If you’re wondering how to create a contract, you’ve come to the right place.
This guide will explain what contract law is and how contracts are used in business.
Then we’ll reveal how you can make your own contract with the help of some templates.
What is a contract?
A contract is a legally binding agreement between two or more parties.
A contract clarifies the details of an agreement between the parties and outlines the responsibilities of each party in relation to the fulfillment of that agreement.
If that sounds a little confusing, think of it like this. In simple terms, a contract is like a legally enforceable promise.
If one party breaks the promise, there are legal consequences set out by the contract.
What makes a contract legally binding?
Those seven elements are:
- Identification (Defining all the parties involved)
- Offer (The agreement)
- Acceptance (Agreement mirrored by other parties)
- Mutual consent (Signatory consent of all parties)
- Consideration (The value exchanged for the offer)
- Capacity (Legal/mental competence of all parties)
- Applicable legal framework (Local laws, e.g., state law)
Common types of contracts
Contracts are everywhere, from our mortgages to our phone plans.
Creating an exhaustive list of types of contracts would take many pages. Instead, here are the most common contract types you’ll see in day-to-day business:
1. Simple, standard business contracts
This type of contract is a simple outline of an agreement between two parties.
For example, a non-disclosure agreement (NDA) or an employment contract between an employee and a business owner.
It’s legally binding and enforceable, even though it doesn’t require an official seal.
These kinds of contracts can be verbal agreements, although written contracts are always advised. Verbal contracts can be difficult to enforce when disputes arise.
2. Express contracts
An express contract occurs when two or more parties interact and agree on terms.
For example, if you’re at an auction and you bid on an item, you form an express contract to buy that item.
There doesn’t need to be a written agreement for this to happen.
3. Lump-sum contracts
Also known as a fixed-cost contract, parties agree to a lump-sum payment in advance.
For example, an agreement to pay an independent contractor’s estimate.
There’s usually a consideration for unexpected costs built into the payment.
That’s because the payment details stay the same even if costs increase during work.
Cost estimation can be a lengthy process with these contracts. It’s important for estimates to be accurate to avoid one party losing out on the deal.
4. Unit price contracts
In these legally binding contracts, the price of a “unit” is agreed upon by both parties.
A unit can represent time, materials, or labor. For example, one unit might be the cost to complete one square foot of flooring.
Therefore, the total cost of the contract is only determined once the work is completed.
Total costs can be estimated based on the scale of the project.
That means it’s easy for both parties to understand and adjust in case of a change of scope.
5. Time and materials contracts
This one is quite self-explanatory; payment is based on the time and materials needed to complete a project.
This is a highly flexible form of legal agreement, but it can lead to escalating costs if project parameters change.
6. Cost-reimbursable contracts
A contractor is reimbursed for the costs incurred over the terms of the contract.
This is normally estimated by the contractor before work is completed. Parties can also agree on a cost ceiling to avoid costs going beyond a certain point.
This is quite common for lawyers or legal advice.
These kinds of service contracts allow for ongoing work with a contingency. Parties can meet and discuss the next steps if the cost ceiling is reached.
Simple steps on how to write a contract
You can create a contract agreement from scratch or with the help of contract management software.
Either way, follow these simple steps.
They’ll help you determine what type of contract you need and write a basic framework:
- Discuss the details of the agreement with all parties
- Choose your contract type based on this discussion
- Create an introductory paragraph with the legal names and contact information for all parties and a start/end date for the contract
- Define the key terms that appear in the document for clarity (e.g., unit price)
- Define the scope of work, deliverables, and responsibilities of each party
- Define the payment terms and schedule
- Set penalties and clauses for failure to adhere to the contract terms
- Review the contract details between all parties and make any amendments
- Have all parties sign the agreed contract. Note that some legal documents may need legal representatives to witness the signing
Best practices for how to make an effective contract and agreement
There are a few best practices you can follow that will help you make an effective contract.
The first thing to remember is to keep it simple. It’s important that all parties can understand the terms of the agreement, so avoid unnecessarily complex “legalese”.
Agree on a way to terminate the contract and a way to resolve breach of contract disputes ahead of time.
This can save a lot of time and resources if problems arise later. Agreements to mediate disputes can avoid costly legal action.
Having an open dialog between parties when making the contract is vital.
All requirements and responsibilities should be set out in the contract in plain English. That includes payment schedules and penalty clauses.
Can I make my own contract?
You can absolutely make a contract, such as a service agreement, yourself and customize details, such as a warranty, within your contract.
PandaDoc has business document templates that can help you, too. As long as an agreement includes the seven essential factors we outlined above, and all parties agree, you have a contract.
Whether you’re creating a sales contract or an employment contract, PandaDoc has contract templates for hundreds of contract types.
Scale up and make a solid contract with PandaDoc
As you scale up your small business, whether you own a real estate business or an online store, contracts can start to slow you down.
You can easily get to the scale where you need to create hundreds of contracts every month. PandaDoc’s end-to-end document workflow solution can help.
You can create contracts in minutes with our contract management software features, and then easily share and collaborate on contracts, automatically track renewals, and more.
Try PandaDoc for free today.