Agreement Duration: What is it?
Agreement duration refers to the length of time an agreement between parties is enforced. Agreement duration can sometimes be for a fixed timeframe or, sometimes, for a duration that exists until a specific event occurs. Whether a contract is intended to exist for a specified period or until something happens depends on the circumstances of each case.
In either circumstance, understanding agreement duration is essential in determining your rights and obligations in a contractual relationship. For example, the obligation to pay rent, or some other consideration , may continue until the expiration of an agreement. In such an instance, if, for example, the person paying fails to make timely payments, then action may be required when that payment is missed to preserve the right of the party receiving consideration under the contract or agreement. On the other hand, if a contract exists until a specific event occurs (for example, the death of a specific person), then the party relying upon that provision must ensure that enforcement of the contract occurs in a timely fashion to avoid any potential liability for damages resulting from the failure to enforce the agreement.
Agreement Duration: Types
There are generally three types of agreement duration: (a) a fixed-term agreement; (b) a recurring agreement; or (c) an indefinite agreement. A fixed-term agreement is an agreement for a firm duration. For example, a lease is usually a fixed-term agreement in that the terms of occupancy and possession are for a fixed term. The result is that the relationship cannot continue beyond the term unless it is extended. Thus a lease may provide that the lessee has the right to renew its lease for an additional term or continue the relationship indefinitely upon agreement between the parties. It is not uncommon for lease agreements to provide for an annual increase in the rent paid by the lessee over the term of the lease.
Similarly an indefeasible employment agreement for a term is an example of a fixed term agreement. As with a lease, the employment contract is for a fixed term or duration. For example, the employment contract may specify a period as long as five years. There typically is provision for an increase in salary or at least a review of the annual salary during the term of the contract. While there is no legal obligation to extend the employment agreement or enter into a new employment agreement upon expiration of the current agreement, depending on the circumstances one or the other of the parties may have a right to extend or have the new agreement entered into by the parties.
A recurring agreement provides for a series of consecutive relationships. A classic example is the recurring employment agreement. For example, a working week. Thus Monday through Friday may constitute a recurring weekly agreement. If a lessee pays by the week such a lease may constitute a recurring agreement. The employment agreement may provide that the employee is to be paid a salary for 50 weeks every year. The effect of the employment agreement is that the employee is to receive income for 50 weeks during each year until the employment agreement expires.
An indefinite agreement is an agreement for an indefinite period of time. An agreement may have no beginning or end. For example, the phrases "forever," "as long as the grass grows and the water runs," or "my natural life." In such cases the nature and actual intention of the relationship must be determined, taking into consideration the history of the agreement. Clearly a tenancy for a period of 12 months is unequivocally a fixed-term lease. The same language may be used in different documents to convey different intentions. In the case of a letter of credit, the language "until our last installment," is clearly for an indefinite period. A series of leases may be held to be concurrent leases, falling under the rule against perpetuities. A large factor in determining whether a transaction is an ongoing or continuing agreement or a recurring agreement is the intention of the parties based on the facts and circumstances of each case.
Agreement Duration: Why is it Important to Specify?
The inclusion of specific agreement durations is often of paramount importance to the parties. For example, in a consulting agreement, a consultant may seek to offer his or her services only with respect to a specific target date and, after that date, may want to ensure that all rights to use of any software, inventions, improvements, or derivative works developed by or for the consultant during the consulting term are reserved to the consultant alone. Likewise, a software development agreement may provide that all rights to software or other code developed by the developer during the term of the agreement are reserved to the developer. Conversely, in a license agreement, the licensee of software or other material may want to ensure that the license survives indefinitely, while the licensor may want the license to last for a period of 1 year or 3 years and then be renewable indefinitely upon payment of fees.
A tangential but important consideration when drafting an agreement is that if the duration of the agreement is not clearly set forth, and the agreement has been partially performed with respect to some matter, a party may later claim that the agreement is in force with respect to that matter for an indefinite period, to the detriment of the other party. For example, if a confidentiality agreement does not set forth a duration, a party may argue that even if the two parties had similar yet unexpressed expectations with respect to the duration of the agreement, the confidentiality obligations of the agreement may run for some unbounded indefinite time. In that case, the confidentiality obligations will remain in force indefinitely until the party whose information is confidential no longer "has reason to believe" that the other party continues to require such information to be confidential. Obviously, this would be a result that would be unsatisfactory to most parties.
Agreement Duration: How to Decide What is Right for You
A number of different factors can be taken into account when deciding how long an agreement should last. The nature of the agreement is usually the first thing a drafter will consider in determining its duration. For example, many supply arrangements will last for one year or longer, while product distribution agreements are often for a more extended period of time.
An important factor in deciding an appropriate duration for an agreement is the terms of the parties’ relationship. A longer term can give both sides comfort that their investment will be insulated from competitive pressures during the life of the arrangement. However, a long duration can also make it harder to part ways if the relationship becomes strained or the business changes. Also, if a party expects business improvements or developments with the passage of time, they will wish to tie a partner to other-side agreement. On the other hand, if a party will doubtless want to realign its alliances in a few years, it should seek to keep its options open and prefer a shorter agreement.
Drafters will also choose a duration based on corresponding provisions of other agreements. For example, if an agreement provides for a five-year license term for intellectual property, a supply agreement covering associated products will likely share the same duration.
The culture of a particular industry can also play a part in an agreement’s duration. In the technology and consumer goods spaces, for instance, arrangements will usually be shorter than in industries with past history of relatively stable relationships over the course of several years, such as pharmaceuticals or agricultural products.
Finally, consideration should be given to how long the parties expect to maintain the heart of the arrangement, e.g., the sale of a product. This is particularly important if long sales cycles can threaten to extend the duration of the agreement.
Agreement Duration: Common Mistakes and How to Avoid Them
One of the most common mistakes made in our line of work is to set an agreement term without carefully considering whether the duration of that term aligns with the practical and legal realities of the contractual relationship. For instance, Clause 3.3 of a commercial lease states that "the term of this lease is five (5) years from the start date. The tenants shall have two (2) options to extend the lease for forty-eight (48) months. The further term rent shall be negotiated."
What seems to be missing here is the extension period being conditional on the parties’ agreement to the "further term rent." If the tenant is unable to negotiate a rent agreeable to the landlord, is the lease then terminated? Or does this option for extension return to the open market to be negotiated between the landlord and tenant? Is the tenant permitted to accept the existing rent, despite any market fluctuations? While the tenant has the right to renew, does the landlord have the obligation to negotiate in good faith with the tenant each time in order to determine rent that is fair in the existing market? This would be a significant issue. A better approach would be to either specify the rent for the second option or provide the tenant the right to determine the rent, either of which would provide some certainty to both parties.
Another common mistake is that of assumption. Under Clause 1 of a standard agreement of purchase and sale (APS) in British Columbia, in the absence of an exception, the buyer shall pay the purchase price on the completion date. Clause 3 of the APS states that "the buyer acknowledges that he must pay the balance of the purchase price on the completion date generally known as the closing date. The buyer acknowledges that the seller may be entitled to an interim occupation payment if the subject property has not been completed and closed for registration prior to the closing time."
It is a very common occurrence where the buyer obtains possession and the seller is entitled to payment in lieu of closing. Law firms and real estate agents frequently assume that any disputes shall be dealt with after the fact by the Real Estate Council as opposed to dealing with the matter at the time it occurs. The buyer and seller should have some recourse against each other in the case of a misrepresentation or delay , but Clause 3 indicates that the seller must stand aside for the full amount of the claim and end up waiting for the results of the Real Estate Council’s investigation, with no immediate recourse. Breach is bred out of poor drafting, incorrect assumptions or failure to observe the specific circumstances of that particular agreement.
Next, are the terms of the extension of the basic agreement. A licenseo to occupy is a licensee during the term but the agreement to license must be specific to the licensee’s premises only. It is axiomatic that the licenseo does not get equity in the property. In effect, the agreement must specify both duration and successor tenant. Even where the agreement is for one year and is the sort of thing that can be renewed, the renewal should be in writing in order to avoid having the agreement treated as a tenancy and exposing the parties to the Residential Tenancy Act.
Even in those cases when an agreement can be renewed, are all of the terms of the initial agreement subject to renewal? If a clause specifies that on three months’ notice "this Agreement may be renewed in writing for an additional term under the same terms and conditions", does this mean all new terms, but the old conditions? Are the parties bound by the dispute provisions in the initial agreement? All too often such things are ignored in the hope that they will disappear, but they rarely do.
The enforceability of an agreement will depend on its readability, clarity of meaning, and explicitness of expression. These attributes can create satisfaction by both parties while also contributing to a contract which is enforceable and meets the parties’ needs.
Agreement Duration: Negotiation Tips
Consider the following when negotiating the duration of an agreement with the other party:
•Consider the type of relationship. A steady relationship is more likely to continue if it depends on only one or two individuals, rather than a range of roles and cross-departmental support. The absence or departure of any one person can have a significant effect on long-term intention.
•Consider synergies of trust and goodwill between the parties. Develop confidence that a good working relationship has been established and will be maintained. Greater trust will often lead to a longer duration period, provided both parties have capitalised on this in the deduction of fee requirements and possible other obstacles to implementation.
•Include a review clause when both parties can negotiate revised terms after a defined period, which allows the parties to determine whether the agreement is providing them with the benefits originally expected. It also can provide an opportunity for your client to consider the effect of changing market conditions (including alternative delivery models), which may affect future delivery and pricing. However, a review clause can only result in adjustments where this is a true representation of the partnership. Without a review clause, the parties are more likely to rush to a specific conclusion about the duration period they need from the outset, irrespective of its true nature.
•Take into account that any material clause requiring majority agreement between the parties is often included in the duration clauses, including IP development, change control, governance and pricing. Material clauses are enforced for life of the agreement, often overruling any other shared objectives. Both parties should give commercial consideration to the importance of the length of these clauses, or the duration of the agreement will not meet either parties’ expectations, especially as the chance of future negotiation and agreement is likely to diminish with time.
•Consider that a shorter duration will allow both parties to renegotiate terms and conditions after a period of time. However, it can also inhibit both parties in terms of capital investment, resource commitment, and depreciation. For example, the client may be worried about onerous exit costs and the credibility of a new, unproven solution.
•Consider short periods with automatic review and re-negotiation if specific and necessary KPIs have not been achieved. For example, anything less than a three-year term can lead to client and supplier indecision, as this is generally considered to be the minimum period for any new solution to be impacted. For larger projects, incentivising both parties is often important, as a five-year tenure at a higher price will encourage better performance from the incumbent.
•Benchmark partner fees and value the relationship prior to initial negotiation of the agreement duration and review periods. The fee levels required by the client should be used to assess the duration of the agreement. On the other hand, the ability of an outsourcer to absorb the impact of fees/changes to its structure will impact the duration of the deal. If the outsourcer has to increase the rates to protect itself, it may well reconsider the deal and its investment into the relationship.
•Understand how the cost of transition (both initial and during the contract) will impact the cost/benefits of a shorter term. The effect of underestimating an outsourcer’s commercial expectations may have an impact on the duration. For example, inadequate consideration of the transition costs that the outsourcer may incur during the term of the agreement (as a result of changes to the organisation) may lead to the duration being reduced or even an exit being demanded.
Agreement Duration: Legal Considerations
"Third-party beneficiaries often have a right to enforce the contract as long as it is clear that the parties intended to confer that right on them. But, in most cases, a third party does not have to plead such an intent."
It is important to discuss the legal implications associated with the different "durations" that are commonly found in agreements. These include default terms, renewal options, and termination and/or expiration rights. A cardinal rule of Agreement drafting is always to specify what happens at the end of the term. The questions to ask include whether the Agreement can be renewed or extended, whether there are any termination rights, and what happens when the initial term expires.
The starting point is the scope of the default provisions: does the term "evergreen"- which has the meaning of renewing on an automatic basis – apply? If so, the parties must make it clear that this provision does not encompass the termination rights.
If the agreement contains a renewal option , the natural question that follows is what is the process for renewal. The answer may be contained in the renewal language and the operative term varies from agreement to agreement. The renewal process is usually similar to what is required for entering into an Agreement in the first instance (i.e., notice, negotiation of a renewal price, etc.).
Termination rights are clearly important to consider, as they go to the essence of the performance of the parties. Indeed, if an essentially critical term is breached, the injured party has the right to terminate the agreement and obtain damages as well even in instances without a termination right. In this day and age of continuing performance obligations (e.g., confidentiality), having a right to terminate the Agreement is essential.
Durations give rise to a number of factors to consider. Outside counsel should be consulted to provide exhaustive advice on the topic and help the parties promote the objectives of the agreement.