Contracts are the fiber of our business world. In fact, almost everyone makes contracts everyday.
But do we know what we’re really reading, what we should expect to see and statements we should look out for? Not many people truly do. As a small business owner, you will need to use a contract of some sort in your business transactions.
Let’s start at the beginning. A contract is an agreement on the fundamental terms of a business deal that may or may not be informally or formally written down. Sometimes just a handshake or a letter of confirmation about a transaction can carry as much weight as a formal contract. Therefore, you must be conscious of both oral and written communications in any business negotiations between you and clients or subcontractors, or between two other parties.
A contract does not have to be printed on stiff paper with gilded edges to be binding. Nor does it have to be packed with legal jargon. A contract can be any form of document that spells out the terms of a sale, including:
- A preprinted legal document, with blanks for the name of the author, the title of the material being sold, and the fee.
- A letter of agreement. This may be an original letter tailored for a particular sale, or a standard form letter.
- A “fill in the blanks” or “check the boxes” form.
A contract must be negotiated before the ownership of the material actually changes hands. It is not acceptable, for example, for a publisher to simply send you a check and then claim that certain rights have been “transferred” by your acceptance of that payment.
Contracts may be transmitted by fax or e-mail. Faxed signatures are generally considered legally binding. E-mail is trickier; it may lack the editor’s signature, and you’ll have to print it out to sign it. While agreements may be negotiated entirely via e-mail (without signatures), doing so depends on a degree of trust between author and publisher.
Understanding Contract Terms
Business contracts are used to remember important agreements you (or your business) enter into with others. This includes any agreement on which you are relying and that can affect the future of your business.
Sure, small business owners operate all the time on informal understandings that they may never write down or even completely verbalize to the other party. But it’s often worthwhile for you to take the time to draw up a formal contract. Contracts allow the parties the opportunity to
- Clearly define their obligations to and expectations of each other
- Limit their liability
- Lay out payment terms
- Divide up business risks
- Make sure each side understands its responsibilities
After the parties reach a meeting of the minds regarding the deal, they must both exchange something of value in order to create a contract. Often, one party provides its goods or services in exchange for the cash of the other party. But consideration can take many other forms, as long as each party is giving up something of value to it to convince the other party to enter into the contract.
Knowing Key Contract Components
To help guide you, we’ve included guides on both contract terminology and contract elements.
Contract Terminology
First, we’ve collected some of key contract terms to help you get started:
Boilerplate — standard contract terms usually found at the end of the contract which are important but which do not reflect the essence of the deal. Examples of “boilerplate” terms include provisions describing notice, governing law, or payment of attorneys’ fees.
Breach — a claim by one party to a contract that the other party has failed to perform as required under the contract.
Conditions — Provisions in a contract that deal with certain events happening or not happening. Conditions are like triggers that, when pulled, cause some other part of the contract to come into effect.
Consideration — a benefit or right that the parties to a contract exchange with each other in order to form the contract. Consideration can be a promise to execute an action, such as a promise to pay money or to lease your office space, or a promise not to do something, such as a promise not to lease your office space to your neighbor’s biggest competitor. Whatever the parties exchange with each other, each party’s consideration must have value.
Damages — a type of remedy for the breach by a party of a valid contract. Damages involve an award of money to the injured, non-breaching party.
Recitals — language at the beginning of the contract that describes why the parties are entering into the contract. Recitals are not always legally enforceable, so significant contract terms should always be repeated in the body of the contract after words such as “the parties agree as follows
Contract Elements
To be enforceable, a contract typically requires the following elements:
1. Meeting of the Minds
The first step in creating a contract is making sure that both parties are talking about the same deal, so that when they subsequently agree to enter into the contract they are both agreeing to the same thing. Take the time to communicate your understanding of the deal to the other party, and listen carefully when he or she responds.
2. Consideration
After the parties reach a meeting of the minds regarding the deal, they must both exchange something of value in order to create a contract. Often, one party provides its goods or services in exchange for the cash of the other party. But consideration can take many other forms, as long as each party is giving up something of value to it to convince the other party to enter into the contract.
If cash is exchanging hands in your contract, think through any assumptions you are making about the way payment will be made.
- If you expect to be paid at the time the contract is signed, say so.
- If one of the parties will be paying after the contract is signed, say whether the payment will be in cash, by check, by cashier’s check, or by wire transfer. Be explicit about the way the money will change hands.
- If payments will be made over time or based on external factors, such as the amount of business done, you may need to define the payment schedule by using a formula. Keep the formula simple and feel free to put examples of how the formula works right in the body of the contract.
- If you have to use a complex royalty or other payment formula, test the formula with the other side to be sure you both understand it.
3. Agreement
After both parties understand the deal and understand what type of consideration each party will exchange, they are ready to form an agreement. Usually, the parties demonstrate that negotiations have ended and an agreement has been reached when the parties sign the contract, unless it is an oral agreement.
4. Legal Competence
Be sure that the party you’re working with is legally competent to enter into a contract. Otherwise, your signed contract may be unenforceable. Specifically, be mindful of the following situations:
- Minors cannot enter into contracts without the additional signature of their parents or guardians. In most states, a minor is a person under the age of 18.
- Persons lacking sound mind usually cannot enter into contracts because, the reasoning goes, they lack the ability to understand what they are doing and to create a “meeting of the minds.” Persons lacking sound mind generally are those who are mentally handicapped or impaired by the use of drugs or alcohol to such an extent that they cannot understand the significance of their acts.
- Persons who lack authority to act on behalf of someone else may not be able to legally bind that other person or company. Make sure that the person signing on behalf of a company or other person has the legal authority to do so.
It is implicit within all contracts that the parties are acting in good faith. In order to be enforceable, a contract cannot violate “public policy.” For example, if the subject matter of a contract is illegal, you cannot enforce the contract.
Checklist for Reading Contracts
When presented a contract, follow these guidelines:
- Review any contract carefully, line by line, to make sure it is what you and your party have discussed.
- If the language is unclear to you, have your lawyer explain it to you, and negotiate to have it reworded to benefit or protect you. It may also help to talk to one or more owners of similar businesses to see what kinds of contracts they have used
- Do not be in a rush to sign a contract, and realize that sometimes both you and your client will have to give a little to come to a final agreement. If you and your potential client or the business that may want to hire you cannot come to an understanding, then politely thank them for their time and perhaps refer them to another entrepreneur. It is better to find out that you really cannot work with someone before a project is launched than after you are committed.
When in doubt, always consult with your lawyer before you commit yourself to any contract. It can help avoid costly consequences.
For additional resources, visit:
http://www.expertlaw.com/library/business/contract_law.html
http://en.wikipedia.org/wiki/Contract
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