Why Do We Need Contracts – and What to Include?

Why Do We Need Contracts and What to Include?

When you buy a paper, you enter into a contract with the newsagent as you hand over the cash.   Every business transaction involves a contract, and generally speaking, unless the transaction is an over the counter sale, it is much safer to put the terms in writing.  As Nobel prize winner, Oliver Hart says in the quote on our homepage: “From shopping in a store to running a corporation, contracts and agreements matter everywhere.”

Whilst it is tempting to agree terms of a transaction on the basis of a handshake or an email, a canny buyer or supplier should always ensure that they have entered into  comprehensive terms which cover the key aspects of the deal.  Contracts are the glue that seal the relationship between a business and its customers or clients and provide certainty.

How to create a contract

A contract consists of an offer by one party to do something in return for a valuable benefit (known as consideration) and acceptance of that offer by the other.

If you are acting as a supplier, you may wish to use your own form of agreement which will  stipulate delivery, pricing and payment terms.  Where you are a buyer, then you will either want to use your own terms, if you have them, or else review and possibly amend the terms provided by the supplier.

If the supplier offers their terms and the customer says yes, they want to buy, but on their own terms, there is no offer and acceptance, but an offer and a counter-offer.  This is known as ‘the battle of the forms ’   To cut a long story short, it is usually the last set of terms to be accepted, or acted on, that apply to the contract.

So, negotiation is likely to be involved, but the important thing is to have a set of clear, unambiguous terms that regulate the deal.

Identify the right parties

Make sure you have the right parties named in the agreement.  It is important to include the correct legal names  so that it is clear who is responsible for performing obligations under the agreement.  You also need this to ensure you have legal rights against the other party if things go wrong.  For instance, if a business is organised as a limited company, identify it by its correct legal name and registered office address:  Jenny Jones Ltd., company no. 99999111, whose registered office is at 1 Horseradish Crescent, Bath.  If, however, you are dealing with a one woman business who has not set up a limited company, include her as a party – e.g.: Jenny Jones, trading as Jenny’s Jockey Shorts  of 1 Horseradish Crescent, Bath.  

This is especially important if another party (for example a parent company) is guaranteeing the obligations of the performing entity. It is also sensible to insert the company registration number as well as the registered address of each of the parties.

And if you are doing building work for a married couple who own a house, they should both be named as parties in the contract.

You can get more information on how to set out these details and on signing contracts at this link .

What terms are key?

A contract is a legally binding promise by one party to fulfil an obligation to another party in return for consideration (i.e. a valuable benefit).  Legally, there are four key elements: offer, acceptance, consideration and intent to create legal relations. 

From a practical point of view, the main terms to consider, whether you are acting as a supplier or buyer, include the specification/description of the goods or services; price; payment terms;  and delivery.  Here is a list. which we deal with in more detail later.

• Description of goods or services – Be careful to specify precisely what is being sold/supplied so as to avoid any risk of ambiguity and later argument.
• Price – Check whether the price includes the cost of packing, shipping, insurance, and any relevant taxes.
• Payment – When is payment made? Will this be at delivery or within a certain time from receipt of the invoice? Or will there be a number of payments at specified periods?
• Delivery– Are the goods being delivered to a specific location or will they be collected? Who will bear the risk of the safety and quality of the goods prior to delivery? What is the position if the supplier delays in the delivering of the goods?  What if the buyer fails to collect them when he is meant to?
• Services If you are providing services instead of goods, you will need to consider when and where those services will be provided and whether there are any standards that need to be adhered to.
• Recourse for faulty goods – The agreement should stipulate the process and timing by which a buyer can return defective goods and what the supplier must do in relation to such defective goods.
• Force Majeure clause – Certain circumstances may arise which mean the supplier cannot provide the relevant goods/services – e.g. a factory fire or some natural disaster. Say what happens in that situation – usually the supplier’s duties will be suspended while the force majeure  situation continues.
• Retention of Title clause – This aims to afford the supplier the ability to recover goods that have not been paid for, and/or to give precedence over other creditors should the worst happen.
• Limit of liability – The supplier may want to limit liability to a fixed amount – perhaps the value of the goods. Here you have to be careful, especially when dealing with consumers, because there is legislation that protects consumers.  If unfair terms are included, the court will treat them as unenforceable.
• Termination – you will need the right to give notice to terminate the contract in certain circumstances. These usually include: insolvency, breach of the terms and, specifically, failure by the customer to pay.

Key contractual terms

Description of goods or services

 In many ways this is the most important provision in a contract – what are the goods or services being supplied?  In the case of goods, this is relatively straightforward, especially if the customer has seen examples of what is being bought.

If, however, the goods are being manufactured specially, then an accurate description of what is being supplied is going to be needed.  If the goods are to be installed in the customer’s property, then you will need to deal with this: e.g. access to the property and any facilities needed from the customer.

Remember too, that there are legal requirements that goods being sold will be of satisfactory quality as well as fit for purpose (assuming the customer made this known to the supplier).

In the case of contracts when services are being provided, a detailed schedule may be needed, describing not just the services but also their timing and frequency.  And when services include design, the service provider should consider limiting the number of changes to the design that the client can request  before an extra fee is needed.

Price & Payment

Agreeing how much you will charge for the goods and/or services you are selling is only part of the financial negotiation.  Just as important, in particular when the supplier is going to be buying in material or is providing services over a period of time, are the payment terms. By trying as far as is practicable to match payment to cash flow, you have a better chance of not  getting into debt – always assuming your customer pays what is due.

An example:

John Turner is a furniture maker and has a customer who wants him to supply ten chairs to a particular design.  The price is agreed at £10,000 and John’s material costs are £3000.  His own time and that of his assistants covers the rest of the cost plus profit. The work is expected to take 2 months.

The customer may want to pay on delivery but this is the riskiest course of all.  If they do not like the goods when they see them, they might refuse to pay or try to renegotiate the price.  Or they might not have the money.  Even with a binding contract, John risks being out of pocket at the end of the day.  He may be able to retain title, but he will then need to find another buyer.

Much better to have some stage payments. For example: £5000 when the contract is signed, £2500 after one month and the remaining £2500 on completion.

If necessary, John can explain to the customer that materials have to be paid for in advance, before work can start, and that his staff also need to have their salaries paid.

If this arrangement or something like it can be agreed, the risks for John are greatly reduced.  He will have more than enough cash up front to pay for the materials as well as his labour costs over the first month.  And provided the second payment is made on time, even if the customer does not pay the last instalment, John’s costs will have been covered.  Also, so long as he retains ownership pending the final payment, the customer is incentivised to find the last instalment, as they will have already paid three quarters of the price.

When providing services or a combination of goods and services, regular payments are always recommended – for much the same reasons that apply in the example above.

Whether you are a tradesman doing work on a house or a website designer, you are exposing yourself to unnecessary risk if you leave the payment until late in the project.

Even if there is no risk of a client not being able to find the money, they may not really know what they want when they sign the contract and that can lead to difficulties when it comes to payment.  By getting an advance when this is justified and by setting up a payment schedule with monthly or other periodic payments, there is more buy-in from the client and the risk reduces as each payment is made.

When establishing a payment schedule, an alternative to time-based (monthly etc.) payments is a series of “milestone payments” – i.e. payments linked to particular events as the project progresses.  For example, if you are a website developer appointed to develop a new website, your costs could include: domain name registration; hosting fee for first year; programmer’s fees, designer’s fees.  The milestone schedule might be:

The payment schedule gives the developer funds up front to cover the domain and hosting costs and, at least n part, the costs of the programmer and designer.  If you think it appropriate, you may want to insert a final date by which each stage is completed and payment becomes due.  The 10% retention on completion of the work gives the client some comfort and if all goes well, the developer may be able to negotiate a maintenance contract for the first year on a monthly or quarterly fee – payable in advance on pre-agreed dates.

Consultant Services.

When providing services as a consultant, fees will usually be charged either by reference to a particular task or by reference to the time spent in a given period, or a combination of the two.  Solicitors, along with a number of other professions, have, historically, charged by reference to the time spent on a particular matter, but when it is long running, then interim bills will be submitted.  Nowadays most firms, conscious of cash flow constraints and the risks inherent in building up large credit with clients, tend to invoice almost all their work on a regular, usually monthly basis.

When a consultant is providing services to the same client over a long period of time, a fixed monthly retainer can have advantages and usually this is payable monthly in advance.  If the payment can be set up on a direct debit basis, so much the better.  With a retainer your agreement needs to make it clear what the parameters are: for example a monthly retainer of £500 to cover up to 10 hours of routine services a month.  Time spent above this limit to be charged at £75 per hour, so the client gets a better rate under the retainer and the consultant has an assured income stream – a win-win situation.

IT support and other maintenance services usually have this type of arrangement. Here the contract will normally contain a schedule setting out the monthly retainer and the work that it covers.  In addition there may be a ‘menu’ of other charges- e.g. £250 per day for onsite support, with a higher rate during holidays or outside normal working hours.

Expenses  Unless a supplier includes all expenses in the fees, it is sensible to identify what expenses are going to be charged and whether this will be on a cost-reimbursable basis. Sometimes an administrative fee is added to cost – say 10 per cent. Some charges are fixed in the agreement – e.g. mileage when travelling by car on client business at 45p a mile.

From the client’s perspective, the charges need to be reasonable and justified, with major items of expenditure agreed in advance – e.g. air fares or hotel accommodation.  One area of contention can be time spent travelling on client business: is this chargeable at the usual rate, at a lower rate or not at all?

These items can all add up and different professions have different approaches.  Not many can get away with the way one Arab lawyer used to bill his oil company clients when he went overseas on client business: he charged for every hour he was out of the country and when asked by a friend, “what happens if you do business for more than two clients on one of your visits?”, he replied – “I charge both of them!”  He no doubt retired a wealthy man!

Payment Dates.  While  the agreement will often specify dates for payment, usually the supplier will still need to issue an invoice in order to get paid.  So, as well as milestone payments etc. your contract needs a clause that says payment will be due within, say, 14 days from the date of the invoice.  For some people 14 days is too short, and 28 or 30 days is more usual.  But make sure you specify a period.

Delivery

Is the delivery date guaranteed?  If not, you need to make this clear in the contract.  For example:

All delivery dates given by the Seller are given in good faith but dates are estimates only and not guaranteed.  The Seller will notify the Purchaser when the Products are ready for delivery at the Seller’s property.

 As a customer, you are likely to want a firm delivery date, and might want a clause on the following lines:

Goods must be delivered by the date specified in the Purchase Order or, if no date is specified, within 28 days of the date of the Purchase Order. 

 Packing & Transportation . Example: Julie Bond manufactures and supplies boxes to certain clients for use in their business and her standard terms of business include the following:

The price of Goods includes the cost of packing.  The Customer is responsible for collection of Goods at the Supplier’s premises.  If the Goods are not collected within 10 days of the notified delivery date, the Supplier reserves the right to charge for storage.  

Alternatively, if the price includes transportation, the following clause is more suitable:

 The price includes packing and delivery to the address in the UK  shown in the Customer’s order. 

Recourse for faulty goods

What can the customer do if the goods are defective or faulty?  Does the supplier have to accept any goods that are returned?

The contract should include wording that says what the position is if a customer returns faulty or defective goods. The supplier may have terms that require the customer to notify the supplier as soon as a defect is found, and give the supplier the right to decide whether to repair or replace goods or, instead, give a refund.  Also, the supplier’s terms should make it clear that fair wear & tear or damage caused by the customer or through failure to comply with operating instructions, is at the customer’s risk.

If the customer is not a business and is a “consumer” (i.e. a private individual), then the consumer will have additional rights of recourse for defective goods.  Briefly:

• Within 30 days from delivery (or installation if this is included), reject the substandard goods and claim a full refund
• After that the 30 days the consumer can require the repair or replacement of defective goods
• If the trader does not replace or repair defective goods at all or does so but the goods are still defective, the consumer can require either a price reduction or a final right to reject the non-conforming goods and get a refund.

For more details see our   Consumer Rights Act  blog post on goods

Force Majeure

A supplier’s life is not always smooth and they should protect themselves where certain events occur which are outside their control and prevent them from performing the contract.  This is known as ‘force majeure.’

A force majeure clause in a contract allows a supplier to delay performance of its obligations without incurring any liability and,  if the event continues for longer than a stipulated period, then it allows the supplier or customer to terminate the agreement.

Example:

The Supplier will not have any liability to the Customer if it is prevented from performing the Agreement on account of any circumstances beyond its reasonable control (a “force majeure event”).  The Supplier will immediately notify the Customer of a force majeure event and take such steps as are reasonably practicable to overcome the same.  During a period of force majeure, the obligations of the Supplier shall be suspended to the extent that they cannot be performed.  If a force majeure event continues for more than 90 days, either party may give notice to the other to terminate the Agreement.

 Retention of Title

When you are providing goods to a customer, we recommend that you include a retention of title clause. This says that ownership in the goods being supplied will only pass from the supplier when the customer has paid in full for those goods.  This does not necessarily mean that risk will pass at the same time as title.  Indeed, it is sensible to make it clear that risk of loss or damage passes to the customer on delivery, but ownership remains with the supplier until payment has been made in full.

For a retention of title clause to be effective, it must be properly incorporated into the contract with the customer, and the goods supplied must be readily identifiable and be capable of being recovered and sold on. It should also give the supplier the right to enter the customer’s property and recover the goods if payment is not made.

If you receive notice that a customer is in financial difficulty, you should notify that customer – or insolvency practitioner if one has been appointed – of your retention of title claim immediately.

As a supplier, it is important that you act quickly and seek assurances that your goods are being preserved. Ensure that you have all of your contractual documentation so that you can establish your claim.

A retention of title clause is not always easy to enforce.  For example, a supplier may find that goods have been sold on or been mixed in a manufacturing process, so recovering the goods may be difficult or impossible. But it is better to include a retention of title clause than to omit it.

Limit of Liability

A supplier will want to ensure that their liability is limited to a certain threshold amount and this will often be the amount paid under the contract.  The supplier will also want to ensure that it is not liable for certain losses such as loss of profits or indirect losses that a customer may incur. Where the customer is not a business but a “consumer”, then a supplier cannot exclude certain of its liability.

When you are providing services, if something goes badly wrong and the client is not happy with the result, there is always a risk the client will bring a claim against you.  So try to ensure that in your contract there is a limit on the amount the client can claim.   For example, if you are paid £100 to run a dance class and you do not turn up, your client might have to refund £200 to the disappointed punters who were waiting for you in vain.  If your contract says that your liability is limited to the fees payable by the client to you, then you will have to make a full refund but you will not have to pay anything more than that.

Example:

The liability of the Supplier to the Customer shall be limited as set out in this clause and shall not exceed an amount equal to the total Contract Price. Under no circumstances shall the Supplier have any liability to the Customer for any loss of income, loss of business or any other economic, indirect or consequential loss or damage (whether in contract or in tort) except as expressly stated in this Agreement.  However this will not relieve the Supplier from its legal liability for death or personal injury which is due to the negligence of the Supplier.

 Termination

If your contract does not have a termination clause, then you will not have any contractual right to bring it to an end.  Instead, if the other party has seriously failed to perform their obligations or has not paid any of the money that is due, then it may be argued that they have, by their action, repudiated the contract but it is much easier to have some clear terms.  A termination clause will usually provide for notice to be given before the contract is terminated and this period can allow for the problem to be remedied within the notice period.  A typical clause might read:

Example:

Either party may terminate this Agreement by written notice to the other if that other party:

(a)        commits a breach of this Agreement and, in the case of a breach capable of remedy, it fails to remedy the beach within 14 days of being required to do so in writing; or

(b)       becomes insolvent, or has a liquidator, receiver, manager or administrative receiver appointed.

Sometimes the termination clause will only give one of the parties the right to terminate.

Example:

If the Customer:

(a)        commits a breach of contract, or

(b)        fails to make a payment on the due date; or

(c)        becomes insolvent or has a receiver appointed

then, in any such case the Seller shall be entitled either to suspend the supply of Goods or, at its option, to cancel the Contract and repossess any Goods for which payment has not been received in full.  The Seller shall also have this right if it reasonably considers that any of the events mentioned (a), (b) or (c) above are likely to occur.

In a contract for supply of goods or services over a long period, either party might want the right to terminate early – for example a company providing IT support services might, in theory, like to have at least a 12 month contract. But if it gets offered better terms by other clients and is finding it difficult to service all of them, or it finds that the fee quoted is not generating the hoped for profit, then it might want to be able to give a month’s notice to bring the contract to an end.

Similarly the client may not want to be locked in for too long and wants a get-out clause if it does not feel it is getting good value or if it simply wants to reduce costs.

Example:

The initial period of the contract is intended to be 12 months from the commencement date.  However, either party may, after the first six months, give not less than one month’s notice to the other to terminate the contract, such notice to expire on the last day of a month.

Consumer Rights

For more information on how contract terms have to take account of the Consumer Rights Act 2015 see our previous blog posts which deal with:

• Goods 
• Services
• Digital Products
• Unfair contract terms

Checklist

What do you need to think about if you are a supplier or a customer?