As businesspeople negotiate and execute contracts, they should always keep the fundamentals of U.S. contract law in mind.
What is contract law?
Contract law governs how courts interpret and enforce agreements between parties. When one party claims the other breached a contract – in other words, the second party failed to adhere to the terms of an agreement – the injured party can ask to enforce the contract or seek compensation (also called damages).
Types of contract law
Most contract law is common law, which arises from judicial decisions. The fundamentals of contract law are consistent across the U.S., but states may interpret and enforce contracts slightly differently. The basic principles of contract law are published in a legal treatise, the Restatement (Second) of the Law of Contracts.
States may have statutes related to contracts, as well, such as a statute of frauds, which determines which contracts must be in writing to be enforceable. And many states have adopted provisions from the Uniform Commercial Code, which applies to contracts related to the sale of goods.
Because not every jurisdiction handles contract issues the exact same way, the parties negotiating an agreement should decide which jurisdiction’s laws apply to a dispute. This part of the contract is called a choice of law provision, and it’s common for businesses to use the state where they’re headquartered.
The choice of law provision determines which state’s substantive law will decide the contractual issue but doesn’t control procedural aspects of the case, such as where parties can file the lawsuit. Businesses typically include a forum selection clause in their contracts to outline whether they require arbitration instead of litigation or where the parties can file a lawsuit.
Who can form a contract?
Individuals, whether for themselves or on behalf of an organization, can create contracts. For businesses, any number of employees can negotiate a contract, but only certain employees can sign and bind the company to the agreement. Businesses must establish who has signing authority.
Hiring a lawyer can be helpful but is not required to enter into a contract. However, most businesses involve their general counsels or outside law firms to negotiate their agreements. A corporate lawyer is best able to identify and mitigate risk in contracts.
Do contracts have to be in writing?
Every state has a statute of frauds, which defines which contracts must be in writing to be enforceable. These statutes vary slightly, but the fundamental principles are similar.
Examples of contracts that parties have to put in writing to be enforceable include:
- Contracts that last longer than one year
- Contracts involving the sale or transfer of land
- Contracts involving products sold for over $500
- Contracts that require an executor of a will to repay debts
- Contracts involving collateral when one party assumes the responsibility for the other party’s debt
- Marriage-related contracts, like prenuptial agreements
Realistically, businesses put their contracts in writing, even if the law doesn’t require it. Business contracts can be too long and complicated to arrange orally. Additionally, if a dispute arises, it’s difficult to prove the existence of an oral agreement in court, and it’s a more significant challenge to establish specific details and obligations.
Elements of a contract
Offer
The first essential element of a contract is the offer. Party A must offer a set of terms, often related to a product or service, to Party B. These parties can be individuals or organizations.
Acceptance
Acceptance occurs when Party B agrees to Party A’s offer. In the simplest scenario, Party B agrees to the original terms. However, a counteroffer might come after an offer. Instead of accepting Party A’s terms, Party B might suggest a slightly different arrangement. It then becomes Party A’s option to accept, counter, or reject the new offer.
Mutual assent
Entering into a contract requires intent on both sides. This concept is also called a meeting of the minds. Both parties have to mean to enter into a formal and enforceable agreement.
Consideration
This legal term means each party gives something up to receive something else. For example, an employee gives up certain freedoms, like their time, and performs labor in exchange for a salary. A company gives up money in exchange for the employee’s work product.
What makes a contract legally binding?
An agreement is not a valid and enforceable contract if it lacks an essential element, such as consideration. It’s also not enforceable if the subject of the contract is against the law or public policy.
Agreement vs. contract
Are agreements and contracts the same thing? Yes and no. People will often use the two terms interchangeably. However, an agreement is not necessarily legally binding, while a properly formed contract is enforceable by a court.
Types of contracts
A few examples of types of contracts include:
- Express contract: The parties exchange promises in writing or spoken words and define the terms of the contract at the time they made the agreement.
- Implied contract: Parties can create legally binding contracts based on their actions and the circumstances. These agreements don’t have to be stated orally or in writing.
- Unilateral contract: Only one party makes the agreement, like an offer to pay a reward for finding a missing pet. The party puts out an offer that’s open for someone to act on and will fulfill its promise once someone acts on the offer.
- Bilateral contract: At least two people complete all four traditional elements of a contract. If either party doesn’t live up to its responsibilities stated in the agreement, then it has breached the contract.
- Option contract: An agreement to keep an offer open in exchange for money. The offerer can’t revoke the offer during the option period, and the other party has the option to accept or reject it.
- Contract of adhesion: A standardized contract offered by a person or organization with more power than the other party. Party B, the person or entity receiving the offer, doesn’t have enough power to negotiate the contract terms. They must either accept the terms or not enter into the contract.
What is a breach of contract?
A breach of contract is a violation of at least one of the terms stated in the agreement. Following a breach, businesses must determine how to move forward. Many disputes aren’t significant enough to warrant pursuing legal action, in which case, the parties part ways.
If the breach is material, the injured party might pursue arbitration or litigation, depending on the contract’s dispute resolution clause. If a business files a lawsuit, the court will first decide whether the contract is valid and enforceable. Then, it will determine if the defendant breached the arrangement and, if so, whether the breach injured the plaintiff.
If the plaintiff wins, there are a few potential remedies:
Damages: The most common outcome is for the plaintiff to receive money in the court’s attempt to make them whole. Courts have several types of damages they can calculate, including expectation damages, consequential damages, liquidated damages, and nominal damages.
Injunction: Sometimes, a court can stop a party from acting a certain way. A prohibition against doing something might be temporary or permanent. Courts often use temporary injunctions to prevent further damages until the parties can resolve the dispute or the court makes a final determination.
Performance: In rare cases, when compensation isn’t an appropriate remedy, the court might order a party to perform what it was supposed to in the contract. This option is usually for contracts involving land, not agreements involving personal services.
Rescission: A court can cancel a contract. The party who didn’t breach the contract may prefer this outcome because it terminates any obligations it still had under the agreement.
Do businesses need a lawyer for a breach of contract case?
Yes, businesses that want to file a breach of contract claim or other cause of action need to hire a lawyer. Entities cannot represent themselves in court. Most businesses hire outside law firms to represent them during court cases instead of relying on their GCs.
What is contract management?
Businesses handle contracts differently than individual people. Most companies, whatever their industry or size, enter into numerous contracts each year, and large enterprises might execute thousands of contracts annually.
Because of the volume and importance of commercial contracts, businesses need contract management policies and technology. Contract management, also called contract lifecycle management, is the ability to understand, plan, create, and enforce contracts with other parties.
Often, the most effective way to handle a high volume of contracts is to adopt contract management software. There are numerous CLM software solutions on the market, some of which have industry-specific features. These enable businesses to store contracts in a central document repository, search for contracts quickly, analyze contract data, and meet all their contractual obligations.
A central contract repository also helps businesses perform contract compliance audits to measure their and other parties’ performance.
