Learning Outcomes
After reading this article, you will be able to explain the function and drafting of defined terms in substantive contract clauses, apply the rules for interpreting contractual language (including measures to reduce ambiguity), identify how clear definitions support risk allocation, and anticipate interpretation issues that arise in substantive clauses. You will also be able to discuss the legal consequences of vague or inconsistent drafting and use practical examples to analyse interpretation disputes as required for SQE2.
SQE2 Syllabus
For SQE2, you are required to understand how defined terms operate within the risk allocation and substantive provisions of commercial contracts, and apply principles of interpretation. When revising, focus on:
- the purpose and use of defined terms within substantive provisions, especially risk allocation and exclusion/limitation clauses
- the key rules of contractual interpretation (including how ambiguity is resolved)
- how contract drafter choices affect risk and legal certainty
- the consequences for parties where terms are unclear or not properly defined
- recognition of and remedy for drafting and interpretation errors commonly examined in SQE2-style assessments.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Why are defined terms included in contracts, and what are the risks if they are missing, circular, or inconsistent?
- What is the difference between interpretation and construction in contract law?
- How do courts ordinarily resolve ambiguity in substantive clauses containing risk allocation where terms are undefined?
- What principle is applied when interpreting exclusion and limitation clauses in cases of ambiguity?
Introduction
Substantive clauses in commercial contracts set out core rights, obligations, and allocate risk between parties. Key to effective and enforceable drafting is the clear use of defined terms and a sound understanding of contractual interpretation. This article examines how using defined terms within substantive clauses manages legal risk, how interpretation rules are applied by courts, and the typical problems that can arise when definitions are omitted or unclear. SQE2 candidates must be able to draft, analyse, and interpret such contract provisions to identify potential disputes and support clients in legal negotiations or litigation.
Defining Terms in Substantive Clauses
Substantive clauses determine the commercial and legal risks for each party. To ensure certainty, contract drafters commonly use defined terms for concepts that would otherwise be imprecise or repeated.
Key Term: defined term
A word or phrase in a contract given a specific contractual meaning, usually by express definition, to ensure clarity and reduce repetition.
Poor or missing definitions lead to ambiguity, which can shift risk unexpectedly between parties and cause disputes about the contract's meaning.
Common Forms of Definitions
Definitions may be:
- Located in a dedicated section at the start or end of the contract.
- Embedded within a clause if used only in that clause.
- Incorporated by reference to other documents or agreements.
Clear definitions use "means" for exhaustive definitions and "includes" to prevent limiting the natural meaning.
Key Term: ambiguity
When a contract term is reasonably capable of more than one meaning, giving rise to potential uncertainty about parties' obligations or rights.Key Term: circular definition
A definition that refers back to itself or depends on another defined term that in turn refers to the first, making the meaning unclear or incoherent.
Interpretation of Defined Terms
When a dispute arises, courts interpret contracts according to established principles.
Key Term: interpretation
The process by which a court determines the meaning of contractual language, considering the contract as a whole and the surrounding circumstances.
The Modern Approach
Courts use an objective test: what would a reasonable person with all relevant background knowledge understand the words to mean? This is set out in cases such as Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 and Wood v Capita Insurance Services Ltd [2017] UKSC 24.
If a term is clearly defined, that meaning prevails unless it leads to absurdity or is inconsistent with the contract as a whole.
Worked Example 1.1
A contract states: "Losses means any financial loss suffered by the Buyer." The substantive clause reads: "The Seller shall indemnify the Buyer for all Losses arising from a breach of this Agreement." Losses is not further explained and the Buyer claims for lost profits, while the Seller argues this is not included. How will a court interpret "Losses"?
Answer:
The court will look at the language of the definition and the surrounding contract. "Financial loss" is a broad phrase that can include lost profits unless a contrary intention is clear. If no exclusion appears elsewhere, the definition is likely to cover lost profits.
Contra Proferentem and Risk Clauses
Where a clause (often an exclusion or limitation clause) contains ambiguity, the courts may apply the contra proferentem principle—interpreting the provision against the party seeking to rely on it.
Key Term: contra proferentem
The legal rule that an ambiguous contractual term will be construed against the party who drafted or seeks to rely upon it.
This principle often arises in the context of risk allocation, as exclusion and limitation clauses are interpreted strictly against the benefiting party unless the language is clear.
Worked Example 1.2
A service agreement defines "Liability" as "any and all claims, losses or damages except as set out herein," and then states, "The Supplier's Liability excludes indirect loss." The customer suffers loss of profit due to a breach. The Supplier claims this is excluded as "indirect loss," but the contract does not define indirect loss. What will the court do?
Answer:
The court will determine whether loss of profit is indirect or direct and whether the lack of definition creates ambiguity. Any lack of clarity will typically be resolved against the Supplier, the party seeking to rely upon the exclusion.
Drafting Risk Allocation Clauses Using Defined Terms
Sound drafting of substantive clauses—particularly those allocating or limiting risk (such as indemnities, caps, and exclusions)—requires defined terms that are:
- Clear, detailed, and non-circular.
- Consistent in their use throughout the contract.
- Appropriately scoped to reflect the parties' intentions.
Failure to define key risks and trigger events, such as "Force Majeure," "Material Breach," or "Gross Negligence," can lead to radically different outcomes if a dispute arises.
Revision Tip
Ensure that every defined term is used consistently, without conflicting language or undefined cross-references. Always check for accidentally circular or embedded definitions before finalising a draft.
Role of Schedules and Interpretation Clauses
Sometimes parties use schedules to set out lists for defined terms (e.g., "Services" or "Excluded Losses"). An interpretation clause may also be used to clarify contract-wide conventions such as references to the singular including the plural, or that headings do not affect interpretation.
Key Term: interpretation clause
A clause setting out general rules for how defined terms or contract language should be read, ensuring consistency for statutory references, plural/singular, or incorporation of schedules.
Typical Problems and Remedies
- Undefined or contradictory terms: may be resolved by court using the natural or ordinary meaning, but scope for dispute increases.
- Circular or reference-based definitions: can render clauses meaningless and may void part or all of the provision.
- Use of non-exhaustive language: if using "includes," be alert to the risk of expanding obligations beyond those intended.
Worked Example 1.3
A contract says "Material Breach has the meaning given in clause 9," but clause 9 contains no such definition. The Seller terminates for "Material Breach." Can they do so?
Answer:
The lack of definition creates ambiguity. The court will apply the ordinary and sensible meaning, but the lack of express definition could make enforcement risky, and the terminating party is at risk if the court finds no material breach occurred on usual understanding.
Practical Measures to Reduce Risk
- Use a dedicated definitions section, placing all definitions in one part of the contract unless they apply only to a specific provision.
- Avoid defining terms by reference to external documents not attached to the contract.
- Test each defined term in context throughout the main body and in each related schedule.
- Avoid "elegant variation"—using different terms for the same thing in an attempt to improve style. This leads to interpretive uncertainty.
Exam Warning
If a defined term is used inconsistently, or if "means" and "includes" are used interchangeably without care, the contract may be construed unpredictably or the clause held void for uncertainty.
Key Point Checklist
This article has covered the following key knowledge points:
- Defined terms are used in substantive contract clauses to ensure precision and reduce ambiguity in risk allocation.
- All defined terms must be clear, non-circular, and used consistently throughout the contract.
- Where ambiguity remains, courts apply objective interpretation with reference to clear definitions and, in risk clauses, may use contra proferentem.
- Poorly drafted or missing definitions may shift or undermine risk allocations and may void the effectiveness of the clause.
- It is essential to test definitions for clarity in context and to avoid referencing external or unincorporated documents.
Key Terms and Concepts
- defined term
- ambiguity
- circular definition
- interpretation
- contra proferentem
- interpretation clause