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Normally, a commercial contract is created through a formal process and involves a written agreement. In reality, it is a lot simpler to find yourself bound by a contract, as a verbal contract or ‘handshake deal’ may still be considered a legally binding contract. Businesses may enter such contracts through email or telephone correspondence. It is even possible for it to be implied through the conduct of the parties involved. This means that when agreeing to perform a job or service in return for a benefit, it is likely that you have entered into an enforceable contract.
Commercial contracts are an integral component of the daily operation of businesses. Business transactions often involve the formation of a commercial contract, which may apply to a one-off transaction or to an ongoing arrangement between the parties.
What is a Commercial Contract?
A commercial contract is a legally binding agreement that is made between two or more parties. The agreement sets out the rights, obligations and responsibilities of the relevant parties. It may also set out the scope of work and stipulate important dates, costs and payments.
In simpler terms, a contract may be thought of as a set of promises exchanged between the parties.
In order for the contract to be legally binding, the contract must contain the following 4 elements:
- An intention to create a binding relationship; and
Elements of a contract
An agreement between the parties forms the basis of a valid contract. This agreement is formed at the point at which there is acceptance of an offer, thus constituting a “meeting of the minds” between the parties.
Offer and Acceptance
The party that makes the offer (“offeror”) must communicate the offer and must demonstrate an intention to enter into some form of bargain with the accepting party (“offeree”).
An offer should not be confused with an invitation to treat. An invitation to treat does not involve the making of an offer, but rather, it “invites” further negotiations and opens up the possibility for an offer to be made by another party.
The offeree must then communicate their acceptance to the offeror. This may be done either orally, in writing or conveyed through their conduct. The offer can only be accepted by a person to whom the offer was initially made and must be in response to the relevant offer.
Though an offer was made, the offeror may revoke their offer at any point before acceptance. Reasons for terminating an offer include:
- If the contract stipulated a time for acceptance and that time has lapsed;
- Failure to satisfy a condition stipulated in the contract; and
- Changes in circumstances.
It is also important to note that a counter-offer is not acceptance of an offer, but rather, it is a rejection of the initial offer and is considered to be a new offer. A mere request for further information does not amount to a counter-offer or rejection.
Intention to create a binding relationship
Each of the parties need to demonstrate an intention to be bound by the contract and its terms. The terms of the agreement must not be too vague or ambiguous. If it is not possible to give a definite meaning to the words used, the contract will not be enforceable. The terms set out must be certain. If the contract is incomplete, that is, if there is a failure to include an essential term, the contract will not be enforceable. The contract must also not be a mere ‘agreement to agree’, namely, an agreement to enter into negotiations or an agreement in the future. This results in a non-binding contract.
A contract involves some form of a valuable exchange between the parties. Thus, a valid contract must involve consideration. Consideration may be thought of as ‘value’, which passes between the parties. For example, one party may provide a service and the other will pay for that service. There is a clear exchange of value here.
What are the different types of commercial contracts?
Commercial contracts may include the following:
- Shareholder agreements;
- Sale agreements;
- Commercial leases;
- Distribution agreements;
- Partnership agreements;
- Joint venture agreements; and
- Supply/production agreements.
Why is it important to understand commercial contracts?
It is important to understand the terms of the contract and what you are agreeing to. A better understanding of the contract will enable you to better negotiate terms which may be more favourable to you.
Why is it better to have a written contract?
Despite the possibility to form an enforceable contract in a number of ways, it is best to have a written contract.
It is easier to have a written document which the parties may refer to in the event a dispute arises, or if a party wishes to seek redress against another.
A written contract can also assist to prevent misunderstandings between the parties, as the terms are clearly set out in the document, making it easier for each party to understand the respective responsibilities and expectations involved.
A commercial contract often acts as a safety net for businesses in the event that a legal dispute arises. Without a written contract, it becomes significantly more difficult to prove the contents of the contract.
When may a contract be declared void or voidable?
It is important to consider the conduct leading to the formation and existence of the contract. One party may influence the other party to enter into the contract, through unfair or unconscionable dealing. This may give rise to a ‘vitiating factor’. Vitiating factors include:
- Misleading or deceptive conduct;
- Undue influence;
- Unconscionable conduct;
- Unfair terms; and
Where vitiating factors are present, a contract may be deemed void or voidable. This may allow for the obligations or responsibilities of the contract to be avoided. A void contract means that a contract was never created. Thus, neither of the parties can seek to enforce any rights or obligations arising from it. A voidable contract on the other hand, remains enforceable and may allow for the innocent party to end the contract.
How do you end a contract?
A contract will often come to an end when all the obligations under the contract have been performed. The parties may also come to a mutual agreement to end the contract. An intention to end the contract may be expressed in writing or implied through the conduct of the parties.
Termination of a contract
In the event that there are remaining obligations which have not been fulfilled, it may still be possible to terminate the contract. However, it is important to recognise that the termination of the contract does not mean that the existing rights and obligations cease to exist, but rather, future rights and obligations will not arise.
Reasons why a contract may be terminated at common law include:
- Repudiation; or
- Frustration of the contract.
By terminating the contract, the parties are no longer bound by the obligations of the contract.
Breach of contract
Failure by one party to honour obligations or fulfil promises that have been stipulated and agreed to, may result in a breach of the contract. The three main types of breach include:
This is the most common type of breach. Failure of a party to perform or uphold their side of the bargain, may constitute an actual breach. This allows the non-breaching party to terminate the contract.
Before performance or payment is due, a party may indicate that it will not be able to fulfil their side of the agreement. After receiving the notice, the non-breaching party may be entitled to terminate the contract.
Failure by one party to perform part of an obligation, will not entitle the non-breaching party to terminate the contract. However, it may nonetheless allow the non-breaching party to pursue a legal remedy for loss suffered.
Repudiation involves one party indicating that they are either unwilling or unable to perform their side of the agreement. Repudiation may be referred to as an anticipatory breach. Implied repudiation through conduct may also be sufficient to amount to repudiation.
In the event of a breach or repudiation, the aggrieved party may choose to:
- terminate the contract; or
- continue or affirm the contract.
It is possible for a contract to be frustrated because of unforeseeable circumstances, which may result in the obligations becoming incapable of being performed. When drafting the contract, the parties may not have anticipated that a particular event or circumstance would arise and thus, it is through no fault of the parties that the contract cannot be performed. The unforeseeable event therefore brings the contract to an end.
It may also be possible to terminate the contract, if there is a delay in the performance of an obligation. This may depend on whether the contract specifies the time or not. Nonetheless, if the contract does not stipulate the time which the obligation must be performed by, it is expected that it be performed within a reasonable amount of time.
It is common for commercial contracts to contain express termination clauses. These clauses may include the specific circumstances in which the contract should be terminated, and may provide the steps that should be followed in order to carry out the termination. Common specified circumstances may include:
- Material breaches;
- Change of control of a party; or
- Actual or expected insolvency of a party.
Ipso Facto Provisions
Although an ipso facto provision may allow a party to terminate the contract in the event that the other party becomes insolvent, it is important to consult a lawyer before attempting to terminate a contract, since there are new (COVID-19 related) rules which may prevent termination in certain insolvency events.
Unfair Termination Clauses
Commercial contracts may contain a termination clause which is deemed ‘unfair’. The termination clause may be unfair if it:
- Provides a serious advantage to one party and causes a significant imbalance in the rights and obligations of the parties; and
- Is not reasonably necessary to protect the legitimate interests of the advantaged party.
In the event that a clause is deemed ‘unfair’, it will be void and thus, not enforceable. However, it is important to recognise that these unfair contractual clauses will only apply to contracts where one party is a small business and where the contract itself has a low value. A contract will constitute a small business contract if the upfront price payable under the contract does not exceed:
- $300,000 (if the contract is for less than 12 months); or
- $1 million (if the contract is for more than 12 months).
It is important to seek advice from a lawyer on the termination of contracts and whether the relevant clauses contained in your contract are enforceable.