Companies enter into contracts as a routine part of business. But some contractual elements could put your business at risk for breach of contract, negative financial consequences and more.
Required Elements to Be Legally Binding
If the contract is not enforceable by law, then all elements are irrelevant. Be sure any agreement contains the following at minimum:
- Legal subject matter: Courts will not enforce a contract that involves an illegal service or product.
- Offer and acceptance: The contract must include a statement of intent to enter into a contract for a good or service that is certain in its terms, and the other party must accept the offer and its terms.
- Consideration: Each party to a contract must provide something of value. This exchange of values is called "consideration." The value exchanged does not need to be money. The consideration could involve a promise to do something that you are not legally required to do or a promise to not do something that you are legally entitled to do.
- Mutuality of obligation: Both parties must be legally bound to fulfill their obligations under the contract. If one party can terminate the contract for any reason, there is no mutuality of obligation and the contract would likely be considered void.
- Competency and capacity: Both parties must be legally and mentally able to enter into an agreement. Minors, who are younger than 18 or 21 years depending on jurisdiction, cannot enter into a contract. Mentally incompetent and intoxicated parties also do not have the competency or capacity to enter into a binding contract.
In some instances, the contract must be in writing. States and local jurisdictions legislate certain types of agreements that must be written to be legally binding. Typically, agreements involving real estate and those spanning more than a year must be written.
Breach of Contract Consequences
A breach of contract occurs when one party fails to fulfill their duty under the terms of the agreement. The duty usually is payment, goods or services. The consequences of a breach of contract can be intangible, such as the loss of reputation, as well as tangible. Breaches of contract can involve significant monetary damages, in the form of compensatory or restitution damages. Consequences of a breach might be specified in the contract, in a cancellation clause.
Hold Harmless and Indemnification
An indemnity and hold harmless clause shifts liability and risk from one party to another. When you indemnify someone, you absorb the losses caused by that party, or you compensate that party if something that you do or fail to do causes them to experience damages or a lawsuit from a third party. Indemnifying can be costly. Read the indemnity clause carefully. Keep these tips in mind:
- Make sure you do not agree to defend against all claims. There is a difference between "all claims" and "reasonable claims."
- Place a limit on the amount of liability by capping the amount you will pay to the other party in case of indemnification.
- If you are allowing another party to use your property, the contract should hold you harmless for any injury or loss that was not caused by you.
Contract language should specify when payment is due, penalties for late payment, and rights in the event of non-payment. Payment terms should be detailed and precisely defined, which will minimize fee-related disputes. Be sure to closely review billing and payment terms. Do not accept language that would permit withholding of payment for disputed invoices.
In case of a dispute between parties, mediation should be specified as the first step in an attempt at dispute resolution. Mediation avoids costly and time-consuming arbitration and litigation. Avoid clauses requiring binding arbitration, especially when the other party can select the arbitrator. Binding arbitration requires the parties to accept the arbitrator's decision, and the courts will enforce it. Also pay attention to what costs each party are allowed to recover in case of dispute.
Your contract should include a termination clause that clearly defines when either party can end its legal relationship. The clause also should specify the rights that each party has when termination occurs. Do not accept language that allows only one party to terminate the contract, since that invalidates the entire contract. Pay attention to timelines for termination to take effect.
How a Contract Management System Can Help Mitigate Risk
A well-written contract can protect your business from a certain degree of risk. But if no one is tracking the terms of the contract, you are at risk of breach of contract and other potential losses. A contract management software solution can identify key clauses and assign appropriate responsibility for fulfilling those terms. Contract management systems can notify you when deadlines are approaching or help easily locate performance obligations. Such applications also can mitigate risk by ensuring the inclusion of standard clauses when negotiating contracts.