Drafting contracts

(c) 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 (ordinary 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.

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 flip to the definitions article each time. If there is no such traditional term, choose a defined term that gives the reader a signal as to 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 narrowly as possible such that it fits 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.