Any business relationship involves a contract. Contract law describes how businesses exchange goods and services. Whether you write your own contract or have a business attorney draft one for you, it's a good idea to know what goes into a legal contract.
This article discusses contract law basics, the types of contracts, and what small business owners can expect in court. We also provide links to other helpful resources about contracts and legal information for business owners.
Contract Law Basics
A contract is a legally enforceable agreement between two parties. A contract must contain these elements:
- An offer by one party for goods or services.
- An acceptance of the offer by the other party.
- Consideration for the offer. There must be a "bargained-for" exchange of value to benefit both parties from the contract.
- Mutual agreement. Both parties must agree to the terms of the contract. If either party changes any of the terms, it becomes a counteroffer.
For instance, Joe offers to paint Fred's house for $100. Fred accepts. The consideration is the $100 Joe gets for painting the house and Fred's newly-painted house at the end of the contract.
Types of Contracts
Contracts come in various forms. They are valid and enforceable as long as they contain the elements mentioned above. Other elements may be necessary depending on the subject matter of the contract or the parties.
- Verbal contract. A verbal contract is as valid as any other contract. It may be more difficult to prove in court.
- Written contract. A written contract includes all the elements of a contract plus information. Business agreements may include delivery requirements, state laws and codes, and boilerplate language on warranties and liabilities. A written contract is evidence in court in cases of breach or fraud.
- Uniform Commercial Code (UCC). This governs the sale of goods over $500. The UCC wants all contracts in writing.
- Service contracts include employment agreements, professional services, and anything involving non-tangible products. Service contracts that will last over a year must be in writing.
- Real estate contracts must always be in writing to satisfy the Statute of Frauds.
Breach of Contract Basics
A breach of contract exists when one party fails to fulfill its obligations. There are four types of breach:
- Actual breach occurs when one party does not perform. If Joe does not paint Fred's house, he is in actual breach of their contract.
- Anticipatory breach occurs when one party expects the other party to breach and breaches first. Some business practices allow anticipatory breaches for legal reasons.
- Minor breach occurs when the breaching party has breached the contract in a small way. If Joe said he would start painting at 9:00 a.m. but didn't begin until 9:30 a.m., that would be a minor breach.
- Material breach means that the breaching party has failed in a way that causes significant harm. A material breach is usually grounds for legal action by the non-breaching party.
Contract issues leading to breach of contract are a serious problem for business owners. If you operate a small business, you should have ready access to an experienced attorney for legal advice. The time frame to file a lawsuit is narrow, and the evidence needed to prove your case can be hard to obtain without legal help.
Enforcing a Contract
Public policy and the common law determine contract enforcement. A contract that is "void on its face" or "void ab initio" is unenforceable. Other types of unenforceable contracts include:
- Lack of capacity. Both parties must be able to consent to the agreement. Some people do not have the legal right to consent because of age, mental condition, or legal status.
- Misrepresentation. Fraud, duress, or undue influence are all grounds for voiding a contract.
- Unconscionability. If the terms of the contract are grossly unfair, or if the parties' bargaining positions are unequal, the court may invalidate the contract.
- Mistake. A mutual mistake happens when both parties are mistaken about the terms of the contract. This can void the contract. A unilateral mistake occurs when one party is mistaken. If the other party was aware of the mistake and used the error to their advantage, it becomes fraud or misrepresentation.
There are two ways a court can handle legal issues with a contract. It depends on what the contracting parties knew and when the error occurred.
- Void contracts are unenforceable from the beginning. A void contract may be illegal or impossible to perform. The courts will not or cannot enforce them and will cancel the contracts.
- Voidable contracts are those canceled by the parties or which become void by law. For instance, a minor child cannot legally sign a contract, but if they do, they can accept the contract terms when they turn 18. Otherwise, the contract becomes void.
All businesses deal with contracts, even if they are unwritten, such as transactions involving goods or services. A contract is a legally binding agreement, and even an honest contractual mistake can cause serious problems. Small business owners should have at least a basic understanding of contract law or else seek legal help.
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