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FAQs: understanding commercial contracts

Businesses are operating in increasingly litigious times and that means when you negotiate a business agreement you can't simply rely on a handshake. Understanding commercial contracts and the intricacies of the law involved will protect your business and reduce the risks of commercial litigation. In this article we answer your frequently asked questions on commercial contracts to help you build your business and simultaneously protect your interests.

What is the definition of a commercial contract?

commercial contract is an agreement between two or more parties on a commercial issue. Sometimes they are referred to as business to business agreements to distinguish them from consumer contracts with a customer.

There are myriad different types of commercial contract. For example:

These are just a few examples of commercial contracts. In almost every aspect of your business you will be making contracts with third parties. Commercial solicitors find that it often isn’t until something goes wrong that business owners realise the importance of negotiating the right commercial contract for their business and prevailing market circumstances.

Does a commercial contract have to be in writing?

A commercial contract can be:

  • A verbal agreement
  • An implied agreement
  • A written agreement

All the above types of contract can be legally binding as there is no legal requirement for a commercial contract to be in writing. However, commercial law solicitors strongly recommend that your commercial contracts are in writing to reduce the risk of misunderstandings and disputes.

What standard terms should be put in a commercial contract?

Although you may be tempted to use an ‘off the shelf’ agreement it’s important that any contract meets your specific business needs rather than using standard wording that may end up costing your business money. That is because a standard contract probably won't reflect what you need in the contract.

What key clauses should go into a commercial contract?

Whilst every commercial contract should be different and bespoke, the key elements to commercial contracts are:

  • Commencement section with date of commencement or effective dates.
  • Parties details to include full names, addresses and company registered numbers where relevant.
  • Definition section with an explanation of any specific terminology used.
  • Background section if required to set out any relevant history to the contract.
  • Conditions precedent to explain how the fulfilment of any conditions will affect the contract (or parts of it) coming into force.
  • Operative section to include such matters as performance obligations (which party does what, where, how and when) and payment terms and obligations (which party pays what, to whom, when and how, including any minimum payment terms, any price increase formulae, payment protection, late payment, VAT and tax issues and third party guarantees).
  • Limitations and exclusions to detail how risk is apportioned between the parties and the limitations of liability of one party to another.
  • Standard clauses that are referred to as boiler plate clauses. These types of clauses include matters such as the non-assignment of rights, force majeure, and the law and jurisdiction the agreement will be subject to, confidentiality provisions, termination, variation, waiver, severance, third party rights, arbitration and mediation. Although these clauses are referred to as ‘boilerplate’ each standard clause needs to be reviewed and adapted to meet your business requirements.
  • Schedules and appendixes to detail any necessary information or contract performance criteria to minimise the risk of a later dispute over the detail.
  • Execution clause for the parties to sign.

What law and principles govern commercial contracts?

Contract and commercial law is complex and its application to a commercial agreement depends very much on the individual circumstances. Commercial deals are subject to:

  • The contractual terms in a binding commercial contract
  • Common law unless it has been expressly excluded in the contract
  • Legislation that is often specific to the nature of the commercial contract save for legislation that governs unfair terms in business to business contracts, The Unfair Contract Terms Act 1977 (UCTA).

What’s the process of putting a commercial contract in place?

There are a number of ways you can begin the process of putting a commercial contract in place. The method you use will depend on whether you are a start-up or an established business and whether you initiated the contract discussions and if your commercial solicitor prepared the first draft contract for review.

The process for putting a commercial contract in place can be summarised as follows:

  • Communicate the main commercial terms you think you want in the agreement to your commercial solicitor. The solicitor can then discuss anything that isn’t clear to them about your business needs and also talk to you about what other clauses and terms could usefully go into the contract to protect your business interests or
  • Read and assess the draft contract provided to you by the other party. Your solicitor will point out any provisions that aren’t favourable to you and suggest compromises that could be negotiated with the other party and additional clauses that should be included in the contract or wording that should be re-drafted so that the meaning is unambiguous or
  • Start with a contract that you use in your business already and get your commercial solicitor to review, amend and update it so that the terms are up to date, cover the specifics of the particular deal and take into account any changes in legislation or developments in commercial contract case law.

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What’s the difference between commercial law and contract law?

Contract law is just one area of the wider area of commercial law. You can find out more about commercial law services on our Commercial services page.

What advice does a business need on a commercial contract?

The extent of the advice that your business needs on a new commercial contract will very much depend on the nature of the contract. If you enter into one type of contract frequently with different third parties it is still advisable to get your solicitor to periodically check the terms to ensure the contract remains fit for purpose and there haven’t been any legislative or other developments that mean it should be revised.

When it comes to commercial contracts an experienced commercial solicitor can advise you on:

  • The process of entering into a commercial contracts
  • Negotiating the key terms of the contract
  • Drafting the contract
  • Reviewing and assessing a contract submitted to you by the other party to the contract
  • Amending or changing a contract
  • Considering if your business or the other party has the right to terminate the contract and the consequences of doing so
  • The consequences of a breach of contract and the legal remedies
  • Resolving contract disputes

Should payment terms be set out in a commercial contract?

In business the payment for goods and services is always a key consideration as every business has to manage cash flow. That’s why it is usually important that payment terms are specified in commercial contracts. Contracts are just one method of managing payments in your business, but problems can arise if any contractual payment clauses are drafted ambiguously.

It is recommended that you consider including the following level of detail in your payment terms:

  • Payment due date from delivery of invoice or the preferred billing method.
  • Late payment penalties including the rate of interest and how it’s calculated (if the interest rate will be more than the statutory rate).
  • Arrears or advance clause detailing how far behind or ahead the payments are to be made for the goods or services
  • Payment method specifying to whom and where the payments should be made, and in what format (for example, bank transfer).
  • Suspension rights so you can stop work or cease delivering services without being in breach of your contractual obligations if the other party fails to pay on time.
  • ‘Time of the essence’ wording as if the payment deadline is made a ‘condition’ of the contract a failure to pay on time can result in your having the option to terminate the contract early if you follow the correct procedure in the contractual termination clauses.

When you are drafting or agreeing to payment terms, consider that the stronger the payment terms the more likely it is that the other party will want to negotiate strict and detailed terms for the delivery of goods or the provision of services.

Can you put an ‘unfair term’ in a commercial contract?

In business to business contracts there is far less statutory protection than in business to consumer contracts. That is because it is assumed that there is more equality of bargaining power between two businesses.

In business contracts there is a concept of ‘freedom to contract’ (the freedom to agree to any terms in your contract as long as they’re not illegal). However, there are limits on that freedom in relation to unfair terms, even in a contract entered into between two businesses.

The legislation that governs unfair terms in business to business contracts is The Unfair Contract Terms Act 1977 (UCTA). This Act imposes statutory controls on unfair terms in commercial contracts, such as trying to exclude liability for death or personal injury arising from negligence.

What does ‘good faith’ mean in a commercial contract?

When business owners see reference to ‘good faith’ in a commercial contract they rightly question exactly what is meant by good faith to avoid unwittingly being in breach of contract.

Good faith is a concept rather than a clearly defined ‘term of art’. That means that the term is open to interpretation by the courts. The court will only look at the concept of good faith if the wording is included in the contract as the court doesn’t imply a duty of good faith in a commercial contract unless the parties include it in their agreement.

If the wording ‘good faith’ is included in your contract and there is a contractual dispute over whether one party acted in good faith then the court will take into account the circumstances of the contract provided that the good faith wording in the contract isn’t too vague for the court to interpret its meaning.

If you, or the other party to the contract, want to include a good faith express term in the contract then it is important that you define what is meant by good faith and what exact actions and steps each party will take (and not take) that constitute ‘acting in good faith’. That way you minimise the risk of commercial disputes over the wording of the contract or the court ruling, in any commercial litigation, that the wording ‘to act in good faith’ is too difficult to interpret and rule on.

For more information read our article about the use of good faith clauses in business contracts.

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Can you cancel a commercial contract?

We are often asked if there is a ‘cooling off period’ in business contracts as consumer law offers such protection for consumers so that they can cancel some agreements entered into with a business.

In business to business contracts there is no cooling off protective legislation so if your business wants to be able to cancel or return goods then this should be clearly set out in the contract.

Can commercial contracts be changed or updated?

A business can change or update a commercial contract provided that the other party agrees to the contract being amended. If they won't agree to change the contract then it is a case of looking at whether:

  • The contract is for a fixed term or not and, if it is, will the fixed term expire shortly?
  • You can give notice under the terms of the contract and then re-negotiate a deal and new contract with the other party or go to an alternative provider or supplier and negotiate better contractual terms.
  • You have the grounds to terminate the contract and then re-negotiate better business terms with the original party or use an alternative provider or supplier. It is best to take legal advice before you try to terminate a contract as if you don’t follow the correct process or if you don’t have the grounds to terminate the contract there could be financial and legal implications for your business.

When you are considering varying or amending an existing contract it is best to check if there is a clause in the contract that sets out how the contract can be varied and how the amendment should be evidenced. Normally any amendment to the contract has to be in writing.

The requirement for a written agreement to the variation of a contract is designed to stop one party from changing its behaviour and then claiming that the other party had verbally agreed to a variation in the contract.

As a contractual variation may make significant changes to the agreement or to the contract’s enforceability it is best to take legal advice from a commercial solicitor on any proposed amendments.

How long does a commercial contract last for?

A commercial contract can be for as short or as long as the parties to the contract want it to be for. A commercial contract can be expressed to be:

  • For a fixed term with automatic termination on the expiry of the fixed date.
  • For an initial fixed term and the contract then requires notice of termination at some point after expiry of that term.
  • On subscription so the contract is for a fixed period which automatically renews for consecutive fixed periods unless terminated by notice.
  • Not a fixed term and the contract can be terminated by giving notice.

Where a contract is for a fixed term no notice will have to be given to achieve termination. However, if the parties continue to trade after the expiry date of the contract then they may be treated, through their behaviour, as having extended the contract on similar terms to those applying in the fixed period. It is far better practice to formalise an extension of the contract or negotiate a new contract and thus avoid the risk of contract disputes.

To avoid any dispute about the end date of the contract, it’s important to be clear in the contract about the end date and the triggers for termination. If the contract will continue unless notice is given, then this should be kept under review so that the contract isn’t continued or renewed automatically against the interests of the business.

What termination notice should go into a commercial contract?

It is inevitable that you may want to bring a business relationship to an end before the expiry of the contract term. Termination is when a contract expires or is brought to an early end. Termination is a complex area of contract law and one that is frequently the subject of business disputes ending up in court litigation.

Commercial contracts should ideally be drafted with express clauses relating to termination. The termination clause should set out any applicable notice periods that will apply. These may differ dependent upon the reason that you are giving notice or the grounds for termination. For example, termination for a serious breach of contract may be immediate, whereas termination without fault on the part of the other party, may result in a lengthy contractual notice period.

Any notice to terminate a contract must take account of:

  • Any express terms about termination in the contract.
  • Any common law grounds for termination that aren’t excluded in the contract.
  • The risks of wrongful termination if you don’t use the correct ground or follow the right process.
  • Where notice periods are not specified in the contract, what would count as ‘reasonable’ notice.

It’s important to check the whole contract to understand the correct procedure and requirements for successfully giving notice (and having the termination notice accepted by the other party). If the terminating party fails to give notice in the method or timeframe specified in the contract, then it’s possible that the notice could be held to be invalid.

Failure to give a valid notice in the correct way could mean that the party who wants to terminate the contract is treated as having repudiated the contract and therefore is potentially liable for losses incurred by the other party.

If there isn’t a termination clause written into the contract then the contract can be terminated by either party giving ‘reasonable notice’. The notice period will vary depending upon the circumstances of the contract. It can therefore be difficult for the parties to the agreement to be clear on what constitutes a reasonable notice period. If a dispute arises about this and it goes to court, some of the factors the court will consider to determine reasonableness are:

  • How long the parties have been working together – longer relationships will often dictate a longer notice period.
  • How much either party’s business relies on the contract – greater reliance will often dictate a longer notice period.
  • How much initial investment a party has made into the contract – the greater the investment (and the extent to which that investment has been recouped) then a longer notice period will be required.

For more information read our article on terminating commercial contracts.

What happens if there is a dispute over a commercial contract?

The commercial lawyers at Harper James are not only experts at drafting and negotiating clear commercial contracts to avoid disputes arising in the first place, they also specialise in business dispute resolution if a conflict does arise.

For more information on business dispute resolution read our article on how to resolve a contract dispute.

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