For most businesses, there is no more important legal concept than contract law. Businesses couldn’t run effectively without contracts, whether written or oral. There was a time when most business was done with a handshake and some small businesses still function that way. Either way, it’s very beneficial to understand the concepts and principles that underlie contract law.
While oral contracts are valid in many instances, there are certain contracts that must be written depending on state law. Generally, they include:
- Contracts which have a period of performance exceeding one year
- Lease for real property that exceeds one year in duration
- Contract that extends beyond the lifetime of the person performing under the contract
- Sale of real property (e.g. houses, condominiums, apartments, industrial buildings, commercial buildings, raw land)
- Promise to pay the debt of another
- Contract which has a value or consideration exceeding the state threshold
- Transfer of property in the event of death of the performing party
A contract is an exchange of promises that form a binding legal agreement. If that agreement is breached by any party, it is enforceable in court or through arbitration.
A contract is formed through an offer, acceptance, sufficient consideration, and adequate terms to define the obligations of all parties to the agreement. When this occurs, there is a “meeting of the minds” and the contract is enforceable. The consideration for the promise to perform is sufficient if a party: (1) agrees to do what they have no obligation to do, or (2) agrees not to do something they are entitled to do.
Types of Contracts
An “express” contract is formed through an oral or written understanding of an agreement. The terms, conditions, and all the elements of a valid contract are specifically stated as part of the agreement.
An “implied” contract is assumed by the circumstances and actions of the parties, or by operation of law upon someone that receives a benefit he is not entitled to keep. For example, if you order and eat dinner at a restaurant, there is an implied contract that you will pay for it at the stated price before you leave. To deny the existence of a contract would unjustly enrich you at the expense of the restaurant owner.
When evaluating the existence of a contract and the remedies for nonperformance by either party, the following questions should be addressed:
- Was a legal contract formed?
- What type of contract was formed?
- Has there been a breach of the contract obligations?
- If there has been a breach, what remedies are available?
- Is there a statute of limitations that would prevent any recovery?
Breach of Contract
If any party fails to perform according to the terms of the contract, without a legal excuse, they have breached the contract. The performance failure must be significant enough to be material in nature and cause the injured party to be relieved of further performance.
A minor delay in delivery would not be considered material unless the contract specified that time is of the essence and the schedule milestone is a critical element of the bargain.
If you suffer a breach by another party, you must take all reasonable actions to minimize damages. This duty to mitigate means that even though you are not at fault, inaction on your part is not acceptable when there are things you can do to avoid further damages.
If a contract is breached, the non-breaching party is entitled to certain remedies that are summarized below:
- Compensatory damages – An award of money intended to compensate the injured party, to the extent the damages can be measured in monetary terms.
- Punitive damages – Used to punish the breaching party and act as a deterrent. While they are available in addition to compensatory damages, punitive damages are rarely awarded in contract cases, and only if a wrong is proved that is independent of the breach.
- Specific performance – Awarded where monetary damages would not adequately compensate the injured party. It forces contract performance where the subject of the contract is unique, such as the sale of real estate or a work of art.
- Restitution – This returns the non-breaching party to the position they were in before the contract was formed.
Uniform Commercial Code (UCC)
The UCC is a detailed compilation of suggested laws for dealing with commercial transactions. Most U.S. states have adopted some or all of the provisions contained in the nine articles.
Of particular interest to small business owners is Article 2 that deals with sales and contracts. A full discussion of Article 2 is beyond the scope and space available here, but anyone engaged in commercial sales should gain a basic understanding of its provisions.
There are legal services available that allow you to develop customized contract templates without the expense of hiring a lawyer. These provide a cost-effective, standardized format that you can use over and over again.
The principles covered in this article represent basic contract law and its application to your business. There are many complexities of contract law that extend far beyond what has been discussed here. Since the success or failure of your business may depend on the validity and enforceability of your contracts, seek professional advice if you have doubts about signing any contract. If you are unable to solve a contract dispute on your own, find an attorney that specializes in these matters.
Always remember rule #1 when dealing with contracts: carefully read the entire contract before signing it. While this should be obvious, many disputes arise when one or both parties discover a provision that they were unaware of, or did not fully understand.
Michael Sanibel is a freelance writer specializing in business, marketing, personal finance, law, science, aviation, sports, entertainment, travel, and political analysis. He graduated from the United States Air Force Academy and is also licensed to practice law in California and New Hampshire. Michael wrote this feature article exclusively for Debbie May.com (www.DebbieMay.com), an organization dedicated to helping small businesses succeed.