Contracting 101: Insights from KO Partner Dan Fredrickson
- Dan Fredrickson
- September 26, 2018
Contract negotiations are a critical component of every deal. For many startups, contracting can feel like a substantial hurdle at the end of a long sales process. Recently, KO partner Dan Fredrickson hosted a session with Galvanize Boulder to share strategies to make contracting as efficient as possible for business, focusing on key contract provisions to help startups and business leaders approach contracting confidently. We’ve compiled some of the critical legal concepts for contracting to get a better look at the keys to a good contract and the important areas that entrepreneurs should focus on.
What makes a good contract?
Good contracts clearly define a business relationship in a manner that all parties understand. It is typical that years after a contract is entered into, individuals not involved in the initial transaction will need to review and understand the terms of the relationship. This occurs in connection with due diligence for financings or acquisitions, or even if there is a dispute relating to the contract. If a contract doesn’t make sense to you, it won’t make sense to anyone else.
Make sure you understand your contracts
Whether or not you engage a lawyer to assist with a contract, you should always read your contracts. You are in the best position to know what the core of a deal is and the underlying context. If you have questions about the terms of any proposed contract, don’t hesitate to ask your lawyer – you are the one who must live with the terms of the contracts you agree to.
The terms of contracts can vary drastically depending on the deal at issue. However, there are legal terms that are typical in most contracts that are essential for anyone reviewing a contract to understand. Below are some of these common terms and a quick primer on some of the issues you need to consider when reviewing them.
Intellectual property, and specifically the ownership of intellectual property, should be addressed in most commercial contracts. It is important to thoughtfully consider what IP elements may be created during a relationship and what pre-existing IP elements will be contributed by the parties. It is also important to understand that in most cases, absent an agreement to the contrary, a party that develops intellectual property owns the intellectual property – which is why written intellectual property assignment provisions in certain agreements like independent contractor agreements are essential.
Limitations of Liability
A common and often controversial provision in a contract is the limitation of liability provision. Limitations of liability place boundaries and limitations on the risk your company takes in connection with a contract. Without these limitations, a company’s potential liability is less known and potentially unlimited – it could exceed all revenues received or paid under the contract. Many contract drafts will not include a limitation of liability provision, but you should always consider adding it in. In general, limitations of liability help to balance the potential rewards of the deal with the risks and potential liability by providing parameters and preventing potential “company killing” events.
Indemnification provisions can be the most difficult parts of a commercial contract – at least in part because they are confusing and tend to be written poorly. In commercial agreements, indemnification provisions allocate risk when a third party initiates a dispute against the other party. This type of indemnification obligation is a promise to stand in the other party’s shoes by defending that party against the third-party claim and agreeing to indemnify that party against liability and loss arising from that claim. When reviewing an indemnification obligation, consider the following:
- Who are you agreeing to defend and indemnify? You may be asked to include your counterparty along with its officers, employees, directors, and affiliates.
- What triggers the defense and indemnification obligations? Ideally it would be limited to a claim, action, or demand that is brought against the other party that is based upon risk for which you should be responsible (e.g., intellectual property infringement).
- What are the defense and indemnification obligations? Typically, this includes an obligation to defend the indemnified party against the third party claim and to pay any losses, liabilities, fines, costs, and other expenses that arise from the claim.
- What are the exclusions to the defense and indemnification obligations?
At some point, and under a variety of circumstances, almost every contract must come to an end. Some contracts will terminate early for cause or convenience, while others will expire pursuant to their terms. This is a small, easy to overlook consideration, but one that has importance as part of a successful contract cycle. Every contract should have a provision that permits the parties to terminate the contract under certain circumstances, like an uncured breach. It is especially important to clearly define what happens upon termination of a contract, to best outline the implications for all parties involved, including moving on to new contracts, or in the event of termination by cause, any essential payment or legal ramifications.
Assignment provisions most often state that the parties cannot assign the agreement, or their rights and obligations under the agreement, to a third party without the other party’s consent. In the absence of assignment restrictions, contracts tend to be assignable by the parties, but there are exceptions, so the agreement should be clear. Assignment restrictions can create problems in connection with acquisitions, where an acquirer desires to assume a contract. Where possible, include an exception that permits your company to assign all of its agreements in connection with a merger, acquisition, or similar event.
Warranties and Disclaimers
Warranties act as a promise or affirmation of fact that a product or service will meet or conform to a certain requirement. When reviewing a performance warranty, consider: (a) what product or service is covered, (b) what standard or condition is promised, and (c) what obligations apply if the warranty is breached. In addition to expressly stated warranties, additional warranties may be implied into your contracts by law. If you are providing products and services, be sure to disclaim all implied warranties and specifically call out certain implied warranties.
After your contract is finalized, making plans for strong contract maintenance and organization can be critical. Every company has a system, and by implementing a clear, organized maintenance and storage plan early on, you set yourself up for success in future contracts, and ensure that your entire contracts program is diligence-ready at any time.
Be prepared – and take it all in stride
Many entrepreneurs are focused on contracts around intellectual property, usage and other licensed rights, and warranties and breach of warranty remedies. Although the details and nuances of contracts will differ, the most important things to remember when dealing with contracts at any level are:
- Have a good form in place as a starting point, where possible
- Contracts should conform to the business and specific product/service being provided
- Be reasonable/flexible
- Know your “walk away” issues
- Most importantly: read your contracts
Contracts can often feel like a daunting part of any growing business, but by remaining focused and clear in the development, organization and execution of your contracts, you have a great opportunity to both manage and grow your business for the future.
To learn more about KO’s contract management expertise and how we can support you, contact Dan Fredrickson at (720) 477-7131 or firstname.lastname@example.org