Contracts 101: Part 1

At one time, conducting business was a much simpler affair than it is today. Two individuals would agree to make a trade, and both parties would honor their word. Fast-forward to the 21st century and it’s a whole new world—making legally enforceable contracts essential for the efficient and reliable conduct of virtually every single transaction of goods or services. 

As a business owner, understanding contracts is important because these documents dictate the terms of all the key relationships you need to maintain long-term profitability and growth. 

To assist you in understanding what can be a nuanced and complex area of the law, the following is the first of a three-part series on how to read and comprehend the main components of a business contract. 

Recitals

Often referred to as the “whereas” clauses, contract recitals precede the agreement and provide the overall scope and purpose of the document as well as the identity of the parties involved. In terms of functionality, recitals can mitigate the potential for subsequent disputes by clarifying key reference information. 

There are several types of recital clauses, including: 

  • Contextual: These clauses review the circumstances leading up to and surrounding the agreement such as transactional timelines, associated trademarks and any existing patents
  • Compliance: This category lays out any pertinent industry-specific regulations or prerequisites that must be fulfilled prior to the execution of the contract—such as obtaining the prior approval of a third-party regulatory entity
  • Transactional: Often found in nuanced or complex transactions in which multiple phases/steps are associated with the performance of one or both parties
  • Interrelated: Several recitals can be incorporated in the initial section of a contractual agreement if there are multiple agreements being entered into simultaneously
  • Step-Up: Parties often prefer to express the general nature of the agreement that, while admittedly redundant, can prevent confusion down the road 

Term

It is essential to be aware how long a particular contract is enforceable. The period of time that a contract remains in effect is also called the “term” of the contract and is defined as the window in which an agreement dictates the transactional or professional interaction between two or more parties. 

Depending on the underlying purpose and context of the agreement, the term can either be mutually agreed upon by the parties or, alternatively, be dictated by relevant statute or industry-specific norms. For example, automatic renewal clauses (also called “evergreen clauses”) automatically renew the terms of the existing agreement unless the contract is terminated via mutual agreement or breach. 

Long-term contracts typically utilize this clause in order to gain an economic edge and reduce expenses. Depending on the jurisdiction, the advance notice time period, extent of contractual transparency and grounds for contract termination may have to meet certain thresholds in order for an automatic renewal clause to be enforceable. 

In New York specifically, a new Automatic Renewal Law (ARL) was implemented in February 2021 that imposes significant new obligations on business entities operating in New York that offer goods or services on a subscription or auto-renewal basis including: obtaining consumers’ affirmative consent, clearly disclosing auto-renewal terminology and offering user-friendly cancellation options just to name a few. 

Termination & Notice Periods

The business world is inherently dynamic. Market fluctuations and constantly changing economic conditions influence the nature and feasibility of professional relationships, oftentimes making it necessary for parties to a given contractual agreement to prematurely modify or cancel their agreed-upon obligations. 

That is the general purpose of termination clauses, which give either party the unilateral right to end the contract and provide the procedure for doing so as well as any associated consequences for doing so. Typically, a party seeking to terminate a contract must provide an advanced notice of its intent to do so to the other party in writing so that they can conduct any needed contingency planning to mitigate potential losses or delays.

Fees

This is one of the key components of the contract because it sets forth the “consideration” for the agreement. Without consideration, which simply means an exchange of value, there is no contract. In product agreements, consideration is the price of the product provided; in service agreements, consideration is the price of the services provided.

The fees or expenses clause also specifies how expenses associated with matters such as travel, materials, legal matters, etc. that are essential to contract performance will be handled. The clause will lay out which party will pay their own expenses, whether one party will provide reimbursement to the other, or if one party will advance expenses to the other at the onset of the agreement. 

An important aspect of any fee clause has to do with dispute resolution. An attorney fee clause is a provision that states that the prevailing party in any dispute arising under the agreement will be entitled to reasonable attorney fees and costs. The “prevailing party” is typically the party who recovers the greater relief in any action brought to enforce his or her rights under the agreement. 

If Janet sues Fred for breach of contract and wins a damage award, Janet will be the prevailing party and will be awarded her reasonable attorneys’ fees that she incurred if the attorneys’ fees clause is included in the contract. A court typically determines the “reasonableness” of attorney fees and costs. A party who brings an action for breach of contract, or any other action based on the agreement, will likely incur substantial legal costs in seeking to recover damages. Not only will that party incur the cost of attorney fees, but there are also a multitude of “costs” associated with bringing a lawsuit, including expert witness fees, payments for court reporters, fees for filing documents with the court, as well as costs of travel, printing, photocopying, postage, telephone, and messenger services. 

The general rule is that, absent a contractual provision, statute, or case law to the contrary, attorney fees and other litigation costs are generally not recoverable by the prevailing party in a breach of contract case. If an attorney fees clause is missing, then each party is responsible for the cost of paying his or her attorney fees, costs, and expenses. Essentially, if there is no attorney’s fee clause, you could end up having to pay your own attorney fees and costs — even if you win.

Understanding the initial terms and conditions of a contract including the recitals, term, notice period and fees is a good starting point that will set you up for successfully managing your contractual relationships. 

Head to Part 2! And Part 3!

More Contract Resources

Contract Basics

11 Smart Decisions

Francine E. Love is the Founder & Managing Attorney at LOVE LAW FIRM, PLLC which dedicates its practice to serving entrepreneurs, start-ups and small businesses. The opinions expressed are those of the author. This article is for general information purposes and is not intended to be and should not be taken as legal advice. To learn more about LOVE LAW FIRM please see our website, www.lovelawfirmpllc.com.

Francine E. Love
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Founder and Managing Attorney at Love Law Firm, PLLC which dedicates its practice to New York business law