10 expert tips to safeguard your startup from costly contract disputes

10 expert tips to safeguard your startup from costly contract disputes

Signing the first contract for your startup can be an exciting milestone for a first-time founder. But contracts can get complicated, voluminous, and often confusing documents that founders would rather not deal with. 

As a startup lawyer, it is common to find out that the founders may even realise that they may not be in complete agreement on their initial terms.  Rather than taking the time needed to understand the terms or precisely agree on each term of the contract, they rather settle on vague descriptions of each party’s rights and obligations in the contract. 

Startups may also often be tempted to use legal templates, as they’re a cheaper alternative than hiring a startup lawyer and as far as the founder is concerned, it does the job to get the deal going.

This strategy works well in the short term which is to let parties “finalise” now and sign the contract. But when disputes arise, this initial approach to dealing with contracts usually results in time-consuming, expensive, embarrassing, and unpredictable litigation of the contract. 

Let’s take a look at several tips that you should know to avoid contract disputes for your startup.

Not putting things in writing

Relying on a “gentleman’s agreement” or a “handshake deal” is the usual excuse people make not to engage a startup lawyer to draft a contract. Under the law, a verbal or oral contract may be just as enforceable as a written contract.

However, considering that the parties may understand things differently from the meeting, it is often hard for the parties to agree on a default situation if one party ends up with a different view as to what was initially agreed upon. 

Under the law, all intellectual property (IP) created by a founder will not be automatically assigned until an assignment agreement is executed. In our experience, the IP created sometimes never gets transferred to the company at all and the company will be at risk if the founder decides to leave the venture without assigning the IP to the company. 

“Kick the can down the road” approach

In our experience, founders are eager to close off a deal and may rush to enter into a contract. It is easier to ignore and defer the important terms by ‘kicking the can down the road’ by persuading the other party to agree on the terms only in the future. As a founder, you may be delaying crucial discussions with the counterparty. 

Also Read: Going solo: Legal considerations for starting a small business in Singapore

Disputes may arise if the parties cannot agree to new prices in the next six months, or if the parties cannot come to a consensus on the new revised features when the terms are subjected to future review each calendar quarter. 

“Best effort” basis

Instead of agreeing on specific obligations and measurable metrics for objectively determining if a party has met those targets, first-time founders often prefer to use “best efforts”, “commercially reasonable efforts”, “reasonable efforts”, “good faith” or some other vague standards. 

The parties may not even know the differences between these phrases when asked. If the contract ends up in a court, you may be surprised to learn that judges usually may not agree on the meaning of these standards. The meanings will be interpreted differently depending on the court’s approach to interpreting the contract at the time. 

Vague terms

Founders tend to take definitions for granted. Similar to the previous ‘kick the can’ approach, they may instead hope the definition will somehow be mutually agreed upon in the future. For example, words such as “reasonable expenses”, “costs” and “standard quality” can mean differently to different people. 

In reality, it is impossible to agree on what will be the “standard” terms as they are not uniformly defined across the industry.  In the case of a dispute, even among expert witnesses.  

If you want your startup to get paid, your contract needs to have a series of deliverables described in the scope of work (SOW), a milestone table with deliverables, dates, and acceptance criteria (i.e. “When are we done?”), and a payment schedule is a good way to set everything out clearly.

Vague timeline

Rather than agree on a specific time period or date for certain tasks to be carried out, contracts that vaguely specify for tasks to be performed in a “timely manner”, “as soon as possible”, “as soon as practical” or “immediately” will invite problems in the future. It will be a better practice to state the number of days by which each party must get so and so done.

Conflicting terms

Let’s look at the duration clause inside a contract as an example. To avoid agreeing upfront on an agreed duration for the length of a contract, parties may end up entering into agreements specifying a one, two or three-year contract term and may even simultaneously agree that any party may terminate the agreement at any time upon written notice. When a party intends to terminate the contract, it may cause confusion as the terms are conflicted.

Excluding important terms from the contract

If it’s part of the agreement, you need to include it in the contract. A business plan or even a financial forecast spreadsheet can be incorporated into an agreement and is legally binding between you and the other parties (whether among shareholders or with new parties including investors). 

Legally speaking, if there is an agreement entered by the parties, any statement made during initial meetings or negotiations will not be binding as these statements will be presumed to have been superseded (by the new express terms set out in the contract). 

Also Read: All that you need to know about the term sheet for approaching investors

As a founder, you need to make sure that all terms of the deal are included in the contract or incorporate key documents by reference.

 Ambiguous terms 

If you’ve agreed to form a company with another Co-Founder, the founders’ agreement needs to address the agreed allocation for the set of duties and activities between the parties, the required time to get the tasks done, and the method for the work to be carried out and remedies (like forfeiture of the shares if the cofounder fails to perform the agreed set of tasks).

Unenforceable provisions

For a layperson, it may be hard to know if certain terms that you have included are known to be unenforceable under the law. If there is a dispute,  the judge will have to “figure it out” for the parties. The judge may either modify the relevant clause to make it enforceable or even decide that the clause is unenforceable. 

A non-compete clause may or may not be enforceable depending on the choice of governing law for the contract (for example, a non-compete is not enforceable in Malaysia). Even if is enforceable, it may be subject to the degree of reasonableness such as a geographical area or a duration for its enforcement may also need to be considered.

Overreliance on legal templates

When parties rely on a legal template, it can be tempting to just copy and paste or nowadays use the ‘online legal template generator’ by filling in the placeholders with your preferred terms. This ‘one size fits all’ may work a few times but not all the time as deals may end up getting complicated quickly. 

Don’t get me wrong. Legal templates are a huge help to get started but there is no such thing as a “standard” contract. There must be a good reason why every legal template you download will have a big legal disclaimer written in red bold letters.

Conclusion

Aside from the legal expenses, you will have to deal with the opportunity costs involved with the judicial process as there is an ambiguity when it comes to the litigation outcome as there is no way to predict how the court would interpret the contract. 

As a founder, you need to act prudently, don’t rush to close a deal for fear of “losing out’, and take the time needed to understand all the terms before signing a contract.

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