Drafting contracts

(c) Principles related to drafting the text of a definition

16) The defined term as such should correlate with the substance of the definition.

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. The defined term Bicycle would not be suitable to include cars, buses, trains and motorcycles as part of its definition (rather use Means of Transportation. Also, a defined term in the form of a verb should not also be defined as a noun or adjective.

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).

17) Never include obligations, conditions or warranties in a definition.

This is an important best practice principle. The inclusion of obligations, conditions or warranties creates ambiguity as regards the interpretation of the body text in which the defined term is used. A common flaw (which also conflicts with other best practice principles) is:

Agreement means this agreement, including any amendments, supplements and addenda from time to time, except that any amendment, supplement or addendum shall be valid or enforceable only if it is in writing and entered into by each Party.

The following example illustrates how this ‘do not’ can create ambiguity:

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. Technical designs and related specifications developed by Licencee in connection with the Specification shall be owned by Licensor.

The defined term in the example will probably be used in connection with an obligation of the Licencee to produce the underlying Product in accordance with the Specifications. In such context, the example is full of uncertainties and ambiguities: which specifications apply if they are not developed by the Licensor? Which specifications apply if a third party is the developer or owner of the specifications? Does the definition refer to draft specifications (i.e. those to be provided)? Are the contents of the Specifications implicitly conditional upon the capability of Manufacturers to meet those specifications? What happens if a Licencee must warrant that the Product will in all respects meet the Specifications?

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).

18) Define a term as narrowly as possible so that it fits in all provisions where 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 “…written Confidential Information…” if Confidential Information may well have been presented orally. Also, do not use adjectives that deviate from the meaning of the definition. For example, do not use “…draft Financial Statements…” if the Financial Statements are defined as “the published financial statements as certified by the Auditor and approved by the Annual General Meeting from time to time“.

19) A definition may include a defined term (defined elsewhere).

This is phenomena referred to as ‘nesting’ or ‘embedded definitions’. Do not cross-reference a defined term in a definition even if it is defined later in the definition article. Cross-references such as “(as defined below)” are redundant because the language introducing the definitions tells a reader where the agreement’s definitions are.

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 shall mean 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 shall have the meaning ascribed to it in the definition of Confidential Information.

These definitions cross-referring to other definitions are often omitted.

20) 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. The following underlined words illustrate what a circular definition is:

PDA means a Mobile Phone with an agenda and e-mail functionalities.Mobile Phone means any cellular phone for use in a GSM Network or UMTS Network, including PDAs.

For the sake of clarity, this best practice principle does not apply to the inclusion of the non-capitalised term in the definition. For example:

Licence Agreement means the licence agreement attached as Schedule3.

Such use of the term rather emphasises that the defined term is well chosen.

21) 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 differing 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 2007 and 14 July 2008”).

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“.

22) If a defined term should also capture any future, yet unknown version, value or amendment, the definition should qualify the referenced subject 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.

23)       The definition of a person, legal entity or organisation 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. See also paragraph 3.4(g).