Most business owners understand that good contract provisions and practices can reduce the risk profile of their companies, but, along with risk reduction, a thoughtful and disciplined approach to contracts can also significantly enhance a company’s value.
Broadly, a company should manage its risks by negotiating for the inclusion in its contracts of risk allocation provisions that are favorable to it. Such risk allocation provisions include warranties regarding goods and services, remedies provisions, disclaimers of consequential damages, and limits of liability.
A seller of goods and services should seek to include contract terms to achieve the following:
- Limit its warranties to narrowly focused warranties – such as a warranty that goods or services will comply with their specifications – and disclaim express and implied warranties, including warranties of merchantability and fitness for a particular purpose.
- Provide narrowly tailored remedies for the breach of a warranty, such as the repair or replacement of a non-compliant good or services or the refund of the purchase price if repair or replacement is not feasible, minimizing potential money damages.
- Disclaim consequential and other indirect damages, especially classes of indirect damages that can be very large, such as lost profits and diminution in value.
- Limit its liability for money damages, such as, for example, to the amount of the purchase price for the goods or services.
On the other hand, a company purchasing goods or services should endeavor to make the representations and warranties of the seller as broad as possible, preserve all remedies available at law (including money damages), and avoid the inclusion of any disclaimer of consequential or indirect damages as well as any limitation of liability of the seller.
Finally, there is little benefit to negotiating favorable contracts if they are not actually signed or cannot be found. Missing and unsigned contracts are of limited value to a company in its operations as a going concern. Companies therefore should have procedures in place to ensure that they are signing their contracts and a storage system that allows signed contracts to be found quickly in case of any contract dispute or due diligence review.
In an exit event, a company’s contracts can have a powerful influence on a potential acquirer’s perception of the business and its value. A business owner may not immediately think about a valuation impact of commercial contracts – including contracts for the sale or purchase of goods or services – when preparing for the sale of his or her business. Acquirers conducting due diligence, however, typically will review the target company’s significant commercial contracts. Unfavorable or poorly drafted contracts may give a potential acquirer pause or cause it to attempt to negotiate a lower purchase price.
This post was written by Matthew D’Ascenzo