No matter what type of business you run, contracts are essential. If you’re reading this and thinking to yourself “they aren’t essential to my business”, or “I hardly use any contracts at all” then YOU ESPECIALLY need to read on.
When used properly, contracts help to accomplish several vital objectives:
- Set expectations between the parties
- Allow businesses to take advantage of opportunities
- Protect against risk and exposure
So it’s worth spending the time to implement them and understand how they work. But for most business owners, this can be overwhelming, and rightfully so because you’re not a lawyer. So be proactive and find a lawyer you trust to help you with this: an ounce of prevention = a pound of cure.
As we saw in our last article, “Key Contracts & Contract Terms For Any Business Part 1: Important Terms Common To All Contracts”, many contracts share a number of common features and provisions. Having discussed some of the commonalities among contracts, we’re now going to dive into a few important terms in a handful of the most common, and most important types of contracts.
- Limited Liability Company (“LLC”) Operating Agreements: (i) Clearly delineate who the members are and their respective ownership interest; (ii) Figure out if and how new members are added, and how the LLC can raise money by taking on new investors; (iii) Stipulate how decisions are made, such as by unanimous vote of the members, majority vote of the membership units, etc.; (iv) You want to carefully work out and delineate if and how members can transfer their membership interest and if/how they can exit the LLC; and (v) Don’t forget to address under what circumstances the LLC is able to make distributions to the members.
- Nondisclosure Agreement (“NDA”): Thoughtfully define the “Purpose” of the NDA because this is the purpose for which the parties are permitted to use each other’s confidential information – everything else is a breach of the contract. Spend time reviewing what’s considered “Confidential Information” because this is the meat of what’s protected by the agreement. As part of this, remember to address: (i) what format the information may be in to qualify (written, oral, etc.); (ii) whether the information needs to be labeled as “Confidential”; and (iii) any permitted exceptions to what is considered Confidential. It’s important to remember there’s a distinction between the term of the NDA, and the confidentiality term – the former is how long the contract will last and therefore how long the parties can trade confidential information and expect it to fall within the bounds of the NDA, and the latter is how long the information that does fall within the bounds of the NDA must be treated as confidential. Finally, it’s important to spend the time specifying how Confidential Information must be treated or protected by the recipient – often NDAs will say something to the effect of “each party must treat confidential information of the other party with the same amount of care as they treat their own Confidential Information.” This is a fairly safe and standard threshold, but certain situations may require a higher degree of care.
- Employment Agreement: First, it’s important to figure out if the employment will be for a specified term, or period of time, or whether it will be “at-will”. “At-will” means that, subject to any other provisions in the employment agreement, the parties are free to terminate the agreement for whatever reason, and whenever they like. If the employment agreement is for a specified term, then it’s a good idea to think about some “for cause” termination provisions that allow one or both parties to end the contract if certain, particularly egregious things happen, such as the employee breaking a law. Compensation is a key provision with several levers to pull such as: cash v. equity compensation, incentive-based compensation, and hourly v. salaried. Often employment agreements will use a combination of these to achieve a happy compromise between the two parties. Most employment agreements will provide some restrictions on employee behavior, with two of the most common being restrictions around the use of confidential information learned on the job, restrictions on the employee’s ability to work for competitors (“non-competes”), and restrictions on the employee leaving and hiring some of the employer’s other staff (“non-solicitation”). Lastly, the employer will want to make sure that any agreement ensures that any inventions created by the employee while working for the employer remain the property of the employer.
- Independent Contractor Agreements: Many of the terms from the paragraph on Employment Agreements will apply here. Rather than reproduce those in this context, the following are some that stick out more prominently with Independent Contractor Agreements. At the outset, it’s vital to properly classify your workers as either employees or independent contractors – misclassifying someone as an independent contractor can be incredibly costly when you tally paying missed wages, multipliers, and penalties from the Dept. of Labor. Assuming the person is properly classified as an independent contractor, your Independent Contractor Agreements will want to address: (i) The fact that the parties both agree and desire for the contractor to be treated as an independent contractor; (ii) Whether or not the contractor has a duty to use its own resources to correct substandard services; (iii) The fact that the independent contractor doesn’t get access to any company benefits; and (iv) Stipulating that the contractor either has their own worker’s compensation insurance, or that, even if they don’t have it, they understand they’re not covered by the employer’s worker’s compensation insurance.
In the first part of our series on Key Contracts & Contract Terms For Any Business, we highlighted and explained some of the key contractual terms common to most, if not all, contracts a business will encounter. In this installment, we’ve dived into a few specific types of contracts in order to explain some of the provisions that are key to each, individually, and some common potholes to avoid.
If you need assistance drafting, reviewing, or negotiating a contract or if you wish to consult with an attorney to take proactive steps to avoid potential contractual pitfalls, please feel free to reach out to Phocus Law by phone at (602)457-2191 or by email at firstname.lastname@example.org.
by Michele Leonelli, Phocus Law