It's likely that this week alone, you'll enter into multiple contacts—perhaps without realizing it. Generally, these contracts are informal and unwritten; for example, splitting up household chores, borrowing a friend's car, lending your lawnmower to a neighbor, or making a purchase online, in a store, or at a garage sale. With these types of contracts being routine parts of our day, it's unlikely that you ever draft formal agreements for these instances. However, for business owners, choosing to not put an agreement in writing can have devastating consequences—especially for smaller or brand-new businesses. Failing to document agreements through formal contracts can create unnecessary stress for business owners.
Take the following example: a person sets up and operates a business out of their home. They sell products online, which are purchased wholesale from a manufacturer. No formal agreement is entered into by either party—except for a very short purchase order, which merely outlines the product, a unique SKU, and the number of units purchased. When the business owner receives the product, the box is heavily damaged. Upon opening the package, the business owner realizes half of the products they ordered were damaged and, therefore, unsellable. However, when the business owner calls the manufacturer, they refuse to take responsibility for the damages. They claim that they aren't liable for any products damaged in transit. In this case, who is responsible for covering the loss? What is the business owner's recourse if they cannot convince the manufacturer to send them additional product?
Unfortunately, this type of dispute happens all the time, highlighting the need for formal, written contracts. For a seasoned business, a situation like the one described above may not be as detrimental to the company, as the losses can be absorbed over time. However, for newer or smaller businesses, capital is critical to continued growth—and a 50% loss on a transaction is less easily weathered. Typically, formal contracts will address issues such as:
- Which party bears the risk of a loss in transit
- Purchaser remedies
- Limitations on damages in the event of a default
Although routine transactions may never require a formal, written contract, there are several situations in which a business owner should be sure to have a documented agreement:
- Hiring employees, especially key employees who will have access to sensitive financial information or business data.
- Long-term vendor relationships, where there will be a high volume of transactions occurring on a regular basis.
- Transactions with ongoing obligations, whether those obligations be on the buyer side or seller side.
- Businesses with multiple owners, which should always have partnership agreements in place that dictates how profits and liabilities will be distributed, and places limits on what each owner can and cannot do.
- Large transactions, whether it's a loan, purchase, or investment that total over $5,000.
- Any situation or dealing that presents inherent risk from the goods or services that a business provides.
Of course, there are many situations in which it's advisable to have the agreement put in writing. Consulting an attorney is critical if there is any uncertainty about whether a written contract is needed. Many small business owners worry about the cost of hiring an attorney to draft a contract. However, the real concern should be whether the business can bear a loss that stems from not having a formal contract in place. In fact, the long-term cost of having an attorney draft an agreement is not high, considering that if a business ends up in court, a straightforward agreement will make the terms easier to enforce. The last thing a business owner wants to do in the midst of a dispute is to have to prove that an agreement even exists.
Take a proactive measure to protect your business and contact Catalyst Legal for a free consultation. We can walk you through any potential gaps in your business’ processes that may be putting you at risk for unnecessary liability.