The Basics of Business Contracts and Agreements

Businesswoman writing on paper at desk
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Why Do We Need Contracts and Agreements? Back in the "olden days," there were few written business contracts. Many business and personal deals were done with a handshake. And if there was a problem, the two parties could take the issue to a court, who would hear it even if the contract was not put into writing.

Today, although a verbal contract is still legal (except for specific situations, most contracts are in writing. Contracts are very detailed these days, and every effort is made to make all possibilities clear. In addition to being clear, a contract must meet certain criteria to make sure it can be enforceable. A contract that is enforceable can be taken to court for a decision on a disputed item. If a contract does not have the essential ingredients, it is not enforceable.

Most contracts never see a courtroom and they could easily be verbal unless there is a specific reason for the contract to be in writing. But when something goes wrong, a written contract protects both parties. If one party to a valid (enforceable) contract believes the other party has broken the contract (the legal term is "breached") the party being harmed can bring a lawsuit against the party who it believes has breached the contract.

The legal process (called "litigation") determines whether the contract has been breached or whether there are circumstances that negate the breach. But, remember, the court will only hear a contract dispute if the contract is valid.

Difference Between a Contract and an Agreement

Many people use the terms "contract" and "agreement" interchangeably, but they are not precisely the same thing. Black's Law Dictionary defines an agreement as "a mutual understanding between...parties about their relative rights and responsibilities." It defines a contract as "An agreement between...parties creating obligations that are enforceable." 

Essentials of Business Contracts

There are six essential elements for a contract to be valid (enforceable by a court). The first three, considered here together, relate to the agreement itself; the other three relate to the parties making the contract

  • Offer, Acceptance, and Mutual Consent: Every contract must include a specific offer and acceptance of that specific offer. Both parties must consent of their free will. Neither party can be coerced or forced to sign the contract, and both parties must agree to the same terms. Implied in these three conditions is intent of the parties to create a binding agreement. If one or both parties are not serious, there's no contract.
  • Consideration: There must be something of value exchanged between the parties. The thing of value may be money or services, but both parties must give something (otherwise, it is a gift, not a contract).
  • Competence: Both parties must be of "sound mind" to comprehend the seriousness of the situation and understand what is required. This definition requires that neither party be a minor, both must be sober (not under the influence of drugs or alcohol when signing the contract), and neither can be mentally deficient. If one party is not competent the contract is not valid and the non-competent party can disavow (ignore) the contract. 
  • Legal Purpose: The contract must be for a legal purpose. It cannot be for something illegal, like selling drugs or prostitution. Remember that it is not illegal to enter into a contract that doesn't have all of these essential items; it just means that if an essential is missing the contract cannot be enforced by a court.

    When a Contract Has to Be in Writing and When It Doesn't 

    As noted above, verbal contracts can have the force of law, but there are some types of contracts that must be in writing, like long-term contracts and contracts for marriage (pre-nuptials). There is also such a thing as an implied contract. You can unknowingly enter into a contract with someone and be forced to abide by its terms.