When you go into business for yourself, you may encounter written business agreements or contracts for the first time. While you’ve undoubtedly encountered written contracts before as a consumer, such as gym membership agreements or car purchase contracts, business contracts may produce an additional level of anxiety and confusion. For business owners, it’s crucial to understand the terminology used in standard business contracts as well as why those terms and clauses are so important. Contract language may be written in “legalese” or preferably in plain English, yet either way, the terms and phrases included in your contract will determine your rights and obligations. So, it’s important to make sure you understand why these phrases and clauses are critical and what they mean for the parties involved in the contract.
Basic Contract Terminology
Agreements don’t necessarily have to be reduced to writing in order to constitute a binding contract – that is, a contract that is legally enforceable against both of the parties who made that agreement.
However, generally speaking, a written contract is a more enforceable and reliable contract. It’s always preferable from an administrative and management perspective, since the parties and their employees don’t have to rely on their memories or second-hand information in order to find out what they’re supposed to do or refrain from doing. Rather, they can simply consult the written document. If the contract was well-drafted (or written), it can actually reduce or eliminate contractual disputes. Clear, well-drafted contracts make business matters much easier.
The parties to the contract are the two businesses (in this context) that agree to an exchange of obligations. In the simplest kind of contract, one business agrees to sell an item to another business. The parties in that case would be the seller and the buyer. However, the parties can also be assigned other labels, depending on the nature of the underlying agreement.
The written agreement itself may consist of a few distinct parts. There may be a written caption at the beginning of the document, establishing the applicable jurisdiction and a title for the contract (such as “Commercial Lease for Manufacturing Facility” or “Contract for Sale of Office Equipment”). Generally, following the caption is a preamble. This section may start with some formal language such as “WHEREAS, the parties having agreed on this _ day of the month of _, 20.” After the preamble, the body of the contract will set forth the various terms in numbered paragraphs, generally referred to as “clauses.” At the end of the contract, a signatory page or signature block will provide spaces for the parties to sign and date the agreement. In a few cases, contract law may also require the contract to be notarized. If that is the case, the last part of the contract will be the notarization signature and affixed seal.
The Elements of a Legal Contract
A legally enforceable contract requires four specific conditions to be met:
- Mutuality of obligation
The offer is the initial proposal or indication that a potential party to the contract is open to forming an agreement. An offer can be express, in which case, for example, the owner of a business can state to the owner of another business, “I would like to sell you 25 office desks for $500 each,” or it could be implied, as with a business’s website offering the same deal on the same terms. In either case, the business owner (or the business behind the website) is called the offeror.
Acceptance is the second required element. It takes place when the other party assents to the terms offered by the offeror. Typically, however, contractual acceptance doesn’t follow immediately. Instead, the other party (the offeree) makes a counteroffer. A counteroffer simply alters the proposed offer in some respect, either by changing a term or adding one. For example, the offeree could reply, “I’ll buy your 25 office desks but only if you give me a 10 percent discount off the total.” If this occurs, the original offeror needs to accept the new terms or make a different counteroffer. The exchange continues until the parties agree on some set of terms or decide to move on, in which case no contract results.
Consideration is a difficult concept to grasp for first-year law students and new business owners alike. Consideration is merely something of value that is exchanged for the thing being offered or the subject of the original offer. In the case of a straightforward sale, the consideration is typically financial in nature. If the offeree agrees to the original terms for the sale of the 25 desks, the consideration is the sale price for each desk, or a total of $12,500.
Mutuality of obligation simply means that both parties are similarly bound by the contract’s terms. In other words, if one party might perform his part of the contract or might decide not to perform without any consequence, then the transaction is not really a contract at all. Rather, it’s a gift or a proposed gift. If both parties are not mutually bound by the terms to which they’ve agreed, then the contract is not enforceable.
Other factors that courts consider in evaluating a contract’s validity and enforceability may also be included in the list of basic contractual elements. Competence and capacity may be phrased as necessary elements or in the negative as affirmative defenses. In other words, if a seller sues a buyer over a contract, the buyer could allege that one party lacked the competence and capacity to enter into a binding contract. This is usually invoked when one of the parties in question is a minor, since children generally cannot legally bind themselves to a contract.
In some cases, a contract must also be reduced to writing in order to be legally enforceable. This is governed by a legal concept called the statute of frauds, which sets forth the types of contracts that need to be in writing before a court will deem it valid. These contracts include contracts for real estate and contracts where performance necessarily will take more than a year, among others.
What Are the Terms of the Contract?
An enforceable and well-drafted contract should contain a number of specific terms or separate provisions that form a part of the underlying agreement.
One of the most important terms in a contract is the price, assuming that some exchange of money is one of the contractual obligations. Price terms include more than the mere purchase price. They include time, form of payment (i.e, check or cash) and other arrangements that the parties agree to regarding the price. For example, if a sale of goods or services is the subject of the contract, how much will the purchasing party have to pay? Will the seller accept a check or bank transfer, or does the purchaser have to provide the full price in cash? Does it have to be paid in one lump sum, in periodic payments or in some other fashion? Finally, when does the buyer have to pay? In many business contracts, the price terms give the purchaser 10 or 30 days, for example, to pay after delivery of the goods. These terms are called “net 10” or “net 30,” respectively.
Another important term of the contract is the description of the goods or services to be provided. As simple as this may seem in a straightforward sale of 25 desks for $500 each, it can get complicated with more complex goods or services. Quantities, colors, sizes, types, flavors and many more characteristics can be (and in many cases should be) described in the contract to ensure the parties’ intentions are carried out properly.
These are simply some of the major and most commonly included terms of a typical business contract. Other terms are also commonly included, such as choice of law, arbitration, incorporation and other clauses, which may collectively be referred to as “boilerplate.”
What Is a Clause in a Contract?
A clause in a contract is generally one numbered paragraph or section of a written contract that covers one specific aspect or term associated with the contract. For example, a contract will generally have separate clauses to name and describe the parties, describe the parties’ obligations, outline the price and payment terms and assign a specific court or legal forum for resolution of contractual disputes, among other terms.
Clauses are generally numbered or otherwise labeled in order to make it easier for the parties to first negotiate and then refer back to the written document. They may also be further labeled with a descriptive phrase such as “Choice of Forum” or “Mandatory Arbitration.”
What Is a Contractual Breach?
A contractual breach is basically a violation of the terms of the contract that’s been committed by one party to that contract. A party is said to be “in breach” when they are in a state of not abiding by the terms of the contract or not fulfilling its obligations under the agreement. For example, in a contract for sale that obligates the purchaser to submit the full purchase price by check 15 days after receipt of the goods, the purchaser is in breach on day 16 if the check has not been submitted to the seller.
Simply being in breach or having the other party declare a breach in writing may not be sufficient to convince the nonperforming party to correct the situation. Sometimes, a contractual breach dispute must be litigated in order to be resolved. Assuming the contract does not mandate some alternative dispute resolution method, such as binding arbitration, this usually means a lawsuit in the court and state specified in the contract. If a court declares the party to be in breach, it will usually then issue a judgment for financial damages, or a sum of money to be paid to the wronged party to compensate for the breach.
Other Common Contract Clauses
Other commonly included contract language includes clauses such as the following:
- Force majeure
- Choice of law and forum
- Arbitration and mediation
Force majeure clauses provide that one or both of the parties to the contract may be excused from their contractual obligations if an “act of God” occurs. These are typically unforeseeable, uncommon events such as terrorist attacks, natural disasters or severe weather.
Choice of law and forum clauses specify which state or other legal jurisdiction will govern the interpretation of the contract’s terms and in which disputes will be litigated. Typically, the selected state for both of these clauses is one in which at least one of the parties is located or does business.
Arbitration and other alternative dispute resolution methods may sometimes be specified in contracts. These methods of dispute resolution are typically viewed as being less expensive than full-fledged litigation in a court of law. They also typically can resolve a dispute much more quickly than a court’s docket will allow.
Despite the name, incorporation clauses don’t have anything to do with whether the parties are properly incorporated as business entities. Rather, they generally state that the contractual document is the only agreement between the parties and that all of the agreed-upon terms are included in it. In other words, it limits the interpretation of the contractual terms to the pages of that document alone, excluding other documents such as emails or letters between the parties.