What is a Contract?
Article 1 of the Uniform Commercial Code copyrighted by the American Law Institute is considered the primary source for the definition of a contract. All of the 50 states have incorporated all or most of the definition of this code as statue. A contract is defined as a legal obligation between two or more parties. A contract has to have four elements for it to be binding on the parties. These are 1) an offer, 2) acceptance, 3) consideration and 4) performance. This is the core definition. It does get more complicated as you move towards business agreements and I will reiterate a very important belief; THERE IS NO SUBSTITUTE FOR GOOD LEGAL ADVICE AND COUNSEL. I am not an attorney and this article is written to assist you in understanding a basic tenet of business.
Contracts are most often verbal between two parties. A very common type is between an owner of property and someone doing a small job of some sort. As an example, after a snowstorm, the neighbor’s kid comes to your door and says ‘I’ll shovel your driveway for $15’ and you agree. He makes the offer – element one; you accept – element 2; there is consideration of $15 – element three; and once he performs – element four you owe him $15. This is the simplest example of a contract between two parties. But in business, it isn’t that simple. Oral agreements are not a good idea, because nothing is as simple as shoveling the driveway. And even with something as simple as shoveling the driveway, there can be a lot of misunderstanding. The boy may not realize how wide your driveway is. Or it keeps on snowing and after he is done, the part where he started has another ¼ inch of snow accumulated. You can see that having a legal document between you and the other party is important in the business world.
From a vendor agreement to a franchise agreement, many business contracts can be as short as one page long to over 200 pages in length. You need to fully grasp the concept. But always remember the four essential elements of a contract and make sure you identify them before you agree and sign on the bottom line.
What is an offer? This is basically a statement of what one party is willing to do in the due course of business. Just as the boy offered to shovel your driveway, both parties need to understand what the offer includes. With vendor suppliers, what exactly are you providing, when would you provide the items, what level of quality are we talking about. How are you going to provide this and what is included in the offer. Note that this one element asks the questions of who, what, when, where, and how of the transaction between the two parties. It is important for both to fully grasp the offer.
Acceptance gets a little more complicated. This is due to misinterpretation between parties. Often the party making the offer can misunderstand the response from the second party. In any legal proceeding acceptance can be express, conditional, or implied.
- Of the three types of acceptance the best for any contract is the expressed acceptance, in our simple example above, the homeowner accepts the offer by the boy by just saying ‘OK’. In business agreements, it can be this simple or acceptance is done by signing the contract. Express acceptance is clearly interpreted and explicitly understood between the two parties.
- Conditional acceptance is sometimes referred to as a qualified acceptance, like a counteroffer. I’ll agree to you shoveling the driveway, if you include the sidewalk. Notice that this puts the onus back onto the boy to decide now if he wants to accept the new terms of the contract. Common conditional issues are related time constraints, third party approvals, or the consideration amount is modified.
- Implied acceptance is where much confusion starts. The person receiving the offer doesn’t expressly state acceptance but makes acts as if he is accepting the deal. An example would be instead of saying to the boy that ‘NO’ do not shovel the driveway, you instead wave the boy away but you wave him towards the driveway with a backward wave of your hand which can be interpreted as ‘Go Ahead’ from the boy’s perspective. After about 5 minutes of him shoveling the driveway, you look out the window and both of you see each other and smile. It is at this moment that you can either go out and stop the boy from continuing the service because of the misunderstanding or by doing nothing you implicitly accept the terms of the deal.
Once acceptance is made, consideration is required. An agreed amount of financial implication is essential to a deal. For our deal, it is $15 to shovel the driveway. But in the business world, it gets a lot more complicated. Often the product or service isn’t exactly 100% of what we agreed to in the offer and acceptance portion. Many written contracts account for this possibility. Terms such as ‘like’ or ‘similar’ are used to describe substitution in the agreement thereby negating the full compliance to the agreement. The question then becomes do you pay the full amount. The answer in the business contract is generally yes and you will be held to that standard.
The final element is performance. If the offeror completes the task or provides the product, than one side of the contract is now complete and you must pay the consideration as negotiated. But sometimes there is a misunderstanding between the two parties and so the question becomes, did he perform his side of the contract? In this example, the boy shovels the driveway, but puts the snow onto the side of your car whereby you can’t get the door open to get inside! The question becomes, did he do his job as offered? Well, he shoveled the driveway so technically he fulfilled his side of the bargain. ut common sense tells everyone that you don’t shovel the snow in such a way as to block the door of the car. It defeats the purpose of shoveling the driveway.
In a court of law, any reasonable judge would most likely say that he failed to perform as agreed. It is implied that you will shovel the snow a reasonable distance away from the driveway. Therefore, you do not have a fully completed contract. However, he would probably say that the boy has partially fulfilled the contract and award some consideration to the boy for that partial fulfillment of the contract. In addition, the judge would be lenient because the plaintiff is a boy and award him a good portion of the consideration. Naturally, nobody would go to court over $15. You would counsel the boy on his error and award him the $15 and move along or have him shovel the snow away from the door.
Using the example of the verbal agreement to have the driveway shoveled we can see that there are essential elements involved in a contract. An offer, acceptance, consideration, and performance are all required to make a contract enforceable. Use the Uniform Commercial Code as your guide in negotiating a contract. Review what your state statues are for contracts and gain a true understanding of what is required before proceeding in business. Act on Knowledge.
Do you want to learn how to get returns like this?
Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.
There are four key principles used with value investing. Each is required. They are:
- Risk Reduction – Buy only high quality stocks;
- Intrinsic Value – The underlying assets and operations are of good quality and performance;
- Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
- Patience – Allow time to work for the investor.
If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above.
Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:
- Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
- Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
- Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.
Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:
- Lessons about value investing and the principles involved;
- Free webinars from the author following up the lessons;
- Charts, graphs, tutorials, templates and resources to use when you create your own pool;
- Access to existing pools and their respective data models along with buy/sell triggers;
- Follow along with the investment fund and its weekly updates;
- White papers addressing financial principles and proper interpretation methods; AND
- Some simple good advice.