How Business Contracts Protect You and Your Company

Roy Rasmussen
Roy Rasmussen
Roy Rasmussen

A business contract provides you with legal protection, but only if it is drawn up correctly. 

Learn what you need for a valid contract.

What Is a Business Contract?

As Cornell Law School explains, a contract is an agreement between private parties that creates a mutual obligation subject to legal enforcement. 

In a business context, this may involve agreements such as:

  • An arrangement between business partners on how to divide ownership of a company, responsibilities and profit shares
  • A commitment between employers and employees defining the terms of employment and compensation
  • An understanding between employers and contractors on project terms and compensation
  • A nondisclosure promise from employees or contractors not to reveal proprietary information
  • A lease between a commercial real estate renter and tenant
  • A lease between an equipment lessor and lessee
  • An indemnity waiver between a business and another party promising not to hold the business liable in the event of damages

Whatever the context, a business contract includes several fundamental components:

  • An offer from one party to do something or refrain from doing something
  • Something of value from the other party exchanged in consideration of the offer
  • A mutually considered understanding of what the contract means
  • An acceptance of the terms of the contract, communicated through words or actions

Business contracts only can be made between parties who are both mentally capable of understanding what they are agreeing to and not acting under undue influences such as coercion. Only legal activities can be the subject of business contracts.

A business contract can be verbal or written. Obviously, written contracts are preferred because they provide clearer communication and better documentation and they are easier to enforce in court.

Types of Contracts in Business

As law firm Bitman, O’Brien & Morat summarizes, several common types of business contracts are most frequently encountered:

  • Partnership contracts, where business partners agree to terms such as ownership percentage, management responsibilities, capital contributions and profit sharing
  • Employment contracts, where employers offer employees compensation in exchange for services
  • Contractor agreements, similar to employment contracts but made between employers and independent contractors
  • Nondisclosure agreements, where employees or contractors agree not to disclose proprietary information owned by the employer
  • Property and equipment leases, made between property or equipment owners and companies entering into leasing arrangements
  • Indemnity agreements, where the signer agrees not to hold a company liable in the event of damages

There are other types of business contracts, but these are some of the most common. Each type of business contract has its own nuances, such as variations for a specific industry.

A person holds and signs a form labeled “Business Contract.”

Why Do I Need a Business Contract?

A business contract serves several important purposes which help protect both parties involved:

  • It improves communication by explicitly stating what both parties are agreeing to, what they expect and what is expected of them
  • It helps resolve disputes by reminding both parties what they agreed to
  • It discourages disputes from escalating to lawsuits by providing written documentation of both parties’ legal obligations
  • In the event of a lawsuit, it establishes what both parties agreed to, protecting parties whose contractual rights have been violated as well as protecting parties who are falsely accused of breaking contract terms

To provide you with maximum protection, a business contract should be written. Verbal contracts are binding, says Katz Law Group, but their existence is more difficult to prove than written contracts.

Likewise, verbal amendments to written contracts might be valid, according to Branscomb Law, but they can be difficult to enforce. If you amend a written agreement, make sure the amendment is also in writing.

The Elements of a Contract

The basic parts of a contract include some key elements which make up the contract itself, as summarized by the University of New Mexico’s Judicial Education Center:

  • Offer
  • Consideration
  • Mutuality
  • Acceptance

In addition to these internal elements which constitute the contract itself, a contract has external elements defined by the parties agreeing to the contract:

  • Competence
  • Legal intent

Together these elements make up the contract and its context.

Offer

The offer component of a contract consists of what the party making the offer is promising to do or to not to do. For example, they may be promising to provide some service, or they may be agreeing not to disclose some proprietary information.

Consideration

Consideration refers to what the other party is receiving in exchange for what the first party is offering. Usually, consideration is monetary, but it can also take another form such as a service.

Mutuality

Mutuality, also referred to as mutual assent or a meeting of the minds, means that both parties have a shared understanding and agreement as to what the contract means, so that they are agreeing to the same thing. Courts determine mutuality by considering the meaning of the terms used in a contract, along with testimony from the parties involved and consideration of correspondence or other communication between parties.

Acceptance

Acceptance happens when both parties unambiguously agree to the terms of the contract. This agreement can be expressed through words, as in a signature, or through deeds, as when the parties act in a way that signals acceptance of the contract.

Competence

To enter into a contract, a person must have the mental capacity to understand what they are agreeing to, a condition referred to being of sound mind. This means they are legally of age to enter into a contract and they aren’t under an undue influence such as alcohol or mental incapacity. They also must be acting of their own free will rather than under force or duress, known as coercion.

Legal Intent

As a legal agreement, a contract can only involve legal matters. Illegal activities can’t be the subject of a legal contract.

A person sitting at a desk tears up a document labeled “Contract.”

What Can Make a Business Contract Illegitimate?

Each of the elements described above must be present to meet the requirements of a valid contract. If all the elements of a valid contract aren’t present, the contract may be vulnerable to a legal challenge. 

Here are some common scenarios where one of the conditions of a valid contract may be absent:

Invalid Offer

The first condition of a proper contract is a valid offer. An offer should lay out the essential terms of the contract, including the subject of the contract, price and other details such as deadlines. 

The offer must be communicated by one party to the other. This can be done verbally, but writing provides better documentation. A contract may be rendered invalid because its offer lacks key details or because there is no evidence the offer has been communicated.

Invalid Consideration

To be valid, consideration must define something of value in the form of payment, an action or a promise to refrain from an action. If nothing of value is being exchanged in consideration for the offer, the offer is a gift and there is no contract.

Invalid Mutuality

Mutuality can be lacking if one of the terms in a contract is ambiguous, causing the parties to understand it differently. It can also be absent if one party misunderstands the contract.

Invalid Acceptance

Acceptance must encompass all the terms of an offer unconditionally. This means that an offer must be accepted without any changes or conditions. If one party suggests changing the terms of a contract, this is considered a new offer called a counter-offer, and doesn’t constitute acceptance.

Acceptance must be communicated between parties. A contract may specify which method of communication should be used to express acceptance, in which case that method should be used. For instance, a contract may specify that it is to be signed digitally. If no method is specified, the court may accept any standard, reasonable method.

Invalid Competence

Lack of competence can invalidate a contract. This can happen if, for example, a party is a minor, intoxicated, suffering from dementia or being pressured or threatened.

Invalid Legality

Finally, a contract must express legal intent. A contract that offers an illegal agreement automatically loses legal validity.

What Should Be Included in a Business Contract?

What to include in a business contract to make it valid depends on the specifics of an agreement as well as the general principles outlined above. For example, an offer for a contract in the construction industry will need certain details differing from a contract in the life insurance industry. 

In general, regardless of details, a business contract agreement should include certain features to make sure it meets the criteria of a valid contract and to strengthen your position should you face a contract dispute, advises legal resource provider Nolo. Essential features include:

  • The agreement should be written so that all elements are documented
  • The legal names of all parties should be identified, using the correct parties (for example, if one party is a corporation, it should be identified as a party by its corporate name and not by the name of the people signing on behalf of the business)
  • If one party is located in another state, specify where the contract is being drawn up and where any legal actions will be handled
  • Include all details when describing offers, such as any services being proposed, what is included in the scope of the contract and what isn’t and deadlines
  • Include all details of consideration, including the amount to be paid, the method of payment and payment schedules
  • Lay out procedures for how disputes will be resolved (such as procedures for late payments)
  • Identify conditions under which parties have the right to terminate the contract (such as nonperformance of services or nonpayment of compensation)
  • Get any changes to contracts in writing

Including these items will help you cover all your bases for drawing up a valid contract. However, unless you’re experienced with contract law, it’s easy to miss important details. For best results, work from a contract template that has been drawn up by a professional business lawyer, or consult an attorney to draw up a customized contract.

Protect Your Business With Valid Contracts

A valid business contract provides you with documentation that you can use to avoid a legal conflict or enforce your rights in a court of law. To be valid, a business contract should include a properly worded offer and consideration, there should be mutuality and acceptance, both parties should be competent and the contract must involve legal activity. 

If any of these elements are missing, it can invalidate the contract. To ensure the validity of your contract, seek legal advice from an experienced business lawyer.

Roy Rasmussen Contributing Writer at Fast Capital 360
Roy is a respected, published author on topics including business coaching, small business management and business automation as well as an expert business plan writer and strategist.