Types and the Formation of Business Contracts

Contracts are a necessary part of every business entity. Contracts are used for large and small businesses between customers, suppliers, other companies, labor, logistics and many other uses. Contracts are formed for business interactions such as leases, partnership agreements, purchase orders, sales agreements, promissory notes, letters of acceptance, or employment contracts.

This article will discuss forming contracts, contracts and fraud, and sales contracts.

The contract is an agreement between two or more parties. In most states contracts can be verbal or written. Obviously the written form is more easily enforced. Contracts are used every day in the management of businesses. Contracts afford protection for their users because they can be enforced in a court of law. Contracts are used to ensure that people follow through on their actions or commitments. Contracts are developed if both parties are clear on what they've agreed to and want to be bound by their promise. They are typically bilateral in nature which means each party promises to do something for the other such as trade work for payment. A written contract provides proof of the specifics of an arrangement when needed for legal enforcement. Contracts also help the contractor and the client when delineating the terms of an agreement.

The key components of a contract are a valid offer, acceptance of the offer, a valid consideration, legal competence of the parties, and the underlying legality. The offer is a proposal to venture into an agreement with another party. This individual is called the offeror. The next component is acceptance. Acceptance is when the individual who receives the offer accepts the terms and agrees to the contract. The next component is called consideration. Consideration is the tangible asset that is given as a result of the contract such as money or property. If you have a valid offer, acceptance of the offer, and valid consideration you basically have a contract as long as both parties are competent and the underlying premise of the contract is legal.

Forming a Contract

When you are forming a contract, it should be well written, clear, and concise. It is important to be concise and the obligations of each party. These are the basic components of a contract:

  • The timeframe of the contract performance this should be annotated in days, months, weeks, years, or hours.

  • The required time frames to make payments such as due upon receipt or net plus 30 days.

  • The forms of payment to be made this includes cash, check, or credit payment terms.

  • The duration the contract is in effect.

  • The details of how the contract is to be performed. Which include what is done, how it will be done who it will be done by. The details are a very critical part of the contract because they state specifically what is done and set the framework for accountability.

  • The termination requirements, early termination requirements, and the full performance level.

  • Who will pay for additional costs such as materials are additional expenses

  • Any additional agreement details such as privacy requirements or non-compete clauses

  • The requirements for any notifications and how they will be sent such emails, postal mail, or certified mail.

  • Whether the contractor is able to assign the contract or portions of it to subcontractors

  • The damages to be paid in the event of a breach of contract

  • The remedies available when specific performance measures are not met. This is advantageous in lawsuits because an arbitrator can force the party breaching the contract to perform their obligations under the contract rather than just pay damages.

  • Any warranties provided by either party

  • Any provisions related to arbitration such as who pays legal costs of resolving the dispute

  • And what point in a contract arbitration may be required

  • Any applicable state laws related to the contract such as environmental

  • What occurs in the event the contract is terminated

Businesses can develop their own contracts or often there are a contract templates available for free on the Internet. If you do not have a contract there is no required form that it must be placed on. You can be as simple as a piece of paper with pen and pencil on extremely complex word document. Both parties can simply lists what is important to them in the contract with the required performance standards, quality, and schedules.

Contracts and Fraud

Instances of fraud are common in business transactions. As an entrepreneur you should be cautious of misrepresentation in a contract. If the party you are negotiating with makes false or inaccurate statements as you enter into the contract the false statements often result in legal battles.

In order for a contract to be enforced there are several requirements for the contract to be enforceable. These include capacity and authority, legal subject matter, offer and acceptance, and consideration.

Under the capacity and authorization, both of the contracting parties must have the legal capacity to enter into a contract. This means both parties must be mentally competent and they must be of legal age to enter into an agreement. Any of the legal business structures have the capacity to enter into a contract. Typically there is an individual who is appointed as having the authority to sign contracts for the business.

Legal subject matter is the legal jargon that simply means that the content or reason that the contract has been initiated is not against public law. Meaning for example, that you can't pay someone $50.00 to break out an automobile window of a person you do not like because vandalism is a legal so the contract is unenforceable.

Contracts require an offer and acceptance. Contracts require that there is a valid "offer" and a valid "acceptance". Each party must agree on what the other is doing and one must offer and one must accept. A counteroffer for different terms or a different price may be offered and both parties must agree to the counteroffer.

Contracts are required to have consideration. Consideration means that each party must be giving something to the other. This may be in the form of money or property. Contracts require that consideration flows both ways.

Contract fraud occurs when one party of a contract presents information to the other party in the contract is deliberately incorrect, deceitful, or false. Contract fraud occurs when any of these elements occur:

  • This misrepresentation was made knowingly

  • The misrepresentation was made with the intent to defraud one of the parties

  • One of the contract signatures relied on the information as they signed the contract

  • The results cause and injury to either party in the contract

Misrepresentation means that one of the individuals in the contract knowingly misrepresented an essential fact which influenced the decision of the other party to enter into the contract. The two main types of contract fraud are fraud in the inducement, which means the entire contract is fraudulent because one party was deceived into signing the contract based on fraudulent circumstances. The second type is fraud in the factum which means only part of the contract is fraudulent such as a specific description which states one quantity are results and another quantity.

To determine fraud you must be able to prove that the other party has made a representation of one or more material facts, that the representation was false when it was made, the other party knew that the representation was false when they made it and that they made of recklessly, they made the representation with the intention that you would rely on it, you relied on the information, and suffered damages.

Fraud is based on material fact and reliance

Material Fact

Material fact is a fact that would affect the judgment of one or more parties in a contract where the material fact is significant in importance that one of the parties would have relied on it to make a business decision.


Reliance means that you would not have taken an action related to the contract had the other party not make the representation for created a false impression.

Silent fraud

Silent fraud occurs when a contracted party fails disclose material facts and the silence under the contract negotiations supports silent fraud where one party fails to disclose material fact, they had knowledge of the fact, their failure to disclose the fact caused the other party to have a false impression and the intended for the other party to rely on the false impression. When the other party to relied on the false impression the suffered damages.

Innocent Misrepresentation

Innocent misrepresentation of a material fact is a representation made in good faith that is reasonably believed to be true by the person making it and in fact untrue. To sustain a claim of innocent misrepresentation a contracted party must establish that the other party made a representation of one or more material facts, the representation was made in connection with the making of a contract between both parties, the representation was false when it was made, and the other contracted party would not have entered into the contract had the party not made the representation. As a result, the party suffered a loss as a result of entering into the contract and loss benefited the other party.

Fraud options

Your options in the event of contract fraud are to rescind the contract and ask for consideration for the amount you have paid for second option is to sue for damages. Most contracts are written under good faith which means there is honesty in fact of conducting or transacting business. Most business actions are based on honest behavior and fair trade within commercial standards.

These are some tips to preventing fraud when working with contracts.

  • Read your contract carefully. Make sure you understand the length of the contract, requirements, quantities, conditions, and remedies within it. Carefully matching the words of the contract against what you receive from the contractor will help you eliminate opportunities for fraud.

  • Deal with reputable contractors. Ensure that the contractors you deal with have an established reputation, are in good standing in the community, and have a history of work.

  • Be aware as a small business owner of the opportunities for bribery and corruption especially on your warehouse dock. Monitor your inventories levels, cash receivables, and be aware of employee actions such as possible collusion between contractors and them.

  • Be aware of performance schemes where vendors begin performing work in one manner and it changes to another form which is contrary to the contract and requirements.

  • Develop your own fraud detection and prevention methods. This may involve random spot checks of warehouse deliveries by a second employee to verify accuracy of inventories versus receipts. Develop checklists for reviewing inventories, deliveries, audit frequencies, and requirements of your contractors.

  • Investigate any perceived fraud as soon as possible and document your findings. This may include civil or criminal charges or contract remedies.

Be aware of unscrupulous contractors who may fail to perform contracted work, overcharge, over bill, or take kickbacks. Always check your contract and deliverable items carefully to ensure you have received the contracted obligation.

Legal protection

Hopefully as an entrepreneur your contracts will be fulfilled successfully. In reality we know that is not always the case. The law and statutes provide requirements related to contract fraud. The "statute of frauds" requires that certain contracts be in writing and signed by all of the parties that are bound by the contract. Fraud law applies to any contracts involving the sale or transfer of land, contacts for the debt or hiring of another individual, any contracts that cannot be completed within a year, and any contracts that sell goods under the Uniform Commercial Code. The terms of all contracts should be easily identified in the essential terms and conditions. The purpose of the "statute of frauds" is to prevent injury to business owners from fraudulent conduct. This law makes certain contracts voidable by one of the parties in the event of party does not wish to follow through on the agreement. A voided contract cannot be enforced.

Fraudulent contract activity include activities such as these:

  • Delivering goods of an inferior quality or that are in violation of inspection, testing, or the technical requirements.

  • Charging higher rates than what is agreed to the contract

  • Performing false billing

  • Misrepresenting indirect and overhead labor charges as direct labor

  • Using collusive bidding schemes conspiring to rig prices

  • Providing a false certification of regulatory compliance

  • Providing goods or services that do not conform with federal, state, or local statutes

  • Presenting a claim for payment when a failure to abide by the contract requirements has not been disclosed to the other party

  • Failure to abide by environmental protection laws, equal employment opportunity laws, or federal wage and hour law regulations

Protecting yourself

Businesses lose significant amounts of annual revenues across the U.S. related to fraud. It is important as a business owner that you understand the basic elements we discussed for fraud and why people commit fraud. Fraud occurs when making a misrepresentation of material facts, making a false and misleading statement, that is made intentionally, knowingly, or recklessly against a victim and they incur damage. In general terms the causes for fraud are explained as this:

  • Fraud occurs because the person committing the fraud feels personal pressure

  • Fraud occurs because the individual committing the fraud perceives an opportunity to relieve this pressure without being caught

  • This individual rationalizes in their mind that they can justify their fraudulent activity

This seems reasonable as an explanation for fraud. As a business owner in knowing these causes for fraud you can prevent them by placing control structures in your business. Fraudulent people often use bribery and corruption to wrongfully influence a business transaction in order to receive a benefit for themselves or another person that is contrary to their duties for the rights of another person. It is a good idea to include in your employee handbook verbiage on contracts including conflicts of interest and discipline related to dishonesty.

Sales Contracts

No matter what business you own you are the business to make money and this certainly involves sales. Sales contracts are used between two parties of the buying and selling of bids are services. Sales contracts should contain the identities of the parties involved, the description of the goods, a buyer's rights and obligations, the sellers obligations, and the signatures of both parties. A sales contract should specifically include these items:

  • The terms of the contract which state the day of the first delivery and last delivery.

  • The requirements for delivery such as delivery notices and freight charges.

  • Any risk of loss and who will be responsible for the loss.

  • The acceptance requirements, which mean the buyer inspection of goods and claims for damages for the quality or condition of goods.

  • The charges for invoicing for each shipment and any late payments or interest for overdue invoices.

  • Any deposits that are required for the initial shipment for the sellers performance.

  • Any warranties related to defects and workmanship or materials.

  • Any tax requirements or tariffs.

  • Any state law requirements

  • Verbiage for Force Majeure is standard wording in contracts are simply states that a seller may cancel a contract related to circumstances beyond their control such as strikes, acts of god, political unrest, casualties, or embargo.

  • Any other miscellaneous information

By definition sales contracts are contracts for the sale or purchase of consumer goods or the agreement to transfer ownership of an asset. A sales contract may be for the sale of goods, services, or real property. Sales contracts are governed by state and Federal contract laws and are required to maintain standards for professional conduct required by the merchants. The three forms of sale agreements are purchase orders, bill of sales, and warranties. A purchase order is a document that a buyer of goods provides to the seller of goods outlining the terms of the sale and conditions of the transaction. A bill of sale is a written document confirms the transfer of ownership of property and identifies the property sold and the amount paid. A warranty is a guarantee made in connection with the sale of a product or property that make specific promises guaranteeing the sale.

Sales contracts include unilateral contracts when one party agrees to perform without the assurance that the other party will perform the duties in the contract. Unilateral contracts are not enforceable that of the performance is completed. These are not commonly used due to the risk of not performance.

Formal contracts are contracts that are written and enforceable. They include sealed contracts, negotiated instruments, and recognizances.

Informal contracts include a contract that does not have specific legal requirements requiring it to be sealed, written, or witnessed. Informal contracts should be avoided if you do not trust the individual you are dealing with.

Express contracts are contracts for the terms are clear and concise and the leave no room for interpretation. Express contracts are based solely on the statements of the party or written requirements of the contract.

Summary Reminders and Takeaways

Contracts are an important and necessary part of every business action between buyer and seller. As an entrepreneur you want to understand how to form a contract, understand possible issues with contracts and fraud, and how to successfully develop a sales contract. Contracts are used for large and small businesses between customers, suppliers, other companies, labor, logistics and many other uses. The contract is an agreement between two or more parties developed if both parties are clear on what they've agreed to and want to be bound by their promise. A written contract provides proof of the specifics of an arrangement when needed for legal enforcement. The key components of a contract are a valid offer, acceptance of the offer, a valid consideration, legal competence of the parties, and the underlying legality.

Every entrepreneur should understand how to draft and review contracts they come in contact with in the daily operations as a business owner. Contracts are the formal documents with which we conduct business on routine basis and having a good understanding of contracts will help the chances of contract fraud and help you to successfully grow your business.