Business contract review process requires consideration of the negotiation background leading up to the contract, the relationship with the other party, and circumstances specific to the contract, so it is not amenable to mechanical processing.
However, there are commonly used contract review techniques and points to be aware of, so knowing these can be a hint when reviewing a contract.
In this article, virtual assistant for attorneys will explain some useful techniques to remember and checkpoints to pay attention to when reviewing a contract.
Contract review techniques
When reviewing a contract, it is important to keep in mind two things: clarifying rights and obligations, and minimizing legal risks. When reviewing a contract from this perspective, it is useful to remember the following techniques:
Setting a cap on damages
Example clause: The amount of damages that Party A bears to Party B in connection with this Agreement shall not exceed the amount that Party A has received from Party B under Article.
Under the Civil Code, if a party fails to fulfill a contractual obligation and causes damage to the other party, the party is liable to pay compensation unless there is a reason for exemption from liability. And in some cases, you may have to pay huge amounts of compensation.
Therefore, even if you are found liable for damages, you can avoid paying a large amount of compensation by limiting the amount of damages.
However, when determining the maximum amount of damages, you need to consider whether your company is likely to be liable for a large amount of damages or whether it is likely that you will have to claim against the other party.
For example, in a service outsourcing contract, it is unlikely that the principal will be held liable for a large amount of damages to the contractor. This is because the principal basically only has a monetary obligation to pay the service outsourcing fee, and even if the principal is held liable for damages, the amount will not significantly exceed the amount of the service outsourcing fee.
On the other hand, the contractor may be liable for large damages to the client if the contractor cannot carry out the entrusted work.
Therefore, in the case of a contract for services, setting a limit on the amount of damages does not benefit the principal much, but it does benefit the contractor greatly.
On the other hand, if the amount of damages is limited, the principal may not be able to receive sufficient compensation when claiming damages, so in some cases, it may be better not to have a limit.
Limiting the debtor’s fault in damage claims
Example clause: If Party A violates this agreement and causes damage to Party B, Party A will be liable to compensate for such damage only in cases of intent or gross negligence.
Under the Civil Code, even if a contractual obligation is violated, liability for damages is exempted if there is no attributable cause. This attributable cause is determined in light of the cause of the obligation, such as the contract and socially accepted conventions regarding transactions.
Under the Civil Code before the revision, liability for damages occurred in cases of intent or negligence, so even after the revision, negligence may be found to be a reason for attribution.
Therefore, liability for damages can be limited to intentional or gross negligence cases, so liability can be avoided even in the case of slight negligence.
In this regard, in the service contract example mentioned above, the trustee is often at risk of defaulting on the contract due to negligence or gross negligence, so it is often the trustee who benefits from limiting the liability to cases of gross negligence. It is natural for the principal to want to include a clause that holds them responsible even for minor negligence.
Limiting the scope of damages
Example clause 1: If Party A or Party B violates this Agreement and causes damage to the other party, they will be liable to compensate the other party for direct and actual ordinary damages.
Under civil law, the scope of damages for which compensation is permitted is ordinary damages and foreseeable special damages. By limiting the scope of damages beyond this civil law principle, you can avoid large amounts of damages even if you are found liable for damages.
Example clause 2: If either Party A or Party B causes damages (including attorney’s fees) to the other party or a third party in connection with the performance or non-performance of this Agreement, they will be liable to compensate such party.
Case law suggests that attorneys’ fees are unlikely to be recognized as damages in claims for breach of contract. Therefore, by including attorney’s fees in the scope of damages in advance in the contract, it is possible to ensure that attorney’s fees are recognized as damages.
In this case, the decision to include or delete this clause will also depend on whether your company is in the position to be sued for damages or make a claim for damages.
Make content fair
When the other party proposes a contract, it is usually in their favor. Therefore, the contract may contain provisions that unilaterally impose obligations on one party or grant favorable rights only to the other party.
For example, a voluntary termination clause may include a provision that allows only the other party to terminate the Agreement, such as, “Party A may terminate this Agreement immediately without any notice or warning if Party B falls under any of the following items.”
However, this means that even if a situation arises in which your company needs to terminate the contract, it will not be able to do so unless the termination is permitted by civil law.
Therefore, to allow voluntary termination within your company, you may consider including provisions allowing both parties to terminate the contract voluntarily, as follows:
Example clause: Party A and Party B may terminate this Agreement immediately without any notice or warning if the other party falls under the following items.
Defining the meaning of a term
Limiting the meaning of terms makes it possible to reduce the obligations assumed by contract. For example, in a confidentiality agreement, the definition of confidential information subject to the confidentiality obligation is of great importance.
The party disclosing the confidential information will often propose a comprehensive provision to ensure that no information is left out of the confidentiality obligation, such as, “Confidential Information in this Agreement means all technical, business, or other operational information of the other party learned through the performance of this Agreement.”
However, management costs will increase for the party receiving the confidential information if the scope of information that must be managed as confidential becomes wider.
Therefore, the party receiving the confidential information can limit its scope by adding the phrase “information that has been designated in writing by the other party as confidential.”
Example clause: Confidential information in this Agreement means any technical, business or other operational details of the other party that becomes known through the performance of this Agreement and that has been designated in writing by the other party as confidential.
Checkpoints to pay attention to when reviewing a contract
Three checkpoints require particular attention when reviewing a contract:
Rights and Obligations
The primary purpose of a contract is to clarify each party’s obligations and rights. Therefore, when reviewing a contract, it is necessary to check whether each party’s rights and responsibilities are accurately reflected in the agreement.
For example, in a sales contract, critical checkpoints include the object’s description, when and where it will be delivered, the price to be paid, and when and how it will be paid.
Duration
The contract period also plays a vital role in a contract. For example, in contracts that assume ongoing transactions, such as a basic transaction agreement, you need to be careful of cases where, even if you want to continue the transaction for as long as possible, there is no automatic renewal clause and the contract will end in one year, or there is a mid-term termination clause that allows the other party to terminate the contract at any time.
If you wish to maintain a stable business relationship, you should include an automatic renewal clause or removing the mid-term termination clause.
Jurisdiction
Contracts are important when you run into trouble with the other party. If you have a dispute with another party and cannot resolve it through negotiation, you may have to go to court to fix it.
Under the Civil Procedure Act, a lawsuit must generally be filed in the court with jurisdiction over the other party’s location, which means extra effort and costs are incurred if the other party is far away.
Therefore, it may be possible for the contract to stipulate that the district court with jurisdiction over the company’s head office location or a district court that the company can handle is the agreed-upon court of jurisdiction.
Overview of contract review process
When handing over a contract from your company to the other party, you will often use a format that already meets your company’s standards, but in principle, it is an important process that must be carried out regardless of the type of contract, the amount, or the relationship with the other party.
When we receive a contract from a business partner, we review the contract mainly as follows:
- Understand the contract details.
- Extract risks and issues.
- Create a revision proposal.
- Perform a final check of the revision proposal.
Understand the contract
The first step in reviewing a contract is to understand the entire picture of the contract. This involves clarifying the purpose and background of the contract and understanding the contents and conditions of the contract.
It is important to organize important basic information such as the names and company names of the contracting parties, the contract period, payment terms, scope of services to be provided, confidentiality and compensation for damages, and to accurately confirm the rights and obligations of the contracting parties.
Check for any inconsistencies or points that are not reflected in the contract by comparing it with related documents (quotations, proposals, email correspondence, etc.) and past contract history.
Identify risks and problems
Once you understand the contents of the contract, the next step is to identify risks and issues. We check each clause of the contract for risks or ambiguous wording, scrutinizing the content not only from a legal perspective but also from a business perspective.
In particular, it is important to check whether the contract contains any clauses that are unilaterally advantageous to the other party (such as contract termination conditions, compensation for damages, scope of liability, etc.).
In light of your company’s business and actual situation, evaluate whether the contract imposes obligations that are difficult to fulfill or whether it will cause disadvantages in transactions. Also, check whether there is any risk of violating laws and regulations related to your business.
Understanding these risks will help prevent future problems. It is important to consult with the legal department and on-site personnel as necessary and consider risks from multiple perspectives.
Create a revision plan
Once risks or issues are identified, we create solutions to address them.
If there are any errors that affect the content of the contract, such as typos or missing particles, or the first and second letters being reversed, we will correct them without fail.
In addition, consider making specific amendments that leave room for negotiation, such as adding conditions to unfair clauses or adding language that clarifies the scope of responsibility. It is important to be prepared to present amendments to the other party so that you can explain the reasons and background for them.
By setting priorities based on your company’s stance and risk tolerance, you can clarify the points that you cannot compromise on and the areas where you can compromise, aiming to reach a practical and smooth agreement.
Make a final check of your proposed revisions
After putting together a list of proposed revisions, we always perform a final check to ensure overall consistency and that nothing has been overlooked.
We will reconfirm whether the amendments are inconsistent with other clauses and whether the wording is appropriate from both a legal and business perspective. It is also important to check whether the amendments have created new risks or upset the overall balance of the contract.
In some cases, it may be effective to ask a legal professional or an outside lawyer to double-check the document. Neglecting the final check can lead to major problems, so it is important to finish it carefully.
Items to check when reviewing a contract
To properly review a contract, be sure to check the following six points:
・Are the contract contents and compensation reasonable?
・Are there any deficiencies or inconsistencies?
・Are they legally valid and lawful?
・Are the contents sufficient to prevent trouble?
・Are the contents effective?
・Is there any risk of it being considered unauthorized practice of law?
Are the contract contents and compensation reasonable?
The basic principle of contract review is to verify whether the contents of the contract and the compensation are reasonable.
For example, check whether the scope of the products or services to be provided is clearly defined, whether the method of provision and delivery schedule are realistic, etc. It is also important to check whether the amount paid as compensation is commensurate with the market price and the man-hours involved in the work, and whether any disadvantageous items are included.
Make sure that the payment terms (payment date, bank transfer fees, payment method, etc.) are clearly stated and that they are not vague.
Are there any deficiencies or contradictions?
Another essential part of the review is checking whether there are any omissions or contradictions in the contents of the contract. If the clauses are inconsistent with each other or important items are omitted, it will lead to differences in interpretation of the contract, which may cause problems later on.
In cases where the contract period is described differently in the previous and following documents, or where “delivery” and “handover” are confused, it becomes unclear at what point responsibility is transferred.
It is also important to ensure consistency in dates and definitions. For example, if terms such as “this Agreement” and “this document” are mixed, interpretations may vary depending on who reads the contract. When reviewing, be sure to write clearly to avoid differences in interpretation when the contract is executed.
Is it legally valid and legitimate?
It is also extremely important to confirm whether the contents of the contract are legally valid and lawful. For example, check whether the contract contains any content that violates public order and morals, or any content that violates relevant laws such as the Personal Information Protection Act, the Antimonopoly Act, or the Subcontract Act. Also check whether the contract format and signature meet the conditions for legal effect.
When using electronic contracts, it is necessary to take into account relevant regulations such as the Electronic Signature Act and the Electronic Bookkeeping Act.
If relevant laws and regulations are not followed, there is a risk that the contents of the contract will not be effective in the event of a problem, which will increase corporate risk. Since laws are revised regularly, it is very important to check whether the content complies with the latest laws.
Does it contain content that can prevent problems?
A contract is an important document that prevents future problems and disputes between the contracting parties. For this reason, it is necessary to make sure that the responsibility and response methods are clearly defined in the event of a contractual violation (termination conditions, scope and maximum amount of compensation for damages) and how to handle cases where performance cannot be performed due to force majeure (natural disasters, infectious diseases, etc.).
It is also important to confirm the governing law and the court of jurisdiction in the event of a dispute. If these are left unclear, it may take time and cost to resolve. By establishing clear clauses, you will be able to prepare a system that allows you to respond calmly and rationally in the unlikely event of a dispute.
Is the content effective?
It is also important to check whether the contents of the contract can be fulfilled in light of the actual work and circumstances. For example, if the delivery date is set extremely short or the terms are all favorable to the other party, your company may not be able to realistically fulfill the contract. If there are many ambiguous or abstract expressions, there may be differences in interpretation in practice, which may hinder performance.
A contract is meaningless unless it is in line with practice. Therefore, it is necessary to check the effectiveness of the contents by incorporating opinions not only from the legal department but also from those in charge of the actual work. When reviewing, make sure the content is easy for anyone to read and understand, and can be applied to work.
Is there a risk of it being considered unlawful practice?
When reviewing contracts, it is also important to be careful not to engage in unauthorized practice of law. Non-practicing legal practice refers to a person who is not licensed as a lawyer performing legal services for a fee, and is prohibited by the Attorneys Act.
For example, if an outside person who is not licensed as a lawyer reviews the contents of a contract in exchange for payment, this may be considered as non-practicing legal practice.
If it is deemed to be unauthorized practice of law, the validity of the contract may be called into question and you may be held legally liable, so you must proceed with caution.
Summary
Contract review techniques cannot be applied mechanically; they must be adapted to the circumstances and content of the contract.