Most people know to use a contract to protect themselves in business. But what exactly is a contract, and how does it protect you and your business?

A contract is a legally enforceable agreement between two or more parties (individuals, businesses, organizations or government agencies) to do or refrain from doing a particular thing in exchange for something of value. Whenever anyone buys, sells, leases, rents or licenses something, a contract is involved. Contracts are so common that you may not even realize that you are acting under a legally enforceable agreement. For example, contracts are not limited to written agreements. Under many circumstances, a verbal contract is binding. There may be a constructive contract created under provisions of state or local laws. When you buy an item from a store, you are buying the item subject to terms of their pricing, return policy and warranty. You may not have signed anything agreeing to the store’s policies; however, you are deemed to have impliedly accepted them if they inform you of the policy. Your notice may be on the back of a receipt or on giant posting at the checkout. It may also be posted on the company website.

A contract consists of an offer and an acceptance. Contracts are valid and binding the moment that an offer is accepted. The terms of the contract (i.e. the who, what, where, when and how of the agreement) define the binding promises or covenants of each party to the contract. If the deal is premised upon certain conditions or assumptions, the contract should state who “guarantees” what. These are usually referred to as “Representations and Warranties”. What happens when the representations or warrantees turn out to be untrue? This is where the true value of a contract is realized. When a contract has been breached, the contract should state specifically what happens.

For example, you purchase a business in which the owner declares $50,000.00 in profits per month, but you discover that it only profits $10,000.00 per month.  Since you relied on the profit that was represented in the contract, the sale of the business was based on a fraudulent representation, and you may have remedies against the seller.

For any deal worth over $500, it is a good idea to have something in writing.  This is particularly important when the deal is made between friends. All too often, deals become costly litigation nightmares because the terms of the agreement were not spelled out clearly enough. Contracts are written to protect parties when things go wrong.

A law suit is often needed to enforce a contract when one party does not uphold its end of the bargain, or when the parties do not agree on what was actually meant in the contract. There are alternatives to law suits to enforce a contract, such as binding arbitration, in which an agreed-upon third party presides over a hearing between the two parties.  Sometimes there is also the option of renegotiation to address a change in circumstances.

It is easy to stipulate the agreements, but the value of the contract, and the most difficult part to mete out, is what happens when things don’t go as planned. Predicting every possible breach and the consequences is where the protection is.  Contract without “Damages” (the consequences of a breach) is basically worthless. Just the act of drafting a contract between parties is a valuable use of time. While negotiating a contract, the parties learn how to communicate and interact with each other and learn what each party’s expectations are in the relationship.

One important thing to note: contract law varies from state to state. Always make sure you know what federal, state and local laws apply to the contract. If the contract involves parties from different states or countries, the contract should state which laws apply. In New York State, for example, certain contracts are required to be written, and are considered unenforceable if they are not. This is called the Statute of Frauds. Contracts subject to the Statute of Frauds are: promises made in the consideration of marriage, agreements that cannot be performed and completed within one year, the transfer of real estate, the sale of goods worth $500.00 or more, promises to pay the debt of an estate from an executor’s private funds, and suretyship (someone who promises to pay the debt of another).

The most important thing to do is read a contract fully before signing it. Be sure to ask questions and consult an attorney if you have any questions. Attorneys will often charge only a nominal fee to review a contract, only a fraction of what it might cost you to get out of it. Plus, an attorney can help analyze the situation and prepare a contract that best protects the client. This includes knowing what is essential in order to address the client’s needs and intentions and to make the contract enforceable. For example, in New York State, you cannot prevent someone from doing something (called ‘injunctive relief’), unless it is stated in the contract. Additionally, you typically cannot get attorney’s fees associated with enforcing a contract, unless the contract specifically provides for this stipulation. An attorney, then, may be the best option for providing peace of mind by ensuring your business deals are adequately protected.