Understanding Common Contract Terms

Understanding Common Contract Terms

Contracts are a necessary part of doing business. But unless you’ve dealt with contracts before, you may not really understand them.

A contract is just an agreement between two or more people. All those dense paragraphs full of legalese explain what was agreed to and describe the parties’ rights and responsibilities.

How Contracts Work

The parties to a contract can be people, or they can be business entities such as corporations or LLCs. To form a valid contract, the parties must agree, and something of value must be exchanged, such as money or property. Most contracts don’t have to be in writing, but it can be hard to enforce an agreement that is purely oral. Some contracts, such as contracts to sell land or goods worth more than $500, must be in writing.

If one party doesn’t do what he or she was supposed to do according to the contract, then that party has “breached” the contract and can be liable for money damages. In some cases, a court can order the person to do what the contract says he or she must do.

Essential Contract Terms

Contracts can be long legal documents, they can be brief letter agreements, or they can fall somewhere in between. A contract does not have to use formal legal language, but at a minimum it must include certain information:

  • The names of the parties
  • The thing that the parties are agreeing to
  • A description of the money, property or other thing of value that is being exchanged. In legal terms, this is called “consideration.”

For example, a contract might say that Sam Smith and John Jones agree that Sam will mow John’s yard at 222 Elm Street once a week for a price of $20 per week.

Other Common Contract Terms

While you can form a valid contract with just the bare minimum terms, most contracts are more extensive because they try to anticipate situations that might arise. In the lawn mowing example above, when and how should John pay for the mowing services? What if Sam damages something on John’s property? What if it rains all week and Sam can’t mow? How can the parties cancel the agreement? By addressing these sorts of issues in the contract, the parties have clear guidelines and reduce the chance of disputes.

There are also common contract terms that appear near the end of many contracts. Often referred to as “boilerplate,” these terms can play an important role in defining the parties’ relationship.

  • Assignment. This clause explains the conditions under which the contract can be assigned, or transferred, to someone else. Or it may say that the contract cannot be assigned.
  • Arbitration.  By including an arbitration clause, the parties agree to arbitrate disputes that arise under the contract rather than litigating those disputes in court. The parties may also agree to mediate disputes before filing a lawsuit or arbitration.
  • Modification. This clause typically specifies that any changes or modifications to the agreement must be in writing and signed by the parties. It is designed to prevent one party from claiming that the parties orally agreed to change some aspect of the contract.
  • Entire Agreement. This clause says that the written agreement is the entire agreement of the parties and that it takes the place of any previous oral or written agreement covering the same subject matter. Its purpose is to prevent one party from claiming that there were additional things that the parties agreed to that were not included in the written contract.
  • Venue. The venue clause says where disputes will be litigated. If venue is in your home state, you avoid the expense of hiring an out of state lawyer and potentially traveling to a distant location for court proceedings.
  • Choice of Law. This clause explains which state’s law will be used to decide any dispute between the parties. It is designed to avoid disputes over this issue when the parties are in different states, or when the contract is signed in one state and will be performed in another.