Contract Review

When carrying out a contract review, there is not always time to analyse the entire agreement and every formulation at the same level of detail. This is particularly true when the timetable is tight and the transaction needs to move forward. Even so, the review should not be carried out at random.

Not all clauses are equally important. Certain provisions have a far greater impact on cost, room for manoeuvre, liability and enforceability than others. Time should therefore be allocated to the issues where the review normally delivers the greatest value: who the counterparty is, which law applies, how the agreement can be terminated, how the price may be adjusted, where liability sits and what happens if the delivery fails.

The question is therefore not whether a short review is sufficient for a complete legal analysis. The point is that the contract review must begin where the most significant problems often arise.

1. Identifiable parties and authority to enter into the agreement

A simple but important point is that it must be clear who the parties actually are. This may sound obvious, but it is a common source of problems in international agreements, group structures, digital standard terms and agreements where the counterparty is identified by brand name rather than legal name.

If it is unclear in which country a party is established, if company registration details are missing, or if several group companies are used in different parts of the agreement, there may be uncertainty as to who the actual contracting party is. This may in turn affect invoicing, liability, dispute resolution, data protection, sanctions, claims handling and the ability to enforce a claim.

It should also be checked that the person signing the agreement has authority to represent the party. Authority may, for example, follow from company signatory rights, a power of attorney or implied authority arising from position, but the assessment depends on the circumstances. For foreign counterparties, the corresponding check may require company registry extracts, a ‘certificate of incumbency’ or other documentation.

It is particularly important to check whether the agreement refers to several different documents in which different legal entities appear, for example in order forms, data processing agreements and special terms and conditions.

Practical control question: Is the legal entity entering into the agreement clearly identified, including where it is established and whether the right person has authority to sign?

2. Governing law and dispute resolution

A governing law clause determines which country’s law is to be used to interpret the agreement. It can have significant implications for liability, damages, breach of contract, termination, limitation periods, invalidity and the ability to invoke remedies. It is not only that the outcome may be affected by which law applies; it also affects the negotiating position if a dispute is conducted on home ground.

In commercial agreements, the parties often choose a law that is natural in light of where they are established or where the delivery is mainly performed. In international agreements, English law, the law of a US state or another foreign law is often used. This is not necessarily wrong, but it means that the agreement and the risks of entering into it may need to be analysed on different premises than if it were governed by domestic law.

It is not enough to check the governing law. The forum for dispute resolution must also be reviewed. A dispute may end up before the ordinary courts, in arbitration or before a court in another country. This affects cost, litigation risk, confidentiality, timing and the practical ability to pursue claims.

If the agreement lacks clear regulation of governing law and forum, the legal position may become more complicated, particularly in cross-border agreements. In such cases, private international law rules may affect which country’s law applies and where a dispute may be heard.

Practical control question: Which country’s law governs the agreement, and where must a dispute be pursued if something goes wrong?

3. Automatic renewal

Automatic renewal is one of the most common hidden cost risks in commercial agreements. The clause may look administrative, but in practice it determines whether the company becomes locked into an agreement for longer than planned.

This is particularly important in subscription agreements, SaaS agreements, licence agreements and ongoing service contracts. The agreement may renew for a year or more if notice of termination is not given in time. The notice period may also fall well before the end of the contract term, for example six months before the renewal date.

The key point is therefore not only to see whether the agreement renews automatically. It must also be checked for how long it renews, on what terms the renewal takes place and what is required to prevent the renewal.

Practical control question: When must the agreement be terminated in order to avoid automatic renewal?

4. Termination

The termination clause determines whether the customer can actually leave the agreement when the arrangement no longer delivers the intended value. It is one of the most business-critical parts of a supplier agreement, but it may be overlooked when the focus is on closing the deal.

It should be checked whether the agreement can be terminated without cause, or whether the commitment is fixed for the entire contract term. It should also be clear whether there is a right to terminate in the event of material breach, repeated minor failures or prolonged operational problems.

A termination right may be weak in practice if the supplier is first given a long cure period, if the defect must be very serious or if the customer must still pay for the remaining contract term.

Check in particular:

• whether the agreement has a minimum commitment period,
• whether termination requires a specific form or notice period,
• whether fees apply on early termination,
• whether prepaid fees are refunded,
• whether the customer must pay remaining fees, and
• whether repeated failures give a right to leave the agreement.

Practical control question: Is it possible to get out of the agreement, and what will it cost?

5. Price adjustments and indexation

Price adjustment clauses often receive too little attention. That can be a mistake. In longer agreements and subscription models, price adjustments may affect the total cost more than the price originally stated in the agreement.

Pay particular attention to words such as “reasonable”, “market-based” or similar expressions. Such terms may be appropriate in certain contexts, but they should not be left entirely open when they govern future costs. A price adjustment should be limited, predictable and linked to clear parameters.

The customer may consider requesting a cap on price increases, a requirement for advance notice and a right to terminate the agreement if the increase exceeds a certain level. This is particularly important where the supplier provides business-critical systems or services that are difficult to replace quickly.

Practical control question: How much can the price be increased, when can it be increased, and is there a right to leave the agreement if the increase becomes too high?

6. Limitation of liability

The limitation of liability shows how much risk the supplier actually accepts. It is therefore one of the most important clauses to check in a contract review.

The limitation of liability may be linked to the annual fee, a fixed amount or the fees paid during a certain period. A low liability cap may make the agreement commercially weak for the customer, even if the rest of the agreement appears balanced.

It is not enough to consider only the amount. It must also be checked which types of loss are covered and which are excluded. Indirect losses, loss of data, regulatory costs, third-party claims and restoration costs may be wholly or partly excluded.

A low annual fee does not necessarily say anything about the loss that may arise if the service fails. The liability cap must therefore be assessed in relation to the importance of the service, potential consequential losses, the customer’s regulatory exposure and the organisation’s actual risk appetite.

Practical control question: If something goes wrong, is the limitation of liability sufficient for the loss that may actually arise?

7. Special compensation undertakings and indemnities

Special compensation undertakings, or ‘indemnities’, are common in international agreements and are becoming increasingly common in commercial contracts more generally. They may concern, for example, intellectual property infringement, third-party claims, data protection incidents, breach of law, security deficiencies or the supplier’s subcontractors.

A special compensation undertaking may go further than ordinary liability in damages. It may mean that one party must hold the other harmless against certain claims, costs or losses. In English-language agreements, the concept may have a specific legal and commercial meaning that does not always correspond to domestic principles of damages.

It must therefore be checked what the indemnity clause actually covers. Is it limited to third-party claims, or does it also apply to direct claims between the parties? Are legal costs, sanctions from authorities, settlements and internal costs covered? Is the indemnified party required to follow a specific process, for example by notifying claims promptly or allowing the counterparty to control the defence and settlement?

It is also important to see how the indemnity clause interacts with the limitation of liability. It is not unusual for special compensation undertakings to sit outside the general limitation of liability in the agreement. In some agreements, they are subject to the same limitations as other liability. The difference may be commercially decisive.

Practical control question: What special compensation undertakings exist, and do they apply within or outside the limitation of liability?

8. Service level agreement terms and remedies

A service level agreement is not strong simply because it contains a high availability level, for example 99.9 per cent. The decisive issue is what happens if the supplier does not deliver at the agreed level.

Service credits are often low and function more as a price reduction than as real compensation. They may be reasonable as part of the contractual model, but they rarely solve the customer’s actual problem in the event of outages, production stoppages or recurring failures.

A useful service level agreement should be linked to the actual needs of the business. It should also contain clear measurement periods, reporting requirements, escalation routes and consequences for repeated deviations.

Check in particular whether repeated breaches of the service level agreement give the customer a right to terminate the agreement. A service level agreement without practical remedies may create false comfort: it looks structured on paper, but provides weak protection when problems arise.

Practical control question: What does it mean for the business if the supplier does not deliver in accordance with the service level agreement?

9. Definitions

Definitions are often perceived as technical or formal. In reality, they may control the scope of the agreement more than many of the main clauses.

Terms such as “Services”, “System”, “Customer Data”, “Confidential Information” and “Deliverables” may be decisive. If “Services” is defined narrowly, the customer may be buying something different from what it believes it is buying. If “Customer Data” is defined unclearly, it may be uncertain what the customer is entitled to receive back on termination. If “Confidential Information” is too narrow, sensitive business information may fall outside the protection.

Definitions affect liability, the service level agreement, support, licence rights, data protection and exit. They should therefore not be read in isolation. They need to be read together with the clauses in which the terms are used.

This is particularly important in IT agreements, SaaS agreements and agreements concerning data, integrations or operations. Small differences in the definitions may have significant practical effect.

Practical control question: Is what the customer believes it is buying actually included in the definition of the service?

10. Exit and transition

Exit clauses are negotiated when the relationship is good. They are needed when the relationship functions poorly.

It is therefore risky to postpone exit issues. Once the agreement is to be terminated, the customer may be dependent on the supplier for data, documentation, history, access, integrations and handover to a new supplier.

Check how and when the customer receives its data back, in what format the data must be provided and for how long the supplier must assist after termination. Also check whether the supplier has an obligation to assist with transition to a new supplier and what such support costs.

For cloud services, outsourced functions and business-critical systems, exit is not an administrative issue. It is a continuity issue. Without a functioning exit clause, the customer may in practice remain locked in even after the agreement has formally ended.

Practical control question: Can the supplier be phased out without affecting the business more than the organisation can accept?

Why these clauses matter in a service level agreement review

In a contract review, prioritisation does not mean that certain parts of the agreement are unimportant. It means that certain clauses typically create greater commercial exposure than others.

These ten control points should often be reviewed carefully because they satisfy several of the following criteria:

• They affect the greatest financial risk.
• They affect whether the agreement can be enforced against the right counterparty.
• They determine which country’s law and which forum govern a dispute.
• They are difficult to correct after signing.
• They are often placed in standard terms, appendices or order forms.
• They may create problems only long after the agreement was entered into.
• They are often negotiable.

The final point is important. Customers sometimes assume that the supplier’s standard terms are fixed. That does not have to be the case. In many commercial agreements, the supplier expects some negotiation around renewal, termination, liability, service level agreement terms, price adjustments, special liability undertakings, governing law and exit.

This does not mean that the customer will always secure every amendment. But it does mean that standard terms should not be treated as neutral simply because they are standardised. Standard terms are often drafted to protect the party that prepared them.

An effective contract review should therefore not try to check everything equally from the outset. It should first identify where the agreement may become costly, difficult to leave, difficult to enforce or operationally problematic. The review must therefore be based on the needs of the business and allow those needs to determine the approach in each individual agreement. A term that may be unproblematic in one agreement may be a dealbreaker in another.

Contract review means choosing the right risks first

A contract review is not about creating a sense of reassurance that everything has been checked when that has not been possible because time is limited. It is about prioritising correctly and placing the review where it delivers the greatest business value.

For the review to create value, the first step does not always have to be reading every word at the same level of detail. It does, however, need to start from where risks are normally hidden. In many supplier agreements, the risk is not found in the most obvious commercial points, but in standard terms, appendices, definitions, operational clauses and fundamental legal issues that determine who can be held liable and under which country’s law.

For companies that regularly buy IT services, cloud services, subscriptions or other supplier services, a clear review method can make a significant difference. It helps the business focus on the clauses that actually affect cost, risk, liability and freedom of action.

Do you need help reviewing or negotiating an agreement? Morling Consulting helps companies across Europe identify the clauses that actually affect risk, cost and freedom of action. Our business lawyers and contract review lawyer specialists help companies structure, review and negotiate commercial agreements, particularly where the legal analysis must be connected to practical business risk.