Lesson 101: The basics of business law – What makes up a simple contract?

While your contracting skills may not be the strongest, every startup entrepreneur must understand the basics in order to be successful. You will come across contracts of all sorts and having a standard understanding of them will allow you to negotiate your next contract to your advantage.

What is a contract?

According to the proper definition, a contract is:

A written or spoken agreement, especially one concerning employment, sales, or tenancy, that is intended to be enforceable by law.

In much more simple context:

A contract is nothing more than an agreement between two parties where there is an exchange of goods or services for something of value (i.e. money).

Contracts are your own set of personal laws that you create. Just about anything you can come up with and both sides agree will work.

Of course you must negotiate in good faith and the subject of the contract is legal; meaning it cannot be a contract that is breaking any laws.

Each contract will contain a promise or multiple promises for something in exchange. However, not every promise is legally enforceable. In order to have a legally enforceable promise, three requirements must be met to create a legal binding contract.

3 Requirements for a Legally Binding Contract

1. An Offer Must Be Made

The first requirement for any legally binding agreement is an offer must be made. An offer must be clear and specific regarding the type of service or quantity of product(s) for an exchange of something else.

Example 1:
"I will purchase 100 chairs from Company XYZ for $55 dollars each.

A more realistic applied example could look something like this:

Example 2:
"Company ABC will provide repair services for Company XYZ on a monthly basis. Services will be provided for 24 months and will be invoiced annually"

An important note here is the offer must be a clear. Something like “I think I would like to buy some chairs” is not an offer because it is neither specific or unambiguous of providing clear terms.   

The offer will remain open until is is accepted by the counter party. While the offer is open, you will have the ability to revoke it if a better offer is found elsewhere. 

Once the offer is accepted, it cannot be revoked.

2. The Offer Must Be Accepted

Just like the offer, an acceptance must be clear and unambiguous. For example “I Accept” is clear but “That sounds good, I will get back to you shortly” is not. You must have a clear understanding of acceptance.

The sole purpose of a contract is to allow the willing buyer and seller to enter into a commercial transaction with clearly defined terms.

Acceptance Is Negotiated

In order to have acceptance, offers and counter offers will go continue until negotiations are in agreement. This dance can go on indefinitely and can become a lengthly process with larger more complex agreements.

Chairs Example Continued:
In the chairs example, a seller may decide to up his price from $55 to $75. In that situation, my offer of $55 is rejected and a counter offer of $75 has been made. I can either accept this offer or reject it.

Acceptance Upon Receipt

There also can be a situation where the offer may not be accepted directly but can still be enforceable. Instead acceptance is based on performance such as “upon receipt of delivery”.

Chairs Example Upon Delivery:
Using the chairs example again, if the 100 chairs is delivered and I accept the delivery, then that can be legally taken as acceptance.

Additionally non-material changes – meaning changes that do not affect the commercial agreement may also be taking place at the same time. These I would recommend connecting with a laywer or speaking with legalzoom.

3. Consideration Of Exchange

Lastly, to create a valid legally enforceable contract you have to show an exchange. In legal terms this is call “quid-pro-quo“. Or in simple terms, and exchange this for that. This is known as “Consideration“.

Chairs Example:
My money for your chairs

Service Example 2:
My money for your repair services

If I said “I want to buy your chairs” and you said “sure” that would not count as a contract. With this statement we do have an offer and acceptance but no consideration.  You cannot get something for nothing. 

In order to be legally binding, you must have an offer, acceptance of that offer, and a bargained-for exchange.

Additional Helpful Notes About Contracts

Additionally, here are a few other things you should know about contracts:

Get Everything In Writing

If it’s not in the contract, it does not exist. An agreement on a handshake basis is not a legally binding agreement. Overtime memories will fade and people may remember promises incorrectly. Without the promise in writing, there is no record of what is correct. Avoid oral agreements and get it in writing.

Contracts Can Be Changed or Modified

You have the ability to make changes to a contract before and after it is “executed” – finally agreed upon and signed by both parties. 

While the contract is going through negotiations, you have the ability to change any item you see fit. That is why it is also call an “agreement” because both parties must agree to all terms.

Changing or modifying a contract after it has been signed/executed is called “amending” the agreement. This is done through an “Amendment” which is an additional document that outlines any changes to be made.

Be Specific As Possible - Never Leave Anything to Chance

When creating your agreement, never leave anything to chance. Think of any possible area that could affect your contractual agreement and make sure you are covered. This is why you see extensively long agreements for sometimes simple things.

Also later down the road the agreement becomes the path for clarity. If the agreement is ambiguous, you will certainly find yourself in trouble down the road potentially ending up in litigation or worse.

Protect yourself and be as specific as possible.

Contracts Can Be Breached

Breach means breaking the terms of the agreement. Contracts can be broken as there are legitimate reasons such as poor performance, fraud, bankruptcy, and plenty of others. Items like this should be defined in your agreement to keep either side protected.

You Can Exit A Contract Early

Lastly, a contract for a certain length of time can be exited early if defined in the terms of the agreement. For example your agreement should include a “Termination for Convenience” or at least have the ability to exit in some manner. 

Sometimes this may include penalties but it could be far more worth discontinuing than taking an additional loss.

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