Entrepreneurs are risk-takers. An idea turns into a vision which is executed with passion and optimism. The latter, optimism, is one of an entrepreneurs’ greatest assets. Each day is seen an opportunity and each failure as a lesson learned.
Entrepreneurs should be aware of exits when entering into contracts. Handshake photo courtesy of Flickr user buddawiggi.
Unfortunately, unrestrained optimism can be a liability, particularly when entering into a contract.
One of the primary purposes of a contract is to allocate risk among the parties. To do that effectively, entrepreneurs need to be more risk-averse. This doesn’t mean to shed optimism—just reign it in a bit. Think about what could go wrong, both in terms of business and business relationships, and address those issues in the contract.
In particular, if nothing else, entrepreneurs should keep the following in mind, a lesson they can pick up by watching any half-decent spy movie: When you find yourself in a new situation, know your exits.
In any contract, there are a few basic exits to be aware of:
Term
- How long the contract will last. A contract might be effective for one month, one year, one decade, etc. The length of time that it is effective—commonly called the term—is a simple yet important element of any contract.
Renewal
- Whether the contract renews and, if so, whether renewal is automatic. A contract might provide that it will renew automatically unless either party gives the other notice that it would like to terminate the contract. Or it might provide the opposite, that is, that one party must notify the other if it wishes to renew the contract.
Breach
- How a party can terminate the contract if the other party breaches it. Louisiana law provides that when one party breaches a contract, the other party can have it terminated by a court. Generally, however, the parties should address termination more specifically—for example, providing for whether the party who breached the contract ought to be allowed time to cure its breach prior to termination.
Benchmark or Other Failure
- Whether one party can terminate the contract if the other fails to reach certain commercial benchmarks or engages in certain bad behavior. Say that one party is a services provider and the other is an independent contractor who resells those services. Their contract might state that the provider can terminate the contract if the contractor fails to make a certain number of sales each quarter, or is arrested for some crime. These types of provisions are important particularly when one party is worried about protecting itself and its image.
Termination At Will
- Whether either party can terminate the contract for any reason whatsoever. Perhaps a better deal comes along. Or perhaps a party can predict that its cash flows are going to be lower than expected next year and that, as a result, it will breach its contract. In both of these cases, it may be best for that party to terminate its current contract. But without a provision providing for that right—commonly called a termination at will or termination without cause provision—that party is out of luck.
These scenarios are by no means exhaustive. Some contracts may call for fewer termination provisions, others may call for more. Regardless, they illustrate an important point: A contract isn’t just a handshake or a piece of paper. It’s evidence of a relationship, one created by weeks or even months of negotiations and by which both parties benefit.
Unlike a friendship or a marriage, it’s a relationship with a twist: Both parties know and expect that their contract will one day end. Therefore, it is best contracting and business practice to address this eventuality at the beginning of the relationship instead of at its close.
This article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only, and you are urged to consult your own attorney concerning your own situation and any specific legal questions you may have.