You’re sitting in your office on a beautiful day when suddenly your email chimes. You click and there it is, an email from your attorney. AND IT HAS AN ATTACHMENT! Time to find a fork as you work your way through what is sure to be a word salad, right?
Well not so much. If you know what you’re looking at and you have a great lawyer that cares about making sure you understand what’s happening and why then understanding complex contract language is easy. You’re already reading a Way Law blog, so have the second part taken care of. Let’s focus on the first; understanding what you’re looking at.
In part one of this series, we explored what a contract is doing and how its most basic parts function. With that background in hand now we can explore a contract’s anatomy. Just like the human body, a contract follows an organizational structure where its smaller parts combine to form bigger parts of varying functions. In our bodies, cells group to form to tissues, and tissues group to form organs. Organs perform distinct, critical functions within our bodies.
And just like the body, a contract involves grouping smaller parts to perform distinct, critical functions. Words and sentences form the cells. These sentences group together to create various terms, like tissues in the body. And the terms group together to form complex structures that perform the important functions of the contract, like organs. Today, we’re going to explore these groups of terms. Let’s get started!
Depending on how your contract is written, its terms may be grouped into sections or articles. They serve the same purpose, organizing contract terms with similar purposes, themes, or functions into groups. You tend to see articles in longer agreements, where an article will contain several sections, with each maybe containing its subsections.
We begin with the first section of a contract, the preamble.
Preamble
The Preamble is the opening paragraph of the contract. It identifies the contract, the parties to it, and the contract’s effective date. A preamble typically looks something like:
“This [Type of Agreement] (the “Agreement”) is made as of [This Date] (the “Effective Date”), by and between A Nice Lady, LLC, a Virginia limited liability company (the “[Short Descriptor of Party 1 Based on Party 1’s Name or Role]”), with principal offices located at [Address], and What a Gentlemen, Inc., a Virginia corporation (the “[Short Descriptor of Party 2 Based on Party 2’s Name or Role]”), with principal offices located at [Address].
Recitals
Recognizable by their common “Whereas” beginnings, Recitals provide the relevant backstory of the contract illuminating why the parties have chosen to enter this agreement. Because of the formality that some lawyers bring to their recitals, recitals can seem dry and unimportant boilerplate. They are not! Recitals provide important insights into why we are in this deal and all the things that led to the parties being here. They create all the background for the world of this contract. Pro Tip: Recitals are not an enforceable part of the contract. They just explain why we are here.
Words of Agreement
The Words of Agreement, usually one sentence, state that parties have agreed to the contract terms following the Words of Agreement. Words of Agreement traditionally begin “Now, therefore, in consideration of…” but are no less effective if they begin in a more modern fashion. The Words of Agreement are the real beginning of the enforceable contract. What precedes them is introduction and what follows is promise or performance.
Defined Terms
Defined Terms provide the meanings of certain words and phrases as the parties intend them to be understood in the contract. Defined Terms may increase or narrow the scope of a word’s or phrase’s ordinary definition. They can also be an entirely new descriptor of something of concern to the parties.
Defined Terms allow a complex description to be reduced to a short word or phrase. This makes the contract more readable as it eliminates the need for a lengthy description every time that concept makes an appearance. When a contract features many defined terms, it’s helpful to group and describe all defined terms in one section of the contract typically at the beginning or end of the contract. When a contract features few defined terms, it may be easier to define them in the body of the contract at their first appearance.
The Business Terms
The Business Terms is not a legal term of art. It’s Way Law parlance. You might see this in an agreement in an article or group of sections labeled “Engagement” in a service agreement, “Purchase and Sale” or “Sale of Assets” in a purchase agreement, or “Grant” in a lease. You may think of this simply as the “Deal Terms”.
Whatever one calls it, THIS section is why there can be such a huge disconnect between you and your lawyer on the appropriate length of an agreement. When a businessperson thinks of a contract these terms are usually what you’re thinking of, and they receive the bulk of the attention. Understandably so.
The Business terms focus on the primary subject matter and purpose of the contract, the reason that you wanted to enter a contract in the first place. This section describes who pays what to whom in exchange for what (referred to as the “consideration”), when, for how long (the contract’s term, again), and, of course, agreement to the contract’s main subject matter and purpose. A fee for services, salary, purchase price, the good or service to be bought or sold, closing date, and closing deliveries will be discussed here in various sections.
The Business Terms may involve the exchange of promises of performance in the future or they may have immediately effective provisions indicating the exchange of performance at contract execution rather than in the future.
The Legal Terms
The Legal Terms of the contract create the lengthiest piece of an agreement. The Legal Terms capture all the side promises that are needed to make sure each side is getting what they expect in the Business Terms. We often don’t think of all of these when we think of the Business Terms, because sometimes they can seem like common sense. But each party to a contract brings their common sense, preconceived notions, and expectations. What might seem perfectly ordinary to you could be the exact opposite of what the other side has in mind.
We use the Legal Terms to align the things that typically remain unsaid between business owners. The Legal Terms support and provide structure to the rights and responsibilities related to and created by the exchange of promises in the Business Terms. Legal Terms generally fall into four camps: 1) Representations & Warranties, 2) Covenants, 3) Termination Provisions, and 4) Miscellaneous or Boilerplate Provisions.
Representations & Warranties
Representations are statements about the contract’s subject matter, presented as fact, offered for the opposing party to rely on in deciding to enter the contract. Representations induce the other side to agree to the contract. Representations speak only as of the time they are made, which limits their usefulness for reliance.
Enter Warranties. Warranties are promises that a Representation will remain true for a particular period of time. Together these provisions shift the risk of loss from the receiver of information to the provider of information.
For example, in a contract to buy property, the buyer would want the seller to represent that it owns the property and has the right to sell it. The seller would do so in a Representation. But that Representation only says the seller owns the property and has the right to sell it at the moment the seller makes that statement. To ensure that the seller has ownership and the right to sell at the time of actual transfer, the buyer would have the seller Warrant that this fact will remain true. Despite being discussed separately, Representations & Warranties always appear together. Our hypothetical contract would read “Seller represents & warrants…” rather than “Seller represents…” followed by “Seller warrants…”
Pro Tip: Representations and warranties are often overlooked by business owners as boilerplate, but if you use them right, they can protect you from a lot of risk by securing promises that things are the way you hope they are or want them to be.
Covenants
Covenants are promises related to the agreement’s main subject matter. They capture expectations about how each side will deal that is outside of the narrower focus of the Business Terms. Covenants could capture things that are common sense to you and would be upsetting if the other side did to you. They could also capture things you need from the other side for you to be successful in using or performing the main subject matter of the contract.
For example, in a contract to provide B2B services, there may be a covenant not to solicit the other party’s clients or employees. Seems like common sense, but wouldn’t that be infuriating if you contracted to provide marketing services to a firm and they poached all your best staff to go in-house with them? In an acquisition or merger, there may be a secondary promise not to disclose the deal before closing or to disclose any facts learned about the other party through the negotiations.
Covenants may include any auxiliary promise that the parties believe will enhance the value of the primary promises. Covenants could concern indemnity, warranties (related to the quality of the contract subject matter) or disclaimers, non-disclosure, non-solicitation, non-competition, and more.
Termination Provisions
Just as all good things must come to an end, so must the contractual relationship. Termination Provisions provide rules for establishing that end. This section allows the parties to decide what natural events, such as complete performance, or unnatural ones, such as breach or the bankruptcy, will get them out this contract. A Termination Provision should address what actions breach the contract. The parties may also agree to provisions that survive the contract’s term and end at some point after the rest of contract has concluded.
Boilerplate/Miscellaneous
Many people refer to any set of seemingly standardized provisions, which they then don’t bother to read, as the Boilerplate. Some might refer to the entire set of Legal Elements as the Boilerplate, again not reading on. Some may even have thought of the entire contract as a “boilerplate”. This is a mistake. Though this horse is likely dead, I will continue to beat it. I’m ruthless. Every contract represents different goals, concerns, and risks, and so its parts will be different. You must understand your contract, know what you’re agreeing to, and make sure it reflects your goals. No matter how broadly you define “Boilerplate” you ABSOLUTELY should read it.
Boilerplate or Miscellaneous terms (also described as the “General” section in some agreements) is a collection of terms that don’t fit into any of the other groups. For example, the Covenants might include an article or section on Restrictive Covenants, grouping non-solicitation and non-competition terms there. The Miscellaneous terms won’t have a central theme. But just because the clauses may not neatly fit elsewhere, doesn’t mean they aren’t just as important as the rest of the contract.
Common Boilerplate provisions are choice of law (which state’s law governs the contract), venue (the specific court in which a lawsuit may be brought), terms directing how to read and interpret the agreement (a very important thing to not overlook), and entire agreement terms (stating that the contract reflects every element of the agreement between the parties and no other writing or discussion should be considered).
Signatures
The parties’ signatures conclude the contract and indicate agreement to it. If you are signing on behalf of someone or something else, for example as the trustee of a trust or officer of a corporation, be sure that the signature section indicates that you are not signing in your capacity.
Now You Know Contracts!
So, there you have it, your very own roadmap to understanding how the parts of a contract fit together and what your lawyer is doing. This is how the attorney-client relationship should work. You share your goals and business strategy; your lawyer creates a tool to achieve them. In this case, it’s the contract.
At Way Law, we help businesses succeed and grow without boring, indecipherable, and expensive jargon. When you’re ready to use legal as a tool for your success, give us a call!