Protecting Your Rights with Formalized Business Agreements
To successfully operate a business or commercial enterprise, you need to know that the parties with whom you conduct business—your vendors and customers—will honor their agreements, so that you won’t incur unnecessary expenses for deals that fall through. In commercial business dealings, the most common way to protect yourself is with a valid, enforceable contract.
What Is a Contract?
A contract is an agreement between two or more parties that involves the exchange of something of value (known as “consideration”). Rather than give something of financial value, a party might instead promise to refrain from doing something they have a legal right to do. A contract may be oral or written, but for it to be enforceable, specific requirements must be met.
How Is a Contract Created?
A contract may be in writing, either in a legal document expressly identified as a contract or agreement, or in written communications between parties that implies the existence of an agreement. A contract may also be entered into orally, through phone conversations or verbal communications in person. As a general rule, unless governed by the Statute of Frauds, oral contracts are enforceable to the same degree as written contracts.
What Are the Requirements for a Valid Contract?
There are five elements that must be present for a document or communication to be considered a valid and enforceable contract:
- There must be an agreement—A contract is formed only if there is an offer and acceptance of that offer. A contract therefore requires a minimum of two parties. There must be evidence that the party making the offer intended for it to be binding, and it must be shown that the party accepting the offer knew it was an offer to enter into a binding contract.
- There must be consideration—Consideration is a legal term of art that essentially means “something of value.” The exchange must be “bargained for,” i.e., the parties must reasonably understand that they are negotiating an exchange of value. Consideration may involve the transfer of cash or other items of value, or it may involve a promise by one or more of the parties to refrain from taking some action that they have a legal right to do.
- The parties must have contractual capacity—The parties must have the mental ability to understand that a contract is being formed and must be able to comprehend the terms of the agreement. A person can lack capacity because of age, intoxication, or mental impairment. As a general rule, minors can enter into a contract but may “disaffirm” or invalidate the contract at any time before becoming a legal adult. Parties under the influence of alcohol or drugs at the time a contract is formed may also seek to void the agreement.
- The parties must voluntarily enter into the agreement—A party to a contract may not induce another party to enter into the agreement through fraud, misrepresentation, duress, coercion, or undue influence.
- The subject matter of the contract must be legal—The courts will not enforce an agreement to commit or support an illegal act.
Must a Commercial Contract Be in Writing?
Under the Uniform Commercial Code (UCC), as adopted in all states, any contract for the sale of goods in excess of $500 must be in writing. The UCC does not, however, apply to contracts for commercial services. In addition, the written laws of every state include a “Statute of Frauds,” which requires certain types of contracts to be in writing in order to be enforceable, including most contracts involving sale of an interest in land.
What Are Common Types of Commercial Contracts?
A commercial contract can address almost any business transaction or relationship, but the most common types of commercial contracts are:
- Vendor and customer agreements—Contracts that establish the rights and responsibilities of buyers and sellers of commercial goods or services
- Employment agreements—Contracts that set forth the duties of employees and employers, typically including provisions regarding term, termination, and severance
- Intellectual property and licensing contracts—Agreements regarding the use of, access to, and payment for patents, trademarks, copyrights, and trade secrets
- Nondisclosure and confidentiality agreements—Contracts that protect proprietary information and processes by prohibiting disclosure by employees, vendors, partners, and others
- Partnership and shareholder agreements—Contracts that identify ownership interests in a commercial entity and establish the rights and duties of owners
- Real estate agreements—Contracts for the sale or lease of commercial real estate
What Law Governs Commercial Contracts?
Unless governed by the terms of the Uniform Commercial Code, contractual rights are typically established and construed under state common law. The UCC is a model law that has been adopted individually by the states, either in whole or in part.
What Clauses Are Typically Included in a Commercial Contract?
Though the specific provisions of a commercial contract are unique to every situation, there are six types of clauses that are commonly found in many business or commercial agreements:
- Confidentiality/noncompete clause, which prohibits the signer from disclosing certain proprietary information without permission
- Clause identifying what events will cause the contract to terminate
- Force majeure clause that identifies the rights of the parties in the event performance of obligations under the contract is affected by a force of nature, such as a natural disaster
- Dispute resolution clause, identifying the process (litigation, arbitration, mediation) for resolving allegations of breach of contract or other disputes related to the agreement
- Jurisdictional clause, setting forth the law that will govern interstate agreements
- Liquidated damages clause, identifying the specific remedies available in the event of breach of the contract
How Is a Contract Breached?
Technically, a contract is breached when either party fails to meet its obligations under a contract when they are due.
What Are the Legal Remedies When a Commercial Contract Is Breached?
The most common remedy for breach of contract is monetary damages for the loss of the bargain, also known as “compensatory damages.” Compensatory damages can include both “expectation” damages, meaning what the nonbreaching party expected to make on the deal, and consequential damages, any additional losses occurring as a result of the breach.
In limited circumstances, where the subject matter of the contract is unique (such as with a contract to sell real estate), a party may ask the court for “specific performance,” requiring the breaching party to do what it promised to do in the agreement. Other remedies include:
- Injunctive relief—Legal action preventing a party from doing something
- Rescission—Rescission means the entire contract is undone and therefore, the nonbreaching party may choose not to perform its obligations under the contract.
- Liquidated damages—Often, a contract will identify a specific dollar amount that must be paid in the event of a breach.
- Nominal damages—The court may find a technical breach but no actual losses or only insignificant harm. In such a context, the court may make a ruling and award a nominal sum, such as one dollar, in damages.
The best way to protect your business and your bottom line is with a legally enforceable contract. It’s important that you understand how a contract is formed, what elements must be present to form a legal agreement, and what your options are in the event of a breach.