Don’t turn a contract into a handcuff

While signing contracts is part of doing business, not everyone understands the full implications of what they are signing, says Adrian Kitchin MAICD, managing director of insurance brokers Insurance Advisernet Australia.

He warns that owners of small and medium-sized enterprises (SMEs) could expose themselves to potential financial difficulty by entering into contracts without understanding the full implications or checking with their professional advisers.

“The business owner is typically focusing solely on the perceived benefit and not necessarily appreciating the liabilities and other consequences of what is being signed,” he says.

“More than ever, large organisations are transferring as much risk as possible from their organisation to the other party to the contract.”

Kitchin adds: “Even an experienced director who is well versed in commercial dealings, including contract negotiation, can sometimes make mistakes that are not immediately apparent.

“Best practice would be for a director to seek advice from his or her solicitor, accountant and insurance adviser prior to signing any commercial contract that binds the company. Quite often, seemingly innocuous terms can have far reaching effects that a director may not readily be able to establish from the wording of a contract.”

He believes the business owner or board of directors should ensure there is a policy in place that deals with the signing of contracts.

“At best, unwittingly entering into a contract with unintended consequences would be considered unwise. To knowingly do so could be considered reckless,” he says.

“Any board-driven policy that is put into place need not be onerous. We would suggest that the policy sets out that commercial contracts require review by the legal, accounting and insurance professionals that are retained by the firm. By doing so, a board in effect transfers its liabilities to its advisers who are charged to provide relevant and accurate advice on the consequences of signing a contract.”

Kitchin says the board should also adopt a sound risk management approach to ensure it does not knowingly or unknowingly enter into risky contracts.

“In addition to the policy of referring the contracts to external advisers for review, the board should actively consider the suppliers and business partners with whom it does business regularly.

“Where possible, it should have its own ‘standard’ commercial contract for its suppliers and another version for its customers that has been pre-approved by its external advisers rather than relying on another party’s contract which is unlikely to be as favourable.

“When the company signs other non-standard contracts, it should have a checklist setting out various matters, in particular, the external sign-off that needs to be followed by the management team which is generally responsible for negotiation for approval by the board. Even where the board and the management team are one and the same, the checklist will still be of great value in avoiding potential mistakes.”

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