Problems with poorly drafted contracts – Part 2

Overworked

Last week in Part 1 we discussed 6 of the most common issues the LegalVision network of lawyers deal with on a regular basis.

As mentioned, many business people don’t bother working with a lawyer when entering into important contracts, and end up agreeing to terms which eventually cause long terms issues, both from a client relationship and monetary perspective.

This article sets out another 5 issues that the lawyers in our network regularly have to deal with.

1. Non-compete clauses that are overly wide

Businesses of all sizes love drafting non-compete clauses into agreements. Non-compete clauses are not just used in employment contracts, but can also be placed in distribution agreements, joint venture agreements, and many other types of agreements. Unfortunately we do see many non-compete clauses which are overly wide. The courts can and will rule that a non-compete is unenforceable if it’s overly wide and restrictive.

You cannot generally restrict a counter party in a way which is unreasonable. Examples of an unreasonable non-compete clause would be restricting an ex-employee from ever working in Australia again. If you choose a time based non-compete then the time frame should be reasonable as well (anything over 12 months in a small business situation is likely to be deemed unreasonable).

2. Shareholding restrictions

Many consulting contracts drafted by larger companies include a clause prohibiting the consultant from directly or indirectly owning shares in a competitor to the principal. These clauses are particularly prevalent in US law contracts that businesses have used as a template. Make sure you don’t agree to such a clause. If you invest in managed funds (even through superannuation), there is no way you’ll be able to represent or warrant that you’re not indirectly invested in a competitor.

3. Poorly drafted confidentiality clause

We regularly review confidentiality clauses which require one party to potentially breach confidentiality arrangements with other parties. A good example is a clause which allows the principal in a consultancy agreement to review and audit any of the consultant’s business documentation, whether it relates to the business between the two parties or not. Clearly this leaves open the possibility that the consultant will breach confidentiality obligations with other clients. Make sure you don’t agree to this type of clause.

4. Incorrect jurisdiction clause

It’s amazing how many times we see contracts between two Australian parties with US law jurisdiction clauses. It’s important that the jurisdiction clause relates to the state in which one or two of the parties are based. Having a US state jurisdiction clause in your contract just screams “I found this template for free online!”.

5. Indemnification clause not including negligence and willful misconduct

Its standard practice for one party to indemnify the other in certain circumstances, but it’s crucial that you don’t indemnify the other party for losses caused by their negligence and wilful misconduct. We see this mistake quite regularly. You do not want to be in a position where you have to indemnify your counterparty for losses he himself has caused!

Key learnings

Legal contracts are complicated documents. If you’re going to bother with a legal contract, then you should ensure that it’s drafted properly. Working with an experienced contract lawyer is a must. Avoiding some of the pitfalls set out in this article can make a significant difference to your business in both the long and short term.

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