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Contracts

What are legal contracts? Types, functions, and how they work

Whether they’re formatted into a physical document or created through verbal communication and a handshake, legal contracts are foundational in business. In this article, we’ll discuss what legal contracts are, the different types of legal contracts, how they work, and why you need them.

A legal contract is a legally enforceable agreement between two or more parties (e.g., property owners and tenants, businesses and customers, or employers and employees). One party makes a promise to fulfill an obligation to the other party in exchange for payment or action. 

Legal contracts contain the details of the agreement. This includes the obligations and responsibilities of each party as well as any terms and conditions.

Legal contracts drive significant benefits to all parties involved – let’s look at a few of them.

1. Clearly defines the terms and expectations of the agreement

Contracts remove confusion by defining terms and expectations. One example of this could be an agency that provides enterprise SEO services that drive measurable results. A contract would clarify that in exchange for these services, they’ll receive payment.

This helps both parties understand exactly what they’re agreeing to, reducing the risks of contract value erosion due to missed performance benchmarks and unmet obligations. 

According to the World Commerce & Contracting 2023 report, average contract value erosion is now 8.6% of contract value.

2. Safeguards the rights and interests of all parties involved

Contracts safeguard the legal rights and interests of all participating parties by protecting them from wrongdoing. Parties are formally aware of what they’re entitled to, such as compensation, performance quality, etc. 

3. Provides a legal basis for enforcing the agreement in court

Legal contracts serve as evidence that an agreement was made. This means that if one party doesn’t uphold their end of the deal or breaches the terms of their contract, the other party can take legal action.

4. Offers a framework for resolving disputes and misunderstandings

A well-communicated contract prevents and resolves conflicts, misunderstandings, and disputes. The details of the agreement are fully acknowledged and agreed upon by both parties, reducing contract value erosion.

5. Ensures all parties are held accountable for their commitments

Legal contracts hold parties accountable for the promises they’ve made. They ensure that participants know the legal ramifications of unmet terms and conditions, improving the quality of the agreed-upon obligations and encouraging collaboration.

This can be particularly beneficial when entering into agreements with suppliers and subcontractors, especially if you’re in a service-facing industry like hospitality. 

Read also: Are verbal contracts legally binding?

What types of legal business contracts can you enter into?

Written contracts

Written contracts are physical or digital legal documents that clearly outline the terms of the agreement. Both parties review and sign the contract to confirm their participation. Additionally, accurate data entry is crucial in the management of these documents, ensuring that all details are correctly recorded and easily accessible for future reference.

Verbal contracts

Verbal contracts are agreements that are made in person, over the phone, or by other means of spoken communication.

Contrary to popular belief, most verbal contracts are legally binding. However, the lack of physical proof of the agreement makes them difficult to prove in court, complicating dispute resolution. And, without a detailed contract to refer to, disputes are more likely to occur due to misunderstandings or uncertainty.

Implied contracts

An implied contract is an agreement that’s assumed to exist based on common laws or the actions and behaviors of parties, without a written or verbal agreement. For example, if a customer were to order food at a restaurant, it’s implied that they’ll pay for their food once they’ve finished.

Read also: Everything you need to know about electronic contracts

Express contracts

Express contracts explicitly detail all terms and conditions of the agreement, either verbally, in writing, or a combination of both. They aim to clarify each party’s role in the agreement. This way, the contract is easier to enforce in a court of law and is less prone to misunderstandings.

Similarly, in the technology sector, express contracts are used when companies provide digital services, such as VPNs, to ensure that both parties agree on the level of data security and privacy that will be maintained.

Unilateral contracts

A unilateral contract, or one-sided contract, is a legal agreement in which one party promises to complete an action once the other party has fulfilled the terms of the contract. In other words, it’s a promise in exchange for performance.

For example, a business might promise to pay SEO costs to a company after they’ve delivered specific performance results. These results could be anything that you’d see in a B2B SaaS SEO case study, such as a specified percentage increase in organic traffic. 

Bilateral contracts

Bilateral contracts are two-sided agreements. Each party has legal obligations to fulfill and terms to adhere to. Many business transactions, partnerships, rentals, and leases use bilateral contracts to help ensure that both parties are clear on their individual rights and responsibilities.

Adhesion contracts

In adhesion contracts, one party defines their terms, and the other party either accepts or refuses. They exist when one party has significant bargaining power over the other, leaving no room for negotiation. Mortgages, insurance, and vehicle purchases fall into this category. 

Elements of a legally binding contract 

What are the seven characteristics of a contract? Let’s find out.

1. Identification

Legal contracts must contain the up-to-date identifying information of all parties involved for the purposes of legal communication. This includes the full legal name/s of the businesses or individuals along with addresses, registration numbers, trading names, etc.

2. Offer and acceptance

The offer is the foundational element of the contract. It defines the actions one party promises in exchange for something of value from the other party, along with key terms.

The offeree can accept the contract verbally or in a written format. Written contracts typically require a signature to declare acceptance. For digital documents, parties can sign using legally binding electronic signatures.

3. Consideration

A valid legal contract must contain a promised exchange of value between two or more parties. The asset being traded (e.g., products, property, vehicles, or services in exchange for money) is known as the “consideration”. 

4. Mutual assent

The importance of understanding your contract is crucial, as a lack of mutual awareness can result in contracts being deemed void in a court of law. Mutual assent, or “meeting of the minds”, occurs when both parties recognize and comprehend their active contractual participation and responsibilities.

5. Capacity

All parties must demonstrate that they have “legal capacity” for a contract to be legally binding. If an individual signs a contract while under the influence of drugs or alcohol, for example, they’d be said to lack capacity. 

6. Legality

All contracts must abide by jurisdictional law to protect parties from risk. If one party were to perform an illegal activity in the process of creating or fulfilling the contract, then the contract would become void.

7. Certainty and completeness

Contracts must have clarity and precision to be considered valid. Any ambiguities or unreasonableness may render the contract void.

Read also: Electronic contracts vs. traditional contracts: A handy comparison

Many businesses use contract management platforms to automate and streamline the contract process. However, the fundamental process of how legal contracts work remains the same. 

Parties negotiate terms, propose, and may counteroffer

Parties can propose and negotiate terms to align the contract with their best interests. In B2B software, the most commonly negotiated terms are pricing, auto-renewals, and invoice periods.

Clear terms are documented in a legally binding contract

A legally enforceable contract must have clear, reasonable terms and conditions to be considered valid.

Both parties thoroughly review the contract before signing

Both parties must conduct a thorough review before the contract can be signed. Typically, enterprises take longer to sign B2B software contracts than small and medium businesses. 

Obligations are fulfilled according to contract terms

The obligations stated in the contract are carried out, and the exchange takes place. 

Legal recourse is pursued if contract terms are breached or disputed

If either party breaches the terms or fails to deliver on their promises, legal action may be taken against them. 

Conclusion

Legal contracts provide clarity to business deals, safeguarding you against contractual disputes. Be aware of what type of contract you enter into, ensure it includes all the essential elements, and follow the steps above to protect your business. 

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