Drafting a Contract

Drafting a Contract

In this lesson, you’re expected to learn about:
– the steps to follow when drafting a contract
– the structure and content of a contract
– some practical advice for contract drafting

The preparation of a contract involves difficult or doubtful legal questions and it usually follows a process which includes negotiation, drafting, finalization, and monitoring the contractual arrangement.

When drafting a contract, it is important to understand that a model form or sample document can never be applied directly to a particular transaction, as every transaction requires specific provisions based on many factors, such as:

• laws of the applicable jurisdictions;
• the nature of the agreement;
• the parties to the contract;
• the type of business organizations involved;
• the remedies available;
• choice of law and forum issues; and
• numerous other factors based on the unique needs of the client and the specific circumstances of the transaction.

Before Drafting a Contract

Basics such as the requirement of a written contract, the form of the agreement, the choice of law, and the language to be applied must be agreed upon before the parties can even engage in the structuring or drafting of an agreement.

More importantly, the possibility of breach or termination must be considered at the outset and an exit strategy must be carefully developed at the beginning of the negotiations.

The whole process of making a contract involves a lot of time and effort for drafting, review, discussion, revision, and completion of all preliminary actions.

The adoption of these measures increases the chances to successfully establish a contractual arrangement.

Goals of a Contract

A contract serves multiples purposes and the drafter of the document should aspire to convert into written language the following goals:

• Accurately memorialize the business deal;
• Resolve problems pragmatically;
• Be sufficiently specific that the parties know their rights and obligations but flexible enough to cope with changed circumstances;
• Allocate risks to the party best able to manage it;
• Give each side enough of what it needs so that each leaves feeling that it negotiated a good deal;
• Create provisions to prevent application of undesired default provisions;
• Establish remedies and means of enforcing the rights and obligations arising from the agreement; and
• Prevent litigation

[Optional] Introduction to Contract Drafting
Watch this 11-minute video to learn more: https://www.youtube.com/watch?v=gSDm3hGg7yI
Before lawyers begin to draft, they learn the terms of the business deal. Then they must find the contract concepts that best reflect the business deal and use them as the basis of drafting the contract provisions.

The main contract concepts, which when integrated result in a contract, are:

1) Representation 

It is a statement of a past or present fact, made as of a moment in time to induce a party to act.

For example, in a purchase agreement, the seller represents that he/she has a good and valid title of Product X free and clear of any liens* or encumbrances; on the other hand, the buyer represents that as of the date of the signing of the agreement, he/she is financially prepared for the payment of Product X.

NOTE: Although a party can make a representation with respect to present or past fact, it cannot do so with respect to future facts, which are mere statements of opinion.

Lien: a right to keep possession of property belonging to another person until a debt owed by that person is discharged.

2) Warranty

A promise that if the statement in the representation is false, the maker of the statement will indemnify the other party for any damages suffered because of the false statement.

A warranty requires the statement’s maker to pay damages to the statement’s recipient if the statement is false and the recipient was damaged.

3) Covenant

It is a promise to do or not to do something (promise to perform obligations). It creates a duty to perform if a contract has been formed.

Covenants refer to future promises. If the signing and the closing of the contract are not on the same day, there is a gap period between signing and closing. Then the parties may make pre-closing, at-the-closing, and/or post-closing covenants

• Some covenants, e.g. confidentiality provisions, apply both before and after closing.
• Other covenants apply only at closing, e.g. the seller’s promise to transfer the product X and to buyer’s promise to pay the purchase price.
• Finally, some covenants apply only to the post-closing period, e.g. indemnities and non-competition provisions.
Example of an Acquisition Agreement
Enlarged version: http://bit.ly/2q6cLeT
4) Right

It is a flipside of a covenant. It flows from another party’s duty to perform; that is, it flows from a covenant.

The person to whom the performance is owed has a right to that performance.

5) Condition to an Obligation

It is a state of facts that must exist before a party is obligated to perform. From every condition to an obligation, the contract must include an obligation.

6) Declaration

It is a fact as to which both parties agree, generally a definition or a policy for the management of the contract. Sometimes a declaration is subject to the satisfaction of a condition.

Risk Allocation in Contracts

Contractual risk transfers are intended to assign responsibility for risk exposures to one party or the other.

Although it is usually carried out via a contractual indemnity or insurance provisions, the allocation of risks in a contract can also be made by other means such as representations and warranty (commonly known as “reps and warranties”), covenants, rights, or conditions.

Regarding reps and warranties, each statement establishes a standard of liability – if a statement is false, the party making it is subject to liability. The degree of risk that each party assumes with respect to the statement varies depending on how broadly or narrowly the statement is drafted, shifting risk of loss from one party to another.

Affirmative covenants, i.e. those relating to obtaining approval, can allocate risk to the seller or to the buyer. Also, when drafting covenants, typical covenant expressions are usually used to determine different degrees of obligations.

For example, use of “all efforts”, “commercial efforts”, or “commercial reasonable efforts” to do something. The different degrees of obligations may also allocate risk.

By agreeing to a condition, the parties have agreed that the performing party has no duty to perform if the condition is not satisfied. Thus, the contract allocates the risk of the failure to satisfy the condition to the party who would have been entitled to performance.

Summary of Contract Structure
Source: Stark, T. L. (2007). Drafting Contracts: How and why lawyers do what they do.
Enlarged version: http://bit.ly/2plFDSk
Remedies as a Consequence of Breach of Contract

Only misrepresentations or breach of warranties / covenants represent a breach of the contract and so, entitles the injured party to seek remedies (usually damages).

Conversely, a party cannot sue to obtain damages on a false declaration or failed condition.

As a consequence, parties may frame a business issue into a specific contract concept – reps and warranties or covenants – aiming at being able to eventually sue the other party in case of its breach.

[Optional] Contents of a Contract 
Watch this 17-minute video by Law Sessions:
Practical advise
While drafting contracts, there are many things to consider and below are some of the most important ones:
1) Regardless of whether it is required, put agreements in writing. The written document serves as:

• evidence that there was a contract.
• evidence of the agreement terms. Memories fade, but written evidence remains.

2) Before writing, develop a checklist of all items that the contract might or should address. The writing process helps to clarify ideas, hence making the contract better.
3) When structuring complex projects, it is appropriate to prepare a preliminary agreement (e.g. letter of intent and memorandum of understanding) to be sure the parties are in agreement regarding the essential terms before time and effort is spent on contract preparation.
4) In negotiations, ask about who should take the risk and allocate it properly by using the appropriate contractual concept for the provision.
5) Use defined terms to ensure that future readers will know exactly what your document means. Defined terms are a short hand way of referring to complex concepts and they can expand or narrow the ordinary meaning of a word or phrase.
6) It cannot be assumed that the American (or some other specific country) approach to contracts and business conduct will work in foreign markets. Be sensitive to restrictive national and local laws of the countries of their business partners favoring nationals and their interests.
7) Arbitration as opposed to the use of courts is normally preferred in international arrangements, as explained in the previous lesson.
8) Business practices differ from country to country so the course of dealings and trade usages common to domestic transactions must be considered anew when involved in international practice.
9) In international contracts, try to be the party that will define all of the key terms. Pay particular attention to delivery terms, elements affecting the passage of title, force majeure* and termination issues.
Force Majeure (“superior force”):  unforeseeable circumstances that prevent someone from fulfilling a contract. Also known as “chance occurrence / unavoidable accident”.
[Optional] Tips for drafting a clear-cut contract


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