What to Watch Out for in Commercial Contracts

When two companies come together and agree on a joint venture, how that agreement is put down on paper is usually the most overlooked part of the deal. Once the parties reach agreement on price and delivery date, the contract is considered "done," yet the real risk lies hidden in the gaps left between the lines of the text. When the scope of the obligation is left vague, when payment terms are not written clearly, or when the termination provision is inadequately structured, these deficiencies go unnoticed as long as the business relationship proceeds smoothly; the moment a problem arises, however, the weak points of the contract text suddenly come to the fore.

Commercial contracts are too varied to be reduced to a single template; the risks of a service contract and a distributorship agreement are not the same. Even so, there are common headings that recur in every commercial contract: definition of scope, payment, penalty clause, confidentiality, termination, force majeure, and the method of dispute resolution. Each of these headings, if not carefully structured before signing, can later put the parties in a difficult position. Below, we address in concrete terms the points at which these provisions require attention.

Why Must the Scope of the Obligations Be Clearly Defined in the Contract?

The foundation of a commercial contract is a clear written statement of what the parties expect from each other. A general expression such as "a service shall be provided" can, in practice, give rise to different interpretations between the parties as to which work is included in this service and which is subject to an additional fee. The more concrete the definition of scope, the lower the likelihood of later disputes of the "we thought this was included too" variety.

In practice, ambiguity of scope generally emerges not at the outset of the work but as the work progresses. When one of the parties makes an additional request, a dispute becomes inevitable if the contract contains no clear criterion as to whether that request falls within or outside the original scope. Writing out, item by item, elements such as the quality, quantity, and manner of delivery of the product or service to be delivered is one of the most practical methods of preventing such differences of interpretation.

When defining scope, not only the principal obligation but also the ancillary obligations tied to that obligation must be considered; for example, in a software development contract, questions such as who will own the source code in addition to delivery, and whether maintenance and support service will be a separate item or count as part of the scope, are frequently overlooked. Leaving such ancillary matters undiscussed at the outset can cause the parties to carry different expectations as the work progresses. It is generally useful to also check separately whether the matters the parties assumed "of course this is included too" during contract negotiation have actually been reflected in the text.

• Definition of the work or service. What is to be delivered, to what standard, and through which stages, must be clearly written.
• Matters excluded from scope. Work that will be subject to an additional fee must be separated out from the outset.
• Delivery and acceptance process. When delivery is deemed to have taken place and the acceptance criteria must be determined.
• Change requests. The procedure by which scope will be updated if it later changes must be written.

How Should Payment Terms Be Structured in the Contract?

Payment terms do not consist solely of the amount of the consideration; when, in which currency, against which document, and by which method the payment will be made is at least as important as the amount. Leaving the due date vague, or flexible expressions such as "payment shall be made within a reasonable time after delivery," can in practice cause the parties to develop different expectations and prolong the collection process.

The interest rate to be applied in case of late payment, to which item partial payments will be attributed, and whether there are advance or security mechanisms are also matters that must be regulated separately in the contract. Particularly in long-term commercial relationships, tying the payment schedule to project stages and writing clearly the completion criterion for each stage can significantly reduce collection risk.

• Due date and payment date. This must be determined as a concrete date or a calculable period.
• Default interest. The rate or method to be applied on late payment must be written from the outset.
• Partial payment and set-off. Which debt the payments made will be attributed to must be clarified.
• Advance and security. If any, the conditions under which they may be demanded must be regulated.

What Purpose Does a Penalty Clause Serve in the Contract?

A penalty clause is a security mechanism that provides for the payment of a predetermined sum in the event that one of the parties acts in breach of the contract. The main function of this provision is to enable a certain amount to be claimed in the event of a breach without the loss having to be separately proven. However, if it is not clearly written in which cases of breach the penalty clause will come into play, the enforceability of the provision may become disputed.

Determining the amount of the penalty clause at a reasonable level is also important; penalty clauses set excessively high may later be reduced upon the application of one of the parties. In addition, clearly regulating in the contract points such as whether the penalty clause replaces the actual loss, or whether additional compensation can be claimed when the actual loss is exceeded, reduces differences of interpretation at the time of a dispute.

In practice, whether the penalty clause is provided separately for different types of breach — such as delay, defective performance, and complete non-performance of the contract — also requires attention; a single general penalty clause provision may create uncertainty as to how much is to be claimed in which case of breach. Writing separately whether the delay penalty will operate on a daily or weekly rate, or on a one-off fixed amount, reduces disputes that may arise at the calculation stage.

At Which Points Must Confidentiality Provisions Be Structured?

In commercial contracts, the parties generally gain access to each other's sensitive information such as pricing, customer portfolio, and production method. The confidentiality provision regulates the purpose for which this information may be used and that it may not be shared with third parties. The more concrete the definition of confidential information, the more clearly it can be established which information must be protected when an allegation of breach arises.

Whether the confidentiality obligation will continue for a certain period even after the contract ends, what sanction will be applied in case of breach, and what information is excepted (such as information that has become public or independently developed) are also generally addressed separately in this section. Particularly in long-term collaborations, it is preferred that the confidentiality period be regulated so as to cover the period after the contract's end.

In Which Cases Can the Contract Be Terminated?

Termination provisions regulate the conditions under which and the manner in which one of the parties may bring the contract to an end. In fixed-term contracts, termination by observing an advance notice period is generally possible; however, concretely listing which conduct will be deemed sufficient for immediate termination for just cause prevents the later dispute of "was this termination justified."

How the parties' obligations toward each other after termination — such as the winding up of ongoing work, unpaid amounts becoming due, and the return of delivered materials — will operate must also be set out in the contract. Clearly determining the procedure (in writing, through a notary, to a specific address) by which the termination notice will be given reduces disputes that may arise as to the validity of the notice.

In long-term commercial relationships, whether the counterparty will first be granted a cure/notice period in the event that one party breaches the contract is also a point to be considered; in some contracts, instead of immediate termination, a written notice is first sent and the breach is expected to be remedied within a reasonable time. Such a graduated termination mechanism can prevent minor disruptions from immediately leading to the complete termination of the contract and can contribute to the sustainability of the relationship between the parties.

• Termination with notice. The advance notice period and procedure must be determined.
• Immediate termination for just cause. Which conduct will fall within this scope must be illustrated by examples.
• Post-termination winding up. The fate of ongoing work and outstanding receivables must be regulated.
• Notification procedure. The manner in which the termination notice will be given must be written.

Why Must a Force Majeure Provision Be Regulated Separately?

Force majeure refers to events that develop outside the control of the parties and render the performance of the obligation temporarily or permanently impossible. If the contract does not state which events this concept covers and how the parties' obligations will be suspended in case of force majeure, a dispute over responsibility may become inevitable between the parties when an unexpected situation arises.

Whether the contract can be terminated if the force majeure period is prolonged, what will happen to payment obligations during this period, and within what time the force majeure must be notified to the counterparty are also integral parts of this provision. Generally, failure to comply with the notification obligation is a factor that can also weaken the right to rely on force majeure.

In Case of a Dispute, Should the Competent Court or Arbitration Be Chosen?

In commercial contracts, the parties may decide in advance in which court a dispute that may arise will be heard; this is called a competent court clause. Alternatively, the parties may prefer to resolve the dispute through arbitration instead of a state court. Since the choice between these two methods may produce different results in terms of the speed, confidentiality, and cost of the process, it must be made deliberately when the contract is concluded.

When an arbitration clause is chosen, details such as whether the arbitration will be conducted by a sole arbitrator or a panel, which institutional arbitration rules will apply, and where the seat of arbitration will be must also be included in the contract; otherwise the enforceability of the arbitration clause may be opened to dispute. When a competent court clause is preferred, writing the clause in a clear manner that leaves no room for doubt prevents time being lost on procedural objections at the time of a dispute.

Why Should Assignment and Subcontracting Provisions Be Taken Seriously?

Whether one of the parties may or may not assign the rights and obligations arising from the contract to a third party is often a heading overlooked at the negotiation stage of commercial contracts. If the contract contains no provision on this matter, whether an assignment made without the counterparty's consent will be deemed valid may become disputed. Writing this provision clearly is particularly important in contracts where there is a possibility of a company merger, acquisition, or transfer of the business unit to another legal entity.

Similarly, whether part of the obligation may or may not be performed by a third party through a subcontractor or subcontract must also be regulated separately. If subcontracting is to be permitted, whether the main contractor's liability for the acts of the subcontractor will continue must be clarified; otherwise, when a disruption occurs, the parties may resort to different interpretations as to whom the responsibility belongs.

Why Should a Pre-Contract Legal Review Be Carried Out?

Most commercial contracts are negotiated on the basis of a draft prepared by one of the parties, and this draft generally contains provisions structured in favor of the party who prepared it. Examining the text item by item before the contract is signed reveals which provision carries a disproportionate weight in favor of the counterparty. This examination is far less costly than correcting an imbalance noticed after the contract has been signed.

During the legal review, not only conspicuous provisions such as the penalty clause and termination but also the annexes, technical specifications, and other documents referred to must be evaluated together; because the integrity of the contract is ensured by these documents. Such an examination carried out before signing also makes visible whether the matters the parties thought they had agreed upon have truly been reflected in the text.

Commercial contracts are documents that remain in the background as long as the business relationship proceeds smoothly, but become the parties' only anchor when a dispute arises. Structuring provisions such as the scope of obligations, payment terms, penalty clause, confidentiality, termination, and the method of dispute resolution in a concrete and consistent manner can prevent many disputes that may arise later. Av. Aydın, within İzmir Avukatım, provides support in the pre-signature review and preparation of contracts between companies according to the concrete structure of your file; if you would like to discuss this matter in Konak/İzmir, you can reach the line 0553 595 67 82 around the clock, 24/7.