In Short
- Defined terms in a contract are capitalised words given a specific meaning within that contract, which may override their ordinary meaning.
- They reduce ambiguity, ensure consistency, and make contracts shorter and easier to read.
- Misusing or overlooking defined terms can create legal uncertainty and affect your contractual rights and obligations.
Tips for Businesses
Always check the definitions of capitalised terms in contracts before signing. Avoid introducing unnecessary or inconsistent terms, and ensure all defined terms are clearly explained. Understanding these definitions protects your rights, clarifies obligations, and reduces the risk of disputes or unintended commitments.
Do you enter into contracts as part of running your business? Do you wonder why certain words throughout the contract have capital letters? These terms likely have a definition somewhere else in the contract. Additionally, these definitions may alter the meaning of clauses within the contract. This article will consider when and why a contract may include defined terms.
What are Defined Terms?
Defined terms are words that are given a specific definition in a contract. The term’s definition applies in the context of the particular contract, and the definitions are usually only applicable to that contract. If you see a capitalised word in a contract, the chances are its definition is somewhere in the document. You should be sure to check this definition. If you do not read the defined term, you may be agreeing to something different from what you understood the word to mean.
Why Define Terms?
Defining terms can override the everyday meaning of that particular term. It is also helpful to reduce the risk of ambiguity and uncertainty in a contract. Further, defining terms ensures that certain terms used throughout a contract have the same meaning each time parties use them.
Parties often use defined terms strategically. For example, if you are providing services to another business, they might aim to include a broad definition of ‘Services’ by including wording like: “and includes any services that are necessary or incidental to the services set out in the Contract”. Understanding this definition is important, as it would extend your obligations beyond the services in the scope of services listed in the contract, and beyond what you may have priced for.
Defining terms can also make a legal document shorter and easier to read. This approach avoids the need to repeat long definitions throughout the contract. This makes the process of reviewing the contract simpler for both parties and makes the contract easier to read and understand.
Continue reading this article below the formHow to Define Terms in Your Contract?
You may find definitions of terms in a standalone section at the beginning or end of a contract. Alternatively, the contract may embed the definitions throughout its text.
Each time the person drafting the contract wishes to refer to that definition, they can simply insert ‘the Services’, using the capitalised term, and the parties will know that they are referring to the defined term. If the contract used the word ‘services’ without capitalisation, the definition would not apply, and you would interpret the word in its everyday meaning.
You may not need to use defined terms where the plain language definition of the term is clear and applicable in the context of the contract.
Common Pitfalls to Avoid
While defining terms can be useful to help clarify what you mean in a contract, it can also create potential issues and unintended legal consequences for your business.
A common mistake is introducing defined terms that never appear elsewhere in the contract, which adds unnecessary complexity and can cause confusion. Conversely, you might capitalise words throughout the contract, intending to define them but forget to include the actual definitions, leaving both parties uncertain about what you meant.
Another common error is using inconsistent terminology. You might have different defined terms referring to the same concept, or use defined terms in one instance but not in another. This can leave you and the other party confused about the application of certain terms in the contract. For example, if you define one party as ‘the Company’ but later refer to it as ‘the Supplier’, it may create uncertainty about whether you mean the same party.
Key Risks When Using Defined Terms
Sometimes, the other party might use a defined term that is not what you would expect. You might gloss over the defined term, thinking that it has its ordinary meaning, but defined terms can affect your contractual rights and obligations in ways you might not anticipate.
Instead, you would have to rely on other termination rights, like termination for convenience. Contracts often require parties to give longer notice periods to terminate for convenience, which could lock you into a contract with a non-paying customer for an extended time.
Similarly, if you are engaging someone to do work for you, a contract might define “Acceptance” as something that happens automatically once a certain amount of time has passed, regardless of whether you have actually accepted the work or not. This could leave you with limited recourse to challenge the quality of the work and may impact your legal remedies.
What if a Contract Fails to Define Terms?
If the contract does not contain defined terms, this may result in a dispute arising due to the parties having different understandings of the term. In situations where a dispute arises, the parties may not be able to settle the dispute between themselves. In this case, the Court may interpret the relevant terms and generally, the Court will give the term its ordinary meaning. Where the ordinary meaning is ambiguous or the term has multiple ordinary meanings, the Court will:
- consider the context of the agreement; and
- assess the parties’ intentions when entering into the agreement.
The Court will also consider the definition of the term from a commercial perspective, that is:
- what an ordinary business person would understand the term to mean;
- the overall purpose of the agreement and the particular clause; and
- any other relevant provisions within the agreement.
Such a situation could lead either party to interpret the contract in an unintended way. Therefore, agreeing on clearly defined definitions can reduce:
- disputes; and
- time and cost involved in dealing with disputes.
Download this free Commercial Contracts Checklist to ensure your contracts will meet your business’ needs.
Key Takeaways
Defining terms in a contract can make the contract more concise and reduce uncertainty when interpreting the contract. When reading a contract, it is important to read (and not skip over) the defined terms.
If you have any questions about the interpretation of terms within your contract, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Defined terms are words in a contract that receive a specific meaning. These terms are defined within the context of that particular contract and generally apply only to it.
It is important to define terms because it reduces the risk of uncertainty in a contract, especially when defined terms override the usual meaning of a term. Further, it ensures that terms used in a contract are given the same meaning each time they are used.
You can define terms in a standalone section at the start or end of a contract. Alternatively, you can embed the definitions throughout the contract.
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