Contractual Agreement: Definition, Purpose, Types

What is a Contractual Agreement?

A contractual agreement is a legally binding agreement between two parties. The contract's terms and conditions will require the parties to either do or refrain from doing specific actions. A contractual agreement is legally enforceable if it meets these specific requirements:

• Offer and Acceptance: One party must make an offer, and the other party must accept that offer.
• Mutual Consent: Offer and acceptance must occur mutually and without coercion.
• Consideration: Consideration means that something of value is exchanged between the parties, whether money, goods or services.
• Competence: Parties entering the contract must be legally competent. Parties cannot be under the influence of drugs or alcohol, mentally deficient, or a minor.
• Legal Purpose: The contract cannot require any unlawful action.

Contractual agreements come in many different forms and are used for various purposes like employment contracts , business contracts , and sales contracts . Most people don't realize that something as simple as purchasing an item from a store is a contractual agreement.

If either party breaches the terms of the contract, the party not in breach has the option to file a lawsuit. If the judge determines that the contractual agreement was valid by meeting all the contract requirements, the court can order completion of the terms of the contract or compensation for monetary damages.

For a more detailed definition of a contractual agreement, click here.

Purpose of a Contractual Agreement

The purpose of a contractual agreement is to serve as a record of the agreement between the two parties. By entering into a contractual agreement, both parties are legally obligated to the terms of the contract. Contractual agreements protect both parties by ensuring that they both follow through on the agreed-upon terms and conditions .

Some things to consider when entering into a contractual agreement include:

Formalities: Although an oral contract can be enforceable in some cases, it is best to have a contract in writing. When terms are written, there is less of a chance of varied interpretations. Having a written contract also proves that the contract exists.

Signatures: Written contracts should be signed by both parties involved in the contract. The signer of the contract needs to be legally competent and cannot be under the influence of any substances, mentally ill, or under 18 years old.

Read this article for more information about the purpose of a contract.

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Types of Contractual Agreements

Several different types of contractual agreements can be used for different kinds of agreements and transactions. Some of the more common types of contracts include:

• Express Contract: An express contract's terms are clearly stated, usually in writing at the time the contract is entered. This is the most basic type of contract.
• Implied Contract: Implied contracts include terms that must be inferred based on both parties' actions, facts, and circumstances to show that they knew a contract was being created.
• Unilateral Contract: When only one party promises to act or provide something, it is a unilateral contract. This type of contract is most often seen with a reward offer for a lost item being found.
• Bilateral Contract: Bilateral contracts are formed when both parties agree to exchange items or services. These are the most common types of contracts.
• Option Contract: Option contracts are most often seen in real estate transactions. Option contracts allow parties to enter into another contract at a later time by exercising the option.
• Fixed Price Contract: Also called a lump-sum contract, in a fixed-price contract, the buyer and seller agree to a fixed price for a project regardless of the amount of time or cost of material it may take.
• Aleatory Contract: This type of contract is an agreement that isn't triggered until a specified event occurs. An example is an insurance contract. The insured will pay a premium to the insurance company, and should a specified event occur, the insurance company will cover the damages.
• Unconscionable Contract: An unconscionable contract gives more power or advantage to one of the parties over the other. This could be in the form of limiting damages in the event of a breach or limiting one party's rights. Whether a contract is unconscionable is decided by the courts. A judge can determine whether a contract is unconscionable and therefore unenforceable.

Examples of When to Use a Contractual Agreement

There are various examples of when to use a contractual agreement. Anytime two parties enter a business deal where money, goods, or services are being exchanged, a contractual agreement should be utilized.

Contracts legally bind both parties to the duties they have agreed to perform and provides a record of that agreement. In addition, the contractual agreement provides a recourse should one party breach and not perform their duties.

Some common examples of when to use a contractual agreement include:

Partnership Agreement. A partnership agreement is used when two or more people decide to go into business together. It will outline each partner's share in the company and all duties and responsibilities of each party.

Employment Agreement: Sometimes, when a company hires a new employee, the employee is required to sign an employment agreement . This contract will outline important employment details like pay, benefits, term of employment, and grounds for termination.

Non-disclosure Agreement (NDA): An NDA is a confidentiality agreement used to ensure one party does not share a business's proprietary information. This keeps confidential or sensitive business information safe within the company.

Indemnity Agreement: An indemnity agreement , much like a liability waiver , protects a company from liability for any loss or damage experienced by someone else. These are often seen when businesses are involved in high-risk activities. When a person goes skydiving, they will sign an indemnity agreement where they release the skydiving company from liability in the event an injury occurs.

Lease Agreement: Lease agreements are used whenever one party is renting a property from another party. This can be seen in residential lease agreements or commercial lease agreements . This agreement will lay out terms like the property being rented, use of the property, rental cost, and who is responsible for paying additional expenses associated with the property.

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What Should Be Included in a Contractual Agreement

Although contracts will vary greatly depending on the parties and the agreement, an effective, legally enforceable contract should include the following key elements:

Element 1: Obligations and Conditions: The contract should detail the specific agreement and the obligations and conditions required by each party.

Element 2: Performance: Performance describes how each party is to complete their obligations and conditions.

Element 3: Payment Terms: Payments can be made monetarily, with goods, or with services.

Element 4: Breach of Contract: The contract should include repercussions if either party breach.

Some option elements that often be found in contracts but are not required include:

Arbitration Clause: Arbitration clauses prevent disputes from going to court and instead are handled by an independent arbitrator. These clauses are often seen in credit card contractual agreements

Force Majeure Clause: A force majeure clause voids the contract should an event occur that is out of the control of either party. For example, a natural disaster destroying a house that is in escrow.

For more examples of clauses that are commonly found in contracts, check out this contract clause guide.

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