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Contracts Basics

Most businesspersons enter into contracts more frequently than they may realize. In almost all business dealings, any time you or your company agree to take some action or make a payment in exchange for anything of value, a legal contract has been created. For example, most bills of sale, purchase orders, employment agreements, and other common business transactions are legally enforceable contracts. Following is a discussion to help you understand the basics of contracts.

What is a contract?

A contract is a legally enforceable agreement between two or more parties that creates an obligation to do or not do particular things. The term "party" can mean an individual person, company, or corporation. No matter who the parties are, contracts almost always contain the following essential elements:

  • Parties who are competent to enter into a contract. For example, a mentally disabled person could not enter into a contract. Minors can enter into contracts, but can void them in most cases before they reach majority age.
  • Mutual agreement by all the parties; i.e., all parties have a meeting of the minds on a specific subject. Each party either promises to perform an act that the party is not legally required to perform, or promises to abstain from performing an act that it is legally entitled to perform.

Why should I use a written contract?

To be enforceable, some agreements must be in writing. The situations in which an agreement must be in writing can differ from state to state, but usually include transfers of real estate, sales of goods valued at over $500, and contracts that require more than a year to perform.

Your written agreement becomes your proof of what was agreed upon, and prevents someone from forgetting or changing the story later. Writing the contract down also makes the parties focus on the essential points, and come to a definite agreement.

Can and should I write my own business contracts?

Yes, you can write your own business contracts. If there is much at stake or if the matter is complex, you may want to use a lawyer. Your best money may be spent up front in preventing any potential legal problems, rather than battling it out in a lawsuit later on. If the amount at stake in your business contract is moderate or the terms simple, you may use a legal form that both sides understand.

What laws govern contracts?

Contracts are usually governed and enforced by the laws of the state where the agreement was made. Depending upon the subject matter of the agreement (i.e. sale of goods, property lease), a contract may be governed by one of two types of state law. The majority of contracts (i.e. employment agreements, leases, general business agreements) are controlled by the state's common law -- a tradition-based but constantly evolving set of laws that is mostly judge-made, from court decisions over the years. The common law does not control contracts that are primarily for the sale of goods, however. Such contracts are instead governed by the Uniform Commercial Code (UCC), a standardized collection of guidelines governing the law of commerce. Most states have adopted the UCC in whole or in part, making the UCC's provisions part of the state's codified laws pertaining to the sale of goods.

What is "breaching" a contract?

In the business world, disputes can arise over contracts, and one party (or both) may accuse the other of breaking his or her obligations under the agreement. In legal terms, a party's failure to fulfill an end of the bargain under a contract is known as "breaching" the contract. When a breach of contract happens (or at least when a breach is alleged) one or both of the parties may wish to have the contract "enforced" on its terms, or may try to recover for any financial harm caused by the alleged breach.

How are contracts enforced?

The most common method used to resolve business contract disputes and enforce contracts (if informal resolution methods fail) is through lawsuits and the court system. If the amount at issue is below a certain dollar figure (usually $3,000 to $7,500 depending on the state), the parties may be able to use "small claims" court to resolve the issue.

Courts and formal lawsuits are not the only option for people and businesses involved in contract disputes. The parties can agree to have a mediator review a contract dispute. The parties are not bound by a mediator's decision, but may be convinced to avoid a costly court battle by how the mediator rules The parties can also agree to binding arbitration of a contract dispute. In arbitration, a neutral party listens to the arguments from both sides and issues a decision that is binding on the parties. This is cheaper and less time-consuming than a court battle.

When attempting to enforce a contract, an individual or business should always consider the effect any dispute will have on any long-term business relationship between the parties involved.

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