Making a Business Contract
Most businesses must enter into contracts to conduct their operations effectively. For example, a business may have employment contracts with its workers, lease agreements with the owner of its office space and companies providing equipment, supplier agreements with merchants that sell what the business makes, and non-disclosure agreements with people or businesses that have access to proprietary or confidential information. A contract is not worth much, though, if a business cannot enforce it.
A contract must meet certain requirements to be enforceable:
- Mutual assent (meeting of the minds): there has been a valid offer and acceptance
- Consideration: each party promises to give the other party something of value
- Capacity: each party must be capable of entering into a contract, which usually excludes minors and people who lack mental capacity
- Legality: the parties cannot agree to do something that would break the law
A doctrine known as the statute of frauds provides that certain types of contracts must be in writing to be enforceable. These generally include contracts that cannot be completed in less than a year, contracts for the sale of goods worth more than a certain amount (typically $500), and contracts for the sale of land.
However, just meeting the basic requirements to make a contract enforceable may not fully protect the interests of a business. Contracts should be carefully drafted to avoid surprises down the road. Their contents can vary, but this is a look at some of the typical components.
Introductory Sections
A contract usually starts with a preamble, which briefly identifies the type of contract at issue and the parties to the contract. It also notes the effective date of the agreement. After the preamble, a contract may contain recitals. These describe the background of why the parties entered into the contract and what it is meant to accomplish. Recitals are not legally enforceable, but they may be helpful in interpreting enforceable parts of the contract.
A definitions section often will follow recitals. This allows the parties to explain specifically what certain words or phrases in the agreement mean. Definitions may be especially vital when a contract concerns technical subject matter, or when the parties intend a different meaning for a term than its ordinary meaning.
The Details of the Deal
The contract then will set out what each party will do for the other party. This is the core of the agreement. If one party is providing goods or services to the other party, for example, the contract generally should identify the nature of the goods or services, any quantities, and any dates that may be relevant. It also generally should state the price and explain how and when payment will be made. For example, the parties might agree to payments in installments as certain stages of the contract are completed.
Representations and Warranties
A contract usually contains representations and warranties. These are fairly similar to each other, but a representation can be seen as a statement, while a warranty can be seen as a promise. A representation thus involves the past or present, while a warranty can involve the past, present, or future. A representation states that a certain fact related to the deal is true. If a representation turns out not to have been true, the party that made the representation could be liable to the other party for misrepresentation. Meanwhile, a warranty promises that something is true or will be true. This can result in a breach of warranty claim if the promise is broken.
Getting Out of the Deal
Sometimes a party will need to exit a deal and stop performing their obligations under the contract. A termination clause can allow parties to back out without penalties in specified situations. These might include a material breach of the contract, insolvency, or a change in control of a party, among others. The clause also may provide that a party can terminate the contract for any reason by providing a certain amount of notice. Some grounds for termination may be available to both parties, while others may be available to only one party.
Certain provisions of a contract may survive after termination, such as a confidentiality provision. A contract might contain a single survival clause that lists the provisions that will survive after termination, or each provision that will survive may have language to that effect.
Resolving Disputes
While the parties hope that their relationship goes smoothly, they should not ignore the possibility of a dispute. If this arises, a dispute resolution provision might help the parties minimize the effort and expense needed to solve the problem. Rather than going to court, they might agree to engage in alternative forms of dispute resolution. The most common types of ADR are mediation and arbitration. Mediation involves asking a third party to help the parties come to an agreement, while arbitration involves having a third party decide the dispute. Sometimes a dispute resolution clause provides that the parties will engage in informal negotiations before resorting to mediation and then to arbitration.
Two further provisions that may affect dispute resolution are a choice of law provision and a venue provision. In a choice of law provision, the parties agree that the law of a certain state will govern the interpretation of their agreement. Since laws can diverge greatly among states, this can have a major impact on the substantive rights of each party. A venue provision states that any lawsuit related to the contract must be brought in a certain place.
Other Standard Clauses in Contracts
Some other clauses that are often found in a contract include:
- Integration/merger: the contract represents the complete and final agreement between the parties
- Severability: if a certain provision of the contract is found to be invalid or unenforceable, the rest of the contract remains in effect
- Confidentiality/non-disclosure: certain subject matter related to the contract must not be discussed with third parties
- Assignments: rights or obligations under the contract may (or may not) be transferred to a third party
- Indemnification: a party that breaches the contract or acts negligently must compensate the other party when they incur liability to a third party due to the breach or negligence
- Corporate authority: the people who sign the contract have the authority to bind the corporations that they represent
- No presumption against drafter: this negates the default rule that any ambiguities in a contract are interpreted against the drafting party
- Further assurances: a party must do what is necessary to give full effect to the contract upon a reasonable request
- Right to audit: a party can arrange for an independent audit of the other party’s financial records if it believes that it has not received proper payment (the parties can negotiate over who pays for the audit and whether and when the cost is reimbursed)
- Non-compete: an employee cannot work for a competitor of the employer or start a business that competes with the employer after their employment ends (often limited by time and place)
- Force majeure: the parties do not need to continue performing their obligations if a natural disaster or some other “act of God” outside their control occurs
- Damages limitation: this restricts the amount or type of damages available to each party in a contract dispute
If a clause may be invalid or unenforceable in certain situations, depending on the applicable law, the parties might qualify that clause with a phrase such as “to the extent permitted by law.” This may seem redundant because a provision cannot be enforced if this would break the law, but including this phrase can encourage a court to enforce the provision whenever possible. It also can alert the parties to the fact that the clause will not be enforceable in every situation.
This is not an exhaustive list of all the provisions that a contract could potentially include. Some provisions may be specific to a certain industry, such as entertainment, real estate, or construction. Each agreement is unique, moreover, and each business has its own priorities and concerns when entering into a deal. When the stakes are high, a business owner may want to consult an attorney to ensure that their interests are protected.
