How to Reduce the Risk of Commercial Disputes Through Better Contracts

Understanding Why Commercial Disputes Arise

Before turning to solutions, it is worth identifying principal sources of contractual conflict. Disputes tend to cluster around a number of recurring themes.

Ambiguous or Incomplete Terms: The most common source of commercial disputes is ambiguity. When contract language is vague, imprecise, or open to more than one reasonable interpretation, each party will naturally adopt the reading most favourable to its own interests. Courts and tribunals are then asked to resolve a disagreement that should never have reached them, often at considerable expense to both sides.

Incompleteness is a related problem. Contracts that fail to address material contingencies — a change in market conditions, a failure by a sub-contractor, a regulatory shift, or a global event such as a pandemic — leave parties to argue about implied terms or fall back on default rules of law that may not reflect what either party would have agreed had they turned their minds to the issue. Given recent events in the Middle East, this is perhaps more relevant than ever.

Poorly Defined Deliverables and Performance Standards: In services and technology contracts in particular, disputes frequently arise because neither party can agree on precisely what was supposed to be delivered, when, and to what standard. If a contract describes a software system merely as “fit for purpose” without defining what “purpose” means, or requires a consultant to deliver “satisfactory” work without setting out objective criteria for satisfaction, the seed of future conflict has already been sown.

Inadequate Risk Allocation: Every commercial transaction involves an allocation of risk. The question is not whether risk exists, but who bears it and in what circumstances. Contracts that fail to allocate risk explicitly — for example, in relation to delay, force majeure, price fluctuation, or intellectual property ownership — leave parties exposed.

Lack of Clarity on Payment: Payment terms are a perennial source of contention. Disputes about when payment is due, what triggers an invoice, what rights a party has to withhold payment, and what constitutes a valid set-off or counterclaim are common and often disproportionately expensive to resolve relative to the sums in dispute.

Principles of Contract Drafting

With these themes in mind, a number of drafting principles can significantly reduce the likelihood of disputes arising.

Clarity Above All Else: The overriding objective of commercial contract drafting should be clarity. Every provision should be capable of being understood — without the need for expensive legal interpretation — by a reasonable businessperson reading it for the first time. This requires:

• Plain, precise language: Legal jargon should be used only where it has a settled and well-understood meaning. Wherever possible, use plain language that leaves no room for ambiguity.
• Consistent terminology: Define key terms at the outset and use those definitions consistently throughout the document. Avoid using different words to describe the same concept, as this can suggest a distinction when none was intended.
• Avoid “or” and “and” traps: “And” and “or” are surprisingly potent sources of ambiguity. Where a list of conditions must all be satisfied, confirm this explicitly. Where alternatives are permissible, say so.
• Specify timeframes: Any obligation that must be performed within a set period of time should state that period precisely. “As soon as practicable” and “without undue delay” are not the same as “within five business days,” and the latter is almost always preferable.

Comprehensive and Measurable Definitions of Performance

In any contract where services or deliverables are to be provided, the performance standard must be defined with sufficient precision that both parties can objectively determine whether it has been met. Best practice includes:

• Detailed specifications: In technology, construction, and manufacturing contracts, attach technical specifications as schedules. Do not incorporate them by reference to documents that may change.
• Objective acceptance criteria: In IT and professional services contracts, set out the precise criteria that must be met before a deliverable is accepted. Consider staged acceptance processes with defined testing periods and a mechanism for raising and resolving defects.
• Service level agreements (SLA): For ongoing services, define performance metrics (e.g., availability, response times, error rates) and specify the consequences of failing to meet them. Graduated remedies — service credits escalating with severity of breach — are often preferable to a binary pass/fail approach.
• Key performance indicators (KPI): For longer-term relationships, define the indicators by which performance will be measured and the review process through which they will be assessed.

Thorough and Explicit Risk Allocation

Risk allocation provisions should be negotiated and recorded with the same care as commercial terms. This includes:

• Liability caps and exclusions: Determine the maximum financial exposure each party is prepared to accept and record this explicitly. Cap liability by reference to a fixed sum or a multiple of fees paid. Exclude liability for indirect and consequential losses unless there is a specific reason to include them, and define clearly what falls within those categories.
• Indemnities: Use indemnities deliberately and precisely. They should be reserved for situations where a party is assuming risk of a third-party claim or a specific category of loss.
• Warranties: Distinguish between warranties that go to the root of the bargain and those that are more operational. Consider whether breach of a particular warranty should give rise to a right to terminate or merely a right to damages, and draft accordingly.
• Force majeure clauses: Define the events that will constitute force majeure with sufficient specificity. Consider whether the clause should merely suspend obligations or permit termination, the notice requirements that apply, and what obligations to mitigate will be imposed on the affected party. The experiences of the Qatar blockade, the COVID-19 pandemic, and now the Iran war have demonstrated the importance of well-drafted force majeure provisions.
• Change in law provisions: In long-term contracts, consider who bears the risk and cost of compliance with future regulatory changes. This is particularly important in regulated sectors.

Precise Payment Provisions

Payment terms should be drafted to eliminate any possible doubt about the following matters:

• Amount or basis of calculation: Whether payment is fixed, variable, milestone-based, or linked to an index, the methodology should be set out unambiguously.
• Trigger for payment: When does the right to invoice arise? Is it on completion of a milestone, on acceptance of a deliverable, at a calendar date, or on the occurrence of some other event?
• Payment period: How many days from receipt of invoice must payment be made? Define “receipt” — do a physical invoice and an email invoice trigger the same period?
• Disputed invoices: Specify the process for raising a dispute about an invoice, including the timeframe within which objections must be raised and what happens to any undisputed portion of the invoice in the meantime.
• Set-off rights: Where set-off is to be excluded, say so expressly. Where it is to be permitted, define precisely what may be set off and against what.
• Consequences of late payment: Address statutory interest rights, and where applicable, agree contractually on the applicable interest rate and any rights of suspension.

Effective Change Management Provisions

One of the most fertile grounds for dispute in services and construction contracts is the management of change. Scope creep — the gradual expansion of what a party is required to deliver without corresponding adjustment to price or timeline — is responsible for a significant proportion of project-related litigation. To address this:

• Define the scope clearly at the outset, ideally with a schedule that describes in detail what is included and (where helpful) what is excluded.
• Establish a formal change control procedure that requires any variation to scope, price, or programme to be agreed in writing before work begins. Specify what constitutes a variation and what does not.
• Provide a mechanism for pricing variations, such as an agreed schedule of rates, a process for obtaining quotes, or a formula for calculating the cost of change.
• Ensure that no variation is binding unless formally approved by an authorised representative of each party, and define who those authorised representatives are.

Clear Termination Provisions

Disputes frequently arise at the end of contractual relationships, particularly where termination rights are ambiguous, the consequences of termination are undefined, or the parties have different views about whether a right to terminate has arisen. Effective termination drafting should:

• Distinguish between termination for breach and termination for convenience. The grounds, notice requirements, and consequences should be separately and clearly addressed.
• Define what constitutes a material breach sufficient to trigger a termination right, whether a right to cure must first be given, and if so, for how long.
• Address the consequences of termination. Specify what happens to work in progress. What amounts are owing on termination? Does a party that terminates for convenience owe a break fee? What survives termination?
• Consider step-in rights where the subject matter of the contract is critical infrastructure or an essential service, allowing a contracting authority or lender to step in if the service provider is in default.

Structural and Procedural Measures

Beyond the substance of individual clauses, a number of structural and procedural practices can further reduce dispute risk.

Invest in Negotiation: Disputes are more likely to arise from contracts that were signed hurriedly, without proper legal review, or under commercial pressure to close quickly. While it may be tempting to accept a counterparty’s standard terms without scrutiny to expedite a transaction, the potential cost of doing so invariably outweighs the time saved in negotiation.

Both parties to a commercial contract should ensure that they understand what they are agreeing to, that the terms reflect the deal they have actually struck, and that they are comfortable with the risk allocation. Where terms are non-negotiable — as in consumer or standard form contracts — this should be made transparent, and the business should ensure that its commercial teams understand the implications.

Ensure Commercial and Legal Alignment: One of the most common sources of contractual difficulty is a disconnect between what the commercial team agreed in negotiation and what appears in the final contract. Legal teams should be involved at an early stage — not merely at the point of drafting — to ensure that the legal documentation accurately reflects the commercial deal. Similarly, commercial teams should be made aware of key contractual provisions and their operational implications, so that the contract is understood and followed by the people responsible for its performance.

Maintain a Consistent Contract Playbook: Businesses that enter into a significant volume of similar contracts should develop and maintain a contract playbook: a set of standard positions, approved fallback positions, and escalation procedures for non-standard requests. This approach produces several benefits:

• It reduces the risk of ad hoc concessions that create inconsistent exposure across the contract portfolio.
• It speeds up the negotiation process by defining what can be agreed at a working level and what requires escalation.
• It ensures that lessons learned from disputes and near-misses are captured and reflected in future drafting.
  

Consider the Entire Contract Suite: In complex transactions, the commercial contract does not stand alone. It sits alongside confidentiality agreements, ancillary service agreements, statements of work, purchase orders, and (in some cases) financing documents. Care should be taken to ensure that these documents are consistent with one another, that the order of precedence is clear, and that a purchase order or statement of work cannot inadvertently vary the terms of the master agreement without proper authorisation.

Building in Effective Dispute Resolution Mechanisms

Even the best-drafted contract cannot eliminate all risk of dispute. The question is therefore not merely how to prevent disputes, but how to ensure that they are resolved as quickly, cheaply, and proportionately as possible.

Tiered Dispute Resolution Clauses: A well-designed tiered dispute resolution clause can resolve a significant number of disputes before they escalate to formal proceedings. Each tier should have a clearly defined process, defined timescales, and a clear trigger for escalation to the next level. A typical escalation ladder might include:

1. Operational escalation: The issue is first referred to the operational teams responsible for day-to-day contract management, with a defined period to attempt resolution.
2. Senior management escalation: If unresolved, the matter is referred to senior management on each side, again with a defined resolution period.
3. Mediation: If the issue is still unresolved, the parties agree to attempt mediation before a neutral third party.
4. Arbitration or litigation: Only if mediation fails does the matter proceed to formal adjudication.

Choice of Forum and Governing Law: The choice of governing law and dispute resolution forum should be considered deliberately, not left to the counterparty’s standard terms by default. Key considerations include:

• Predictability and certainty: Some legal systems (English law being a notable example) are preferred in international commercial contracts because of the depth of case law, the clarity of contractual interpretation principles, and the quality of the judiciary.
• Enforcement: Where a counterparty is based in a jurisdiction different from the governing law, consider how easily a judgment or award can be enforced against them. Arbitration awards are more widely enforceable internationally than court judgments, by virtue of the New York Convention.
• Confidentiality: Arbitration proceedings are generally private; litigation is not. For commercially sensitive disputes, this may be a decisive factor.
• Cost and speed: Court litigation in some jurisdictions is slow and expensive. Arbitration can be tailored to the parties’ needs, though it too can become costly in complex cases.

Expert Determination: In contracts where technical or valuation disputes are foreseeable — such as construction contracts (disputes about the value of variations), shareholder agreements (disputes about the value of shares), or long-term supply contracts (disputes about pricing adjustments) — consider including an expert determination clause. This allows a nominated expert to resolve specified categories of dispute quickly and definitively, without resort to formal proceedings.

Practical Steps for Businesses

Drawing together the principles discussed above, businesses seeking to reduce their exposure to contractual disputes should consider the following practical steps.

Conduct a Contract Audit: Review your existing standard form contracts and key bespoke agreements. Identify provisions that are ambiguous, provisions that fail to allocate risk clearly, and provisions that have given rise to disputes or near-misses in the past.

Invest in Legal Resource at the Right Stage: The drafting and negotiation of contracts should not be treated as an afterthought. Legal resource — whether in-house or external — should be engaged at the term sheet or heads of terms stage, not merely when a final document is required.

Keep Contemporaneous Records: When a dispute does arise, the outcome is often determined by the quality of the contemporaneous documentary record. Encourage teams to keep accurate records of instructions given, decisions made, performance issues noted, and communications with counterparties. In particular, ensure that any matters agreed orally or informally are confirmed promptly in writing.

Act Promptly When Problems Emerge: Many commercial disputes escalate unnecessarily because early warning signs were ignored. When a potential issue is identified (e.g., a missed deadline, a disputed invoice, or a concern about quality), it should be raised promptly and constructively, in accordance with the contractual mechanisms agreed. Early intervention is almost always cheaper and less damaging to the commercial relationship than allowing a problem to fester until it becomes a formal dispute.

For more information or if you have any queries, please reach out to Matthew Williams, Counsel at Crowell & Moring: matwilliams@crowell.com.