Defined terms and definitions in contracts are a powerful tool to improve the readability of a contract. At the same time, it is a contract drafting discipline in which almost invariably mistakes or drafting flaws are found. Thanks to M&A practice, several best practice rules can be identified for drafting and using definitions and defined terms. Those principles are discussed in this section.
One of the final drafting steps before circulating a first-draft document (or a mark-up) is to check whether all defined terms are indeed used. If a term is defined but not used, it may trigger the inclusion of contract clauses or subjects that the drafter probably tried to avoid.
Similarly, the drafter should verify that there are no terms that are used but never defined. This error occurs when a definition is deleted but not all references to the term are removed, or when text containing a defined term is copy-pasted from another document (without copying the definition).
In the following best practice principles, a strict terminology can be identified: definition refers to the description, or object, of what is defined; defined term refers to the (capitalised) word or words chosen to refer to the definition. In common parlance, both are somewhat interchangeably referred to as definitions. The body text refers to the preamble, warranties, conditions, covenants and contract clauses other than the definitions article.
Principles related to the use of defined terms in contracts #
1) Defined terms and definitions must be used to make the interpretation of a contract easier: they make contract provisions concise; whereas the use of defined terms should at all times reduce any risks of ambiguity.
This is the overriding principle that must be taken into account when deciding whether and how to define a term. In interpreting the contract, the defined term must be substituted by the definition of that term.
A defined term should not include “(s)”: where defined, a defined term is either singular or plural. In the body of the contract, both the singular and plural can be used interchangeably regardless of whether the definition refers to the singular or plural term.
Licence Agreements mean collectively, the Trademark Licence and the Technology Licence; and Licence Agreement means either of them.
Realise that the plural encases the risk of ambiguity, so the singular would be preferable (see paragraph 1.1(d)).
2) The first letter of the defined term should be capitalised. If a defined term consists of more words, each word should be capitalised, except for its conjunctions and prepositions (e.g. and, but, or, on, in, under, beside, of, by, for, with, as, about).
This best practice rule is well-established and prevents that more clarification of how defined terms and definitions work. For example:
- Seller hereby sells the Goods and undertakes to provide the Services…
- Within ten Business Days after each calendar quarter, the Management Board shall…
- Each party may terminate this agreement upon a Change of Control over the other party.
The defined terms are underlined for the sake of clarity only. When a reference is made to an article or section of a statute, regulation or to another contract, write ‘article’ or ‘section’ (without capital).
Defined terms should not be in all-capitals, unless this is desirable in view of the language (e.g. the German language capitalises all nouns, which may justify a full-capitalisation of defined terms).
If a name or reference, such as an institution, report or statute, that is usually written with a first capital (or all caps) is not defined as such in the contract, it should be clear that the term is not a defined term. This may be achieved by printing the reference in italics. Note the ‘break’ between the reference to the institute and its rules in the following example:
All disputes in connection with this Agreement, or further agreements resulting from this Agreement, shall be finally settled in accordance with the Arbitration Rules of the Netherlands Arbitration Institute.
When a reference is made to an Article or Section of a statute, regulation or another contract, write “article” or “section” (without capital). For example:
Unless explicitly stated otherwise in this Agreement, the Parties waive their rights, if any, to annul, (partly) rescind, (partly) dissolve or cancel this Agreement, or to request annulment, (partial) rescission, (partial) dissolution or cancellation of this Agreement after Completion on the basis of articles 228 or 265, book 6 or title 7.1 of the Dutch Civil Code.
3) A defined term must be used in the body text (or in definitions) by capitalising the term as defined.
The contractual provision must be interpreted by substituting the definition for the defined term. If the drafter intentionally avoids the definition, the capitalisation should also be avoided (but mistakes are made all too often); in view of this error sensitivity, the drafter may prefer to use a synonym where the defined term is meant to be avoided. Here is an example of correctly using a defined term in combination with an undefined (similar) word:
Distributor shall not sell any products that are equal to or fulfil a similar function as the Products.
In the body contract text the defined term should not be underlined or printed bold (except where it marks the immediately preceding definition – see best practice rule 13).
4) Do not create a defined term if its plain-language meaning is clear and unambiguous.
Especially in transactions in which no sharp line is intended to be drawn between concepts that could either fall within or outside the definition, it is often better to leave the term undefined. Consistent with the overriding drafting principle that contracts must use plain language (and not business jargon or legalese), the same applies to defining terms.
For example, in most contracts it will be superfluous to define what a ‘third party’ is (e.g. whether it includes legal entities that form part of a contracting party’s group), what is captured by clauses referring to a ‘person’ (e.g. in addition to legal entities, does it also include governmental agencies?) or ‘business hours’ (if ‘response time’ or ‘availability of service’ would not affect the economics of the underlying transaction).
Similarly, defining the terms ‘Parties’, this ‘Agreement’ (or ‘Contract’) is generally unnecessary. But it must be admitted that in the specific case of Parties and Agreement, this best practice principle is often ignored.
5) Create only one defined term for each definition, and never use a synonym where the defined concept, word or expression is meant to apply.
This best practice rule overlaps with best practice rule 6. For example, do not define a contracting party as
(the “Company” or “Weagree”)
For another example, do not refer both to ‘Product’ and to ‘TV Sets’, if they are both defined as “tv sets as specified in Annex 1”. If a defined term originates from and refers to exactly the same definition in another (related) contract or document, refer to that contract or document (“TV Sets as defined in the Distribution Agreement”); you should not repeat such definition.
6) Use the defined term each time the definition is meant to apply, and avoid creating a defined term if it will be used only once.
It is confusing if a word or concept is defined (e.g. the Goods sold under the agreement are “all products listed in the annex”) and the agreement would ‘refer’ to it by using similar words or concepts. For example, it is confusing if the agreement would interchangeably refer to “Goods”, “the products listed in the annex” and “the goods contemplated by this agreement”. Confusion gives rise to ambiguity and interpretation questions.
In case a word or concept would be used only once in the contract, it is sufficient clarifying that word or concept in a subsequent sentence or paragraph. After all, defined terms and definitions are used to make the interpretation of a contract easier.
Occasionally, it may be helpful to define a term if it improves the interpretation of the provision. In such case, the definition should be placed in that section. For example:
In this article, “Encumbrance” means any right of pledge, mortgage, attachment, bla bla bla.
7) If a term is defined, do not repeat a part of its definition in connection with the use of the defined term.
For example, do not refer to the “Management Board of the Company” in the contract provisions if the “Management Board” is already defined as “the management board of the Company”. When substituting such incorrectly used defined term, the result would read “the management board of the Company of the Company”. In other words, the principle of substituting a definition into the defined term must be applied strictly.
8) A term defined in the body text should not be used before it is defined.
Principles related to the place and presentation of defined terms #
9) If a contract uses more than one defined term in several places and the contract is more than six or seven pages long, bring the definitions together in one article.
Normally, definitions would be listed in the article 1 of a contract. It aligns with best practice rule 8, that defined terms must not be used in the body text before they are defined. The lead-in of the definitions article could be:
In this Agreement:…
If a definition is used in only one article, consider inserting one, initial section in that article for that definition. The lead-in could be:
For the purpose of this Article,…
If the defined terms and definitions are presented in the format of a table, you may prefer to use the following lead-in: “In this Agreement, the following capitalised terms have the meanings ascribed opposite to them:”
Many contract drafters prefer to bring the definitions together at the backend of the contract or in a separate schedule. This prevents the somewhat inconvenient reading a contract (to first go through a list of definitions before reading the core provisions).
If one defined term is used in the recitals, it should be followed by “(as defined in article 1)“. If more than one defined term is used in the recitals, the text after the first defined term should be “(capitalised terms are defined in article 1)” or “(a capitalised term has the meaning ascribed to it in article 1)“.
If a term is defined in a separate contract or document, use the defined term (capitalised) and add “(as defined in…)” immediately following the first instance where the defined term is used. Refer to the contract or document only, not to the article or section of that contract or document (provided that the definition can be traced easily upon a prima facie reading) of such contract or document.
For contracts longer than about nine or ten pages, it is recommended that the terms defined in the body of the contract are referenced in the definitions article. The referencing text should refer to the section number in which the definition appears (and the referencing text must be consistent):
Product has the meaning ascribed to it in Section 3.4.
10) In the definitions article, order the defined terms alphabetically together with its definition, a paragraph for each.
If the definitions are defined in a dedicated definitions article, they are invariably ordered alphabetically. In the definitions article, the defined terms should not be numbered (a), (b), (c), or 1.1, 1.2, 1.3 etc. As they are ordered alphabetically, it does not make sense to enumerate the list as well.
Sometimes, the defined terms and definitions are placed in a table, visually distinguishing the defined term (in the left column) from its definition (placed in the right column opposite that defined term).
11) A term defined in the definitions article must not be preceded by an article or a preposition and should be followed, consistently, by the word ‘means’.
If the defined term is a verb and may be confused with a noun, exceptionally, the defined verb can be preceded by “to”, which should not be printed bold and should be placed outside the quotation marks (if used at all).
Note that grammatically, ‘shall’ exclusively refers to an obligation (an action by a person). Accordingly, ‘shall mean’ would be incorrect. A correct example is:
“Products” means the products listed in Annex 1.
12) In the definitions article, never repeat a part of a term that is already defined in the body text and never summarize or rephrase such a definition.
For example, do not use “Management Board means the management board of the Company” together with a section “4.1. The Company shall be managed and represented by the management board (the Management Board).” What happens in such combination of ‘definitions’ within one contract is that there are two definitions of the same defined term, and both are ascribed a (fundamentally) different meaning. Although the draftsperson may not intend to differentiate, the defined term is anyhow ambiguous.
It would be even worse to use the following definition in combination with such section 4.1: “Management Board means the Company’s formal body, collectively responsible for the day-to-day affairs of the Company.” Where in the previous example the definition aimed at different elements for identifying the Management Board, in this example, the definitions even collide.
A term should be defined completely. Sometimes, it is unavoidable or more convenient to work with a definition defined in the body text. In several jurisdictions, it is common practice to define terms as much as possible in the body text rather than in the definitions article.
Do not re-define or refer to the “Parties” or “Agreement” in the definitions article, provided that the terms are defined (or, for example in the case of a separate schedule identifying each party, referred to) in the initial contract line and parties block. Sometimes, but wrongly, a clause is added to the definition of Agreement, modifying its ordinary meaning or limiting its scope to the body text (or expanding its meaning to schedules and annexes). Such modifications should be addressed in a separate interpretation section (e.g. section 1.2) or in the miscellaneous provisions.
13) A term defined in the body text should (a) be placed immediately following the concept it defines, (b) be placed between brackets together with an article, (c) be distinguished clearly from the other text, and (d) be marked consistent with the terms defined in the definitions article.
A defined term is clearly distinguishable when printed bold, but traditionally, the term is also put between “double quotation marks” (it is odd to use ‘single quotes’). It is common practice to mark the defined term in bold where it is defined. For example:
The article “the” is not part of the defined term. For example, do not define products as (“the Products”) but instead write (the Products), or (the “Products”) if quotation marks are used. It is unnecessary to indicate that a term is defined elsewhere in the body text, by also inserting words such as ‘hereinafter’, or ‘hereinafter referred to as’.
It is unnecessary (and old-fashioned) to indicate that a term is defined elsewhere in the body text, whether in the parties block, the preamble or the definitions section, by also inserting between the brackets words or phrases such as hereinafter, or hereinafter referred to as.
In letters (and letter agreements) it is common to use quotation marks only and not to print the defined term in bold or all-caps.
14) A term defined in the body text must be placed immediately after the definition (taken in its entirety).
The defined term should not be placed halfway through the description it intends to cover. This creates ambiguity. Consider the different scopes of definition of when a notice qualifies as an “Option Notice” in the following examples:
- …Purchasers, shall give Seller a notice in writing referring to this Agreement and this Article (an “Option Notice”), specifying the precise nature, background and details of the Triggering Event and the date on which the Triggering Event occurred, as well as the date on which Purchaser anticipates that the effect of the Triggering Event may reasonably result in…,
- …Purchasers, shall give Seller a notice in writing referring to this Agreement and this Article, specifying the precise nature, background and details of the Triggering Event and the date on which the Triggering Event occurred, as well as the date on which Purchaser anticipates that the effect of the Triggering Event may reasonably result in… (such notice, an “Option Notice”).
By the placement of the defined term, the scope of the captured definition differs: in the first example, a mere written notice by the Purchaser to the Sellers pointing at its option under the referred-to Article will already qualify as an Option Notice, with all the effects stipulated in the agreement (for example, the right to exercise the agreed option right may lapse permanently within a stipulated period of time after the Option Notice, or uncertainty may exist regarding the question whether there was a Triggering Event at all).
Occasionally, the defined term precedes the object it defines. This is especially the case for listings of items: termination events such as bankruptcy, suspension of payment proceedings, change of control and material breach or assets to be sold (or excluded from sale). For example:
For the purpose of this Article 7, a Triggering Event means the occurrence of any of the following facts or events:
Principles related to drafting the text of a definition #
15) The defined term should correlate with the concept of the definition.
In interpreting the contract, the meaning of the definition (substituted into the defined term) prevails over the (plain-language meaning of) the defined term. Use a term that is concise and yet informative. The choice of the defined term should preferably reflect what is relevant, to distinguish it from other defined terms. Keep the defined terms short (like captions).
When substituting the definition in the body text for the defined term, the meaning of the sentence should be the same and no grammatical errors should occur. For example, the defined term ‘Bicycle’ would not be suitable to include ‘cars, buses, trains and motorcycles’ as part of its definition (in such case, rather use ‘Means of Transportation’).
Terms that are somewhat characteristic for certain kinds of agreements are often given the same defined term. Examples for an asset purchase agreement are Assumed Liabilities, Receivables, Excluded Assets, Contracts and Payables. In credit agreements, examples would be Indebtedness, Maturity Date, Guarantors and Majority Lenders. The advantage of using such defined terms is that an experienced reader will understand immediately what is being referred to without having to go to the definitions article each time. If there is no such ‘term of art’, choose a defined term that helps the reader by signalling what it means.
Conversely, if you use a commonly used defined term that has a generally accepted meaning (such as Net Sales or Taxes) but ‘redefine’ it in a somewhat unorthodox way, consider modifying the defined term appropriately (e.g. to Adjusted Net Sales or Income Taxes).
16) Never include obligations, conditions or warranties in a definition.
This is an important best practice principle. Ignoring this rule frustrates the principle of substituting the defined term by its definition, with all negative consequences. The inclusion of obligations, conditions or warranties creates ambiguity when interpreting the body text in which the defined term is used. A common flaw of such ‘error’ is, for example:
Specifications means the technical design and related specifications, which shall be developed and owned by Licensor and which are to be provided to the Manufacturers that wish to manufacture the Product meeting those specifications.
Such definition will be problematic when the contract would furthermore stipulate:
“Technical designs and related specifications developed by Licensee in connection with the Specifications will be owned by Licensor.”
The complications triggered by including an obligation in the definition are difficult to oversee (and any right to compensation or payment problematic): the definition includes an obligation on the part of Licensor, the contract provision contains an entitlement of Licensor to Licensee’s contributions; but what happens if the Licensee requires the Licensor to further develop its design (e.g. to match the requirements of Licensee’s technical designs)?
The proper way to redraft the above sample definition would be to take out the circumstantial and descriptive language. The word shall creates ambiguity in that it may refer to a future fact without further obligatory intentions, or imply an obligation (for the Licencee to transfer ownership or not to claim ownership). If necessary at all, references to development and ownership, to the process of handing over to Manufacturers (qualifying in terms of their ‘wish’) should be moved to the body text and be rephrased there in the form of actual obligations, whether or not qualified or conditioned, or to the warranties (without obligatory phrases).
This best practice rule is important; let’s repeat it: never include an obligation, a condition or a warranty in the definition.
17) Define a term as precise and narrowly as possible; it must be capable of substitution everywhere it is used.
Expansion of the scope of the definition may be included as part of the appropriate substantive provision, warranty or condition. If accordingly, such additional text is repeated several times, consider creating an additional defined term that embeds the narrowly-defined defined term.
Do not use adjectives in the body text to distinguish, qualify or limit certain defined concepts from concepts covered by the same definition, unless substituting the definition into the defined term fits entirely (and without overlap) in the intended meaning of that defined term.
For example, do not use “…draft Financial Statements…” if the Financial Statements are defined as “the published financial statements from time to time as certified by the Auditor and approved by the Annual General Meeting”.
18) A definition may include a defined term (defined elsewhere).
This is phenomenon is referred to as nesting or embedded definitions. Because definitions are ordered alphabetically in the definitions section, do not ‘clarify’ (e.g. “(as defined below)”) that such nested defined term is defined later in that section.
If, exceptionally, a term is defined within the definition of another defined term (and provided that the definition is in the list of defined terms and not in the body text), the embedded defined term should be listed separately in the alphabetical order and refer to the definition:
Confidential Information means the written information disclosed by one Party (the Disclosing Party) to the other Party (the Receiving Party) and marked ‘confidential’ or ‘proprietary’;
and (in alphabetical order):
Disclosing Party has the meaning ascribed to it in the definition of Confidential Information.
These definitions cross-referring to other definitions are often omitted.
19) Never create circular definitions.
A circular definition is a term directly or indirectly defined by reference to that same term. Circular definitions occur in case of nested definitions or when several defined terms are intertwined.
For the sake of clarity, this best practice rule does not apply to the inclusion of the non-capitalised term in the definition. For a correct example:
Licence Agreement means the licence agreement attached as Schedule 3.
Such use of the term rather emphasizes that the defined term is well chosen.
20) To exclude a concept that may ordinarily be within the scope of a definition, the defined term, or a part of it, should be followed by ‘excludes’.
Similarly, some drafters believe that if a definition is not intended as an exhaustive description, the defined term should be followed by ‘includes’ (and not ‘means’). For example:
- “Fruits” means all fruits commercialized by Seller, including mini tomatoes and olives.
- “Products” means all fruits commercialized by Seller. “Products” exclude peppers, cucumber, peas, string beans, eggplants, avocados, corn, zucchini and beans.
Note that botanically, both the included and the excluded vegetables are actually fruits. Especially if there can be discussion about the scope of the contracted goods, the clarification is helpful. Such discussion may be relevant if also a non-compete clause or exclusivity is
21) If a definition must also capture any future, yet unknown version, value or amendment, it must qualify the relevant concept by the words “from time to time”.
The relevant date as of which such version, value or amendment will apply, should be clear from the definition or the context in the body text. The addition from time to time clarifies that the version, value or amendment in force on a date of delivery or performance, rather than on the effective date of the agreement, should apply. For example:
REACH means EC Regulation No. 1907/2006 on Registration, Evaluation, Authorisation and Restriction of Chemicals, as amended from time to time.
Another example: a deed of pledge could refer to the defined terms in the underlying credit agreement. This would ensure that the definitions in the two agreements are exactly the same. If the scope of the pledge must ‘follow’ any amendments, supplements and addenda of the credit agreement, the reference to the contract should not prevent this. Inserting from time to time avoids ambiguity.
22) The definition of a (signed) ‘contract’ should identify the title of that contract, its date, the parties and the amendments (if any).
If the contract is attached as a schedule, there is no need to include more than a reference to the schedule and, if desired, the title or type of contract (not capitalised).
If more than one name can be attributed to the contract, the title as it appears most prominently on the first page, including any subtitles, should be used.
If a contract refers to several dates (e.g. because each signatory wrote down a different date of signature), the printed date should be used and failing such date, the first date on which the first signatory of the last signing party should be used. The names of each party should include the type of entity (e.g. GmbH, N.V., Sàrl). In the case of one or more amendments, supplements or addenda, only the dates of those documents should be included (e.g. “as amended on 18 June 2016 and 14 July 2017”).
Some drafters precede the contract title by the useless and non-specifying words that certain. Omit them. It should be sufficient to simply refer to a contract in order to give the terms of that contract their effect: it should be effective as per its terms (emphasised by its reference). Accordingly, do not include legalese such as “the terms and conditions are herein incorporated by reference“.
23) The definition of a person, legal entity or organization should be consistent with the details provided for the parties.
If a person, legal entity or organisation is referred to in relation to an obligation to be fulfilled by it or otherwise as a subject of an obligation, condition or warranty, it is recommended that it be identified accurately and consistently with other references to persons or entities in that contract. Omit the details if their inclusion serves no useful purpose.