Is cutting corners on your contracts putting your business at risk?

It is common ground that business owners need to be smart with their money and minimise expenses where possible. Unfortunately, this often means cutting corners by making important decisions without legal advice, using oral contracts, and attempting to get by on patchy form contracts hacked together from a late night on the internet.

While it might seem biased for a law firm to say so, this is playing Russian Roulette with your business.

Failing to secure the legal rights that your business model depends on

Modern business is fast paced and the temptation is to ‘just get it done’ and worry about the ‘legal stuff’ later. Unfortunately, the task of formalising the agreements between the parties seems to be constantly pushed to the back, and each party assumes that the other has pretty much the same understanding of the arrangement as they do. This seems to work ok for a while…and then an unexpected cost arises and everyone rushes to their legal positions hoping not to get stuck with the short straw.

A good example of this occurred in the case of TMA Australia Pty Ltd v Indect Electronics & Distribution GmbH [2015] NSWCA 343. TMA was an installer of third-party car park guidance systems (if you’ve been to a Westfield you’ve probably seen the sensors that tell you how many free spaces there are on each level of the car park), and Indect was a manufacturer of these systems.

TMA and Indect had a co-operative arrangement for a while, with Indect reps even attending TMA sales meetings sometimes to provide support and endorsement. They didn’t bother with full written contracts. The only written clauses were some brief terms about deliverables and warranty periods on the Indect quotes, with some reference to ‘standard terms & conditions’ which were never identified. Other than that the contracts for purchase of the systems were oral.

TMA built a large part of its business model for these systems on making a profit from the maintenance period, which required it to be able to purchase replacement parts directly from Indect for many years after installation. Some negotiations to formalise this as an exclusive dealership arrangement were attempted but nothing was signed.

The relationship eventually broke down when TMA withheld payment, asserting that Indect’s late delivery on a project had caused it to incur LDs. This led to threats of sabotage, and then to litigation to recover the debt, and then to Indect refusing to directly supply TMA with parts.

This all ended up in the NSW Court of Appeal (an expensive exercise for anyone) where TMA had the hard task of trying to assert that certain arrangements and understandings existed between the parties that were never recorded in writing. Ultimately, TMA’s case failed on all grounds and they were forced to perform their maintenance contracts with parts purchased from a supplier who was also a direct competitor.

Failing to ensure that you own the intellectual property that a contractor has produced for your business 

Another very common pit fall is using contractors to develop a website, software platform, artwork, media, documents, etc etc and failing to have them assign the intellectual property rights over to the company. Only in very particular circumstances will a court find that the company owns the IP rights without a written agreement.

The best approach is always to get written agreement upfront that what the contractor produces for you will be owned by your company. Trying to fix this up later, when your business relies on their work to operate, leaves you in a vulnerable position.

Cutting corners here will also undermine your bargaining position when it comes to selling your business or seeking investment. The business is the bundle of systems and legal rights that you use to convert wages, materials, and information into profits. If you don’t clearly own all of those systems, and the rights to use those systems, this harms your valuation. It also increases the discount that a purchaser applies to any offer to account for the risk this poses, and the cost of fixing this and other problems which they might find.

Relying on contracts hacked together from the internet 

Contracts can be likened to computer programs, they are a set of instructions that determine the rights, benefits and liabilities of the parties according to the events that occur throughout the transaction. Just like a computer program, you need to understand the underlying laws that govern the operation of contracts to properly understand how it actually works. A contract that that has been hacked together by a non-lawyer is about as reliable as a program that has been hacked together by a non-programmer – it’s going to be full of bugs, fail to handle important events, generate unintended results, and probably crash when put to the test.

The world is full of these DIY contracts, many of them readily available on the internet. They are verbose, self-contradictory, often contain terms that are invalid, and seldom provide the protections that their users hope they will provide.

It is important to control your costs, but not at the expense of protecting your business. Cutting corners on your contracts will leave you vulnerable, and it only takes once for your business to suffer real financial damage. Some expenses can be avoided, but when it comes to your contracts it’s important to bite the bullet and get it done right.

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