Reading Contracts: What am I Missing?

August 28th, 2009

One of the hardest things to do when reading a new contract is to figure out what is not covered.  It’s relatively easy to review an agreement and pick out things that are completely wrong or run contrary to one’s interests.  On the other hand, the sea of words can prevent readers from noticing, for example, that a license agreement provides a nonexclusive, worldwide, perpetual license, but doesn’t say clearly whether the license fee must be paid and once paid whether it must be periodically renewed.

The best way to be sure a contract contains all the terms one needs is to do the same type of transaction over and over until you know it cold.  Next best is to find someone else who has to rely on.  Those aren’t particularly helpful suggestions to someone in unfamiliar territory with a deal on the line, though, so here are some suggestions to help identify missing terms.

1) Make up a hit list.  Before you start reading, write down list of the important terms.  This step takes a surprising amount of mental discipline but it is incredibly important.  Avoid the temptation to dive straight in and “see what the contract says”.  Even if you think you know what terms you need, write them down before you start reading.

2)  Take the contract in sections.  This goes along with my piece on How to Read a License Agreement.  Instead of reading front-to-back, search the contract to find all the terms on your hit list.  Do they match your requirements?  Is anything from your list missing?  Bonus points for lining up your hit list in one column on a piece of paper and writing down the comparable terms in the contract in the next column.  I have only taken this extra step a handful of times, but found it very helpful when the deal was complex or I was having a hard time getting through the contract language.

3)  Put it Back Together.  Now that you have found the biggest points, you can read through and see how other terms flow around them.  Do all the defined terms match your understanding of what they should be?  Do any subparagraphs under one of the big points limit its applicability?

4)  Try to Break it.  It’s also easy to read a sentence, squint a bit and say “yeah, that basically covers it”.  Instead of trying to read the contract in a way that fits your needs, do the opposite.  How could a paragraph be read against you?  E.g. if you quit vs. being terminated by your employer, will you lose any vesting in your stock?

5)  Read with a Friend.  If the deal is important it merits more than one set of eyes.  I frequently find that useful points come out of discussion with a co-reader.

6)  Search for Exemplars.  I am putting this last because it’s really hard to find good examples of many types of agreements.  The SEC’s EDGAR database is a good source, but search is very limited unless you pay for advanced search capabilities.  Docstoc and Scribd have pretty good libraries but since there is no clear way to judge quality it is best to look for at least 3 samples of the type of agreement you need, then compare terms carefully before relying on any one contract.

I hope these ideas are helpful.  Reading carefully and catching everything is a genuinely hard task.  Practice very much makes perfect and these are some of my favorite practice tools.

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