What’s in commercial contracts and how to manage them.
A commercial contract is a legally binding agreement between two or more parties. Different industries and deals call for a range of different types of clauses.
What is a commercial contract?
A commercial contract is a legally binding agreement between two or more parties regarding a business arrangement—typically the sale of a specified good or service. The contract lays out the terms and conditions of the transaction or relationship, including the quantity of goods or the nature of services to be provided; the amount of compensation to which the seller is entitled for providing those goods or services; and what happens if either party doesn’t hold up its end of the deal.
If a contracting party fails to fulfill its obligations under the agreement, that failure constitutes a breach of contract. The other party to the contract can typically sue for damages or specific performance (a court order to follow through on satisfying the contractual obligation). Conversely, contracting parties might preempt costly, time-consuming litigation by specifying that they’ll engage in alternative dispute resolution (typically meeting with a predetermined arbitrator) instead.
One of the main reasons to enter a contract is to minimize the impact of disagreements that might arise later. The more aligned and thorough the parties are when they draft the contract in the first place, the more likely that they can avoid acrimonious legal battles later.
What are the different types of commercial contracts?
A contract can address any subject on which two or more parties need to agree, but here are a few of the most common types of commercial agreements:
Letter of intent (LOI).
An LOI is a way for parties to discuss a potential working arrangement at a high level and make sure they’re on the same page with respect to the big picture before they start hashing out more minute details. While it’s possible that the deal still won’t go through, starting with an LOI helps the parties to determine whether it’s worth continuing the discussion before they waste time and money on a deal that is unlikely to close.
Nondisclosure agreement (NDA).
NDAs help to protect a business’s trade secrets and other sensitive information. When a business engages outside contractors or hires new employees, it’s important to ensure that those workers don’t leak information that might harm the business in some way, such as by giving its competitors information about the products it has under development or the specialized processes it uses.
Purchase and sale agreement (PSA).
This is a contract for the sale of a specified good or service at a set price. This type of agreement is most helpful for a large, individual purchase, or for a high number of repeated purchases from the same vendor over time.
Service-level agreement (SLA).
Establishing clear expectations for the quality of the work is generally just as important as defining what the seller will provide. An SLA specifies terms such as quality guidelines, delivery times, and response times for service and support.
Six key commercial contract clauses.
Different industries and deals call for a range of different types of clauses, but there are some provisions drafted and negotiated in virtually every business agreement. These are six of the most common and important clauses to include in commercial contracts:
1. Confidentiality.
Every business needs to ensure that outsiders don’t have access to sensitive information that could give competitors an edge, whether that information is about the business’s dealings, its intellectual property, or something else. Confidentiality clauses help to ensure that the parties to a contract will take steps to keep that information secure.
2. Damages.
If a party breaches the contract, the other party needs to have some sort of restitution. Setting it out in the contract can help to prevent a drawn-out court battle later, which saves time, money, and potentially entire business relationships.
3. Dispute resolution.
Similar to defining damages up front, agreeing on alternatives to litigation can smooth things out later if the need for dispute resolution arises. It’s common for parties to agree in advance that they’ll work with a mediator or arbitrator instead of going to court, and even to identify the firm or individual they’ll hire to guide the process.
4. Indemnification.
Sometimes while fulfilling its obligations, a party to a contract will cause harm to a third party that may not be in on the agreement. Indemnification clauses specify when and how one contracting party will step in to protect the other party from liability to a third party.
For example, let’s say Party A fails to deliver a component to Party B on schedule, and as a result, Party B misses a deadline to deliver its finished goods to Party C. An indemnification clause might establish that Party A will compensate Party B for any damages owed to Party C as a result.
5. Jurisdiction and governing law.
Businesses today conduct commerce with partners around the globe. When parties are located in two different legal jurisdictions, whether separate states, countries, or even supranational regions (think of the European Union and the GDPR), it’s helpful to know in advance which jurisdiction’s law governs the contract and any disputes that might arise under it.
6. Termination.
Whether or not both parties fulfill their obligations, it’s vital to know when the contractual agreement terminates and thereby releases the parties from any further obligations to each other. Completion of the sale and payment will usually be a termination trigger, but other possible triggers include predefined term limits and breach of contract.
How to manage commercial contracts.
Contract lifecycle management entails everything from creating templates, to negotiating and drafting new agreements, to reviewing contractual obligations in order to stay compliant and track business partners’ performance relative to their promises, and ultimately either renewing or terminating executed contracts by the end of their terms.
A business with low deal volume and no in-house legal team might delegate much of its contract management to a law firm that will keep track of drafted contracts. However, that approach is untenable for a company that has a high number of active contracts in effect at any given time, given the inconvenience and high cost of having to ask outside counsel to review agreements every time a decision-maker in the business needs to ascertain what’s in them.
Today’s in-house counsel and procurement managers need smart, fast, secure systems that streamline contract drafting and management at scale. The best cloud-based contract management product can boost the team’s efficiency when closing deals, the accuracy of contract review and data extraction, and the security of the business’s sensitive information.
Ready to learn how Workday Contract Lifecycle Management, powered by Evisort AI, can help you efficiently manage your commercial contracts? Schedule a demo today.