What Is the Effective Date
As the term implies, the effective date of a contract means the date on which the contract has become effective. More specifically, it is the date set forth in the contract as the effective date, rather than the date on which the contract is executed (the signing date). The effective date is significant because it is then from that date that parties can begin to determine their rights under the contract. If, for example, one party owes another party a payment based on the contract, having an effective date set out in the contract can clear up confusion as to when that payment is due. What if, for example, the payment was due monthly, but the contract was not signed until the 30th of the month, clearly that first payment would be due on the 30th of that same month, but what about the following months? It would generally be due on the last day of each month thereafter, unless otherwise stated in the contract. However, if the effective date of the contract was the first of the month, that first payment would be due on the first of the following month. Thus, the effective date of a contract could impact the rights of the parties.
Here is a simple example to illustrate the point. For example, if the parties enter into a contract on August 1, 2015, the contract is signed on August 5, 2015, but the effective date of the contract is August 5, 2015 , the parties have just entered into a contract as of August 1. Assuming the parties want the obligations under the contract to begin on August 1, that is the date the contract should state is the effective date. If the effective date were August 5, the obligations of the contract would not begin until August 5, and would run through August 5 of the following year, or however long the contract is set to be in force.
The difference between the effective date of a contract and the date on which the contract is signed may have little practical effect given a short term contract (a month for a rental agreement). However, on a long-term contract, the effective date can become significant in determining payments for payroll purposes. A company may choose to enter into a contract signed in September for the provision of services to take effect on November 1 of the same year. The fact that the contract is dated in September would not change the fact that the obligations of the contract only begin on November 1, and run through one year from that date. Another example may be a two year lease for premises. The lease may be signed in April, but the effective date could be July 1. The new tenant could begin paying rent five months before the premises is ready to move into.
It is always best to think about the impact of whether and when a contract should become effective, and clarify the date in the contract.
The Impact of the Effective Date on Contracts
The effective date is not only relevant to the overall contract, but it is also important to the commencement of any contractual obligation. In other words, several contractual obligations under a contract might not begin immediately upon execution or delivery of the contract. Even though the contract has been signed by both parties, certain obligations might not be due until after the effective date of the contract.
As a basic example, the effective date might be followed by a detailed schedule of milestones, deliverables, or other obligations. The effective date is significant because it acts as the triggering event for the commencement of the obligations. It is important that you read the contract to determine whether the effective date has any input on whether the contractual obligations have commenced. The answer to this inquiry is likely found in the contract. However, if the answer to this question is not addressed in the contract, it is possible that the commencement of certain obligations could turn into a point of dispute at some point in the future.
How to Determine the Effective Date in Various Situations
Contract terms can establish different effective dates in a wide variety of circumstances. For example, you may be involved in corporate acquisitions or dispositions where the effective date requires regulatory approval. A contract may require certain conditions to be satisfied prior to its effectiveness, such as third party consents. Consensus of the parties may dictate that the effective date occur at a point after signing, such as when you want the ‘effective date’ to be the date all parties have signed an agreement, not the date the agreement was signed by the last party.
Such situations require careful legal savviness. It is important to ensure that the contract language accurately and unambiguously reflects the intent of the parties regarding the effective date and that the contract continues past the effective date as may be required under the law. Such contractual stipulations are typically deemed to be effective prospectively. This is true unless otherwise specifically noted, such as the addition of a clause stating, "It shall be presumed that this contract was always in effect from the effective date," or words of similar effect. Absent such an additional clause, a contract that is effective as of a given date typically will not ex post facto create legally-recognized relationships prior thereto.
To illustrate, let’s again consider the following scenario: A company and its owner feel their product could achieve much greater success in a foreign country than domestically and therefore plan to move their production facilities to a third country solely for the purpose of manufacturing product. To accomplish its goal, the company has asked its attorney to assist in negotiating contracts with a Chinese company, under the contingency that the contracts are only effective in 30 days at which time the operator of the facility agrees to reimburse the company and its owner for the expenses incurred in relocating the operation’s facility to China. Almost immediately after the negotiating the language, the company approches the attorney to explain that they are new to international transactions. In this case, the language would read as follows: "This contract is effective as of 90 days; 30 days after signature."
Typical Pitfalls and How to Avoid Them
It is all too common that parties will overlook the effective date altogether or misinterpret its importance. For example, in addition to the effective date of a contract, parties often insert an earlier "date of signing" or "contract date." While a contract will only be binding on the effective date, the contract will nevertheless be subject to binding obligations – including confidentiality and exclusivity obligations – as of the "contract date." It is therefore imperative that the "contract date" is clearly identified to avoid an undue delay in the start of rights triggered by the contract. Likewise, if there are any conditions for the contract to enter into effect, such as the receipt of regulatory approval or financing, the precise conditions of which may change over time, the contract should clearly provide that the effective date is subject to the mutually agreed extensions of time.
In contrast, parties will often overlook a term of an agreement that may unintentionally provide that the contract shall not take effect until after the agreement was concluded. For example, agreements are often drafted to take effect from the date of their signing, unless the parties specify that they shall take effect from an earlier date . Drafting in this manner means that the agreement is not binding (except for certain limited obligations such as confidentiality and exclusivity obligations), notwithstanding that the agreement may expressly provide a later date that precedes the date of signing of the parties. Some contracts are drafted to come into effect conditional on a clause or condition precedent in the agreement being satisfied, alone or in conjunction with one or more other clauses or conditions precedent. Such clauses may be used to trigger an update or true-up to the consideration that the purchaser will pay to the seller under the agreement, for example to allow for an adjustment to the purchase price on a completion account basis based on validated net assets or normalized working capital. Unless appropriate relief is sought, in the event that such clause or condition precedent is not satisfied, the whole of the agreement may fall away. As a consequence, the intended commercial benefit of the agreement may be lost, leaving the parties no better off than before.
Parties should be mindful of the circumstances in which they wish a contract to take effect and the intended duration of the contract with a view to drafting the effective date provision accordingly.
Legal Implications for Establishing an Effective Date
Contracting parties should consider whether the effective date is before, on or after the date the last party signs the agreement. This raises timing issues and introduces compliance considerations that contracting parties should understand. For example:
The effective date – and the parties’ respective obligations – should be clearly spelled out in the contract so as to avoid any confusion. When drafting the effective date, you should be specific. For example, "The effective date of this agreement shall be the date of the last party executing this agreement (‘Effective Date’)."
The effective date might also refer to a particular event. For instance, "This agreement shall become effective upon receipt of the insurance proceeds required under this agreement (‘Effective Date’)."
The practical effect of the effective date clause is that the contract does not become binding on the parties until the effective date occurs. The practical result of a contract that is not yet effective is a lack of obligations for performance or enforcement.
Examples: Disputes Over the Effective Date
In FGC Associates, Inc. v. University of Chicago, 797 N.E.2d 907 (Ill.App. Ct. 2003); 2003 Ill. App. LEXIS 518; 2003 IL App (1st) 020815-U, a contractor billed its customer for work that it had performed in 1999 but for which it received no payment until 2001. The contract provided that the effective date of the work would be "the date of the agreement execution." The court construed that phrase to mean the date that both parties signed the contract. Further, the contract provided for timely completion of the work and scheduled milestone payments accordingly. In determining that the work was late, the court construed the word "completion" to mean "substantial completion," which is the standard construction usage and usage in the contract. Finally, because the work was not complete when the customer terminated the contract in December 2000, the contractor was not entitled to the unpaid amounts. The court noted that even if the contract had not been terminated, the contractor would have been entitled to same amounts.
In International Paper Co. v. Schulke, 635 S.E.2d 727 (N.C. App. 2006), a landowner and a forestry service entered into a "Special Use Agreement" for the landowner to allow the forestry service to plant loblolly pine trees on his land. The contract stated "volunteer" pines were easily killed by fire until they were mature. The contract gave the developer ten years to conduct timber harvesting activities for one million dollars (the "Option Period"). During the Option Period, the landowner was prohibited to assign or subdivide his interest in the property. After year six of the Option Period, the landowner planned to divide the property into ten parcels and transfer nine of them to family members who planned to develop the properties as real estate subdivision lots. The trial court held the landowner had an equitable fee simple title in the entire parcel. The court of appeals in North Carolina found that the owner had an equitable fee simple absolute title to the land before allocating it into the ten separate parcels because he exempted the Option Period from any property conveyance and because the special use agremement only allowed the use of the land but did not give ownership of the land to the forestry services .
In re Midland Enterprises., Inc., 392 B.R. 494 (Bankr.W.D.Tenn. 2008). In this case, the bankruptcy court determined that the contract was not binding on the debtor because it was entered into while she was in bankruptcy, which is always after the effective date. "The effective date of the plan [was] the day after the bankruptcy court entered its order of confirmation. Because [the debtor] did not sign the contract in question until after the bankruptcy court confirmed the debtor’s plan, the contract [wa]s void and had no effect."
Souza v. T.L. Brown Elec. Co., 2007 Mass. App. Div. 144 (Massachusetts App. Div. Appellate Court). In this case, the claimant contested the effective date to collect under a home improvement contract. The contract contained an effective date, but the claimant argued that it was not the date he and the homeowner signed. The contract called for a $100 deposit, and the claimant and the homeowner signed the contract, including the effective date, at creation of the contract, but the claimant did not give the homeowner the top copy of the contract, including the effective date, until the following week. The effective date was July 11, 2005, the claimant testified that it was August 4, 2005. The home improvement contractor statute makes contracts entered into after the effective date of the statute void, and that contractor failed to follow the current law in effect. Martinez v. J&M Builders, 2007 Mass. App. Div. 172 (Massachusetts App. Div. Appellate Court). The home improvement contractor statute provides that, to meet the requirements, the claimant must have a valid contract. In this case, the claimant did not obtain a license to perform home improvement work until two weeks after the contract. The claimant, in this case, contested the effective date of his license. The court said that the claimant "made no attempt to show the license was still pending and contested its revocation on this basis. Instead, he merely challenge the validity of its revocation."