FLAWS IN CONTRACTS
Commercial litigation often occurs as a result of common and recurring mistakes that are made
during the drafting and negotiation of contracts. As litigators and transactional attorneys, we
(and our clients) often wish that we could turn-back-the-clock so that a provision or two could
be added to resolve a contractual problem. Such daydreaming is particularly painful because
commercial disputes frequently result in protracted and costly litigation.
Businesses that are conscious of the following top ten mistakes and seek to avoid making them
will be less likely to face litigation. If suits are filed, the avoidance of these mistakes will
enhance the likelihood of a favorable verdict or settlement.
1. Not Investigating and Understanding Future Business Partners
Perhaps the most fundamental mistake made by businesses is failing to adequately investigate
the persons or entities with whom a business intends to enter a contractual relationship. While
most companies analyze whether a proposed deal is financially advantageous, a surprising
number fail to adequately study their proposed business partners. Such investigations are
important because they can provide early warning signs about the desirability of a proposed
business partner, the likelihood that contractual obligations will be met and whether litigation
is likely if disputes arise.
Pre-contract investigation should, at a minimum, include a credit search to determine the
financial viability of a proposed partner and a litigation search, which may indicate how
litigious the proposed business partner is, the nature and types of its past legal disputes and the
likelihood of litigation if problems arise.
A litigation search should do more than merely identify the number of suits involving a
potential business partner. It should focus on the nature and type of conduct that led to the
litigation as well as the nature and reasonableness of the positions taken in the litigation. If
your proposed partner has been difficult and unreasonable in the past, it may be a good
indication of future conduct. Most contentious commercial litigation involves one or more
parties who are frequent litigants.
2. Hasty, Inadequate or Non- Existent Due Diligence
Assuming that a proposed business partner appears to be reliable and reputable, the next step
should be to conduct thorough due diligence. In some instances, businesses are so eager to "do
the deal" that they perform hasty or inadequate due diligence.
While the pressure to complete a transaction may be so great that companies elect to take
"calculated risks," there are real risks to circumventing due diligence. If a deal appears to be
too good to be true, the need for due diligence is often even greater.
We realize that in some situations a complete and thorough due diligence is not feasible. For
example, in large asset based transactions, it may be impossible or economically impractical to
perform a complete investigation. When this occurs, a risk benefit analysis should be performed
to decide the scope of due diligence. If thorough due diligence will not be performed, the parties
should consider including provisions providing compensation if representations, warranties or
other contractual assumptions later prove to be inaccurate.
3. Entering a Contract that Was Neither Written or Approved by a Lawyer
Given society’s negative view of lawyers and the perceived cost of legal services, it is not
surprising that companies often make the mistake of entering contracts without having them
reviewed or approved by a lawyer.
The temptation to do so is greater when contracts "seem" simple and straight forward.
However, the old adage that "things are rarely as simple as they seem" applies here. In most
instances, paying a lawyer to briefly review a contract is an investment that more than pays for
itself and, if nothing else, allows a company to identify the risks of proceeding without greater
attorney involvement. In situations where companies enter the same type of transaction over
and over again, the use and development of form contracts is appropriate as long as those
agreements are drafted or approved by a lawyer, its use is not expanded to transactions other
than those initially contemplated and the form is occasionally reviewed and evaluated in light
of new laws and past performance and enforcement of the contract.
4. Not Defining Terms and Including Ambiguous Provisions
To ensure that contractual intent is achieved, contracts must contain well defined terms and
Whenever a party seeks to avoid contractual obligations, their primary strategy is to identify
contractual ambiguities. While it is impossible to entirely eliminate the risk that a party will
assert that ambiguities exist, careful drafting avoids creating loopholes and increases the
likelihood that contracts will be fulfilled and construed as intended.
5. Failing to Include a Choice of Law Provision
While identifying the state law that will be used to construe a contract may seem formalistic
and unnecessary, the failure to do so is a major mistake that can make contractual disputes
more difficult and expensive to resolve.
Where contracts either involve parties from different states or interstate performance, the law
used to govern and construe a contract may be uncertain. If litigation occurs and there is no
choice of law provision, motion practice will probably occur involving a complex and highly
fact specific interest analysis, which is often expensive and is particularly frustrating because
the inclusion of such provisions is often uncontroversial.
In many instances, laws that can have a major impact on contractual interpretation vary from
state to state and some jurisdictions have laws that, for public policy reasons, do not enforce
certain types of contracts.
Inclusion of a choice of law provision should not be a knee jerk decision to merely identify the
law of the home state. Instead, the choice of law decision should be made after considering
both the contractual intent and the proposed jurisdiction’s laws.
6. Failing to Include Provisions Relating to Defaults, Opportunities to Cure and
In some instances, companies are reluctant to raise issues like defaults, opportunities to cure
and termination because they worry that doing so will cause their business partners to have
second thoughts about entering the contract. However, these types of provisions are important
ways to promote performance and avoid litigation. If notice of potential breaches and
opportunities to cure are required, parties that might otherwise litigate are forced to attempt to
work out their differences.
Another important benefit of these provisions is that they can require alleged contractual
breaches to be raised and addressed when they first arise and not after problems fester and
Contracts should also include provisions that define how long an agreement will remain in
force and how and when the agreement might be renewed or terminated. An early termination
provision is often desirable so there is an escape route if undesirable circumstances occur.
Absent such provisions, a business unhappy with contractual performance will have little or no
other recourse and could conceivably be forced to live with a contract that fails to achieve its
7. Specifying the Damages that Should Be Available If Disputes Arise
Potential business partners should also specify the damages that can be awarded if material
Some business partners may be unwilling to assume the risk of certain damages. When this
occurs, parties can include provisions either limiting recovery to a certain dollar amount (which
sometimes can be the contract price), or barring collection of certain damages, e.g.
These clauses help insure that companies do not assume unnecessary risks or liabilities.
Moreover, by limiting possible damage recoveries, these clauses may reduce the risk of
8. The Written Contract is the Final Expression of the Agreement
The parties should also limit evidence that can be used to construe a contract and the
circumstances under which an agreement can be changed after execution. Typically, provisions
are included stating that the written contract is a final expression of the parties and that the
agreement supersedes all other prior communications and understandings and that any
modifications must be by a written and signed amendment.
These provisions make it more difficult to argue that there were side agreements or other
understandings. Moreover, such provisions make it harder to argue that agreements were later
modified by subsequent performance or conduct.
9. Considering Where and How Contractual Disputes Should be Resolved
Parties entering contracts should also consider and address where and how disputes will be
resolved. First, they should decide if disputes will be litigated in court or in some alternative
forum such as arbitration. They should also decide where a case or dispute will be tried or
arbitrated, which can be important particularly when the contracting parties are located far
away from each other. A party with the "home court advantage" may not only be more likely
to prevail, but also will likely have to spend less to prosecute or defend its case. Another
consideration is that a potential litigant who will be forced to travel great distances may be less
inclined to insist that disputes be adjudicated.
10. Establishing Internal Procedures and Protocols to Insure Contractual Compliance
and Avoid Disputes
The final and often most serious mistake that businesses make is that they merely file a contract
in a cabinet and then proceed to "do business." Having gone through the time and effort to draft
and negotiate a detailed agreement establishing their rights and obligations, companies too
often ignore the contract and only consult it when severe problems arise. By failing to establish
procedures to monitor performance, companies may unwittingly breach their contracts or may
waive the right to insist that their business partners fulfill their obligations.
Executed contracts should be forwarded to the managers and employees responsible for
performance. Similarly, individuals should be assigned to insure that their business partners
fulfill their responsibilities. These people should understand the agreement and should be
explicitly told what to do if problems arise. If personnel changes occur, companies should have
procedures to insure that the new managers or employees are similarly educated about the
contract. Finally, companies should verify that its managers and employees are fulfilling the
requirements of the contract. It is often not enough to merely send a detailed letter or
memorandum establishing procedures. Instead, companies should regularly check to insure that
protocols are followed. Needless to say, companies that establish and later ignore their own
internal audit procedures will face difficult problems when litigation ensues.
When parties enter contracts, they expect that their goals will be achieved. That expectation
alone is not likely to be achieved if companies rely solely upon the cooperative spirit that often
exists at the onset of a relationship. Instead, agreements should fully reflect their expectations
and the common mistakes set forth above should be avoided. If this occurs, it is less likely that
parties will find themselves involved in commercial litigation.
MISTAKE # 1 – Overlooking that a binding contract might be oral Only in a few situations
must a binding contract be evidenced by writing. So, an oral consensus on the essential deal
points might be enough to form a contract. A party might then refuse to sign some later,
different writing because a contract already exists, and cannot be deviated from without consent
of all parties.
MISTAKE # 2 – Overlooking that a MOU might be binding If a Memorandum of
Understanding, Heads of Agreement, Terms Sheet, or other ‘preliminary’ document is not to
bind as a contract, it should say so. A binding ‘preliminary document’ is often a mistake,
because it is unlikely to address all the issues to a desirable level of detail.
MISTAKE # 3 – Poor use of a template Simply inserting transaction details in a template might
be a mistake. The template might be of poor quality, or out of date.
MISTAKE # 4 – Poor use of a precedent A prior working document (precedent) likely was
tailored to the specific deal it was created for. You might spot any novel clauses, but fail to
‘see’ worthwhile clauses deleted during negotiations for the prior deal.
MISTAKE # 5 – Exerting undue pressure to sign The appearance of undue pressure, without
the counterparty having time to read and negotiate the terms of the contract and perhaps obtain
advice, might be ‘unconscionable conduct’ on which the contract can be set aside.
PART 2 - Problems with Parties
MISTAKE # 6 – Failing to keep separate Council’s commercial and regulatory functions The
contract should be clear that it does not fetter or evidence the exercise of any regulatory
function or power the Council has now or in the future, and that when the Council exercises a
regulatory function or power, the Council would be taken to be a third party to the contract.
MISTAKE # 7 – A named party is not a legal person Only individuals (usually at least 18 years
of age) or corporations (e.g., a company, incorporated association, Minister of the Crown) can
be party to a contract. A partnership / trust / registered business name / registered trade mark
is not a legal person – the contracting party is the partner(s) / trustee / owner of the business
name or trade mark.
MISTAKE # 8 – A party is not legally qualified to contract Example 1: In a building contract,
the contractor must hold a building licence in its own name, and it is not sufficient that its
subcontractor holds the requisite licence. Example 2: In a financial services contract, the
contractor’s Australian financial services licence does not extend to the full scope of work
which the contract requires.
MISTAKE # 9 – Two or more counterparties are not jointly and severally liable If
counterparties are only jointly liable, a release or waiver in favour of one benefits all.
MISTAKE # 10 – A signatory for a party lacks authority to bind that party Ideally, a signatory
for another person (e.g., an attorney) should warrant their authority to bind that other person.
A director / company secretary might have actual or ostensible authority to bind their company;
a partner might have such authority to bind the partnership. There are however, legal limits to
MISTAKE # 11 – A person signing a deed for a party was not appointed as agent / attorney by
deed An attorney (or other agent) can only sign a deed for his / her principal if he or she was
appointed by deed.
MISTAKE # 12 – An individual’s signature to a deed is not properly witnessed An individual’s
execution of a deed / indenture must be witnessed by an adult not a party to the deed.
MISTAKE # 13 – Individuals signing for a company, or witnessing its common seal, are not
officers of that company A company may execute a document (including a deed) without using
a common seal, if the document is signed by certain signatories. And a person may assume a
document has been duly executed under common seal if the fixing of the common seal appears
to have been witnessed by certain signatories (usually at least 1 director + a company
secretary). To get the benefit of some statutory assumptions, identify the officers from a current
ASIC search of the company.
MISTAKE # 14 – Failing to hold a fully signed, original of the contract Lack of a party’s
signature makes for an strong argument the document was not to be effective unless all parties
signed. If a contract is to be signed in counterparts, the contract should expressly allow for
counterpart execution. PART 3 - Language Problems
MISTAKE # 15 – A ‘business day’ definition fails to exclude the period between Christmas
Day and New Years Day Most enterprises in fact close down in that period.
MISTAKE # 16 – Using ‘includes’ unwisely Sometimes a definition is broadly expressed, then
followed by ‘and includes this and that’, with the parties then focusing only on the ‘this and
that’ and overlooking that the initial broad expression might have a wider operation than
intended. For an exhaustive list, say ‘means’.
MISTAKE # 17 – Using different words for the same thing Example (1): A ‘Lessee’ in clause
1, becomes a ‘Tenant’ in clause 7, becomes an ‘Occupier’ in clause 9. Example (2): In clause
1 ‘may’, in clause 7 ‘might’, in clause 9 ‘has power to to’. Example (3): In clause 1 ‘shall’, in
clause 7 ‘will’, in clause 9 ‘must’, in clause 11 ‘is obliged to’, in clause 17 ‘should’. Different
terminology hints at different meanings, when likely none was intended.
MISTAKE # 18 – Use of industry ‘terms of art’ without settled legal meaning An example is
“practical completion” of building work – Court cases have been fought on this.
MISTAKE # 19 – Use of ordinary language that lacks definite legal meaning Examples: n good
faith – the legal meaning is variable, and the obligation may be so vague as to be unenforceable
n reasonably – means to act on the balance of reasons – non-lawyers may read more into it,
such as a duty to act in good faith (whatever that means, see above) n promptly, immediately,
forthwith – no precise legal meaning, depends on the facts as assessed by the Court – use fixed
periods or dates instead.
MISTAKE # 20 – Failing to import statutory definitions If an Act forms the backdrop for a
contract, it is a mistake to assume that expressions defined in the Act would naturally have the
same meaning in the contract. The contract should say that expressions in the contract have the
same meaning as in the Act.
MISTAKE # 21 – Use of language that has special meaning only to the negotiators Sometimes
the negotiators will informally agree what a word or provision means to them, but which has a
different meaning to an objective outsider (e.g., a Judge). Obviously, the negotiators should
record their agreed meaning on the face of the contract. PART 4 - Problems with Terms and
MISTAKE # 22 – Rules are stated in the Recitals rather than the body of the contract Recitals
(or Introduction) to a contract have a very limited legal function, and are not the place for rules
of behaviour to operate between the parties.
MISTAKE # 23 – Uncertain use of conditions precedent If a contract lists out conditions
precedent (e.g., a third party consent), does that mean a contract does not even exist until the
conditions are satisfied, or only that closure of the deal is conditional upon the conditions being
satisfied? If a contract does not exist until conditions are satisfied, any terms dealing with
confidentiality / dispute resolution / document preparation costs / amendment of the document
etc., do not operate until that time, if ever.
MISTAKE # 24 – Failing to operate the contract from the start of the deal If a contract is signed
only after the deal is underway, it should expressly govern those steps in the deal taken before
the contract was signed.
MISTAKE # 25 – Failing to gel with contract terms implied by an Act Some terms that an Act
would imply into a contract are rebuttable (e.g., when risk / ownership pass on a sale of goods
under the Sale of Goods Act 1895, whereas others cannot (e.g., those implied by the Retail and
Commercial Leases Act 1995).
MISTAKE # 26 – Conflict with an Act Some Acts would invalidate a contract that is not
expressed to be conditional upon the obtaining of some consent (e.g., planning consent,
Ministerial consent) or other step (e.g., the deposit of a plan of division).
MISTAKE # 27 – Failing to specify all essential terms required under law Example 1: In a
lease, that the tenant obtains right to exclusive possession of a specified area, for a specified
time, for a specified rent. Example 2: In a sale, that the purchaser obtains ownership of a
specified good, for a specified price.
MISTAKE # 28 – Failing to list out any ‘deliverables’ If the counterparty is to provide a
document, drawing, raw data, draft report, final report or something else, list it out in the
contract (and with a timetable for delivery).
MISTAKE # 29 – Failing to answer ‘what if?’ If some step agreed to be taken by one or both
parties fails to occur, what happens?
MISTAKE # 30 – Failing to provide for ‘top up’ security If the counterparty is providing a
bond / bank guarantee, is it obliged to top up the security if you have recourse to the original
security during the life of the contract?
MISTAKE # 31 – Failing to make the grant of an option effective The questions to be
answered: which party has the option?; when may the option be exercised?; how would the
option be exercised?; what results if the option is exercised?
MISTAKE # 32 – Failing to address liability for transaction taxes These might include GST,
stamp duty, CITB levy. An application or lodgement fee payable to a regulator might also be
MISTAKE # 33 – Failing to provide for late payment interest In law, there is no automatic
right to interest on an amount not paid on time.
MISTAKE # 34 – Time is not of the essence The contract law rule is that a time period or date
is not critical to performance of an obligation. To except the rule, the contract should say that
time is of the essence of periods and dates.
MISTAKE # 35 – Not using an ‘entire contract’ clause Lack of that clause might allow the
counterparty to argue that the writing only evidences part of the total deal, with there being
some collateral commitment not recorded but still binding the parties.
MISTAKE # 36 – An ‘entire contract’ clause not effecting release of prior obligations A basic
‘entire contract’ clause would say the contract supersedes any prior contract or obligation
between the parties about its subject. A better clause says the contract also release Common
Contract Mistakes PART 5 - Unthinking use of Some Provisions
MISTAKE # 40 – Unthinking use of indemnity clauses Most indemnity clauses afford the
innocent party no greater recovery than would be had under general law principles without the
clause. A poorly drafted clause might however, inadvertently shift risk from one party to
another. An indemnity should exclude loss to the extent caused by the innocent party’s own
default. A ‘continuing’ indemnity is not time-limited by the Statute of Limitations. The general
law does not itself oblige an indemnified party to minimise the loss indemnified, so the contract
MISTAKE # 41 – Unthinking use of non-compete promises A non-compete promise is void
unless it goes no further than reasonably necessary to protect a legitimate interest of the other
party, as objectively and retrospectively assessed by a Court. Failing that test, the clause is
void. A non-compete promise might also offend the ‘cartel conduct’ rules in the Competition
and Consumer Act 2010 (as applies to Councils by the Competition Policy Reform (South
Australia) Act 1996). Further, a non-compete promise should be obtained from key individuals,
as well as from a corporate counterparty.
MISTAKE # 42 – Unthinking use of liquidated damages clauses To be valid, the amount
specified must be objectively reasonable. If unreasonable, the clause is void.
MISTAKE # 43 – Unthinking use of a force majeure clause In practice, a force majeure clause
(one that excuses a party’s failure to perform due to circumstances outside their control) might
benefit one party greatly (e.g., service provider) and the other party (e.g., customer) not at all.
MISTAKE # 44 – Unthinking use of ‘evergreen’ options to extend the period An option to
extend ‘on the same terms as this Contract’ (including the clause that gives right to extend) can
lead to unlimited, successive, extensions.
MISTAKE # 45 – Unthinking use of an arbitration clause Arbitration might be as expensive
and time-consuming as litigation.
MISTAKE # 46 – Failing to expressly carve out statutory disclosure from a duty of confidence
A counterparty likely does not know that the contract simply stating that the contract, or some
portion of the contract, is ‘commercial-in-confidence’ is no assurance the contract details
would not become public in the minutes of the elected members, or that the contract would be
an ‘exempt document’ for the FOI Act. PART 6 - Conduct Post-Contract
MISTAKE # 47 – Delay in enforcing rights An innocent party who acquiesces to a contract
breach may be taken to waive a right to complain, despite a ‘no waiver’ clause in the contract.
MISTAKE # 48 – Undue reliance on a ‘no waiver’ clause See immediately above. The
‘doctrine of election’ can override a ‘no waiver’ clause.
MISTAKE # 49 – The contract is not formally modified to accommodate changed realities If
the reality of the deal deviates materially from the written contract, and you don’t formally
modify the written contract, you risk a Court finding the terms of the deal not in the written
contract, but in what the parties did (or appeared to do) in practice. And you don’t know in
advance how the Judge would rule.
MISTAKE # 50 – An attempted modification of a contract fails for lack of ‘consideration’ A
modification (amendment) must be supported by ‘consideration’ moving from all parties,
unless the modification is set out in a deed.
MISTAKE # 51 – An assignor thinking they are completely released In law, an assignor is not
released from future obligations by assigning the contract – they remain liable should the
assignee at any time later fail to perform the assigned obligations. If the Council is the assignor,
obtain an express release from future obligations under the contract assigned.
MISTAKE # 52 – Improper termination of the contract for breach The innocent party may have
a right to terminate under contract law, and / or under an express contract clause. The contract
law right to terminate is an art, not a science, and requires legal advice. To use an express
contract clause’s right to terminate: n the facts must match exactly the circumstances the clause
requires n notice of termination must be given in a manner and time the contract requires n on
occasion, the Courts imply a duty requiring the innocent party to terminate for a ‘proper’
purpose – even if the contract language gives a clear right to terminate for breach An improper
termination of contract by the innocent party is itself a serious breach of contract.
MISTAKE # 53 – Allowing an insolvent counterparty to continue making payments If you
know a counterparty is likely insolvent, any payments afterwards received from them may have
to be paid back as ‘undue preferences’ if the counterparty is bankrupted in the proximate future.