Contract disputes are not anything small business owners want to spend their time dealing with, they can get expensive and time consuming. It’s probably inevitable over the course of your business's lifespan that you’ll find yourself in a situation where you want to get out of a contract you've entered into. If you need to know how to get out of a contract, there are legal ways to do so. Simply put, it just depends upon how the contract was written.
Businesses often only look at the economic terms of contracts and forget to pay attention to the allocation of risks, this could cause problems down the road. If you’re taking on considerable liability you don’t realize, it’s going to open you up to either potential increased costs, or reduce your profit margin; either of which could lead to some serious financial problems. Contracts present one of the biggest risks that small business owners encounter, and all of the agreements your company enters into should be taken seriously and scrutinized.
What Effect Can A Bad Contract Have on A Business?
Any time you’re in a bad contract there’s a cost to the business, and if your only option for contract termination is to resolve it in litigation you’ve lost - even if you “win” the lawsuit it’s a loss if you’ve ended up at that point. Litigation is expensive, time consuming, a serious drag on company morale, pulls resources away from day-to-day operations and often leaves companies too risk averse even when they are on the prevailing side. Those reasons should be enough to drive home the point that contracts are important in business, and that backing out of a contract may not always be as easy as you think.
Businesses end up in bad contracts for a couple of reasons. They become, or always have been, complacent about contracts; it won’t happen to me, or I’ve been doing this for years now, there’s no need to keep being this diligent with contracts. That’s all good and well until you have an issue, and it only takes one. The vast majority of small businesses aren't allocating capital towards litigation costs, and if your cash flow, margins or cash on hand aren’t well positioned a lawsuit could easily be the end of your business.
Here’s what bad contracts do - they leave everything to be a guessing game. What happens if there is a breach of contract? How do we handle dispute resolution? How can the contract be terminated? Bad contracts often include unreasonable terms which will put your business at risk. You may have inadvertently agreed to something achievable, or something that binds your business in a way that makes it difficult to operate. Think about a contract that includes some sort of non-compete clause or non-solicitation clause that prevents your company from doing business in a certain geographic area or severely limits your business development opportunities. Think about the bind you’d find yourself in if the other party enforced such a clause.
Bad contracts also open your company up to lawsuits. According to one study by the Small Business Administration, 43 percent of small business owners have been involved in or threatened with lawsuits. Odds are you’re going to find yourself in at least a contract dispute over the course of your business. Undefined terms, ambiguous terms, issues around interpretation (all things that could be addressed proactively before the agreement is signed) are common ways business contract disputes end up in court, and are common loopholes in contracts the other side may rely on to not perform.
How To Terminate A Contract.
There are options for legally breaking a contract. Contract law certainly comes into play, and you could look into whether or not you even entered into a contract, but odds are you did, since it doesn’t take a whole lot to get there. Here are some options to consider when it comes to ending a business contract:
- What does the contract say about termination? Oftentimes the agreement itself will spell out some early termination provisions and a period under which the contract can be terminated. There may be a fee involved with doing this.
- Lack of consideration. Each side has to give something in order for the contract to be valid. Think paying a third party for services in return. While this is a possible way out of a contract, it’s unlikely that you’ll be in a situation where one side didn’t receive value. Value doesn't necessarily mean money, doesn’t have a limit (it could be as little as a dollar), and could mean that a party agrees to not do something or exercise some right as opposed to taking an action.
- Lack of capacity. Was everyone of age to enter into the specific agreement? Did everyone have the mental capacity to enter into the contract? Again, these may not be common in business but if you’re trying to get out of a bad deal, all your options should be at least considered.
- Unconscionability. This can be a defense to a bad contract. If the other party was so powerful that, in effect, you were unable to negotiate a deal with them and were left without a choice other than to enter into the contract you may have an argument that the deal is unconscionable and unenforceable. Think a situation where you’re paying way, way over market value for something and don't have an alternative.
- Misrepresentation, Undue Influence or Duress. Threats that force you to agree to the contract, or relying on false promises and statements made by the other side may be reasons to void or cancel a contract. Whether or not these are options will depend on the specific circumstances and facts surrounding the contract.
- Breach of contract. If the other party breached the contract, meaning they didn’t perform an obligation or responsibility, and it’s a material breach you may be able to terminate the contract. A material breach is a situation where the failure of the other party strikes at the heart of the agreement, of what was agreed to, and defeats the purpose of making the contract in the first place. A situation where someone refuses to pay you for services you provided may be a material breach. Whether or not something is a material breach that allows you to cancel the contract depends on the specific circumstances and the agreement. The contract itself may address how to handle a material breach (for example you may have to give them notice and time to make it right before you can cancel the contract), or you may have to follow a specific dispute resolution process to resolve the situation before it can be canceled. Whatever the case, if the other side doesn't live up to their obligations and breaches the contract it’s worth looking at whether this will allow you to cancel the agreement.
The best way to avoid contract issues is to carefully look over the agreement and consider any potential issues before signing. Contracts need to be managed for risk management, efficiency and increased profitability. While resources may be strapped if your business is just getting started or still working through the start up stage, taking some cautionary measures when it comes to contracts and taking the time (or hiring a professional to help) to understand will save a lot in the long run, both in time and money.
Contracts can be tricky and time consuming, and you’ve got a business to run. If you need help or want a free consultation, CONTACT US to see how we can be of assistance.