A commercial contract is a crucial necessity in the modern business world, outlining the rules of engagement across transactions and ensuring organizations get the value they're entitled to.
Without it, business transactions are liable to end in disputes, financial losses, and overdrawn legal proceedings.
In this guide, we will explore everything you need to know about commercial contracts, including examples, associated challenges, and the best approach for handling commercial contracts.
What are commercial contracts?
Commercial contracts are legally enforceable agreements between two or more parties. At companies, in-house lawyers draft contracts that inform stakeholders of the dos and don’ts and terms and obligations of upcoming engagement(s). Precisely, they help in achieving two things:
- Assist buyers in receiving the intended products and services on time and in the agreed quantity
- Aid sellers in getting appropriate and timely payments
Moreover, properly drafted commercial contracts can help you avoid costly litigation. In the rise of unexpected events, say a breach of contract, these contracts act as a guide. They usually include effective dispute resolution mechanisms. Typical examples of commercial contracts include acquiring a company, launching a joint enterprise, and outsourcing tasks to another company.
Examples of commercial contracts
The world of business is run by commercial contracts. Whether you’re transacting with small businesses or corporations, commercial contracts set the stage for successful and legally sound business relationships.
However, commercial contracts take different forms, and the one you use will depend on the nature of the business relationship and associated legal requirements.
Here are common examples:
- Sales contracts: These agreements govern the sale of goods or services between a buyer and a seller. They outline the terms of the sale, including price, delivery, and payment terms.
Also Read: 7 Types of Sales Contracts and Best Practices for Executing Them
- Service agreements: These contracts detail the terms under which a service provider will render services to a client. They cover areas like the scope of work, fees, and performance standards.
- Lease agreements: Lease agreements establish the terms for leasing property, equipment, or other assets. They cover rent, duration of the lease, maintenance responsibilities, and termination conditions.
- Licensing agreements: These contracts grant permission to use intellectual property, such as patents, trademarks, or copyrights, under specific terms. They outline royalties, usage restrictions, and enforcement mechanisms.
- Partnership agreements: This form of commercial contract establishes the terms of a partnership between two or more individuals or businesses. They define profit sharing, decision-making processes, dispute resolution mechanisms, and exit strategies.
- Non-Disclosure Agreements (NDAs): These contracts protect confidential information shared between parties. They define what information is confidential, how it can be used, and penalties for unauthorized disclosure.
- Employment contracts: They define the terms of employment between an employer and an employee. They cover salary, benefits, working hours, termination conditions, and sometimes non-compete clauses.
Also Read: How to Review Employment Contracts: A Comprehensive Guide
- Franchise agreements: These contracts grant the right to operate a business under an established brand name and business model. They specify fees, marketing requirements, operational standards, and termination conditions.
- Joint venture agreements: These establish a partnership between two or more parties to undertake a specific project or business venture. They outline the roles and responsibilities of each party, profit sharing, and dispute resolution mechanisms.
Also Read: How to Review Joint Venture Collaboration Agreements: A Comprehensive Guide
- Distribution agreements: These agreements establish the terms under which a distributor will sell or market a manufacturer's products. They specify territories, pricing, marketing support, and termination conditions.
Also read: How to Review Distribution Agreements: A Comprehensive Guide
Benefits of commercial contracts
Commercial contracts are mission-critical to the long-term success of organizations establishing business relationships at scale. Not only do they minimize risk, they also ensure that the interests of all parties are protected.
Let’s discuss these benefits in detail:
#1 Setting objectives and expectations
Commercial contracts lay out specific expectations for each party. They detail the terms that involved parties agreed upon earlier. Moreover, they ensure requirements are met and provide teams with a much-needed legal defense.
#2 Minimizing business risk
"To me, a risk only matters if it's material. If it's immaterial, I don't care about it. If it's likely to occur, but it's not very costly, I probably don't care. If it's unlikely to occur, but man, if that meteor hit the earth today, it would be bad — I also don't care. It's just not likely to happen."
~Jonathan Franz, Head of Legal at Crunchbase
Navigating Economic Turbulence and Thriving in Chaos
High-value transactions come with considerable risks. To combat potential losses, parties need a commercial contract in place. These contracts also formalize relationships, safeguard business interests, and help achieve contract compliance.
#3 Conducting your business with professionalism
When you have a contract written, it creates a massive impact. As a result, parties accept full responsibility for any violations of the agreement they commit. Commercial contracts establish a paper trail, help build trust, and make parties appear credible and proficient.
#4 Dispute resolution
Contracts often include provisions for resolving disputes, such as mediation or arbitration. This can provide a faster and more cost-effective alternative to litigation.
#5 Relationship building
Contracts can help build trust and foster positive relationships between business partners by establishing a clear framework for cooperation. When expectations are clearly defined and risks are fairly allocated, businesses are more likely to feel comfortable and confident working together.
Seven common clauses in commercial contracts
Commercial contracts identify involved parties and their deliverables. They outline transaction details, payment terms, goods or services exchanged, date, and price. However, it's important to note that each commercial contract is different and contains varied elements.
Some standard clauses you can find include:
#1 Confidentiality
Parties promise to keep sensitive information out of reach of the public. The confidentiality clause impedes unauthorized disclosure of confidential information such as business dealings, intellectual property, or similar entities.
Also Read: NDA vs. Confidentiality Agreement: Which One to Choose?
#2 Dispute resolution
This clause mentions how parties will handle disputes in case of a conflict in the future. In light of similar events, it has helped organizations avoid litigation to a greater extent and instead submit for arbitration.
Also Read: Finding Common Ground: How to Resolve Contract Disputes
#3 Damages
The liquidated damage clause will shed light on the damages if someone has breached the contract. Usually, a trespasser owes a predetermined amount as default in addition to other damages.
#4 Termination
Whether during acquisitions or breach of contract, parties have the option to end the contract, freeing themselves from any obligations initially accepted. These clauses also mention the circumstances leading up to termination.
Also read: Managing Contract Terminations: The Ultimate Guide
#5 Indemnity clause
Indemnification defines the compensation one party pays to another in the event of loss faced. In short, this clause provides compensation for liabilities upheld by other party(s).
#6 Jurisdiction
With prevalent cross-border transactions, it is good practice that a commercial contract explicitly states which jurisdiction law governs it. Since each country or state has its distinct governing rules, the jurisdiction clause brings clarity and offers legal protection.
#7 Force Majeure
A Force Majeure clause outlines the line of action when any of the party(s) is not able to fulfill its obligations due to reasons not in human control. For instance, natural calamities or similar catastrophic events may hinder either party from performing obligations. In these situations, failing or not yielding promises is not considered a breach of contract.
Also read: 5 Most Negotiated Terms and Clauses in a Contract
Limitations of commercial contracts
Commercial contracts, while essential for business operations, have some limitations capable of impacting its effectiveness, enforceability, and overall utility.
Here are some limitations worth considering:
#1 Interpretation and jurisdiction
The interpretation of commercial contracts can be complex, especially when dealing with parties from different jurisdictions.
Varying legal systems and cultural norms can lead to misunderstandings and disputes over the meaning and intent of contract terms. This can create uncertainty and legal challenges, impacting the contract's effectiveness.
#2 Limited flexibility
Commercial contracts are legally binding agreements, and once signed, they can be difficult to modify. Changes often require renegotiation and mutual consent, which can be time-consuming. This can be problematic in dynamic business environments where circumstances can change rapidly.
#3 Risks
“It’s difficult to be part of any business and not hear about “risk.” It’s everywhere. Risk is the new black. It’s on the lips of every CEO, CFO, and board member, as it should be. And, anything that is important to the board and the C-Suite, is important to the legal department.”
~Sterling Miller, CEO and Senior Counsel, Hilgers Graben PLLC
Ten Things: Spotting, Analyzing And Managing “Risk”
Commercial contracts involve inherent risks for all parties involved. These risks can include non-performance by one or more parties, financial losses, damage to reputation, and legal liabilities. While contracts aim to mitigate these risks, they cannot eliminate them entirely.
Also read: Tackling Commercial Contract Risks: Strategies + Best Practices
#4 Unforeseen events
Contracts may not adequately address unforeseen events or circumstances that arise after signing. Force majeure clauses can provide some protection, but they may not cover all contingencies.
#5 Changes in law
Laws and regulations can change over time, potentially impacting the validity or enforceability of existing contracts. A change in law may render certain contract terms illegal or unenforceable, creating legal complications and requiring renegotiation or termination of the contract.
Drafting commercial contracts: the role of the in-house counsel
One of the main responsibilities of in-house counsel is ensuring that all contracts involving their organization are legally sound, protect the organization's interests, and comply with applicable laws and regulations. This often involves playing a significant role in drafting commercial contracts.
In-house counsel are uniquely positioned to understand the organization's business objectives, risk tolerance, and internal processes. This allows them to tailor contracts to the specific needs and goals of the business.
“Businesses are always communicating on commercial terms and are looking for that same commercial aptitude from their legal employees. More commercial lawyers are able to take stock of business operations and provide legal recourse or suggestions that can help generate sales or raise profits.”
~Shiv Vyas, GC, Compusoft Group
Building Commercial Mindfulness
The drafting process typically involves close collaboration with other departments within the organization, such as sales, procurement, and operations. In-house counsel act as advisors, providing legal expertise and guidance as needed. They review contract terms, identify potential risks, and propose solutions to mitigate identified risks.
“Often because of their years of reading about worst possible outcomes and risk-adverse nature, they tend to evaluate (and exaggerate) risk based on the worst happening. But is that outcome a likely or probable one?”
~Sheikh Shaghaf, Vice President and Assistant General Counsel at Informa
Exploring risk likelihood in commercial contracts
In addition to drafting, in-house counsel also play a crucial role in negotiating contracts with external parties.
They advocate for the organization's interests, making sure that the final agreement reflects a fair and balanced allocation of risks and rewards.
Common challenges associated with managing commercial contracts
#1 Poor visibility
When you have commercial contracts spread across systems, you face problems like losing sight of contract owners, chaotic status-tracking, and much more. There are umpteen chances of losing a contract, which may expose you to risks unknown before.
Sometimes, more than one department owns the commercial contract, meaning partnership becomes quintessential. The solution is to use a CLM software, such as SpotDraft, that can help you collaborate internally.
#2 Lean legal teams and voluminous contracts
Your legal team might be spending more time on administrative activities like data entry, which results in less-than-ideal results. They have to switch between different platforms from the drafting stage to the execution stage. These activities may expose the contracting process to human biases.
Top-performing businesses have most likely cracked and streamlined their commercial contract strategy, which is less-error-prone. Additionally, without expanding the legal teams’ throughput, scaling commercial contracts becomes practically impossible.
#3 Lack of automated workflows
Often, procurement teams create SPA contracts, but legal and finance teams must approve the same. Building and executing routine commercial contracts becomes more challenging without automated approval workflows.
Enterprises swirling out a large number of contracts on a regular basis can get baffled by the sheer amount of manual administrative tasks they have to carry out every day. Also, when you consider the post-execution phase, tracking and reporting commercial contracts, finding insights for a competitive edge, and fine-tuning their renewals are odd and irregular.
SpotDraft’s approach to handling commercial contracts
Approval workflows
For commercial contracts that surpass a given value or include a specific jurisdiction, approval processes might be set up. SpotDraft enables you to build these unique approval series while creating templates. The platform ensures the accuracy of each contract exchanged with the counterparty.
Also, custom approval workflows enable interdepartmental collaboration and provide confidence when executing the already negotiated terms. These workflows also help in reducing turnaround time on contracts and actively mitigate risk.
A single source of truth
Finding contract information is as easy as a few clicks, thanks to the way SpotDraft stores your contracts in a safe, searchable repository. The risk of having multiple contract versions in circulation is eliminated when all parties involved can monitor all revisions in real time.
Furthermore, SpotDraft eliminates the need for manual contract reports hosted on Microsoft Excel or other such software. The platform helps you instantly create reports and visualize critical contract data. Additionally, it offers a chance to link those commercial contracts with supporting documentation.
Seamless review and collaboration
SpotDraft's 100% Word compatible contract editor automatically detects definitions and errors in commercial contracts. By simply uploading them to the platform, you may review them in just a few minutes.
Also read: How to Review a Contract Faster and More Efficiently
Additional FAQs for commercial contracts
- What makes a commercial contract legally binding?
To make commercial contracts enforceable, there must be an offer, acceptance of the offer, consideration, and the intention to be legally bound. Also, the term 'consideration' means "something in return."
- What does the content of commercial contracts look like?
Commercial contracts specify the parties, the deliverables, a clear plan for what will happen if the parties don't fulfill their responsibilities, and the applicable law.
- Why are commercial contracts difficult to manage?
More shrunken legal teams, increased risk, and a ton of administrative work make it hard to manage commercial contracts.
- What are some outcomes of having a commercial contract?
Some well-known results of creating a commercial contract include achieving contract compliance, minimizing risk, offering legal protection, and setting clear expectations.
Conclusion
SpotDraft makes the entire contracting process transparent, allowing each department to securely access and track commercial contracts. Managing commercial contracts throughout their lifecycle couldn't be simpler or more powerful.
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