Contracts FAQ

Small businesses run on contracts and legal documents. Small business owners should have a basic understanding of contract law when they open their doors. You don't need a business law degree, but you should know what you're looking at when you sit down with vendors or apply for a business loan.

All valid contracts have a few things in common. Read on to learn what your contracts need, what to do in case of a breach, and what makes a contract invalid, as well as to get answers to frequently asked questions (FAQs).

For additional information, visit FindLaw's Business Contracts and Forms Section.

What do valid contracts need?

All types of contracts contain the same elements. The parties must have the capacity to enter into a contract. They must be mentally and legally able to agree to the contract terms. There must have been mutual agreement between all parties. Parties indicate agreement by offer, acceptance, and consideration. The offer is the the subject of the contract, acceptance is approval of the offer, and consideration is the exchange of value for the services or goods.

Do contracts need to be in writing to be valid?

Not always. Binding contracts can be written or oral, but a few types must be written to be valid. These include:

• Documents related to marriage, including prenuptials
• Transfers of real estate
• Contracts that will take longer than one year to complete
• Agreements to pay another person's debts
• Contracts for the sale of goods over $500
• Transfers of personal property at the death of one party involved

Construction contracts are often in writing because they involve subcontracting. The prime contractor contracts with the homeowner, so there is a primary document to bill the subcontractors.

Independent contractor agreements for goods or services are like any other type of business contract. It's always best to have an agreement for an exchange of money in writing.

Why is it a good idea to get contracts in writing?

A written contract allows the parties to understand their obligations under the contract. If there are issues later, a written document provides evidence of the parties' negotiations and their final agreement. In court, contract law requires the judge to look at the "four corners of the contract" if there is a dispute. There are limits on other evidence outside of the written contract, called parol evidence, that can be introduced in a contract law case.

The contracts that must be in writing are most often the subject of court cases. It's always a good idea to have any exchange of goods or services for money in writing, even if it's just the neighbor kid mowing your lawn.

Can a contract be illegal?

An illegal contract is either:

• A contract where the subject matter itself is illegal. For example, a contract to purchase illegal narcotics is not legal.
• A contract that requires illegal activities to complete the terms. A contract that does business with a nation under federal government sanctions would be such a contract.

Illegal contracts are unenforceable, even if they are otherwise legally written. The courts will not enforce a contract containing illegal subject matter or terms.

Contracts may be legal on their face but void in reality. That is, they cannot be legally enforced because of some flaw in their execution. Common reasons to void a contract include:

• Lack of capacity on the part of one party
• Fraud or misrepresentation
• Unconscionable or unfair terms
• Impossibility or impracticability

A non-disclosure agreement (NDA) is a type of voluntary contract. NDAs appear in employment contracts and intellectual property law to protect trade secrets and confidential information.

Many states have banned or restricted NDAs, which are difficult to enforce in court. Most NDAs are enforceable when they involve specific confidential information or are time-limited.

What is a breach of contract?

A breach of contract occurs when one party fails to perform its obligations under the contract. The nature of the breach depends on the type of contract.

• Failure to complete obligations on time: For instance, a contractor could fail to finish building a roof by a specific date.
• Failure to abide by the terms of the contract: The contract specified the delivery of five tons of green grapes, and the shipper delivered three tons of red grapes.
• Failure to perform on the contract at all: You hired someone to take photos on your wedding day, and they never showed up.

All of these are breaches of contract. Some kinds of contracts have specific remedies for breach of contract. In commercial shipping contracts, the non-breaching party may have a certain number of days to demand a correction. The Uniform Commercial Code (UCC) governs these contracts.

When a party breaches a business contract, the non-breaching party can sue to recover damages.

All states have statutes of limitations for breach of contract claims. In most states, the statute varies depending on the nature of the contract. The statute can be as long as 10 years for written contracts and as short as two years for oral contracts. You should contact a contract law attorney as soon as possible in case of a breach.

What relief is a person entitled to in the event of a breach?

The non-breaching party has two types of remedies. Monetary damages are the payment of the amount the non-breaching party lost due to the breach. Equitable or injunctive relief occurs when the court orders the breaching party to do something, usually canceling the contract.

The most common remedies after a breach are:

• Restitution: The breaching party must "make whole" the non-breaching party by paying them the money they lost due to the breach. This can get quite complicated. For instance, suppose you hired a wedding photographer for $100, and they never showed up. You made some emergency phone calls and found another photographer who charged $200. You can sue the first photographer for the $100 you paid them and the $200 you had to pay the emergency photographer.
• Punitive damages: These are seldom seen in contracts cases. Judges award these when the breaching party's behavior is unusually egregious or reckless.
• Nominal damages:​ These are awarded when there was a breach, but the non-breaching party suffered no material harm.
• Rescission: Rescission means the judge cancels the contract and terminates the business relationship. The parties are to be restored to the position they would have been in had the contract not been made. Rescission and restitution are often ordered together.
• Specific performance: This is seldom granted for breach of contract cases. It is only granted when no other relief is possible, and the subject of the contract is unique. Real estate, original artwork, and custom goods are typical subjects for specific performance. Parties cannot receive specific performance for breach of service contracts.

What is the difference between a contract and a memorandum of understanding?

A memorandum of understanding (MOU), similar to a letter of intent, is a non-binding agreement that memorializes the agreements between parties during negotiations. Businesses write the MOU after a letter of intent. Its purpose is to obtain the signatures and approvals needed for the contract.

In large businesses and corporations, a contract may undergo many stages and departments before finalization. The MOU ensures that everyone who needs input has a chance to give it before writing and signing the contract.

Where can small businesses get contract assistance?

The Small Business Administration (SBA) assists businesses seeking contracts with other government agencies. Many federal agencies, such as the Department of Defense, offer procurement contracts to private sector companies.

Some types of businesses can bid on government contracts. Small business programs require federal agencies to open their bidding process to SBA-designated companies, including:

• Small disadvantaged businesses(SDB): An SDB is one owned and operated by someone recognized as a socially disadvantaged person. The SBA qualifies small businesses for placement on this list.
• Women-owned businesses: The business must be at least 51% owned and operated by women, and qualify as a small business by the SBA.
• Veteran-owned businesses: Service-disabled veterans qualify for assistance under SBA and VA programs.

The System for Award Management (SAM) allows small businesses to self-certify and register for assistance programs and federal contracts.

Getting Legal Help

If you have any questions or concerns about business contracts, you should discuss them with a business and commercial attorney in your area.