12 Tips to Avoid Contract Pitfalls: Minimize Risk by Following These Suggestions
Many CPAs spend at least a portion of their time dealing with contract negotiations. These negotiations may involve software development, professional services, independent contractors, technology transfers or the purchase of goods. In most cases, a CPA must not only negotiate the terms and provisions of an agreement, but also document the final agreement in the form of a written contract.
Failure to properly document the terms of an agreement can result in confusing or delayed payment terms, disagreements regarding the scope of services, or inflexible delivery dates that may set the contract up for failure. These disputes can waste your valuable time and resources or, worse yet, result in time consuming and costly litigation.
This article is intended to provide some tips to help guide you through the contract drafting process.
1. Begin with the correct template.
Never spend time attempting to draft a contract from scratch. Virtually every type of transaction has previously been reduced to a written contract, so there are almost always templates and sample contracts available that will obviate the need for you to reinvent the wheel.
However, working from the wrong template document can also be problematic. For example, trying to use a contract for professional services to address a sophisticated software purchase may cause more problems than it solves. This is why you should dedicate time to make certain that the template you begin with is structured to address the type of transaction you are memorializing. Further, do not simply assume that a preferred model document provided by the opposing party is necessarily the correct template for the particular transaction at hand.
2. Document control.
Although potentially more time consuming, it is always preferable to control the drafting process after negotiations with an opposing party. Working from your notes and your understanding of the parties' agreement will allow you to draft language that best represents your company's position and protects your company's interests.
Ceding control of the drafting to the other party requires you to carefully inspect each version of the document you receive to ensure that all agreed-upon revisions have been made, and that no other revisions have been incorporated without your consent. Moreover, you will then negotiate from the opposing party's preferred language, which may require you to reassert positions that were not properly captured in the opposing party's draft.
3. There can be only one quarterback.
No matter how much specialized expertise may be required to successfully negotiate and draft a contract, a single individual in your company should be assigned to "quarterback" the process through to completion. When people work as a team on a transaction, there are always unspoken assumptions as to who will review provisions for clarity and consistency. Inevitably, details are lost and clarity suffers because each team member believes someone else will address those issues.
The best solution is to assign one team member as the lead. Oftentimes, in-house legal counsel or outside legal counsel will be assigned to that role but, even where attorneys are involved, there still must be clarification of which attorney has the final responsibility for overall contract review. This is not the time to worry about stepping on a colleague's toes or duplicating efforts -- clear communication is required to determine how the final review will be handled.
4. Avoid jargon.
When drafting a contract, limit your use of phrases that the average person would not understand. Inclusion of specific industry phrases and acronyms or broad references to generally accepted industry practices should be avoided. Terms with special meaning should be defined in the contract to avoid confusion, ambiguity and inconsistency. Defined terms should not be buried in the body of a contract, but rather in a dedicated section at the beginning of the contract for quick access. Capitalize these defined terms throughout the document to alert the reader to their special meaning.
Keep in mind that, someday, a neutral third party outside of your industry (perhaps a judge or jury) may have to interpret the contract to determine which party is in compliance. Drafting a contract with limited jargon and simple-to-understand obligations will work to your advantage when seeking to enforce compliance.
5. Standardized terms/forms.
Whenever possible, attempt to use standard language when addressing recurring themes in your company's contracts. Using the same indemnification, insurance, enforcement, venue, governing law, confidentiality and other similar contract provisions will ensure consistency and speed up the contracting process. These standard provisions should be vetted internally in advance to avoid the possibility of missed details or conflict with the company's typical contracting policies and procedures.
6. Scope of service.
Provide a detailed scope of service description for any contract involving professional services. Where necessary, attach exhibits or other explanatory documentation to clarify the exact expectations of the parties. Such explanatory descriptions or documents may include service level agreements to clarify deliverables, timing for performance, levels of performance and other technical specifications. Avoid subjective phrasing when drafting a scope of service provision to provide a clearly enforceable and objective obligation.
7. Deadlines and delivery.
Be particularly careful to specify the precise deadlines for each deliverable in the contract, and the options for cure in the event the deadlines are not met. Avoid catastrophic enforcement provisions -- such as contract termination -- unless the agreement cannot be salvaged. Focus instead on reasonable ways in which the alleged breach can be cured and the performance brought back online. An escalated enforcement process, based on the severity of the alleged breach, often works best to preserve the contract and the working relationship of the parties.
8. Referencing other documents.
When drafting a contract, it is not uncommon to attach exhibits, purchase orders, legal descriptions or other side agreements between the parties. When referencing such attachments, make certain that the contract clearly indicates which provisions take precedence in the event of a conflict. To avoid ambiguity and confusion, consistently reference the terms used within the attached documents and those within the body of the contract.
9. Rely on your experts.
There are certain provisions in every contract, particularly software development and technology transfer agreements, for which your company should rely upon specialized expertise. Examples of crucial provisions that require careful attention include: warranty provisions, service level agreements, intellectual property, cyber security and bankruptcy. Do not assume you can simply borrow template language to address these issues without first consulting appropriate team members who have the relevant expertise.
10. Don't limit your review to what is "in" the contract.
One mistake companies often make when drafting a contract is to consider only the document being circulated and ask questions specific to the provisions already within the contract. Remember -- it is equally as important to consider what has been omitted.
One tip to help avoid overlooking required provisions is to make certain the proper template document has been used containing a list of all key provisions. Further, include financial, technical and legal experts on your team to provide different perspectives regarding the agreement and the issues to be addressed.
11. Always consider the worst-case scenario.
Many times, companies will negotiate agreements assuming their historically positive working relationship with the opposing party will continue in perpetuity. They assume there will never be disputes over standard contract provisions, and everyone will always work in good faith to meet the contract objectives. Of course, if that were the case, there would be no need for a written contract -- a simple handshake would serve the same purpose.
These assumptions, although common, are never safe. Always consider that individuals you know and trust at the opposing company may no longer be employed there during the term of the contract. A new management team with an entirely different philosophy regarding contract compliance and enforcement might assume control. Or, the opposing party's financial situation could become so stressed that it is no longer able to meet the contract terms. By roleplaying and assessing the "what ifs" of the potential contract relationship, you can draft protections in the agreement to cover potential worst-case scenarios. This exercise may help you to protect against unforeseen events, and potentially allow your company to avoid expensive and lengthy contract enforcement proceedings.
12. Take extra time to review the final agreement.
In most contract negotiations today, there are different individuals working on various sections of the agreement, usually under tight timelines to bring the deal to a close. Multiple versions of the agreement may be transmitted via email at all hours of the day, and email strings can include 50 or more replies regarding open, unresolved issues. As the pressure mounts to close the deal, there is a tendency to avoid a final read-through, or to simply accept the final version submitted by the opposing party.
Instead, take time to step back and carefully review the entire agreement. Make certain that all terms are used in a consistent manner, that cross references have been accurately checked, that exhibits have been properly referenced and that there are no other inconsistencies in the document. This last step is often crucial to catching drafting errors that could lead to potential disputes down the road.
Expand your checklist
As the saying goes, drafting a contract can be like making sausage: It's not always pretty, but the outcome can be very satisfying with the right ingredients. Adding these tips to your own contracting checklist allows you to successfully negotiate quality contracts that will save your company time and money, and minimize the risks inherent in contract drafting.
*This article originally appeared in the September 2015 edition of Footnote, a publication of The Minnesota Society of Certified Public Accountants. Republished by permission of the publisher.