The idea that “any contract is better than no contract” gets many new businesses into hot water. Small businesses, start-ups, and business partners eager to hit the ground running will skim over early documents or sign “temporary” agreements, intending to revisit the topic later or amend the agreements as the business grows. These hastily signed documents, however, can cause major issues if the parties get involved in future litigation. Here are some common and easily avoidable contract issues we’ve seen.
Signing “Placeholder” Contracts
When starting a business, some people will sign a “placeholder” or “temporary” contract, planning to draft a “permanent” contract later. Believe it or not, oftentimes the parties never get around to forming a definitive agreement.
“Placeholder” contracts are often valid contracts, though. Even if the parties have verbally discussed drafting formal contracts later, they may still be bound by the terms of the original placeholder agreement. This can be problematic during litigation because the signed agreement may contain provisions that the parties had not considered carefully before signing. For example, a “placeholder” operating agreement may have a mandatory arbitration clause that neither party realized was in the document, or may contain complicated terms about how and when the members may dissolve the company. This can make litigation increasingly expensive as the parties try to piece together the intended terms of their agreement after the fact.
Signing “Key Terms” Contracts
Some parties may try to avoid signing initial contracts by instead signing “preliminary” documents that summarize the main points or key terms of their overall business transaction. Unlike “placeholder” contracts, these preliminary agreements may provide a false sense of security by including provisions that state that the parties will draft and agree to additional formal business documents later.
But if a party takes action pursuant to a signed “key terms” agreement, they run the risk of binding all parties to the agreement’s terms. If the agreement has enough essential terms, a preliminary contract may still be legally binding, even if the parties see it as incomplete. A court may enforce such a binding agreement even if it has open terms or minor terms that the parties intended to address later. This is so even when the contract contemplates that the parties will negotiate and agree upon additional terms set forth in a “final” agreement.
A related issue is the agreement to agree. The problem with agreeing to agree to later terms or documents is that—surprise! —both parties will eventually have to agree to the later terms or documents. If the parties are unable to agree at the beginning, when they are both excited about the new business and eager to work together, the likelihood of being able to agree on those terms once the realities of business ownership set in will probably be much lower, especially in the event of a business dispute.
Who’s Signing This Thing?
Many business owners choose to form multiple entities that will each focus on one portion of their larger business plan. This makes it important to keep track of exactly who is signing because one misplaced signature can put unintended people and entities at risk.
The signature blocks on any corporate document should be clear regarding the entity that is party to the contract. One entity breaching a business loan contract, for example, could endanger the assets of other entities under the same business umbrella if the contract is not clear on which entity entered into the contract. Other companies not intended to be responsible for the loan may be named in a lawsuit along with the breaching entity and may incur significant costs trying to remove themselves from the lawsuit.
Inaccurate signatures can even expose business owners to personal liability. If the incorrectly named entity does not exist, but the managers signing the contract do, a court or arbitrator may hold them personally liable for debts of the nonexistent entity. This absurd result – and the significant legal fees that may be incurred correcting this result – might be avoided by simply cross-referencing the contract with the Oregon Secretary of State business registry prior to signing.
Look (For A Lawyer) Before You Sign!
Signatures—even on initial, preliminary, or placeholder business documents—can carry far more weight than parties realize or intend. Litigation issues over signatures like these can be avoided by consulting with an experienced business attorney at the onset of a business, rather than waiting until litigation disputes arise when it can be too late. And, once litigation proceeds, it is crucial that the parties provide any and all signed business documents to their attorneys, no matter how unimportant or inconsequential the documents may seem, so that any potential contractual issues can be resolved as quickly and smoothly as possible.