What Does an Ancillary Contract Do?
An ancillary contract is a legal agreement that is separate from, but also complementary to, a main contract. For a contract to be considered "ancillary," it must exist for the purpose of securing an added benefit to the principal agreement. Ancillary contracts are often used in commercial agreements, such as real estate sales, mergers and acquisitions, service provision, distribution and franchising. However, they can also be used in individual relationships to clarify responsibilities between parties who will be doing business together.
The most obvious characteristic of an ancillary contract is that it is signed in addition to the principal agreement. The secondary agreement usually deals with the same subject matter (such as the sale of goods), but does not include all of the terms that are in the initial agreement. The parties to an ancillary contract are not always the same as the main contract; the terms involved may apply to separate entities who will work together under the main contract.
Because they deal with the same subject matter as the main contract, ancillary contracts almost always have some kind of relation to the terms in that principal agreement. They are usually written to add clarity and definition to the duties of the separate parties in a principal business agreement. For example, if two retailers are opening a store together, each retailer might separately hire their own employees. The principal employment contract might include terms for the shared expenses of the employees, but the companies might create an ancillary contract to specify how the costs of the employees will be shared , how employees are assigned to each store, and how employees will be compensated with regard to the store they work in. Both contracts have a bearing on the employees in the store, but the ancillary agreement exists to more specifically explore the topic.
Ancillary contracts exist to serve as a complement to principal contracts—there would be no point in the existence of a secondary contract if it did not exist to add some clarity to the principal agreement. However, secondary contracts should not include terms that alter or contradict any of the terms in the principal contract. In some cases, it can be helpful to simply list the terms in the principal contract that are not duplicated, rather than trying to create a whole new agreement. In the example above, rather than creating an ancillary contract that describes the costs of employees in great detail, the retailer could simply list the relevant terms from the employment contract that are applicable in this case. The ancillary contract should avoid attempting to restate the terms of the principal contract.
Depending on the terms of the primary business contract, it may not be necessary to create an ancillary contract. In some cases, the terms of the principal contract may be sufficiently clear to also apply to secondary parties in the agreement. In other cases, the specific terms relevant to the work of secondary parties can be included in the main contract. Consider whether an ancillary agreement is really necessary before creating one to avoid the creation of unnecessary agreements between parties.
Purpose and Function in Commercial Transactions
Within the context of a business transaction, an ancillary contract supplements the primary agreement in a manner that enhances the value of the transaction for its parties. Contractual relationships between the parties to the primary agreement may require clarity in their terms and conditions to properly guide their implementation. A necessary or desired degree of clarity is a key function of an ancillary contract. While specific provisions within the ancillary contract help outline the contractual relationship between the parties, the contract should also speak to the relationship among the parties to the primary agreement, its supporting contracts, and the transaction as a whole.
An ancillary contract may include terms and conditions that govern the circumstances leading to or following the execution of the primary agreement to create synergies among the positions of the parties and to harmonize interrelated or overlapping objectives. The ancillary contract can avoid disruptive ambiguity and provide certainty of purpose, intent, and enforcement of the terms and conditions between the parties. Where certain obligations contained in the primary agreement are impossible or impractical to enforce, an ancillary contract can provide an effective means of enforcement where the obligation of a party to perform their duties in accordance with the terms and conditions of the primary agreement is subject to their performance of the terms and conditions of the ancillary contract.
Common Examples of Ancillary Contracts
Ancillary contracts can take different forms and be used in a wide variety of situations. The most common types are those that supplement the parties’ main contract by either allocating risk or providing additional value to the parties:
- Confidentiality Agreements: When disclosing sensitive information and trade secrets, businesses typically use a non-disclosure agreement (NDA). This keeps proprietary information secure while allowing necessary data to be shared.
- Service-Level Agreements (SLAs): SLAs wait to be invoked by one party when the other fails to provide an agreed-upon outcome. The injured party usually has the right to compensation, a fee reduction or the right to demand that specific conditions in the contract be reformed.
- Subcontractor Agreements: These agreements allow the main contractor to delegate a portion of the overall contract to another contractor, under a framework contract that governs a set of activities over a longer period of time. This is often employed in construction and defense contracting.
- Indemnification Agreements: The purpose of this is to "hold harmless" one party when a third party brings suit. A lawsuit may be the result of an accident on the property, or because someone has been injured in some other way. In turn, indemnification agreements can govern what value – like insurance policy payouts – may be available to a party fighting legal action.
The Legal Nature of Ancillary Contracts
The enforceability of ancillary agreements or contracts depends on several factors, including the jurisdiction in which they were entered into. In general, ancillary contracts are enforceable against the parties in jurisdictions in which they were validly entered into by the contracting parties. This means that an ancillary agreement that is enforceable in a certain jurisdiction will also be enforceable in other jurisdictions where the parties are performing their obligations under the contract. For example, if a party enters into an ancillary contract in Indiana and then seeks to enforce it in Ohio, it will generally be paid according to Indiana law. On the other hand, an ancillary contract may not be enforceable in all jurisdictions. For example, if an Indiana court finds that an ancillary contract does not comply with Indiana’s statutory law on such contracts, then it may not enforce even if the parties agreed to it. Some common legal challenges that arise with ancillary contracts include: whether a contract meets the contractual requirements to be enforceable; whether the contract is void for illegality; whether the party that enters the contract has the legal capacity to enter into such an agreement given his prior commitments; whether the contract is voidable due to misrepresentation, lack of consideration or material mistakes in the contract language; and whether one party breached the contract and the effect of such breach. Further, the exact language of the contract plays a large role in its enforceability. As noted, courts make every effort to uphold the parties’ agreement if possible and where the agreement cannot be tailored so, courts will find ways to limit the agreement to its express terms rather than declaring the agreement void. When there is a breach of contract claim, some issues that may arise are whether conditions precedent have been fulfilled or have to be waived by the parties before a party can seek legal remedies for breaches of the ancillary contract. If conditions precedent are not met or have not been waived, courts may choose to stay specific performance of the contract until the condition precedent is met, but that does not mean that parties cannot seek any other legal action regarding enforcement of the contract in the meantime. Courts will apply the provisions of the U.C.C. where applicable. The U.C.C. does not apply to all ancillary contracts and where it applies, there are different interpretations depending on the type of agreement. A court in one jurisdiction may apply one interpretation of a provision of the U.C.C. while another jurisdiction does not. Courts, where possible will base their decisions on the substantive provisions of the U.C.C. so as not to affect market practices and unless there is a clear showing that applying the provisions of the U.C.C. would lead to an unfair result.
How to Draft an Ancillary Contract
When it comes to the drafting of contracts, there are certain useful best practices that can help ensure that the terms are properly aligned with the main contract. Too often, parties to a contract will neglect the specificity of an ancillary contract. Without such specificity, the effect of the ancillary contract may be completely eviscerated in the event of a dispute, causing undue harm to one of the parties. To avoid this, here are some tips regarding the drafting of ancillary contracts:
Be Specific This may seem obvious, but many parties to a contract fail to detail the following: One of the best approaches to creating a truly enforceable ancillary contract is to mirror the language of the main contract. For instance, if the original contract discusses the licensor and licensee at length, the ancillary contract may simply need to state that the terms and conditions apply as they do in the main contract . Imagine writing up a contract with a contractor that uses the term "the party" dozens of times throughout a 10-page contract. If you create an ancillary contract without repeated reference to "the party" as used in the original contract, it may be difficult to interpret what you intended in the new contract.
Consider the Enforceability Of course, many will not be satisfied with simply copying and pasting from the main contract into the ancillary. That is unfortunate, because certain types of contracts are much more likely to be made enforceable when they are for a specific duration. For this reason, consider using a clause that automatically renews the terms of the contract for a pre-specified period. This way, your client or your other party will not need to renew the contract within a set period of time; instead, they will be automatically bound by the contract’s terms until the next specified renewal.
Ancillary Contracts Case Examples
Case studies involving ancillary contracts can often shed light on the importance of these documents when entering into or reviewing energy service contracts.
One case of particular interest is that of Access Energy Partners, LLC v. Northstar Energy Industries, LP, Case No. 12-3-00938 in the United States Bankruptcy Court, Southern District of Texas (2013). In Access Energy, the bankruptcy court was asked to determine whether a natural gas supply agreement would be treated as an executory contract or a true lease under the Bankruptcy Code. The debtor, Norstar Energy Industries, LP, (Northstar) was in bankruptcy and had entered into a Master Service Agreement (MSA) with Access Energy Partners, LLC (Access). The MSA was comprised of three parts: 1) a natural gas supply agreement; 2) a construction contract; and 3) a facility lease. The court learned that the first agreement, the natural gas supply agreement, appeared to have been completed prior to the transaction closing because Northstar began to purchase gas from Access even before the paperwork was finalized. The court also learned that someone at Northstar made a handwritten notation on the gas supply agreement stating that "Freeman – do not sign." In fact, Mr. Freeman never signed the gas supply agreement. Rather, the first page of the agreement states, "This contract to be executed on closing." The final agreement with Northstar’s signatures appears to be backdated because the closing date was in the last month of 2011, yet the final contract has a date of July 2012. Interestingly, the court determined that the Master Service Agreement contained cross default language in which the debtor, Northstar, waived any defaults in the MSA and ratified the contract forward. The court determined that the handwritten note was to disregard the first contract and move forward with the backdated contract. Interestingly, Northstar later argued that ratification of the contract was not valid because they did not mean to ratify it. Instead, Northstar argued that the gas supply agreement should be treated as a lease under the Bankruptcy Code because the MSA was in fact entered into for the purposes of disposing of natural gas. The court determined that the contract was a supply and construction contract and not a lease. A second case of interest is In re(Teal) Consulting Inc., Case No. 11-4-01887 in the United States Bankruptcy Court, Northern District of California (2013). In this case, the bankruptcy court held that an ancillary contract between two parties entitled Access to recover attorney’s fees and costs secured by a deed of trust, in an action to enforce a note, was valid and enforceable. The case highlights the importance of securing any perceived attorney fee arrangements using an ancillary agreement such as a deed of trust. This could have a significant impact in any bankruptcy proceeding. The bankruptcy court had originally declared the document invalid merely because it was referenced in a loan modification agreement. However, upon review of the case, the district court overturned the bankruptcy court’s decision and held that the document was indeed valid and enforceable. In a bankruptcy context, the question of whether an ancillary contract is valid or enforceable can have a significant impact on collections. In a bankruptcy proceeding, the cost to chase down additional money owed by the debtor can be significant and the outcome of a collection action isn’t always guaranteed.
Anticipated Developments within Ancillary Contracts
As ancillary contracts continue to play a significant role in business transactions, we see a burgeoning set of future trends that are likely to alter the landscape of how these contracts are created, administered and ultimately analyzed. In the past, contracts were entered into with the expectation of long-term, stable relationships. The parties could reliably plan on the benefits of the contract lasting well past the expiration of the initial deal period and into the renewal term. However, in the world of business, speed is a key differentiator. Contracts must adapt to new realities, changing needs of the business or even quickly terminate certain deals to allow the parties to pursue other opportunities. New technologies are entering the business space and necessarily changing the way contracts are managed. No longer are contracts collected in filing cabinets or exchanged by physical delivery of signed copies. Most contracts are now digitally created, stored and delivered. While digitization offers many benefits (sustainability, ease of transfer, etc.), it also requires increased vigilance over data security, fortifying these contracts against unauthorized access. With the proliferation of digital contracts, sustainability takes on a new meaning. The transferability of digital contracts makes it cost-effective to use the same contract in many jurisdictions . When contracts were paper-based, one holding company might have traditionally had different contracts for all of the territories where its subsidiaries operated in order to comply with local laws. Now they can utilize the same contract and simply amend as needed or append a territory specific addendum that can be shared with the subsidiaries and easily translated. As contracts continue to evolve and become imbedded in the procurement process, an even greater focus on compliance will be required. As increasingly complex contracts are implemented throughout the supply chain, supply chain management systems must be able to integrate program and contracting requirements into their operating processes. How supply chain requirements are introduced to the supply chain will be key to their success and ultimately the success of the overall contract. The most significant, emerging trend we see is a move towards shorter contract life-cycles and more flexible agreements. Such contracts will include terms to facilitate breaking the contract if certain key factors change which make the existing contract no longer viable. This evolution will likely lead to more contracts following a modular design, as the parties are incentivized to break only certain segments of a contract instead of the entire agreement. Therefore, it will become increasingly important to develop analytical tools to help the parties understand the various pieces of a contract, the interrelation of the sections and how they impact the entire agreement.