Contract Fundamentals
Contracts are Agreements among Parties to Do or Not Do Something
Every contract is an agreement between parties to do or refrain from doing a particular thing. By agreeing to the contract terms, each party assumes a legal duty to the other and may be liable for damages to the other if it fails its obligations under the contract.
Basic components of every contract and why understanding basic contract law is so important is discussed in this post.
First, generally each party to the contract must have the "capacity" to contract, meaning that they understand the nature and effect of a contract and can stand behind the legal obligations imposed by the contract. Some people, such as minors and those with diminished mental capacity do not have capacity to contract.
Second, the subject matter of the contract must be lawful, and it also must not be in violation of public policy. For example, a contract to rent an apartment for illegal drug sales is not a lawful or valid contract because it is unlawful, even if it was not against public policy. Conversely, a contract to murder someone is against public policy and is not a valid contract , even if it is lawful.
Third, the offer and its acceptance must be absolute, not merely a general outline of the contract terms and conditions. For example, a party intends to buy a boat and tells the seller "I will pay you $500 for that boat if you will sell it to me." This is not a definite offer because it does not have absolute clarity as to the terms of the deal.
Fourth, there must be meeting of the minds between the parties, meaning that there is mutual understanding and agreement as to the material terms of the deal.
There are often other terms in the contract, and these are usually laid out expressly in the written contract itself. For example, a term that the seller must deliver the boat "as is" may be spelled out in the written contract as a term of the deal.
Additional terms may be implied into the contract based on the nature of the contract itself or its subject matter.
In my next post, I will explain the "essential" terms that must be in every contract to make them enforceable.
Under certain circumstances, you can overcome the damage award or limit your contract liability!
Key Terminology and Definitions
Regardless of the type of contract that is being analyzed during a review, it is critical that the legal terminology and jargon within that agreement are clearly defined to ensure there are no misunderstandings down the road. Every contract should define any and all terms that could be misinterpreted, and it should preferably define them in the same area of the contract where they first appear. For longer agreements, it may be sensible to compile a glossary of terms to go at the end of the contract.
Some of the most common contractual terms that require additional definition or description include:
Admission: A statement of acknowledgement by one party toward the other, typically regarding any of the terms outlined later in the agreement.
Discharge: When all of the terms of a contract are performed, the contract is discharged.
Indemnifier/inDamnor: The individual who gives a guarantee or an indemnity is the indemnifier, while the individual who receives it is the indemnor.
Records: The term "records" can refer to anything and everything under the sun when left undefined. Specify what is meant by this term.
Obligations: Like records, obligation is a very broad term. It should be as specific as possible so as to not include responsibilities not necessarily related to the contract at hand.
Warranties: This term refers to guarantees provided by the disclosing party that certain facts are correct. Without a clearly defined set of warranties, the existence of warranties could be disputed.
Evaluating Duties and Responsibilities
Both practical and legal issues can arise in a party’s fulfillment of its obligations in the contract. Fulfilling contractual obligations often requires a party to take specific actions that may cause financial costs or personal inconveniences.
A number of issues can impact the actual completion of obligations, or concerns are raised if the obligations are not completed:
When working through a contract review, a party should analyze the actions required to be taken and performed by itself and by the other parties.
In analyzing the party’s contractual obligations, it is important to determine how the party intends to fulfill its obligations. Is the performance expressly required to be by the party itself or can the performance be completed by another party or even be outsourced? This can be important. Some contracts contain high level implied standards of care or provide implied non-delegable obligations. For example, with construction and development agreements, there may be high level implied standards of performance or implied obligations for a developer to directly oversee the project – a right to approve entities and works may be rendered meaningless if the developer is able to delegate or outsource many of its responsibilities.
An additional point of analysis in determining whether to approve a contract is the likelihood that the party will be able to fully complete the obligations. If the performance requires, for example, the party to get third party approvals and then takes several years to complete, the likelihood that the obligated party will follow through on the obligation must be considered. Despite the contract requiring a party to start work within one week of execution of the contract, the value of that obligation is extremely limited if it is highly unlikely that the party will be able to complete the obligation.
Determining Risks and Liabilities
Identifying risks and liabilities in a contract is a key focus of a contract review. When assessing the potential risks, the objective is to let the facts speak for themselves. In this section, it is important to outline the strategies that can be employed to manage the risks and prioritize those strategies by likelihood of occurrence and impact. After identifying and prioritizing risks associated with a contract, those risks can be broken into 4 categories: (1) critical and common; (2) critical but uncommon; (3) common but critical; and (4) common but noncritical.
After categorizing the identified risks, an attorney may have recommendations for strategies and clauses that can be inserted into a contract to manage the risks. Risk management strategies are just as important as identifying potential risk and liabilities within an agreement. It is much more effective to address the risks up front than to react to them in the future.
Reviewing Fees and Compensation
Reviewing the payment and compensation terms is a critical part of any contract review. The payment structure should outline when payments are due, how much they are, and under what circumstances they might change. There are two components to this type of contract provision—first, is the payment structure itself correct, and does the work that the party is being paid for make sense? Second, are the payment terms fair given the livelihood of the person performing the work?
You’ll want to identify the relevant terms to test. For example, in a publishing agreement, is the author being paid based on the number of copies sold? If the publishing agreement has a flat fee or advance payment, does the author receive additional royalties if the book becomes successful? Does he or she have duties that affect the value of the contract, such as a publicity and promotions clause? You’ll want to look for anything that might change the compensation.
While compensation within a contract may seem obvious, it is helpful to consider every term that might affect how the parties are compensated under the contract. This includes reviewing how frequently payments will be made—current, future, and otherwise—with an eye towards what would be fair and reasonable for your client’s circumstances. Such provisions can be hidden in sections called various things, including "Payments," "Fees," "Invoices," "Royalties," or "Consideration."
Updating contract language about the term can help define how you are meant to be paid and can help avoid disputes with the person seeking your services over how and when you seek compensation. For example, sometimes people are charged extra fees because their work is rejected for approval. Such provisions should generally be simplified to state: "All work performed is deemed accepted unless rejected by licensee within 10 days of delivery."
Assessing Termination Provisions
Understanding the terms of contract termination is essential to maintaining a favorable and lasting business relationship. Before executing a contract, an employer should seek to understand the terms under which the contract may be terminated. An employer could be faced with a number of different termination situations, from the termination of the contract by agreement, to the employer’s unilateral termination or the vendor’s unilateral termination. Each type of contract termination brings a unique set of implications, which are well worth understanding before executing the contract.
In particular, employers should focus on the termination clause’s provisions regarding a breach of the contract, often included under a subsection titled "breach." The breach of contract provision will set forth the consequences, both for the breaching party and any damages to which the non-breaching party may be entitled if either party breaches the contract . It is of particular importance to determine the extent to which one party may be in breach of a contract. If one party is in breach, the other is typically afforded the right to cure the breach in a reasonable amount of time, and sometimes the right to terminate the contract if the opportunity to cure the breach is foregone.
If the vendor does not have the ability to service the employer, the employer can avoid contract disputes by terminating the contract if the vendor’s ability to perform under the terms of the contract is affected by the unavailability of the product or service. In addition, if the product or service is unavailable after efforts to acquire the product of service have been made, the employer should be given the option to terminate the contract with the vendor.
Adhering to Applicable Rules and Regulations
It is critical to ensure that a contract is in compliance with all relevant local, state, and federal laws, rules, and regulations. Non-compliance can lead to unenforceability of the contract as well as civil or even criminal liability. At the very least, non-compliance with applicable laws may make a contract such a moving target that it can be difficult to know whether the underlying agreement remains enforceable at all, and therefore impossible to ascribe legal certainty to either party’s rights and obligations.
Applicable statutory law is almost always interpreted in accordance with its plain meaning when it plainly resolves an issue. A court will not make a contract enforceable (or unenforceable) where the applicable law clearly says the opposite. The law can become more nuanced when statutory amendments or other developments have not yet been interpreted by the courts. In such cases, it can be ambiguous whether a contract complies with the applicable law, directly impacting the viability of available remedies for breach.
Including Addendums and Modifications
In addition to conforming to the various contract law concepts, a contract should also provide for what happens after it is signed and the obligations are bound. To that end, an essential component to a contract is the parties’ ability to amend and/or modify the contract itself. In many cases, the parties will experience unforeseen circumstances that change a material aspect of the original objectives for entering into the contract. A rigid contract may not realistically account for such eventualities and could bestow an unfair advantage on the party that attempts to rely on the written contract and its specific terms and conditions.
Normally, broad general provisions are included in a contract to allow for amendments and modifications. For example, many contracts will provide that the parties may amend or modify the contract by mutual agreement in writing to address unforeseen circumstances. If that information is not included in the contract, however, then the parties would not be able to amend or modify the contract unless it is specifically outlined within as a term or condition.
As a note, amendments and modifications are not the same. An amendment is a major change to the signed contract. A modification, on the other hand, is a minor change. Many times, the parties include broad or comprehensive terms and conditions in the main body of the contract and list the specific changes, amendments and/or modifications as an attachment known as an exhibit. That way, the amendments and/or modifications can easily be changed in the future simply by updating the exhibit.
Finalizing and Signing the Contract
After making any final adjustments to the language and securing agreement from all parties, it is time to finalize the contract. In most cases, this will require execution by an authorized party on behalf of each affected company. An authorized party or agent, in a business context, typically means the principal who has been given authority to enter into the contract . To ensure that the contract is enforceable: Finally, ensure that you have enough copies of the contract, so that you can provide one to all relevant parties, including each signer and all individuals who may perform tasks related to the contract.