What are Term Contracts?
A "term contract" is a contract that lasts for a specified length of time. "Term contracts" therefore typically include an express, specific duration such as "3 years," "2 months," or "4 weeks" (rather than an amount of days). The term of a term contract can run for any period of time.
The primary purpose of term contracts is certainty. Term contracts offer parties some level of confidence and predictability in terms of what is expected of them for the duration of the contract.
For example, in Texas, the general rule is that contracts for a "definite term" automatically terminate when the term ends . For various reasons, however, parties might want to delete the default termination rule. Parties are then free to agree, for instance, that their contract will automatically renew every year unless one of them provides notice of termination 30 days in advance. Such a contract then arguably becomes a "term contract," instead of a contract for an "indefinite term."
Term contracts are governed by statutes, regulations, and case law. Below, this post summarizes several of the key legal rules that apply to term contracts.
Characteristics of Term Contracts
Term contracts, as the name implies, are fixed in duration. The obligation to perform is expressed with specificity and certainty. Such a contract specifies a period during which the supplier is bound to perform, to provide products or services, in exchange for payment at pre-agreed prices. Once the term has been established, the external elements that may affect performance and the movements of the marketplace no longer impact the basic bargain between the contracting parties. For example, if a farmer enters into a contract with a buyer for a certain quantity of oranges over a particular period, the law expects that the farmer will provide that number of oranges and that the buyer will pay the specified prices during the agreed term. Events outside the control of either party – including the possibility of damage to the crop by hail or other precipitation, the potential for pests, the effects of labour strikes or acts of God such as earthquakes, floods or fires – cannot be used as an excuse by the supplier, the farmer in this case, to justify non-performance. Nor can they be relied upon by the buyer, the consumer of the oranges, to justify refusal or failure to pay the price. While the law does provide exceptions – force majeure events, for example – they are limited and are not there to allow either party to take advantage of the circumstances for their own benefit. The law assumes the parties are acting on the basis of rational self-interested behaviour. It also assumes that one party to the transaction – the buyer – has more knowledge about the marketplace than the supplier. This means, as a general rule, that the supplier has little or no negotiating power and must accept the terms being presented by the buyer in order to obtain payment in return for performance. On occasion, however, the opposite will happen – and the buyer will be obliged to enter into a deal on terms demanded by the seller. The term of the contract may well be one imposed on the seller as a condition of buying the product being sold. There are limits, of course, to a supplier’s willingness to provide a product or service for an extended term. One such limit is the extent to which the supplier believes it will be able to fulfil the contract terms. A farmer will plant a crop – seed germinated in the ground, incrementally tended as it grows under the sun and watered, as needed, using rainfall or irrigation – only if satisfied that the crop supplied will meet the target (or forecast) price for the product. If demand is curtailed or prices fall, other factors may prevent the harvest being delivered in the anticipated amount. A second limit is that the supplier is seeding the future, often years ahead of the harvest; the supplier is convinced that sufficient water and sunlight (excessive precipitation) will be available when needed, there is sufficient security against theft or injury by pests and predators, that mechanical issues related to the farm will be resolved. There is significant uncertainty and risk involved in term contracts, particularly those of longer duration.
Pros and Cons of Term Contracts
As with anything in life, there are advantages and disadvantages to entering into term contracts. The biggest benefit is that both parties know how long an obligation will last. For example, if you lease a hotel ballroom for your wedding reception or schedule a work project to be completed by a specific date, you know months in advance when you can expect performance to fulfill your expectations. The construction market in particular uses term contracts when drafting contracts for construction projects.
For the hotel, it can plan its staff on what days it will need extra help and raises the price of the room on those days. And the contractor knows when the construction project must be complete. When the construction project is complete, the contractor no longer has a bond or other obligation to provide its services to the general contractor. In this case, the term contract will have achieved the goals of both parties.
On the downside, if both parties don’t perform under the term, both parties run the risk of exposing themselves to liability for the other’s non-performance under a term contract. For example, both parties may incur the expense of having to now look for another ballroom that it can find at the same affordable price as their first choice. Both parties will be expending time and energy trying to mitigate the damages the other incurred. Thus, the term contract does not provide either party with a true remedy for the breach.
Types of Term Contracts
There are many different types of term contracts across a variety of industries. These contracts have become an indispensable part of commerce as businesses seek to better manage their cash flow and risk. Below are a few examples of how some industries are using these agreements to drive their growth.
Employment Contracts. Employers use term contracts to limit their risk and manage their payroll. For example, all lawyers (most notably military and sports) use term contracts as a way to attract and keep their talent. You will also find term contracts in corporate where employees have complex compensation structures such as stock options and other rights or privileges that extend beyond their employment.
Service Agreements. Service Agreements are used by almost all companies in service based industries. Many IT departments, for instance, have strict Service Agreements with their vendors to provide internet and telephone services. Similarly, it is hard to imagine a hospital or doctor’s office not entering into Service Agreements to provide the facilities and services required for the proper treatment of patients.
Extension Agreements. Contracting parties use Extension Agreements to informally renew the underlying contract. For example, both a landlord and tenant may use an Extension Agreement to extend the lease term if they have not yet found a tenant or tenant. In these situations, Extension Agreements operate like Amendments but are significantly more cost effective, this is why it has become standard procedure in many commercial transactions.
Lease Agreements. Lease Agreements are probably the most recognizable type of term contracts. Although the formal lease contracts can vary significantly, any of the underlying usage agreements of the lease are likely to be term contracts. For example, a lease for a restaurant may include Service Agreements for food supplies and Equipment usage Agreements for refrigerators, tables, and other areas of the establishment.
Manufacturing Agreements. Similar to Lease Agreements, Manufacturing Agreements are the quick and dirty version of a contract for long terms leases of equipment. Long term leases of real estate are more often than not considered term contracts (Commercial and Residential).
How to Write a Term Contract
There are a number of contract clauses and requirements that must be considered when drafting a term contract. First and foremost, is the element of consideration. A term contract must be supported by adequate consideration. Simply agreeing to a lower price in exchange for a longer arrangement will not be adequate consideration. Often times, if the term of a contract is longer than one year, then it must be supported by – and in fact is required to be supported by – an adequate legal description of what is being provided to the other party.
The written contract itself must be signed and approved by Resolution or Order of the governing body, under the requirements of the Local Government Code. The most common form is an Order, because the requirements for an Order are easier to satisfy than for a Resolution.
If the contract is approved by Order, the Order must set out the specifics of the contract. If the contract is approved by Resolution, the language of the Resolution may be incorporated into the contract, but the incorporating language should be clearly stated at the beginning of the contract to avoid issues of incorporation.
Term contracts with a term of one year, are governed by the general provisions set forth in Local Government Code 263 . 003. If the term of the contract exceeds one year, than it is governed by 271.903. In order to satisfy the requirement for adequate consideration, the contract must provide for goods or services that are capable of being continued beyond the expiration of the term, and that the party providing the same would ordinarily be expected to continue past the expiration of the contract. The good or service must be of the type that a local government is permitted to purchase for its use. For example in one case, a contract providing for sidewalk repair was found to be acceptable over a two year term, because the work would ordinarily be required from time to time (City of College Station v. Turtle Creek Estates Homeowners’ Ass’n, 257 S.W. 3d 434 (Tex. App.-Austin 2008, pet. denied). However, in another case involving a professional service contract to be governed by Section 271.903, the court held very plainly that a contract for professional football analytics and statistics in exchange for the use of Jerrell Freeman’s likeness was not a valid contract made under the terms of 271.903 (Jerrell Freeman v. Montgomery County, Texas, 08-14-00076-CV (Tex.App.-El Paso 2015), rehearing overruled, 2016).
Legal Aspects of a Term Contract
Term contract arrangements must also account for legal considerations. These aspects are sometimes overlooked by those creating term contracts. Therefore, it is advisable to address them in the agreements from the get-go to avoid any problems later. Here are a few of the most essential elements to consider:
Does the contract have to be in writing or signed? Occasionally, verbal agreements are valid, but most business contracts require a written agreement. Furthermore, some types of verbal agreements are void or voidable once a performance occurs. For example, when an individual goes out for dinner and pays for the meal, then all aspects of such an agreement are binding. The agreement cannot be overturned once this step is taken. On other occasions, it is necessary for an agreement to be written and signed. For example, many states require that certain types of agreements be in writing, while others require them to be both in writing and signed. Despite this fact, oral or unsigned contracts can still be enforceable to certain ends, such as being able to recover spent resources.
Are there disputes or a need for dispute resolution? Term contracts often require provisions for dealing with disputes. This is not always the case, but in certain situations, it is crucial to include them. The reason is that they will govern how both parties should proceed in the event of a dispute. Typically, there may be many options that you should consider, depending upon your particular arrangement and the surrounding circumstances. Here are a few of the most common dispute options that you might use in a term contract.
What regulations and rules should apply to the contract? In the past few decades, there have been certain regulations which have been added for the purposes of protecting individuals from being overexposed to a single company. A few examples of these include the following:
In addition to these regulations, there are also other restrictions with companies that are regulated by the Federal Communications Commission as well as the Justice Department. However, while these specific criteria may not be applicable for your particular agreement, provisions which seek to guard against market monopolies and other antitrust issues are often desired, especially for businesses that deal directly with consumers.
What consequences are there for breach of contract? A clear definition of what a breach is should not be left out of a term contract. This is very important so that both parties have a better understanding of what could happen if one or the other decided to break the terms of the agreement. The terms of the agreement can then specify the consequences. For example, many contracts allow the wronged party to walk away entirely from the contract with no consequences. You could also provide for penalty clauses, liquidated damages, performance bonds, set offs or take other approaches. Therefore, carefully consider your options and choose wisely, as your choice could play a significant role in your bottom line.
Term Contract and Other Legal Contracts
Unlike other types of employment contracts, the use of a term contract does not create a presumption that the employee may be fired only for just cause. A term contract is generally not subject to the Alabama law that requires employment contracts of indefinite duration to state that the agreement is terminable at will by either party.
Most term contracts will clearly state the duration of the contract, typically as a specified number of months or years, and will either be silent as to the possibility of termination prior to expiration of the term or will specifically state that the contract may be terminated by either party prior to the expiration of the term.
In Sterling v. University of Alabama at Birmingham, a district court found that an employment contract for a professor was for a definite term and therefore not terminable only for just cause. Notably, that case followed a line of cases from many other jurisdictions not applying the "at will" standard to employment contracts for a definite term or duration. Likewise, in Holt v. Coastal Bancorporation, the Alabama Supreme Court found that an employment contract was for a duration of two years and therefore terminated only by expiration of the two-year term. The Court further chose not to imply a provision for just cause termination.
For those reasons and based on the additional case law that has developed since the time that the foregoing cases were decided, many employers will enter into a term contract with an employee for a certain term that clearly provides that either party may terminate the contract upon proper notice. Others, however, would consider entering into a term contract for a fixed period of time that is silent as to the termination rights of the parties.
Examples of Term Contracts
As with workers’ compensation issues, the need for clear and unambiguous policies and procedures regarding the use of term contracts is paramount. The following are two typical scenarios in this regard.
Scenario No. 1: Wage freeze and short-term extension. The employer had scheduled wage increases for microwave technicians for a given month of the year. Due to business needs, the employer determined a need to extend the technicians’ collective-bargaining agreement by several months. The negotiations for the short-term extension were very difficult, as the union was unwilling to agree to any rollbacks in pay. The employer did not want to be forced to grant the same wage increases proposed for a longer term, so the employer offered the union a "wage freeze" for the short-term extension. The union agreed to the wage freeze; however, the parties never signed a "term contract" reflecting the wage freeze. The employer simply treated the wage freeze as a modification of the original agreement and treated it as if it were a subject permitted to be covered by modification. The contract expired , the wage freeze applied, and the negotiations for the long-term agreement were very successful.
Scenario No. 2: Terms of a term contract not followed. In an industry experiencing steep competition, the employer proposed an enhanced version of the pay and benefit package of the previous collective bargaining agreement, with the idea being that it would attract good employees and drive away weaker ones. The bargaining agents for the union agreed to the package on a term contract, but provided the employer with a list that defined the types of jobs covered by the term contract. An assisting bargaining agent saw the eventual contract come in, saw that the jobs at the bottom of the hierarchy were not covered by the term contract, and did nothing. The term contract expired, and the first employee in the list sued and received an arbitration award in the amount of 20 times the wages he would have received had he been covered by the term contract. The collection process for this award is still pending.