Fundamentals of Contract and Commercial Management (eBook)

2.1   Overview: what is a contract?

What is a contract and when does a domestic or international contract actually come into being? The answer is not always simple.

A contract is a binding legal obligation between two or more parties. It is enforceable in a court of law. All contracts involve the principles of offer, acceptance, and consideration, but the rules and principles vary from one country to another.

Basically one party makes an offer and the other party accepts it. The offer and the acceptance have to match for the contract to be formalized. In the simple snow-shoveling example the young man’s act of raising his snow-shovel with a questioning look constitutes his offer. The older man nods his head as acceptance after establishing the price, or consideration.

Offer

When a potential customer puts out a request for tenders or alternatively, a Request for Proposal, he or she is inviting a seller to make an offer. When a seller issues a tender or proposal document in response, which is an offer to the customer. This tender could become the contract if it is accepted by the customer ‘as is’ and either:

•   The customer signs it, or

•   The customer places an order on the terms of the seller’s offer

This is a straightforward and intentional exchange to create a contract, but many other customer interactions have the potential of becoming a contract. Requirements for a valid contract vary from one country to another. It does not necessarily have to be in writing to be considered a contract. In some countries, a contract may be established via a series of faxes, an exchange of messages between computers, or simply an oral agreement during contact at a trade fair—or even through the actions of the parties as if a contract is in place, often referred to as ‘through performance’.

Acceptance

Acceptance is voluntarily agreeing to the terms of an offer and results in the creation of a contract. Perhaps the most common business scenario is the exchange of standard forms. The seller will submit standard terms of sale to the buyer who will respond with a pre-printed purchase order containing conditions. Both parties agree that they want a contract, but they do not agree as to what terms should govern. This sets up what is known as the ‘battle of the forms’. If a dispute arises when there has been this type of exchange and there is no clear agreement, courts will generally rule that the last form exchanged before performance is the governing contract.

Looking at another example on the principle of acceptance, a customer sends in an order for a tractor, including its own purchase order terms and conditions. This is the customer’s offer to buy. The seller may either ship the goods, in which case the seller has accepted the customer’s offer, or they may send back a confirmation of the order, referencing the seller’s own terms and conditions, in which case they have made a counter offer. Offers and counter offers may be exchanged any number of times until an agreement is reached.

Consideration

The third element in forming a valid contract is the principle of consideration. This means that a valid contract must provide value to both sides. One party provides the goods and the other party pays, or offers to pay. Consideration can also take the form of some other value. In forming a joint venture agreement, one party may provide technology and a patent license. The local partner may provide land and office space, local influence and personnel. The consideration is the value that each party is providing.

2.2   Different types of agreement

This section outlines the commonly used agreements relating to a contract:

•   Non-disclosure agreements (NDAs)

•   Preliminary agreements

•   Sale of goods only

•   Sale of services only

•   Sale of goods and services

•   Licenses

•   Leases

More complex and specialized agreements are discussed in the subsequent section.

Non-disclosure agreements

Non-disclosure agreements (NDAs) are often the first formal contractual relationship between two parties and their use has become far more extensive in the last ten years. They govern the protection of information that is shared and fall into two general types, unilateral and mutual. A unilateral form protects the information of one party and places obligations on the other. A mutual form protects the information of both parties and places the same obligations on each.

The nature and type of NDA should reflect the business needs and information sensitivities and not simply reflect the respective market power of the parties or a “we always do this” attitude. Key questions to consider include:

•   What do we want/need to do with the information received?

•   What do we need the recipient of the information to be able to do with it (for example, talk with potential subcontractors)?

NDAs are discussed in more detail in Chapter 10.

Preliminary agreements

It is often wrongly assumed that the individuals involved in preliminary discussions are free to negotiate without having to worry that their actions, written communications or phone calls may have legal consequences. In fact, legal obligations can take effect in pre-contract situations when the elements of a contract are present. Similarly, these interactions may be deemed part of any eventual contract that is created. If there is an eventual dispute, all communications can become material in its resolution.

Preliminary arrangements can take many forms. From the time the initial customer contact is made until the moment a contract is signed by both parties, there are many different preparatory or preliminary arrangements that take place. These can be:

•   Oral discussions or agreements

•   Exchanges of information, marketing materials, product descriptions

•   Price estimates

•   Exchanges of letters, emails, text messages

•   Memorandums of Understanding/Letters of Intent

It is important when having these preliminary discussions for both sides to be upfront and honest about their intentions, their authority or lack of authority, and whether these are exploratory discussions only. Contractual liability can arise whenever suppliers and...