Anatomy of a Contract

Always a question that concerns business owners is what should be included in a contract? The short answer: everything that is needed. However, there are ways to break up drafting a contract to make it easier to know what should be included, and when it is too much and jeopardizes the deal getting done.

Even though there are many different parts of a contract and some of them can be quite long, there is a way to think about contract drafting as a three part system. I call them “Information”, “Action”, and “Insurance”:

INFORMATION SECTION:

This is the easy part of the contract, it simply states what the contract is about, who is involved, and where the actions should take place. Take a look at the top of a fictitious contract-

This is about as simple as it comes, but it is illustrative as to the general idea of the “Information” stage of a contract. Often a more detailed explanation of what each party does, or perhaps where their relationship to each other is already at, but at the core of it, the “Information” section simply explains who is in the contract and what they want to contract for. This section is more formally known as the Recitals section.

ACTION SECTION:

To me this is the most important, and often most overlooked part of a contract, especially by those drafting contracts without the help of an Attorney. The most important aspect of the contract is setting out exactly what it is that the parties are contracting for. This takes work and some foresight, but the dividends for spending the extra time upfront pay off 10 fold in its ability to prevent and resolve future disputes.

Here is a small section from the “Action area” of a fictitious contract for the management of a golf course.

Even this example is a bit simplistic, but you can see that the statement “XYZ shall manage and maintain ‘Green Acres’ golf course as a first class facility.” Many do it yourself contracts would simply leave it at that. At the beginning of a new deal, everyone is excited and it seems everyone is on the same page. It is not until later that problems may arise.

So, instead we go on to define a “first class” facility in specific detail all the way down to the length of the grass on the greens.

Imagine a scenario where the owner of the course is upset that the Managing company is not keeping the course nice enough. Without all of the sub-categories defining what a “first class facility” is, you are stuck arguing over, and possibly litigating a subjective standard. With the added detail in the “Action” section, now the dispute is an objective one. (ie- either the greens were kept within the 1″ standard or they were not.”)

Having such specificity not only makes future litigation easier, it can make it completely unnecessary. Both parties go into the deal knowing what is expected of them, and knowing what the outcome of any litigation would be because it is so plainly spelled out.

INSURANCE SECTION:

In the above two section I mentioned that the “Action” part of a contract is the most important part of a contract; and it is, but mainly because of how it relates to the “insurance” part of a contract. Everything that is discussed below about the “insurance” part is almost useless without a properly written “Action” section of a contract. If however, the “action” portion properly leads into the “insurance” section, you can create a piece of paper that does exactly what it is designed to do, protect your business in case of emergency.

Below are some cut and pasted examples of the “Insurance” section of a contract.

Probably the most important part to be clear on is what happens in case of breach. All too often this section is left out, or is inadequate. The purpose of having a contract to protect you is that in the event the other party does not live up to its obligation, you should not have to go to court as the remedies are already clearly laid out. With a well written contract, even if you do have to go to court, you may be able to succeed at summary judgment and get your attorneys’ fees paid for.

Going hand in hand with breach provisions are the provisions outlining when the contract ends and how it will unwind. This can be a complicated issue and requires a fair amount of foresight to think of the many possible outcomes. Not adequately addressing what happens in certain situations or setting out when the contract should end or unwind can easily leave either party in a lurch and lead to easily preventable litigation.

Finally, there is the boilerplate language. Things such as indemnification, survival, modification, and choice of law. These are all provisions that are standard to every contract and are usually even included in those internet form contracts that you can download and fill-in. While I could go on for pages about little things and tweaks that are often missed, I wanted to mention one provision in particular that is routinely incorrect, even in Attorney generated contracts, and that is the “Choice of Law” provision. Whenever you make the choice of which State’s law should apply, the caveat that the State’s “conflict of law” laws should not apply must be included. Most states have statutes that determine which state’s law should apply in the case of a possible conflict or just multi-jurisdictional deals. So, applying Wisconsin law uniformly also means that you are applying Wisconsin’s conflict of law statutes which tell you to look at Illinois law instead, which is exactly what you did not want to have happen.

This is a brief overview at best of what is involved in drafting a contract, but it should give you a good idea of the types of things that should be included and hopefully impresses upon people the need not just for a written contract, but for a well written contract. As I always like to say, “an ounce of prevention is worth a pound of cure.”

Attorney Sean M. Sweeney

You can read my regular blog at www.MilwaukeeBusinessLawBlog.com