When you start a business, you must decide

Starting and Running a Small Business:

Put it in Writing: Small Business Contracts

As the owner of a small business, it’s likely that you’ll often encounter both written and oral contracts. The most important piece of advice about contracts is obvious: Put all important agreements in writing. This chapter shows you how, and tells you what to do if something goes wrong.

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A. What Makes a Valid Contract

A valid contract requires two and sometimes three elements:

• An agreement (meeting of the minds) between the parties.

• “Consideration”—a legal term meaning the exchange of things of value.

• Something in writing, if the contract covers certain matters, such as the sale of real estate and tasks that can’t be completed in one year.

For example, suppose you’re opening a new store. You meet with Joe, a sign maker, to discuss the construction and installation of a five-foot by three-foot sign. Joe offers to do the work for $450 and to have the sign ready for your grand opening on June 15. “It’s a deal,” you say. You now have a legally binding contract, enforceable in court or by arbitration. All the necessary elements are present:

• An Agreement. Joe offered to build and install the sign at a certain price by a certain date. You accepted the offer by telling Joe, “It’s a deal.”

• Consideration. The two of you are exchanging something of value. You’re giving your promise to pay $450. Joe is giving his promise to build and install the sign.

• Written Agreement Not Required Here. Normal business contracts that can be performed in less than a year don’t have to be in writing to be enforceable.

To understand why “consideration” is important, let’s explore the difference between a contract and a gift. Assume that Joe installs the sign on time and you pay him $450 as agreed. Impressed by the high quality of his work, you say: “Joe, to thank you for the great job you did, I’m going to send you a $100 bonus next week.” Can Joe enforce your promise to pay the bonus? No. He got what he bargained for—the $450 payment. He didn’t promise you anything (consideration) for the extra $100 payment. If you pay it, fine. If not, Joe can’t force you to.

1. Negotiations

Negotiations, which may or may not lead to an agreement, do not constitute a contract. So if instead of meeting face to face with Joe, you call him and describe the job, and he says he can probably do it for about $450, you don’t have a contract.

2. Offer and Acceptance

If after negotiations, two people reach an agreement, a contract is formed. Say that after discussing the job with you by phone, Joe promptly sends you a letter in which he says: “I can build and install the sign shown on the enclosed sketch for $450. I’ll have it in place by June 15 when you open. You can pay me then.” You send back a fax saying: “Sounds good. Go ahead.” This is a valid contract. Joe has made a clear offer. You’ve just as clearly accepted that offer. The fact that you and Joe didn’t meet face-to-face and didn’t even use the same type of communication medium doesn’t alter this conclusion.

In this example, you accepted Joe’s offer promptly. But what if you’d waited two weeks or two months to accept? The legal rule is that an offer without a stated expiration date remains open for a reasonable time. What’s reasonable depends on the type of business and the facts of the situation. If you’re offered a truckload of fish or flowers, it might be unreasonable to delay your acceptance more than a few hours or even minutes, while an offer to sell surplus wood chips at a time when the market is glutted might reasonably be assumed to be good for a month or more. But there’s really no need to tolerate any uncertainty in this regard. Include a clear deadline for acceptance when you present an offer. If you want to accept an offer, do it as promptly as possible.

3. Counter-Offers

In the real world, negotiations aren’t usually as simple as making an offer and having it accepted. And until an agreement is reached, there’s no contract.

For example, say Joe sends you the letter offering to provide your sign for $450. You call his office and leave a message on his voice mail saying: “Go ahead, but I can only pay $400.” So far, there’s no contract. By changing the terms of Joe’s offer, you’ve rejected it and made a counter-offer. The two of you are still negotiating. If Joe calls back and says, “Okay, I’ll do it for $400,” you now have a binding contract. Joe has accepted your counter-offer. Again, the fact that you and Joe weren’t in the same room or never spoke to each other isn’t significant. What is key is that one of you made an offer (in this case, in the form of a counter-offer), and the other accepted it.

4. Revoking an Offer

Until an offer is accepted, it can be revoked by the person who made it. So if you’re about to write Joe a letter accepting his offer, and Joe calls to revoke his offer because he’s decided $450 isn’t enough, you’re out of luck. Joe revoked his offer before you accepted it, so there’s no contract.

How an Offer to Contract Ends

• The person who made the offer revokes it before it’s accepted.

• The offer expires. Example: “This offer will expire automatically if I don’t receive your acceptance by noon on May 10.” But unless you’ve been paid something to keep the offer open (as is common for an option to buy real property), you (the offeror) can still revoke the unaccepted offer before the period for acceptance expires.

• A reasonable time elapses. As discussed in Section 2, above, there are no hard and fast rules as to what’s reasonable. It all depends on circumstances and the practices in your industry.

• The offer is rejected. If you reject an offer and then change your mind, it’s too late. To get the deal going again, you’ll need to make an offer to the other party.

• Either party dies before the offer is accepted.

5. Option to Keep Offer Open

If you want someone to keep an offer open while you think about it, you may have to pay for the privilege. If you do, and the person who made the offer agrees to keep it open, your agreement (which is itself a contract) is called an “option.” Options are commonly used when real estate or businesses are sold.

To stay with our sign example, say that when Joe sends you the letter offering to provide your sign, you tell him you’re not ready to respond yet, but you want to be sure the offer will stay open while you think about it. Joe responds that if you pay $100 now, he’ll keep his offer open for two more weeks. You pay the $100 and accept the offer within the two-week period. The resulting contract would be valid even if Joe tried to withdraw his offer before the end of the two-week period. You and Joe already have a contract (an option), which consists of your right to purchase his services at the $450 price if you act within the two-week period. He received something of value (your $100) in return for granting you this option.

6. How Offers Are Accepted

Usually, offers are accepted either in writing or orally. But that’s not always necessary. It is an area of considerable legal complexity, but generally an offer can be accepted by a prompt action that conforms with the terms of the offer. For example, you might leave the sign builder Joe a note at his workshop, saying “Please add a red border to this sign today; I’ll pay you an extra $100.” Joe comes back that afternoon and adds the red border. You’re obligated to pay him.

7. An Advertisement as an Offer

Under traditional contract law, ads are considered only invitations to negotiate or to make an offer; you have no obligation to go through with the deal just because someone offers to meet your advertised price. So if a customer appears and says she wants to buy the house, land or business that you advertised in the classifieds for $200,000, there’s no binding contract. One major exception to this rule involves rewards. Generally, an ad offering to pay a reward is binding if someone performs the requested act.

Consumer protection laws have also changed this traditional rule. For example, the law in many states requires merchants to stock advertised items in quantities large enough to meet reasonably expected demand, unless the ad states that stock is limited. And some states require the merchant to give a rain check allowing the consumer to purchase the same merchandise at the same price at a later date.

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B. Unfair or Illegal Contracts

What if a person makes a bad bargain? Suppose you agree to pay $800 for a used laser printer that’s worth only $200. Can you call off the deal on the ground that the contract was grossly unfair? Probably not. As long as there’s a valid contract, it doesn’t usually matter whether or not the item is objectively worth the price paid for it.

Sometimes, however, a court sets aside a contract if the terms are unconscionable—that is, shockingly unfair. For example, a judge or arbitrator may release an unsophisticated consumer (say a recent immigrant with a language problem) from a grossly unfair contract extracted by a sophisticated, high-pressure salesperson. Applying this principle of law, a contract to sell a $500 television for $5,000 might be set aside. But even though a judge might cite contract law, the decision would probably be based more on the doctrine of fraud or misrepresentation. Or the decision might be based on a state consumer protection statute that prohibits taking advantage of someone who can’t protect his or her interests because of disability, illiteracy or a language problem.

When it comes to reasonably experienced business people working out contracts with each other, however, unfairness is rarely if ever a legal ground for setting aside a contract. Usually, a party who negotiates a bad deal is stuck with it.

If a contract clause is illegal or against public policy, a judge or arbitrator won’t enforce it. For example, a remodeling contract stating that neither party will obtain a legally required building permit would be void as a violation of public policy, as would a similar contract obligating a party to bribe a building inspector.

Excerpted from the “Legal Guide for Starting and Running a Small Business”, by Fred S. Steingold