Contract Basics: Why contracts are important
Modern business deals have made contracts more dynamic and complex than ever before.
What is a contract?
Contracts are a voluntary agreement between two or more parties to perform a service, provide a product, or commit to an act. Written agreements are commonly known as ‘friendship keepers’ as they clearly outline each party’s rights and obligations.
Written contracts are often a very important part of any deal or business process. The digital era has connected business partners across the globe, rendering oral contracts all but obsolete. Modern business deals have made contracts more dynamic and complex than ever before -- so much so that it is advisable for businesses of any size to operate with written contracts.
The following are requisite elements that must be established to demonstrate the formation of a legally binding contract:
- Offer
- Acceptance
- Consideration
- Capacity to contract
- Intent of parties to contract
- Object of a contract
An offer is a promise to act or refrain from acting, made in exchange for a return promise to do the same.
Accepting a contract is agreeing to the terms as specified in the contract.
Consideration is when each party to a contract provides something of value that induces the other to enter the agreement.
Both parties must be bound to perform their obligations or the law will treat the agreement as if neither party is bound to perform. When an offeree and offeror exchange promises to perform, one party may not be given the absolute and unlimited right to cancel the contract.
Why are contracts considered Friendship Keepers? Written contracts are tools that create enforceable actions that negate “word against word” and can be accurately interpreted by the judicial system.
Most states in the country have determined that contracts must be in writing to be enforceable.
Contracts help provide security and peace of mind
In any business dealing, a written contract can provide security and peace of mind to all the parties involved in the transaction.
“Additional Insured Status” is when a person or organization enjoys the benefits of being an insured under an insurance policy, in addition to the named. An additional insured often gains this status by means of an endorsement added to the insurance policy which identifies the additional party by name.
Case example: A written contract could have solved liability
An insured hired a contractor to build a new grain bin and the agreement was made with friendly handshake.
The contractor supplied his own equipment/tools, employees and materials for the job. During construction, a customer of the insured entered the premises and sustained an injury from a hazard created by the contractor. After the injury, the contractor informed the insured he would take care of everything. A few days later, a lawsuit was filed by the injured party, naming the insured and the contractor as defendants. The contractor’s insurance company would not agree to defend the insured, as the allegation was that the incident arose out of the insured’s premises liability and there was not a contract (written agreement) to trigger insurance coverage on the contractor’s policy.
As a result, both the insured and the contractor had to hire separate attorneys to defend their case. The attorney representing the insured tried to get the insured dismissed from the case by filing a MSJ (Motion for Summary Judgment), that would have plead that the contractor was responsible for the injuries because they arose from his operations. The Judge ruled that “It was a question of fact for a jury to decide”, as the judge did not have a written contract to reference. If one of the parties to the suit did not like the result of the trial, ruling in favor of the MSJ would have provided an opening for the case to be appealed.
If there had been a contract that clearly outlined that the contractor was responsible for any incidents resulting in bodily injury or property damage arising out of his operations and agreeing to pay for any defense or settlement, then the MSJ would have been successful.
If a signed written contract would have been in place, the contractor’s insurance company would have accepted the tendering from the insured’s carrier and extended coverage for this loss as stated in the Insured contract clause.
What happens when a loss occurs without a signed contract?
As shared in the case example, if you do not have a signed written contract, you could incur legal expenses to defend a case when your actions did not contribute to the cause of the loss. Not only could legal expenses be incurred, but a jury could decide that your company is responsible for all or some of the injury/damages. In addition, if you have insurance, you will have a claim on your insurance policy that will show an incurred payment.
What if I have a Certificate of Insurance? Is that enough?
Much like a contract, producing a Certificate of Insurance (COI) based on your elected coverage can be an important aspect of protecting your business in the event of a loss scenario, but is in no way a substitute for a properly orchestrated and approved written contract. A COI is a document used to provide information on specific insurance coverage. The certificate provides verification of the insurance and usually contains information on types and limits of coverage, insurance company, policy number, named insured, and the policies' effective periods. COIs are generally issued by the agency and not the insurance company and do NOT provide, extend nor amend insurance coverage or guarantee coverage.
What are the benefits of having a contract?
- A contract document spells out in specific language the obligations of each party
- A contract document clearly outlines each party’s responsibilities in the event of a loss
- Friendships can be preserved; handshakes are not evidence in a court of law
- Contracts are legally enforceable in a court of law
- Contracts often represent a tool that companies use to safeguard their resources
- Written contracts also help in the event the other party breaches an agreement
- A contract sets clear expectations for insurance companies involved in resolving a problem(s)
- A contract provides security and peace of mind
- A contract can help avoids expensive litigation proceedings
Consult legal counsel
Insurance coverage varies by state, coverage and additional insured status and the effectiveness of contracts depends upon governing law, case law interpretation, policy forms in effect, and policy forms in place at the time of the loss. Policyholders should consult legal counsel for advice on the execution of contracts and contact their agent to discuss their policy options.
Learn how to identify contractual risks and avoid inheriting liability risks.
By taking steps to protect your business, you can minimize exposure to unnecessary claims or lawsuits. The attached Contractual Risk Transfer guidelines can help you better understand and identify contractual risks and evaluate if you should consider transferring the risk to the responsible party.
Before entering into a contract, reference these guidelines to evaluate risk transfer, make informed decisions and educate your employees. For more information about contracts, contact an attorney who specializes in contracts.
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