About This Article
This article is an introduction to business contracts and is written for non-legal professionals. It is intended to provide an explanation of how contracts are used in business and includes typical contract structure, clauses and other suggested considerations and guidelines. This paper discusses contracts which involve the procurement or sale of products or services in the USA. There are many other types of contractual documents, each with their own business purpose, specific terms and strategies.
Topics covered in this paper include:
- What is a Contract?
- Contract Law
- Contract Elements
- Contract Clauses and Appendices
- Other Considerations & Guidelines
- Contract Applications.
1. What is a Contract?
A contract is a promise enforceable by law. A promise is an undertaking that something will or will not happen in the future.
The American Law Institute defines a contract as “Promise or set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty”.
2. Contract Law
Contract law is a type of civil law, is based on private law, and deals with the rights and obligations of individuals, families, business and small groups. Contract law relates to making and enforcing agreements. In the USA, contract law is universal and accepted. However, court interpretations may vary from state to state and affect certain terms of a contract (see 3) Severability).
The use of contracts ensures that business parties can execute their mutual obligations confidently.
Other types of law practiced in the USA include Admiralty Law, Criminal Law, Family Law, Immigration Law, Intellectual Property Law, Labor Law, International Law, Personal Injury Law, Real Estate Law, Tax Law and other legal areas.
3. Contract Elements
Certain demonstrable facts must exist in order to create a contract.
Offer – An offer is a definite expression or overt action which starts a contract. It is what is offered to another for the return of another’s promise to act. It cannot be ambiguous. It must be spelled out in terms that are specific and certain, such as the identity and nature of the object which is being offered and under what conditions and / or terms it is offered.
Acceptance – As a general proposition of law, the acceptance of the offer made by one party (the offeror) to the other party (the offeree) creates the contract. This acceptance, as a general rule, cannot be withdrawn; nor can it vary the terms of the offer, or alter it, or modify it. To do so makes the acceptance a counteroffer. The basic rule in all legal systems is that silence does not constitute an acceptance.
Consideration – Consideration for a contract may be money or may be another right, interest, or benefit, or it may be a detriment, loss or responsibility given up to another. Consideration is a necessary element of a contract.
Contractual Capacity – Both parties entering into the contract must have the contractual capacity to do so; they must be recognized by the law as possessing the characteristics that qualify them as competent parties. The courts generally presume the existence of contractual capacity.
Intent – It is a basic prerequisite to the formation of any contract (oral or written), that there must be a meeting of the minds of both or all the parties to a contract; the fact that each agrees to all the terms and conditions, in the same sense and with the same meaning as the others.
Legality – A contract, to be enforced in court, must not call for the performance of an illegal act; that is, any act that is criminal, tortious, or otherwise opposed to public policy or law.
4. Contract Clauses and Appendices
Depending on the scope of the contract and business risk that may exist for either party, the number and type of contract clauses can vary. The following list of clauses, and brief explanation of each, is meant to cover the most common, but not all, contract clauses dealing with the procurement or sale of products and / or services.
Preamble – Identifies the parties to the contract and statement of what the parties intend to accomplish with the contract.
Definitions – Provides the meaning of word(s) or phrase(s) used in the context of the contract and not the meaning of the same word(s) or phrase(s) that would be used in everyday language.
Intent – see “Intent” in 3) above.
Contract Documents – Defines documents that explain the roles, responsibility and work and incorporates them as a binding part of the contract.
Scope of Work – Defines the goods or services sold or purchased, in clear and unambiguous terms.
Delivery and Contract Term – Defines the date the parties agree the goods or services will be delivered. These dates can be multiple, depending on the scope of work.
Compensation – Defines the amount of money or services to be exchanged between the parties.
Notices & Communication – Defines how and between whom communication about the contract will be exchanged. Normally, written communications are required and must be agreed to by both parties.
Performance Requirements – Defines the obligations of the parties to perform the requirements of the contract and to release the parties of liability once contract requirements are met.
Final Acceptance – Defines the satisfactory completion requirements of the contract and when risk of loss is legally transferred between the parties. This is typically used in purchase contracts.
Termination for Default – Defines under what terms the contract can be cancelled because of either party’s actual or anticipated failure to execute the terms of the contract.
Termination for Convenience – Defines, in both goods and services contracts, when either or both parties may terminate the contract, the timing of termination and what contractual obligations remain between the parties.
Suspension – Is a temporary halt to performance of the contractual obligations by either party and defines the terms and obligations of each party during work stoppage (complete or partial).
Performance Guarantee – Is a commercial bond used to secure performance of contractual obligations by the seller. Performance Guarantees are typically issued by seller’s parent company or banking institutions. These methods are more common outside the USA.
Payment Guarantee – Is a commercial bond used to secure payment of contractual obligations by the buyer. Payment Guarantees are typically issued by buyer’s parent company or banking institutions. These methods are more common outside the USA.
Force Majeure – Frees both parties, temporarily, from liability in an event or circumstance which is not under the control of the parties.
Inventions & Patents – Defines which party has ownership of inventions or patents developed as part of the contract scope of work.
Confidentiality – Is an agreement between the parties to not disclose to other parties any information considered confidential and non-public by the parties.
Liens & Claims – Defines how each party shall indemnify and hold the other party harmless from claims made by third parties.
Assignability – Defines each party’s right to give away obligations of the contract to another party before the contract expires. These obligations could include compensation, performance responsibility or other terms.
Independent Contractor – Defines the relationship between the parties as that of an independent contractor, that no employment relationship is created and that neither party is an agent of the other.
Subcontractors – Are a type of contractor, working directly for the contractor and offering a specific set of skills in exchange for agreed compensation.
Materials – Normally means all tangibles supplied by the seller that constitute the scope of work accepted by the buyer.
Changes in the Work – Defines how variations, concessions or other changes in contractual scope are communicated and processed between the parties.
Regulatory Compliance – Means conforming to legal or industry rules / requirements which both parties agree to observe in executing the contract.
Warranty – Normally refers to how the seller of goods or services promises to undertake ensuring the character, quality and fitness for purpose of the scope of work.
Title – In goods and services contracts this refers to when, specifically, the formal ownership (title) of the completed scope shall happen. Also see Risk of Loss.
Risk of Loss – Defines when, during the delivery process, either party assumes the risk for damage occurring to the goods.
Special Patterns & Tooling – Defines development of any special patterns or tools necessary to develop the scope of work and which party pays for and / or retains ownership.
Right to Audit – Defines who and what elements of the contract and / or its deliverables are subject to audit by either party.
Insurance – Defines the type and coverage of insurance required by each party. This coverage could include commercial general liability, professional liability, Jones Act, product liability, non-owned and hired auto and others.
Indemnities – Identifies how risk is transferred between the parties when loss, due to a specific event, occurs.
Consequential Damages – Identifies damages proven to occur when one party fails to meet their contractual obligation. The Seller should examine consequential damage provisions carefully.
Non-Waiver – States the rights and remedies of either party during a breach of contract.
Severability – States that contract terms are separate from one another and if terms are decided by a court to be invalid, all other terms and conditions of the contract will prevail.
Language – Defines the language of contract communications between the parties, both written and oral.
Governing Law – Is a declaration of what State or local rules and laws govern the contract.
Dispute Resolution – Identifies the method of resolving disputes between the parties. Resolution in court vs. arbitration is to seller’s favor.
Entirety of Agreement – Is a declaration between the parties that the contract and its attachments are the complete agreement between the parties and it replaces all previous oral or written agreements.
Effective Date & Signatories – Defines the authorized person(s) of each company who has / have the authority to enter into contractual obligations and the date the contract takes effect.
Contract Appendices are supplementary information but an integral part of a contract. Appendices are added before contract execution and do not change the main body of the contract. Appendices typically include, but are not limited to, the following topics:
- Scope of Work
- Materials – contractor furnished & free-issued
- Price/Rate Schedule, Invoicing and Payment Terms
- Project Execution Instructions
- Planning & Scheduling
- Project Management
- Status Reporting
- Inspection & Quality Requirements
- Work Site Facilities
- Loadout & Delivery
- Safety Requirements
- Completion, Acceptance & Turnover
- Packing Marking & Shipping Instructions
- Supplier Data Requirements List and Definitions
- Document Control Requirements
- Forms & Examples
- Bank Guarantee
- Parent Company Guarantee
- Certificate of Acceptance
- Lien Waiver
5. Other Considerations and Guidelines
a) Contractual perspectives for both parties include:
- Limited warranty
- Disclaim implied warranties
- Disclaim consequential damages
- Firm prices, cost increase pass-through
- Delivery flexibility
- No indemnities
- Broad warranties
- Warranty for intended use
- Coverage for consequential damages
- Cost saving pass-through
- Time is of the essence – damages for delays
- Broad indemnities
b) Contractual breach remedies for each party include:
- Withhold delivery
- Stop delivery
- Resell & recover
- Damages for non-acceptance
- Rejection of offer
- Revocation of Acceptance
- Breach of Warranty
- Liquidated Damages
c) The following contractual areas could be onerous and each party should be mindful of:
- Consequential Damages
- Personal Injury
- Property Damage
d) Be aware the USA has stringent business practice laws which apply to contracts and include the following topics:
- Pricing (unfair or discriminatory)
- Market power (abuse of dominant position)
- Cartel (agreements to restrain competition)
- Exclusive dealings
- Export control
- Economic embargoes
- Foreign Corrupt Practices Act (FCPA)
e) International contracts have potential issues in multiple areas. These areas include, but are not limited to, the following:
- Scope of work
- Delivery Terms
- Force Majeure
- Termination & Default
- Taxes & Duties
- Choice of Language
- Choice of Law
- Choice of Jurisdiction
- Dispute Resolution
- Working Across Cultures
f) Another key factor of international contracts is working with different cultures, social norms and customs which can include the following topics / challenges:
- Geographic origin
- Migratory status
- Language or Dialect
- Religious Faith
- Ties that transcend kinship, neighborhood and community boundaries
- Shared traditions, values and symbols
- Literature, folklore & music
- Food preferences
- Settlement and employment pattern
- Special interest in regard to politics
- Institutions that serve and maintain the group
- Internal perception of distinctness
- External perception of distinctness
- Contract applications
6. Contract Applications
Many areas of the business process use contracts. The following are a few examples of those contractual document types:
- Letter of Intent
- Memorandum of Understanding
- Purchase Agreement
- Construction Contract
- Contract / Subcontract Agreement
- Confidentiality Agreement
- Non-Competition Agreement
- Technical Services Agreement
- Consulting Agreement
- Frame Agreement
Business contracting principles, elements and considerations are complex. This article is based on the author’s experience and US business contracting principles. It is intended to be educational and not to serve as the basis for any business decision. For more information about the content of this article or if support or guidance is needed with contract development or management systems, technical documentation development or business workflow analysis, contact the author at [email protected].