Lessons Learned the Hard Way: Small Business Contracts

As small business owners, you've got a lot on your plate without worrying about legal pitfalls. You probably don't have time to get a business law degree or look for a business attorney. You're busy trying to collect late payments, making sure you have cash flow, and taking care of the day-to-day business needs.

Getting your agreements in writing (contracts) is usually the last thing on your mind. Yet these contracts can make or break a small business. Even the most seasoned entrepreneurs have war stories of legal actions based on contracts, whether for vendors, partners, or independent contractors.

Learn from these small business owners' contract mistakes to lessen the chances of having to take or defend legal actions.

Types of Contract Mistakes

Most contract disputes could be avoided if the parties took the time to make their intentions and expectations clear to each other from the start.

The best way to avoid the time-consuming and money-draining headache known as litigation? Before signing on the dotted line, ensure you both have a contract and understand it.

Contract mistakes come in two forms: mistakes of law and mistakes of fact.

Mistakes of Law

Mistakes of law are when you sign a contract not knowing a law governing it exists. This is a rare defense in contract law. It is used as a defense if the law was not yet published when you signed the contract.

For example, you sign a contract to sell medical marijuana in a state where it is legal. However, unbeknownst to you and the other company, that state outlawed medical marijuana earlier that day. No state allows contracts for illegal activity.

Mistakes of Fact

Mistakes of fact are the most common. This is when one or both parties have a different understanding of the facts of a contract. This includes the meanings of words in the contract or the facts behind you signing it.

Mutual Mistake

A mutual mistake is when both parties have a mistaken understanding of the terms of the contract. For example, you enter into a contract for 700 Barbies. You think you're getting dolls, but the other side thinks you want barbeque grills.

Another example is a pastry chef ordering flour from a wholesale distributor. The pastry chef expected bleached flour for baking, but the wholesale distributor sent unbleached flour since it was not specified.

These are mutual mistakes of fact. Both parties were confused about the terms. You can void (cancel) the contract and redraft it.

Unilateral Mistake

Unilateral mistakes are mistakes where only one party has a mistaken belief about the contract. Unilateral mistakes can force the contract to be reworded or canceled.

An example would be a one-party misunderstanding of an industry term like EOD, meaning End of Day, and other words, quantities, and products.

Common Business Contract Mistakes

Failing to think through your business practices before startup can cost you a lot of trade secrets and ruin business relationships if you're not careful.

Here are some common general mistakes business attorneys often see:

• Using online contract templates without knowing the law in your state: Your lack of knowledge will hurt your business.
• Using the wrong types of contracts: For example, you use an agreement to sell a piece of business property. Your state requires that it be done by "authentic act," meaning it needs two witnesses and a notary signature, but you only had the other party sign.
• Not having written contracts at all and relying on verbal agreements: These are much harder to prove in court and enforce.
• Having a written contract, but the other party never signs it: If both parties haven't signed, it's not binding.
• Not having business insurance to cover contract mistakes: In the event of a breach or any injuries, your business insurance policy could cover claims so you don't have to pay out of pocket.
• Failing to have employment contracts, independent contractor agreements, and nondisclosure agreements: They all protect your small business' trade secrets. Protecting them is crucial.
• Signing a business contract in your personal name without adding “doing business as" the company name: This opens you up to personal liability should you default on the legal document. You have limited liability when you enter into a written contract as a business. That will no longer exist if you sign your name personally. 
• Not including a social media etiquette policy in your contract: This allows you to terminate the contract if the other party posts anything that would damage your product or company's reputation. It also could include the sharing of unauthorized copyrighted or licensed images or photographs.
• Not thinking about where arguments under the contract will take place (known as venue): If you sign the agreement in Sunnydale County, California, but the other side lives in Summersville, New York, you could be forced to go to court in New York unless you agreed to a venue in the contract.
• Arbitration: The arbitration process keeps your legal argument out of public court records and can be quicker than litigating in front of a jury or courtroom. You must put this in your contract when both parties sign it.
• Failing to include each party's contact information like address, email, and phone number: You should want to know how to find the other party in case you need to send legal notice. You will need to know this in case of default.
• Failing to include a glossary or definitions for essential terms: For instance, when you agree to bimonthly payments, do you understand that you will be paid every other month? Or will you expect to be paid twice a month - semi-monthly?
• Make sure that you and the other party agree about the meaning of any potentially ambiguous words or phrases: Even a misplaced or unnoticed punctuation mark can dramatically change the scope of your rights and obligations under a contract. For example, "5,000 vs. 50,000" is a typo that's a big problem.
• If you are making payments, clarify how the payment should be made: Some contracts may specify the business only accepts cashier's checks or business checks. Others may allow for credit cards, Venmo, or PayPal.
• Failing to negotiate the terms before signing: Courts will hold you responsible for the terms of the agreement and expect you to have had an opportunity to construct the contract to your liking before signing.
• Failing to include severability clauses: This means that if a judge rules that any part of your contract is invalid, then the rest of it can still be enforced.
• Failing to include the prevailing party in a dispute wins attorney's fees and court or arbitration costs: You cannot recover attorney's fees unless it is written in a contract or allowed by law, which is rare.

Find a Contract Attorney Before Signing Important Agreements

Because so much is at stake for your small business, the safest course of action is to have an attorney experienced in contract law give you legal advice. Let them review and approve all agreements before signing. It may require a little extra time and money, but it can help protect intellectual property rights, product procurement, and keep your business safe from litigation.