Bad Contracts: Red Flags to Watch For

Contracts are everywhere in business. From online click-through agreements to the service contracts you use with your clients and customers, contracts are simply part of doing business in the modern world. And in this day and age where information is quite literally at our fingertips and just a Google search away, it’s all too easy to throw an agreement together or borrow a sample from an internet website.

But contracts are like the rules to a game. A game of Uno will almost certainly end in a fight if half the players aren’t aware of the unwritten “house rules,” if sections of the rule book are missing, or if the rules say one thing but the drafter meant something completely different. The rules need to be clear and unambiguous from the start, and they need to address as many “what-ifs” as possible.

Here are 5 red flags to watch for before signing any business contract.

1. Misunderstandings

Do you truly understand everything in the contract? Don’t just rely on what the other side says about the contract. If something doesn’t work out, the courts do not care about what you “thought” you were signing or what the document “should have” said. The only thing that really matters is what’s actually in the document.

Are there any words, phrases, or sentences that you aren’t sure about? Is there anything in the contract that doesn’t match your discussions or negotiations with the other side? Is there some “boilerplate” language that doesn’t really apply? For example, in reviewing commercial leases, clients often tell us about various maintenance tasks the landlord has supposedly agreed to and the types of repairs that the landlord will be responsible for making. Inevitably, these promises haven’t made it into the actual lease agreement. The time to fix these issues is before signing the lease, not after getting an expensive repair bill.

These situations can easily be innocent mistakes. Perhaps someone simply forgot to update the standard terms. But once the contract is signed, it’s too late to go back to “what we really meant” or “what they really promised.”

2. Not Planning for Possible Disputes

Business disputes happen. It’s much better to plan for possible disputes while everyone likes and trusts each other than to wait for someone to start threatening litigation. Instead of leaving the “what ifs” to chance, ask yourself: What all could possibly go wrong? What should we do about it if that happens? Both sides will be much more reasonable when answering these questions before the contract is signed than they will once something has actually gone awry. For example, if it’s important that the services are provided by a deadline, then what is going to happen if that deadline is missed or pushed back? What if your business paid for the services beforehand? What if the services aren’t up to par?

Because litigation is incredibly expensive and time consuming, it also pays to consider ways to keep costs down. For example, we’ll often add a cooling off period to an agreement: Before running to the courthouse, the parties can agree to spend 30 days negotiating a resolution in good faith. Or they can bring in a neutral mediator to try to resolve the dispute short of litigation. And if it really does come down to litigation, where will the case be filed? Many internet form agreements call for the use of New York or California courts. Do you really want the travel expense, not to mention time away from your business and having to find an attorney in another state, just to get your dispute resolved?

There is also a common misconception that in the event of a dispute, you’ll be able to recover your legal fees if the other side loses the case. This is almost never true unless the contract specifically says that the loser will pay the winner’s legal fees.

3. Extremely One-Sided Terms

We see way too many small businesses that are willing to sign whatever contract is put in front of them for the chance to work with a “big” client. But if it feels like you’re selling your company’s soul for the opportunity, you may need to take a step back. Is the contract clear about what the “big” client considers confidential and how their intellectual property needs to be protected while remaining silent about your concerns? Are you required to indemnify the other side for any of your company’s mistakes while the contract is silent about what happens if they make a costly mistake? Are you putting your ownership and management of the business at risk if you cannot pay back a loan or satisfy an investor?

Does the contract give the other side every excuse for potentially not paying you? Be careful with contracts that allow the other side to reject your work in their “sole and absolute discretion.” We’ve even seen contracts where the other side can reject your work, not pay you for the effort, and still claim ownership over the work product. 

4. Naming the Wrong Parties

Who is actually agreeing to do something, sell something, provide some service, etc.? This might seem like a no-brainer, but we see small businesses get this wrong all the time. You are not your business. If you are entering into a business contract, the party to the contract should be the business, not you. There’s almost never a good reason to name yourself, individually, as a party to the agreement. If your customer or client is unhappy with your services and you’ve named yourself as a party to the contract, then that disgruntled customer or client now has every reason to sue you personally and come after your personal assets.

Do the named parties actually own whatever it is that they are selling? This is usually fairly straight-forward when the business contract relates to the sale of a physical product. But when the contract involves something less tangible, it’s important to double-check ownership. For example, when reviewing licensing agreements, it’s not unusual to find that the trademarks or copyrights in question were never transferred from the individual founder to the company itself, meaning the company doesn’t have the right to license the intellectual property.

Does the party named have the right to do whatever it is that they are agreeing to do? For example, when hiring a new key employee, do they have the right to come and work for you, or are they still subject to a non-compete agreement with their last employer? When looking to bring on investors for your business, do they need to be “qualified” investors under securities laws? What if one of the company’s founders is selling their interest in the company? What does the company’s operating agreement say about the founder’s interest in the company and their right to sell that interest?

5. Ambiguity

Finally, if you hand your business contract to a neutral third party, will they understand who is supposed to do what, by when, and for how much money without any other background information or explanation? If the document can’t stand on its own when reviewed by a business colleague, it almost certainly won’t make any sense to a judge later if something goes wrong.

If it’s time to go back to the drawing board and get your contracts professionally drafted to avoid red flags like these, then schedule your consultation today.

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