How to make sure your contracts are legally valid?

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Key Takeaways

• A legally enforceable contract is an agreement where two or more parties delineate responsibilities for each other to uphold.
• A few fundamental factors that determine whether a contract can be legally enforced include mutual agreement (proven by means of a proper offer and acceptance), sufficient deliberation (though in some cases, this can be substituted by a legitimate alternative), the ability of the contract’s participants to enter into legally enforceable contracts (e.g., being of minimum age, possessing a sound mind, etc.), and whether the purpose of the contract is legal or not.
• For the majority of legal agreements, using extremely formal and technical language is neither important nor useful. The terms and conditions of your contract should be straightforward and easy to understand.
• Founders often wonder if it is necessary for a contract to be in writing. The truth is that under some circumstances, the validity of an agreement largely depends on if it is in writing. With that said, it’s generally advisable to have all contracts related to your startup in writing, even the ones that your state doesn’t require you to put in writing. Why? Simply because written contracts are far easier to prove in court than verbal (handshake) agreements. 
• The legal validity of most contracts hinges on the presence of two key points. The first point concerns all parties being in agreement. Once one party extends an offer and another party accepts it, both parties should agree to the main points of the contract. The second point concerns the exchange of value. In other words, some kind of value should be swapped for something else. This could mean money, goods, or services on either side. If any side is not exchanging something of this sort, then they must at least provide the promise to exchange it.

What is a (legally valid) contract?

A legally enforceable contract is an agreement where two or more parties delineate responsibilities for each other that are legally valid. A few fundamental factors that determine whether a contract can be legally enforced include: 

• Mutual agreement (proven by means of a proper offer and acceptance)
• Sufficient deliberation (though in some cases, this can be substituted by a legitimate alternative)
• The ability of the contract’s participants to enter into legally enforceable contracts (e.g., being of minimum age, possessing a sound mind, etc.)
• Whether the purpose of the contract is legal or not

When a contract is breached (or violated), then certain reparations have to be made, such as general damages, special damages, reliance damages, etc. Reparations could also include performance-related remedies where the party that breached the contract has to deliver on its responsibilities as laid out in the contract. 

Essentially, contracts are guarantees that the legal system will impose. The law surrounding contracts is in the jurisdiction of a state’s common law. The general law of contracts is the same across all states; however, different states may have different ways to interpret specific clauses of a contract. 

In the case of a violated contract, contract law generally stipulates that remedies be provided to the injured party. This could take the shape of financial reparations or court rulings that bind the party that breached the contract to deliver on the promises it had initially made. 

How to make sure your contracts are legally valid

Many contracts are strewn with inexplicable legal jargon. In fact, founders (and most people, in general) are so used to head-spinning legalese, that they forget that this is not a desirable objective in the contracts that they are drafting. For the majority of legal agreements, extremely formal and technical language is neither important nor useful. The terms and conditions of your contract should be straightforward and easy to understand.

Founders often wonder whether or it is necessary for a contract to be in writing. The truth is that under some circumstances, the validity of an agreement largely depends on if it is in writing. For example, laws in many states necessitate that contracts surrounding transactions in the real estate industry be in writing. They also necessitate the same for contracts that would go on for more than twelve months. To get the final and official say on the subject, it would be best if you look up the laws of your state to find which contracts necessarily need to be in writing. With that said, it’s generally advisable to have all contracts related to your startup in writing, even the ones that your state doesn’t require you to put in writing. Why? Simply because written contracts are far easier to prove in court than verbal (handshake) agreements. 

The legal validity of the majority of contracts hinges on the presence of two factors in them:

• All parties in agreement: Once one party extends an offer and another party accepts it, both parties are agreeing to the terms of the contract.
• Exchange of value: Some kind of value should be swapped for something else. This could mean money, goods, or services on either side. If any side is not exchanging something of this sort, then they must at least provide the promise to exchange it.

To develop a better understanding, let’s analyze these two factors in a little more detail.

All parties in agreement

1. While this might appear to be clear and self-evident, it bears repeating: unanimous consensus/agreement between all relevant parties (on all key concerns) is a hard and fast requirement for a contract to be legally valid. Practically speaking, several borderline situations exist where the distinction between a proper/valid contract and conversations regarding entering a potential contract becomes fuzzy. 

To offer clarity on such situations and draw a more concrete line between valid and invalid, the legal system has drawn up certain norms and regulations that determine when a contract is legally valid. 

1. One party accepts another party’s offer

The most essential element of a legally valid contract is the arrangement when one party extends an offer to the other party which then accepts the offer. In the case of the majority of contracts, this arrangement could be either verbal or written. For example, say you are looking to get an accounting software application for your startup and are in talks with a vendor that says that they’ll charge $35 per month (plus a base fee) for your startup with up to five users. This forms the vendor’s offer. If you agree with the vendor’s offer, then you are accepting their offer. In other words, after you agree to the vendor’s offer, you enter into a contract right then. From the courtroom’s perspective, this makes you legally answerable for sticking to your contractual obligation. What is this obligation? It simply refers to paying the amount that you agreed to ($35 per month + base fee) when you finalized the discussion with the vendor. 

On the flip side, if you don’t get back to the vendor after receiving the details of their service or if you simply tell them that you would like to look into other service providers, then there is no contract or agreement as you have not yet accepted the offer. Furthermore, if you tell the vendor that although you like the deal, you would only be satisfied if the application would offer the feature of customizing late fees/interest as per client(s) or as per invoice, then again there is no contract in place as you have not agreed to each of the key terms. In fact, you have modified one of the terms of the offer. Based on how you phrased it, you might even have made a counteroffer.

2. To accept, or not to accept, that is the question

In the course of conducting daily business, the apparently straightforward practices of extending an offer and receiving an acceptance can become complicated quite quickly. This is because a host of potential scenarios can play out with every contract. Maybe the offer is not promptly and clearly accepted as the other party wishes to either mull over the deal or see if they can get a better deal elsewhere. Maybe one party moves to modify or retract the offer that they extended before the other party gets around to accepting it. Therefore, when either party withdraws an offer, puts forward a counteroffer, or waits for a long time before accepting an offer, it can cause problems. 

To mitigate the possibility of such confusion and conflict, founders need to be acquainted with and adhere to some basic norms.

3. Specify how long an offer remains open

The length of time for which an offer stays open usually plays out in one of two ways. On one hand, are offers that mention a firm deadline. On the other hand, are offers that don’t mention a date and are assumed to be open for a “reasonable” amount of time. What constitutes a “reasonable” length of time obviously depends on how one interprets it. It will also depend on the nature of your startup and the specifics of the situation.

To ensure that the other party understands the latest time by which they can make a decision, it's a good idea to include a deadline when you extend the offer. When you are the one who needs to accept an offer, obviously, it's important to do your due diligence and decide if you want to try to seek a better deal. However, don't leave the party who extended the offer hanging. Try to get back to them with your decision at the earlier end of the deadline period. Otherwise, you run the risk of the party extending the offer to retract it.

4. Withdrawing the offer

Until it is accepted, the contract can be revoked by the issuing party. This applies when you are the issuing party as well. So if the party to whom you’ve sent the offer takes more time to consider the deal than you feel is necessary or if they propose a counteroffer with conditions that don’t work for you, withdrawing the deal is an option. Only after the other party consents to all the major terms will there be a legally valid and enforceable contract in place. 

Bottom line? 

If either party wishes to revoke the offer, they must do so before the other party accepts it. Of course, the issuing party cannot revoke an offer before the other party’s potential acceptance if both sides had initially consented to the offer staying open until a specified date or time. 

5. Date of expiration

Offers that include a deadline are known as “options” and they typically come with a price. For example, consider a vendor that wishes to sell something to you; you tell them that you’d like some time to think about the deal but that you don’t want the vendor to either extend that offer to someone else or to revoke it while you’re considering it. Then you and the vendor could hash out a length of time that the offer will remain on the table.

For example, say that this length of time is 15 days. Now if you do reach an agreement on this, you might have to pay some money for this 15-day option. Why? Because in those 15 days, the vendor can’t sell that item/service to another party. Even if you are not asked to pay, the fact that an “option” contract exists, prohibits the vendor (up until the expiration date) from revoking the deal or selling what was proposed to you elsewhere.

6. Proposing a counteroffer

Human nature heavily influences our response to business developments. And if there’s one consistent characteristic that people involved in negotiating contracts exhibit, it’s the urge to make a counteroffer right after an offer is extended. Bargaining over the cost of the deal is a common theme of negotiations. After a counteroffer is extended, the party that extended the original offer can decide whether to accept or reject the counteroffer. They can even choose to extend a different counteroffer to the other party. 

Exchange of Value

The agreement of all parties is not the only requisite for a contract to be legitimate; instead, both sides also have to engage in the exchange of tangibles as per their agreement.

1. An exchange of promises

The “something” that is exchanged from either side is legally known as “consideration.” It is generally a promise of carrying out a specific action. This could be a promise to complete a particular type of work or the promise to compensate someone for the work they do. Even in the scenario of you searching for an accounting software application, there is an exchange of promises or “consideration” after both sides reach an agreement. You promise the vendor $35 per month (plus a base fee) while the vendor promises to provide the accounting application to you. 

2. The reason why an exchange of value matters

The reason why a two-sided exchange of value needs to occur to constitute a legally valid contract is because such a contract can then be distinguished from a verbal commitment or other non-binding agreement. Why is it important to distinguish a contract from such less formal arrangements? Simply because a contract can be legally enforced whereas one-sided commitments can’t be. Therefore, generous agreements where the receiving party does not provide or promise any valuable thing to the party that offers something of value are not legally valid contracts. 

3. Getting work done is as good as a promise

When it comes to contracts related to startups, more often than not, both sides exchange promises of delivering something of value to each other, thus fulfilling the requirement of legally valid contracts. But an interesting exception to this is that instead of promises, if one side performs the job discussed earlier (without first promising to do so), then that counts as a legitimate exchange of value. In other words, actually getting the job done is as good as promising to get the job done. Therefore, actions can constitute a valid exchange of value. 

For example, going back to the example of the accounting software vendor, if you tell the vendor that you’ll be remitting your payment only if the software can offer a wider variety of invoice templates, and the vendor configures the application to make this happen, then by their actions alone (without having to make promises), the vendor wraps up the formation of a legally valid contract. After they have met your stated conditions, you can no longer retract your word. (In this case, your promise to compensate the vendor as discussed) since you will be bound by the newly formed contract.

Learn more with us

• How to handle vendor contracts?
• How to build a successful relationship with your vendors?
• What to include and what to avoid in a vendor contract?
• Tips to manage vendor contract negotiations

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