The Importance Of Contracts For Small Companies

THE IMPORTANCE OF CONTRACTS FOR SMALL COMPANIES¹

1. Introduction

In the normal course of business, legally enforceable contracts are pivotal to the success of a company. The Black's Law Dictionary defines a contract as an agreement between two or more parties creating obligations that are enforceable or otherwise recognisable at law. These include, but are not limited to; simple, express, implied contracts, etc.

Despite its importance, it is quite common for small companies to conduct business without a legally enforceable contract or in consulting with advisers. Varying reasons have been identified as the cause of this anomaly, foremost of which is the cost of legal services. However, in the long run, an avoidable error may prove to be more costly.

Within this context, this article shall analyse the elements of a valid contract and its importance to small companies.

2. Elements of A Valid Contract

The main element of a contract is that the parties must "mean business"². In essence, they must intend to enter into legal relations. For example, the acceptance of an invitation to dinner creates no obligation which the law will enforce. In addition, there must be an agreement (i.e., a promise of which the offer has been duly accepted) and the promise must either be contained in a deed under seal or be supported by consideration (i.e., a promise, performance, or forbearance, usually represented in monetary terms bargained for by a promisor).

In most cases, these three elements must be present to render a contract valid. In addition, an enforceable contract must be valid with regard to the following:

1. The capacity of the parties to enter same;
2. The form, if it is oral or written,
3. The state in which consent is given, such as undue influence, duress, and illegality.

Some of these requirements may render a contract void, and others voidable or unenforceable.

3. Importance of Contracts for Small Companies

From a business perspective, contracts are important in several ways, especially when it comes to revenue protection, compliance, conflict prevention, operational efficiency, and future reference.³ Admittedly, oral contracts are valid and binding between parties. However, these types of contracts are difficult to enforce in the event of a dispute and are better suited for mundane, non-complex transactions.

Considering the foregoing, it is recommended that companies adopt written contracts when entering into transactions, as they offer more protection to both the business and the other party. A contract documenting the offer and other terms will protect the company and parties to the contract.

4. Breach of Contract

A breach of contract occurs when a party acts contrary to the terms of the contract either by non-performance, partial performance or by performance outside of the terms in the contract. A party that has performed its obligation under the contract is entitled to seek redress against the party in breach of the terms. Indeed, the Supreme Court in Pan Bisbilder (Nig.) Ltd. v. First Bank (Nig.) Ltd⁴ held that a party who has performed its obligations in consonance with the terms cannot be said to have been in breach thereof and such party can make a claim against the party who violated the terms of the contract. This decision underpins the recommendation for all small companies to adopt the practice of having legally binding contracts to protect their business, in the event a breach occurs.

5. Remedies for Breach of Contract

There are two main remedies for breach of contract - damages and specific performance. Essentially, the performing party may insist on the actual performance of the contract or seek damages for breach.⁵

1. Damages: In Kopek Const. Ltd v. Ekisola,⁶ the Supreme Court held that damages, in law generally, refers to a disadvantage which is suffered by a person as a result of the act or default of another for which a legal right to recompense accrues. Damages are thus, the pecuniary recompense given by process of law to a person for the actionable wrong that another has done to him. In Wahabi v. Omonuwa,⁷ the Supreme Court found that in a claim for damages for breach of contract, the primary concern is only regarding damages that are the natural and probable consequences of the breach caused by the party in default at the time of the contract. In the preparation of the claim for, as well as in the consideration of an award in consequence of a breach of contract, the measure of damages is the loss flowing naturally from the breach and incurred as a direct consequence of the violation. The damages recoverable are the losses reasonably foreseeable by the parties and foreseen by them at the time of the contract as inevitably arising if one of them broke faith with the other. The party whose contract was breached should be placed in the same position as if the contract had been performed and executed completely.
   
   
2. Specific performance: Specific performance is defined as the rendering, as nearly as practicable, of a promised performance through a judgment or decree; a court ordered remedy that requires precise fulfilment of a legal or contractual obligation when monetary damages are inappropriate or inadequate, as when sale of real estate or a rare article is involved. Specific performance as a remedy is discretionary and can only be ordered if the contract is valid and enforceable. This was decided in Help (Nig.) Ltd. v. Silver Anchor (Nig.) Ltd.,⁸ by the Supreme Court. The jurisdiction to order specific performance is based on the existence of a valid, enforceable contract. The courts will not decree specific performance if the contract suffers from defects such as informality, mistake or illegality which makes the contract invalid or unenforceable. The court can only grant specific performance for a purpose which can be achieved or enforced and must examine and carefully weigh every competing interest before making an order.

6. Clauses and Terms to Look Out for in a Contract

1. Parties to the contract – The contract must contain proper parties and the same parties should execute the contract.
   
   
2. Unclear or ambiguous terms – Some lawyers deliberately use unclear or ambiguous terms in their contracts to hide and confuse the other party. If there are any unclear or ambiguous terms in the contract, ensure to get clarification from the company's lawyer.
   
   
3. Liability or indemnity clause – Some contracts contain a liability or indemnity clause. Always make sure that the clause does not exceed the company's liabilities.
   
   
4. Non-compete clause – If your contract contains a non-compete clause, the company must ensure that it is in line with its policies.
   
   
5. Unreasonable penalty clause – A penalty clause may be necessary, but not always. The company should consider the implications of the penalty if it is reasonable and necessary.
   
   
6. Consideration clause – Consideration is one of the elements of a contract and must be contained in every contract. This clause must capture the consideration, if there is any payment plan or timeline, deposit paid, balance to be paid etc.
   
   
7. Renewal clause – Not every contract will contain a renewal clause; however, if the contract contains one, it should be looked at thoroughly. Some renewal clauses carry the same terms, while some may introduce new terms or trigger different obligations. New terms should be agreed upon by all parties before execution.
   
   
8. Termination clause – A termination clause signifies the end of a contract. This is an important clause because all dues/obligations owed under the contract must be dealt with before the end of the contract and same should be captured in this clause.
   
   
9. Governing law – Some contracts may be valid or require performance in more than one jurisdiction and the governing laws are different. In such event, the parties must agree on a governing law to enforce the contract.
   
   
10. Dispute resolution clause – It is necessary to provide for the resolution of disputes, in the event one occurs. This is why a dispute resolution clause is important. This clause makes a resolution easy to reach and provides guidance on how to reach same.

Conclusion

Contracts outline the responsibilities of the parties, the costs, terms, and details of termination, among other clauses. They essentially show that parties are going to take certain actions, e.g., render a service, pay costs, fulfil obligations, etc., during the validity of the contract.

Before executing a contract, all the terms above must be reviewed carefully, and an agreement reached by both parties. After execution, a breach may occur despite the best efforts of both parties. That is why there are provisions for what happens in the interim and other remedies. Therefore, it is important for small companies to engage the right professional to review all contracts before execution. They should communicate the company's preferences and make sure they are included. No contract is minor, and each one should be reviewed with a fine-toothed comb, to protect the company's interests.

Footnotes

1. Ufuoma Eferha, Associate Corporate Finance & Capital Markets, S.P. A. Ajibade & Co., Lagos, Nigeria.

2. Chitty on Contracts, 23^rd Edition, London: Sweet & Maxwell, 1968 p. 2.

3. See, Veloce International https://www.veloceinternational.com/business/why-contracts-important/. accessed 26^th January 2023.

4. See (2000) 1 SC p 31-32.

5. See (1993) 5 NWLR (Pt. 291) p 1.

6. See (2010) 3 NWLR (Pt. 1182) p 618 at 660.

7. See (1976) LPELR-3469.

8. See (2006) All FWLR (Pt. 311) p. 1838.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.