What Makes a Good Contract?

Many times I’ve seen entrepreneurs ask what makes a good contract, or ask attorneys to draft up a contract that will “fully protect” them. However, what exactly makes a good contract, or goes into a contract that fully protects a party?

First, it is important to remember that there is often no such thing as a “standard contract” — consumer purchase agreements are a notable exception, but between businesses all terms are negotiable or should be negotiable (of course, there may be industry standard *terms*, but even they should be open to negotiation if the situation warrants it). Even if the other party sticks their standard contract in front of you and tells you to sign it, don’t sign it unless you’re comfortable with its terms. If you want to negotiate terms, do so, and if the other party considers it a “take-it-or-leave-it” proposition, it may be better to leave it than to get stuck in a unfavorable contract.

What makes a good contract is whether its terms are favorable or at least acceptable to you and your business — if necessary, retain the services of an attorney to help you understand more complicated terms, and to serve as an impartial adviser. You may really want the deal so bad for your business (or think that your business desperately needs the deal) that you overlook or dismiss unfavorable terms, but an attorney may help you refocus on the long-term view and recognize terms that may end up being harmful to your company.

There are also a couple of issues entrepreneurs should be cognizant of when drafting a contract that “fully protects” them. I’ve seen entrepreneurs ask for contracts that make sure they can’t be sued. This is impossible — if someone wants to sue you, a piece of paper is not really going to stop them. Indemnity clauses, hold harmless clauses, and liability and warranty disclaimers can go a long way to limiting your liability in litigation, but it is very difficult to get a valid waiver of a party’s right to seek redress (whether it be in court on in mediation/arbitration).

Two other issues to consider in order to avoid surprises from the contract are illusory promises and merger clauses. An illusory promise is a contractual promise that on its face appears to bind a party to an action, but in reality does no such thing — for example, a contractual clause that provides for the party who makes the promise to exercise its “discretion” in fulfilling the promise may be an illusory promise, for the party may be able to exercise its discretion to not do anything! Finally, you may want to ensure that your contract has a merger clause — this clause essentially states that the relationship between the parties is defined solely by the contract. Any negotiations that occurred before the signing of the contract cannot vary the relationship. With a merger clause, the other party cannot (usually, but that’s another, longer discussion) claim a different interpretation of the contract based on your prior negotiations and discussions. However, this also means that you must ensure that the contract includes every term and describes the relationship exactly as you want it.