Every day we enter into contracts without even realizing it. Whether it is something as simple as buying groceries or downloading software or as complex as buying a business, every transaction involves entering into some sort of a contract. At its simplest, a contract involves one party making an offer, another party accepting the offer, and an exchange of something of value, usually money for a product or service.
When drafted well, contracts can be a fundamental tool in business dealings, helping to establish clear expectations and obligations between parties. However, poorly drafted or ambiguous contracts can lead to disputes and even lawsuits, which can be time-consuming and costly to resolve. To avoid these pitfalls, it's important to follow best practices when drafting and negotiating contracts.
IDENTIFY THE PARTIES
Identifying the parties is important not just for now but also the future. First, use the correct legal names. If the entity is a company, make sure that you use the legal name of the company including whether it is a corporation or a limited liability company. Identifying the wrong entity could lead to having a vague or invalid contract. If you ever need to enforce the contract or collect from the other party, naming the party incorrectly could leave you with nothing. Second, identify whether subsidiaries, family members, or other parties are included. Third, determine what happens if one party dies or the business is sold. Is the contract assignable or is it terminated? This makes a big difference when a large competitor buys the business or if that architect that you hired to design your new headquarters dies.
DEFINE THE SCOPE AND BASIC TERMS
Without clear objectives, parties run a risk of entering into an agreement without fully understanding the terms. Specify the scope of work, timelines (e.g., when do different parts of the agreement have to be completed, when does the contract end), payment terms (e.g., how much, when, and what happens if payments are late), and other essential details. When these terms are left undefined, misunderstandings can arise, leading to disputes between the parties. It's also important to include provisions for how changes to the project will be handled, as well as dispute resolution mechanisms.
TO WRITE OR NOT TO WRITE: THE STATUTE OF FRAUDS
Depending on the type, the amount, and the length of the contract, the contract may need to be in writing to be enforceable (the “Statute of Frauds”). Buying groceries at the local food stand does not need to be in writing, but buying a building or renting commercial real estate for more than a year certainly does. The purpose of the writing requirement is to prevent fraud and promote clarity and certainty in contractual relationships.
Under the Statute of Frauds, the following types of contracts typically need to be in writing:
1. Contracts for the sale of land: Any agreement that involves the transfer or sale of an interest in real property generally needs to be in writing. This requirement helps prevent fraudulent claims or disputes over land ownership.
2. Contracts that cannot be performed within one year: If the terms of an agreement cannot be completed within one year from the date of its creation, the contract must be in writing. This provision prevents misunderstandings and unreliable oral agreements for lengthy terms.
3. Contracts for the sale of goods over a certain value: In many jurisdictions, the sale of goods over a certain monetary threshold (such as $500) requires a written agreement. This provision applies to transactions governed by the Uniform Commercial Code (UCC) in the United States.
4. Contracts made in consideration of marriage: Promises related to marriage, such as prenuptial agreements or contracts involving the transfer of property upon marriage, generally need to be in writing.
5. Contracts by executors or administrators to answer for debts of the deceased: If a person assumes personal liability for a debt or obligation of a deceased individual, that agreement must be in writing.
6. Contracts for the transfer of copyrights or intellectual property: Certain agreements involving the transfer of copyrights, patents, or intellectual property rights generally require a written contract.
It is important to note that the specific requirements of the Statute of Frauds may vary by jurisdiction, and there may be exceptions and nuances in different legal systems. However, the general aim is to ensure that important agreements are documented in writing, reducing the potential for fraud and disputes arising from unreliable oral contracts.
KEEP IT SIMPLE
Contracts should be written in plain English, avoiding legalese and jargon whenever possible. This ensures that all parties can understand the terms of the agreement, reducing the risk of misunderstandings or misinterpretations. Remember that any ambiguity is read against whichever party drafted the contract.
CONSIDER THE UNEXPECTED
Consider the possibility of unforeseen events or changes to the project. Contracts should include provisions for how to handle changes in scope, delays, or other unforeseen events. Failing to include these provisions can lead to disputes over delays or additional costs. While the parties are on good terms, consider the possibility of disputes and include provisions for dispute resolution mechanisms, such as mediation or arbitration. The best time to determine how to resolve a dispute is before one happens while the parties are on good terms.
Always consider that individuals you know and trust at the opposing company may no longer be employed there during the term of the contract. A new management team with an entirely different philosophy regarding contract compliance and enforcement might assume control. The opposing party's financial situation could become so stressed that it is no longer able to meet the contract terms. By assessing the “what ifs” of the potential contract relationship, you can draft protections in the agreement to cover potential worst-case scenarios. This exercise may help you to protect against unforeseen events, and potentially allow you or your company to avoid expensive and lengthy contract enforcement proceedings.
HOW AND WHEN DOES IT END
Start with the end in mind. – “Stephen R. Covey
How will you know if the contract is successful or when it ends? What happens if you want to get out of it before the end? If you start with the end in mind, you will always have the comfort of knowing that the agreement isn’t forever, even if it feels that way.
In some contracts, you can return the item or cancel the agreement and walk away. If a contractor comes to your house and signs you up for those solar panels, you may have time to change your mind. If you refinance your mortgage, you have three days to cancel the contract according to federal law. Not every contract has the possibility of walking away. For some contracts, like a lease agreement, once you sign it, you are bound to it.
When the contract ends, it doesn’t always end. Some contracts automatically renew. If you miss the termination window, you will be bound for another term, which can be as long as the original agreement. So pay attention to and follow the provisions for ending the contract if those terms are present.
WHO BEARS THE RISK?
What happens when prices rise or supply chain disruptions happen? Who bears the risks associated with the new prices or delays? What happens when one party is sued because of the actions of the other? Will one party indemnify the other? Are there warranties for the products? Are there service level guarantees? Will certain damages be limited? Will there be any limitation on liability? Can the winning party collect attorney fees for going to court?
A properly drafted contract will not only answer these questions, but it will also ensure that one party isn’t responsible for paying for more than they bargained for. Again, the time to negotiate the answers to these questions is at the contracting stage before you become responsible for renovating the building because of a provision that you didn’t read or maybe didn’t mean. If you don’t plan for disaster, you may even end up paying for renting new space for your customer because supply chain disruptions caused a delay in building out the space needed for their business.
SEEK LEGAL ADVICE
Contracts are an essential tool in business dealings, helping to establish clear expectations and obligations between parties. Contract disputes can be costly and time-consuming for businesses and individuals. It is essential to draft clear and comprehensive contracts that define the terms and obligations of each party. Additionally, it is important to have a process in place for resolving disputes before they escalate to litigation. By taking these steps, businesses can minimize the risk of disputes and protect themselves from the potential consequences of litigation.
Seek legal advice when drafting and negotiating contracts. If you need an experienced attorney to help you draft a contract, negotiate the terms of a contract, review an existing contract and identify any potential issues or areas of concern, have specific questions related to this article, or would simply like a consultation regarding your current practices, please contact Mitchell Goldstein (firstname.lastname@example.org) at (804) 377-1269, or Steve Setliff (email@example.com) at (804) 377-1261.