Drafting commercial contracts in Scotland: what SMEs should watch for

Almost every commercial contract in circulation among British small businesses was drafted for England and Wales. The templates sold online, the precedents inherited from a former employer, the standard terms that a larger counterparty sends across: the overwhelming majority assume an English legal system, because that is where most of the market is. For a Scottish business this makes no difference most of the time. The document works, the parties perform, and nobody looks at it again.

The exceptions are not distributed evenly, however, and they tend to cluster around the clauses a business would rely on if something went wrong.

The differences that matter

The most frequently cited difference is the absence of consideration. In Scots law a promise may be binding without the promisee giving anything in return, which means that some of the machinery English drafting uses to manufacture consideration, such as the nominal pound and the elaborate recitals of mutual benefit, is unnecessary in Scotland. That is a curiosity more than a trap.

The difficulties lie elsewhere. Where a contract confers a benefit on somebody who is not a party to it, the Scots rules are contained in their own statute and not in the English act that businesses often assume applies throughout the United Kingdom.

A clause drafted to exclude or to confer third party rights by reference to the wrong statute achieves nothing at all.

The statutory control of unfair contract terms likewise operates in Scotland through a separate Part of the legislation, with tests of its own.

An exclusion clause that has been drafted, and perhaps litigated, against the English test has not necessarily been tested against the Scottish one.

Incorporation of standard terms

The most common contractual failure we see has nothing to do with jurisdiction. It is a business that has excellent standard terms and has never successfully incorporated them into a single contract.

Terms printed on the reverse of an invoice arrive after the contract has been made. Terms referred to in a quotation may or may not have been brought to the counterparty's attention, and the more onerous a clause is, the more clearly it must have been drawn to their notice. Where both parties send their own conditions back and forth, the last set sent before performance began will usually, though not invariably, be the ones that govern.

None of this is peculiar to Scotland. It is, however, where a great deal of money is lost.

Limiting liability

The liability provisions are the part of a contract most likely to be tested and the part most often copied without thought. Three points repay attention.

A cap has to be expressed in terms that can actually be applied. "Liability is limited to the value of the contract" invites an argument about what the value is where there is an ongoing supply arrangement.

Exclusions of indirect and consequential loss do not mean what most commercial people take them to mean. They do not exclude the ordinary lost profits that flow directly from a breach, which is very often the loss the client actually cares about.

An indemnity operates in the opposite direction to a limitation. It is an obligation to pay on a different and usually more generous basis than damages, without the ordinary requirements to prove loss and to take reasonable steps to reduce it. Accepting an indemnity because it appeared in a template is how a business assumes a liability it never priced.

Prescription

Scots law extinguishes obligations by prescription. This is not the same idea as English limitation, which bars the remedy while leaving the obligation in existence. In Scotland, after the relevant period, the obligation is gone. The ordinary period for a contractual obligation is considerably shorter than most businesses assume, and it runs whether or not anyone has noticed.

The practical consequence is that a claim about a contract performed several years ago may already be worthless, and that a business sitting on a dispute while it sees how the relationship develops may be spending an asset it does not know it holds.

Governing law and jurisdiction

A Scottish business that signs up to English law and the exclusive jurisdiction of the English courts has agreed to litigate in another system, at a distance, under rules its own solicitors do not practise in. That is occasionally right, where the counterparty is much larger and it is the price of the contract, or where the subject matter genuinely sits there. It ought to be a decision somebody took.

Where to start

Find the last three contracts the business signed. For each of them, establish whose terms actually govern, what the liability cap is and whether it can be applied, which law and which courts have been chosen, and whether anyone would be able to answer those questions in two years' time without a solicitor. Any of those questions that proves difficult is the place to begin, and it is a considerably cheaper piece of work than the dispute it prevents.