12.2: Structure of Contracts

Written contracts can be organized in many different ways. However, having a structure can help keep information organized, clear, and easy to find. The best contracts have clear headings that accurately describe what is contained in that section. Using emphasis, such as bold and underlining, work better than italics alone for capturing the reader’s eye.

In general, contracts often contain a structure like this:

1. Title
2. Introduction of Parties and Purpose
3. Definitions of Material Terms
4. Covenants and Promises of Performance
5. Conditions
6. Breach and Its Consequences
7. Representations and Warranties
8. Standard (often called “Boilerplate”) Provisions
   • Procedure to Modify Contract
   • Rights of Assignment and Delegation
   • Alternative Dispute Resolution
   • Choice of Law and Forum
   • Integration
   • Severability
   • Exculpatory Clause
   • Force Majeure
   • Attorney Fees
9. Signature Block

Not all contracts will contain all these elements and provisions. The parties’ needs and the purpose of the contract drive the structure of the document.

Title

Contracts have a title, often in bold or CAPITAL letters, at the top of the page. Titles should be as descriptive as possible. “Contract” or “Agreement” are not useful because they require the reader to read through the contract to know what it is about. The best contracts capture the nature of the document in the title. For example, “Employment Agreement Between Jane Doe and Stanford University.”

Introduction of Parties and Purpose

The introduction should name the parties and describe the nature of the contract. If background information is useful in explaining the parties’ interests and objectives, then it should be included here.

Definitions of Material Terms

Most business contracts contain some definitions, unless the subject matter and parties are clear. Definitions are useful because it is an area readers can reference to ensure compliance with the contract. For example, did the seller provide the specific goods as defined by the contract?

Definitions are not necessary for every term, though. If not defined, legal terms are given their legal meaning. And ordinary words are given their common, ordinary meaning. Therefore, businesses should define the material terms of the transaction: goods, services, quantity, quality, price, etc. Definitions that are specific to the industry are also helpful to include.

Covenants and Promises of Performance

A covenant is a formal promise to perform. This is the section of the contract where the parties state exactly how they will perform the contract. Buyer will pay a specific amount for the goods or service. Seller will deliver a specific item at a particular location.

To ensure clarity, the best contracts use active verbs in this section. For example, “Buyer will pay Seller ten dollars.” It is clear who will be paying whom, and how much is owed. Passive voice injects ambiguity, which can be problematic. For example, “Seller shall be paid ten dollars.” Will Buyer pay Seller the money or will someone else tender payment? If payment is not made, is Buyer in breach of contract?

Conditions

As discussed in Chapter 10, conditions are things that must occur before performance is due. Usually conditions must be expressly stated in a contract to be legally enforceable. The best contracts identify any conditions and delineate a timeline for when performance is due after the condition is met. For example, if an inspection of a property is a condition precedent of purchasing it, how long after the inspection is completed must the buyer perform?

Breach and Its Consequences

To constitute a violation of the contract, a breach must be material. A material breach is a substantial breach of contract that excuses aggrieved parties from further performance and affords them the right to sue for damages.

In contracts that require performance over a period of time, or payments in installments, it is helpful to define what constitutes a material breach. This clarifies when the non-breaching party can seek a remedy. The best contracts anticipate reasons for breach and identify consequences for them.

Acceleration Clause

An acceleration clause makes all future payments due immediately under the contract. Acceleration clauses often exists in contracts where periodic payments occur. For example, a contract to purchase a vehicle may require payment of all remaining money owed under the contract if the buyer misses a monthly payment. This allows the business that sold the vehicle or the bank that issued the loan to sue for breach of contract once, rather than filing a new lawsuit for each month.

Liquidated Damages

A liquidated damages clause allows parties to determine the amount of damages in the event of a material breach. Agreeing to the value of the contract before any breach occurs often saves time and money should the case be litigated. To be enforceable, the liquidated damages must apply to all parties equally, and be based on the value of the contract rather than act as a penalty.

Representations and Warranties

Representations are statements of fact made to induce someone to enter into a contract. Common representations by businesses include:

• They are properly licensed;
• They are insured;
• Their financial statements are accurate;
• They own all relevant assets;
• They have legal authority to enter into contracts.

Warranties in a contract are express promises that guarantee something in furtherance of the contract by one of the parties. For example, a seller warrants that the object being sold is as represented or promised.

Warranties differ from representations in four ways:

1. A warranty is an essential part of a contract, while a representation is usually only a collateral inducement;
2. A warranty is written in a contract; while a representation may be written or oral;
3. A warranty is conclusively presumed to be material, while a representation must be proven to be material by the party claiming breach; and
4. A warranty must be strictly complied with, while a representation must be substantially true.

Please note that express contract warranties are different from implied warranties under the Uniform Commercial Code (UCC). A party may disavow implied warranties under the UCC through a written contract.

Modification

Often with contracts that require an extended period for performance, modification becomes a concern. What happens if prices or deadlines need to be altered? Does that require a new contract or can the existing contract be modified? Good contracts often include a procedure for how to modify a contract. This may be as informal as writing changes directly on the original contract with the parties’ initials and date. Or it could be through a formal addendum procedure.

Regardless of the chosen procedure, it is a best practice for businesses to discuss modification procedures when entering into a contract. If the procedure is clear, less friction occurs when a party seeks modification.

Assignment and Delegation

In general, parties are free to assign and delegate their rights and duties under a contract. Parties can limit those rights or they can request notice if an assignment or delegation occurs. This is a provision that is often not needed unless a party has a concern about assignment, such as in the insurance industry.

Alternative Dispute Resolution

As discussed in Chapter 4, many businesses want to reduce their risk of litigation by participating in alternative dispute resolution (ADR). Mandatory arbitration clauses are common in consumer and employment contracts. Before including an ADR provision in a contract, parties should be fully comfortable with the option that they choose. If a party agrees to mediation or arbitration, a court will enforce that choice even if the parties change their mind.

Choice of Law and Forum

Choice of law provisions determine which state’s laws will be used to interpret the contract. Choice of forum provisions determine the state in which any litigation will take place.

This provision is often unnecessary for contracts involving individuals and entities in the same state. If the parties do not select that state law or location for litigation, the courts look to:

1. Where the contract was signed;
2. Where the contract is performed;
3. Where the parties are residents; and
4. The court’s jurisdictional rules.

Integration

An integration clause is a provision stating that the contract represents the parties’ complete and final agreement and supersedes all informal understandings and oral agreements relating to the subject matter of the contract. In other words, it is the agreement.

The purpose of an integration clause is to prevent the parties from later claiming that they agreed to additional or different terms than what the contract states. This means that any statements made before the parties signed the contract are not part of the contract and they will not be used to interpret the meaning of the contract.

Severability

A severability clause is a provision that keeps the remaining provisions of a contract in force if any portion of the contract is declared unenforceable by the court. It is also known as a savings clause because it “saves” the whole contract from being declared unenforceable.

For example, if a non-compete clause in an employment contract is declared unenforceable by a court, then the rest of the employment contract remains in effect.

Exculpatory Clause

An exculpatory clause is a provision relieving a party from any liability resulting from a negligent or wrongful act. They are often employed when the risk of injury exists. Exculpatory clauses cannot limit liability when a party acts with gross negligence, commits an intentional tort, or when public policy or state laws prohibit them. Exculpatory clauses have been struck down by courts in some cases where parties to a contract have greatly unequal bargaining power, especially when the party with greater power acts unethically or with gross negligence.

Force Majeure

A force majeure clause is a provision allocating risk to a certain party if performance becomes impossible as a result of an event that the parties could not have anticipated or controlled. Force majeure events are big, disruptive events such as natural disasters, war, terrorist attacks, and fires.

For example, if the subject matter of an international sales contract is destroyed by a hurricane, does the buyer or seller lose the money in the sale?

Attorney Fees

Business contracts often have an attorney fees clause that entitles a party successful in litigation over the contract to be reimbursed its attorney fees. This clause often has the effect of limiting frivolous lawsuits because it becomes more expensive for parties to litigate weaker claims. It may also give leverage to a winning party to prevent or end appeals of a court judgment.

Courts will usually enforce an attorney fees provision in a contract. However, courts review attorney fee awards for reasonableness. Therefore, the amount of fees usually must be deemed reasonable by a court or arbitrator before a party can collect under a contract.