Introduction

Reading a contract can feel like you’re trying to crack the code of an old treasure map. But don’t worry, you don't need a law degree to make sense of all that fancy legal language. Here’s an easy guide to help you read contracts like a pro lawyer, so you can spot the important stuff and keep your interests safe.

Read: The top 5 contract negotiation tips for your business

Grasping the structure

Every contract has its own structure, much like a plot in your favorite TV drama. Knowing these parts makes it easier to follow along. Here’s a quick tour:

• Preamble or recitals: These opening statements are the “Once upon a time” of your contract. They introduce the parties involved and the purpose of the agreement.

• Definitions: Early on, you'll often find a list defining key terms. This is crucial because if you think ‘Delivery’ means getting your pizza on time, but in contract-speak, it refers to something else, you'll want to know that up front. Carefully review the definitions and make sure they’re accurate.

• Body: Here’s where the action happens. It's the main plot with all the promises, rights, and drama (hopefully, the good kind). Every task, responsibility, and expectation lives here.

• Boilerplate: Don't skip the end credits. These general clauses might seem boring but can include crucial information, like dispute resolution and terms about ending the contract.

• Signatures: No signature, no deal. The signature section is where all parties agree to sign the agreement.

Critical clauses worth a closer look

When reading a contract, there are a few key sections that demand a bit more scrutiny. These clauses can really impact your business, so it’s important to understand exactly what you’re agreeing to. Here’s a closer look at each of these critical clauses.

Indemnity clauses

In the business world, an indemnity clause determines who is financially responsible if something goes wrong, like a legal claim or a loss related to the services or products provided. This clause can significantly impact your risk and liability, so it’s essential to understand both sides of it—whether you’re the one giving the indemnity (promising to cover losses) or receiving it (protected against losses).

When you give an indemnity, you agree to cover costs if specific problems arise. This increases your risk because you’re responsible for paying potentially hefty fees if claims are made against the services or products you provided. For example, if you're a software developer and the software you’ve developed infringes the intellectual property of a third party named Technology Solutions Inc, and Technology Solutions Inc sues your client, if you’ve given an indemnity to your client, your client could recover the costs related to the lawsuit from you.

On the flip side, receiving an indemnity means you're protected from certain losses. This lowers your risk since another party promises to compensate you if specific issues occur due to their actions or failures. For instance, if you hire a contractor to install new hardware and they damage your existing systems, they (if you’re properly covered by the indemnity clause) would be responsible for the repair costs.

Capping an indemnity means setting a maximum limit on the amount one party has to pay to the other under the indemnity. This is crucial for managing risk and ensuring that a severe mistake doesn’t lead to a financially devastating situation. Always consider whether it’s appropriate to cap an indemnity, taking into account the risks involved and the context. If you do decide to cap it, you might decide to cap the indemnity at the total value of the contract.

Let’s consider a simple example of how indemnities work in practice.

Imagine you own a small catering business. You enter into a contract to provide services for a corporate event. Your contract includes an indemnity clause stating that if you fail to deliver the food on time, causing the event to be delayed, you’ll cover the additional venue and staffing costs incurred due to the delay. To manage your risk, you cap your indemnity at $10,000. This means if the costs of claims exceed this amount, your liability stops there, protecting your business from overwhelming financial damage.

Read: The pros and cons of using standard contract templates

Termination

Every business needs a clean break option—kind of like an emergency exit in a movie theater. That's where a termination clause comes in. It's the part of the contract that spells out how you or the other party can call it quits.

When you're looking at the termination clause, pay close attention to the rules of the road for ending the contract. Ask yourself:

• Are there any penalties or fees if you decide to end things early?

• Do you need to give a heads-up if you quit, and if so, how long in advance? (This is often called “notice” or a “notice period.”

It's crucial to have these conditions crystal clear to avoid any "he said, she said" about whether the contract was ended on the up-and-up. Make sure everything is spelled out so everyone knows the deal from the start, preventing any messy breakups later on.

Confidentiality clause

Got some juicy secrets that give your business the upper hand? That’s where the confidentiality clause steps in. A confidentiality clause safeguards your valuable information under a contract—especially crucial in businesses where keeping your secret sauce under wraps is key to staying competitive.

First off, check how “confidential information” is defined. You want to make sure it covers all the bases without sneaky loopholes. For example, some contracts might only protect information that's marked as “confidential” in writing, so you'll need to keep your eyes peeled for those details.

Next up, consider the exclusions. Sometimes you need to share some of that secret stuff with people on your team, like employees or consultants, or maybe even your professional advisors, like a lawyer. Make sure your clause allows for that, and also covers you if the law forces you to spill the beans.

Lastly, don’t forget to look at how long this secrecy pact lasts. You want a timeframe that makes sense. Locking down information forever isn't practical, unless you're dealing with eternal trade secrets or it makes sense for the context. Aim for a duration that protects your interests without overdoing it.

Limitation of liability clause

When things go wrong in business, a limitation of liability clause is like having a safety net. It's there to make sure that if you have to pay out due to a problem, you won't be left emptying your pockets entirely.

Think of it as your financial damage control plan. This part of the contract specifies the maximum amount you could be responsible for if there's a mess-up. It’s about setting a ceiling on what you could owe, so a single mistake doesn’t sink your business.

When reviewing a limitation of liability clause, always make sure there’s a clause that says you’re only covering the direct costs (unless the context otherwise requires it). For example, if a delivery goes wrong, you’d cover the cost to correct it, but not the lost sales or the hit to the customer's reputation because of the delay. It’s crucial to say that you won't pay for the domino effects, like lost future profits or damage to reputation. These are indirect and can get wildly expensive and hard to measure.

Next, decide on a reasonable but maximum amount on your liability that you can handle if you break a promise under a contract—this could be a fixed amount or a percentage of the contract value. This cap helps keep things fair and makes sure you’re not on the hook for more money than the deal is worth.

The cap should make sense for both you and your partner in the contract. It shouldn't be so high that you're taking on too much risk, or so low that it's unfair to them.

Setting limits on your liability is about protecting your business from being overwhelmed by financial claims. It helps you manage risk and assures everyone involved that you’re serious about your commitments, but also cautious about your business's health.

Force majeure clauses

Every now and then, life throws a curveball—like dropping a pandemic on your lap (we’re looking at you, COVID-19) or stirring up a hurricane. That’s where a force majeure clause comes in handy. It’s your get-out-of-jail-free card for those times which stop you from keeping your end of a deal under a contract.

So, how should you read a force majeure clause?

First, start by reviewing what counts as a force majeure event. Typically, this includes major incidents like natural disasters, wars, or government actions that make it impossible for you to meet your promises. It’s important to get the wording right so it's clear what’s included. An "act of God" usually refers to natural events only, like hurricanes or earthquakes, while force majeure covers a wider range, including human-caused events like strikes or wars.

Then, lay out the necessary steps if such an event happens. Generally, you should promptly notify the other party, explaining that the force majeure clause is being invoked due to circumstances beyond your control.

Finally, understand the duration of the coverage. The clause should specify how long you can pause your promises under the contract and what happens if the event continues longer than expected. This keeps both parties informed during extended disruptions.

Read: Why you should always have a contract when doing business

Other tips to review a contract

• Read with purpose: Grab a coffee and read the contract from start to finish. Understand the big picture before diving into the weeds. For example, do the commercials align with your expectations? Get the financial details right before diving into the contract.

• Highlight like it’s an art form: Arm yourself with a highlighter for key responsibilities and terms. Make annotations or notes on margins for anything unclear or needing a double-take.

• Fill in the gaps: Watch out for what isn’t there as much as for what is. If something you expect isn't written down, it’s usually as good as nonexistent in the eyes of the law.

• Track changes between drifts: If you’re juggling multiple versions, compare them like you would suspicious characters in a mystery show. Ensure all your agreed edits made it into the final draft.

• Question everything: If something reads odd, ask. Never assume.

Avoid these common traps

• Ignoring the small print: It’s tempting to skim the boring parts, but that's often where the gotchas hide. Always read the contract carefully, even the not-so-exciting bits.

• Thinking it’s set in stone: Most "standard" clauses are more like guidelines. Negotiate your heart out if something doesn't suit you.

• Missing references: If the contract mentions other documents or sections, read those too. They’re often crucial to understanding your full responsibilities.

Conclusion

Reading a contract like a lawyer means paying attention, being thorough, and not getting intimidated by the formal language. Take it step by step and always ask questions if something doesn’t look or read right.

Now that you’re equipped with these tips, you can tackle contract reading with confidence.

How Cobrief can help with contract review

Reading your business contracts can feel overwhelming as an owner-manager of a small to medium-sized business. That’s where Cobrief comes in. Cobrief helps business owners and operators review their business-to-business contracts for legal risks.

Upload your contract to Cobrief's AI contract review software, click review and you’ll get a list of all the risks, in plain English. This helps you decide whether to sign, negotiate or reject the terms of your contract, or hire a lawyer. Think of it as a heat map for your contracts.

Get started here.