I recently led a workshop in Winston Salem on how micro and small businesses should think about and use contracts. This is an important issue for a business, and a clear understanding of when contracts can best be used to secure a business relationship is important for the business’ long-term growth. Here are some of the points from the workshop:
Contracts come in many forms and with many names, but in the end, they are agreements between parties that promise one party will do something and the other will do something else in exchange. Parties to a contract are generally looking to the future to assure an act will occur and they build their expectations around the performance of this act. Because a business is always looking to the future, contracts play a significant role in just about everything the business does.
1. Understand the stage your business is in. A business will move along a series of several stages during its life. It may seek to have more or less formal agreements with other parties depending on where a business finds itself along this continuum. Generally, the continuum can be described to several stages from existence to maturity. (See Churchill and Lewis, The Five Stages of Small Business Growth). At the start when the business first comes into existence, business owners face the challenge of balancing their need for certainty in relationships against the need to move forward as quickly as possible. It is important at this point for the owner to identify those relationships that will be most important to the business’s launch and early growth, this includes things like the partnership agreement, non-disclosure agreements, employment agreements with key people and supplier agreements. While careful thought should be put into all contractual relationships, these early agreements should rise to the top of the list.
As the business grows, new relationships emerge that will look different from those faced earlier. For example, a business owner may find that one client or customer accounts for a large amount of revenue, in fact, so much revenue that the health of the business is linked to this client relationship. The owner will want to consider how to formalize the relationship for the future, perhaps through a long-term agreement. Similarly, as the business grows and takes on new partners, existing agreements should be reviewed and revised.
In the end, the contracts that are needed for a business will depend in part on the stage the business is in.
2. Know what you want from any contract. Contracts memorialize relationships between people, but they are not the only mechanism for doing this. If the business owner wants a formal relationship that may be enforced by a court in a proceeding, then a contract will be useful. But this is not always what is wanted. I often tell my students of the client who was a church and who wanted to rent a space to a nonprofit food pantry. The pastor came to me with a lease he had been given by a member of the parish. The lease contained three pages of detail on defaults and remedies, including clauses on punitive damages and shifting of attorney’s fees. While the lease reflected a bundle of legal rights that would be available following a default by the food pantry, the church really did not want to sue the people who were trying to feed the poor or exact punitive damages following a breach. After some thought, the lease was reduced to one simply page that better reflected the relationship between the parties and the values of the church and its members.
3. Use standard form contracts for standard things. Many, perhaps most, businesses regularly work in a few areas. Think of a general contractor who works with homeowners. The contractor will spend most days pricing bids and preparing work contracts that reflect the work to be done. This involves a standard range of work, price and time. As such, it is easy to use a standard form contract that is edited for each customer to include work, price and time.
While form contracts are good at saving time and effort, it is important to keep in mind that they have been prepared with a set type of work in mind from the start. A formwork contract for a general contractor doing home remodeling will contain provisions that will not make sense for a business consultant working with farmers. Moreover, a form contract works as a whole, any changes or edits may have unintended consequences.
When developing and using form contracts the business owner should remember to use the appropriate form for the particular matter. A lawyer can add tremendous value to a business by developing form contracts that are tailored to the business’ needs.
4. Think about how you will enforce a contract. While contracts may create rights for a party, these rights will still need to be enforced, which may mean filing a lawsuit. The costs of litigation can be very high, in both financial and personal terms. Some lawyers advise clients that litigation is not worth pursuing if the controversy involves less than $75-100,000. In addition, the time spent on discovery and other trial matters is time taken from the business, as well as stress created for the owner and the owner’s family.
As a party to a contract, the business owner should always consider how to address failure or breach on the other party’s part. To do so, the business owner may want to decide early on whether there are informal enforcement methods that will be useful. Such methods include mediation or other non-litigation approaches, but also include referral networks for clients/customers and long-term relationships. When litigation is unavoidable, the business owner will want to assure that all contracts contain provisions that reduce the burden of going to court. Typically, these provisions will include choice of law, choice of venue and fee shifting provisions. In some cases, such as a nondisclosure agreement, provisions allowing for injunctive relief may be included.
In the end, contracts provide a business owner with a degree of certainty about the future. The business owner, however, must be sure to work with contracts that are crafted to the needs of their business and to recognize that types of contracts and value of the relationships they memorialize will grow and develop over time.
Posted by Steve Virgil