Business Contracts 101: The Basics
When you are running your business, almost everything you do is contractual, even if you do not see yourself as making and accepting contracts. If you email over a purchase order to one of your suppliers, that is a contract.
In business, contracts can be quite simple. They can also be quite complex.
Contract Formation Basics: Offer, Acceptance, and Consideration
The basics of contract formation are offer, acceptance, and consideration. “Consideration” is a legal term that means “something of value given.” If you offer to sell your particular red car for a $100 and Maria says “okay,” then you have offer and acceptance. Maria then gives you the cash and you sign over the title. This is a simultaneous exchange of consideration. A legal contract was formed and then almost immediately consummated.
In theory, once a contract is consummated, it fades out of legal existence. However, case law and statutes have appended onto contracts various obligations that might keep the contract lingering for awhile. For example, did Maria buy the car “As-Is?” or is she expecting the car to run perfectly for another 100,000 miles? This gets to the concept of “merchantability” and “fit-for-intended-use.”
Promises have value, so an exchange of promises is valid consideration in most circumstances. If Maria gives you the cash right now and you promise to deliver the car tomorrow, that is a binding contract for both of you. You are bound because Maria gave consideration consisting of cash ($100) and she is bound because you gave consideration consisting of a promise (future delivery).
The vast majority of retail and internet businesses operate on just these sorts of simple contracts. A grocery store piles up fruits and vegetables with prices listed. Essentially, that is an offer. If you go in and pick up a head of lettuce and take it to the cashier, you have accepted (and, of course, you are accepting at the price listed). You and the store then have a simultaneous exchange of consideration when you pay that price and then leave the store with your lettuce.
Written, Oral, and Course-of-Conduct
Contracts can be written, oral, or course-of-conduct.
Most business relationships involve all three types of contracts. For example, you and your business sign a written Vendor Agreement with your widget supplier. After a few months, you want a bulk discount. The owner of the widget factory says, “yes, if you buy 10,000+ plus units, I’ll cut the price by 10%.” You say “great.” The mutual promises and eventual performances are the consideration.
But you never get around to writing the bulk discount agreement into the written Vendor Agreement. Nonetheless, you have a legally binding contract. As your business relationship continues, over the next weeks and months, you receive invoicing from the widget factory showing the discount and you pay the lesser amount. Under the law, you now have a “written memorialization” of an oral agreement. The combination of oral agreement and written memorialization is strong and binding on both parties.
Now, one day, a box of widgets arrive that are broken and bent. In legal parlance, they are non-conforming goods. You send then back to the widget factory. You do not call or email or get permission; you just send them back. Nobody says anything, nothing is written down, but the factory sends you a replacement box containing perfect widgets. Over the years and months this happens a few times and the same thing happens each time. This is a contract via course-of-conduct.
Uniform Commercial Code (“UCC”)
If your business involves the sale of goods and products, then your commercial dealings are covered by the provisions of the Uniform Commercial Code (“UCC”). Because business is fast, manufacturers and sellers do not always have time to get the legal niceties reduced to writing. One purpose of the UCC was to provide statutory provisions that cover problems like non-conforming goods, fitness for use, etc. So, in the widget example, if there is a dispute, the parties have their course-of-conduct to rely on and they also have recourse to applicable UCC provisions.
The UCC consists of a series of numbered sections, each dealing with specific categories of commercial activity and how to deal with certain problems, such as impossibility of performance. At present, versions of the UCC have been enacted in all 50 states and the District of Columbia. The Wikipedia page on the UCC can be found here.
Complex Business Contracts
Despite the help provided by the UCC, truth is, it is not wise to rely on oral and course-of-conduct contracts in running your business. They pose risks and those risks are unnecessary. The best business practice is to have all essential agreements reduced to writing with the help of good business lawyers. The more essential some agreement or relationship is to your business operation, then the more essential it is to get it in writing. This is true with
- Key suppliers
- Key distributors
- Landlords and/or mortgage holders
- Franchisees and licensees
- Creditors, investors, and other financial-related arrangements
The main problem with oral and course-of-conduct contracts is that, unknowingly, the parties might be using different definitions of key terms. Likewise, over time, expectations diverge or new situations arise and now the parties are acting on conflicting understandings. A written contract avoids these pitfalls.
As an example, Forbes reported a business “war story” concerning the words “responsible for.” The boss and his commission-based employee made an agreement verbally whereby if the employee was “responsible for” X amount of new business, then the employee would get Y amount of money. The employee is reported to have said: “Great.” Six months later the employee said she was owed a significant sum for generating new business. The Boss said: “You were not involved in those projects.” She said, “Well, I coached the person who landed the deal, which makes me responsible for it.” Obviously, the term “responsible for” was not clearly defined.
A good written contract will specify and clearly define important terms.
Another unnecessary risk involves transferability. A good written contract is easily transferable to new owners and/or to new business circumstances. Oral and course-of-conduct agreements tend to be people-centered and do not necessarily transfer easily if there is a sale or change in personnel.
The Interplay Between Running Your Business and the Business Contract
Every business has three basic goals: maintaining the current and expected volume of business, exploiting upside potentials, and avoiding downside risks.
The main purpose of all of your business contracts is to cement and reinforce these three primary organizational goals. If, for example, maintaining “current volume” depends on you having sufficient supplies of widgets, then you need a good, solid, legally binding contract with your widget supplier. Or, if you need dependable loyal employees, then you need a good set of employee contracts that include non-compete and confidentiality clauses.
In addition, buying and selling businesses require written business contracts to ensure all the parties are getting the benefits of their bargains. Financing arrangements also must be in writing to fully protect your business interests.
Contact Revision Legal
Every business needs experienced business attorneys to help draft and review complex business contracts. You need the professionals at Revision Legal. We can be reached by using the form on this page or by calling us at 855-473-8474. We look forward to helping your business succeed.