FURTHER EXAMPLES OF RISKY CLAUSES
Some contract clauses are copy-pasted from previous contracts and used repeatedly, without much attention to what they mean. This is especially true for clauses considered to be "part of the boilerplate.” Not many business people read their own or the other side's boilerplate clauses. Someone, however, should pay attention to such clauses. We now turn to a few clauses that may prove to be quite risky.
A time of the essence clause can stand alone or be part of a clause dealing with performance. It may simply state: Time is of the essence. It may also state whose or what performance it relates to—for example: "The Supplier shall deliver the goods to the buyer's premises by [date], time being of the essence.”
The concept of time of the essence is deeply rooted in some legal traditions and unknown in others, where the interpretation of the clause is somewhat uncertain. The clause might not be discussed during contract negotiations. Non-native speakers representing the sell-side may agree that foreign law governs the contract and accept the proposed clause without knowing that the ordinary-looking words time is of the essence carry a specific legal meaning. What the phrase actually means (under the legal systems where it is recognized) is that the performance in question is so essential that any breach amounts to a fundamental breach of the contract. A fundamental breach, in turn, normally entitles the non-breaching party to terminate the contract.
If the seller's negotiators knew that, they would probably not agree that any delay in delivery is a fundamental breach entitling the other party to terminate. They might rather work out a solution using a grace period and liquidated damages and build in more clarity as to when and how the contract can be terminated and what the consequences are.
While a risk management tool for a buyer whose plans change, a contract that contains a termination for convenience clause can be a high-risk contract for a contractor. Predictability is low when the continuation of the project depends solely on the other party. While the clauses and their compensation conditions differ, in most cases when the contract is terminated for convenience the contractor will lose money and seldom earn the profit that it anticipated when making the contract.
Termination for convenience clauses differ from termination for cause clauses in that they allow termination without any fault on the part of the contractor. The clause might read like this: "the owner may at any time and for any reason terminate the Contractor's services and work at the Owner's convenience.” The clause might also state: "Upon receipt of such notice, the Contractor shall immediately discontinue the work and placing of orders for materials, facilities and supplies.” While such clauses are customary in certain projects and industries, they can (and should) be deal killers in others.
Some contractors use another type of risk-oriented clause, pay-when-paid or pay-if-paid, to pass the risk of not being paid down the chain to their subcontractors. A pay-when-paid clause can read, for example: "The Contractor shall pay the Subcontractor when the Contractor receives payment from the Owner.” Or, taken from the standard form of a contractor: "Payments will be made not more than thirty (30) days from the submission date or ten (10) days from the certification or when we have been paid by the Owner, whichever is the later.” A pay-if-paid clause might read, for example: "Payment by the Owner to the Contractor is a condition precedent to the Contractor paying the Subcontractor.” Sometimes the clause continues by highlighting the risk to the subcontractor: "The Subcontractor understands and agrees that it will be paid if, and only after, the Contractor is paid by the Owner. The Subcontractor fully understands that it bears the risk of nonpayment by the Owner.”
Sometimes such clauses go unnoticed by subcontractors, who often have no way to control such risk. The reason for nonpayment might be the contractor's default under its contract with the buyer, whose financial status the subcontractor may not know and may not be able to ascertain. The use of such clauses is not without risk for the contractor, either. Courts have differing views as to whether pay-when-paid clauses specify a condition governing the subcontractor's legal entitlement to payment or merely the time of payment. To be effective, the clauses must be worded clearly. Even then, laws in some countries prohibit such clauses or allow them in very limited circumstances. In any case, such clauses— unless read, fully understood and knowingly accepted—can create uncertainty and friction and increase the risk of matters ending up in a legal dispute.
Another clause that can be either risky or a valuable risk management tool is the suspension of work clause. Many contracts (and standard contract forms and terms) give the buyer the right to suspend work not only for cause but also for convenience. A suspension of work clause, when used as a risk management tool by the buyer, results in uncertainty and risk for the supplier, as the schedule, the dynamics of work and payment, are then out of its control. While the supplier might include the same clause in contracts with its own suppliers and subcontractors, the risk of not being paid still remains.
On the other hand, the supplier can use a suspension of work clause as a risk management tool for its protection in case the buyer does not pay. This situation becomes more risky to the supplier as the project moves forward. For example, as a construction project nears completion, the contractor loses—and the owner gains—leverage. Close to obtaining a completed project, the owner might be inclined to suspend or reduce payments to the contractor. If the contractor continues working regardless of non-payment and completes the project, the contractor loses whatever commercial leverage it had because the owner has already received what it needs.
If the contract contains a suspension of work clause, the unpaid supplier/contractor can suspend work. The clause might read, for instance: "if the owner fails to pay the Contractor any amount due within 14 days from the due date, the Contractor may, after giving 7 days' prior notice to the Owner, suspend work.” Without a clause specifying the procedure and timeline, the issue of whether and when non-payment becomes a material breach of contract justifying suspension (or termination) by the contractor is a gray area. The laws of different countries vary. A contractor who has not been paid and whose contract does not include a suspension of work clause might have to wait several weeks before suspending work. A contractor who suspends (or terminates) work too early risks breaching the contract, with all the consequences that can follow.
Choice of law and dispute resolution clauses might seem standard and of little, if any, business value. However, they can be pivotal to whether and how well a contract works as a risk management tool. There are many aspects to this, one being the invisible terms that are determined by the choice of law. If the parties do not choose law or dispute resolution forum, then the implied terms make that choice for them. As noted earlier, different countries have different requirements regarding, for example, the formation of a contract and what becomes part of it and regarding the validity of liability disclaimers and limitations.
Choice of law and dispute resolution clauses should provide clarity and legal predictability if a legal dispute arises. At this point, carefully made choices will prove valuable, as these clauses may literally make or break the contract.
Selecting the "wrong” applicable law or dispute resolution forum may be expensive and cumbersome and bring disastrous results. Your entire contract or your disclaimers or limitations may not be legally binding and you may lose the protection you thought that you had. Choosing your own country's court system as the exclusive dispute resolution forum may lead to losing even if you win because the other party may have no assets in your country and your winning court judgment may not be enforceable in the other party's country. While arbitral awards are widely enforceable globally, court judgments can be more difficult to enforce.
An attorneys' fees clause (or the lack of such a clause) is another area where contracts—especially when made across borders— may lead to a negative surprise. Many Europeans take it for granted that if you win a dispute you will automatically have the right to have your attorneys' fees compensated—that is, the loser pays. This, however, is not the general rule in the United States—unless your contract provides otherwise.
The above examples illustrate some typical high-risk issues and risky clauses in contracts. Many of them represent risk allocation or risk transfer clauses. A number of further examples could be added, such as on-demand bond or insurance requirements, force majeure clauses, and notice requirements. While many of them may seem desirable risk control mechanisms for one party, they can also represent a major risk. in reality, such clauses do not make the risk disappear. instead, they may lead to risks being allocated to parties unable to manage them. in the long run, this is not in anyone's best interest. in Chapter 6, we will explore ways in which businesses can deal with risky issues and clauses and secure systematic contract risk recognition and response.