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4 Tips for Defining Contract Terms

thinkstockphotos-616226892When drafting a contract, make sure to give attention to the defined terms portion. Defined terms are important because they allow the use of short-form references for names, terms, and concepts that are frequently repeated in an agreement, thus saving space, improving readability, and assuring consistency. They also encourage the drafter to be precise in stating important concepts and procedures. Use these four tips next time you draft a contract.

1. Define critical terms. The definitions section should define every word that’s critical to understanding and enforcing the agreement. This section helps avoid arguments over whether a word is to be interpreted in its normal, technical, legal, or local sense or whether a meaning peculiar to the trade is to be given to the word. Definitions are particularly important when parties have different levels of sophistication or when one party is a foreign entity, because words often have different meanings when translated from or interpreted in light of different cultural backgrounds, economic or legal systems, or trade experiences. Examples of critical terms that generally should be defined include:

  • The property that’s the subject of the agreement;
  • The territory involved in a distribution agreement;
  • The markets covered by a sales representative agreement; and
  • Financial terms and requirements.

2. Don’t overly define. Despite the value of defined terms, be judicious in creating them. If defined terms are overused, readers will need to continually look up the definitions, consequently losing their train of thought. Excessive use of defined terms can also result in stuffy prose. There is usually no need to define short terms or terms that have commonly understood meanings, such as the United States of America as the “U.S.” A defined term generally should not be created unless the term is used at least several times in the agreement.

3. Use consistent meaning. Any defined term should have the same meaning regardless of where it’s used in the agreement. For example, in an acquisition agreement, certain representations relate to the acquired company and its “Subsidiaries” (defined in the agreement as entities in which the acquired company owns 100 percent of the voting stock). Counsel should not later provide, in the same agreement, that the acquiror covenants that neither it nor its “subsidiaries” (entities in which the acquired company owns more than 50 percent of the voting stock) will disclose or misuse confidential information that the acquiror obtains in the course of its preclosing due diligence, because “subsidiary” has a different meaning in this clause.

4. Don’t use acronyms as defined terms. It’s generally not a good idea to use acronyms as defined terms because often their meaning isn’t self-evident, or they may have a common meaning different from that intended in the agreement, causing confusion for the reader. For example, the term “customer deposit” should not be defined as “CD,” because that acronym customarily refers to either a “certificate of deposit” or a “compact disc.”

For more on the use of defined terms in an agreement, including the best options for where to place them, turn to CEB’s Drafting Business Contracts: Principles, Techniques and Forms §§5.23-5.35.

Other CEBblog™ posts on contract drafting tips:

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