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Minimizing Risks When Entering Into A Contract

by Kevin G. Harvey August, 2011

All thriving businesses regularly enter into contracts. Agreements to buy supplies, to lease equipment, or to sell goods or services to customers are all contractual relationships. Contracts are sometimes verbal or confirmed with a handshake, sometimes documented with a simple invoice or email exchanges, and sometimes memorialized with a carefully negotiated, multi-page document. No one enters into contractual relationships thinking or expecting that they will end badly, but there is always the risk that it will happen. While those risks cannot be completely eliminated, here are five tips for minimizing the risk of an adverse litigation result involving a contract dispute:

1. Know the laws that apply to your customer relationships.

There are a plethora of laws that apply to a broad range of contract topics. For example, businesses that provide products or services to homeowners that are defined as “improvements” to an existing home are required to use written contracts that include certain specific information. Some contracts that involve in-home solicitation or negotiations require the inclusion of a three day right to cancel the contract.[1] Failure to comply with laws that apply to particular kinds of contracts may not become an issue as long as you have a satisfied customer; but if the relationship goes sour and the customer seeks a legal remedy, the failure to comply with laws applicable to contract formation will become problematic.

2. Assess the other party before you enter the agreement.

The best way to eliminate the risk of having a bad contractual relationship is to avoid entering it in the first place. Of course, that is easier said than done. First, it takes real discipline to turn away a good salesperson or opportunities for work despite clear signals that the potential contract party may not be someone with whom you wish to do business. Other times it may simply be difficult or impossible to identify, early on, that customer who can never be satisfied. However, each contract opportunity should be carefully evaluated not only for its potential value to your business but also for the discernable risks that exist for a bad relationship. When you are able to identify potential risks before you have entered a contractual relationship, you can then take those risks into account when negotiating contract terms.

3. Accurately describe the scope of your engagement.

The primary purpose of a written contract is to document the terms in such a manner that both parties have, or should have, a clear understanding of their respective obligations. To minimize the possibility of misunderstandings, an accurate description of the goods or services to be provided should be clearly, completely, and definitively described in the agreement. If the description is vague, incomplete, or reasonably susceptible of more than one meaning, the parties may have thought they had reached an understanding of the scope of the engagement but later learn they were badly mistaken. When the expectations of a contract party go unmet, the failure to accurately describe the scope of the engagement in the contract will result in conflict and potentially litigation.

4. Document all modifications to the initial agreement.

A common mistake committed in contractual relationships is the failure of the parties to document modifications to the original agreement. Sometimes the parties to a finalized contract subsequently become comfortable in their relationship and simply do not think about the formality required for effective modifications. Other times business proprietors will neglect to obtain a customer’s signature on a contract modification simply because of the rush to get the work done. However, the failure to obtain the other party’s signature on any modification of a contract may jeopardize the ability to collect payment for extra work subsequently performed.

5. Document customer communication when the relationship begins to deteriorate.

While sudden breaches of a contract do occur, they most often follow the souring of a relationship over a period of time. It is important to learn to recognize communication from the other party (or the absence of communication) that signals trouble and to then document all subsequent communication with that party. Taking the time to send brief email confirmations as events occur or as discussions take place is an easy way to document the course of a relationship that is beginning to fail. If email is not practical, then periodic letters summarizing the status of matters can be used. If a judge or jury is later trying to sort out exactly what happened to cause a contractual relationship to fail, the “paper trail” created with well-documented communication to the other party will have been worth the effort.

There is no way to guarantee that every contractual relationship will be successful — even if these tips are followed. However, following these guidelines will leave you better equipped to deal with the problems presented in those few contractual relationships that will fail despite your best efforts to prevent it from happening.

[1] Not all contracts involving homeowners are subject to the laws that impose a three day right to cancel the contract. Consultation with an attorney is recommended before you include the provision in contracts you are drafting or before concluding, as a consumer, that a particular contract to which you are party should have included the cancellation right.