As the old joke goes, a contract is a list of ways the other person can hurt you. Many of us go into contract negotiations expecting to find obvious hurt—big-dollar penalties, limitations on the other side’s liability, and aggressive timelines. But much of the danger in contract negotiations lurks in less obvious places.
This blog breaks down a few hidden risks found in most contracts. We’ve previously covered the Three Questions to Ask Before Signing Any Contract and the Five Clauses That Matter More Than Contract Length. While there is some overlap, we’ll focus here on hidden risk factors.
1. Definitions.
When reading a book, we often skip over the table of contents. It is natural to want to do the same with contracts. If at the beginning, we skip ahead to the “substantive” clauses; if at the end, we feel like we’ve “finished” once we’ve reached the definitions. This is a mistake.
Definitions are embedded in every defined term used throughout the agreement. Skillful drafters know how to insert their framing into definitions. Take, for example, a term like “Defective Unit.” It seems straightforward enough, but what criteria are used to determine a defect and who gets to inspect the product unit? Or take a term like “Indemnified Parties.” Does this include affiliates, successors, and assigns? These are important questions and can have a major impact on how “substantive” questions in the agreement get resolved.
2. Cross-References.
Cross-references are another contract tool that gets overlooked. Skillful drafters include cross-references for three main reasons: (1) to avoid length and repetition; (2) to preclude inconsistency; and (3) to obfuscate unfavorable content. Rather than saying “liability shall be capped at $100” multiple times—and risking inconsistency—a drafter may just say “liability shall be capped in accordance with Section 11.1.” This keeps it short, simple, and practically lulls the reviewer to sleep.
But cross-references are no sleeping matter. If you are the drafting party, it is essential to get the numbering right. Aside from looking amateurish, wrong numbers can risk voiding a term you wish to enforce. Judges may be forgiving, but it will be expensive to prove the clause you meant to reference.
The non-drafting party’s greatest risk is oversight. Adequate review of cross-references involves time and effort—flipping back and forth between pages, copy-pasting, adding margin notes and keeping multiple factors in mind. The complexity compounds when cross-references chain together. Using our example above, you may see something like: “deliveries not conforming with the requirements set forth in Appendix C shall be subject to liquidated damages set forth in Section 16.”
Carefully checking cross-references is a painstaking but necessary endeavor. Contract rights often live or die by cross-referenced terms. Both the drafting party and non-drafting party can be put at a disadvantage by getting these wrong.
3. Termination Provisions
We’ve written extensively about termination provisions on this blog, so why beat a dead horse? Termination poses a hidden risk for three main reasons: (1) timing; (2) placement; and (3) the “it won’t happen to us” problem. We look at each of these in turn:
- Timing. Termination provisions are negotiated at the beginning of a relationship. Both parties are optimistic about closing the contract. No one wants to plan for failure and a conversation about such failure would be awkward. This creates a predictable blind spot—people are in the wrong mental state for discussing what happens when things go wrong when things are going right.
- Placement. Termination clauses are generally located near the end of a contract, after most negotiated terms and physically close to the boilerplate terms. This creates two problems: (1) exhaustion; and (2) the impression that termination is mere boilerplate. By the time someone has worked through commercial terms that they care about, there is often little energy to negotiate termination. There is also an impression that it isn’t worth negotiating.
- It Won’t Happen to Us. Termination is often treated more like a contingency than a commercial tool. Many companies assume a contract will only be terminated if something goes catastrophically wrong. This assumption ignores the very real practical benefits of good termination clauses, including leverage, optionality, and a safety net if the relationship deteriorates.
In sum, termination gets ignored more often than it should because of certain structural factors. This creates hidden contract risk.
4. A Few Final Thoughts
Contract risk often lurks where you least expect it. Rarely is it enough to just skim through and focus on the big-ticket commercial and legal items. Most of the risk—and what lawyers will argue over in a dispute—comes in details like definitions and cross-references. And sometimes risk isn’t technical at al. It’s psychological. When things get bad, being able to walk away is worth every breath of an awkward conversation.
Disclaimer: This blog is for informational purposes only and does not constitute legal advice. Reading or interacting with this content does not create an attorney–client relationship. You should consult a qualified attorney for advice regarding your specific situation. Mehaffy, PLLC disclaims all liability for actions taken or not taken based on this blog.