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10 Common Contract Gotchas to Avoid

image for thodonal88 / Shutterstock
thodonal88 / Shutterstock
  • A number of issues could cause a contract to become null and void.
  • Loopholes, financial obligations and automatic-renewal clauses are just a few of the issues you need to pay close attention to when writing or signing a contract.
  • There are several key elements, such as an offer and an acceptance, that all contracts must include for them to be valid.
  • This article is for business owners who are trying to avoid problems with their legal contracts and employees who may be asked to sign employment contracts.

Signing a contract can be exciting. Whether you're gaining a new client, buying property or purchasing a much-needed service, the signing is the culmination of a lot of planning and hard work. However, it could be disastrous if you fail to thoroughly review the legally binding document.

To help you with your contract due diligence, Business News Daily talked to business owners, attorneys and other experts to find out what common contract "gotchas" you should be on the lookout for. Keep an eye out for these dirty tricks.

In some cases, contracts incorporate terms such as "notwithstanding" to offer a way out of previously stated requirements. Keep an eye out for a contract that contradicts a party's previously stated obligations by using this terminology.

"If you've read a services agreement or another business's boilerplate, chances are, words like 'notwithstanding' and 'hereunder' discreetly pop up during the course of your read," said Alex Lauderdale, founder of EducatedDriver.org.

"One can go through an entire contract, up to the end, thinking they've just landed the most amazing terms and conditions the world has ever seen. But wait! There it is: 'Notwithstanding the terms and conditions set forth in clauses A-Z,'" Lauderdale said. "If you see this phrase, it's time to start paying close attention. Chances are good you just ran into your part of the bargain, and it may not be what you were expecting."

When you are entering into an agreement, it's important to consider who owns the work of a contracted party. If you're hiring a creative freelancer, for example, make sure you retain the intellectual-property rights to the work for which you've paid. Otherwise, that content could be used elsewhere at the discretion of the other party, with no regard for your intended use.

"Under U.S. copyright law, the owner of a work is generally its creator," said Ozelle Martin, founder and managing attorney at Cre8tiv Legal. "Therefore, an independent graphic designer may be the copyright owner of the work that he or she produced for you unless a written agreement says otherwise. "Many entrepreneurs are not aware of this and tend to think that if they paid for the design, they own it, but this is not how it works under U.S. copyright law," Martin added. "To attain full ownership of the work, you must ensure that the language of the contract indicates that the graphic designer will convey all rights, title and interests in the work to you."

Don't let one party's constant revising of a negotiated contract trip you up. If you see excessive revisions, chances are, they're trying to hide something in the edits. While it might be exhausting (or expensive, if you're paying an attorney), review every revision, even if the other party claims it was just a clerical change. Otherwise, it could cost you big time down the line.

"The most common form of a pitfall is in an altered contract," said Jesse Harrison, founder and CEO of the Employee Justice Legal Team. "An investor may make a change and claim majority ownership or may state that termination can be a possible option if profits do not meet a certain standard. This is generally not present on the first draft of a contract; it is often added in later after numerous changes have been made and negotiations agreed upon."

To ensure you understand all of the terms in the contract, have a dedicated attorney to oversee all contractual exchanges and to help you determine the best terms of partnership or investment, he said.

Sometimes, specific accounting practices might mislead investors to expect their dividends to be paid before management compensation, when, in reality, the opposite is true. To really understand the flow of money in an organization you're investing in, it's important to read the contract in its entirety and see what counts as a company expense.

"Frequently, investors will believe they are getting a preferred return, [where] they are repaid their investment plus interest before management and others receive any payout," said Geoff Morgan, founder of Croke Fairchild Morgan & Beres. "Be careful, because management can pay themselves bonuses or other salary or compensatory payments that are classified as 'expenses' on the company's income statement but have the effect of funneling money to management ahead of the investor."

Sometimes, contracts appear to have a set end date, but one party will sneak an automatic-renewal clause into the text. If you sign a contract with one of these clauses, you will have to provide advance notice for termination to the other party, which is difficult to do if you aren't aware the clause exists. Check thoroughly that a contract really sunsets when you expect it to, without renewing automatically.

"In countless instances, small business owners, often without their knowledge, continue having payments deducted from their bank account or charged to their credit card long after they ceased using the service," said Marc Rapaport, founder of Rapaport Law Firm PLLC. "I suggest carefully reviewing a contract to determine whether it provides for automatic renewals. Either negotiate these out of the agreement or carefully calendar the date on which you need to give notice of termination."

Another common "gotcha" is any clause that requires you to pay the other party's legal fees or fulfill other financial obligations in the event there is a conflict or pricing change. If you sign a contract with these clauses, there is little you can do to defend yourself.

"Business owners should carefully review the default provisions in a proposed contract," Rapaport said. "Contracts that require a business owner to pay the other party's legal fees, or which escalate the balance of periodic payments, put you at the mercy of the other party."

Forum selection clauses could make it geographically prohibitive for you to litigate against the other party if a conflict were to arise. These clauses stipulate that if there is any sort of litigation, it must occur in a specific venue. Agreeing to a clause like this could put you in a situation ranging from inconvenient or expensive to purely untenable.

"The first thing I tell clients to avoid is 'venue selection' or 'forum selection' clauses that require that any dispute be resolved only in a far-off jurisdiction," said Sam Ventola, a commercial litigation attorney and founder of Ventola Law. "Signing such a provision can effectively prevent you from obtaining any redress in court if it's too expensive to appear in the selected jurisdiction, and, at a minimum, they put you at a tremendous disadvantage."

If you sign a contract subject to the laws of a foreign country, you could find yourself without the protection of rights you took for granted and assumed would cover the terms of the contract. Always be sure you understand which national laws your contract is subject to and the implications of those laws.

"Contracts governed by the laws of another country that don't provide the same rights for individuals and companies [can] be prohibitively expensive for you or your company to contest or litigate," said Anne Miner, founder of The Dunvegan Group.

Agreeing to at-will employment in contracts gives you very little recourse if you're fired without cause or compensation. Agreeing to a contract containing at-will employment clauses can put you in a precarious position that leaves you high and dry if your employer terminates you for any reason, at any time, even if the company withholds severance payments.

"Contract terms like 'at will' in an employment contract mean you can be terminated at will and with no right to notice or severance," Miner said. "[This is a] big 'watch out,' especially if you will be posted in a remote area or foreign country!"

If you're writing a contract for a client, consider adding a clause that stipulates what happens if that client is acquired by another company during your time working together. Otherwise, you could lose time and money.

"If you're serving other businesses, it's worth addressing in your service contracts what happens if your client gets acquired," said Eagan Heath, founder of Get Found Madison. "This happened to us when our largest client, an assisted living company, was purchased. Fortunately, the new company at least paid the termination fee, but we weren't totally sure whether our claim would hold up if they didn't. We had to revisit our contracts after this."

Key takeaway: Loopholes, client acquisitions, financial obligations and foreign laws are some of the areas that could cause complications with your contracts if you don't address them from the start.

The terms and conditions of a contract are necessary components of a valid contract because they address scenarios that aren't part of the main substance of the contract, according to Alex Knaub, a transactional attorney at California-based law firm Lewis Brisbois Bisgaard & Smith LLP.

"Terms and conditions address the rights of parties in the event of breach or default," he said. "[They] can control where disputes on the contract will be heard, which state's law will apply and even if arbitration is required. Terms and conditions can allocate risk to each party, answering questions like who repairs the building if it burns down, who bears the loss if the shipment is destroyed in transit, etc."

Without any terms and conditions, it would be difficult to prove guilt because of the ambiguity of the contract's statements, said Sherry Mandajos, chief marketing officer at Tankarium.

"A victim of the breached contract can use the statements found in the terms and conditions to hold the other party accountable for not upholding their part of the agreement," Mandajos said.

Terms and conditions are not a required part of a contract, though. Jordan Peagler, a partner at MKP Law Group, said that, even though terms and conditions aren't required, they benefit the contracting parties by providing structure to the agreement.

"The clauses and terms that need to be included in the contract depend on the type of agreement the parties intend to reach," Peagler said. "If the contract is for the sale and purchase of goods, then the amount of goods being transferred and the agreed-upon price are essential terms and conditions."

With all that said, contract law is a state-by-state inquiry and is very fact-specific. But generally speaking, most terms and conditions are legally binding, according to Tim Billick of TBillick Law PLLC.

Key takeaway: The terms and conditions of a contract should not be an afterthought, as they can protect you if your contract is breached.

A valid contract must contain certain components, and while there are some ancillary elements that may or may not be included depending on the type of contract or the parties involved, without the core elements, a contract is not valid. Here are the key requirements:

  • Offer. One party must present the contract to the other party for review. The offer is usually the terms of the contract that would be up for dispute.
  • Acceptance. The non-offering party must respond positively to the contract before the process can proceed. Acceptance doesn't need to be written down or even said out loud. Conduct is enough to determine acceptance.
  • Consideration. This is the step where an exchange of goods, services or money takes place as stipulated in the contract. With a contract, both parties will want something, so this element is where one party is trading one right for another as determined by the contract.
  • Meeting of the minds. This element is also known as mutuality or intention. It basically means that all parties involved intended to create a valid and enforceable contract.
  • Legality. The contents of the contract must be legal in nature and with respect to the location. For example, you can't create a contract around recreational marijuana in a state where it is not legal. 
  • Capacity. This determines the eligibility of parties forming a contract, as there are certain mental and age limitations, as well as limitations for past or current incarceration.

If the basic requirements are met, Peagler said, the terms and conditions of the contract become legally binding on both parties. "However, per the statute of frauds, many types of contracts are only enforceable, and therefore legally binding, if they are put in writing," he said.

A few conditions can also void a contract. Note that void and voidable mean different things when it comes to contracts. For a contract to be void, it must be in violation of at least one of the aspects above in the legality element. If someone is found to be underage, bankrupt in some instances, for example, or the contract violates a party's rights in some way, it is also void.

A voidable contract is one that is valid under the law and still enforceable if both parties agree to it but contains some elements that could lead it to be unenforceable. If a contract was signed under duress (force or threat of force) or a lack of mental capacity, it will be voidable. Also, if one or more parties breaches the contract or there are mistakes or misrepresented facts in the contract, it is voidable.

Key takeaway: There are a number of important elements that all contracts must include, including an offer, acceptance, consideration and intention.

Yes, the terms and conditions of a contract are legally binding, but they are not a requirement of a valid contract.

According to Knaub, the answer is maybe. It depends on the context of the formation of the agreement between the parties. Contracts do not always have to be signed to be valid. A signature is not an element of the contract, but a signature is excellent evidence of the intention to enter into a contract.

It varies depending on the industry, but here are some common clauses to include:

  • Where disputes will be litigated (venue, jurisdiction)
  • Arbitration agreement
  • Identification of the parties
  • Disclaimer of guarantee
  • Right to edit contract if/when necessary
  • Liability
  • Copyright/any intellectual-property specifics
  • Confidentiality of information
Jennifer Post

Jennifer Post graduated from Rowan University in 2012 with a bachelor's degree in journalism. Having worked in the food industry, print and online journalism, and marketing, she is now a freelance contributor for Business News Daily and business.com. When she's not working, you will find her exploring her current town of Cape May, New Jersey, or binge-watching "Pretty Little Liars" for the 700th time.