A contract clause is an element of a contract document that specifically states the rights, obligations or conditions of one or more parties in the contract. In any commercial contract, some of the most important contract clauses include: indemnity (allocation of liability for losses), limitation of liability (setting limits to damages), force majeure (exemption in cases of unforeseen events), confidentiality (protection of confidential information), termination (terms of exit from the agreement), governing law (specifying the laws applicable to the contract), dispute resolution (method of solving disputes in relation to the contract), intellectual property assignment, payment clauses, warranties, representations and warranties, integration, severability, non-compete, non-solicitation, assignment, notice, amendment, waiver, audit, and survival clauses. Cornell Law LII reports that there are three elements in an enforceable contract; offer, acceptance, and consideration. Contract clauses are the refinement of those elements.
Clause of the contract is a complete provision of the written agreement dealing with a particular aspect of relations, rights or obligations of the parties to the contract. Cornell Law School’s Legal Information Institute explains that a valid contract involves mutual consent, offer and acceptance, and consideration - however, it is only through the clauses that a simple agreement is transformed into a functional and enforceable contract.
Badly crafted clauses constitute one of the main reasons behind commercial disputes. Omitting the indemnification carve-out or failing to provide a clear force majeure trigger may lead a company to incur costs worth millions of dollars. It is crucial to know the function of each clause and its importance and potential consequences of its omission for any person involved in negotiation, signing, and management of agreements.
The modern world demands modern solutions. The contract management is being modernized to keep on functioning as a solution to all enterprise operations. With the change in the dynamics of how we are evolving in our businesses, it is becoming more necessary than ever before to change the contract management software along with them in this new decade.
There are lots of contracts currently being executed in each company since there will always be additional contracts added for future business purposes. Some common contract pressures may include multiple parties, multiple procurement processes, multiple customers, multiple suppliers in the supply chain, etc. Dynamics of doing business has now changed. There is a need to draft contracts taking into consideration the contemporary needs.
Some entire clauses can be added to a contract in order to cater to the needs of the present times. But which contract clauses are supposed to be added to the contract? One cannot add all the clauses in the contract, right? In this blog post, we have outlined 23 clauses which we believe are essential to be added in a modern commercial contract. As discussed in one of our earlier blog posts on why contract management is important, let us now look at some contract clauses which make up a modern commercial contract.
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Clause Name |
Core Function |
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|
1. |
Indemnification |
Allocates liability for losses or third-party claims |
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2. |
Limitation of Liability |
Caps the maximum damages one party can recover |
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3. |
Force Majeure |
Excuses non-performance due to unforeseeable events |
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4. |
Confidentiality / NDA |
Protects sensitive information shared between parties |
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5. |
Termination |
Defines rights and procedures for ending the agreement |
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6. |
Governing Law & Jurisdiction |
Specifies which state or country's law applies |
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7. |
Dispute Resolution |
Sets the method for resolving conflicts (litigation, arbitration, mediation) |
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8. |
Intellectual Property Assignment |
Determines ownership of IP created during the contract |
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9. |
Payment Terms |
States amounts, due dates, and late-payment consequences |
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10. |
Representations & Warranties |
Statements of fact each party confirms as true at signing |
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11.. |
Entire Agreement (Integration) |
Confirms the written document is the complete agreement |
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12. |
Severability |
Keeps the rest of the contract valid if one clause is struck |
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13. |
Non-Compete |
Restricts a party from competing for a defined period |
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14. |
Non-Solicitation |
Prohibits poaching of customers or employees |
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15. |
Assignment |
Controls whether rights/obligations can be transferred |
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16. |
Notice |
Specifies how and where official communications must be sent |
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17. |
Amendment |
Sets the process for modifying the agreement |
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18. |
Waiver |
Clarifies that failing to enforce a right doesn't forfeit it |
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19. |
Audit Rights |
Grants one party the right to inspect records |
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20. |
Survival |
Lists obligations that continue after the contract ends |
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21. |
Warranty |
Guarantees the quality or fitness of goods/services |
The indemnification clause obligates one party (indemnitor) to indemnify another party (indemnitee) against specific losses or damage or legal expenses. The clause is mostly employed to cover risk related to third party claim – for instance, the vendor can commit to indemnify the client for third party injury caused by the vendor’s product. According to Cornell Law LII, indemnity obligation may be contractual in nature or imposed by law. Broad versus mutual indemnity wording is an important negotiating issue because “broad form” indemnity covers liability even when the indemnitee is negligent and “comparative fault” indemnity distributes liability in proportionate manner.
The Limitation of Liability (LL) provision limits the maximum amount of damages that one side can claim from another side by restricting it to either the total fees paid under the contract or to a set dollar amount. Some damages are not even included in the provision. LL provisions are normally upheld in commercial contracts where both sides are sophisticated, but LL provision may be invalidated because of gross negligence.
A force majeure clause relieves a party from performing its obligations if the party is prevented from doing so by unforeseen circumstances that fall outside its control, including natural disasters, wars, governmental actions, and even epidemics or pandemics. According to Cornell Law LII, the courts construe a force majeure clause strictly: the event must either be expressly mentioned or fall under the general wording of the clause.
Post-pandemic drafting tip: Expressly list "pandemic," "epidemic," "government-mandated shutdown," and "supply chain disruption" in the enumerated events list to avoid interpretive disputes.
The Confidentiality Clause, or Non-Disclosure Provision, is a requirement on the part of the recipient to maintain the secrecy of the specified information and utilize it solely for the purpose of the agreement. It must specify: (1) what "confidential information" is, (2) for how long the obligation holds, (3) allowed disclosures (to attorney, for example, if mandated by statute), and (4) return/destruction of documents upon contract termination. A Non-Disclosure Agreement serves the same purpose but prior to any agreement being signed.
A termination clause governs when and how a contract can be ended. The main types are:
Termination clauses should always specify: notice requirements, the effect on outstanding obligations, return of materials, and which clauses survive termination.
A governing law provision (alternatively referred to as “choice of law”) provision dictates the law of which jurisdiction shall govern the interpretation of the contract. The relevant “jurisdiction” or “venue” provision dictates in which jurisdiction any dispute arising out of the agreement should be heard. Both provisions are particularly important for multi-state or international contracts. Generally, courts tend to uphold governing law provisions unless (a) the selected state has no substantial connection to the parties; or (b) the application of such selected law violates fundamental public policy of the forum.
A dispute resolution clause sets the mechanism and procedure for resolving conflicts. Options include:
Many commercial contracts tier these options: negotiate first, then mediate, then arbitrate.
An IP assignment provision involves the transfer of IP created under the agreement from the IP creator, normally a contractor or an employee, to the other contracting party. In the absence of such an assignment provision, the creator of the IP can be considered the owner of the IP by virtue of copyright law regardless of being paid for their services.
The payment terms section sets out the financial responsibilities, which include the total amount owed, when payment is due, how invoices will be processed, acceptable forms of payment, any interest to be paid for late payment, and procedures for disputes on invoices. Typical payment terms might be "Net 30", "Net 60" or milestones.
A representation is an assertion of present facts at the time of making the agreement (for example, “we own the complete intellectual property of this software”). A warranty is a promise regarding future performance (for example, “the software will perform as per documentation for 12 months”). The importance of distinguishing between the two lies in the fact that a representation, which is false, may be the basis for fraud claims whereas a breach of warranty is usually the ground for contract damages.
The merger clause is also known as the integration clause. The clause indicates that the written contract is the sole and final agreement between the parties and replaces any previous negotiations, statements, and agreements. This means neither party can refer to any other promises or previous drafts. According to Cornell Law LII, the parol evidence rule makes use of the merger clause.
The severability clause allows that in case some provision in the contract is considered unenforceable or illegal, the rest will still be enforced. Otherwise, when a certain provision is struck off the contract, everything else may also be invalidated by the court. The severability clause is regarded as boilerplate by courts, yet it offers significant security, especially to non-compete or non-solicitation contracts.
A non-compete clause prohibits a party (typically an employee or contractor) from competing with the other party for a specified duration and geographic area after the contract ends.
The function of the non-solicitation clause is to bar an individual from soliciting clients and other employees of a company during a certain period after leaving the employment of the company. Non-solicitation clauses are generally enforceable in the United States provided that they are appropriately drafted.
The assignment clause determines the conditions under which the party can assign its rights or obligations under the agreement. In the absence of an assignment clause, the law provides that the assignment shall be allowed unless the contract involves personal services. A sample clause would prohibit the assignment of the contract without the prior written consent of the other party.
The notice clause sets out how notice should be given according to the contract – notice of breach, notice of termination, and notice of force majeure, etc. The clause usually demands that the notice be in writing and delivered in any of the following methods: by email (with read receipt confirmation), by overnight courier, or by registered mail.
Clause of waiver says that the non-enforcement of a particular contractual right by a party in one situation shall not constitute waiver of such right in the future. In its absence, repeated acts of negligence towards certain breach may be seen as an act of waiving away the right. The typical waiver clause mandates that any waiver must be in writing.
The audit rights provision grants the right of one of the parties to examine the records or systems of the other in order to ensure compliance with the terms of the contract. The provision is frequently used in licensing, revenue sharing, outsourcing agreements, and regulated industries. It should address such aspects as who is authorized to perform audits, how often, and more.
The survival clause is a clause that outlines the obligations of the contracting parties that are supposed to be enforceable after the end of the contract period. Some of the clauses that will survive include the following: confidentiality, indemnity, limitation of liability, ownership of the intellectual property, any outstanding payments and the method of dispute resolution.
Bear in mind that modern problems call for modern solutions. Although contract clauses still matter, contract management software solutions can safeguard your organization from overlooking any relevant aspect of each and every clause in a particular contract. Utilize contract templates. Safeguard your organization. Carefully evaluate and discuss each and every clause contained within a certain contract among all parties to the agreement before signing and finalizing the deal. Make use of your contract management solution to talk to all other parties. Let all parties make changes and adjustments to the contract and then execute the same.
As for commercial contracts, it is crucial that you consider giving priority to analyzing the contract agreement clause. In case you have many contracts to deal with daily, it may become extremely difficult for you to carefully analyze all sections of each and every contract. This is why successful enterprise organizations depend upon an automated contract management system to manage their contracts. With the features like clause library in the contract management system, you can make sure that you have added all the required clauses to the contractual documents. There are several other exciting features in a contract management system that help to streamline the entire process. Plan and strategize your contract management process with certified contract management professionals empowered by an efficient contracting software.
