Formal Agreement: Everything You Need to Know
A formal agreement requires a signed document in addition to verbal consent. If this written contract does not exist, and it is not legally enforceable.3 min read
A formal agreement requires a signed document in addition to verbal consent. If this written contract does not exist, the formal agreement is not legally enforceable. An agreement refers to any understanding between at least two parties regarding specific responsibilities and rights. For informal agreements, an oral contract is sufficient.
Informal vs. Formal Agreements
Contracts are binding legal agreements between two or more parties and are enforceable in court when a party does not fulfill the contractual obligations. Contracts must contain several elements to be legally valid, including:
- An offer made by one party to another party in exchange for goods or services
- Acceptance of that offer by the second party
- Consideration, which is something of value that must be provided by both parties in the form of goods, services, money, or benefits
- A legal purpose that adheres to applicable regulations
- Capacity and competence of both parties to enter into the agreement
- The intention of forming a legally binding agreement on behalf of both parties, without coercion or misrepresentation
Formal contracts must also be notarized or otherwise witnessed, while informal contracts do not. The most common types of business contracts are purchase orders, security agreements, bills of sale, and warranties.
When Is a Written Contract Required?
Most business contracts must be in writing, including non-disclosure agreements, employment contracts, and license agreements. Informal agreements are more flexible and are recommended if the parties involved trust one another. This allows them to make changes without the assistance of an attorney.
Formal contracts are recommended when you need to outline specific obligations and rights for a project, relationship, or partnership.
How Do Courts Settle Contract Disputes?
If a contract is breached, which means one or more parties fails to fulfill its duties, the other party or parties can have the contract legally enforced by the courts. For this reason, formal contracts are recommended for situations in which you need legal protection. Even when working with friends, family members, or long-time business associates, contracts allow you to:
- Establish expectations and obligations
- Delineate payment terms
- Equally share financial risks
- Limit personal liability
- Make sure that all parties are on the same page
The court will examine the contract language to determine whether a breach of contract has occurred. They will use the most basic meaning of the words in question to make this determination. When negotiating a contract, have it reviewed by an attorney to ensure you understand what you are responsible for under its terms and conditions.
If contract language is vague or no consideration exists, the court may find the contract invalid.
The Importance of Partnership Agreements
When starting a business with a partner, a formal partnership agreement is a necessity. As your business gets more successful, having this document in place can prevent disputes from arising and help resolve disagreements that do occur.
Even if you do not create a partnership agreement, if you are in business with someone else you are legally bound by the provisions of the 1890 Partnership Act. Important provisions to understand include the following:
- Any two people doing business together constitute a partnership.
- Each partner, in this case, is personally liable for business debts and obligations regardless of fault or investment level.
- All profits are shared equally, including interest on capital regardless of the contributor.
- All partners must agree to bring in a new partner.
- The partnership must be dissolved if one of the partners leaves, dies, or goes bankrupt.
Creating a partnership agreement allows you to create your own provisions for these circumstances.
Provisions to Include in a Partnership Agreement
The partnership agreement should include clauses that detail:
- The financial or skills investments of each partner
- The daily management structure
- Profit-sharing arrangements
- Provisions for sharing losses
- Rules about removing money from the business
- Provisions to follow if a partner wants to leave
- Provisions for removing a partner who is not performing up to expectations
- Provisions for resolving disputes among partners
Keep in mind that a formal partnership agreement is flexible and can be tailored to the needs of your specific business, your relationship, your industry, and other factors. Have your business attorney review to make sure it is legally valid before signing.
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