As a small, medium, or enterprise business owner, you will certainly understand the importance of contracts as you deal with people and other businesses on a daily basis.
Clients, employees, investors, suppliers, landlords, tenants, consultants and partners - you had, have or will have business contracts with them.
By understanding the basics of contracts, you will be able to make sure that your business is protected from a legal, commercial, and financial perspective. This is because breaches of contracts
can lead to disputes, which, in turn, can lead to costly claims and reputational damage. Unfortunately, global external events such as COVID-19 are only increasing the number of contract disputes
. In the construction sector, for example, according to Arcadis’ 11th annual ‘Global Construction Disputes Report 2021: The road to early resolution’, the average contract dispute value has now reached £27.7million, rising a considerable 117% from 2019. The report also highlights that over 75% of respondents in their survey had encountered contractual disputes due to COVID-19
. So what exactly are the legal requirements of a contract, and how can you use this knowledge to protect your business interests?
What is a contract in business?
Most SMEs have a number of contracts in place covering all aspects of their business. At its core, a contract is a legally binding promise by one party to fulfil an obligation to another. This might include leasing a building to a business, employing a member of staff, providing a service, or providing a product.
Contracts can be verbal or in writing and must contain five parts in order to be legally binding (i.e. legally enforceable); there must be:
- an offer
- acceptance of the offer
consideration (something given in return, e.g. payment or transfer of ownership)
- an intention to form legal relations
- certainty of terms
This fifth requirement is often overlooked, but in practice, if the terms of a contract are not agreed upon and understood by both parties, there is no binding obligation to deliver on a contract.
When entering into a new contract, it is essential that you consider each of these elements.
Should I use a standard contract template?
While standard templates can be useful as a guide as to what to include, to be watertight, a contract should be tailored to the needs of the parties involved and the contractual arrangement being entered into. Many businesses and individuals using templates often do not understand what they contain and do not realise that far from protecting their interests, they may be left legally exposed. For this reason, it is always recommended to engage the services of a commercial law Solicitor who can ensure that the correct type of contract is used, and this reflects the needs of both parties.
What is meant by an offer in a business contract?
When an offer is made, this means that one party is promising that they will enter into a contract with another party on certain terms. Importantly, for an offer to be legally valid, it must be specific, complete, capable of acceptance, and offered with a genuine intention to be accepted.
An offer can be made to a single individual or a group of people.
No, an offer is different from an ‘invitation to treat’. An invitation to treat means that one party is inviting the other to negotiate, but there is no intention to be bound by a contract at that time.
What constitutes acceptance in a business contract?
In some cases, one party may believe that the other has accepted the terms of a contract when, from a legal perspective, this is not the case. For a contract to be accepted, it must:
- be final and unqualified
- be made in response to an offer
- correspond with the terms of the offer with no variations
In most cases, acceptance of a contract is communicated by one party to the ‘offeror’, but in some situations, acceptance occurs when a product or service is delivered (if accepting the contract was the intention of delivering the product or service).
It may also be the case that rather than accepting an offer, a counter-offer is made - this means that the person who made the original offer can now choose to accept the new offer.
Acceptance is considered to take place when it is received (or if sent by post, when the acceptance was posted).
What is ‘consideration’ in a contract?
Central to contract law is the concept of ‘reciprocity’; i.e. something is given in return (such as payment or transfer of ownership of property). This ‘consideration’ does not need to be adequate as this is left to the discretion of the parties to the contract; what matters is that it has some value.
What is meant by an intention to form legal relations?
This simply means that for a contract to exist, the parties must intend to be legally bound by its terms. If one or both of the parties do not want to be bound by the terms of the contract, it is not valid. In commercial contracts, there is an automatic presumption that both parties intend their agreement to be legally binding. If this is not the case, one or both parties need to ‘rebut’ this presumption.
What is meant by ‘certainty of terms’?
Not only must the terms of a contract be agreed upon by both parties, but the agreement must also be complete (i.e. there should be nothing missing that is essential to the contract) and should not be vague or unambiguous. This is because where a contract is contradictory or does not include provisions for real-life situations, there is a chance that a court will not be able to enforce it.
To avoid complications arising from the uncertainty of terms, one option is to break a project down into several smaller and sequential agreements (this is common with large IT delivery projects). This means that each can be delivered with greater certainty.
If you are about to enter into a new contract of any type (or to renew an existing contract), it is important to do so in a clear and methodical manner and only sign the contract when you are sure that it reflects your best interests and offers the protection necessary. To achieve this, we recommend taking the following steps:
- gather your existing contracts of the same type and review whether these have been effective (often lessons can be learned about how to enter into a new contract based on past experience).
- consider how any new contract you plan to enter into can be drafted to better suit your financial, commercial, legal, or operational needs.
- put in place a contract management system for managing new and existing contracts to ensure you are not left legally exposed, risks are managed, and you can gain full benefit - e.g. where a supplier is not delivering on time, are you enforcing your contractual right to compensation? And do you know when your existing contracts are due to come to an end?
- don’t be afraid to consider renegotiating contracts where they are no longer working for you. If the other party values your contractual relationship, they will be more willing to make changes, especially if these are mutually beneficial.
- engage a commercial law Solicitor who can tailor a new contract for your needs or recommend changes to a contract from another party.
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