Five Contract Provisions to Avoid Unwanted Outcomes and Potential Litigation

Five Contract Provisions to Avoid Unwanted Outcomes and Potential Litigation

There are five clauses in particular that can result in disputes, surprises, and unwanted litigation if not properly drafted:

1. Pricing

Locking in contract pricing may reduce future uncertainty and help with budgeting/planning, but without some level of price flexibility for unplanned circumstances, businesses could end up absorbing significant costs that impact the bottom line. Consider including a contractual pricing clause once the following is determined:

• Length of the locked pricing in the contract
• If pricing is firm for an extended period, how will new unexpected costs be treated

If a contract includes a lengthy pricing term, consider adding a price adjustment clause tied to measurable indexes, to help mitigate risk to the business. A price adjustment clause allows change to an agreed-upon price based on certain predetermined factors – fluctuating market conditions, tariffs, inflation, changes in labor or material costs, etc. This is especially helpful in long-term contracts as it protects both parties from potential future financial burdens.

In this type of clause, make sure to include what triggers the need for a price adjustment. Examples include an increase in raw material prices, changes in the Consumer Price Index (CPI), or specific tariffs. The clause should also specify how the new price is calculated, such as formulas based on index changes, percentage increases, or a specific cost-sharing arrangement between the parties.

It’s also important to include provisions for late or non payment, such as interest charges, suspension of services, or termination rights.

2. Termination

Another contract provision to consider is termination. It’s important to understand how and when the contract term will end, and what the obligations of the parties will be at that time. Some contracts have auto renewal provisions, that allow only a brief period of time to “opt out” of renewal before the renewal term commences. Contracts that auto-renew without a clear ending date may limit strategic flexibility and cause potential issues (for example, you may miss the “window” of opportunity to renegotiate terms such as pricing), and you can find yourself locked into a long renewal term if you don’t carefully track the “opt out” window. To help mitigate risk, consider adding a termination clause that outlines the specific circumstances under which the agreement can be ended regardless of an auto renewal provision, or limit the number of auto-renewal terms.

Consider a termination “for convenience” clause. This clause typically allows a party to end a contract without requiring proof of breach by the other party, or without stating any reason for the termination, without incurring penalties or requiring proof the other party failed to meet their obligations. The “for convenience” clause typically requires the terminating party to provide advance notice of termination, in writing, before the termination takes effect, and often includes provisions relating to winding down the relationship and transitioning business to a third party.

3. Warranty

A third provision is a warranty clause. This clause outlines specific guarantees that a product or service is free from defects, and meets specific performance standards. A warranty clause often includes the scope, duration the guarantees are valid, the nature of the guarantees, and the remedies in the event of breach (i.e. repair or replacement of goods, re-performance of services, or a full or partial refund). It’s important to include disclaimers where appropriate and specify whether warranty remedies are exclusive. It’s also important to consider applicable underlying warranties that are provided by law, and to disclaim such underlying warranties where appropriate and possible.

Be mindful of how warranty obligations interact with indemnity clauses, especially in product liability or service performance contexts. Both warranty and indemnity clauses offer protection, but limited warranties can often be inadvertently expanded beyond the agreed-upon limited scope by indemnification provisions. These provisions should be drafted so work together to accomplish your goals and provide the protections you desire.

4. Indemnification

Indemnity clauses are clauses that result in a contractual allocation of risk or expense between two contracting parties. The indemnitor assumes a risk or agrees to pay or otherwise bear an expense, whereas the indemnitee is relieved of a risk or entitled to receive compensation. Business owners often fail to understand just how broad an indemnity clause can be, and the kinds of liabilities that can be inadvertently “taken on” by incautious drafting.

Indemnity clauses often contain provisions such as:

• indemnity for claims by third parties only, versus claims between the parties
• indemnity for damage to property or personal injury, in some cases even where the damage was not caused by the indemnifying party, in other cases only where the indemnifying party played a role in causing the damage
•  indemnity for breach of contract
•  indemnity for infringement of intellectual property rights of a third party

Indemnity clauses are enforceable under Texas law and are construed under standard rules of contract construction. The clauses must be “clear and unambiguous” and must expressly state the liabilities and damages intended to cover.

An important concept that often results in litigation is the parties’ failure to comply with the Express Negligence Rule. This occurs where  one party seeks to be indemnified for losses resulting from that party’s own negligence. In that instance, the indemnity clause must generally  satisfy the requirements of the Express Negligence Rule in order to be enforceable:

• It must meet “fair notice” requirements (e.g., it must be conspicuous such as being bold, all caps, etc.); and
• The clause must clearly and “expressly” state that it covers an indemnitee’s own negligence.

Considerations when drafting an indemnity clause include:

• Is the clause reciprocal?
• What result is the client attempting to achieve? What kinds  of losses are likely to arise in the context of the commercial relationship of the parties, and how does the client want those liabilities to be allocated?
• What rights must be preserved (a duty to defend, choice of counsel, etc.)?
• Has the Express Negligence Rule been met if a party is seeking to be indemnified for his or her own negligence?
• Are ancillary costs covered?

5. Limitations of Liability

Limitation of liability clauses limit the amount of exposure a company faces in the event a loss occurs for which a party is otherwise liable. Limitation of liability clauses are enforceable in Texas and generally limit “classes” or “categories” of damages. In order to be enforceable, imitation of liability clauses must be (1) conspicuous; (2) not unconscionable; and (3) not contrary to public policy.

Limitation of liability clauses can limit the amount of liability in the following ways:

• Caps on the dollar amount of losses relating to an event or time period, often expressed a a percentage of the contract value of a fixed dollar amount
• Caps tied to the amounts covered by insurance
• Helpful hints when drafting and reviewing limitation of liability clauses:
• Boilerplate language is almost never your friend.
• Confirm the indemnity provision cannot be construed in a manner that  conflicts with the limitation of liability clause. This is an open invitation to litigation.
• Be clear, concise and conspicuous.

CONCLUSION:

One of the most important takeaways is always “say what you mean and mean what you say.” Be mindful of contractual terms, be cognizant of client needs, and ensure that indemnity, warranty, limitations of liability and other provisions do not inadvertently conflict. While this does not guarantee that litigation will not be needed down the road, it puts a business on the right path.

This Insight was originally published on January 25, 2019, and was updated with additional information about contract provision