Be Careful With Your Business Contracts
As a small business owner you will be making many contracts. If you think of a contract as a "legally binding agreement between two or more parties," you can appreciate how many business activities involve contracts. Things you buy, such as inventory, supplies, machinery and equipment, usually involve some form of contract. The products or services that you sell are sold under contracts of various types. When you buy or lease real estate, a contract is nearly always involved. If would be difficult to find any area of business where contracts would not be important.
Some business advisors will tell you to hire a lawyer to help you with your contracts. I could offer this same advice, but I know that you probably will not do it. If you are a typical small business person, you will say either "I can’t afford to do that" or "I don’t want to deal with a lawyer."
Like many entrepreneurs, you will probably think of hiring a lawyer only after you are in some trouble and need the lawyer to help get you out of it. I will not try to lecture you on the merits of using lawyers to help keep you out of trouble in the first place. Rather, I will give you some helpful tips on contracts and suggest you follow along with me and learn a few fundamentals of contract law. This will benefit you in at least two ways.
The first benefit for you will be personal knowledge. Look upon it as part of your personal business database – things you should know when in business. This knowledge can be applied every time you begin to enter into a contract. It can be applied so you avoid the dumb mistakes you could make when you don’t have the knowledge.
The other benefit will come when dealing with a lawyer, if you need to do so. You will better understand contracts and the rules and laws that apply to them. You will avoid having to pay the lawyer for time spent educating you on these matters. Lawyers typically charge from $60 to $90 per hour for their time – and much more in some areas. At $60 an hour, you are paying $1.00 a minute for this basic education.
Experienced small business owners will tell you that time spent thinking BEFORE you sign any contract will avoid time spent crying AFTER you sign. To say this in another way, any difficulty you experience with a contract you signed probably had its origin in the drafting of the contract. From the viewpoint of your time and your money, you will save a lot of both if you apply sound knowledge and good information to the makeup of the contract BEFORE you sign.
Before we start, let me tell you a couple of things that you may already know. The first has to do with the difference between civil law and criminal law. Civil law concerns relationships between individuals. Criminal law deals with the government’s regulation of conduct. In civil law, individuals use the courts to help settle disputes or to provide redress for private injury. In criminal law, the state or federal government can fine you or send you to jail for various reasons. If you steal property, harm someone, drive drunk or violate any of the many laws in our society, you risk criminal prosecution by a government prosecutor. Rather than a dispute with another person (civil law), you have a dispute with a government (criminal law).
The area of civil law has two major parts. One is called contract law and the other is tort law. Contract law deals with obligations specified in a contract between two or more parties. Tort law deals with obligations created by law. For example, if your neighbor drives his car into your house, he is breaching his legal duty to operate his car in a safe manner – a tort violation. Other examples of torts are fraud, slander, invasion of privacy and trespassing. There is no contract violation in torts, but there is a violation of a duty established in the law -–a duty not to commit fraud, a duty not to slander, or invade privacy, or trespass.
What follows deals only with contract law, it talks about only those agreements and understandings freely and willingly entered into by two or more parties. In other words, it speaks to your relationships with your customers, suppliers, landlords, employees and others with whom you carry on business.
You should understand a couple of things before you read what follows. One is that most contracts are entered into and performed without problems. This "good thing" can lull you into an attitude that can lead to "bad things." If you make 99 contracts that cause no problems, you may lower your guard and feel that you need not bother to be cautious in making the 100th. That may be the one that kills you.
The other thing you should understand is that you don’t have to follow any particular rules in making contracts. You and the other party can do whatever you want. If you both agree to it, you can enter into it. The one catch is this: if you expect to use the courts to help you enforce a contract, you do need to follow certain rules. Thousands of contracts are made every day that could not be enforced in the courts. If they are performed to the satisfaction of all parties, who cares?
I bet you $100 the Cowboys will make it to the Super Bowl next year. If they do, you pay me the $100. If you don’t pay, can I take you to court? No. The reason I can’t is that this type of contract is not enforceable by the law.
To use a business example, you sell a car to a fifteen-year-old on time payments. She doesn’t pay as she agreed. Can you enforce that contract? No. She is a minor and can avoid the contract. The law will be of no help to you.
In studying what follows, please keep this in mind: You can make virtually any contract you please, but you can only enforce certain types.
Here are the rules.
Earlier I said that a contract was a "legally binding agreement between two or more parties." This is to say that parties can, by mutual agreement, establish a private set of rules to govern a specific business or personal relationship. In order to use the courts to enforce this agreement, certain elements must be present.
Briefly stated, to make a contract with you, I must make an offer and you must accept it. Your acceptance must be backed up with some consideration (usually money). In addition, both of us must have the legal capacity to make the contract and there must be a proper legal purpose and a proper legal form. Finally, we cannot use fraud or force to get the other one to sign the contract.
This doesn’t sound complicated, but there is some detail you should know. Let me back up and talk about these elements, one at a time.
Let’s imagine that I hand you a piece of paper that says: "I will install your business fixtures in your store for $1,200 including all materials and supplies needed for the installation. I will start tomorrow and finish by next Tuesday."
I have made an offer. You can say "yes," "no," or "let’s talk about it." An offer is usually what starts the bargaining process that usually precedes contracts. For simple matters, this bargaining process is short and to the point. At other times, it can be long and complex.
Either way, for an enforceable contract, there must first be what is called a "valid offer." To be legally valid, my offer to you must do three things:
- Describe what I am offering.
- Give specific terms (price, dates, descriptions and other important matters.)
- Be communicated to you.
These rules are to ensure that we understand each other – that we both have the same understanding of what I will do and what you will do. In this example, I will do the work and you will pay money to me.
If I had said to you, "I will install your fixtures when I can get to it and you can pay me what is fair," my offer would be too vague to be valid. Imagine asking a court to interpret "when I can get to it" and "pay me what is fair."
You and I must have a firm agreement so that there is no question about our intentions.
You may respond to my offer by saying you want to think about it and get back to me later. To deal with this possibility, the rules of offers explain how offers can be withdrawn and become void.
My offer to do work for you has some time limitations. If you come back to me five years from now and say, "Okay, I accept your offer," I probably will not know what you are talking about.
Unless a time limit is specified in my offer, it will automatically expire after a certain amount of time. What amount of time depends on the situation and the parties. If we are talking face-to-face about the sale and purchase of a car, the offer is usually good only as long as we are talking face-to-face. When we separate, any outstanding offers will probably expire under the law. If we don’t specify a time limit for the offer to remain open, it will expire quickly.
To take another example, if I am trying to buy a house in another city and I make an offer, that offer will remain open for a longer period of time. It is a good practice to place a time limit on any offer you make so it is clear to both parties when it will expire. If you do not set a time, you leave it up to the sometimes uncertain interpretation of the law.
My offer to you will automatically expire if I die or if the subject of the offer is destroyed. If I offer to buy your house and the house burns down before you accept, my offer is voided. I can also take back my offer at any time, provided I haven’t given you a certain amount of time to accept it. This is called revoking an offer.
Finally, my offer will expire if you reject it outright or if you make a counter-offer. A counter-offer is any response you might make to my offer that modifies the terms or proposes additional conditions. If I offer to sell you my old truck for $2,000 and you say, "I will buy it for $2,000, provided you fix the driver’s side door." The added provision to fix the door amounts to a counter-offer and this counter-offer cancels my initial offer. If you later come back and say, "Okay, I will accept your offer of $2,000" I can legally say "no" because you voided my offer with your counter-offer. While it is true that real-life negotiations usually don’t get this technical, contract law specifies these technicalities.
To avoid getting tripped up by some of these offer technicalities, it is a good business practice to put offers in writing and state all important terms and conditions. Include the manner in which the offeree is to respond and the time limit before the offer expires. If you choose not to put it in writing, at least be specific about the terms and conditions.
The rules for acceptance of an offer are fairly straightforward. The acceptance must:
- Mirror or reflect the terms of the offer.
- Have no conditions or changes added.
- Satisfy all requirements set forth in the offer.
- Be communicated.
- Be given only by the person to whom the offer was made.
In accepting an offer, you must be careful to accept it in the proper way. Usually, this presents no problem. If the offer specifies the manner of acceptance, such as "in writing," then you must accept in that way. If no method is specified, you will be safe in accepting it in the same manner as it was offered. An offer by phone can be accepted by phone. A verbal offer can be accepted verbally.
For sales of personal property, the Uniform Commercial Code (explained in a minute) says an offer can be accepted in any manner and by any medium "reasonable in the circumstances." That is vague and leaves much room for interpretation. Usually, in practical terms, an acceptance by mail or telegraph is considered valid.
One caution: an invitation to make offers is not an offer. For example, if a building contractor asks for bids from subcontractors, the bids are not offers. Neither is the invitation by an auctioneer considered an offer. Rather, the bids one makes to the auctioneer are offers that can be accepted or rejected by the auctioneer.
This can be a confusing part of contract law. On the one hand the laws of contracts say that contractual promises must be supported by some consideration. Consideration is defined as something given in exchange for making a promise. On the other hand, the law allows consideration to take different forms and exempts certain types of contracts from any consideration at all.
While consideration is often money, it can be almost anything that one party promises to do or not to do in exchange for the other party’s promises. Some contracts contain the opening statement: "For one dollar and other valuable consideration, John Smith promises ..." Some consider this legal mumbo-jumbo just to satisfy the consideration requirement of contracts law.
Some types of contracts do not require consideration. A firm written offer that cannot be revoked for a specified period of time requires no consideration. Neither does an agreement to change a contract for the sale of goods. If you were to reasonably rely on my promise to do something, even if no consideration was involved, a court might well enforce that promise anyway.
Because of the vagaries of this area, it is smart to always write contracts so that the consideration exchanged by the parties is clearly set forth. Should the matter go to court, this written record can help avoid a challenge that the contract was not supported by consideration.
Except for people younger than age eighteen, legal capacity is usually not an issue with business contracts. The law defines legal capacity as the ability to understand the general nature of a contract and the fact that it is being made.
It does not mean that you must fully comprehend the legal meaning or implication of each and every provision in the contract. It also does not mean that being high on alcohol or drugs will absolve you of responsibility for a contract you made while under the influence.
In dealing with minors and contracts, you should remember that while a minor can make a contract, that minor might also avoid the contract at his or her election up to the age of eighteen. If the contract continues in force after age eighteen and the person does not act to avoid it, the contract is usually considered ratified. This means that it can be enforced in the courts.
To be legal and enforceable, a contract cannot be illegal or violate public policy. This means that you can’t have a contract to violate the law or to commit a crime. Public policy refers to such things as wagering, usury, price fixing, agreements to obstruct justice or contracts in restraint of trade.
Legal form refers to oral versus written contracts. While it is good business practice to write contracts, oral contracts are sometimes legal. The problem with oral contracts is that they are difficult to enforce. In a dispute, the opposing parties claim the oral contract specified different things. It comes down to one word against another.
Some types of contracts must be in writing to be enforceable. These include the following:
- Contracts involving land.
- Sale of goods over $500.
- Promises to pay another person’s debts.
- Contracts that will not or cannot be performed within one year.
- Marriage settlement or prenuptial agreements.
Concerning written contracts that are modified by oral additions, the courts’ position is clear. Rarely will the spoken word be allowed to modify a written contract. Only in cases of fraud or mistakes will spoken words (called parol evidence) be allowed. As often happens in business contracts, the written contract that is signed is different from the oral representations made. This is why a thorough reading and understanding of the contract before signing is important.
Written changes can be made to written contracts. To avoid problems, final written contracts usually contain such words as "the parties agree that this written contract constitutes the final agreement and there are no other written or spoken words necessary to supplement or interpret it."
Uniform Commercial Code (UCC)
Some of contract law is based on the old common law from England and on case law that has developed. Some contracts, however, are governed primarily by specific statutes of recent times. The most important statute relating to business is the Uniform Commercial Code. The UCC makes rules for dealing with all aspects of sales and purchase transactions.
Other statutes set down rules for real estate transactions, insurance agreements, employment contracts, agency agreements and extension of credit or installment purchase contracts.
In addition to all of the above issues that make a contract valid or not, there is another overall factor called genuine assent. This means that a contract must be freely and willingly intended. All parties to the contract must have intended to enter into the contract. Furthermore, none of the parties was under any duress, undue influence or fraud.
Occasionally, a misunderstanding of the important facts in a contract or significant mutual mistakes will also void a contract. In all of these circumstances, a court might grant relief if it is determined that a party’s assent was not freely or genuinely given.
Suppose you make a contract and later feel that you were deceived by the other party. You can seek to void the contract by claiming fraud. However, be aware that the burden of proof will be on you and that fraud is difficult to prove. In order to prove fraud, the law says you must show that all of the following circumstances existed:
- The other party intended to deceive you.
- The other party knew he or she was deceiving you.
- A material fact was misrepresented (as opposed to a minor issue).
- You relied on this misrepresentation in making your decision to make the contract.
- You suffered injury as a result of the fraud.
Proving some of these will not be enough. You must prove them all. The one that is most difficult to prove in law is the intent of the other party. You may know in your heart that he intended to deceive you, but how do you prove it?
Duress or undue influence may also get you off the hook on a contract. If you were threatened or subjected to other wrongful acts that caused you to make a contract, you may be able to void a contract. If you were under the strong influence of someone, such as your boss or some other dominant party, you can seek to void a contract.
Even mistakes can void a contract, provided both parties to the agreement made the mistake. A mistake on the part of only one of the parties is not enough. The mistake must be material and not some minor issue.
Should You Sue?
This short course in contract law will not make you an expert, but it may save you some mistakes. It is still a good idea to use lawyers when dealing with legal matters. Contracts are not only business matters. They are legal matters.
A well considered contract will help keep you out of the courts. Consulting with a lawyer BEFORE you sign will also help. However, even with these precautions, you may still have need to use the courts to enforce or break a contract.
Here is some old fashioned advice based on the experience of thousands of small business owners: STAY OUT OF THE COURTS.
There are four compelling reasons to do everything you possibly can to avoid taking contract disputes to court. They are lawyers, rules, judges and money. Here is what I mean:
Lawyers: To use the courts usually means you must hire a lawyer. Lawyers are businesses that exist to make a profit. Lawyers are trained in a system that is called "adversarial." This means that they are trained to fight for your rights. While they are fighting for your rights the opposing lawyer is fighting for your opponent’s rights. The operative word here is "fighting." Fighting or war does resolve disputes, but in inevitably involves bloodshed and suffering.
Rules: Our legal system is complex and governed by many rules. One of the reasons you need a lawyer if you go to court is because he or she knows the rules – you don’t. You may know the facts, but you don’t know the rules. Many cases are lost because rules are not followed. Miss a filing deadline, make misstatements in a pleading, fail to make a motion hearing, fail to make a timely response, or violate any of thousands of other rules and your case can be lost or seriously harmed. You may have the facts on your side, but if you don’t follow the rules, you will probably lose.
Judges: Judges (and sometimes juries) are the decision-makers in your lawsuit. They are human, often over-worked, sometimes prejudiced, occasionally incompetent, and hardly ever view matters exactly as you see them. Judges make errors, have emotions, get mad and frustrated, and sometimes take the easy route out of a problem. Their unusual power within the legal system contributes to their occasional unwillingness to be prompt, fair, or competent. As with any group or profession, there are good, bad and terrible members. Many are political appointees. Disciplining or removing a bad judge is difficult and seldom attempted.
Money: Using the courts and lawyers costs money, usually a lot of money. Unless a lot of money is at stake in your contract dispute, you may well spend more to take it to court than it is worth. Lawyer businesses are like any other professional business: the good ones are expensive and the others may fail you. Either way you pay. Someone once said that there were just three types of people who hire a lawyer and go to court. One was a person with a lot of money. A second was a personal injury type matter where a lawyer took the case on contingency. The third was someone who did not know any better.
Even if you were to take your contract dispute to court and fight your way through the lawyers, rules, judges and money to win, that win usually only gives you a legal right to collect your damages. Collecting them from your opponent is entirely another matter. If he or she still refuses to pay, you can go back to court with more lawyers, rules, judges and money.
NOW, if this doesn’t scare you into being more careful with your contract matters – then I don’t know what to tell you. home page.