Business owners are a hopeful, positive and adventuresome group. The strong character traits that propel people into commercial enterprise, however, may also reveal areas of weakness that may lead to difficulty and even disaster down the road. Business owners are not shy about entering into contracts, but sometimes they are big picture people and do not pay attention to the details. The devil is always in the details, as “they” say.
Basic contract law is such a simple formula that is intuitive even for playground enterprise, but the simplicity of the formula is fraught with traps for the unwary.
Formation of a contract includes three basic elements: an offer, acceptance and consideration. If any element is missing, no contract is formed. A contract, contrary to some belief, can be formed verbally; however, a verbal contract is subject to the uncertainty of faulty and even biased memories. Therefore, business owners should be in the habit of putting contracts in writing for most transactions.
A contract is always initiated by an offer. A contract is not formed until an offer is accepted. If a person accepting the offer proposes any additional term or changes any term of the offer, the acceptance is not effective to create a contract. In fact, any response to the offer that changes, subtracts or adds new terms is not considered an acceptance; rather, it is considered a counteroffer. Sometimes offers are countered and counteroffers are countered through a series of back-and-forth exchanges. Only when an offer or counteroffer is accepted without change is a contract formed. This is called the “mirror image rule”. The acceptance must exactly mirror the offer; otherwise it is considered a counteroffer.
Of course, as soon as a rule is laid down, an exception comes along. The rule of offer, counteroffer and acceptance does not apply to transactions between merchants (like manufacturer to wholesaler or wholesaler to retailer). With merchants there are requests for quotations, quotations, purchase orders, acknowledgments, bills of lading, etc. In these situations, the “battle of the forms” is the rule, and the process is governed by the UCC (Uniform Commercial Code)… but that is a story for another day.
There are other exceptions and quasi-contractual principals also that may apply to create obligations knowingly or unwittingly. For instance, an offer that has not been verbally accepted, but which has been partially performed can create an agreement that is binding on both parties. Likewise, a promise that is acted upon can bind the promisor when the other person changes position in reliance on the promise to his/her detriment. Further, in an interchange in which one person would be unjustly enriched by the other person, even if no contract was formed, the person unjustly enriched may be obligated to provide compensation for the benefits received. A business person should understand these rabbit trails and be cautious when encountering them.
As a general rule, even with an offer and acceptance, no contract is formed without consideration. Consideration can be anything of value, and the value must flow both ways. Although, it must be a two way street, consideration does not necessarily need to be fair or balanced. Courts will not undo a contract just because one party made a bad deal. The law allows parties the freedom to enter into contracts and will not undo a contract just because it appears to be unequal. Consideration can take many forms, but must consist of some benefit or detriment; it involves giving something or giving something up. It can be money, property, services, or performance of an action or non-performance of an action – anything that involves a combination of benefits or detriments flowing from or to each person.
There also must be a meeting of the minds. Sometimes the terms of a contract are confusing or contradictory. Sometimes important terms are missing. If the terms of a contract are not clearly and accurately stated, misunderstandings can arise that give way to disputes and eventually to lawsuits.
A person entering into a contractual relationship with another person should want the terms of the agreement clearly and thoroughly stated. In the process of attempting to state all of the terms of the agreement in writing, it is very typical that areas of disagreement or misunderstanding become evident. It is far better to deal with those issues up front in the process of forming a contract, then on the back end when things have gone wrong and both parties have had their expectations dashed.
Client often ask for a contract to be prepared, but they want to “keep it simple”. Of course, a contract should be stated simply in clearly understood language; but a complex arrangement cannot be captured accurately or adequately in a page or two. The type of agreement/arrangement will dictate how long or complex the agreement is. Forcing a complex agreement into one or two pages is ultimately a recipe for litigation if anything goes wrong because it will not accurately or thoroughly state each parties’ expectations.
A good contract does not simply state the basic terms of what the parties have agreed. The basic terms will suffice only if nothing unexpected or unforeseen happens. Even in the most basic of circumstances (exchanging money for an item of property), things can go wrong. A check may bounce. The product may have an unseen defect. It may not work as expected. The more complicated the transaction, the more time it takes to complete the transaction, the more likely something will go wrong – or at least will not go perfectly right. A good contract anticipates the possibility of things not going perfectly right and provides a way to address them.
The world of contract formation and contract performance that we live in every day can sometimes be a complex and frustrating environment. It has been said that contracts are not necessary among gentlemen; likewise, the best contract in the world will not avoid disputes between unsavory businesspeople. The reality is, however, that even gentlemen can have disputes growing out of misunderstandings, unspoken expectations, bad memories and bad circumstances. A well-drafted contract can limit the inherent risks of doing business with people that are unfamiliar with each other (and, perhaps, even more important, when people know each other too well). Understanding the basic components of contractual relationships and knowing when to get good legal advice is important to the health and success of your business.
A business person who routinely enters into contractual relationships (i.e.; a contractor) should have a form contract that addresses clearly, thoroughly and adequately the terms of the relationship. It will take time to create a good contract, but the time is worth the effort. The first time something goes wrong, it will pay for itself. A person entering into a significant one time transaction (i.e.; the sale or purchase of a business) should expect to take time to negotiate and finalize a written contract before closing the deal. It will take some time and involve attorneys and some back and forth revisions, but it is important to flesh out all of the issues and to protect both parties’ expectations. The need for a contract is even more important for an ongoing business relationship (i.e.; a joint venture, partnership, etc.). Plan to take some time and spend some money to get it right. You will be glad you did.