Developing and understanding contracts is an important business skill that small business entrepreneurs must learn to run a successful business. Drafting ineffective contracts or signing contracts without understanding all their implications can lead to big financial losses and other difficulties for business.
Contracts are a fundamental part of the business world. Contracts are legally binding and enforceable documents that are made among businesses, employees, suppliers, service providers, the government and others.
Essentially, a contract is an agreement among two or more parties that creates a legal obligation. They can be made orally or in writing, although oral contracts are tougher to litigate in court. If a contract is breached, the party that breaches the contract can be forced to pay damages, in the form of a specific action or a monetary award.
In business, contracts are used to ensure that agreements are acted on, and to enforce the terms of the agreement. Business contracts typically comprise independent contactor agreements, basic sales contracts, leases and rental agreements, selling or buying a business, franchising, joint ventures, partnerships, non-disclosure agreements, etc.
Elements of a contract
There are four basic elements of a contract: the offer, acceptance, intention to create legal relations and consideration.
The offer and acceptance of a contract are the key principle of the legal concept of contracts. Agreement is composed of an offer to another party that he or she is willing to enter a contract on specified terms. The contract comes into existance when the offeree accepts the contract.
This formula rests on the idea that the contract is formed when the parties involved are all of one mind regarding the terms of the contract. However, legal concepts such as promissary estoppel, misleading conduct, unjust enrichement and misrepresentation can be used as arguments in court that the contract is invalid.
The offer and acceptance do not always have to be verbal or in writing. Implied contracts may exist in some cases when the agreement or its terms have not been expressed in words. For example, a contract may be implied in fact when circumstances give credence to the belief that two parties have come to an agreement even when they have not done so expressly in writing or in an oral contract. For example, a patient going to a therapist has an implied contract with the therapist that he or she will pay a fair price for the services offered. If the patient does not pay, he or she may have breached a contract that has been implied in fact.
A contract in law offers courts the opportunity to remedy situations where unjust enrichment may have occured. For example, if a business were installing swimming pools at several homes along a street and mistakenly installed one at a home that did not request installation, and the homeowner allowed installation knowing that he or she did not order the pool and later refused to pay for the pool, a court could hold that a quasi-contract existed and hold the homeowner liable for the cost of the pool.
Intention to create legal relations is primarily the difference between social obligations and obligations at law. An agreement to give your brother a ride in exchange for gas money is a social obligation, an agreement to transport products for another business that’s made orally or in writing is more likely a legal relationship.
Consideration is basically something of value offered by the offeror that will be exchanged for something else of value from the offeree. For example, a product or service may be exchanged for another product or service or a payment.
Requirements for forming a contract
In order to form a contract, five legal requirements must also be met. Each party must have the capacity to contract. That is, the person signing the contract must have the standing and authority to do so. The purpose of the contract must be lawful. Contracts for unlawful purposes are not valid and are not enforcable in court. The form of the contract must also be legal. The two parties in the contract are required to have the intent to form a legal relationship when they agree to the contract. Lastly, each party involved in the contract must consent to the contract.
Contracts with customers and suppliers
Contracts can come in a variety of forms, non-disclosure agreements concerning business secrets, non-competition agreements with former employees or other businesses, employment contracts with independent contractors, etc. However, the most common contracts small businesses will sign are contracts with customers and suppliers.
The following are some tips for understanding contracts and making sure you don’t get trapped in a contract that is impossible to complete or is extremely disadvantageous:
- Make sure the contract is a specific as possible. The very best contracts for small business are clear and specific and focused on a limited number of issues. Terms of the contract such as number of products or services, delivery times, repeat service, etc. should be very clearly defined and unambiguously spelled out in the contract.
- Clarify all questions. Don’t automatically assume that conditions of the contract are implied. Always clearly answer every possible question the other party may ask in the language of the contract.
- Make sure it’s legal. Contracts for illegal actions are not enforceable. For example, if you sign and agreement to rent a facility to a business, and later find out that city regulations prohibit that business from operating there, your rental agreement may become invalid as a result.
- Read and understand the language of the contract. Make sure you understand all conditions of the contract, especially language detailing dates, services to be rendered, etc.
- Hire an attorney. When drafting your run-of-the mill service agreement, ask for an attorney’s advice on the document to ensure it’s legal and that all your bases are covered. If your business is negotiating a big contract, it’s also probably worthwhile to have an attorney review it before you sign it.