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Avoiding a Claims Tsunami | Debunking Commercial Contract Myths

Callum Sinclair

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Commercial contract

With disruptions from the coronavirus and Brexit risking a tidal wave of claims, having expert legal backing when dealing with a commercial contract is more important than ever. Callum Sinclair, Head of Technology & Commercial at Burness Paull tells us more.

Choppy Waters

I was connected recently to the brilliant FOCI project, whose mission is to repatriate the Falls of Clyde, the world’s only remaining sail-driven oil tanker. She is the only survivor of her sister ships built at Port Glasgow in the late nineteenth century and is currently moored at Honolulu, where she sits neglected and at risk.

It got me thinking. Keeping ships afloat and in good repair is critical, particularly if you’re setting sail in choppy waters. Without proper maintenance, they will be unsafe and unfit for their purpose. They will cost you more in repairs, insurance and claims in the long run. And you don’t allow just anyone to repair them either – you need an expert shipwright.

So it is with commercial contracts.

A Contract is a Contract?

But surely a commercial contract is a commercial contract, right? Wrong.

Contract law is a highly expert field in itself, covering areas like unfair contract terms, consideration, warranties, indemnities and so on.

However, to compound matters, commercial contracts come in so many different forms involving different specialist areas of legal knowledge: agency and distribution (involving agency and competition law); sponsorship, licensing and franchising (requiring a robust knowledge of intellectual property law); and sale of goods/services (specialist B2B and B2C legislation applies).

Then there are technology contracts (e.g. IT outsource, cloud, development, website/app, and data-related agreements), requiring highly specialist knowledge of areas like data privacy.

There are also differences between laws of the various UK jurisdictions, and the picture is about to become more complex with the end of the Brexit transition period. Some European-based law is likely to remain substantively the same, at least for now (e.g. data protection), but in other areas, it is bound to change fundamentally.

And all of that is before we get to cross border contracts – often cloud technology contracts are governed by the law of particular US states, for example.

Everyone’s an Expert…

If you’re selling your house or your business (or indeed repairing a ship), you wouldn’t have a stab yourself. So, when it comes to commercial contracts, why do so many assume they are an expert?

So often we come across situations where senior management, or personnel in finance, procurement, sales or administrative functions take the lead in preparing or negotiating commercial contracts. Or worse, they are designated as responsible for ‘signing off’ on ‘standard’ terms and conditions, often represented by the counterparty as being ‘non-negotiable’.

I entirely understand that these individuals may well be experts in their respective fields (and that their input will be important) – but their field is not contract law.

Of course, contracts are one mechanism amongst others for managing risk (albeit a critical one). But it simply isn’t possible to identify the risks, understand them fully, spot gaps, and ensure those gaps are addressed by other means (e.g. insurance), without expert input in the relevant areas of law.

Particularly with choppy waters ahead – with a post-Covid recession and Brexit to navigate – it has never been more important to get the support of an expert.

It’s Not What’s on the Page!

The biggest and most damaging waves are often not visible until the last moment. When those who are not contracts lawyers review or negotiate contracts, they usually focus on what is on the page in black and white. But very often, it’s what’s not on the page that matters most – and to the untrained eye, that is hard to spot.

I’ll give just a few common examples, though there are many others.

Probably the most common is that if a contract is silent on liability, then parties’ liabilities for breaches, etc. will be uncapped. Sometimes that will suit one party, and if that party has produced the draft then invariably it will expose the other to a great deal of risk and they must beware.

Another common example is where a party is commissioned under a contract for services (as opposed to a contract of employment) to create a body of work, e.g. to develop a bespoke software platform.

In those circumstances, unless there is an express written transfer of related intellectual property rights (in this case, copyright in underlying source code), the contractor will own the IP and not the commissioner of the work. The best the commissioner has – having paid the money and perhaps assuming it has ownership and control – is an implied licence, the terms and scope of which are unclear. Not good.

Finally, the law in both England and Scotland can imply terms into a contract even where they have not been included. Generally speaking, terms can be implied to lend business efficacy to a contractual arrangement, or implied by general law (whether by statute or otherwise).

For example, the law says that services under contract should be performed in reasonable time, and to a reasonable standard of care and quality. There is a raft of legislation which implies terms into B2C contracts. Terms can also be implied by custom and practice of the parties.

The law in this area is complex and can have a significant effect on commercial outcomes – it is very important to understand the possibilities for implied terms when reviewing contracts.

Proving the Negative

The challenge we often have as contract lawyers is proving a negative. “We’ve always worked this way and it has been fine…”. Or “We have a great relationship, we never need to get the contract out of the drawer.” Or “Hopefully we can avoid the legalese…”. Anything like that sound familiar?

If 20 years of legal practice has taught me anything, it is that everything is fine until it’s not – and when it’s not, things can escalate and become very costly and damaging rapidly where a lax attitude to contracting has been adopted.

To paraphrase the old adage: always better and less costly to have the fence at the top of the cliff than the ambulance at the bottom.

Low value does not mean low risk

Another trend I’ve picked up on is the “commoditisation” of commercial contracts, which has perpetuated a myth that low value contracts generally mean lower risk.

Often this manifests in contracts below a certain value not even reaching a lawyer.

For example, sometimes procurement teams or in-house legal teams set up their governance this way, so that complex, higher value, higher risk contracts are prioritised where there are limited legal resources or budget.

I am not saying there is anything wrong with this approach per se, and sometimes it can be the case that lower value = lower risk. But there are notable exceptions and it is crucial to understand those and to ensure appropriate legal scrutiny of even lower value contracts where they carry disproportionate risk.

Among several examples I know of, one example which stands out was a testing contract for fire and safety systems valued in the low tens of thousands, which ended up costing the client millions after lengthy litigation due to an inappropriate liability regime.

This is something that a skilled contracts lawyer would have picked up on and addressed in minutes.

Consequences of Getting it Wrong

In circumstances like these, the consequences of getting things wrong represents an existential threat to your business. We have already seen an upturn in queries, claims and litigation arising out of the Covid-19 pandemic, and the predicted tidal wave is yet to come.

This is running through different cycles: initially, there was a great deal of focus on force majeure and the law of frustration of contract in order to obtain relief from contractual obligations, or seek to avoid them altogether.

We have now moved into a more strategic phase, where longer-term relationships are being evaluated, and contracts are being scrutinised for cost saving opportunities. As job losses mount and government protection measures are eased, expect a new wave of claims and litigation.

With the end of the Brexit transition period, and ongoing coronavirus issues, you can also expect continued disruption to supply chains.

Again, the message is clear: it has never been more important to ensure that your contracts are in order now.

It’s Not Just Risk Management

There is often too much of a focus on risk management, and not enough on value creation.

An expert contract lawyer with a strong commercial sector focus is a value creator for you. They will have seen similar contracts multiple times, represented both sides, and presented and heard all of the arguments, and they will know where they can make you savings and drive value.

I remember in one instance a few years back, I saved a client £50k – which they had budgeted and were ready to pay – for a gold master disc (when those were a thing) thanks to just a single sentence summarising recent experience and insight.

Recommended

Countless times, I have seen businesses in M&A transactions achieve significantly higher multiples/values where good legal teams have supported their contracts work over the years, or been engaged in pre-transactional diligence readiness programmes, to ensure contracts are robust, clear, and up to date.

It is indicative of a level of care and professionalism in running the business which engenders confidence. The same can be said for businesses raising investment or finance.

The reverse is also true of course – deals have died at the first sight of a shambolic data room, or poorly drafted / onerous contracts.

Plain Sailing

There are some choppy waters ahead for the UK economy. With disputes on the rise already, and a tidal wave of insolvencies and disputes predicted on the horizon, it is now more important that it has ever been to ensure that proper attention is given to expert scrutiny of your commercial contracts.

While that does involve some time and money to be set aside, businesses which make that smart investment will be setting themselves up best for plain sailing in uncertain times ahead.

If you would like to speak to any of our commercial contracts experts, on English or Scots law contracts of whatever flavour, please do drop me a line at callum.sinclair@burnesspaull.com, or connect with me on Linkedin.

And, tenuous maritime analogies aside, if you do get a chance to engage with the fantastic FOCI project, I’m sure your support would be welcome!

Callum Sinclair, Partner and Head of Technology, Burness Paull

Callum Sinclair

Head of Technology and Commercial, Burness Paull

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