Contracts Drafting and Negotiations – Definitions and Interpretations

The next in our series of Contracts Drafting and Negotiations — Definitions and Interpretations.

Definitions are the anchor on which your entire Contract need balance itself. Correct referencing is the key to making best use of this anchor and interpretations are like your private rule book that need to be drafted first but finalized just before your last draft. 

Importance of Definitions in a Contract

RB: The art of defining and correctly referencing is the first key to a clear and a flawless Contract. The aim is not only to define correctly but to have an inclusive list of what is covered in the definition. Your definitions drafting should be the first step in Contract drafting. In fact, in complex commercial arrangements, I have always undertaken only definitions finalization before we proceed with drafting of the rest of the Contract. Then comes referencing. Once defined, you have, for the purposes of the Contract, made the generic term a noun. Throughout your Contract while referencing to the defined term, you will use with the same rules that a noun is used, unless you are referring to the general English meaning of the term, in which case you will use it like any other term. Most mistakes in drafting are interchangeably using the term after defining it. Most common example is when you define the term, “Business” and include a list of activities, if you use the term business without using it as a noun, you essentially are not referring to the defined term but general English word business. Yugandhara surely can give us a better perspective how the definitions play out in courts. But from a drafting standpoint it is the basic foundation which must always be set perfect. 

Interpretations

Why do we need interpretations in a Contract? Because interpretations are the most disputed when in dispute. They are used as a mechanism to give reading and understanding rules with regards to terms or clauses or headings in the Contract. This is where you record rules of interpretation of time zones, singular vis a vis plural references, tenses references etc.

YJ: Definitions are often thought to be standard / copy-paste provisions which can be simply replicated from the earlier ones. However, at the time of interpreting Contractual terms in any dispute resolution proceeding, ‘Definitions’ play a pivotal role especially for disputes of commercial nature as each term is scrutinized to bring out the true intent of the parties for using a particular term and its effect. Therefore, definitions of terms with commercial and legal bearing on the transaction (e.g. terms like ‘costs’, ‘loss’, ‘charges’, ‘fee’, ‘compensation’, ‘share value’, ‘intellectual property’, ‘confidential information’, ‘claim’, ‘dispute’, ‘force majeure’) need to be constructed carefully and should not be standardized so that each such term correctly reflects the understanding of the parties. Defining a term in a clear and unambiguous way is a sure shot way of restricting courts / tribunals from implying its own reasoning while interpreting the terms of the Contract which may land before it.

When a Contract reaches the dispute resolution stage, and the dispute hangs on interpretation of certain key terms and typically, each party will try to enforce its own version of interpretation so as to strengthen its claim before the courts/tribunals. When faced with such a predicament, courts/ tribunals do not go beyond what is expressly stated in the written Contract. However, there are times when the term is not expressly defined or there are two ways of interpreting it.

In Nabha Power Limited v. Punjab State Power Corporation Limited, the Hon’ble Supreme Court had the occasion to interpret terms of a commercial Contract by looking inter alia into the Definition clause and formulae and lay down guiding principles on how terms of commercial Contracts should be interpreted. The bench comprising of Justice Rohintan F. Nariman and Justice Sanjay Kishan Kaul held that “It should certainly not be an endeavour of commercial courts to look to implied terms of Contract. In the current day and age, making of Contracts is a matter of high technical expertise with legal brains from all sides involved in the process of drafting a Contract. It is even preceded by opportunities of seeking clarifications and doubts so that the parties know what they are getting into. Thus, normally a Contract should be read as it reads, as per its express terms. The implied terms is a concept, which is necessitated only when the Penta-test referred to aforesaid comes into play. There has to be a strict necessity for it.” 

For ease of reference the ‘Penta test’ referred by the Hon’ble Supreme Court to ascertain ‘implied terms’ while interpreting commercial Contract is as follows-

“(1) it (the implied term) must be reasonable and equitable; (2) it must be necessary to give business efficacy to the Contract, so that no term will be implied if the Contract is effective without it; (3) it must be so obvious that ‘it goes without saying’ (4) it must be capable of clear expression; (5) it must not contradict any express term of the Contract.”

To sum it up, it is important to remember that, even though one may be drafting a Contract of common occurrence, the transaction in each case has its own nuances and uniqueness. Definitions shall be such that it leaves no room for speculation about what the actual parties to the Contract or authors of the instrument actually wanted.