Contracts: The Foundation of Successful Business Relationships
What is a Contract and Why Are Contracts Important for Your Business?
As a small business owner, contracts are an essential part of your operations. A contract is a legally binding agreement between two or more parties that creates obligations for each party to do or not do specified things. Having valid, carefully-crafted contracts in place with your customers, vendors, employees, and partners provides critical legal protections and clarity for your business relationships.
Why Contracts Matter
Contracts serve several key purposes:
Clarifying expectations and responsibilities. A well-written contract clearly spells out what each party has agreed to do, by when, under what conditions, and for what consideration. This helps ensure everyone is on the same page regarding the business arrangement.
Protecting your interests. Contracts enable you to safeguard your business interests by including terms that limit your liabilities, preserve your intellectual property rights, maintain confidentiality, and more. They also give you legal recourse if the other party fails to uphold their end of the deal.
Preventing and resolving disputes. By specifying upfront how various situations will be handled, contracts can prevent misunderstandings from escalating into full-blown disputes. If a conflict does arise, the contract provides a roadmap for resolving it via negotiation, mediation, arbitration, or litigation.
Enhancing enforceability. Oral agreements can be difficult or impossible to enforce. Getting your agreement in writing significantly increases the likelihood you'll be able to hold the other party to their commitments.
What Happens When a Contract is Breached?
A breach of contract occurs when one party fails to fulfill their obligations under the agreement. For example, if a vendor delivers a defective product, misses delivery deadlines, or overcharges you, they may be in breach.
When a breach happens, you may be entitled to various legal remedies, including:
● Damages. The breaching party may owe you monetary damages to compensate for losses caused by the breach. Damages can include direct losses (e.g., costs to fix defective goods) as well as consequential damages (e.g., lost profits due to business interruption).
● Specific performance. You may be able to obtain a court order requiring the breaching party to fulfill their contractual promises.
● Termination. Material breaches may give you the right to terminate the contract and be excused from further performance on your end.
● Restitution. You may be entitled to get back any money or property you have already provided to the breaching party.
To preserve your rights, it's critical to follow the notice and cure procedures specified in the contract, document the breach and your damages, and consult with an attorney about next steps.
Key Contract Clauses to Protect Your Business
Now let's look at some important clauses to consider including in your contracts:
Payment Terms
- Payment terms cover the timing and method of payments.
- As a business owner, the following payment terms are ideal:
- a) payment in advance;
- b) shorter payment terms (e.g., net 30 after invoice date); and
- 3) the right to charge interest and collection costs for late payments.
Client Service Agreements
- For contracts involving ongoing services, these agreements specify the vendor's required uptime, responsiveness, and quality standards.
- Include “commercially reasonable efforts” standard, and manageable targets, as well as exceptions for things beyond the vendor’s control (e.g., general internet issues).
- Robust CSAs, including a right to service credits or refunds for excessive downtime, as well as a right to terminate after a certain number (or length) of incidents.
Representations & Warranties
- Reps and warranties are the promises each party makes about key facts related to the deal
- For example, if a transaction involves IP rights, then a party may make a representation that the product/service will meet specifications, that they will comply with laws.
- It is ideal to secure reps and warranties that are broad and enforceable against a range of different potential scenarios.
Indemnification
- Indemnification clauses require one party to cover the other's losses if specified bad things happen
- For instance, if a vendor’s negligence causes injury, the other party wants to be protected from this liability.
- It is ideal to secure broad indemnities from counterparties to a contract that has limited exclusions.
Limitation of Liability
- Liability caps place upper limits on the amount of damages one party can owe the other.
- It is ideal to cap total liability at a fixed number, such as a percentage of the contract value.
- This provides certainty in case of an unforeseen event.
Termination Rights
- Termination clauses specify when and how each party can end the contract early.
- It is ideal to secure the right to terminate for any material vendor breach, repeated failures, or deterioration in service.
- Again, the goal is to create certainty, in case of an foreseen event.
Conclusion
Contracts provide essential protections and set the ground rules for your business's most important relationships. As a small business owner, taking the time to structure and review your contracts with experienced counsel carefully can save you from major financial and legal risks down the road. While no one enters a deal expecting it to go wrong, having a strong contract is crucial for protecting your interests if and when issues arise.