Put It In Writing: Small Business Contracts
As the owner of a business, it’s likely that you’ll often encounter both written and oral contracts. The most important piece of advice about contracts is obvious: Put all important agreements in writing. This blog shows you how, and tells you what to do if something goes wrong. Of course the information here is very general, you may want to consult an attorney to help tailor this information to your business need.
First, let’s start with the question: What makes a valid contract?
A valid contract requires two and sometimes three elements: 1. an agreement (meeting of the minds) between the parties; 2. “consideration”- a legal term meaning the exchange of things of value; and 3. something in written, if the contract covers certain matters, such as the sale of real estate and tasks that can’t be completed in one year, among others.
For example, suppose you’re opening a new store. You meet with Joe, a sign maker, to discuss the construction and installation of a five-foot-by-three-foot sign. Joe offers to do the work for $450 and to have the sign ready for your grand opening on June 15. “It’s a deal,” you say. You now have a legally binding contract, enforceable in court or by arbitration. All the necessary elements are present: 1. An Agreement. Joe offered to built and install the sign at a certain price by a certain date. You accepted the offer by telling Joe, “It’s a deal.” 2. Consideration. The two of you are exchanging something of value. You’re giving your promise to pay $450. Joe is giving his promise to build and install the sign. A written agreement is not require in the example above. Normal business contracts that can be performed in less than a year don’t have to be in writing to be enforceable.
Now, to understand why “consideration” is important, let’s explore the difference between a contract and a gift. Assume that Joe installs the sign on time and you pay him $450 as agreed. However, impressed by the high quality of his work, you say: “Joe, to thank you for the great job you did, I’m going to send you a $100 bonus check next week.” Can Joe enforce your promise to pay the bonus? The answer is “no.” Here is why, he got what he bargained for – the $450 payment. He didn’t promise you anything (consideration) for the extra $100 payment. If you pay it, fine, you want to be nice. If not, Joe can’t force you to.
What about the negotiation phase, can that create a valid contract?
Negotiations, which may or may not lead to an agreement, do not constitute a contract. Let’s say you call Joe and describe the job. He says he can probably do it for about $450. You say, “Thanks, let me think about it.” There was no agreement, so you don’t have a contract.
However, if after negotiations, two people reach an agreement, a contract is formed. Say that after discussing the job with you by phone, Joe promptly sends you a letter in which he says: “I can build and install the sign shown on the enclosed sketch for $450. I’ll have it in place by June 15 when you open. You can pay me then.” You send back a fax saying: “Sounds good. Go ahead.” You just created a valid contract. Joe has made a clear offer. You’ve just as clearly accepted that offer. The fact that you and Joe did not meet face to face and you did not even use the same type of communication medium does not alter this conclusion.
In this example, you accepted Joe’s offer promptly. But what if you’d waited two weeks or two months to accept? The legal rule is that an offer without a stated expiration date remain open for a reasonable time. What’s reasonable depends on the type of business and the facts of the situation. For instance, if you are offered a truckload of fish or flowers, it might be unreasonable to delay your acceptance more than a few hours or even minutes, while an offer to sell surplus wood chips at a time when the market is glutted might reasonably be assumed to be good for a month or more. But there is really no need to tolerate any uncertainty in this regard. Include a clear deadline for acceptance when you present an offer. Also, if you want to accept an offer, do it as promptly as possible.
On the other hand, negotiations aren’t usually as simple as making an offer and having it accepted. And, until an agreement is reached, there’s no contract. Suppose Joe sends you the letter offering to provide your sign for $450. You call his office and leave a message on his voice mail saying: “Go ahead, but I can only pay $400.” So far, there’s no contract. By changing the terms of Joe’s offer you have rejected it and made it a counteroffer. The two of you are still negotiating. Now, if Joe calls back and says, “Okay, I’ll do it for $400,” you now have a binding contract. Joe has accepted your counteroffer. Again, the fact that you and Joe weren’t in the same room or never spoke to each other isn’t significant. What is key is that one of you made an offer (in this case, in the form of a counteroffer), and the other accepted it.
Additionally, until an offer is accepted, it can be revoked by the person who made it. So if you are about to write Joe a letter accepting his offer, and Joe calls to revoke his offer because he decided $450 isn’t enough, you’re out of luck. Joe revoked his offer before you accepted it, so there’s no contract.
What about the option to keep an offer open for a period of time?
If you want someone to keep an offer open while you think about it, you may have to pay for the privilege. If you do, and the person who made the offer agrees to keep it open, your agreement (which is itself a contract) is called an “option.” Options are commonly used when real estate and businesses are sold.
To stay with our sign example, say that when Joe sends you the letter offering to provide your sign, you tell him you’re not ready to respond yet, but you want to be sure the offer will stay open while you think about it. Joe responds that if you pay $100 now, he will keep his offer open for two more weeks. You pay the $100 and accept the offer within the two-week period. The resulting contact would be valid even if Joe tried to withdraw his offer before the end of the two-week period. You and Joe already have a contract (an option), which consists of your right to purchase his services at the $450 price if you act within the two-week period. He received something of value (your $100) in return for granting you this option.
How an offer to contract ends, you may ask?
There are 5 ways for offers to end. First, the person who made the offer revokes it before it’s accepted. Second, the offer expires. For example, if you include language such as, “This offer will expire automatically if I don’t receive your acceptance by noon on May 10.” But unless you’ve been paid something to keep the offer open (as is common for an option to buy real property or a business), you, the one making the offer, can still revoke the unaccepted offer before the period for acceptance expires. Third, a reasonable time elapses. There are no hard and fast rules as to what’s reasonable. It all depends on the circumstances and the practices in your industry. Fourth, the offer is rejected. If you reject an offer and then change your mind, it’s too late. To get the deal going again, you will need to make a new offer to the other person. Lastly, an offer ends when either person dies before the offer is accepted.
How offers are accepted?
Usually, offers are accepted either in writing or orally. But that’s not always necessary. It is an area of considerable legal complexity, but generally an offer can be accepted by a prompt action that conforms with the terms of the offer. For example, you might leave the sign builder Joe a note at his workshop, saying “Please add a red border to this sign today; I’ll pay you an extra $100 dollars.” Joe comes back that afternoon and adds the red border. You are obligated to pay him.
Lastly, let’s consider this last question: Are advertisements offers?
Under traditional contract law, ads are considered only invitations to negotiate or to make an offer; you have no obligation to go through with the deal just because someone offers to meet your advertised price. So if a customer appears, and says she wants to buy the house, land, or business that you advertised in the classifieds for $200,000, there’s no binding contact. One major exception to this rule, however, involves rewards. Generally, an ad offering to pay a reward is binding if someone performs the requested act.
Consumer protection laws have also changed this traditional rule. For example, the law in many states requires merchants to stock advertised items in quantities large enough to meet reasonably expected demand, unless the ad states that stock is limited. And some states require the merchant to give a rain check allowing the consumer to purchase the same merchandise at the same price at a later date.