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CONTRACT LITERACY: THE FOUNDATION FOR IDENTIFYING AND MANAGING CONTRACT RISK

Most people involved in making and implementing business deals are literate in that they are able to read and write. Whether they are willing to use their literacy when it comes to contracts is another matter, as many business people are reluctant to read contracts. And we do not blame them. When under time pressure, one needs to prioritize, and today's commercial contracts are seldom reader-friendly documents where one can find required information quickly and easily. As we will see in the context of lean contracting and contract visualization later in this book, this may change with the development of more user-friendly contracts. Even without this change, if contract-related decisions are to be taken knowingly, contracts need to be read. But mere reading is obviously not enough— contracts need to be understood as well. To succeed in today's networked business, managers need to be contractually literate.

According to dictionary definitions, the word literate has two basic meanings: someone who can read and write and a well- informed, educated person. Literacy means the condition or quality of being literate or knowledgeable in a particular subject or field (for example, computer literacy, financial literacy, health literacy, media literacy). Contract literacy goes beyond having contracts or legal experts available when an issue arises.

Contract literacy starts with an understanding of the business and legal dimensions of contracts and the impact of contracts on successful business outcomes as well as the related risks. it involves recognizing contracts even when a document bearing such title is not present, and understanding when and how to read them. This requires a basic understanding of the laws that apply and are relevant to the company's business deals and relationships. Contract literacy enables business people to exercise informed judgment when negotiating and working with contracts, and knowing when professional legal help is required.

if we focus on the art of reading contracts in order to recognize contract risk, there are two principal aspects of contract literacy: being willing and able to read and understand (1) what the contract (even the small print) says and, often the more demanding task, (2) what it does not say but perhaps should. these aspects are presented in Figure 2.4 below. [1]

Contract literacy

Figure 2.4 Contract literacy12

Both of the above aspects of Contract Literacy include additional factors, particularly in international business. Understanding what the contract says—the express terms—requires a good grasp of the language of the contract in question. Non-native speakers knowledgeable enough to deal with daily business correspondence and routines may not be able to fully understand the language and contents of contracts or the laws that apply to them.

Even native speakers (including lawyers) sometimes have trouble with legal terminology and concepts. Legal English is not the same throughout the world, and the meaning of concepts such as "consequential loss” or "force majeure” varies in different legal systems. In addition to mastering the relevant language and vocabulary, one often needs to master a number of abbreviations, such as the Incoterms trade terms, and their correct meaning and use. Some ordinary sounding words like "time is of the essence” may carry legal effect, and some terms may go unnoticed unless the reader has been educated to recognize them. Examples of key words and terms are discussed in Chapter 5 in connection with risky terms.

Often what is omitted from a contract is as important as (if not more important than) what is included. understanding what the contract does not say and what that means requires a basic understanding of the relevant legal rules and principles as well as of trade usage and practices. The choice of law—as well as many other choices—may be made explicitly or implicitly.

Where no choice is made explicitly, a court or arbitral tribunal will apply choices made by default. For instance, if the parties have not specified the consequences of breach of contract, this does not mean that there will be no consequences if the innocent party suffers a loss and claims damages. Instead, the consequences (including damages) will be dictated by the applicable law, which might mean unlimited liability for the party breaching the contract. or, to use another example, if the parties have not chosen to settle their possible disputes through arbitration, they may have inadvertently chosen litigation because once a dispute has arisen, it is more difficult to steer the dispute to mediation or arbitration. By making no explicit choices, the parties are assumed to have chosen the applicable law to provide the answer. This is why managers must understand the implied terms and default rules that will apply to their contracts. These are part of what we call "invisible” terms.[2]

Figure 2.4 illustrates another important requirement for contract literacy, namely that of being able to recognize a contract. This may sound trivial, but is not as easy as it sounds. As already stated, it is not always self-evident that people recognize that there is something "contractual” in documents such as a quotation, purchase order, confirmation, letter of intent, or memorandum of understanding. By the same token, some people tend to incorrectly believe that project plans, schedules, work scope definitions, technical specifications, drawings, etc., are "non-contractual,” even when these are attached to a contract.

In addition to the "visible” and "invisible” terms, managers should have a basic understanding of the key variables that determine the sources of contract law. one of these relates to the subject of the contract. A real-estate contract, for instance, might be governed by a different set of legal rules than a contract for the sale of goods, which in turn is governed by a different set of legal rules than a contract for the sale of services. Contracts for the sale of goods are further complicated by the fact that either a domestic law (for example, the Sale of Goods Act in the Nordic Countries or the uniform Commercial Code in the united States) or an international law (the Convention on Contracts for the International Sale of Goods or CISG) might apply depending on whether the parties are in business, whether they are from different countries, whether and how the contract specifies the law governing the contract, and whether and how countries have adopted the CiSG.[3]

In addition to specific laws governing the sale of goods, implied terms (or implied conditions) may be provided by general rules or principles of contract law. For example, most contracts contain a condition—often an invisible condition— along the lines that if one party does not perform, the other party does not have to perform either. Whether and how one party can excuse its performance using such a condition depends on which party was expected to perform first and what the contract requires. (For example, a notice of default is often required in such a situation.)

It is also important to understand that as a general principle a buyer is entitled to recover on a claim only if the supplier's alleged breach (such as delay or non-conformity) does not arise from a cause attributable to the buyer. This principle is expressed in the CiSG, and it is also part of the uNIDRoIT

Principles of International Commercial Contracts[4] and of the Principles of European Contract Law.[5]

Freedom of contract is a fundamental principle of contract law. in business-to-business dealings, the parties can "write their own law” through their contract. However, managers should understand that this principle is subject to constraints that vary from one country to another. For example, there are legal doctrines that limit unfettered freedom of contract and set requirements regarding which commitments are legally binding and how contracts are formed.

In the business arena, the people developing tender and contract specifications or preparing proposals (a.k.a. bids, tenders, quotations and offers), purchase orders or order confirmations are seldom lawyers or contracts professionals. The same is true for people evaluating these documents and for those implementing the contracts that are made on their basis. They may be experienced, sophisticated, and business- savvy people, but their concerns are not primarily legal or contractual, and they may lack contract literacy. If this is the case, they are not likely to make full use of the power of their contracts. In order to identify and manage contract risks and opportunities, they need to become contractually literate.

  • [1] Siedel and Haapio 2011, p. 112; adapted from Haapio, H. (2006) Businesssuccess and problem prevention through proactive contracting. in P. Wahlgren and C.Magnusson Sjoberg (Eds.), A Proactive Approach. Scandinavian Studies in Law, Volume 49.Stockholm: Stockholm institute for Scandinavian Law, pp. 149-94, 170, available athttp://www.scandinavianlaw.se/pdf/49-9.pdf.
  • [2] For invisible terms more generally, see Haapio, H. (2004) Invisible terms ininternational contracts and what to do about them, Contract Management, July, 32-5,available at http://www.ncmahq.org/files/Articles/81EEB_cm_July04_32.pdf; Haapio,H. (2009) Invisible terms & creative silence: what you don't see can help or hurt you,Contract Management, September, 24-35, available at http://www.ncmahq.org/files/Articles/CM0909%20-%2024-35.pdf; and Haapio (2006).
  • [3] the CiSG can be found at http://www.cisg.law.pace.edu; for the declarationsand reservations applicable to the adoption of the CiSG made by various countries, seehttp://www.cisg.law.pace.edu/cisg/countries/cntries.html.
  • [4] The International Institute for the Unification of Private Law (UNIDROIT)(2010) The UNIDROIT Principles of International Commercial Contracts, available at http://www.unidroit.org/english/principles/contracts/principles2010/integralversionprinciples 2010-e.pdf.
  • [5] The Commission on European Contract Law, The Principles of European ContractLaw (PECL), available at http://www.law.kuleuven.be/web/mstorme/PECL.html andhttp://frontpage.cbs.dk/law/commission_on_european_contract_law.
 
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