One of the most common reasons entrepreneurs seek out legal advice is with regards to contracts.
Attorney and CEO of Britain Renecke, a boutique corporate commercial law firm, Cézanne Britain, outlines all the fundamentals of contracts that every entrepreneur should know.
Understanding contracts is a critical skill for any entrepreneur to have, especially if they are starting out in business. By the same token, it’s also vital that more established entrepreneurs hone their skills, the older – and more complicated – their business becomes.
Whether the entrepreneur is a ‘new’ business owner or one with many years’ experience, contracts should be one of the most fundamental pillars of their day-to-day running. The reason for this is because contracts, either written or oral, not only govern the relationship between parties at various stages of the relationship, but they also provide a degree of protection should things not go according to plan.
A contract sets the ground rules for entrepreneurs doing business with others – and vice versa. A contract is clear in specifying the terms of engagement between the parties involved when it comes to what’s expected (the responsibilities and duties for each party), and it also sets out the consequences that may occur should your dealings (or relationship) go awry.
A good, clear contract also helps business owners to protect themselves against misunderstandings and disputes that may arise, which can not only be disruptive to their business, but which can also threaten their cash flow and profitability if things go wrong.
It’s not always straightforward or easy for you as an entrepreneur to get out of an agreement
Types of contracts you should know about
The type of contracts that entrepreneurs will enter into during running their business daily will depend largely of the type of business they run. There are, however, some contracts that many entrepreneurs will typically have to enter into at the very beginning stages of setting up their company. These are, for example:
- A Memorandum of Incorporation, which is the constitutional document of a company, should an entrepreneur incorporate a business.
- A Shareholders’ Agreement if an entrepreneur becomes the owner of a business.
- Letters of Appointment and Employment Contracts, should the entrepreneur take on employees.
- A Lease Agreement for the premises from which they will run their business, as well as Equipment Lease Agreements and Service
- Level Agreements.
- Insurance Agreements.
- Financial Agreements.
- Non-disclosure or Confidentiality Agreements to protect the proprietary information of the business.
- Standard terms and conditions with suppliers or service providers.
- Independent contract agreements.
When contracts get broken
Unless otherwise agreed on by the parties involved, there are generally two avenues of recourse available to the aggrieved party: specific performance with or without claiming damages; or a claim for damages.
In most cases, the aggrieved party will have to begin legal proceedings against the party that she or he has a claim against. In some cases, the parties could also opt for an alternative way to resolve the dispute, such as mediation, before deciding on instituting formal legal proceedings.
How to get yourself out of a contract
It’s not always straightforward or easy for you as an entrepreneur to get out of an agreement – it depends on what the terms and conditions of the signed contract are – so an exit will, in all likelihood, need to be negotiated.
If the contract that the entrepreneur has entered into includes a provision that allows them to terminate the agreement without cause, as long as they inform the counterparty to the agreement, then “getting out of it” will be fairly easy. But this comes with a caution that the entrepreneur should be mindful of any conditions that could be linked to the termination, even if it’s without cause. For example, the contract may contain an early termination fee that the entrepreneur would need to pay if they invoked the right to terminate. So it’s up to the entrepreneur to check the contract’s wording carefully before acting on it.
Termination fees and other consequences
If the contract doesn’t specifically give you the right to terminate it “without cause”, you won’t be able to “get out of it” unless you’ve negotiated a termination of contract with the counterparty. In this case, you may have to pay the counterparty the balance of the contract, an early termination fee, or a penalty for doing so. What these costs are would have been established during the termination negotiations.
When it comes to getting out of a fixed-term contract, like a two-year cellphone contract with a service provider, things become far more complicated. Depending on the nature of the contract and whether the business owner is defined as an entrepreneur or as a consumer who’s not operating his or her business through a juristic entity, the Consumer Protection Act, No. 68 of 2008 may be applicable.
If you are defined as an ‘entrepreneur or as a consumer’ and you cancel any fixed-term contract, you could be liable to pay a reasonable penalty set out by the counterparty you contracted with, based on the following criteria:
(a) The amount that the ‘entrepreneur as a consumer’ is still liable to the supplier for, up to the date of cancellation;
(b) The value of the transaction up to cancellation;
(c) The value of the goods that will remain in the possession of the ‘entrepreneur as a consumer’ after cancellation;
(d) The value of the goods that are returned to the supplier;
(e) The duration of the ‘entrepreneur as a consumer’s agreement, as initially agreed;
(f) Losses suffered or benefits accrued by the ‘entrepreneur as a consumer’ as a result of the ‘entrepreneur as a consumer’ entering into the entrepreneur as a consumer agreement;
(g) The nature of the goods or services that was reserved or booked;
(h) The length of the notice of cancellation that’s provided by the ‘entrepreneur as a consumer’;
(i) The reasonable potential for the service provider, acting diligently, to find an alternative ‘entrepreneur as a consumer’ between the time of receiving the cancellation notice and the time of the cancelled reservation; and
(j) The general practice of the relevant industry.
Mistake #3: Not negotiating with their best interests at heart
The biggest contract mistakes made by entrepreneurs
In our experience, the nine most common mistakes entrepreneurs make when dealing with contracts are:
1. Not trusting their gut. An entrepreneur’s gut instinct can almost be regarded as a business tool and many business owners simply ignore their gut instinct.
In everyday life, if something doesn’t feel right, it generally isn’t worth doing. The same applies to signing business contracts – if it doesn’t feel right, exercise caution! Whether the entrepreneur is feeling unsure about who they’re contracting with, or what they’re contracting about, when an entrepreneur doesn’t follow their gut instincts about a contract, they could be putting themselves – and their business – at risk.
2. Not having a basic understanding of what contracts are or how they work. At a very basic level, a contract is a promise, so if an entrepreneur doesn’t know the basics of contracts, it can end up being a costly business mistake.
Many entrepreneurs sometimes over-sell and over-promise to win over clients or get more business. This can have far-reaching consequences, especially if an entrepreneur has contracted to do something and then can’t deliver on that promise.
3. Not negotiating with their best interests at heart. Once a contract is signed, it’s very difficult to renegotiate terms. That means an entrepreneur should go into any contract negotiation fully prepared – they must decide what’s important to them and their business before they even get into the room, and then negotiate until all those areas are addressed before they put pen to paper.
4. Not reading a written contract. They say the devil is in the detail! As an entrepreneur, if you haven’t read the contract before you sign it, you don’t know what you’re getting yourself into.
5. Not understanding a written contract. It’s one thing to read a contract, but another thing to read it with understanding and full appreciation the implications of the various provisions contained in a contract.
6. Not having a written agreement at all! While a handshake or a verbal or gentleman’s agreement are all good and well, they can lead to disputes in the event of a misunderstanding. That’s because the parties involved won’t have a record of – or proof of – their agreement. Valid written contracts are better enforced than oral agreements.
7. Not seeking the appropriate legal advice. Spending money on legal fees is usually seen as a grudge purchase by most entrepreneurs, rather than an investment. With this mindset, many entrepreneurs don’t seek legal advice, even if they don’t understand contracts or what they’re entering into. By not seeking the appropriate legal advice, they put themselves at commercial and legal risk.
8. Filing the signed contract away forever. In most instances, once the contract has been signed, many entrepreneurs may never look at it again. That puts them at risk of not making use of the rights they have, or they may be at risk of not fulfilling the duties set out in the contract.
9. Using an agreement off the Internet. To save on costs, many entrepreneurs often use contracts they’ve downloaded from the Internet. While there is a place for this, it’s not always in their best interest to do so. Rather spend the money and protect your interests – it will be less costly in the long run!