Understanding Contracts

Contract Basics

A contract is an agreement between two people or entities. If your business is a separate business entity such as a corporation or a limited liability company, your business can enter into a contract, just as though it was a person. A company's officers typically sign a contract on behalf of the business.

Contracts can be oral or written. An oral contract is usually valid, but as you can imagine, oral contracts are difficult to enforce because there's no written record of the contract or what it says. In addition, some contracts, such as contracts for the sale of land or for goods valued at more than $500, must be in writing to be valid.

A contract requires a mutual agreement between two or more parties, and something of value must be exchanged. This might be money, property, or a promise to do something or not do something.

Formal Contracts and Letter Agreements

When most people think of a contract, they think of a long typed document full of legalese. These formal contracts work well because they fully describe the parties' rights and responsibilities and try to address any situations that might occur.

However, you don't need a long document to have a binding contract. The basic terms of a contract can be specified in a letter that is signed by both parties, or even in an email. A contract doesn't need to include legal–sounding words like ’hereinabove’ to be legally binding – plain English will do.

Understanding Contract Terms

Formal written contracts often contain a lot of legal–sounding language at the end, sometimes referred to as ’boilerplate.’ Much of this is designed to clarify the scope of the contract and describe the parties' rights if there is a dispute. Some of the common contract clauses are:

  • Arbitration. An arbitration clause says that if there is a dispute, it will be resolved through an arbitration process instead of through a lawsuit in court. Arbitration is not public like a lawsuit is, there is no right to a jury, and the proceedings are typically quicker and less expensive than a lawsuit.
  • Integration, or the ’entire agreement’. This says that the contract contains the parties' entire agreement and overrides the parties' previous understandings or statements. This is designed to prevent a party to the contract from claiming that he or she was promised something other than what is contained in the contract.
  • Modification. Similarly, there may be a clause saying that the contract can only be modified in writing. This prevents a party from claiming that the contract was altered verbally.
  • Venue and choice of law. Venue is the place where a lawsuit involving the contract will be filed. Choice of law refers to the state law that a court will apply in deciding the lawsuit. Specifying these things in the contract avoids confusion if your company does business with anyone outside its home state. It's usually less expensive for a small business to fight a lawsuit in the state where its main office is located.
  • Assignment. This clause specifies the conditions under which a contract can be assigned to someone else.