Handling commercial contracts can be complex and time-consuming. Each type of contract comes with its own set of requirements and potential pitfalls. Knowing the key types of commercial contracts and their specific clauses can help you navigate these challenges effectively, ensuring smooth business operations and minimizing risks.
In this post, we will take you through the different types of commercial contracts and their common clauses. You'll also learn about the challenges legal teams face in managing these contracts and how Contract Lifecycle Management (CLM) software can help.
What is a commercial contract?
A commercial contract is a legally binding agreement between two or more parties that outlines the terms and conditions for the exchange of goods, services, or other business activities.
These agreements are the backbone of business operations, providing a clear framework for transactions and partnerships. Whether you're selling products, hiring services, entering a partnership, leasing property, or hiring employees, commercial contracts ensure that everyone knows their rights and responsibilities.
Also read: What Are Commercial Contracts (Clauses, Examples, and Benefits)?
Why do we need commercial contracts?
Commercial contracts ensure clear terms, protect your interests, and manage risks. Businesses with solid contracts face fewer legal disputes and can boost revenue through improved vendor relationships.
#1 To set clear and precise business terms
Commercial contracts specify exact terms and conditions unique to business transactions, preventing misunderstandings that can lead to operational disruptions, strained partnerships, and financial losses. Without clear terms, misinterpretations can occur, potentially resulting in significant setbacks and damaged relationships.
#2 To protect business interests with robust legal coverage
Legally binding commercial contracts provide essential protection for businesses. They ensure that all parties adhere to agreed terms, and offer recourse in case of breaches. Without these protections, businesses face prolonged legal disputes that can drain resources and affect operations.
#3 To manage and mitigate specific business risks
Commercial contracts address risks unique to business activities, such as supply chain interruptions, service failures, and liability issues. They include clauses that help manage these risks, ensuring smoother operations and protecting business interests from unforeseen events.
Also read: Effective Contract Risk Management: Top Tips & Strategies
#4 To ensure efficient dispute resolution for business conflicts
Commercial contracts often include dispute resolution mechanisms like mediation or arbitration, which are faster and less costly than litigation. This helps maintain business continuity and preserves relationships by resolving conflicts efficiently.
#5 To establish trust and reliability in business dealings
Clear, well-drafted commercial contracts build trust between business partners by showing a commitment to fulfill agreed-upon terms. This trust is crucial for long-term partnerships and can enhance your business reputation, leading to more opportunities and growth.
#6 To enforce high standards and deadlines in business operations
Commercial contracts set specific performance standards and deadlines, ensuring that all parties meet their obligations on time. This is vital for maintaining high-quality standards and preventing delays, which can otherwise lead to client dissatisfaction and revenue loss.
What are the types of commercial contracts?
Some common-day commercial contracts examples include - loan and finance agreements, settlement agreements, co-founders agreements, corporate lease agreements, advisor agreements, share subscription agreements, letters of intent (LOI), service level agreements, user agreements, contracts for the supply of goods and services, escrow agreements, non-compete agreements, and agency agreements.
Choosing and enforcing the most appropriate commercial contract type for the situation is vital to the long-term success of your business.
1. Joint Venture Agreement
Joint Venture (JV) contracts are agreements between two or more parties for a particular business project or opportunity. JV contracts specify the conditions, terms, and duties to be met by each party during the project. In a joint venture, parties operate in a partnership and not as independent legal entities.
Critical elements of a JV agreement include:
- Purpose of establishing the contract
- Each party's role in the partnership, including technical contributions or commercial commitments
- Meeting schedules and how parties will discuss the project's progress
- Tenure of the partnership
- Note on how to terminate the agreement if need be
Popular use cases
Put JV agreements to effect when:
- Your business would require or benefit from resources that another company supplies
- The partnership aids in reducing the R&D cost of the project
- Expanding your business by creating a more extensive network
- Your business needs assistance developing a novel product, technology, or service.
- Increasing sales or targeting new clients by doubling down on another company's brand or reputation
2. Shareholders’ Agreement
Shareholder agreements define the duties and responsibilities of shareholders, share issuance, corporate operations, and decision-making processes. Also known as the stockholders' agreement, it protects both the entity and the shareholders' investment in that entity.
Benefits
- Ensures that all shareholders are treated fairly, and their interests are protected
- Gives existing shareholders the right to choose outside members as potential or future shareholders
Popular use cases
- While starting a company.
- Issuing the first shares of a company.
3. Business Purchase Agreement
A Business Purchase Agreement (BPA), also known as a business transfer agreement, transfers the ownership from the seller to the buyer of the business entity. Usually, this type of contract contains terms that govern the sale. BPAs can either be stock purchase agreements or asset transfer agreements.
Benefits
- All assets and liabilities can be valued at fair market value
- The transfer agreement outlines the terms that protect the interests of involved parties
Popular use cases
BPAs are essential for anyone buying or selling a business.
4. Supply Agreement
Supply contracts are those in which the seller promises to provide the specified goods or services at a fixed price and for a set period. Here, as part of the agreement, the buyer also agrees to buy those products exclusively from the seller during that time.
Benefits
- Helps lock in the discounted price and other advantages the supplier agrees to provide in any specific period.
Popular use cases
These agreements are often used by procurement departments when working to procure goods and services for their organization.
5. Sale and Distribution Agreement
A distribution agreement, also known as a wholesale distribution agreement, is a contract between a distributor and a manufacturer. It allows distributors to market, sell, and profit from the bulk sales of products from manufacturers or wholesalers. These agreements typically include terms and conditions addressing territories, exclusivity rights, and reporting requirements.
Benefits
- These agreements help move products/services along the supply chain - from manufacturers to retailers to end-users. A third party can sell suppliers' goods to an unexploited region or new clients, meaning suppliers need not make a presence in a new territory themselves.
- A sale & distribution agreement in place gives the victim party a much simpler time in case of potential breaches or violations.
Popular use cases
A distribution agreement is essential for anyone who wishes to distribute the products or services of another company. Typically, the following business types may need distribution agreements: wholesalers, manufacturers, retailers, software companies, beauty products, clothing and accessories, electronics, and brands.
6. Franchise Agreement
A franchise agreement is a contract that legally binds franchisors and franchisees. These contracts outline what the franchisor expects from the franchisee, how the firm must be run, and other specifics. It is a contract whereby the franchisor (firm) agrees to provide the franchisee the consent to use the brand name or company system (individual or entity).
Benefits
- Defines the relationship between franchisee and franchisor
- Offers better control to the franchisor
- Helps in brand management
Popular use cases
Anyone planning to license a business for use as a franchise must have a franchise agreement to operate legally. Traditionally, the following businesses use franchise agreements: retailers, travel agencies, convenience stores, fast food & chain restaurants, financial advisors, healthcare providers, health clubs, and real estate companies.
7. Non-disclosure Agreement
Non-disclosure agreements, or NDAs, are binding contracts that establish a trusting relationship between the owner of sensitive information and the person who will have access to it. If a relationship is confidential, neither party—nor both parties—should divulge that information.
-> Here’s a post that will guide you through the pivotal steps to follow while dealing with NDAs.
Benefits
- Distinguishes confidential and non-confidential information
- Protects patent rights
- Guards sensitive information
Popular use cases
The following five situations necessitate the signing of an NDA:
- When a company agrees to the sale or licensing of a technology or product.
- When teams are negotiating with a new partner or investor.
- When an employee joins or quits an organization.
- When a new client is being onboarded.
- When a company is planning an acquisition or merger.
8. Partnership Agreement
A partnership agreement is an official contract containing the rules and circumstances governing the connection between company partners. It typically specifies the duties or activities that each partner is expected to do in the business as well as their relative ownership interests.
It is possible to form a business partnership agreement between two or more corporations or between two or more people. For instance, an LLC and an individual or an LLC and a corporation may enter into a partnership agreement.
Benefits
- Serving as a reference for dispute resolution
- Stipulate the rights and obligations between the parties
- Define the business relationship
Popular use cases
The purpose of a partnership agreement could be to increase brand awareness, gain access to a new market, or gain a competitive advantage. Another example includes an instance wherein you use a product or a product feature that resulted from a partnership between two brands.
9. Vendor and Customer Agreement
A vendor contract, often referred to as a vendor agreement, is an agreement between two businesses about the exchange of goods or services in exchange for payment. Vendor agreements lay forth the terms of the commercial partnership and specify what each party is expected to perform. Some common types include fixed-price contracts, cash-reimbursable contracts, time and materials contracts, indefinite-delivery contracts, and letter subcontracts.
Benefits
- Help all parties understand expectations in terms of deliverables and payments.
- Mitigate risks by negotiating at the start of the vendor partnership.
Popular use cases
Events like weddings, art festivals, and food markets may use vendor agreements. Additionally, your company depends on several vendor contracts for anything from office supplies to equipment repair and maintenance, internet and phone services, and even the raw materials for your products.
10. Intellectual Property Assignment Agreement
An agreement that specifies intellectual property ownership is known as an IP assignment agreement. IP assignment agreements are frequently used by businesses to both secure their innovations and developments and to transfer ownership of intellectual property when needed.
These assignment contracts are used to transfer intangible assets like copyrights, trademarks, and trade secrets of businesses. The IP assignment agreement, which is also sometimes referred to as an IP transfer agreement, makes sure that the firm may keep the rights to an intangible work that an employee develops on the company's behalf.
Popular use cases
A smooth transfer of IP ownership rights can be made possible through an intellectual property assignment, regardless of whether you are beginning a new business, purchasing product rights, or buying a firm.
When is a commercial agreement legally binding?
Knowing when a commercial agreement is legally binding is essential because it ensures all parties understand their rights and obligations. This clarity prevents disputes, protects your interests, and ensures that everyone follows the agreed terms in business transactions.
To determine if a commercial agreement is legally binding, consider the following criteria:
1. When both offer and acceptance are clear
A commercial agreement begins with an offer by one party and acceptance by another. Both the offer and the acceptance must be clear and unequivocal.
- Offer: A proposal by one party to enter into an agreement
- Acceptance: The agreement by the other party to the terms of the offer
Example: A vendor offers to supply goods at a specified price, and the buyer accepts this offer by agreeing to the terms.
2. When both parties receive consideration
Consideration refers to the value exchanged between the parties involved in the agreement. It can be in the form of money, goods, services, or a promise to perform (or not perform) a specific action.
- Mutual benefit: Both parties must receive something of value
- Sufficiency: The consideration must be sufficient but does not have to be equal
Example: A company agrees to pay a consultant for their services, and the consultant agrees to provide the services in return for payment.
3. When there is an intention to create a legal bond
Both parties must intend for the agreement to be legally binding. This intention is usually inferred from the nature of the agreement and the circumstances surrounding it.
- Business agreements: Generally presumed to have an intention to create legal relations
- Social agreements: Typically not intended to be legally binding unless clearly stated otherwise
Example: A signed contract between two businesses to deliver products within a specific timeframe typically demonstrates the intention to create legal relations.
4. When there is a legal capacity to enter a contract
The parties entering into the agreement must have the legal capacity to do so. This means they must be of legal age, sound mind, and not disqualified from contracting by law.
- Legal age: Generally, parties must be at least 18 years old
- Sound mind: Parties must have the mental capacity to understand the terms and implications of the agreement
Example: A company entering into an agreement with another company assumes both entities have the legal capacity to form the contract.
5. When the purpose is legal
The purpose of the agreement must be legal. Contracts involving illegal activities or purposes are not enforceable.
- Lawful activities: The contract must involve actions that are legal and not against public policy
- Compliance: The terms of the agreement must comply with existing laws and regulations
Example: An agreement to supply goods that are legally permissible to trade will be enforceable, whereas an agreement to sell prohibited substances would not be.
6. When the terms are certain and clear
The terms of the agreement must be clear and complete enough to be enforceable. Vague or incomplete terms can render a contract unenforceable.
- Clear terms: All essential terms and conditions must be specified.
- Complete agreement: The agreement should cover all necessary aspects to be carried out effectively.
Example: A detailed service contract specifying the scope of services, timelines, and payment terms ensures clarity and completeness.
Limitations of commercial agreements
While commercial agreements are essential tools for business operations, they are not without limitations. Being aware of these limitations can help your legal team mitigate risks and ensure better contract management.
#1 Ambiguity and the risk of misinterpretation leading to disputes
Ambiguous or vague terms can lead to misunderstandings and disputes. If the language of the agreement is not clear, parties may interpret terms differently.
- Risk: Misinterpretation of terms can result in disagreements and legal challenges
- Mitigation: Ensure that all terms and conditions are clearly defined and unambiguous
#2 Insufficient flexibility to adapt to business changes
Commercial agreements may lack the flexibility needed to adapt to significant business changes, such as market shifts, technological advancements, or organizational restructuring.
- Risk: Inflexible contracts can hinder a business's ability to respond to changing circumstances, potentially leading to missed opportunities and operational inefficiencies
- Mitigation: Draft contracts with clauses that allow for adjustments in response to major changes, ensuring the agreement remains relevant and effective over time
#3 Challenges arising from changes in legal and regulatory landscapes
Changes in laws and regulations can affect the enforceability or terms of commercial agreements. Contracts that are valid under current law may become problematic if laws change.
- Risk: Legal changes can invalidate certain terms or make the contract non-compliant
- Mitigation: Include clauses that address potential
Important clauses in commercial agreements
Including the right clauses in your commercial agreements is crucial for protecting your business interests and ensuring clear terms for all parties involved. Here are some key clauses that should be considered in any commercial agreement:
1. Definitions and interpretations
This clause defines the key terms used throughout the agreement, ensuring that all parties have a common understanding of important concepts.
2. Confidentiality
The confidentiality clause ensures that any sensitive information shared between the parties remains private and is not disclosed to third parties without consent.
3. Payment terms
This clause details how and when payments should be made, including the payment schedule, method of payment, and consequences for late payments.
4. Term and termination
The term and termination clause outlines the duration of the agreement and the conditions under which it can be terminated by either party.
5. Liability and indemnification
This clause addresses the extent of each party’s liability in case of damages or losses and outlines the indemnification obligations.
6. Force majeure
The force majeure clause covers unforeseen events that could prevent either party from fulfilling their contractual obligations, such as natural disasters or political upheavals.
7. Dispute resolution
This clause outlines the methods for resolving disputes that may arise during the term of the agreement, such as mediation, arbitration, or litigation.
8. Governing law
The governing law clause specifies which jurisdiction’s laws will apply to the interpretation and enforcement of the agreement.
Create commercial contracts with SpotDraft
Organizations rely on commercial contracts for everything from simple deals to complex partnerships. These agreements share certain elements but are as diverse as the companies using them. They mitigate risk and build strong, mutually beneficial affinities. The above contracts each have a distinct purpose and objective.
Further, commercial contracts can offer new revenue opportunities, setting your company up for success and paving the way for growth. You can connect the people, processes, and data involved in commercial contracts to execute better agreements and advance your organization.
“The search result, contract repository, standardized template creation, and workflow are a few features that have brought down the efforts tremendously. SpotDraft has read our minds while setting up the platform for our use and hit the bull's eye. The introduction of SpotDraft as a CLM solution in our company helped us get our contracting ducks in a row. The easy-to-use functionalities added with superb customer support and implementation have made this transition a smooth process.”
SpotDraft helps create commercial agreement templates, eliminating mundane contracting work and giving businesses thousands of dollars back through efficient processes. It removes friction and makes commercial contracts accessible by offering a data-rich repository.
