By John Huddleston

No matter what kind of business they wish to start, all aspiring entrepreneurs would benefit immensely from acquiring a basic understanding of contract law. While contract law may seem frustratingly complicated to many laypeople, most essential contract principles are actually quite straightforward. All future entrepreneurs should commit the time to master the essentials of contracts because these essentials will almost certainly pay dividends for them down the road.

Equipped with a working knowledge of basic contract principles, entrepreneurs will be able to conduct their affairs with greater efficiency. For instance, they will be able to have more engaging discussions with business attorneys; they will better grasp the implications of conversations with co-workers and prospective hires; they can negotiate transactions with fellow business people with increased confidence. Being conversant with contract essentials will transform entrepreneurs into more competent professionals.

To become acquainted with contract law, entrepreneurs should start at the beginning: they should understand what a contract is and how it is formed.

Basic Definition

A contract is an agreement – or an exchange of promises – which is recognized by law and capable of being enforced by courts. The parties to a contract are obliged to perform the duties assigned by a contract; nonperformance of contractually assigned duties constitutes a breach and may be remedied by a court.

A contract, therefore, is a binding agreement: it is an agreement which imparts responsibility on its parties, and failure to fulfill such responsibility will trigger legally enforceable repercussions.

How a Contract is Formed

There are six elements which must be met in order for a valid (enforceable) contract to be formed. The six elements are as follows: offer, acceptance, consideration, legality, capacity and (occasionally) writing. These elements must be satisfied in order for a facially valid contract to be created.

The mechanics of a contract are simple to understand. An offer clearly and totally discloses the terms of the agreement. The parties must firmly accept these terms. The agreement must have consideration – that is, there must be an exchange of things which are of roughly equal value. Consideration is a somewhat slippery concept – perhaps the most difficult contractual element – but it becomes easy to understand when seen in practice. Consideration is simply a means to distinguish a contract from a gift or donation. If a businessperson were to sell an expensive car – say, a Ferrari – to a customer for just $1 instead of its actual market value, the sale (which is a type of contract) would lack consideration and would therefore be classified as a gift.

The agreement must have legality, which simply means that people may not contract for things which are forbidden under the law. What’s more, the parties of a contract must have the capacity to accept the terms, otherwise any acceptance cannot be considered valid. To have capacity the parties must be of sufficient age and mental status (i.e. they cannot be intoxicated, insane, etc.). And finally, in certain cases, an agreement must be committed to writing. It is best to research whether a given contract must be put in writing on a case-by-case basis.

Important Points to Remember

In addition to the aforementioned points, there are two other points which entrepreneurs should acquire. The first is that even though all contractual elements must be met in order to form a valid contract, this does not mean that non-facially valid contracts cannot be enforced by a court. There are a number of common law mechanisms which can be invoked in certain circumstances for the purpose of enforcing a promise which otherwise appears to be unenforceable. For example, in some instances a person may utilize the doctrine of promissory estoppel to enforce a promise which they relied upon to their detriment. Of course, in most cases, a facially invalid contract will not be deemed enforceable, but the tradition of enforcing certain incomplete contracts is something entrepreneurs should be aware of.

And the other point to consider is the following: the underlying purpose of contract law is to ensure a just outcome given the unique factual circumstances of each case. Sometimes laypeople can be a bit intimidated by contracts; in fact, it is not uncommon for the word “contract” to inspire a measure of fear in those who hear it. But as vast and multilayered as contract law can be, its basic goal is to facilitate commerce by giving parties access to remedy in the event of misbehavior.

John Huddleston is the founder and principal of Huddleston Tax CPAs, a firm based in the greater Seattle area. Huddleston Tax CPAs concentrates on helping small businesses with their various tax and accounting needs. Mr. Huddleston is a CPA and also holds a law degree (JD) and masters degree in tax law (LLM) from the University of Washington School of Law in Seattle.