Drafting contracts

(a) 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.