What is a Defined Term in a contract?
It’s just a shorter way for saying some long phrase or language. Kind of like an acronym, but sometimes not. Hmm, that’s not so clear, so how about an example? Consider the following definition from a stock purchase agreement that’s available online:
As used in this Agreement, the phrase “Seller’s Knowledge” means, with respect to any matter in question, that any director or executive officer of Parent Co., Seller or the Company (not including Paul) either (i) has actual knowledge of such matter or (ii) should, after due inquiry, know of such matter. For this purpose, “due inquiry” means (i) reasonable review of files and other information in the possession of each such person or of which each such person is aware and (ii) reasonable inquiry of employees of Seller or the Company (other than Paul) who have primary responsibilities pertinent to such inquiry and access to information in the possession of Seller or the Company, as the case may be, and responsive thereto. Notwithstanding any other provision of this Agreement or in any Schedule or Exhibit attached hereto, neither Seller nor Parent Co. will be deemed to have breached any representation or warranty in Sections below if Paul had, as of the Closing Date, actual knowledge (with no duty of inquiry or investigation) of the fact(s) causing such breach. The burden of proof as to any such actual knowledge on the part of Paul will be on the party alleging that Paul had such actual knowledge.
Oh boy, that’s a lot for a definition and frankly kind of boring. Scratch that, let’s take a simpler example:
“Waffle Fry” means an ingot of pure delight delivered via the vegetable medium of fried potato.
So instead of saying:
I would like an ingot of pure delight delivered to me via the vegetable medium of a fried potato.
I can say:
I would like a Waffle Fry.
So in an agreement, instead of inserting a large description about something (like a waffle fry or for the less interesting, the definition of what knowledge means), you can include a definition in a completely different location dedicated to definitions (usually called the…definitions section).
Additionally, once you’ve defined a term once, you can reuse it throughout the document, which allows for much cleaner and easier to read contracts.
Take for example:
Paul would like an ingot of pure delight delivered to me via the vegetable medium of a fried potato. Bennifer would like an ingot of pure delight delivered to me via the vegetable medium of a fried potato.
can be rewritten into:
Paul and Bennifer would each like a Waffle Fry.
How do you define a term?
There are two main ways of defining a term in a contract: (A) by using the parenthetical quotes — This Master Services Agreement (this “Agreement”); or (B) literal definition — “Term” shall mean the term of this Agreement. Parenthetical quotes are typically used throughout the text of the agreement, whereas literal definitions are usually contained within a definitions section.
Defined Terms Should Be Capitalized (but aren’t always).
Typically defined terms are highlighted for the reader by making them capitalized words, so as a reader is reading s/he can clearly identify a Defined Term and make the assumption that this short phrase is used to summarize a longer and likely more complex definition.
Preferred Length of Defined Term
The golden rule I use is try to keep defined terms less than 3 words. If your defined term is too long it will lead to potential errors throughout the contract and often creates more ambiguity.
That’s it for now. I’ll get into the do’s and dont’s of defined terms in a future article. This piece was just for those of you that have ever just been curious what people mean when they throw that phrase around.
