From the smallest local shop to the largest multinational corporation, contracts are vital to the long-term success of any business. They outline the terms to which each side agrees, hold parties accountable for what they will deliver, and safeguard business finances and peace of mind.
The problem is that contracts can be confusing - often, very confusing. How well do you know the fundamentals of contracts and the contracting process? If you answered "not as well as I'd like to," you're not alone.
No matter your title or department, it's important to understand how what goes into your contracts and how they are put together. Explore our three-part introduction to contracts - Contracts 101 - and get up-to-speed today!
Get an introduction to the most prevalent contract types across industries.
The Contract Journey
Learn how a contract goes from an idea to a legally enforceable document.
From sales to legal, explore who plays a role in the lifecycle of a contract.
Contracts are legally enforceable agreements between two or more parties, either to do or deliver something in return for money (or something of value), or to establish a formal relationship. Contracts can be oral, written, or a combination of oral and written. Written contracts are the best to use to protect your business with precise terms, should you ever end up in court.
Every single word in a written contract has legal implications. Language and the context it is presented in is vital to protect the parties of the contract. During a dispute, content details are examined to determine intent. Contracts are usually organized using the following elements:
Common types of business contracts include:
For buy- and sell-side contracts, a standalone contract rolls all important terms into a single agreement at the time of signature.
For buy- and sell-side contracts, a master agreement creates a framework of contractual terms for the ordering of products or services and allows a buyer to make one or more order over time, in an open-ended fashion.
Different industries call classic contracts different names. These include:
Some contracts are called “Deeds” — for example, a “Deed of Non-Disclosure.” This is a legal quirk whereby a contract is very one-sided because there is a lack of “consideration” from one of the parties, where they don't offer anything of value in the bargain. Contracts executed as “Deeds” may be considered invalid or valid and enforceable despite the lack of consideration. Local laws can vary.
Sometimes the word “deal” is used as a substitute for “contract.” “Deal” is an ambiguous term with no special legal meaning. It is possible, for example, to use “deal” in a way that refers to a set of related contracts between the same parties that happen to be executed at the same time. Or, “deal” can be used synonymously with “contract.” The parties must be clear about what they mean when they use “deal” to describe a contract. The term's validity can be hard to prove, particularly without a written agreement.
One contract may be made of several documents. For example, a contract may start as a 20-page agreement on Day 1, then be modified by a two-page amendment on Day 100, then be modified by another five-page amendment on Day 200. At this point, the terms of the contract are contained in all three documents.
Conversely, one document can spawn multiple contracts. For example, an agent signs a single contractual document on behalf of several different people or companies they represent. These parties are called the underlying “principals.” If there are five principals represented by the agent, the one contractual document creates five separate legal contracts.
Not really. It may be possible to sign a document that amends one contract and creates a new one. There may not be a need for a written document at all. Rules vary by country, region, and industry. Because contracts are often negotiated by at least two lawyers on opposing sides, the end result of the final contract may contain many complex clauses, words, and meanings.
A contract will typically follow a lifecycle with the following steps:
Classic pre-contractual processes may include:
The first draft of the contract is where one party proposes a complete set of terms and conditions of the contract based on whatever commercial terms have been discussed. There may be an argument over which party gets to complete the first draft in business contracts.
First drafts may contain “boilerplate” clauses, which are common and standard clauses often placed at the backs of contracts. Boilerplate clauses are usually agreed upon and not edited in contracts.
If both parties are willing to negotiate, the parties will edit and exchange new versions of the contract draft. Sometimes internal approval processes must be met during draft negotiations, which are recorded for audit trail purposes.
The final draft may need a final formal approval by each party. When the parties arrive at a contract acceptable for everyone, a final draft will be prepared for signature, or “execution.”
Contracts become active or live when they are properly executed/signed by all parties. Signatures may be “wet” signatures (pen on paper) or “digital” signatures (via an online signature service). Digital signature is convenient but is not yet universally accepted.
Multiple copies may be printed and signed, so when everyone has signed, everyone receives a fully signed contract. Multiple copies are called “counterparts.” The contract may contain a clause that explains that each counterpart, although a separate document, is the same contract.
Parties may also fax or scan signature pages and bind all signature pages to a single document. Because there may be multiple signed counterparts and multiple scanned signature pages, gathering them all together is required to prove there is a full set of signatures. A signed contract is passed to appropriate managers for the contract.
For master agreements, the detail of work to be done or products to be supplied will need to be explained in an order document. This order document is likely to be negotiated and approved similarly to a contract and may go through several drafts. Once the order is finalized and signed, the obligations described in that order are binding.
Over time, a master agreement may support many orders. Other names for orders include:
A master agreement typically ensures the master and all the orders are legally one comprehensive contract, but each order may be treated as a separate contract that incorporates the terms of the master agreement. The approach that applies should be explained.
There are two forms of contract amendments:
Amendments may also go through multiple drafts, approval, and negotiation processes and are only effective when they are signed by all parties.
Orders, assignments, and renewal notices may be considered special cases of amendment.
Amendments can take many forms, depending on the agreed-upon terms of how amendments can be carried out. These may include documents labeled “amendment,” or letters or emails. An amendment document may amend more than one contract, such as when the same two parties have multiple contracts between them.
Amendments are sometimes called “endorsements” in the insurance industry.
In some businesses, “side letters” are used to make modifications. These are usually regarded as amendments but may be considered separate contracts.
A notice is a special form of communication specified in a contract that must be followed in certain circumstances. For example, notices may encompass the desire of one party to exercise a right of renewal or termination. To be effective, a notice may need to be sent in a specific format, through a specific channel, to a specific address, to a specific person.
Unlike “evergreen” contracts with no fixed term or expiration date that require no need for renewal, any contract with a fixed term will expire unless it is renewed. If a fixed term contract has no specifications on renewal, all parties must agree to renew on whatever terms they choose.
In other cases, the contract will describe a renewal process. This usually falls into one of two approaches:
At some point during the contract lifecycle, there may be an event that requires interest transfer of the contract to someone else. Two classic examples are:
Assignment is usually a mini-contract that states as of a certain date, the original party to the contract is replaced by a new party, after which the new party takes on the old party's rights and responsibilities.
Novation is a special type of assignment. If a contract is novated, it has the effect of deeming the new party to have been responsible from the beginning of the contract, as if the old party never existed.
Contract disputes arise when something related to the contract or project changes, and questions come up about who has contractual rights to deal with the problem. The anticipation of disputes should be a factor when creating the contract so that they can be better avoided or dealt with.
Contracts can end by expiring or terminating. Expiry means the contract time period ends, and there is no renewal. Termination ends a contract before it is set to end. The process to terminate the contract is usually explained in the contract. These termination rights may include:
The contract will contain stipulations for timing and mechanism in termination. Also, termination terms may apply to a master agreement and orders. Additionally, a “cross-default” clause may outline the linking of termination events under two or more separate contracts and deem them to be termination events across all contracts. Even when a contract is terminated, certain contractual rights and obligations may still be in effect. For example, these may include nondisclosure obligations, which may last years after a contract is terminated.
The people who may be involved in contract creation include:
Approvers are generally designated by a company to handle various aspects of contract signage. A document outlining these responsibilities is sometimes called a “delegation of authority,” and it may contain different approval rules depending on contract value, type of issue, and level of risk.
Approvals can happen at various stages during the contract process:
The final draft will be signed by authorized people on each side. After signing, all parties should receive a fully executed copy, called a “conformed copy,” of the contract.
The people who manage contracts typically comprise a “back office” operations team and make sure relevant contractual data is captured and made available to various systems. Examples of components to be managed include:
To enhance business value and minimize risks, parties that may monitor and optimize contracts include:
While devising and executing contracts, it is essential to identify parties to the agreement. A party is someone who is bound by the contract and who can enforce it. A third party is someone who is not a “party” to the contract, who is not bound by it, and who cannot enforce it.
Privity is a legal term. If you are privy to a contract, you are a party, and you can sue to enforce it. If you are not privy to the contract, even if you are mentioned in it, you are not a party and cannot sue to enforce it.
Contracts may be executed by one entity acting as agent for another entity. In this case, the contract is likely to declare this agency relationship and state that the agent is not a party but are simply signing the contract as agency of the other entity, called the “principal.”
Similarly, a person may enter a contract as trustee for a trust, in which case the party is the trust, and the trustee is the entity that does things for the trust. Because trusts are not legal entities, they must be represented by trustees, which are legal entities.
For every obligation, right, representation, etc. in the contract, it must be specified which parties relate to each term and to which party each term is owed.
If a human being is a party, it may make sense to refer to “he” or “she” in a contract. If a corporation, organization, or non-natural person is a party, the contract should describe what type of legal entity it is, such as a company, partnership, government/sovereign, trust, etc.