Successful business development depends on the stability and security of transaction terms. Every transaction should be based on an assessment of risks and measures to mitigate them, since transactions form the very foundation of business.
In our practice, we distinguish between two interconnected types of risk: commercial risk and legal risk. A contractual term that has been overlooked or improperly drafted may, in many cases, create a risk of delay in performance or termination of the transaction. In other words, legal shortcomings can lead to financial losses. This article briefly explains why legal precision and experience are important in contract drafting. The wording of a contract, the sequence and interrelationship of its provisions, and their compliance with the law enable the parties to address issues that might otherwise prevent them from achieving their original objectives. Our aim is for a contract to be more than a collection of words on paper: it should be a practical, effective mechanism that helps the parties achieve their goals. In our experience, trust between the parties should develop after the contract has been concluded and should be grounded in the proper performance of their obligations. Before entering into a contract, each party should recognise that circumstances may arise in the future that could lead to a breach. It is therefore essential to anticipate circumstances that may affect the parties when drafting a contract.
This article examines several aspects of contract architecture that help make a contract effective and workable in different circumstances.
The first principle of contract drafting is compliance with the form and content requirements established by law. In many cases, the law requires a contract to be in writing and imposes requirements on its content. These requirements must be observed. We recommend documenting contracts in writing. Failure to comply with statutory requirements concerning the form, content or procedure for entering into a contract may have various legal consequences, including restrictions on the evidence available to establish the circumstances of a transaction, refusal of registration, or invalidation of the transaction where provided for by law.
The second principle is that a contract should answer, clearly and precisely, at least three questions: “what?”, “where?” and “when?”. Once these questions have been addressed, the contract should also consider a second level of questions, such as “how?” and “what if?”. In particular, these questions should be applied to the parties’ liability for breach of contract and to payment terms.
In our view, asking these questions in a clear, coherent and logical sequence provides at least a basic level of risk control.
THE QUESTION “WHAT?”
A contract should clearly and accurately define what each party is to receive as a result of entering into it. In some cases, uncertainty in these terms may render a transaction invalid. This is addressed by defining the subject matter of the contract in specific terms. The subject matter is a material term of the contract where required by law—that is, a term on which the parties must reach agreement. For example, in a lease or a sale and purchase agreement, the subject matter is, respectively, the leased asset or the asset being sold. Each type of property has identifying particulars recognised by law. For immovable property, this may be a unique cadastral number; for movable property, it is often a unique serial number. In an increasingly digital environment, specifying accurate identifying details can provide additional protection because the same details may be recorded in government databases. Cross-checking property identifiers against government records can help reduce the risk of disputes over the identification of the property under the contract.
In a services agreement, it is important to define the nature, scope and manner of providing the services. If the parties expect a particular outcome, that outcome should be described and acceptance criteria established. The payment terms should also be agreed so that both parties understand what is being paid for and what constitutes proper performance, with the relevant criteria set out in sufficient detail.
The payment terms should reflect the nature of the services and the performance model agreed by the parties. It is important to specify what actions the service provider is required to perform, how the provision of services will be evidenced, and when the obligation to pay arises. This helps reduce the risk of disputes between the parties.
Accordingly, where a contract concerns a property transaction, the property should be identified precisely using the relevant particulars inherent to that property and/or recorded in government databases. The property should also be inspected, and the documents relating to it checked, before the contract is signed and before the relevant right is registered, if registration is required by law or agreed by the parties.
Where services are being procured, the expected outcome, if any, and the form and method by which it is to be delivered to the customer should be clearly described. Following these recommendations helps prevent substitution of the subject matter or discrepancies between it and the contracting party’s requirements.
THE QUESTION “WHERE?”
The question “where?” may apply to a broad range of contractual terms. It may concern the place where a transaction is entered into, the place where an obligation is to be performed, or the place where a dispute is to be resolved (jurisdiction and venue). It is also closely connected with the tax obligations arising from and performed in connection with a transaction. This is particularly relevant to international transactions, including intra-group transactions.
It is therefore useful to apply the question “where?” to each section of a contract and draft the relevant terms accordingly. A simple example is the place of delivery of goods. We often see supply agreements that specify only a town or city, rather than an exact address, on the assumption that the parties have worked together for a long time and know where the goods should be delivered. However, the purpose of a contract is to ensure that the carrier knows where to deliver the goods in any circumstances and that the buyer can rely on the stated delivery location if a dispute arises. The seller’s management, ownership or driver workforce may change, and any such change may cause a delivery delay.
Modern contracting practices provide different ways to address breaches, including delays, and to allocate risks. For example, the delivery of goods is addressed in detail by the Incoterms® rules, which allocate risks, costs and obligations at the relevant stages of delivery, including carriage. Incoterms® helps allocate certain obligations, costs and risks, but it does not replace contractual provisions dealing with transfer of title, payment, liability for breach, governing law or dispute resolution.
In practice, a number of clauses and concepts in the Incoterms® rules can serve as models for drafting contractual provisions even where the parties do not expressly incorporate Incoterms® into their relationship. In appropriate cases, we draw on this approach when drafting contracts to help protect our clients’ rights.
When applying the question “where?” to the resolution of disputes, it is important to consider not only court practice or the reputation and rules of an arbitral institution, but also whether a decision can be recognised and enforced in the relevant jurisdiction. The structure of the transaction should therefore be analysed and its performance modelled so that the party concerned has a clear and workable means of judicial or other legal protection. The recognition and enforcement of a foreign court judgment or arbitral award depend on the applicable national law, international treaties, the type of decision and the grounds for recognition or refusal of enforcement. In this context, it is important to analyse the international treaties on mutual legal assistance to which the Republic of Kazakhstan is a party.
Tax considerations are particularly important in light of the entry into force of the new Tax Code. For VAT purposes, the place of supply of goods, works and services is determined under the criteria established by the Tax Code for the relevant type of transaction. The place where a contract is concluded, the currency of payment and the place of payment do not, in themselves, determine the place of supply. Contract drafting should therefore take account of the nature of the transaction and the tax rules applicable to it.
Accordingly, clearly drafted contractual terms addressing the question “where?” can significantly facilitate tax administration for the taxpayers that are parties to the contract.
THE QUESTION “WHEN?”
In certain cases, legislation treats the time for performance as a material term of a transaction, for example in a supply agreement. Even where the law does not impose such a requirement, the party concerned should have a clear understanding of when the transaction, or any part of it, must be performed. The contract should also protect the recipient (buyer) against premature performance. It should specify whether early delivery is permitted, how the delivery time must be agreed in advance, and what consequences follow if the goods arrive outside the agreed delivery schedule.
For example, where the seller’s carrier delivers goods to the buyer’s warehouse or to a warehouse operated by a person authorised by the buyer, the supply agreement should address at least the following:
- The delivery schedule, taking into account the receiving organisation’s operating hours;
- Whether early performance is permitted;
- The seller’s obligation to provide the registration details of the vehicle and trailer, if any;
- Arrangements for weekends and public holidays;
- The minimum period allowed for unloading the goods.
In our practice, there was a case in which goods requiring special storage conditions were delivered to a warehouse ahead of schedule. The carrier consequently sought to recover costs associated with vehicle downtime because the warehouse was unable to accept the goods. In that case, our contract contained a straightforward clause prohibiting early performance (delivery) altogether, which helped keep the dispute within the relationship between the seller and the carrier.
If a contract requires one of the parties to take certain actions, the “Liability of the Parties” section should provide, separately or together, for a remedy in the event those actions are not taken and/or for the other party’s right to take countermeasures to protect itself from the consequences of the breach. Such countermeasures do not necessarily have to accommodate the interests of the party in breach.
We hope this article will be useful in your contract management. If needed, we are ready to undertake all or part of this work on your behalf.