All new businesses need a well thought out plan. It only seems logical to devise a suitable business plan before registering a new business rather than rush into the business before devising a plan. Part of any new business plan should take into consideration what contracts will be needed. There is a variety of contracts that may be valuable when starting and operating a business. Legally binding contracts that have been preferably created with the help of a business attorney can save the business owner or owners from expensive problems in the form of financial losses and liability. This article explains why properly written contracts are so important and give a brief overview of some of the more common types of contract used by businesses.
How contracts protect a business from liability and loss
A contract is a legally binding agreement between two or more parties. There are many different types of businesses and these can vary in size from the very smallest sole proprietorship to the largest corporation. Small businesses can survive for a time without formal written contracts, but sooner than later, misunderstandings and disagreement can lead to serious problems that can result in financial loss and / or the failure of the business. Properly devised contracts cannot save a business from mismanagement or the impact of negative external factors, but they can certainly save an otherwise well run business from getting into financial trouble.
A well worded contract serves to:
- set out the terms and conditions that the contractual parties have agreed to, such as payment terms, timelines, termination procedure;
- provide details of specific actions and services that each party will be expected to perform;
- set out the consequences of failing to meet these responsibilities;
- establish the procedures used in the event of disputes, including negotiation and mediation.
Examples of how a contract can help to limit liability and financial loss
- Workplace compensation insurance is compulsory for most employers in Massachusetts. This is an insurance policy, effectively a contract between the employer, insurer and employee that ensures that in the event that an employee is injured or becomes ill at work, then compensation can be paid to the employee to help with medical treatment and lost wages. Workers’ compensation insurance ensures that the employee cannot sue the employer for negligence, reducing the employer’s liability.
- A business has a contract with a builder to complete a new building. The contract establishes the completion date for the building and how much is to be paid for the construction and when payments are to be made. If the building is not completed on time, then the business may have the right to demand compensation for any financial loss that could result from late completion.
- A rental agreement between a landlord and tenant establishes the amount of rent due, when payments are to be made, conditions set by the landlord on what tenants can and cannot do, e.g. keep the place tidy and clean, policy on keeping pets, etc.
There are many different types of contracts that a business might use. Some are more common than others, and different types of businesses may need to decide which contracts they need to negotiate to protect their business. Consider what might be the result in the examples given above if some sort of legally binding agreement wasn’t in place. A business could be sued by an employee who had been injured at work and alleged that the employer was at fault. The builder who had failed to keep to an agreed timeline would not be legally bound to pay compensation for late completion. The tenant might not keep paying rent on time.
Note that in each case the agreement that is in place benefits both parties. The injured employee in the first example is protected by the employer’s workers’ compensation insurance. The builder’s contract with the business wanting something built knows how much and when payment will be made. The tenant has a defined rent and rental terms established in the rental agreement which limits what the landlord can and should do.
Common types of contract used by businesses
In addition to the examples given above, there are many other types of business contracts which may be used by different types and sizes of business:
- employment contracts;
- non-disclosure agreements;
- partnership agreement;
- commercial lease;
- licensing agreement;
- succession plan;
- stock purchase agreement;
- stockholders agreement;
- buy-sell agreement;
- franchise agreement;
- indemnity agreement;
- bill of sale;
A few of these contract types are discussed in more detail below.
Many businesses in Massachusetts that employ workers don’t use employment contracts if they pay wages on an hourly basis. Massachusetts, like most U.S. states, is an at-will state, which means that business employers can fire an employee more or less whenever they want without giving a reason. However, in some cases, it is preferable for an employment contract to be drawn up by the employer, setting out the terms and conditions of employment, such as the amount of pay in wages or salary, hours of work, job description, benefits, period of employment, notice required for termination, etc. The employment contract, when properly constructed and signed by the employee and employer’s representative, provides benefits and protections for both the employer and the employee.
Non-disclosure agreements (NDAs), also called confidentiality agreements, are often included in an employment contract. They are designed to prevent an employee from disclosing sensitive and potentially valuable information about the employer’s business to others, and thereby potentially causing financial disadvantage to that business. The state government has in the last few years sought to limit the use of NDAs by some businesses.
Partnership agreements are contracts made between business partners. They set out the terms and conditions of the partnership and help to minimize the potential for disputes between partners during the lifetime of the partnership.
A commercial lease is similar to the rental agreement between a landlord and tenant mentioned above, but between a business and the owner of a building leased by the business. It sets out how long the lease should last, how much and how often payments to the building’s owner should be paid, as well as other terms and conditions dependent on the nature of the business.
Whatever the nature of the business, it is advisable for an attorney who is experienced in business contract law to be hired to help draw up a legally binding contract if the contract is to be of value in protecting the business from potential risk of liability or financial losses.