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On the importance of contracts

2:47 pm on Jan 4, 2011 (gmt 0)

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Often in business discussions, I encounter people who enter into working relationships with no formal contract. The stereotype situation is something like:

"I agreed to build a web app for Company X with Buddy Y, they promised to pay me N% of the profit. Now I hear he's earning $Z per year off stuff that I built"

Sometimes businesses start that way. A friend, an acquaintance, or someone with enough charisma to convince you that you can trust them & are willing to jump into a working deal surrounded by promises.

And most of the time, these deals work out fine. When the project goes smoothly, the launch is successful, the venture performs as expected, and everyone involved acts with integrity and honesty.

But what about when things don't work out?

How about those times when the plan doesn't flow as expected? Or if the market analysis was misleading and the project fails? Or when human relationships sour the deal due to personality conflicts and clashing egos?

When a business fails, how do you split up the debris that's left over? Or when it becomes massively successful, who becomes the Zuckerberg?

I can not stress enough the importance of drafting contracts. They are legally binding, can be used to resolve uncertainty when it arises, and can be held in front of a judge if negotiations go awry.

If you've been in business long enough, this is all common knowledge. But I STRESS to you that writing up a contract is IMPORTANT even if you're just building a little web app in your dorm room with your college roommate. You might feel that what you're doing is such a casual venture, everyone is going to be buddies forever and if money starts pouring in you'll all celebrate by buying a jet for your weeekly trips to Vegas and life is going to explode with happiness and wealth and of course no one is ever going to screw you over.

Sorry dudes, it don't work like that.

IRL, that project that you casually worked on together is going to be taken over by the smart one who took steps to document their ownership of assets, and those without a contract are going to get a puzzled look as the former buddy-turned-zillionaire's accountant asks "Why do you think we owe you half?".

A simple contract is something you CAN write yourself, and there are plenty of examples of good contracts (to get the wording right) that you can download from the interweb. If you're entering into a working or partnership deal, make sure your contract includes (if applicable):

- definition of parties (eg "The Company" and "The Contractor")
- ownership of assets
- description of duties
- schedule of compensation (when to be paid, and how much)
- limitations of liability
- definitions of negligence
- provisions if the contract can not be fulfilled
- a process for negotiation & arbitration

That's a list off the top of my head. If I've missed any good bits, say so.

More complex contracts should be passed in front of a lawyer. Stuff you should not leave up to your own wit include:

- complex division of assets
- child custody
- incorporation
- anything to do with real estate
- anything to do with wills, death, marriages, power of attorney, etc

Don't be afraid of writing a contract, or afraid that if you get "into the paperwork" that you will get sucked into paying a lawyer you can't afford. Lawyers exist because law is complex. When your business dealings are complex, you need a lawyer. Simple deals are simple, can be written simply, by the parties involved. A contract written yourself is better than no contract at all.

disclaimer: IANAL
4:44 pm on Jan 20, 2011 (gmt 0)

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Definitely a great post!

I can't count the number of threads in the past that were started because of problems arising where there was no contract.

That said, I am also guilty of doing work sometimes without a contract...

One thing I would add to the list of things to include- a "divorce" clause. All parties need to have some way of getting out of the partnership, whether it's from being bought out, death, inability/unwillingness to continue, etc.

Also, as time goes on and needs/responsibilities change, the contract may need to be updated.
5:04 pm on Jan 20, 2011 (gmt 0)

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Great post httpwebwitch.

The item on the first list that scares me is....

- definitions of negligence.

That term cause my phone to auto-dial my lawyers all by itself!
8:10 pm on Jan 20, 2011 (gmt 0)

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I included that "negligence" bit was because I was recently handed a contract where my liability was defined in terms of "gross" negligence. And I didn't know what "gross" really meant. If I was "grossly" negligent, then I'd be liable for the consequences of code I wrote for the project... and as it turns out the definition of "negligence", gross or not, is fuzzy depending on what "normal expectations" are... A thorough contract should clarify this.

A lot of these things can be boilerplated => that means once you've written (or just modified) one contract, you'll be able to use the same contract for all similar situations. Freelancers and consultants know this already. If someone wants me to do a consulting gig, I have my contract already written and I just need to change a few names and details before sending it to a client. For freelance work I have a different contract, already written from previous jobs.

A well-crafted standard contract is part of your professional toolkit.

And I didn't even touch on "non-disclosure" agreements (commonly: "NDA"), which are usually a separate document...
5:12 pm on Jan 26, 2011 (gmt 0)

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Very good advice generally, but dont assume its all nailed if you have a $9.99 contract template form the web. Good contracts costs a lot of money to put together

They are legally binding

Unles of course (in the UK at least) they contain unfair contract terms or a lack of good faith, which many do. Many contracts are dismissed when things get to the courts - pre-nuptials for example have no legal status in the UK

Also dont forget that emails, faxes, letters and verbal comunications can also be legally binding in addition to any formal contract. I have used verbal agreement to withhold payments to a company even though what was agreed verbally during the sale wasnt in the contract I signed afterwards. The company diddnt puruse it through the courts because they know the law says I win.
5:45 am on Feb 9, 2011 (gmt 0)

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Also in this great list I would include:

- what happens when one party wants to leave
- what happens if a party dies or falls ill
- who is liable for the debts incurred by the business, should it not succeed.
4:16 pm on Mar 7, 2011 (gmt 0)

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I am offering .mobi web sites and looking for a good example contract to use between us and our clients....any ideas?

9:37 pm on Mar 7, 2011 (gmt 0)

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I would caution to not outright discount someone that wants to just "see how things go". Get a check up front or only do 1 week worth of work in advance. The point being to lessen your exposure.

My best client has been with me for over 5 years. We don't have a contract and I strongly suspect that had I asked for one in the beginning he would have walked away.
1:35 am on Mar 8, 2011 (gmt 0)

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Hey guys,


You would be much better off not trying to write legal documents on your own. Youre just asking for trouble.

[edited by: httpwebwitch at 6:55 pm (utc) on Mar 10, 2011]
[edit reason] removed self-promo [/edit]


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