All businesses inherently deal with contracts, even if they are unwritten, as with many transactions involving goods or services. Since a contract is a legally binding agreement, and even an honest contractual mistake can cause serious problems, it is crucial that small business owners have at least a basic understanding of contract law. This section covers the basics of contract law and how it relates to the many facets of running a business, including articles on when a verbal agreement carries the weight of a contract, the meaning of "breach of contract," which contracts must be in writing, and related topics.
A contract refers to a legally enforceable agreement between two or more parties that creates an obligation to do or not do particular things. A "party" can be a person or corporation. Contracts typically involve parties who are "competent" to enter a contract, meaning that they are not a minor or mentally disabled, and a mutual agreement between the parties. Some kinds of agreements must be in writing. Although rules vary depending on the state most contracts involving real estate, goods worth more than $500, and contracts that require a year or more to complete.
A written contract is a good idea even when writing is not required since it provides a clear record of the terms and the parties' explicit acceptance of them. You can draft your own contract, though in more complicated transactions retaining an attorney can be a wise expense to guard your agreement and receive assistance identifying potential issues before they become problems.
When one of the parties breaks the terms of an agreement this is called a "breach." If the non-breaching party sues they can ask the court to "enforce" the contract. This may result in a court order for the breaching party to uphold their end of the contract or they might require payment for the breach if damages are determinable and more easily put the non-breaching party in a position to receive the benefit they sought in the contract.
"Breach of Contract" and Lawsuits
When a breach of contract occurs and one or both parties wishes to have the contract enforced on its terms and attempts at informal resolution have failed the aggrieved party can file a lawsuit in the appropriate civil court. In some cases parties will attempt mediation before a lawsuit is filed. A party that is successful in mediation or court may be granted specific performance (an order commanding the breaching party to hold up their end of the agreement) or one of a number of different kinds of damages including:
- Compensatory Damages,
- Punitive Damages,
- Nominal Damages,
- Liquidated Damages,
- or, Cancellation and Restitution.
Will Your Contract Be Enforced Under the Law
A contract will be enforced if it fulfils some basic rules regarding the formation of a legally binding contract. There are a number of common defenses to the enforcement of a contract that include:
- Lack of Capacity - A person must, at the time of the formation of the contract, have the ability to understand the agreement they are entering into. Someone with a mental disability, a minor, or someone drugged without their knowledge may be relieved of their obligations under an otherwise valid contract because they lacked capacity.
- Undue Influence, Duress, Misrepresentation - Where a contracting party would not have entered into an agreement except for the undue influence of another, due to duress, or had they been aware of the other party's misrepresentations they may have a defense against the enforcement of a contract. Undue influence is when a person is convinced to act against their best interests by nature of their relationship with the other party. Duress occurs when one party agrees because of the unlawful or wrongful threats of the other person. Misrepresentation occurs when one party deliberately misrepresents facts to the other party.
- Unconscionability - When enforcing a contract would result in an outcome considered oppressive or shocking to the conscience the court can choose not to enforce the contract. This typically occurs when there is a gross imbalance in the strength and sophistication of the parties.
- Public Policy and Illegality - If a contract includes terms that require a party to break a law the court will refuse to enforce the contract.
- Mistake - If both parties made a mistake as to a basic assumption on which the contract is based the court may refuse to enforce its terms. This mistake must relate to facts at the time the contract was made. Failing to read a contract does not create a defense to enforcement, however.