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Risk Management Strategies To Avoid Contract Disputes
Contracts are the glue that binds the commercial world together. Given that they are agreed between two parties that may have somewhat different ambitions and objectives, despite wanting to work together towards a common cause, it is unsurprising that contractual disagreements are one of the most common types of commercial law disputes. Therefore, putting robust risk management strategies in place to mitigate the risk of a dispute developing is an essential part of any contract planning, drafting, and negotiation. Contract disputes are expensive in terms of time, resources, and peace of mind. This is despite the fact that most cases are settled outside of court. Mitigating the risk from the outset is essential to meeting strategic goals and maintaining healthy cash flow and profitability.
What are the basics of a contract?
Whether you are entering into a contract to supply fresh produce to your small restaurant or a cross-border property development agreement, the basics of a contract are the same. To be legally enforceable, a contract must include the following elements:
– An offer
– Consideration
– Acceptance of the offer
– An intention to be legally bound by the agreement
– Both parties must have legal capacity (for example, both parties being over 18 years old)
The first step towards mitigating a contract dispute is to ensure all these factors are in place.
How can the risk of contract disputes be mitigated?
According to Harvard Business School Online, risk management is the “systematic process of identifying, assessing, and mitigating threats or uncertainties that can affect your organisation. It involves analysing risks’ likelihood and impact, developing strategies to minimise harm, and monitoring measures’ effectiveness.”
Risks associated with contracts include (but are not limited to):
– One or both parties misinterpreting the terms of the agreement.
– Failure to include adequate indemnities and warranties.
– Communication failures during negotiations.
Let us look at these in detail.
One or both parties misinterpreting the terms of the agreement
In Barton & Others v Morris and another [2023] UKSC 3, a property developer (Mr Barton) concluded an oral contract with Foxplace, a company that owned property (Nash House). The contract governed Mr Barton finding a buyer for Nash House on behalf of Foxplace.
The parties agreed that if Mr Barton found a buyer who would pay £6.5 million, then Foxplace would pay him £1.2 million. This was the only express term.
The case went all the way to the Supreme Court, which concluded that Mr Barton was not entitled to the £1.2m as he had sold the property for under £6.5 million. No other contingency terms had been agreed; therefore, Mr Barton was owed nothing by Foxplace.
Harsh as this judgment seems, it does showcase why parties often choose to have commercial disputes decided in English Courts, where party autonomy and contractual certainty take precedence over judicial intervention.
The lesson to be learned from this case is to ensure contractual terms are drafted in clear, concise, comprehensible language. Daphne Perry, a former Barrister and founder of ClarifyNow, recently wrote that “short contracts, in simple terms, saves work for all the users, improves sales and customer relations, and saves money for the business”.
Failure to include adequate indemnities and warranties
An indemnity is a promise by the party giving the indemnity (paying party) to protect the beneficiary of the indemnity (receiving party) against an identified loss by paying money if a specified event occurs. A common indemnity is one involving the payment of taxes. For example, if a person sells shares to another, as part of the agreement, the seller will indemnify the buyer against any unpaid taxes that arise out of the sold shares. This protects the buyer from an unexpected tax bill if the seller made a mistake when filing their tax return.
A warranty, on the other hand, is a contractual assurance from a seller to a buyer. For example, in the case of selling a business, the seller can provide a warranty that the accounts are accurate and up to date.
A breach of warranty equates to a breach of contract claim, and the party claiming the breach must prove loss, and that loss must have been foreseeable by the party in breach. There is no need to prove loss or foreseeability in the case of an indemnity – if the indemnity is triggered, the paying party must cover the cost.
A common indemnity dispute is where the receiving party believes that the indemnity will automatically cover 100% of the loss. This is not always the case. The terms in the contract determine the extent of the paying party’s liability. In terms of a breach of contract, if the agreement has been poorly drafted, an indemnity may be interpreted as covering only what the receiving party would be entitled to under a damages claim.
Communication failures during negotiations
Negotiating is a key part of the contract process. There are several mistakes people often make when negotiating, from not clearly stating the WIFM (what’s in it for me) to the other party, to failing to put everything agreed in negotiations in writing and then taking the time to ensure everyone involved in the talks understands exactly what has been agreed.
A classic example of a dispute that can develop by not doing the above is when parties agree to terms X and Y in negotiations, and one person impulsively suggests that if things work out, then a new term (B) could be considered. The other party then assumes that B is now part of the agreement. And when B is not delivered or actioned, they argue breach of contract.
Concluding comments
Managing the risks of contract disputes often comes down to expert drafting and clear communication. Taking the time to consider where miscommunication or misinterpretation could occur before anyone signs on the dotted line is imperative. An experienced Commercial Law Solicitor can make sure everyone understands the proposed terms and draft the contract to reflect what has ultimately been agreed.
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