Lesson 2: Bad Contracts

Sometimes, you just have to admit when you’re out of your league! Whatever you want to call it, acknowledging when you’re at the extent of your legal knowledge is the best way to approach a complicated legal situation. Even if you think that you fully understand every aspect of the contract you are entering, sometimes it’s worth an expert opinion (especially if it’s a BIG deal).

We mentioned the use of contract templates you can find online, and honestly, we get the appeal. Why would you pay for legal services when there’s an official looking document you can download free of charge? You may read over the free template contract and think to yourself, “All of this makes perfect sense and it applies to my situation. Woohoo!” and for simple, standard-form agreements between two parties, a template contract could indeed be an effective solution.

BUT, when you’re dealing with crucial aspects of your business like licensing agreements for intellectual property or supply agreements that span over multiple years, there’s going to be a lot of terms that you’ll want to include to protect you and your business. You might understand all of the terms in a sample licensing agreement, but you will most likely lack the expertise to recognize what’s missing, and what is missing from significant contracts is often just as important (if not more) than what’s included!

Representations are a pre-contractual turn of phrase that can impact the legal outcomes of your contract depending on what you said during negotiations. On its own, a representation is what you are saying about what is going to be in the contract. The issue arises when the representation turns into a misrepresentation. While not all misrepresentations (innocent mistakes) are punishable, any purposeful or malicious acts to induce a party into entering a contract can result in failure of that contract. This is where warranties come in. Essentially, they state that your representations are true, and provide indemnity (an exit) for the other party if the representations are false.

Having the wits to acknowledge what you don’t know has to come into play before the physical contracts are signed. When you’re negotiating with other parties, you should try to keep in mind the legal repercussions of representations and warranties. As a general rule of thumb, the distinguishing factor between the two can be boiled down to the idea of reliance: did someone rely on what I said when they entered into the contract, or was it just a nice after-thought?

The most important part of a contract, and the one that needs to be most carefully considered are conditions. Conditions are the actual terms of the contract, and are where the exchange of value is clearly laid out and both parties of the contract know exactly what they have to do. Failure to perform on the conditions you are bound to entitles the other party to terminate the contract and potentially even sue for damages.

Remember when we mentioned that a lot of real-world transactions end up going back and forth on negotiations, particularly on major contractual issues? With the idea of representations and warranties in mind, it can be difficult to keep track of what’s actually going to end up in the final contract. This is especially true when you’re nearing the end of your contractual negotiations and you accept the majority of the terms set out, but still want to amend a couple things. Does that mean you’ve accepted the contract?

The situation described is often called the Battle of the Forms, and usually it is the last contract exchanged that dictates the transaction. However, it’s not black and white so at a certain point, it may be helpful to have someone who knows the ins and outs of contract law and contract formation to be your guiding light when you’re negotiating. At the end of the day, you’ll know what is going to be important for your business, and making sure those contracts specifically set out what you’re looking for is key to your success.

Much of the disputes resulting from contract law is determining whether a contract that two parties signed is actually enforceable or not. We’ve seen a couple examples of uncertain terms, or ambiguous phrasing that would make it impossible to determine what a party meant, resulting in an unenforceable contract. That’s a perfect reason to sit down with a lawyer and see if they think your contract would hold up or not.

The other main area in which you may not have a legally valid contract, and therefore have major implications to your business, is when a contract is unconscionable. Unconscionability can take form in a couple of ways, but generally it means it's blatantly unfair to one party. The assumption is that two parties will enter into a contract on their own terms, so you may think it’s weird that any kind of negotiations would be unfair. While that’s frequently the case, for a small business or start-up negotiating with massive corporate entities there will be a large power imbalance to contend with. Getting hamstrung into signing a contract is often an underhanded business play that hurts many smaller companies, and if it extends into the threshold of unconscionability, there may be recourse for the affected party.

That being said, the idea goes the other way, too. If your business is entering into unfair contracts, or taking advantage of individuals with limited capacity (i.e., their mental cognition may not be sound), courts may find that those contracts are void. Businesses also need to be particularly wary about exclusion clauses that absolve the business of any liability in the event their product or service injures a consumer. Think about how many times you’ve skipped over the terms of service for apps you download or accounts you sign up for! There are strategies that a lawyer can present you with to make sure that your exclusion clauses hold up, even if the customer didn’t see them.

The last topic is pretty much a given, and it’s what a lot of people imagine their only interactions with contract lawyers would boil down to. If your business ever ends up in a contractual dispute, it could have serious ramifications on your business... and you don’t need a lawyer to tell you that. Whatever the penalties or awards to the other party are, they have the potential to make a huge dent in your bank account.

Astute readers of these guides will know that Goodlawyer is a strong proponent of starting early, planning ahead, and addressing legal problems when they arise. The best practices to mitigate the risk of contractual disputes, and to lessen any kind of damage that would come up follows those very principles. Having a lawyer on your side early, before there is even any dispute to begin with, can go a long way into the future success of your business.

These are the most likely avenues that a start-up or small business will use to secure its revenue stream. These contracts generally lay out the details and terms that you wish to conduct your business under and are a good way to outline the specific scope of what you’re willing to perform or sell in exchange for enumerated consideration (money).

There are a lot of ways to customize these contracts to suit your business needs. Payment can be lump-sums or periodic installments, payment can be delayed or asked for upfront, liability can be split different ways, shipping costs can be assigned to one party, and the list goes on. We’ve said it before and we’ll say it again: for important contracts like these, you should talk to a lawyer who understands your business.

Many entrepreneurs are sitting on a great idea they believe could change the world. The practical reality of the situation is that you need help to properly develop your idea, commercialize it, and distribute your idea to users. As it’s nearly impossible to do all of that on your own, relationships have to be formed with partners along the way.

There will be many instances where you (the business owner) will have to divulge the inner workings of your idea to a potential partner. In those instances, you want to make sure that legally, the party you are talking to doesn’t rip your idea off or tell someone else about it. This is where NDAs and Confidentiality Agreements come in. These contracts outline the terms and obligations of both parties regarding the treatment and divulging of confidential information, and the consequences for breaching the agreement by spilling the beans.

We can’t emphasize these agreements enough — if your company has important secrets that are key to its business, you need to make sure your partners and anyone who knows them are keeping their lips locked tight.

These documents are really important for the internal governance of your corporation. As we’ve mentioned in Lesson 1, having a strong foundation to build your corporate structure on is instrumental to long-term success. Without agreements like this, shareholders can do anything they want with their valuable shares in your corporation. These contracts install a sense of certainty and security in managing your relationships with shareholders, and if constructed correctly, can provide the business owner(s) with a lot of control into how they want to see their operation run.

As you expand your business, these documents become even more important as various parties start entering your company in the form of outside investors and directors. Having strong corporate governance will allow you, the founder, to focus on what you do best without having to expend a lot of time and energy diving into the weeds of corporate law.