When reviewing a contract, certain language or clauses within the contract are likely to seem peculiar to a non-lawyer. The purpose of this article is to help explain the purpose and effect language and provisions frequently included in contracts.
The purpose of a merger and integration clause is to prevent the parties to a contract from later claiming that the contract does not reflect their entire understanding, was changed by a subsequent oral agreement, or is not consistent with their prior agreements:
This Agreement and the exhibits attached hereto contain the entire agreement of the parties with respect to the subject matter of this Agreement, and supersede all prior negotiations, agreements and understandings with respect thereto. This Agreement may only be amended by a written document duly executed by all parties.
A party entering into a contract that includes this type of language should make sure that all promises and agreements are actually included in the written contract, as otherwise it will likely be impossible to enforce those unwritten promises. Where amendment of the contract must be in writing, a party seeking an amendment should make sure that the required amendment or change order is created, and that it is signed and dated by the parties.
Contracts will often contain language expressing that they are to be interpreted under the laws of a particular state or jurisdiction, and that any litigation will occur within a specified court system:
This agreement shall be interpreted under the laws of the State of California. Any litigation under this agreement shall be resolved in the trial courts of Los Angeles County, State of California.
Contract provisions for the choice of law and forum language are not always be enforceable, particularly in relation to consumer contracts, but are likely to be upheld for contracts between sophisticated parties and businesses. When entering into a contract you should assume that the provision will be enforced and consider how the provision might affect the cost and burden of litigation in the event of a later dispute.
A statute of limitations clause changes the statute of limitations that applies to litigation relating to the subject matter of the contract. For example, the governing law may define a six year statute of limitations for a lawsuit alleging a breach of contract, but the contract includes a provision that shortens that period, eliminates the "discovery rule" (a rule that may extend the statute of limitations during the period a party is unaware of the breach), or both:
The parties agree that any action in relation to an alleged breach of this Agreement shall be commenced within one year of the date of the breach, without regard to the date the breach is discovered. Any action not brought within that one year time period shall be barred, without regard to any other limitations period set forth by law or statute.
For public policy reasons, particularly in relation to consumer transactions, states will not always enforce a reduction in the statute of limitations. You should assume when entering into a contract that a clause reducing the statute of limitations is valid and, whenever possible, should commence any litigation within the contractual period. As there is a possibility that a court might find the clause to be invalid or contrary to public policy, you should consult with an attorney in your jurisdiction before assuming that you don't have a valid cause of action on the basis of this type of contract language.
An indemnification or indemnity clause requires that one party indemnify the other in the event that specified expenses are incurred. For example:
The subcontractor agrees to indemnify and hold harmless the contractor against loss or threatened loss or expense by reason of the liability or potential liability of the contractor for or arising out of any claims for damages.
Be careful when entering into a contract that includes this type of clause, as the provision can significantly increase your financial exposure in the extent of an unexpected event or breach of the contract.
Some contracts will provide that "time is of the essence", which may support an action for breach of contract where the contract is not completed within a reasonable (or specified) time. This type of clause is often seen in construction contracts, as it is important that construction work be resolved in a reasonably timely manner such that a homeowner or business can return to normal life or operations:
Time is of the essence for the completion of the work described in this contract. It is anticipated by the parties that all work described herein will be completed within two (2) weeks of the date of execution, and that any delay in the completion of the work described herein shall constitute a material breach of this contract.
If you agree that time is of the essence, you should be certain that you can complete your duties under the contract with in the agreed time frame or schedule.
Other contracts may specifically provide that time is not of the essence:
The parties agree that time is not of the essence in the completion of the work described in this contract. All parties shall act to complete the work described within a reasonable time.
Where a contract includes language of the latter variety, you may wish to ask yourself why the other party wants the language. That is, do they anticipate delays which will leave you dissatisfied with the timeliness of their performance?
Some contracts include language specifying that all disputes under the contract will be resolved by arbitration:
All disputes, controversies, or claims arising out of or relating to this contract shall be submitted binding arbitration in accordance with the applicable rules of the American Arbitration Association then in effect.
A typical arbitration clause will be considerably more detailed than this example language. For many contracts, state law may require specific language, forms of disclosure, or regulate the appearance of an arbitration clause, with the failure to meet the state standard rendering the clause unenforceable.
In many contracts, the parties may see mutual benefit to negotiating an arbitration clause, so as to avoid the possibility that a dispute will end up in court or to provide for a faster resolution of disputes than would be available through litigation. In other contexts, the party that seeks to impose an arbitration clause will normally anticipate a significant benefit from the inclusion of the clause in the event of a dispute, such as its making any action in the event of breach unaffordable for the other party who will typically have to pay half the cost of a private arbitration. Arbitration can be significantly more expensive than litigation, and may not be reasonably affordable for smaller claims.
Most contracts include a savings clause, included to ensure that the contract remains enforceable even if part of the contract is later held invalid:
If any provision of this Contract is held unenforceable, then such provision will be modified to reflect the parties' intention. All remaining provisions of this Contract shall remain in full force and effect.
If a single clause of a contract is found to be invalid, in the absence of a savings clause it is possible that the entire contract will be rendered invalid.
In the event of litigation, an attorney fees clause requires that the losing party reimburse the prevailing party's attorney fees:
In the event of litigation relating to the subject matter of this Contract, the non-prevailing party shall reimburse the prevailing party for all reasonable attorney fees and costs resulting therefrom.
If one party to a contract is significantly better positioned than the other to pay legal fees and the cost of litigation, the other party should be careful to consider whether an attorney fee clause will be helpful in the event of a dispute, or if its primary effect will be to discourage the other party from attempting to seek redress through the courts in the event of a dispute or breach.
The purpose of non-waiver language is to protect a party who excuses the other party's non-compliance with contract terms, and to prevent the parties' course of conduct under the contract from resulting in the loss of enforceability of the actual terms of the contract:
The failure by one party to require performance of any provision shall not affect that party's right to require performance at any time thereafter, nor shall a waiver of any breach or default of this Contract constitute a waiver of any subsequent breach or default or a waiver of the provision itself.
For example, if a contract requires monthly payments but the party owing payments only pays every other month but the contract does not include a non-waiver clause, after a year of acceptance of the late payments a court would be likely to hold that the bimonthly payments do not constitute a breach of the contract. With a non-waiver clause, despite the prior course of conduct that was inconsistent with the contract language, the party to whom the payments are due would normally be able to enforce the monthly payment provision.
If it may be difficult for the parties to calculate actual damages, it may be appropriate to include within a contract a liquidated damages clause, a provision stating that in the event of a breach a specific sum of money becomes due as compensation for the breach. The most common form of liquidated damages is the late fee charged following the late receipt of payment on a lease, loan or credit card. An example for the rental of an apartment:
For any rent paid after the fifth day of the month, the tenant shall pay a late fee in the amount of $50 (not to exceed 5% of the monthly rent).
The damages are said to be liquidated based upon the contract's stating a specific sum that will be paid as damages, whatever the actual amount of damages may be. Parties who agree to include a liquidated damages clause within a contract should consider whether the amount of money defined in the clause is fair and reasonable, or if the amount is excessive.
Liquidated damages are meant to compensate the wronged party, not to provide a windfall or to punish the party in breach. The amount of liquidated damages must be a reasonable approximation of the amount of damages that the injured party will suffer as a result of a breach of the contract. A court will not uphold liquidated damages clauses if it finds that the defined payment is disproportionate to the injury, or if the amount of liquidated damages appears to be intended as punitive as opposed to fair compensation for the actual injury.