A Guide to Acquisition Agreements - Definitions

It’s best to think of the definitions in a contract as footnotes to the text of the contract.  They add extra information about how to read the text.  When they are well used, definitions make the text of the agreement easier to read.  For that reason, the best practice (sadly, the minority practice) is to put them in a schedule attached to the end of the agreement so they don’t get in the way of someone who wants to pick up the agreement and understand it.

There are three basic reasons to define a term.  The first two are drafting issues.  Your lawyer should be handling them and you shouldn’t waste your time with them.  The third requires your attention.  I’ll describe all three, both so you can understand what the definitions are doing there and so you can better identify the ones you really need to follow.

The first reason to use a definition is to elaborate on the common meaning of a common term.  For example, contracts often define the word “Liability.”  In most cases, that’s not because the word is intended to have an unusual meaning.  Rather, the definition usually either lists a lot of different kinds of liability, hoping to indicate to a court that the parties intended “liability” to include the broadest reaches of its common meaning, or lists specific things that might be included in the common definition of “liability” but the parties want to exclude.  Bear in mind that definitions of this kind become relevant only when the parties are fighting.  At that point, they have hired lawyers to twist and bend the contract’s words to the meaning they want.  In that context, a broad definition (or a very narrow one, if that’s what the parties wanted) of a common term can head off some silly arguments.  So there’s a reason to use 100 words to define a common concept like “liability.”  But repeating those 100 words over and over would make the contract unreadable.  To streamline the drafting, lawyers use 100 words once to define the term and then get on with drafting.

The second reason to use a definition is to head off an anticipated interpretive issue in the meaning of a common term.  A good example of this is the definition of a “material adverse change” that might justify the buyer calling off the deal.  The definition of this term commonly goes into detail about certain changes (such as general market and industry trends) that do and don’t count.  These are the result of long experience with issues that come up when this phrase comes up in litigation.  The lawyers know these issues may come up, so they use the definition to make sure they’re considered and resolved in advance.  Note that “material adverse change” will always be an ambiguous term.  There’s no helping that.  But it’s possible to avoid certain foreseeable problems by paying attention to the definition.

A third reason for using defined terms is as a stand-in for a concept specific to the deal.  .  In some cases, for example, the parties will agree to a complex formula for adjusting the purchase price to reflect changes in working capital between signing and closing.  Rather than repeat the whole formula over and over, the lawyer will relegate it to the definitions section and use a simple stand-in phrase (like “Working Capital Adjustment”) to refer to it in the document.  Notice that these terms have no obvious common meaning that you could figure out without a definition.  If the defined term is chosen well, however, they will suggest to the reader the kind of concept to which they refer.

Definitions in the third category are the only ones you need to read and understand.  Usually, it will be pretty obvious to you which ones fall in this category, but ask your lawyer if you’re unsure