Definitions are a key part of any sophisticated contract. They provide an efficient way to package a concept and to employ that concept repeatedly in a contract. Here are five tips for drafting your definitions, including some “errors” in drafting definitions that I routinely encounter.
1) Do not use “shall” when defining a term.
The word shall should be used to convey an obligation, and should not be used otherwise in contract drafting. See my prior post on this: The Contract Drafter Shall Not Use “Shall” (Except to Convey Obligations). Definitions employ language of policy, not obligations. And please don’t use shall as a proxy for I really mean it. Rhetoric has no place in clear contract drafting. So don’t write:
“Securities Act” shall mean the United States Securities Act of 1933.
You’ve just tried to obligate the term “Securities Act” to mean something. You’re fired. Take a deep breath and use the present tense of the verb “to mean”:
“Securities Act” means the United States Securities Act of 1933.
2) In a definitional index, do not embed obligations or categories of language other than language of policy in your definitions.
Language of policy–the category of contract-drafting language used to convey the “rules of the game” for a contract–should be used when defining a term. As noted above, this means using the present tense of the verb “to mean.” (Or, if you’ve got a conditional definition, then you would use the future tense.) But do not sneak in other categories of contract-drafting language. For example, do not do the following:
“Closing Certificate” means a certificate in the form attached as Exhibit A, which the Seller shall deliver to the Buyer at the Closing.
I’m not saying that a court would not enforce the Seller’s obligation to deliver the Closing Certificate at the Closing. It’s just that you’ve lumped in an obligation in an unnatural place. The definitional index is supposed to tell the reader what contract terms mean, not what the parties’ respective obligations are.
3) A definition might vary depending on the context in which it is used.
Suppose that you want to include a definition for gross revenues for each party to a contract. That definition will vary depending upon the party that is being referred to in the sentence in which the definition is being used. You could get by with something like:
“Gross Revenues” means a Party’s gross revenues for the period beginning on January 1, 2014 and ending on (and including) December 31, 2014, calculated in accordance with the manner in which such Party prepares such Party’s financial statements during such period.
However, when used in a stand-alone definition in this manner, a Party begs the question: which Party? The implication is that there will be a reference to a particular Party in the operative provision when referring to the term Gross Revenues. But I like to make this “pointing reference” explicit in the definition:
“Gross Revenues” means, with respect to a Party, such Party’s gross revenues for the period beginning on January 1, 2014 and ending on (and including) December 31, 2014, calculated in accordance with the manner in which such Party prepares such Party’s financial statements during such period.
4) Be mindful of defined terms that require temporal references.
If the meaning of a particular term could change depending upon when the parties are making a particular determination, then you’ll need a temporal reference in your definition. I see this come up with the definition of Affiliate. Take the following obligation and definition:
Section 2.4 The Stockholder is permitted to Transfer any Shares that the Stockholder holds to any of the Stockholder’s Affiliates.
“Affiliate” means, with respect to a specified Person, any other Person that controls, is controlled by, or is under common control with such specified Person. [I'm putting aside for now what "control" means.]
Are we talking about a Person that is an Affiliate at the time the contract containing this definition and obligation is signed? Or are we talking about a Person that is an Affiliate at the time of Transfer of Shares? There could be a different set of “Affiliates” depending upon how you answer this question. In order to clarify things, you’d want to reference a timing element in the obligation in Section 2.4 and then update the definition of Affiliate accordingly:
Section 2.4 The Stockholder is permitted to Transfer any Shares that the Stockholder holds to any Person that, immediately prior to such Transfer, is an Affiliate of the Stockholder.
“Affiliate” means, with respect to a specified Person and at a given time of determination, any other Person that controls, is controlled by, or is under common control with such specified Person at such time.
Note that, by including a temporal reference in this definition, it means that a “time of determination” must be addressed when using the defined term Affiliate in your operative provisions. Sometimes you can get away with implicit references:
The Company shall not transfer any Shares to any of the Company’s Affiliates.
When in doubt (“Affiliates” as of the time transfer, or as of the time that the contract is entered into?), err on the side of being explicit:
The Company shall not transfer any Shares to any Person that, as of immediately prior to such transfer, is an Affiliate of the Company.
5) Do not use more than one defined term per concept.
Do NOT do the following:
“Company” or “Verbiage Co.” means Verbiage Company, a Colorado corporation.
In the interest of brevity, just pick one. Remember, unlike other forms of writing, with contract drafting, we’re concerned about functionality, not rhetoric or how “nice” a given term “sounds” in a given context.
Feel free to disagree (bonus points if you use one or more defined terms in conveying your contention) and to pass along tips of your own.