Defined Terms
It goes without saying, I love contracts. As a business owner, I want to help you love them too. Because they are a critical element of your business’ operation. Contracts are the written expression of your relationship with someone else. They control each parties’ rights, obligations, and expectations.
Every contract you sign contains language that can significantly impact these. Among the most critical yet often overlooked elements are defined terms—specific words or phrases that carry precise legal meanings within your agreement. Just like the perceived “boilerplate”, even sophisticated business owners can make the fatal mistake of skipping over these “to get the good stuff”: the thing you get, the thing you give, the money. But understanding how defined terms work, where they appear, and how they can be manipulated is essential for protecting your business interests.
Let’s explore!
What Are Defined Terms?
Defined terms are words or phrases that have been given specific meanings within a contract. Importantly, defined terms may differ from their ordinary dictionary definitions or common usage. They may really differ. This is why you must pay attention to the defined terms of the agreement you are signing. Even if you’re a savvy contract pro that’s entered into 50 license agreements, MSA’s, etc. there’s no guarantee that the 51st treats a specific word or phrase the same as the others. Defined terms can subtly shift the meaning of both common words and those that would appear to be legal terms of art.
Defined terms appear throughout the contract and are typically capitalized to signal their special status. When you see a capitalized term like “Services,” “Territory,” or “Confidential Information,” you’re looking at a defined term that has a precise meaning established elsewhere in the contract.
The fundamental principle is simple: whenever that defined term appears in the contract, it means exactly what the definition says—nothing more, nothing less. This precision eliminates ambiguity and ensures all parties understand exactly what they’re agreeing to, at least in theory.
The Purpose of Defined Terms
Defined terms serve several critical functions in business contracts. First and foremost, they provide clarity and consistency. Instead of repeatedly writing out lengthy descriptions, contracts can establish a definition once and then use the shortened term throughout. For example, rather than writing “the software application known as CustomerManager Pro version 3.2 including all updates and modifications” dozens of times, the contract might define “Software” to mean exactly that, then simply use “Software” throughout the agreement. Defined terms help provide the brevity and simplicity all business owners crave.
Defined terms also prevent misunderstandings by establishing precise boundaries. When a contract defines “Business Hours” as “9:00 AM to 5:00 PM, Monday through Friday, excluding federal holidays,” there’s no room for interpretation about whether Saturday morning counts as business hours.
Additionally, these terms create legal certainty. Courts interpreting contracts must use the definitions provided within the agreement, even if those definitions differ from common understanding. This gives parties control over the meaning of critical terms in their relationship.
Placement: Dedicated Definitions Section vs. In-Context Definitions
Defined terms appear in contracts in two primary ways, each with distinct implications for your business.
Dedicated Definitions Sections typically appear at the beginning or end of a contract under headings like “Definitions,” “Terms,” or “Interpretation.” This approach offers several advantages. All definitions are centralized and easy to locate, making contract review more efficient. The alphabetical organization common in these sections helps you quickly find specific terms. Most importantly, having definitions upfront forces you to understand key terms before diving into the substantive provisions.
However, this approach can also create distance between the definition and its application, potentially making it harder to see how a particular definition affects specific contract terms.
You’ll typically see this approach used in longer contracts like asset purchase agreements, equity purchase agreements, operating agreements, terms of service, shopping center lease, and so on.
In-Context Definitions are woven throughout the contract, typically introduced with phrases like “hereinafter referred to as” or enclosed in parentheses. For example: “Company shall provide customer relationship management services (the ‘Services’) according to the specifications outlined in Exhibit A.”
In-context definitions offer immediacy—you see the definition right where it matters. They can also provide better context for understanding why a term is defined in a particular way. However, they’re harder to track across a long contract, and you might miss important definitions buried in dense paragraphs.
You’ll typically see this approach in a shorter contract like a confidentiality agreement, certain service agreements, employment agreement, or contractor agreement.
How Defined Terms Can Manipulate Deals
As I mentioned, defined terms can change the meaning of words from their ordinary understanding. Beyond that, sophisticated parties often use defined terms to subtly shift the balance of a contract in their favor. Understanding these tactics helps you identify potential problems before they become costly disputes.
Scope Manipulation occurs when definitions are crafted to be broader or narrower than they initially appear. A software license might define “Permitted Use” in a way that seems reasonable at first glance but actually severely restricts how you can use the software. Similarly, a consulting agreement might define “Deliverables” so narrowly that the consultant can charge extra for work you assumed was included.
Hidden Obligations can be embedded within definitions. A term like “Maintenance” might be defined to include not just fixing problems but also providing training, updates, and 24/7 support—services you might expect to be negotiated for separately.
Asymmetrical Definitions create different standards for different parties. A contract might define “Material Breach” differently when applied to you versus the other party, making it easier for them to claim you’ve breached while making it harder for you to make the same claim against them.
Time Manipulation often appears in definitions of periods like “Business Days” or “Prompt Notice.” These might be defined in ways that favor one party—perhaps “Business Days” excludes not just weekends and federal holidays but also the other party’s industry-specific holidays, effectively giving them more time to perform their obligations.
Recognizing Defined Terms
Identifying defined terms requires more than just spotting capitalized words. Start by looking for obvious signals: terms that appear in quotation marks when first introduced, words that seem unnecessarily capitalized, or phrases preceded by “means” or “refers to.”
Pay special attention to terms that seem like ordinary words but carry special significance in your industry or in the specific contract context. Words like “delivery,” “acceptance,” “force majeure,” or “intellectual property” often have precise legal meanings that differ from everyday usage.
Be particularly wary of defined terms that reference other documents. A definition that includes “as set forth in Exhibit C” means you must review Exhibit C to fully understand your obligations. Don’t assume these external references are mere formalities.
Red Flags and Protection Strategies
Several warning signs should prompt extra scrutiny of defined terms. Circular definitions that reference other defined terms can create confusion and potential loopholes. Definitions that seem overly complex or include extensive lists of exclusions may be designed to limit your rights or expand your obligations.
Vague language within definitions defeats their purpose. Terms like “reasonable,” “material,” or “substantial” within definitions may be questioned and replaced with objective criteria. Though there can be strategic reasons for leaving these alone.
To protect yourself, always read the definitions section first, regardless of where it appears in the contract. Refer back to that section as much as needed as you review the contract, noting how each defined term affects your rights and obligations. When negotiating, don’t hesitate to propose changes to definitions that seem unfair or unclear.
Consider the practical implications of each definition. How will this definition affect day-to-day operations? What happens if circumstances change? Could this definition be interpreted in a way that disadvantages your business?
Best Practices for Business Owners
Approach defined terms strategically during contract negotiations. If a definition seems one-sided, propose revisions that create more balance. If a term is vague, suggest specific criteria or measurements. Remember that definitions are just as negotiable as any other contract provision.
Most importantly, don’t rush through the definitions section because it seems boring or technical. These terms form the foundation of your entire agreement. A few minutes spent understanding definitions can save you thousands of dollars and significant headaches later.
Conclusion
Defined terms are the building blocks of contract language, providing precision and clarity while also creating opportunities for manipulation. By understanding how these terms work, where they appear, and how they can be used to shift deal terms, you position yourself to negotiate better agreements and avoid costly surprises.
Take the time to read, understand, and negotiate these terms carefully. At Way Law, we’ll show you how! Call us today.