Common Mistakes in Contract Clauses That Cost Companies Money

October 3, 2024 • Contract Management • 8 minutes

Table of contents Newsletter

  1. Why contract clause mistakes matter
  2. Best practices for avoiding contract clause mistakes
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Contract clauses are the essential parts of every contract, which lay out the key responsibilities and expectations between your company and its vendors or suppliers. If mistakes slip into these clauses, they can trigger financial losses, legal battles, and derail your financial planning.

In this post, we’ll break down the most common contract clause mistakes finance professionals should watch out for, using real-world examples to show their impact on your business — and how to prevent them.

Why contract clause mistakes matter

Mistakes in contract clauses can throw your entire finance department into chaos. They often lead to serious financial and legal consequences. Overlooking key details or failing to clarify terms will expose your company to unnecessary risks, including:

  • Unfavorable payment terms
  • Expensive penalties
  • Unclear liability and responsibility

Here are some of the most common mistakes in contract clauses and how to avoid them.

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1. Vague indemnity clauses

Indemnity clauses protect your company by clearly outlining who is responsible for specific losses or damages. When these clauses are vague, they leave your company open to major financial setbacks.

What is an indemnity clause?

Indemnity clauses shift financial responsibility for certain risks, damages, or legal claims from one party to another. Think of them as your “get out of jail free card” when someone else drops the ball.

Common mistakes in indemnity clauses

  • Failing to specify the scope of indemnity, leaving uncertainty around what losses or claims are covered. If the scope of indemnity isn’t clearly defined, your company could end up paying for damages caused by a vendor’s mistake, such as a defective product or service, even if it wasn’t your fault.
  • Overlooking third-party claims in the indemnity clause can leave your company open to lawsuits if a vendor’s product or service causes harm to a customer or another business. Without clear language covering third-party claims, your company could be on the hook for damages or legal fees.

Case law example about indemnity clauses

Northrop Grumman Corp. v. Zambrano (2016) – In this case, Northrop Grumman enforced an indemnity clause when their subcontractor failed to meet their performance standards. With clear indemnity terms, Northrop Grumman recovered damages from the subcontractor without a lengthy, expensive legal dispute. Had the indemnity clause been vague, Northrop Grumman could’ve taken the hit for the subcontractor’s mistakes.

Questions to ask when reviewing indemnity clauses

  • Is the scope of indemnity clearly defined? If the scope isn’t clear, your company may have to cover costs you didn’t anticipate. Make sure it specifically outlines what risks and damages are included.
  • Are third-party claims and legal fees covered, and by whom? Ambiguity here can lead to disputes over who pays for third-party claims or legal fees.

Why indemnity clauses matter

Without a well-defined indemnity clause, your company could be liable for damages or legal claims caused by a vendor’s actions that were completely out of your control. A vague indemnity clause can cause lengthy legal disputes and financial losses.

2. Unclear termination clauses

Termination of contract clauses allow either party to exit a contract under certain conditions. An unclear termination clause can leave you trapped in unfavorable terms or facing penalties.

Common mistakes in termination clauses

  • Failing to spell out conditions for early termination, forcing you to pay penalties even when the vendor fails to deliver. This can lead to financial strain and limit your flexibility.
  • Not specifying the termination notice period, leading to disputes over whether the termination procedures were followed properly. This lack of clarity can equal expensive legal battles and being stuck with underperforming vendors.

Case law example about termination clauses

Case Law: Barton v. B.C. Medical Association (1991) – In this case, the absence of a well-defined termination clause led to a time-consuming legal dispute. The parties disagreed on how the contract could be terminated, resulting in financial losses and a long court battle. Clear termination terms could have saved them from costly legal and financial headaches.

Questions to ask when reviewing termination clauses

  • What are the notice requirements for termination? Clear notice requirements let both parties know how much time is needed to legally end the contract. Without this, you risk expensive delays or disputes if you want to terminate the agreement.
  • Are there penalties for early termination? Understanding potential penalties helps you avoid surprises if you need to exit a bad agreement. Without clear terms, you could end up paying hefty fees, even if the vendor is underperforming.

Why termination clauses matter

A poorly drafted termination clause locks your company into an unfavorable contract, leading to financial strain and limiting your options. Clearly defined termination terms give you the freedom to adapt to changing circumstances without paying stiff penalties.

3. Inconsistent payment terms clauses

Payment terms contract clauses establish how and when payments have to be made. Inconsistent or unclear payment terms can disrupt your company’s cash flow and damage vendor relationships.

Common mistakes in payment terms clauses

  • Leaving out payment deadlines making it difficult to hold the other party accountable when the bill is due. This uncertainty can disrupt cash flow and strain your vendor relationships.
  • Failing to define late payment penalties or early payment discounts, resulting in delayed payments. This contract clause mistake means slower cash flow and fewer cost-saving opportunities.

Case law example about payment terms clauses

Linnell v. Hall (2010) – The buyer lost out on key savings due to unclear early payment terms, highlighting why crystal-clear payment clauses matter. This case shows how vague terms can negatively affect cash flow and increase expenses.

Questions to ask when reviewing payment terms clauses

  • Are the payment deadlines and methods clearly defined? Without specific deadlines and payment methods, there’s room for confusion that can cause delays or missed payments.
  • Are late payment penalties and early payment discounts specific enough? Vague terms leave your company without recourse if payments are late or opportunities for cost savings are missed.

Why payment terms clauses matter

Unclear payment terms cause payment delays, disrupting cash flow and adding avoidable costs. Clear payment terms prevent disputes, speed up payments, and keep your financials running smoothly.

4. Overlooked confidentiality and data security clauses

Confidentiality and data security clauses protect your company’s sensitive financial information. Overlooking these clauses can result in data breaches and financial losses.

Common mistakes in confidentiality clauses

  • Failing to specify what constitutes confidential information, creating confusion about what should be protected. For example, proprietary financial data or client lists could be mistakenly shared, leading to competitive disadvantages.
  • Not outlining the consequences of a breach, making it impossible to recover damages or take legal action. For instance, if a vendor leaks sensitive data, your company could face reputational damage without a clear path for recourse.

Case law example about confidentiality clauses

IBM Corp. v. Comdisco, Inc. (2002) – In this case, Comdisco breached a confidentiality agreement by using IBM’s proprietary information in a way not authorized by the contract. This led to a legal dispute and large financial losses for IBM, reinforcing why it’s so important to have clearly defined confidentiality clauses in contracts.

Questions to ask when reviewing confidentiality clauses

  • Is confidential information clearly defined? If confidential information isn’t explicitly defined, there’s room for misunderstanding. This confusion could expose sensitive info like financial reports or trade secrets, putting your company at risk.
  • What are the consequences of a confidentiality breach? Without clearly defined consequences, a breach of confidentiality can happen without any real accountability or recourse. Setting penalties in advance guards your company against financial fallout and reputation damage from data breaches.

Why confidentiality clauses matter

Without strong confidentiality clauses, your company’s financial data could be exposed, leading to competitive disadvantages, legal challenges, and lost revenue.

Best practices for avoiding contract clause mistakes

These actionable tips will help your finance team avoid common mistakes in contract clauses and strengthen your vendor agreements.

1. Create a contract review checklist

Develop a checklist to review vendor and supplier agreements that highlights key vendor clauses like indemnity, termination, payments terms, and confidentiality terms. This will help you make sure no important details are overlooked and identify financial risks or opportunities before the contract is finalized. For more guidance, consider elements from this contract review checklist designed for finance professionals.

2. Use contract management software

Contract lifecycle management (CLM) tools like Concord simplify the contract review process. Features like Agreement Intelligence and an unlimited custom clause library make it easier to manage and organize your contracts.

3. Collaborate with finance, procurement, and legal teams

Work closely with procurement and legal teams to verify that all contract clauses — especially financial ones — align with your company’s objectives. This cross-departmental collaboration reduces the risk of mistakes, helps negotiate favorable terms, and makes sure that every clause reflects your company’s financial strategy.

4. Regularly audit contract performance and compliance

Perform routine audits of your vendor contracts to verify that key clauses, such as payment deadlines and penalties, are being met. Regular audits help identify issues early and enable you to address non-compliance before it impacts your bottom line.

Conclusion

Understanding and avoiding these common contract clause mistakes will help you protect your company’s finances and maintain healthy vendor relationships. Taking the time to thoroughly review each clause and working closely with your legal team will help you spot risks before they turn into costly problems. With clear, mistake-free contracts, you can help set your company up for smoother operations.

Explore how Concord’s Agreement Intelligence, powered by AI can help you manage contract review more effectively.

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