Our world is made up of contracts, verbal or written. Contracts are the language of business. They capture the words that define our business relationships.
We live under a social contract, a concept defined by Rousseau centuries ago. Now, in the business world, having knowledge of written contracts is vital.
That is why we have prepared for you, concisely, all the information you need to know about contracts: what they are, what their types are, what you should take into account when facing one, and how to create one.
What is a Legal Contract?
A legal contract is a binding agreement between two or more parties that is enforceable. It details the exchange of something of value, whether goods, services, intellectual property, or promises. It can be oral or written, as long as all the required elements to make it valid are satisfied.
By elements, we refer to those that the law demarcates as requisites for it to be considered a law between parties. These elements sometimes depend on the type of contract; in some cases, elements may be added to a contract beyond the usual or standard ones.
Here are some key points to keep in mind when dealing with contracts:
- Contracts don’t have to be written for enforceability, because a verbal agreement made with a handshake can be a valid contract. Nevertheless, we recommend written contracts because written agreements are less open to disputes. Written agreements define the terms and conditions of a bargain, while oral contracts are very difficult to prove.
- Anyone can write or prepare a contract; so, legal advice is not a must, but still a great source for consultation. Every party involved in the agreement must act according to a series of rights and obligations and be legally capable, that is, to be above the age of majority and being of sound mind.
- A breach of contract occurs when a party fails to fulfill its contractual obligations. This may be considered a cause to terminate the contract or give the non-breaching party the right to damages.
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A breach of contract is a violation of the terms and conditions of a binding agreement. To read about the types of breach of contract and remedies for this situation, click here.
Legal contracts are governed by common law, statutes, and regulations. All contracts must provide a clear and accurate description of the bargain made between the parties. Errors, ambiguities, omissions of terms, and illegality as well as mistakes can make it invalid. The lack of capacity of any of the parties or the lack of parties’ free will may also be reasons for invalidation.
To be unambiguous, every valid contract agreement must include the following essential elements:
Offer
A valid offer takes place when one of the parties involved promises to do something or to refrain from doing something.
Acceptance
Acceptance occurs when the other party involved explicitly accepts the agreement. This can be done through words, actions, or performance of the promise required by the contract.
Consideration
Consideration is a promise, performance, or forbearance made in exchange for an offer of contract. It may be something of nominal value as in the case of the classic “peppercorn” given in exchange because the courts typically do not assess the adequacy of the consideration. However, there are exceptions to the nominal consideration rule that may be applied in the case of a non-competition agreement.
Legal Purpose
Legal contracts serve a legal purpose: to enforce legal, and not illegal or criminal activities.
Capacity to contract
The parties must understand the terms, responsibilities, and consequences of the contract before they sign. Only parties with legal capacity may sign a contract by themselves. Minors, certain felons, and individuals who are not of sound mind are some examples of people lacking the capacity to contract.
For instance, if one of them is a minor, has a disability, or is intoxicated, they are not legally capable. Such lack of capacity makes any contract invalid, except in the case of these individuals wanting to act through a legal representative and the other party agrees and is legally appropriate considering the purpose of the agreement.
Awareness
The parties must have what it’s named as “a meeting of the minds”, meaning they must be fully aware of what they are committing to.
Legality of a contract
The contracts must be subject to the laws of the jurisdiction where they are signed. However, federal laws and state laws sometimes do not agree, and in those cases the Contract Clause of the US Constitution will prevail.
Remember to include all the terms of the contract, accounting for any possible contingencies, the time and manner of termination, and any non-disclosure agreements—known as NDAs—, that the parties would like to insert.
Types of Contracts
There are potentially thousands of different contract types. In general, they can be classified by the nature of the parties, the nature of the asset, right, or interest, and the nature of the bargain.
From the parties' viewpoint, agreements can be grouped into:
- Unilateral contract is an agreement made by one person to do something, such as a will or a contest agreement.
- Bilateral or Multilateral contract is an agreement made between two or more parties to exchange something of value, such as a sales agreement, employment agreement, or merger agreement.
- Organizational contract is an agreement to set up or manage a business or other assets, such as a partnership agreement, condominium association agreement, or retirement plan.
From the asset viewpoint, agreements can be grouped by the nature of the asset, performance, right, or interest that is the subject matter of the agreement, such as real property, stock, or the performance of services.
Finally, agreements can be classified by the nature of the bargain
- Sale, transfer or assignment of the full rights in an asset;
- License to use an asset; or
- Performance of services (or forbearance).
Some of the most common types of contracts are:
Sales Contracts
In a sales contract, the buyer promises to pay for certain deliverables—property, goods, services, or intellectual property, and the seller promises to transfer ownership or perform the service in question.
They are also known as sale of goods contracts, sales agreements, or purchase agreements, and include promissory notes, bills of sale, payment details, and even purchase orders, among others.
Employment Contracts
Here, the terms and conditions of any type of employment, even for freelancers, consultants, or other independent contractors, are defined. You may find termination agreements in case the employee is fired, as well as NDAs and confidentiality clauses, which protect companies from liability and disclosure of sensitive information. Non-compete agreements can be included to retain talent.
A non-disclosure agreement (NDA), confidential disclosure agreement, or confidentiality agreement is a legally binding contract that defines the conditions upon which individuals and businesses agree to share confidential material, knowledge, or information with each other, and protect it from disclosure to others. If you want to know more about NDAs, like types or key terms, click here to read the full article.
General Business Agreements
Partnership formation, capital investment, the sale or purchase of stock as well as NDAs and waiver of rights are considered business contracts. This type of contract agreement comprises all elements of doing business. In other words, it describes how the partnership or company will operate.
The name of the partnership, capital contributions, duties as partners, and sharing and assignment of profits and losses, are some elements defined in these legal documents.
Settlement Agreements
They are usually found in franchise contracts and business sale agreements. This type of contract is frequently used to save time and money in a trial because In case of a dispute between the parties involved in the binding agreement, they serve as a resolution alternative. Their goal is to resolve a problem, avoid a trial, or end employment, in the case of employment contracts.
Since these contracts avoid going to trial and often going through mediation or arbitration, this is a type of “alternative dispute resolution” in itself (as well as mediation or arbitration), from which an agreement is reached—but can be bypassed, depending on the case.
How To Draft a Contract?
All contracts are based on a common set of building blocks. Organized in a consistent manner, the universal contract framework can serve as a standard framework and a decision tree to evaluate what terms should be included in any exchange contract. The framework is organized as follows:
Using the universal framework, it is possible to see that every transaction component (such as the provision of services, access to information, or transfer of assets) has a corresponding set of terms assuring that the parties will perform their contractual obligations as intended and a set of contract terms to ensure the parties allocate any risks in the event of unintended events.
Core terms
The introduction typically states the type of agreement or bargain, the names of the parties, and the date of the agreement.
Roles and responsibilities of the parties
The agreement should clearly define the roles and responsibilities of the parties. At its simplest, the agreement should outline what each party must do, what each party cannot do, and what each party can do. For example, in an employment agreement, the employee must perform specified services, he or she may not during the term of the agreement work for competitors, however, the employee may take time off for vacations and sick leave. In return, the employee is required to pay the employee for the services provided.
Assurances
Assurances are the statements and promises that seek to guarantee the parties will perform as the contract intends.
For example, in the case of the sale of a car, a standard term of assurance is a warranty that the seller owns the car and can transfer good title. Or, in the case of a complex services agreement, acceptance, and milestone payments assure the purchaser that each component of the engagement is performed and delivered in accordance with the purchaser’s specifications and requirements.
Insurances
In addition, the parties should consider what events and circumstances could frustrate or prevent the parties from realizing the benefit of the bargain. Typically, this analysis will take two parts: first, identifying what are the most likely intended events that could arise, and second, determining what are the parties’ rights and remedies.
For example, in the case of a confidentiality agreement, one of the most common unintended events is inadvertent disclosure. In such a case, the party disclosing the information should inform the other party, providing sufficient details about the disclosure so that the other party can contain any damage. Under the common law, the parties will also have the right to damages for breach of contract. However, it is unnecessary to reiterate these common law rights in the contract.
General provisions or terms of the agreement
In case of a breach of contract, the information about how to nullify the contract is provided here. The situations and circumstances that would imply this must be specifically described.
If you want to modernize your contracting processes, click here to get a demo. Lots of customers have improved their process with Akorda, read a case study here.
Kingsley Martin
Kingsley is a founder of Akorda. He holds law degrees from Oxford University (First Class Honours) and Harvard Law School, and has 30 years of experience in the practice of law, software design and development, strategy, and management. Kingsley pioneered the new discipline called contract analysis. He is a founder of KMStandards and has developed software capable of automatically analyzing legal agreements and creating contract standards.
