All About Commercial Terms
Commercial terms are essentially the skeleton of a contract. They detail each parties’ obligations and responsibilities, identifying the deliverables and associated timings of those deliverables. The details of commercial terms can vary throughout a contract, or can be very rudimentary if it is a standard form of contract. Each contract will define commercial terms based on the terms at hand and the services being provided.
Commercial terms are usually contained in contracts to understand the types of obligations being required of each of the parties. A broad definition may simply say that the contractual agreement is to provide services, such as a service level agreement. Alternatively, it could be defined much more broadly, or narrowly, as all the commercial terms required of the parties .
The commercial terms of a contract identify the scope of the agreement being entered into between the parties. This ensures that the same expectations of each party exist from the outset. If both parties have agreed to the scope of service, they are more likely to comply with the agreement against the background of their respective obligations. For example, they will be more likely to jointly indemnify each other if the scope of that indemnity is clear from the outset. If the parties have the same expectations, they are more likely to adhere to the contract. That is not to say that the scope of the contract cannot change over time, but to do so, both parties need to agree to a variation of the contract.
Key Elements in Commercial Terms
While there are numerous ways of describing the different elements that constitute a commercial term, we will use the following broad headings: Payment terms – this is an important topic as it is inextricably linked to many other issues. It may come as a surprise to some that payment terms are not always considered a condition of contract. Difficulties in determining when specific payments such as milestone or retention occur have developed largely due to the English courts’ focus on the construction of contracts over the practicalities of a particular industry. In England, Spark v NCH/Belair Construction Ltd no longer reflects the current distinction in English judicial approaches to contractual clauses providing for retention and milestone payments. The bulk of the case law now focus on establishing the reasonable meaning behind the chosen terms by using the established principles in Black Clawson International Ltd v Papierwerke Waldhof-Aschaffenburg AG to construe the wording used. Therefore, a court would consider the factual background (or matrix) including the parties’ intentions and the factual circumstances surrounding the management of the project which lead to the payment terms being agreed in the document, although the subsequent conduct of the parties is specifically excluded from this assessment. Delivery dates or hours – the main consideration when negotiating delivery terms is to ensure that either a time is defined or a mechanism for assessing the time frame for delivery in the event that there is a delay is put in place. The latter option is recommended as it provides the benefit of certainty if the project takes or is thought likely to take longer than originally anticipated. Service levels- it is important to ensure that if there are service level agreements in effect you incorporate these into the commercial terms. It is not uncommon for parties to forget the actual service level requirements that were agreed in the course of discussions to get to contract conclusion. Incorporation of agreed terms – payment, delivery, service – Care must be taken that the commercial terms negotiated between the parties are incorporated into the final copy of the agreement. If there is any doubt in the final copy of the contract (unless specifically incorporated by reference) the initial agreed terms will prevail.
Examples of Commercial Terms
The most frequently used commercial terms differ between industries. More importantly, certain terms do not have the same meaning in each industry and consequently the wording of such terms must be adapted to the specific type of contract. When drafting contracts, this can result in lawyers using "industry jargon" that may not be understood by the parties to the contract. While the legal principles governing the interpretation of a contract largely depend on the common or civil law, the way in which the contract has been drafted can also have an impact. Be careful to ensure that commercial terms have the same meaning as intended in the relevant context.
Examples of commercially used terms include:
Discomet – A discomet is a document which commits a bank to make a payment before a given date (the "Due Date") following receipt of documents meeting the predefined criteria. The bank’s obligations end at the Due Date, so this term must be understood.
Facil – Also known as a facility letter or a term sheet, this is a simplified loan agreement, which is a written "commitment" of a lender to make a loan. It sets out the key commercial terms of the proposed loan.
Standby – This is a rather complicated financial instrument. A bank undertakes to pay a beneficiary if an LC application is made and the applicant is unable to repay the amount.
Call Option – Call options are usually used as a financial tool and serve as an implicit right to obtain a difference in price, often between the spot and forward market. The option buyer has the right, but not the obligation, to purchase the underlying assets at the exercise price.
TEU – This is a standard term used for containers. A twenty foot equivalent unit (TEU) is a measure of cargo capacity (being the standard size of a shipping container).
Incoterm – The ICC International Court issued a publication on international commercial terms (Incoterms). These are well-known definitions enabling those involved in international transactions to understand one another. There are currently eleven different types of Incoterms in use, which define the responsibilities of the seller and the buyer during a sale, i.e. the costs and risks implied.
Note – A note, i.e. a note payable, is a promissory note to pay a sum plus interest on a fixed date. A note also refers to a strip issued by the government. Notes can sometimes be investment vehicles.
Term Sheet – A term sheet is a financial tool, serving as a preliminary letter of intent. It contains the key terms of a proposed financing transaction.
The Legal Basis of Commercial Terms
The commercial terms are typically at the heart of the contractual relationship, governing the duties and rights of the parties. However, there is a legal framework of rules (sometimes drafted with reference to the relationship that the commercial terms will govern) that must be adhered to in certain circumstances. Parties may wish to consult specific sources of law, which may provide guidance or more specific regulation as to the formulation and enforcement of commercial terms.
Regulatory compliance
One source of regulation of commercial terms is the Consumer Rights Act 2015 (Consumer Act), which provides legal protection for consumers. If commercial terms are used as part of the sale of goods and/or services, then there are various consumer rights that must be complied with. For example, if the commercial terms are unenforceable under Chapter 4 of the Consumer Act, then the relevant clauses of the commercial terms may be unenforceable against the consumer.
The consumer rights are further enhanced by EU consumer laws, for example Article 5(3) of the Unfair Commercial Practices Directive gives a consumer the right to withdraw from a contract (within 14 days) if they have not been given the necessary information. The same is true in relation to distance contracts under the Consumer Contracts (Information, Cancellation and Additional Charges) Regulations 2013 (the 2013 Regulations). You will need to check carefully whether the EU Directive applies, but in theory you should provide information on the right to cancel, in accordance with the Directive, if the contract is intended to be enforced in an EU state.
There are further regulations under the 2013 Regulations that apply to distance and off-premises contracts, including the specific form of drafting required for information to be provided prior to entering into a contract. The Regulations may also apply if you are selling goods or services to consumers via an online platform and consumers may be located across the EU. You should be aware of these regulations and the effect that they may have on the drafting of your commercial terms, particularly if those terms will be used to govern any aspects of dealing with consumers.
Choice of law and jurisdiction
It will be important for the parties to consider which law will apply to the contractual arrangement and which courts of a specific jurisdiction will be permitted to adjudicate on any disputes. In the UK, the jurisdiction of the courts is governed by the Judgments Act 1982 (the 1982 Act) and the jurisdiction may be determined by agreement of the parties. Despite being governed by UK law, the 1982 Act has a similar effect to that of the Rome I Regulation 2012, which applies to EU cross-border commercial contracts and determines the applicable law.
Article 25 of the Rome I Regulation provides that parties may agree to the applicable law. For contracts of goods or services, the parties may freely choose the applicable law (regardless of where the parties or the assets are based).
Negotiable Aspects of Commercial Terms
Effective negotiation of commercial terms is crucial to the success of any business transaction. However, negotiations can sometimes become contentious if the parties reach an impasse over certain terms or conditions. In this section, we discuss strategies for effective communication, compromise, and seeking mutually beneficial solutions to ensure that both parties achieve favorable terms while maintaining a good relationship.
When disputes arise, it is essential to manage the negotiation process effectively to prevent damage to the business relationship in the long run. The first step is to ensure very clear and open communication about the issues at stake. Acknowledge each party’s concerns and objections to certain terms. It is therefore important to listen actively and ask clarifying questions so that you fully understand the other party’s perspective .
In some cases, it may be possible to make concessions on some terms in order to reach a compromise. However, it is also essential that concessions are made by both parties so that one side does not feel that they have been hard done by. If a solution cannot be reached on the basis of compromises, then seek a middle ground that both parties can agree on. This could involve altering the wording of a particular clause or changing the way in which a particular aspect of the contract is executed.
Finally, do not rush to conclude the agreement if it would require you or your client to make excessive compromise. Attempt to find a mediator or third party to break the deadlock and bring the deal to a successful conclusion. Effective communication, compromise, and collaboration are key to ensuring that both parties walk away from the table with a favorable deal, and that the business relationship can be good in the long term.
Common Issues in Drafting Commercial Terms
One of the greatest challenges in drafting commercial terms is ambiguity. This can arise where terms and conditions are poorly worded or avoid usage of precise legal words which can lead to difficulties in interpretation. In the case of ambiguity, the question that the court must decide upon is what is the objective meaning of the language used, as at the date of the contract. A court will be reluctant to find that an agreement is void for vagueness and it will strive to make sense of any express or implied provisions in order to give effect to the intention of the parties. A good approach to avoid vagueness is to draft commercial terms in the positive as opposed to attempting to list what may not be done. Another example of a possible unfairness or imbalance of interests is where a manufacturer specifies certain terms on which it sells products or services (known as "unilateral terms"). The consumer is often able to accept those terms but not negotiate them to achieve a better deal. The recent ECR decision highlights the importance of obtaining full and informed consent when concluding an agreement, in order to avoid such an unfair situation. It is essential that the consumers understand and are aware of the implications of the agreement which they are contracting into. When drafting commercial terms and conditions, it is best practice to ensure that the agreement is written clearly and in a manner which protects the business against liability and is fair to all parties. Ultimately, the parties should be left with certainty regarding their respective rights and obligations.
Consequences of Vague Commercial Terms
Having a good commercial contract is not enough. The commercial terms should be clearly defined and people within the respective organisations that have signed the contracts should be able to interpret the terms consistently with their real meaning. Otherwise, there is a risk of commercial disputes arising from differing interpretations of what was meant by the terms. Such disputes can lead to wasted management time and legal fees in dealing with and resolving the disputes.
Where commercial terms are poorly defined, an obvious example of how they could be misinterpreted is in calculating a sum due on termination of a contract. A product supply agreement provided for a payment to be made "equal to 2 month’s purchase at the average monthly purchase price during the 3 month period prior to the termination date". This was however ill-defined in two respects. First, it indicated that the 3 month period was the 3 month "prior to" the date of termination when it was really the period "of" that date. Second, it assumed that the price of goods would not change during the final three months before termination and all monthly purchase prices would be the same throughout that period. The real meaning was probably the average monthly purchase price over the three months before termination.
When the supplier terminated the contract before the end of a year, the buyer wanted to pay the supplier on the basis a three month period immediately preceding the termination date was used to value the payment due to the supplier. The supplier argued that was not what was meant by a termination payment and insisted on using the three month period which was "prior to" the termination date.
Given the poor definition, it is not possible to deflect the claim on a point of legal principle as the court would largely need to get into the "intent" of the parties when entering into the contract. The outcome will depend on how the judge resolves the doubt in the contract in favour of one party or another.
Careful drafting of any provisional contractual provisions for a long contact is key. Drafting them in clear language to control future changes to a contract when there has been no time to negotiate details of those changes puts you in a much stronger contractual position. However, you must take care to avoid binding yourself to something which is not yet final when you have not had the time/facility/knowledge to consider the matter fully.
We have seen instances of poorly worded, provisional contractual provisions giving rise to claims that the parties did not intend to make but the poor drafting put the parties in a position where they are unable to resist the claim. Particularly if a termination payment provision is found to be specific to the contract for supplies in question, there is a risk of the buyer facing claims under such provisions relating to supplies that have not yet been made.
Final Thoughts on Drafting Commercial Terms
In conclusion, best practices dictate the use of concise and unambiguous terms in commercial contracts. The above list is not exhaustive and the critical importance of fully understanding the context of a transaction and the scope of the business relationship before drafting emerges as an essential take home message; ambiguity wrapped in complexity has no role to play here. The foregoing prescriptive list is based on the widely-accepted drafting principles described above that can be distilled from extensive English case law, in particular cases from the Chancery Division of the High Court, ranging back to the 1700s, and Court of Appeal decisions in the 19th and 20th centuries . It is often quoted and applied in England and Wales in domestic and cross-border trade, particularly in common law jurisdictions (and most obviously, in the United States). The second key take home message is that jargon and a tendency to modify terms are best avoided. Take the time to describe the parameters of a deal (or any contentious issue) in clear terms that set out the parties’ respective rights and liabilities in a logical and straightforward manner, without resort to complex phrases. If you cannot translate a requirement into plain English, it requires further analysis.