Navigating Business Contracts: What you need to Know.

5 May 2023 in Business Law, Commercial Lawyers

Contracts are a fundamental part of conducting business. They are legally binding agreements that govern and regulate the terms and conditions of a business relationship. It is crucial for business owners to understand the essential elements of a contract to ensure their business is protected and they are dealing with a valid contract. This article will explore the basics of contract law, common types of business contracts and best practices for contract negotiation and management.

1. Understanding Contract Law

A contract exists when there is a legally binding agreement between two or more parties that creates obligations that can be enforced by law. Contract law is largely based on common law principles as well as legislative provisions such as the Australian Consumer Law and the Competition and Consumer Act 2010 (Cth), the Contracts Review Act 1980 (NSW) and various other legislation including industry specific legislation such as the Motor Dealers and Repairers Act 2013 (NSW) and the  Home Building Act 1989 (NSW).  Contract law governs the formation, performance and enforcement of contracts.

In the context of business contracts, contract law is particularly important as it can help ensure that parties understand their obligations, rely on the other party to perform their obligations and hold each other accountable if those obligations are not properly performed.

For a contract to be valid and enforceable by law it must satisfy a number of legal rules or contract elements.  There must be offer, acceptance, consideration, mutual agreement and an intention to create legal relations.

There are less frequently encountered rules, such as the requirement for each party to have legal capacity or the legislative requirement for some contracts to be in writing.  These rules are beyond the scope of this article. The highly experienced Contract Lawyers at BSM are happy to provide advice on these more legally complicated issues.

Offer

An offer is a promise to do something made by one party to another in exchange for a promise in return, indicating a willingness to be bound by a contract on specific terms. An offer can only be the basis of a binding contract if it contains the key terms of the contract.

An offer can be oral or in writing.  Offers involving complex matters should be provided in writing. 

An offer may be revoked prior to acceptance.

Acceptance

Acceptance occurs when the other party agrees to the terms of the offer.  The acceptance must be an unqualified acceptance of all of the terms of the offer.  The acceptance must be communicated orally, in writing or by conduct of the accepting party.  One exception to the rule regarding communication relates to unilateral contracts (which are not explained in this article) and which do not require communication of acceptance.

An offer may be rejected by a statement to the offeror that the offer is rejected, by allowing the offer to expire beyond the date of validity or by making a counteroffer.  A counteroffer may take the form of the original offer with some amended terms, for instance the seller agrees to sell a motor vehicle to the offeror at the price in the original offer but not until a date 30 days later than expressed in the original offer.

A counteroffer has the legal effect of rejecting the original offer.  However, a counteroffer may be accepted by the other party.

Offer and acceptance in complex transactions should always be in writing.  However, in daily transactions this is not necessary.  For instance when a consumer buys a loaf of bread the offer is in the form of offering money to pay the price and acceptance is simply the shop keeper accepting the money,

Consideration

Contractual Consideration refers to something of value that each party promises to provide to the other as part of the agreement. This could be money, goods or services. For example the offer may be a promise to provide a motor vehicle in exchange for the promise to pay the purchase price.  The purchase price is the consideration for the motor vehicle. 

Mutual Agreement

Mutual agreement occurs when both parties have a clear understanding of the terms of the contract and have consented to them.  There is a common understanding of the formation of the contract. This is often referred to as a meeting of the minds and is determined objectively.

Intention to be Legally Bound

The parties must intend to be legally bound by the agreement for the contract to be a legal, valid and enforceable contract.  This intention can be inferred from the circumstances.

There is a presumption at law that friends and relatives do not intend their agreements to be legally binding and that there isn’t an enforceable contract. There is an old but interesting English case Balfour v Balfour 1919 in which the husband left England to work in Sri Lank (Ceylon at the time), the wife decided to remain in England during this time and the husband orally offered to pay her 30 English pounds per month.  The wife found another partner and commenced legal proceedings to enforce the husband’s promise to pay her 30 English pounds per month.  The Court (the King’s Bench) found that the husband did not intend to create legal relations and the promise was not legally binding.

Breach of Contract

A breach of contract is when one of the parties involved fails to perform one or more of the party’s obligations under the contract. The legal consequences of breach of contract can vary depending on the specific circumstances, but may include damages, termination of the contract and possible legal action.

For any breach that results in loss to the non-breaching party damages will be available.  Damages may be awarded to compensate the non-breaching party for any losses suffered as a result of the breach. Termination of the contract will only be available to the non-breaching party where the breach is serious or fundamentally undermines the purpose of the contract. 

In some cases, legal action may be necessary to enforce the contract or seek damages for the breach. This may involve simply making a demand, relying on any dispute resolution clauses in the contract, going to court or resolving the dispute through alternative dispute resolution such as mediation or arbitration.

2. Key Function of Business Contracts

There are several common types of business contracts that companies may encounter, including supply agreements, distribution agreements, construction contracts, leases, loan agreements, shareholder agreements, advertising and marketing agreements, talent agreements, settlement deeds, employment contracts, vendor agreements and non-disclosure agreements.

In very broad terms contracts should govern and regulate three elements of any transaction, quality (including timing), price and risk.

It is important that key contracts are properly negotiated and drafted. A properly negotiated and drafted contract will ensure that the parties understand their obligations, can rely on the other party to perform their obligations and can seek redress in the event the other party does not properly perform its obligations.  A party’s obligations should be properly and clearly drafted to describe, the scope and quality of the goods or services to be delivered pursuant to the contract. 

Contracts also perform the important function of allocating risk between the contracting parties. In general risk should be allocated to the party best able to manage that risk.  Accepting obligations is a contract obviously carries the risk of non-performance.  However, key contractual clauses can also be used to allocate risk, such clauses include: limitation of liability, which limits a party’s liability to a predetermined amount; release clauses which provide that one party may release the other party from claims in certain circumstances; and indemnity clauses which determine the circumstances in which one party will be liable to the other and may extend such liability beyond the usual liability for breach of contract and may determine the types of damages that a party may recover.  

Contracts also govern the manner and timing by which payments are made under the contract.  It is important that the party receiving payment ensures that the other party’s payment obligations minimise the risk of non-payment by providing payments at suitable times using a secure method and may require security for such payment.  Security (such as bank guarantees of letters of credit) for promises to pay are particularly important for large payments or where the payer is overseas.

3. Best Practices for Contract Negotiation

 Contract negotiation is a crucial part of business transactions, and preparing for it effectively can ensure that you secure the best possible outcome for your business. One tip for preparing for contract negotiation is to ensure that you have a thorough understanding of the contract and the key terms that are relevant to your business’ needs. It is also essential to understand the other party’s interests and objectives to be able to negotiate a mutually beneficial agreement.

When negotiating a contract, it is important to have a clear understanding of what your business wants to achieve from the agreement. This can include specific terms and conditions that you want to include in the contract or aspects of the agreement that you are willing to compromise on. Developing a clear negotiation strategy includes identifying the elements of the transaction which are non-negotiable and the elements of the transaction which are negotiable for your business and preferably the other party as well.  Such a well planned negotiating strategy will assist you to achieve your objectives while maintaining a positive relationship with the other party.

Contracts may be amended after formation of the contract by the mutual agreement of the parties.  It is important that any amendment is properly drafted and documented. Documenting amendments to the contract is another important aspect of contract negotiation. Keeping detailed records of any amendments can help to ensure that both parties are clear on the terms of the agreement and amendment and can minimise the risk of misunderstandings and disputes later on.

By following these best practice principles, you can increase the likelihood of securing a favourable agreement for your business and avoiding costly disputes.

4. Best Practices for Contract Management

Effective contract management is essential for ensuring that the other party is performing its obligations and managing the planning the performance of your own business’s obligations. Effective contract management is also important to ensure that any risks presented by a contract are properly managed and addressed by your business.

Organising and storing contracts in a consistent and accessible manner is an important part of contract management. One tip for organising contracts is to develop a filing system that makes it easy to find the relevant documents when needed. It is also important to keep backups of important documents. 

Tracking contract milestones and deadlines is another crucial aspect of contract management. This can include dates for deliverables, payments and renewals, as well as any other important deadlines or milestones outlined in the contract. Establishing a clear process for tracking these milestones can help to ensure that they are met in a timely manner and that both parties are meeting their obligations under the agreement.

Allocating responsibility to key staff for the performance and management of the contract is an essential element of proper contract management.

In the event of contract disputes or conflicts, it is important to have a clear strategy in place for addressing these issues. One strategy is to first attempt to resolve the issue through negotiation or mediation, which is more cost-effective and less time-consuming than legal action. If negotiation or mediation is not successful, however, it may be necessary to pursue legal action to resolve the dispute.

By following these best practice principles, you can ensure that your business is effectively managing its contracts and minimising the risk of disputes.

Navigating business contracts can be complex, but it is essential to ensure your business’ success and protection. Understanding contract law, common types of business contracts and best practices for negotiation and management can assist in making informed decisions and mitigating risks. 

We recommend seeking professional legal advice when looking to develop, draft and negotiate a contract. Brander Smith McKnight’s team of expert business lawyers are here to ensure you make the best decisions for your business.