Contracts come in all shapes and sizes, from small 1 page agreements between individuals to hundred page, multi-billion dollar deals between major corporations with a team of lawyers, bankers and advisors working for each side. Regardless of the size, however, only three elements are required in order to have a binding contract: an offer, acceptance of the offer and consideration. Put another way, a contract is an agreement where there is a promise to do something in return for a “valuable benefit.” Once the fundamentals of a contract are established, however, parties are free to negotiate in a manner that befits their particular situation, provided they do so in good faith and without fraud.
When analyzed, contracts, both large and small, are made up of six basic categories. At times (especially with smaller agreements), these issues will not be explicitly stated in the contract, but will, rather, be implied by law. These default rules are a construct of both case law and statutory law, with Article 2 of the Uniform Commercial Code being the primary means of “filling the gaps.” In larger agreements, most of these issues will be spelled out with exacting detail. While this list contains broad headings, it does provide an overview of what to look for in a contract. The 6 issues inherent in all contracts are as follows:
1. Rights and Obligations Under the Contract. The fundamental issue in all contracts determines who is obligated to perform under the contract and who is entitled to the benefits of that performance. Those with rights can be the individual signing the contract, the company on whose behalf the signatory is signing, “successors in interest” (i.e., a company that subsequently purchases the original beneficiary), and sometimes “third party beneficiaries.” Those with obligations under the contract are the signors and their successors, but may also be guarantors, co-signors, or other parties subject to “joint and several liability.” For example, a partner will be liable for contracts entered into by his/her partners regardless of whether he/she signed the contract individually.
2. Representations and Warranties. Representations and warranties relate to the underlying matters and facts presented in the contract. Specifically, a representation is a statement made by one party at the time the contract is entered into, regarding a fact which is influential in bringing about the agreement. A warranty is a promise that a statement of fact is true. In larger contracts, a specific section entitled “Representations and Warranties,” is devoted to this issue and lays out all of the representations and warranties each party is making subject to the agreement. Regardless of whether there is a dedicated section of the agreement, however, parties will rely on the representations of each other in entering the contract. Examples of what may appear under this heading include statements related to the condition of the goods being sold, statements that a party has the legal right to sell the property, or statements that a party is not in default on any other obligations. Disclaimers and/or “as-is” provisions in a contract are a means of minimizing representations and warranties.
3. Conditions. Conditions are events that must happen (or not happen) in order to obligate a party to act pursuant to the contract. If specified conditions do not occur, a party need not perform under the contract. An example of a condition common in business contracts is that board or shareholder approval must be obtained prior to enforcement of the contract. Other conditions may state that all documents be properly delivered prior to the contract taking effect or that all representations and warranties discussed above are proven accurate. Conditions do not have to relate solely to the parties to a contract. They may involve third parties approvals that are necessary for the contract to happen. Examples of such approvals may be governmental approvals or obtaining insurance.
4. The Deal. After conditions have been satisfied, “the deal” is the real meat of the contract and states who must do what, when they must do it, and what price will be paid. The deal includes allocation of risk (will one party indemnify the other, will damages be capped at a specific amount), and also states the beginning and end of the contract, including rights of the parties to extend or terminate the contract.
5. Enforcement. Usually the “boilerplate” of a contract, enforcement issues state how, when and where the contract may be enforced by a party. Enforcement issues include (i) what law will be applied in the event of a dispute, (ii) who will hear disputes (will it be a judge, jury, mediator or arbitrator?), (iii) where a dispute will be heard (city, county, state), and (iv) which party has the burden of proof when enforcing the contract.
6. Remedies. Remedies determine who is entitled to what in the event of a breach. Remedies often, but not always relate to monetary damages. They will address the ability of a party to obtain and will address whether or not a party can receive punitive damages (which are rare in contracts) or consequential damages (damages that don’t flow directly from a breach, but are somehow caused by it). Other than monetary damages, remedies can also include specific performance (a situation where the court orders one party to perform) and can potentially allow a party the right to terminate the contract for breach.