warranties’ in a sales contract.
While reviewing a warranties clause, you should answer the following key questions:
- What is your product and how will it function?
- What are the service levels you have agreed to?
- What happens when these warranties are not met?
Why is this important?
- Warranties help protect your company against unknown risks. Disclosed warranties cannot usually be litigated upon.
- It clearly sets out the delivery and performance related expectations to your customer from your product
What should you keep in mind while reviewing a warranties clause?
- Ensure that the language describing the warranties is clear and complete
- Limit the remedies available for breach of warranties. It is common to see remedies limited to a fraction of the fees paid under the contract or allowing for a free credit period
- Always read your warranties and remedies with other related clauses such as indemnity and limitation of liability
Limitation of Liabilities Clause
A limitation of liability clause specifies the ceiling for how much you (the seller) can be sued for. This clause typically specifies two types of ceilings, firstly a lower cap for general contractual breaches (delay in delivery etc) and secondly, a higher cap for specific actions such as negligence, misconduct, death etc.
While reviewing a limitation of liability clause you need to answer the following key questions:
- What are the chances of a breach in this agreement?
- If sued, how much money do you need to pay?
Why is this important?
- It clearly sets out the cap on how much you can be sued for
- Reduces exposure to risk for potential investors or acquirers
What should you keep in mind while reviewing the Limitation of Liability clause?
- The liability limitation caps for general breaches and specific breaches should be pre-agreed. Typically these tend to be a multiple of the fees paid under the contract - this also ensures your risk is commensurate to your revenue
- The losses for which you agree to compensate without any limit (e.g. for death, negligence etc) should be clearly identified
- The clause should clearly identify the losses which are completely excluded
Therefore, a limitation of liability clause needs to be carefully drafted as well as reviewed. An effective limited liability clause to help manage liability and reduces the risks attached to contracts. In the absence of such a clause, there is no financial limit on the damages a party can ask for. Therefore, parties who wish to reduce exposure to the risks of a contract should include a limitation of liability clause.
Indemnity Clause
Indemnity is usually amongst the most negotiated clauses in a sales agreement. It is negotiated because it sets out the circumstances in which one party can shift costs to another party.. Also known as the “hold harmless clause”, indemnity clauses can be one sided (only one party indemnifies the other party) or mutual (both parties agree to compensate the other party for losses).
While reviewing an indemnity clause you need to answer the following key questions:
- What should be you as the seller’s responsibility if a client is sued for using your product?
- Do you want similar indemnity protection from the buyer?
Why is this important?
- It protects both parties from potential legal exposure
- Reduces exposure to risk for potential investors or acquirers
- Identifies the extent to which an indemnifying party is responsible for risk
What should you keep in mind while reviewing the indemnity clause?
- Indemnity should ideally be restricted to “direct losses arising from the contract” and should ideally avoid indirect losses
- Your industry may have established standard indemnities, it is recommended that you stick to them
- Indemnity clauses are usually uncapped for breaches of confidentiality, IP violation
Publicity Clause
If you are a growing company, it is important that you are able to use your customer as a referenceable logo. You may also want to use their name in marketing and sales collateral for future customers. Publicity clauses tend to be resisted by teams because of it being rejected by clients.
While reviewing a publicity clause you need to answer the following key questions:
- Can you use the customer as a referenceable logo?
- If yes, what activities can you use the logo for?
Why is this important?
- Customer referenceability adds credibility to your product
- Its common to see resistance on this clause citing “internal confidentiality restrictions”
What should you keep in mind while reviewing the publicity clause?
- Make sure you are able to use the logo for a broad range of marketing and sales activities such as decks, website, case studies, PR etc.
- Agree beforehand that they are willing to be a reference to future clients
- If faced with resistance, it is common to offer discounts to allow the usage of the logo This tends to be more common when working with large enterprise clients
Scope of Work Clause
The scope of work establishes what a customer is entitled under the sales contract. It is important that the scope is clearly established so as to create room for upsells, while ensuring that your team can deliver the requirements of the client.
While reviewing the scope of work clause you need to answer the following key questions:
- What features of your product is the buyer entitled to receive
- Are there limitations on the usage of the product?
- Are future updates, upgrades included free of cost?
Why is this important?
- Its important to lay down the contours of what is included and excluded in the purchase price to allow for strategic growth and retention of clients.
- Restricting what is sold in a deal allows for potential upsells and revenue growth. This becomes more critical if you are still in the phase of price discovery
What should you keep in mind while reviewing the scope of work?
- Make sure your product and technology teams review the descriptions of the product. These need to be tightly worded.
- Make sure you have carved out the difference between an “update” (which are periodic technical and security updates) and an “upgrade” which is a new feature or an enhanced system. The contract should clearly state which of these are paid and which are available for free.
Termination Clause
As the name suggests, a 'Termination Clause' allows for the agreement to be terminated, under the circumstances stated in the clause. It defines the manner and the circumstances in which a commercial transaction is brought to an end. Generally, all commercial contracts have a termination clause that sets out a mechanism which the parties shall follow while terminating the contract. However you need to minimize the circumstances under which a contract can be terminated.
While reviewing the termination clause you need to answer the following key questions:
- Can the contract be terminated without any cause?
- Can you terminate this agreement if needed?
Why is this important?
- If the client does not have the ability to cancel the contract for no reason prior to the end of the term of the agreement, it may make sales planning for unexpected churn difficult to account for
- There could be a potential revenue calculation and recognition related issues for termination
What should you keep in mind while reviewing the termination clause?
- Termination without cause clauses should be rejected as much as possible. If termination for cause is allowed, it should be with at least a 60-90 day notice
- The specific reasons under which the contract can be terminated should be clearly identified
Just the basic know-how of these clauses can save you much of the back-and-forth between teams. After all, closer you are to a deal, the longer the minutes seem.
