Contract Law 101

Key Takeaways:

Contract law governs how legally binding agreements are formed, enforced and remedied when breached, making it foundational to your business operations. A valid contract requires an offer, acceptance, consideration, capacity and legality, and well-drafted agreements should clearly define scope of work, payment terms, liability limits, intellectual property ownership and dispute resolution procedures. Relying on verbal agreements, vague terms or generic templates increases the risk of costly disputes, financial loss and reputational harm. When a breach occurs, remedies such as financial damages, specific performance, rescission or restitution may apply depending on the circumstances. Working with an experienced business attorney helps ensure your contracts are enforceable, aligned with state law and structured to protect your long-term interests.

Contracts form the backbone of your business operations. They govern just about every relationship your business enters into, including agreements with employees, contractors, customers, vendors and other businesses. When contracts are written properly, they clearly spell out the responsibilities of each party and provide important protections for your business. But a poorly written contract can expose your business to costly disputes and other financial liabilities that can damage your reputation and negatively impact your long-term success.

Due to the high stakes associated with the contracts your business enters into, it’s critical to understand the legal implications of these contracts and how they can potentially impact your business in the event of a breach or some other dispute. While the following overview will help you understand the ways in which contract law impacts your business operations, you should always work with a business attorney who can make sure your contracts are legally enforceable and protect the interests of your business.

contract law conceptual image - juridical contract on wooden table with pen and hammer

What Is Contract Law and Why Does It Matter for Small Businesses?

Contracts are legally binding agreements that create obligations between two or more parties. A well written contract will outline the specific terms of the agreement, the responsibilities of each party and the legal consequences for failing to uphold your end of the contract.

Contract law is the area of law governing how contracts are created and enforced. These laws spell out:

When a valid contract exists
When contracts are legally enforceable
The potential consequences when one party fails to fulfill their contractual obligations

Contract law is important because it provides your business with a legal path forward if something goes wrong with the fulfillment of the agreement. Contract law provides you with a variety of important protections when you enter into relationships with other parties, including:

Clarifying expectations
Reducing disputes
Protecting cash flow
Safeguarding intellectual property (IP)

All agreements you enter into, regardless of how simple or complex they are, will be governed by contract law. The rights and protections your business receives can by critical in the event of fraud, a breach of contract or the presence of a contract dispute.

Essential Elements of a Valid Contract

In order for a contract to be considered valid and legally enforceable, the following key elements must exist:

Offer – A clear proposal made by one party to the other. The offer must contain the concrete terms that each party must fulfill as part of the contract.
Acceptance/Counteroffer – The other party agrees to the terms of the offer as they are stated. If the other party wishes to change the terms stated in the initial offer, this is considered a counteroffer, which restarts the process.
Consideration – Each side must provide something of value to the other as part of the contract. This “consideration” can involve money, goods, services or a promise not to do something.
Capacity – Both parties must be legally able to enter into the contract. Individuals who lack capacity to enter into a contract are typically minors or people who are deemed mentally incompetent. Capacity can also apply to a representative of a corporation who is entering into the contract on the behalf of the organization.
Legality – The purpose of the contract must be legal. Agreements to perform illegal acts will not be enforceable.

table containing a signed contract and a pen

Common Types of Contracts Used by Small Businesses

Your business will need to enter into many different types of contracts as part of your ongoing operations. Some of the most common contracts used by small businesses include:

Service Agreements – These contracts govern relationships with third-party service providers such as consultants, creatives, contractors and marketing agencies.
Sales and Purchase Contracts – These contracts are entered into when you sell products to other parties or make purchases from another provider. They also govern distribution agreements associated with sales and purchases.
Employment and Independent Contractor Agreements – These contracts govern relationships with your internal employees or independent contractors who perform work similar to what would be completed by an internal team. They define the scope of work and compensation expected as part of the agreement.
Commercial Leases – These contracts cover all the terms associated with any commercial property you rent as part of your business operations, such as rent, build-out obligations, maintenance requirements, renewal options and personal guarantees.
Non-Disclosure Agreements (NDAs) and Confidentiality Agreements – These contracts protect your trade secrets, customer lists, pricing models, proprietary processes and other sensitive information that is critical to your success.
Partnership, Operating and Shareholder Agreements – If your business includes multiple owners or stakeholders, these contracts will govern how each party shares profits, how decision making is handled and the protocol for an owner exiting the company.

Key Contract Clauses Every Small Business Should Understand

An effective contract should include all necessary clauses to clearly define what is expected of each party and the rights of each party in the event that the terms aren’t fulfilled. While the exact clauses included in each contract will vary based on the specifics of the agreement, it’s important to understand the following essential clauses to ensure they’re addressed when necessary:

Scope of Work and Deliverables – This clause defines exactly what will be done, when, where and to what standard.
Payment Terms – Items covered in this clause include price, invoicing, due dates, late fees, deposits/retainers and milestones.
Term and Termination – This clause defines the length of the agreement, as well as any conditions associated with renewal or termination (whether cause is required, notice periods for ending the contract, etc.).
Warranties and Disclaimers – This clause defines any promises that are made about the quality or performance of the products/services being provided.
Limitation of Liability – This clause defines any caps on damages in the event of a breach, as well as any types of damages that may be excluded from liability.
Indemnification – In the event that a third party not involved in the contract sues or makes a claim for damages, an indemnification clause will define which party is responsible for covering any costs associated with the claim. This clause provides legal and financial protection for one party when an issue is caused by the actions of the other party.
Confidentiality and Non-Disclosure – These clauses define how sensitive information will be protected and how long the information remains confidential.
Intellectual Property Ownership – This clause defines who owns a product or idea that is created, when licenses are granted and how intellectual property can be used.
Dispute Resolution – This clause defines the process for resolving contract disputes, such as whether arbitration or mediation will be required prior to litigation and who is responsible for covering attorney’s fees.

These clauses define actionable obligations between each party. Failing to adhere to the terms of these clauses can result in serious consequences for the party in breach.

Important Contract Pitfalls to Avoid

By far, the most common contract mistake made by businesses involves entering into verbal or “handshake” agreements. When contracts aren’t put in writing, it can create ambiguity regarding the terms of the agreement and the specific obligations associated with each party. This ambiguity increases the risk of a costly contract dispute that can easily be avoided if the terms of the agreement are clearly spelled out in writing.

Other common contract mistakes to avoid include:

Including vague or incomplete terms regarding price, timing, deliverables and scope of work
Using generic contract templates that don’t align with the specific terms of your agreement or adhere to your state’s law
Signing a contract without understanding key clauses such as auto-renewal, personal guarantees or broad indemnities
Failing to have your small business attorney review a contract drafted by the other party
Failing to clearly state how risk and liability will be handled
Failing to outline how dispute resolution will be handled

The best way to avoid these mistakes is to have every contract either written or reviewed by a contract law attorney who can ensure the agreement is legally enforceable and protects your best interests.

What Happens When a Contract Is Breached?

Even when a contract is clearly written and contains all necessary clauses, it’s possible that one party will fail to fulfill their obligations. When this occurs, it is called a breach of contract. Common examples of breach of contract include:

Late performance or non-performance of services
Failure to deliver products
Providing poor quality work
Failure to provide payment for products/services provided
Violating important clauses of the contract, such as a confidentiality clause

Contract law provides you with a set of remedies you can pursue when there is a breach of contract by the other party. These remedies are intended to fairly compensate you for any damages you incurred due to the breach and restore you to the position you’d have been in if the contract had been completed as agreed.

Some of the most common remedies available after a breach of contract include:

Financial Damages – The breaching party provides financial compensation to cover direct monetary losses suffered by the breach.
Specific Performance – In rare cases, the breaching party may be required to fulfill their contractual obligations. This remedy is typically imposed only in situations where monetary damages won’t provide fair and adequate compensation, such as in real estate deals.
Recission – The contract is canceled, and both parties are restored to their pre-contract position. This remedy is often imposed in cases where the breaching party made a mistake or was guilty of misrepresentation.
Restitution – This remedy often accompanies recission, and it requires the breaching party to return any benefit received from the non-breaching party’s fulfillment of their end of the agreement.

Elizabeth Lewis Can Help with Your Business Contracts

Due to the important role contracts play in the success of your business and the complex nature of many of these agreements, it’s critical to work with an experienced contract lawyer who can make sure your interests are protected. At the Law Office of E.C. Lewis, we regularly assist small businesses with their contracts, and we can provide the important guidance you need when entering into a wide range of business agreements.

Elizabeth Lewis has been providing comprehensive legal services for small businesses since 2007. Her contract law services include:

Drafting your contracts to ensure the terms are clear, enforceable and protect your best interests
Reviewing contracts from other parties to help you avoid getting stuck with unfair terms
Customizing contracts to address your unique industry, risk tolerance and growth plans
Translating legal jargon into clear, practical terms so you understand what is involved in the agreement you’re signing
Setting up templates for recurring deals you make as part of your business operations, such as client agreements or contractor agreements
Helping you resolve contract disputes efficiently and, whenever possible, without litigation

Contact us today to schedule a consultation. The Law Office of E.C. Lewis serves clients in Denver and throughout Colorado.