Master the fundamentals of business contracts with these tips

13/10/2017

business contract fundamentals

business contract fundamentalsAs with the purpose of any legally binding contract, the overarching purpose of building an international trade contract is to protect the interests of all parties involved. However, contracts that are written to do business with a foreign market are different than those created for domestic business deals.

A contract is a written or oral promissory agreement between two or more parties to do a particular activity or enter into a relationship enforceable under the law.

When developing a contract, there are specific fundamentals to consider to avoid disputes and set the stage for smooth market entry. The activities leading up to a contract are also worth noting to gain a holistic understanding of the contract process and where things may go awry.

Additionally, there are some principles which are common to both civil and common law that can be summarized in the following ways:

  • A contract is a voluntary agreement.
  • A clear offer must be made and the offer must be clearly accepted.
  • The contract must pertain to a legal activity, that is one not prohibited by the Criminal Code.
  • Contracts must not subvert ethical behaviours or expectations, for example, an employee should not be made to sign a contract for life.
  • The contracting parties are legally bound to the rights and obligations established in the contract.
  • If contractual obligations are breached without a valid legal reason, courts can enforce them.

The elements of a contract

In contrast to a promise or agreement, which are not binding, a contract is a legally enforceable arrangement. As such, an understanding of the elements required for a contract to be binding is necessary.

There must be an exchange of value between the individuals or organizations that enter a contract. These individuals, or organizations, are called the contracting parties. The value exchanged can be money for goods, goods for services, money for services, and other similar exchanges.

The exchange of value for the contract is referred to as the consideration. Consideration must be present for a court to enforce the contract against a party who is not living up to the terms and conditions of the contract, otherwise known as the breaching party.

The Four Corners of a contract

The elements of a binding contract are often referred to as the Four Corners of a contract. A contract must have all four elements present—otherwise, it is a considered an agreement.

The following is a description of each component of the Four Corners:

  • Offer: A promise to perform specified acts on certain terms. The offeror is the person who makes an offer. The offeree is the person to whom an offer is made.
  • Acceptance: An unqualified willingness to contract on exact terms specified. Communication of acceptance is essential. This is an unconditional assent to the offer in its entirety.
  • Consideration: The price paid for a promise. Each party must receive something of value, money or otherwise, from the other. If an agreement is reached to alter or amend a contract, the consideration must also be revised to reflect the changes.
  • Legal intention: The promise must be intended to be a contractual one that can be legally enforced by the courts. If the contract is for a business relationship, there is a legal presumption that it is intended to be binding.

When developing contracts, international trade practitioners will need to ensure that the contract is enforceable by including these four basic components.

How do I differentiate an LOI from a contract?

A Letter of Intent (LOI) or Memorandum of Understanding (MOU) is often used when parties are considering doing business with each other or considering purchasing real estate, capital equipment or other property. At this stage in building a contract, each party has yet to reach a final understanding of what their contractual relationship will look like.

LOIs and MOUs frequently end up in court because one party thinks they have reached a solid understanding, and the other party thinks the document only represents a preliminary negotiation. The best way for an organization to protect its business when using these documents is to place a statement on each page that reads:

THIS DOCUMENT REPRESENTS PRELIMINARY DISCUSSIONS ONLY. THIS IS NOT A BINDING CONTRACT.

It should be noted that under some legal interpretations, if an MOU meets all four of the requirements of a contract, it may be considered as a contract no matter what the documents are called.

Does an email ever count as a contract?

In many situations, a contract can be formed by an exchange of emails. It is important to be cautious, as it is possible to inadvertently become obligated to perform a contractual undertaking even if one party considered email exchanges as preliminary negotiations.

The way to handle this risk is to ensure that email communication only contains preliminary negotiating, and there is no obligation by either party until both enter a mutually signed written agreement.

Battle of the forms

It is not uncommon for issues to arise when contracts are piggybacked on to other processes and forms.

Many companies do business with their suppliers by issuing purchase orders with the major business terms on the front of the purchase order form, such as the price, the quantity of goods, the delivery date or the shipping method. On the reverse side are pre-printed legal terms and conditions.

Suppliers will then send back their acknowledgment form, which has different terms and conditions on its reverse side. These terms and conditions on both forms will often conflict. Lawyers tend to call this situation “the battle of the forms”, as it is not always clear which side will prevail if a dispute arises.

It is not recommended to stop using pre-printed forms for routine transactions as they enable business to be conducted more efficiently. Rather, for significant transactions that involve major revenue or financial risks, it is important to use a mutually signed written contract prepared by a qualified attorney.

For example, multimillion dollar purchases should never be made using an exchange of pre-printed forms. Such forms are more appropriate to smaller purchases, such as routine office supplies.

Written contracts—the gold standard

While a contract does not need to be in writing to be enforceable, the best practice is to negotiate a written contact that is signed by both parties. A properly drawn, written and enforceable contract must have six fundamental aspects. The contract must:

  • Be based upon an exchange of value, such as money for goods.
  • Identify the subject matter, the identities of the parties and the value exchanged.
  • Describe the promised duties and responsibilities of the parties in performing under the contract.
  • Allocate risk between the parties.
  • Set forth a dispute resolution process.
  • Be mutually signed with an effective date and term.

There are serious risks when parties solely rely on verbal agreements, as there is a lack of proof if the parties disagree about their respective obligations. In some jurisdictions, verbal agreements are not enforceable in court, especially for real estate transactions and transactions over a specified dollar amount.

Many entrepreneurs in small-and-medium-sized businesses (SMEs) prefer to save money by drafting their own contracts with forms found on the Internet. Unfortunately, this practice can eventually result in a higher cost than paying legal counsel to draft a contract in the first place.

Beware of verbal modifications of written contracts

Even after taking the time to negotiate a mutually signed written contract, many organizations agree to verbal modifications of the contract, such as delayed delivery dates or changed quantities. Then, if a dispute arises at a future date, one party may be trying to argue the terms in the original contract, while the other party may argue that the verbal modification is the agreement that should be enforced.

Avoid being put in this position by ensuring that everything is documented in writing and both parties mutually sign any modifications to the original contract. As noted above, each modification must be supported by a revised consideration.

What’s the best way to handle service contracts?

A challenge for practitioners entering service contracts in the foreign market is to accurately define the services being provided. Services are much harder to quantify than a contract for the sale of physical goods where, for example, a written product specification exists, such as a schematic and materials list for a motorcycle.

Describing the measure of performance is important in a service contract. If the level of service cannot be documented, it can be almost impossible to prove a breach of contract if the service was unsatisfactory. The challenge can be even greater in international transactions because of cultural differences and differing expectations for service levels.

The best way to handle service contracts is to attach a very detailed statement of work to the contract which documents exactly what the service provider has agreed to provide along with completion milestones. A common mistake that leads to disputes and litigation is when contracting parties fail to take the time necessary to develop an appropriate statement of work.

This content is an excerpt from the FITTskills International Market Entry Strategies 7th edition textbook. Discover a new way to learn with our practical, flexible, leading edge global trade training.

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About the author

Ewan Roy

Author: Ewan Roy

I'm a Content Marketing Specialist for the Forum for International Trade Training (FITT). My background is in writing and research, and I am passionate about communicating new ideas and telling stories that matter to you.

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