The current GFC presents both significant challenges and opportunities for businesses. Good business practice and a strategy to manage risk and capture opportunities during the current downturn and beyond may involve a review of business contracts.

Often the first time you really look at a contract is when something goes wrong in your business relationship with the other party.

The drafting of the contract and what terms and conditions have been incorporated is often critical to a party's success when resolving a dispute.

Accordingly, to effectively manage risk and minimise costly disputes, it is vital to critically review the contracts that make up your business to ensure that they adequately reflect the agreement between the parties. The best time to iron out any confusion in relation to the contract is at the start. In fact, an understanding of business risks and how they may be managed by contract is often a significant factor in the success or failure of a business.

A contract can protect or expose you to risk depending upon how it is drafted. Poorly drafted and prepared contracts expose you to risks including legislative risk, litigation risk and commercial risk. The condition of your contracts determines what level of risk your business is exposed to, which may ultimately affect its profitability and longevity. One poorly drafted contract can have a damaging impact on your business if things don't go to plan.

Many businesses consider the expense of having a contract reviewed or prepared prior to execution as a costly and unnecessary one. However the cost of legal advice at the earliest stage of a contractual relationship is normally significantly less expensive than seeking advice when an issue arises. Most importantly, you have the opportunity to amend the contract to protect your business – an opportunity usually not available once a dispute arises.

Most disputes arise out of miscommunication between the parties to a contract. These issues are exacerbated by the lack of a written agreement or a poorly drafted agreement which is incomplete or ambiguous.

A good commercial contract performs a number of functions including:

  • Providing a clear and concise record of the agreement entered into by the parties
  • Allowing the parties to allocate, limit or exclude the various risks that arise from that particular business activity.

In relation to a supply contract, in addition to a description of the particular product or service to be supplied, the contract will often include terms and conditions governing issues such as the contract price, payment terms and delivery requirements and important risk management provisions including clauses dealing with retention of title, insurance, indemnities, exclusion and limitation of liability.

A retention of title clause will usually ensure that a party retains legal ownership of the product or material supplied until payment is received, even if the product is in the possession of the other party. Proper legal advice is essential to the preparation of such clauses, particularly in instances when the product is used to manufacture another product.

An exclusion clause is included in a contract to limit or exclude the liability that a party would otherwise have. A party may also seek to limit its liability in the event of a breach of contract, limiting the amount that the other party may claim to a pre-defined amount. Clauses of this type may be of great benefit to your business and can significantly reduce your exposure should things not go to plan due to factors within or outside your control.

Another common area of contention is the argument regarding whether a party's quote conditions form part of the contract in circumstances where the client has issued a purchase order which is inconsistent with the standard terms and conditions.

Often the later in time prevails, meaning that any qualification you may have in your standard terms and conditions are not an effective part of the contract.

A prudent business will appreciate that the cost of having commercial contracts properly prepared and reviewed is an investment that may avoid costly disputes and liability. This could result in substantial dividends in the long-term.

This article was prepared by Marissa Dimarco, Senior Associate, from Moray & Agnew's Newcastle office.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.