What Is a Contract?
A contract is a legally binding agreement between two or more parties that outlines the rights and responsibilities governing a transaction. It represents a promise that can be enforced by law, ensuring that each party fulfills its obligations as specified in the agreement. While contracts can be created through either a written or oral agreement, written contracts are typically more reliable and enforceable.
Contracts serve as a means of guaranteeing a standard of practice and providing clear specifications to avoid any misunderstandings between parties. This, in turn, leads to improved work efficiency. Moreover, contracts act as a written piece of evidence in case of a contract breach, providing businesses with protection and remedies in case of disputes.
As you calibrate your contract management strategy for your business, you must understand the differences in any and all types you may encounter to maximise contract performance, preparedness, organisation, and compliance.
Let’s go through a few reasons why it is important to know the different types of contracts.
Importance of Understanding Different Contract Types
Effective contract management ensures that all parties involved in a transaction fulfill their contractual obligations, mitigate risks, and optimise contract performance. This can become challenging, given the wide range of contract types that exist today. The first step is to understand the different types of contracts that you may encounter in your business operations.
Different contracts come with different terms and conditions, rights, and obligations. For example, a sales contract will have different requirements compared to a lease agreement. By understanding these differences, businesses can ensure that they comply with relevant laws and regulations, minimise risks and penalties, and maximise their potential for success.
Moreover, a comprehensive understanding of different contract types allows businesses to prepare contracts more efficiently. Instead of drafting contracts from scratch, businesses can use templates and models that are appropriate for the type of contract they need. This can save time and money while ensuring that the final document is compliant and legally binding.
The Different Types of Contracts
Here are some types of contracts that your business may use in the course of your operations:
- Fixed-Price Contract
A fixed-price contract, also known as a lump-sum contract, is a type of contract where the price is agreed upon before the work or project begins, and it remains the same throughout the duration of the contract, regardless of any changes in the scope or nature of the work.
Fixed-price contracts are commonly used when the scope of work is well-defined, and there is a high degree of certainty about the amount of time, resources, and effort required to complete the project. These contracts provide a clear and predictable cost structure for both parties, which can help reduce uncertainty and risk.
Fixed-price contracts are often used in the following situations:
- Projects with a well-defined scope: If the scope of work is clear and well-defined, a fixed-price contract can provide a clear cost structure and reduce the risk of cost overruns.
- Short-term projects: Fixed-price contracts are typically used for short-term projects, where the scope of work is well-defined and there is a high degree of certainty about the amount of time and effort required to complete the project.
- Projects with limited risk: If the project is low-risk and there is a high degree of certainty about the amount of time and resources required to complete the project, a fixed-price contract can provide a clear and predictable cost structure.
- Projects with limited changes: If there is limited scope for changes to the project or the scope of work is unlikely to change significantly, a fixed-price contract can provide a clear and predictable cost structure.
- Cost-Reimbursement Contract
A cost-reimbursement contract is a type of contract in which the contractor is reimbursed for the actual costs incurred in performing the work, plus an additional fee or profit margin. This type of contract is typically used when the scope of work is difficult to define and the costs of the project are uncertain or difficult to estimate.
One advantage of cost-reimbursement contracts is that they provide flexibility to both the contractor and the client, as the actual costs of the project can be adjusted as necessary. However, they also carry higher risks for the client, as the final costs of the project may be higher than expected.
- Cost-Plus Contract
A cost-plus contract is a type of contract where the buyer agrees to pay the seller for the actual cost of the work performed, plus an additional amount to cover overhead and profit. In other words, the seller is reimbursed for all costs incurred in the performance of the contract, plus an agreed-upon percentage or fixed fee as profit.
The cost-plus contract and the reimbursement contract may look very similar at first glance. However, the primary difference between a cost-reimbursement contract and a cost-plus contract is the basis of reimbursement.
In a cost-reimbursement contract, the seller is reimbursed for actual costs incurred but does not receive any additional profit or fee. In contrast, a cost-plus contract includes a profit or fee that is added to the actual costs incurred.
- Time and Materials Contract
A time and materials (T&M) contract is a type of contract in which the client pays for the time and materials expended by the contractor to complete a project. This type of contract is often used in situations where the scope of the project is uncertain, or when changes to the project are likely to occur. In a T&M contract, the contractor is paid for the actual time they spend working on the project, as well as for any materials used.
These types of contracts provide flexibility for both the client and the contractor, as they allow for changes to be made to the project scope and timeline without requiring a renegotiation of the entire contract. However, T&M contracts can also be risky for clients, as the final cost of the project is not known upfront and can increase significantly if the project takes longer than anticipated or if the materials cost more than expected.
To mitigate these risks, clients should carefully monitor the progress of the project and ensure that the contractor is working efficiently and effectively.
- Unit Price Contract
A unit price contract is a type of contract in which the contractor is paid based on the actual quantity of work completed or materials supplied, at a predetermined unit price. Essentially, the total price for the project is calculated by multiplying the unit price by the actual quantity of work or materials used.
Unit price contracts are commonly used in construction projects, where the actual quantity of work or materials required may be uncertain or subject to change. For example, a unit price contract may be used for a road construction project where the actual quantity of materials required may depend on the terrain and other unforeseen factors.
Unit price contracts can provide flexibility to both the owner and the contractor. The owner can adjust the scope of the project without having to renegotiate the contract, and the contractor can be paid for the actual work or materials provided, rather than a fixed price.
However, unit price contracts may require more detailed record-keeping and monitoring to ensure that the actual quantities are accurately measured and the unit prices are correctly applied. Additionally, the use of unit price contracts may require more time and effort to prepare than other types of contracts.
- Bilateral Contract
A bilateral contract is a type of contract where both parties make promises to each other to do something in the future. This means that both parties are legally obligated to fulfill their promises. For example, if you hire a contractor to renovate your kitchen, you promise to pay them a certain amount of money upon completion of the renovation, and they promise to complete the renovation according to your specifications.
Bilateral contracts are generally a good choice when both parties want to make commitments to each other and create mutual obligations. They can provide both parties with certainty and predictability, as they know what is expected of them and what they will receive in return. Additionally, bilateral contracts can help to build trust between parties by ensuring that both parties are equally bound by the terms of the agreement.
However, it is important to note that bilateral contracts can be complex, and it is important to carefully consider the terms and obligations of the agreement before entering into it. It may be helpful to seek legal advice before signing a bilateral contract to ensure that it is fair, reasonable, and legally enforceable.
- Unilateral Contract
A unilateral contract is a type of contract where one party makes a promise or offer that the other party can accept by performing a specific action or completing a certain task. In a unilateral contract, only one party is obligated to perform, while the other party has the option to accept or decline the offer by performing the specified action.
An example of a unilateral contract is a reward for lost property. If someone loses their pet, they may offer a reward to anyone who finds and returns the pet. In this case, the person who lost the pet is the promisor, and the person who finds and returns the pet is the promisee. The promisor is not obligated to pay the reward unless the promisee performs the specific task of finding and returning the pet.
These types of contracts can be useful in situations where the promisor wants to incentivise a specific action or behavior, but they also carry some risk as they are not guaranteed to receive the desired outcome.
- Implied Contract
An implied contract is a legally binding agreement that arises from the actions, conduct, or circumstances of the parties involved, rather than from an explicit agreement or written contract. In other words, the terms and conditions of the contract are not explicitly stated or agreed upon, but are inferred from the parties' behaviour and the circumstances surrounding their interactions.
Implied contracts are generally used when the parties involved have a pre-existing relationship, such as a long-standing business relationship, and trust each other to uphold their obligations. They can also be useful in situations where it may be difficult or impractical to negotiate and draft a formal written contract.
However, it is important to note that implied contracts can be difficult to enforce, as the terms and conditions of the contract are not explicitly stated. Therefore, it is generally recommended to use written contracts whenever possible to ensure that all parties understand and agree to the terms and conditions of the agreement.
- Express Contract
Express contracts on the other hand, unlike implied contracts, are contracts that are agreed upon verbally or in writing where all the terms are clearly expressed.
Express contracts are typically used when the parties involved want to ensure that the terms and conditions of the agreement are clearly understood and agreed upon. This type of contract is appropriate when there are specific obligations, services, or goods that are being exchanged between the parties. Express contracts can be used in various business transactions such as employment agreements, service contracts, lease agreements, and sales contracts.
- Simple Contract
As the name suggests, a simple contract is the simplest form of a legally binding agreement between two or more persons or parties. They can be either written or orally agreed upon deals, however, written contracts are preferred since they are easier to enforce.
There are a few basic elements of a simple contract such as the intention of the parties, offer and acceptance of the agreement, consideration, capacity to enter, and terms. To read more about the characteristics of a simple contract, what happens when they are breached, and how you can write your own, check out our blog here.
- Unconscionable Contract
An unconscionable contract is a type of contract that is so one-sided and unfair that it is considered to be unconscionable or against public policy. These contracts are often involved in situations where one party has significantly more bargaining power than the other and is able to take advantage of the other party's lack of bargaining power.
In some cases, they may be used to take advantage of vulnerable individuals or to create an unfair advantage in a business transaction. For example, a lender might use an unconscionable contract to charge an exorbitant interest rate or to include hidden fees that the borrower is not aware of.
- Contract of Adhesion
As mentioned above, an unconscionable contract is unfair and one-sided, in contrast, a contract of adhesion is a type of contract where one party has significantly more bargaining power than the other, and as a result, the disadvantaged party is unable to negotiate the terms of the contract. The terms of the contract are usually presented as a "take it or leave it" proposition, leaving the disadvantaged party with little to no bargaining power.
The key difference between these two types of contracts is that an unconscionable contract is a contract that is so one-sided that it is deemed unenforceable by the court, whereas a contract of adhesion is generally enforceable, but its terms and conditions may be subject to scrutiny by the court to determine whether they are fair and reasonable.
- Aleatory Contract
An aleatory contract is a type of contract where the parties involved are uncertain about the outcome or performance of the contract. The performance of one party's obligation is contingent on the occurrence of an uncertain event, such as an earthquake, fire, or flood.
In an aleatory contract, the parties are essentially gambling on the occurrence of a particular event. For example, an insurance contract is an aleatory contract because the payment of premiums by the policyholder is contingent on the occurrence of an uncertain event, such as an accident, fire, or theft.
It's important to note that while aleatory contracts involve a degree of uncertainty, they are still legally binding agreements. As with any contract, it's important to carefully review the terms and conditions of an aleatory contract and seek legal advice if necessary.
How to choose the right type of contract
Choosing the right type of contract is crucial to ensure that all parties involved understand their rights and obligations, and to minimise the risk of disputes or legal issues. Here are some steps to help you choose the right type of contract:
- Understand the transaction.
Prior to signing a contract, whether it's for accepting employment, purchasing a property, or obtaining a loan, there are numerous factors to consider to prevent potential issues down the line. Contract signing may appear to be a simple act, however, your signature entails that you are accepting or rejecting a range of responsibilities and consequences.
By signing a contract, you are agreeing to its conditions and may be held legally accountable for any violations. It is critical to review each page of the contract thoroughly and seek professional advice if you have any doubts or concerns.
- Identify the purpose and scope.
Determine the purpose and scope of the contract. For example, if you are selling a product, a sales contract may be appropriate. If you are hiring an employee, an employment contract would be necessary.
- Evaluate the risks.
Consider the risks associated with the transaction and choose a contract that adequately addresses those risks. For example, if there are significant risks related to confidentiality, a non-disclosure agreement may be necessary.
Parties should also never sign a contract if they are under duress, or if they feel threatened to sign it. As previously mentioned, it is also important to never sign anything you do not understand. The general rule holds that one who signs a written document is legally bound to perform any and all obligations that arise from it, so make sure you know what you are signing into before anything else.
- Consider legal requirements.
Consider any legal requirements related to the transaction and ensure that the contract meets those requirements. For example, some contracts may require specific language or clauses to be legally binding.
A few other legal requirements you should consider before entering into any type of contract include the capacity to contract, specific formalities, statutory compliance, termination and breach, dispute resolution, and so on.
- Seek legal advice.
Consider seeking legal advice to ensure that the contract meets your needs and adequately protects your interests. A legal expert can help you understand the terms and clauses of the contract, including any legal jargon or technical language that may be difficult to comprehend. This can help you avoid misunderstandings and ensure that you are fully aware of the terms and your obligations under the contract.
By seeking legal advice, you can also better identify any potential risks or liabilities associated with the contract and take steps to minimise them. This can help you avoid any legal disputes or financial losses down the line.
Maximise Your Contract Performance, Management, and Compliance With Lexagle
Contracts are an essential element of every business. They are involved in every process, such as hiring a new employee, contracting a supplier, or any other activity in between. Due to the vast number of contract types available, it can be challenging and even overwhelming to determine which one is most suitable for your business. Additionally, drafting and managing contracts can be a daunting task for many businesses.
Lexagle offers a comprehensive platform designed to help organisations streamline their contract management process. Our modern, user-friendly platform empowers businesses to drive contracts with ease, offering features ranging from drafting and editing contracts to secure storage and retrieval. By choosing our contract management platform, businesses can see immediate returns on their investment.
If you're ready to take the next step towards a more efficient contract management process in the digital age, don't hesitate to contact us for a free demo today.