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Contracts & Liabilities by MR. LAW

May 17, 2017


About the Authors: You may notice our legal disclaimer at the bottom of the pages referencing MR LAW® and wonder just who this Mr. Law person is. MR LAW is actually a registered trademark for the entrepreneurship-focused legal services of attorneys Mike McCollum and John Robinson. Mike and John are both attorneys with the law firm of John V. Robinson, P.C. in Richmond, Virginia, and have worked extensively with businesses ranging from single-member startups to international corporations.

Contracts

When we think of contracts we probably have an image of a lengthy legal document with a few “initial here” and “sign here” prompts. But contracts, at their most basic, are simply agreements. They represent an understanding between two parties as to what is going to happen. It could be an employment contract that lays out the duties and responsibilities of an employee and what compensation and benefits will be provided in exchange. Or it could be a verbal agreement that tomorrow morning I’m going to show up and paint your house. Just to be clear, nobody is going to show up and paint your house, so there is no contract here.

Where young businesses often go wrong is when they unintentionally create contractual obligations, and when they enter into contracts without fully understanding all of the terms. A contract with indefinite terms can lead to confusion, mismatched expectations, frustrations, missed deadlines, and cost overruns. Too many times founders who are focused on their business try to write their own contracts and end up relying on forms and documents found on the internet and then trying to customize them to some degree. If you make a mistake, you bear the risk associated with that mistake.
The following, abbreviated true story should serve as an object lesson, and reinforce the importance of the information in this section.

A young company needed a software program to help them continue its rapid growth. They were in a hurry, and on a budget, so they wrote their own contract with a small programming firm that had a good reputation in the community. The total price in the bid was based on a projected total cost from the programmers, who estimated how long it would take them to complete the features the company needed included in the program. The contract itself only included an hourly rate for the programmers. There was no list of features. No delivery date. No cap on the total. And a “work for hire” clause that purported to give the company ownership of the software being developed.
Eight months later, $150,000 over budget (on a $250,000 project), and with an ever shrinking list of deliverables, which had unilaterally been shortened by the programmers, the company realized its mistake. The less efficient the programmers were the more money they got paid. Nothing in the contract required the delivery of specific features. And the work for hire provision was ineffective. All because they didn’t know what needed to be included in a contract. An obligation had been created. But it was the obligation to pay the programmers to work on the project. There was little else either party was required to do.

This guide is provided for educational purposes by MR LAW® and is not intended to be legal advice.
If your business cannot afford to throw away $150,000 you should give careful consideration to the following section, and make sure that you understand your rights, and your obligations, and the obligations of the other party before you create a contract.

Contract formation: To form a contract, there needs to be both mutual assent between the parties and there needs to be some bargained for exchange, referred to as “consideration.”
Mutual assent: Mutual assent simply means that both parties need to agree on what is going to happen and give some indication of their intention of that agreement. Essentially, it is when both parties agree to the terms of the contract, but it requires a bit more than simply stating that you have the same desire. In the simplest sense, mutual assent is demonstrated through an offer by one party and an acceptance of that offer by the other. More complicated transactions are going to be the result of negotiations, rather than a simple offer and acceptance, but in the end it all works out to the same thing: “here is our offer” followed by “we accept.”

Offer: There must first be an offer before there can be an acceptance. An offer occurs where one party makes a proposal to another party, including the terms of the proposed deal. An offer only becomes definite enough to accept when the proposed terms are fixed, so that once the other party accepts those terms a contract is formed (assuming consideration exists – more on this later). For example, if a programming company proposes to enter into a contract where it will write your software in exchange for a fixed fee this is a valid offer because the terms are definitive. Alternatively, if the programmers proposed to design your software and tell you later how much it costs there would not be an offer because this merely invites you to negotiate more definitive terms with them. If the programmers start working and at some point decide they have worked enough and want to get paid, what are you going to owe him: something, nothing, or anything he demands? The answer is, it depends. And that is never a situation you want to find your business in. In a valid offer the terms should be definite enough so that one party does not have sole discretion over the important terms of the agreement. We should also note that an advertisement will generally not be seen as an offer; it is simply an invitation for prospective customers.

This guide is provided for educational purposes by MR LAW® and is not intended to be legal advice.
Acceptance: Once an offer has been made, the focus turns to the person to whom the offer has been extended (the offeree). The offeree has the power to either accept the offer, reject it, or counter with another proposal. If the offeree rejects the proposal she may no longer accept the deal, and any subsequent attempt to accept is likely to be viewed as a new offer directed at the original offeror and the whole process goes back to the beginning. An offeree may counter by changing the terms of the offer (i.e. negotiate the terms). The law views a counter as an offer in and of itself, with the ability of acceptance going back to the original offeror. As an offer needs to be accepted to form a contract, the process of acceptance will be viewed more closely. Simply saying “yes” to an offer may be sufficient to accept some offers, but in other cases this will not be enough to demonstrate acceptance. This is because the offeror holds the power to set the manner of acceptance.

However, like the terms of the offer, the manner by which it is accepted must also be definitively stated. If a manner is not specified, then the offeree may accept by any reasonable manner. Acceptance by promise and acceptance by performance are the main ways to accept an offer. Offerors tend to ask for acceptance by promise, where the offeree merely must agree to the exact terms of the offer by promising to perform his end of the bargain through the method of the offeror’s choosing – thereby giving notice of their acceptance of the offer. Alternatively, acceptance by performance may be acceptable in some contracts, and is satisfied by simply performing the offeror’s desired action – no notice of acceptance is needed because the performance is the acceptance. For example, if you offer John $20 to mow your lawn and he immediately goes outside and starts cutting the grass you’re going to owe him the $20 when he finishes. However, if John only mows half the lawn, gets bored, and quits, you won’t owe him $20, or even $10 because the acceptance is not effective until the performance is complete.

Consideration: Virtually anything can serve as adequate consideration to form a contract, but what consideration really means is a promise. Both parties to a contract need to agree to be bound to do something. In most cases, it is that one party agrees to provide goods or services, and the other party agrees to pay them a certain amount. The tricky part is that “I agree to pay you” is not the same thing as “I agree to pay you $49.95.” Consideration has to be reasonably precise and certain. You can agree to pay someone based on an hourly rate without specifying exactly how many hours of work will be performed, but simply agreeing to pay something is not really sufficient consideration.

As long as these requirements are fulfilled the contract does not necessarily need to be written or appear in a formal document. Some types of contracts must be in writing, but most can be formed verbally. Proving the terms of a verbal contract

This guide is provided for educational purposes by MR LAW® and is not intended to be legal advice.
can be quite tricky if a disagreement arises later on, so it is always best to write down the terms of the deal.
So, where did the company we mentioned earlier go wrong with the programmers? They made an offer: we’ll pay you $X per hour to develop our software. The offer was accepted. And a contract was formed. It didn’t have more definite conditions on the work to be done or the payment to be made. The company had agreed to pay, and the programmers agreed to program.

Contract law can be very complex, with many rules, exceptions to those rules, and specific requirements for certain types of contracts. A business owner does not need to know all of the nuances of contract law; that’s why you rely on your friendly neighborhood lawyers. But it is important to know when the business or owner is legally bound by a contract. To recap, a business owner should look out for:
 Was there an offer with definitive terms?
 Was there acceptance to the terms without changing the terms?
 Did the accepting party use the proper method of acceptance if one is specified?
 Was there consideration?
If all of these are satisfied, then the parties will be bound by contract and will need to perform their respective ends of the bargain.

Breaching a contract: It is important to know when a breach of contract may take place both to avoid doing so and to recognize when the other contracting party has done so. While there are a number of ways that a breach may occur, the two most common are an anticipated breach and an actual breach.
An anticipated breach of a contract occurs where one party of the contract expresses that he will not be performing his end of the bargain. It does not matter whether this has been done through their words or their actions, it merely must be clear that they intend not to perform, and it must be clear to the suffering party that the breaching party likely is not to perform. For example, if Joe agrees to sell his car for $100 and deliver it to on Friday, and then either flat out tells the buyer “I’ve changed my mind and don’t intend to sell you the car,” or if he sells the car to another buyer before Friday, Joe has committed anticipatory repudiation because he has made it clear that he has no intention of performing his end of the bargain.
An actual breach is much simpler; it only requires that one party fail to perform their obligation under the contract. To use our previous example, if John simply

This guide is provided for educational purposes by MR LAW® and is not intended to be legal advice.
doesn’t turn up to deliver the car on Friday as promised, or shows up with a different car, then he has materially breached the contract.
In either case, the remedies available will depend on what was being contracted (goods or services) and the language of the contract itself.

If our unfortunate company had included a definite list of features, a delivery date, and some sort of quality control provision on the contract with the programmers, and the programmers did not deliver the features it agreed to deliver, or missed the delivery date, or delivered a bug-ridden block of code, the programmers would have breached the contract. If they had breached the contract the company would not have had to pay the full price of the contract, and maybe nothing at all, let alone an amount far in excess of the contract price.

Sometimes a contract can be invalidated even once it has formed. Typically, if there was a mistake, a misunderstanding, or a misrepresentation regarding the material terms of the contract there may be grounds to void the agreement. These aren’t tools to rely on, but rather things to watch out for; so when you are forming a contract you should do your best to make sure that the contract is understood by both parties and that it does not contain any misrepresentations.

Signing contracts: When you sign a contract you are legally binding someone to do something. Just who that “someone” is depends on how you sign the contract. If you sign you own name, without specifying that you are signing on behalf of your business, then you, personally, are legally bound by that contract. It doesn’t matter if you are an LLC or a corporation and you only formed the entity to avoid being personally responsible; if you sign on your own behalf you have just circumvented those liability protections. If you sign a contract “John Doe, CEO” then you, John Doe are going to be bound by the contract.

If, on the other hand, you sign your name on behalf of the business, in your capacity as an agent, partner, officer, director, member or manager then your business is the “someone” who is bound by the contract. You may still be liable for the business’ debts in some cases, but signing on behalf of the business as an authorized agent means that the business, not you personally, is one of the parties to the agreement. Signing a contract “Acme Rocket Supplies, BY: John Doe, CEO” binds the rocket supply company, so that John Doe won’t be personally liable if the rockets fail to work as advertised.
In some instances, like a commercial lease with a landlord, you may have to sign on behalf of the business, and to personally sign as well. This has the effect of making both you and the business bound by the terms of the contract.

This guide is provided for educational purposes by MR LAW® and is not intended to be legal advice.
This is one area where form overrides intent. Especially in Virginia, where the laws are very strict regarding the enforcement of contract. So, make sure that you not only know what you are signing, but please be mindful of HOW you are signing.

Be precise: Signing imprecise contracts is not a guaranteed way to cause problems, but it is a risk you cannot afford to take. You need to ensure that when you enter into a contract, whether it is to deliver a product or to engage a service provider, that contract clearly defines what you will give and what you will get. For example, if you hire a group of software developers to create a new program for your business you absolutely, positively must specify what features are to be included, what the delivery date will be, how the scope of the project can be amended, the price, or billing rate, and how that price is impacted by changes to the scope of the project. You also need to ensure that some sort of quality control is included.

The last thing you want is to enter into a contract for a sizable chunk of your business’ funds that allows a contractor to unilaterally remove features you deem necessary, or to charge you some uncapped hourly rate that rewards them for being inefficient. And if you think to yourself, “they wouldn’t do that” you really need to be a little more cynical. Lastly, whenever you deal with any contractors or service providers, you absolutely need to account for the ownership of the rights to the material being created, and that doesn’t mean simply writing “work for hire” into the agreement, because as previously discussed (and contrary to popular opinion) many types of work product are not capable of being classified as works for hire.

The Uniform Commercial Code: The stuff of law school nightmares, the UCC is a set of rules that have been adopted by most states to standardize laws governing commercial transactions. These rules can be incredibly complex, or rather straight-forward. The UCC governs many of the most common activities your business will engage in, ranging from sales and leases of goods to promissory notes, letters of credit, and securities. One item of particular interest is a rule called the Statute of Frauds, an intimidating title for a rule that requires any commercial contract for the sale of goods worth more than $500 to be in writing. This rule also applies to contracts for services, but only if the services will necessarily take longer than 12 months to complete. So while verbal contracts are usually contracts, sometimes they aren’t. And you need to know which are which.

A word of warning: When it comes to contracts we know that they can be verbal contracts or written agreements. If the contract is written pay very close attention to everything that is on the page or pages. The law presumes that you read the whole agreement, even if you didn’t actually read it. If you agree to a term in the contract by signing at the bottom you cannot then dispute a provision of that contract as “something I didn’t agree to.” This also holds true for “click-through” contracts; agreements typically found with software but also increasingly common on many forms of electronic media. They typically look something like this “Click here to acknowledge our Terms of Service” and when you click the button to proceed you have entered into a contract, and it is often a contract that severely restricts your rights. Various states have differing approaches to contract law, but here in Virginia you have quite a bit of latitude to enter into contracts, and that can get you into trouble if you end up entering into an unfair contract. So, if you or your attorney didn’t write the agreement be very sure that you understand exactly what is included so that you don’t end up with an unpleasant surprise later on.

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