Business contracts are the foundation of commercial relationships. This is true whether you’re a small business owner, a startup founder, or part of a large corporation.
These legally binding agreements outline the terms and conditions of business dealings so that all parties understand their rights and obligations. In essence, contracts are what keep the wheels of commerce churning.
Consequently, understanding the fundamentals of commercial contracts is essential for anyone involved in business. This post will provide an overview of the key aspects of business contracts, from negotiations and contract formation to enforceability, breach, and remedies – with links to let you take a deep dive into the fundamentals discussed here.
1. Negotiations
Contract negotiation involves discussions between the parties to agree on the terms and conditions of their deal. Successful negotiations lay the groundwork for a clear and enforceable contract, making this an essential phase in the contracting process.
The role of negotiation in contract formation
Negotiation is a critical part of contract drafting, in fact, that some of the world’s finest institutions offer multi-week courses in this process alone. During this stage, parties discuss their needs, expectations, and the specifics of the agreement. The goal is to reach a mutual understanding that satisfies all involved.
While each party will naturally want to secure the best terms for themselves, successful negotiations inevitably involve some degree of compromise. Both parties should feel that they’ve gained value from the deal, while not giving up too much in the process.
Key elements to negotiate
When it comes to business contracts, certain elements are almost uniformly subject to negotiation. These include:
- Price: The amount to be paid for goods or services, and any payment schedules or terms.
- Delivery terms: The timelines and methods for delivering goods or services.
- Performance obligations: The specific duties and responsibilities each party agrees to fulfill.
- Warranties and guarantees: Assurances about the quality of goods or services and what happens if they fail to meet expectations.
While there are obviously a host of other terms that will be subject to negotiation, these core terms are typically where you’ll spend the vast amount of your negotiating effort.
2. Contract formation
Once negotiations are complete, the next step is formalizing the agreement through contract formation. As with any agreement, a business contract must contain certain essential elements in order to be valid. These include an offer, acceptance, consideration, and mutual assent.
Common business contracts
Business contracts come in various forms, depending on the nature of the transaction. That said, the most common types of business transactions include:
- Sales agreements: Contracts for the sale of goods or services, detailing the price, delivery terms, and other conditions.
- Service contracts: Agreements where one party provides services to another, outlining the scope of work, payment terms, and duration.
- Partnership agreements: Contracts between business partners that define the terms of their relationship, including profit sharing, responsibilities, and dispute resolution.
Each type of contract serves a specific purpose and is tailored to the needs of the transaction. Understanding the different types helps in drafting contracts that accurately reflect the business arrangement.
3. Enforceability
Having a well-written contract is important, but it’s equally essential to draft an enforceable agreement. Enforceability determines whether a court will uphold the terms of the contract and compel the parties to fulfill their obligations.
What makes a contract enforceable?
Several factors contribute to the enforceability of a contract:
- Legality: The contract’s subject matter must be legal. Contracts involving illegal activities, such as agreements to commit a crime, are void and unenforceable.
- Capacity: The parties entering into the contract must have the legal capacity to do so. This means they must be of sound mind, not minors, and not under undue influence or duress.
- Clear and definite terms: The contract must clearly outline the obligations of each party. Vague or ambiguous terms can lead to disputes and may render the contract unenforceable.
- Consideration: As mentioned earlier, consideration is an essential element to any contract. Consideration is the value exchanged between the parties. Without it, a contract is generally not enforceable.
Common issues affecting enforceability
Even with a well-drafted contract, certain issues can arise that affect its enforceability:
- Lack of consideration: If one party provides no value in exchange, the contract may be deemed unenforceable.
- Illegality: Contracts that involve illegal activities or terms that violate public policy are void.
- Mistakes: If both parties make a mutual mistake regarding a fundamental fact of the contract, it may be unenforceable. For example, if both parties mistakenly believe a sculpture is an original when it is not, the contract to sell the sculpture might be void.
- Misrepresentation or fraud: If one party is induced into the contract by false statements, the contract may be voidable by the deceived party.
4. Breach of contract
Even with the best intentions, there are times when one party fails to fulfill their obligations under the contract. This failure is known as a breach of contract, and it can have serious legal and financial consequences.
What constitutes a breach?
A breach of contract occurs when one party does not perform as promised in the contract. Breaches can be categorized in several ways:
- Material breach: This is a serious violation that goes to the heart of the contract. A material breach allows the non-breaching party to terminate the contract and seek damages. For example, if a supplier fails to deliver goods as agreed, the buyer might be able to cancel the contract and sue for any losses incurred.
- Minor breach: Also known as a partial breach, a minor breach occurs when one party fails to perform a small part of their obligations. While this may not justify contract termination, the non-breaching party may still seek damages. An example might be delivering goods a week late but still within a timeframe that allows the buyer to use them.
- Anticipatory breach: This occurs when one party indicates in advance that they will not be fulfilling their contractual obligations. The non-breaching party can treat the contract as breached and seek remedies immediately, rather than waiting until the performance date.
Examples of common breaches
Breaches of contract can occur in various ways, depending on the nature of the agreement:
- Failure to deliver: A supplier does not deliver goods on time, causing the buyer to miss out on sales opportunities.
- Non-payment: A client fails to pay for services rendered, leaving the service provider out of pocket.
- Quality issues: Delivered goods do not meet the agreed-upon standards, leading to losses for the buyer.
Each of these breaches can have significant impacts on business operations, making it essential to address them promptly and effectively.
5. Remedies
When a breach of contract occurs, the non-breaching party is entitled to seek remedies to address the harm caused by the breach. Remedies can take several forms, depending on the nature of the breach and the terms of the contract.
Legal remedies for breach of contract
The primary legal remedies available for a breach of contract include:
- Money damages: The most common remedy, damages, is a monetary compensation awarded to the non-breaching party to cover losses caused by the breach. There are different types of damages:
- Compensatory damages: Compensatory damages are intended to make the non-breaching party “whole” by covering the direct losses and costs incurred due to the breach. For example, if a supplier fails to deliver materials, compensatory damages would cover the cost of sourcing them from another supplier.
- Consequential damages: These are the indirect losses that occur from the breach. Staying with the above example, if our purchaser expected to make profits from selling the products the supplier failed to deliver, the purchaser might be able to recover those lost profits as consequential damages.
- Nominal damages: These are small monetary awards granted when a breach occurs, but the non-breaching party suffers no significant financial loss. Nominal damages acknowledge that a breach occurred without substantial harm.
- Liquidated damages: These are predetermined amounts specified in the contract, to be paid in the event of a breach. Liquidated damages are often used when actual damages would be difficult to calculate, such as in contracts involving construction delays.
Non-monetary remedies
Specific performance
In some cases, monetary damages may not be sufficient to remedy a breach. Specific performance is a remedy that requires the breaching party to fulfill their obligations under the contract. This is often used in cases involving unique goods or real estate, where the non-breaching party seeks the exact performance promised, rather than a financial substitute.
Rescission
Rescission is the cancellation of the contract, returning both parties to their pre-contract positions. This remedy is often sought when a contract is voidable due to factors like fraud, misrepresentation, or mutual mistake. Rescission allows the non-breaching party to undo the contract and be relieved of their obligations.
Conclusion
While business contracts are undoubtedly common, each one contains its own complexities. That’s why understanding the fundamentals of business contracting – from negotiations to remedies – is critical for any legal professional who regularly serves business clients.
