Key Takeaways

  • Reading a contract thoroughly helps identify unclear terms, risks, and responsibilities.
  • Always clarify definitions, vague language, or ambiguous clauses.
  • Consider context like governing law, dispute resolution, and termination terms.
  • Focus on high-risk clauses such as indemnity, limitation of liability, and confidentiality.
  • Don't rush—set aside quiet time to review, and consult an attorney when necessary.

If you are unsure how to read contracts, it is imperative that you ask for clarification. Understanding what you are reading is critical when signing any agreement. Due diligence at this point can reduce your risk of future complications. Whether you are entering a business deal or signing a mortgage document, make sure you understand all of the written terms and conditions.

How and When to Write Business Contracts

Small business owners will often operate without formally documenting terms and understandings. In contrast, when writing a contract, the parties have an opportunity to:

  • Clearly define their obligations and expectations
  • Reduce overall liability
  • Present desired payment terms
  • Divide associated business risks
  • Ensure that each party understands their personal responsibilities

Before you create a contract, the first step will be to create a contract that ensures both parties are talking about the same terms or "deal." That way, when each party goes to sign the contract itself, they are confident that they are in agreement.

Understand the Purpose of the Contract

Before diving into the details of a contract, ensure you understand the overall purpose of the agreement. Ask:

  • What is the contract meant to achieve?
  • Are all parties’ roles clearly defined?
  • Does the contract reflect the verbal agreements made?

Clarifying these points early helps you spot inconsistencies or gaps between the intent and the written terms.

Have Some Quality Alone Time with Your Contract

When reading your contract, it is recommended that you do so alone. When you do not take the time to fully review your contract, you may miss something important. If you're alone, you will not feel rushed and will be less likely to make mistakes. This is particularly the case when you are making a large purchase.

For example, when signing mortgage paperwork, you should request a copy in the mail before your signing date. If you do not, you can expect to be in your mortgage broker's office for several hours. When buying a car, you may be required to sign on the spot. Always request some time to read the contract without any distractions.

Always remember, you are the one spending the money. Do not allow anyone to pressure you and always ensure you know exactly what you're signing. Go through your contract line by line and if you have any questions, write them down so that you can address them fully.

Focus on Key Clauses

When reviewing a contract, pay special attention to certain clauses that typically carry the most legal weight:

  • Governing Law and Jurisdiction: Specifies which state's laws apply and where disputes will be resolved.
  • Payment Terms: Outline amounts, due dates, and penalties for late payment.
  • Termination Clauses: Define how and when the contract can be ended by either party.
  • Confidentiality and Non-Disclosure: Detail what information must be kept private.
  • Indemnity and Liability Limitations: Allocate financial responsibility if things go wrong.

Understanding these sections is crucial to assessing your obligations and protections.

Agree on Definitions

All terms in your agreement must be clearly defined. When it comes to difficulty in contracts, issues generally arise from missing or incomplete definitions. There has been a case where an unclear definition of "overhead" resulted in a lawsuit over payment terms. If you have any doubts and your questions are not answered, be prepared to walk away.

Watch for Ambiguous Language

Contracts often include vague terms like “reasonable efforts” or “best practices.” These phrases may seem harmless but can be subjective and lead to disputes. Whenever possible:

  • Request clear, measurable standards.
  • Replace general terms with specific timeframes, quantities, or descriptions.
  • Ask how undefined phrases might be interpreted in court.

Don't Assume — Ask for Clarification

When it comes to contracts, assumptions are the most challenging component. Even if you think you know what you are reading, always ask for clarification. Do not ever worry about appearing difficult or unintelligent. It is always better to clarify then and there instead of having to deal with potentially severe consequences in the future.

If the contract states something that could potentially contradict what the other party is saying, then you should ask questions. After all, the whole point of a written contract is to ensure that there are no verbal misunderstandings. If you find that the contract is far too complex, request a contract that is stated in simpler language.

Check for Hidden Risks

Beyond the obvious terms, look out for hidden risks that may be buried in the fine print:

  • Auto-Renewal Provisions: Does the contract automatically renew if not canceled within a certain timeframe?
  • Exclusivity Clauses: Are you restricted from working with competitors?
  • Penalty Clauses: Are there heavy penalties for breach, even for minor issues?

If you spot any red flags, ask for amendments or consult legal counsel before signing.

Ask "What is Missing?"

Although it is important to focus on what is potentially missing — this can be rather tricky. After all, how do you know what should be in a contract but is not currently included? A great example is employment contracts. In this case, there should be a clear section stating possible termination guidelines. If you do not see any terms related to when and how an employee can be terminated, it's important to ask.

Regardless of the type of contract you're dealing with, it's best to think of it like this. Simply imagine all of the things that could go wrong. Now, draft up a contract that will prevent future conflict. Proposed methods should also be outlined in case conflict occurs.

So remember, whenever you are signing an important document, always take your time and ask the right questions. When you take a proactive approach, you can avoid being reactive in the future. To avoid any conflict, be sure you understand everything that is written and if you do not, never hesitate to ask for clarification.

Consider Dispute Resolution Options

Many contracts include clauses about how disputes will be handled. Check for:

  • Mediation or Arbitration Requirements: Is court litigation required, or is there an obligation to pursue mediation/arbitration first?
  • Choice of Forum: Which court or jurisdiction will handle disputes?
  • Attorney’s Fees: Will the losing party be required to pay the winning party’s legal costs?

Knowing how disputes will be resolved can significantly impact your decision to sign the contract.

Frequently Asked Questions

  1. Why is it important to read a contract carefully before signing?
    Reading a contract carefully helps ensure you understand your obligations, rights, and potential risks, preventing misunderstandings or legal issues later.
  2. What are the most important clauses to review in a contract?
    Key clauses include payment terms, termination provisions, liability limitations, dispute resolution, confidentiality, and governing law.
  3. How can I tell if a contract term is too vague?
    Look for subjective language like “reasonable” or “best efforts.” Ask for specific definitions, examples, or measurable standards.
  4. What should I do if I don't understand part of the contract?
    Always ask for clarification. If needed, consult an attorney to help explain complex legal language or suggest revisions.
  5. Can a contract be changed after it’s drafted?
    Yes, most contracts can be amended if both parties agree. Any changes should be documented in writing and signed by all involved parties.

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