Contract Basics: Part One

Well- Written Contracts Can Prevent Enormous Trouble and Significant Losses

Strong, well-constructed contracts are the bedrock of sound business dealings. Every business will have contracts with employees, vendors, those among executives, or other types. Contracts are used to define the parameters of acceptable conduct by the parties to the contract. Contracts can also spell out specific actions that the parties must take to resolve disputes, take on new partners, dissolve the business, or any other foreseeable development.

—Dan Fredenberg, Esq.

When it comes to contracts, it has been said that people either pay now or pay later. Pay smaller amounts at the outset to have a skilled professional construct effective contracts to govern every aspect of their business ventures or they can pay later to have lawyers fight in court.

Part of what one pays for in a pay now situation is for a skilled attorney to sit down and think of everything that could possibly go wrong in your new business venture. The attorney then writes a mutually agreeable document—a contract or partnership agreement—for you and your partners that mitigates or eliminates any harm that might result from an undesirable scenario becoming a reality.

The more care-free person can simply engage in business activities with another person or entity without taking the time to construct agreements to govern those activities. This often ends up being the pay-later client.

Why Contracts?

If the parties to a business venture take the time to cooperate in writing and signing agreements that will govern foreseeable outcomes of their business, they can save themselves enormous amounts of time, money, and energy in working out the disagreements covered by the contracts before they become real-world disagreements.

Business professionals generally engage in contracts when things are going well and they do so in order to prevent chaos should the business dealings turn bad. Most businesses will engage in at least one of three major types of contracts:

1. Contracts with employees.

2. Contracts with vendors.

3. Contracts among partners.

With a relatively small investment of time and money, through contracts, all parties to those contracts can protect themselves against risks that might be associated with the partnership. Employees can be protected against employer misconduct. Likewise, employers can protect themselves against the risk of misconduct by employees. A vendor and a client can agree on the terms that will govern their relationship and what the outcome would be should one of the parties deviate from the agreement. Partners can construct agreements that will govern their conduct should one of them want to leave the business, should one of them become disabled, should one declare bankruptcy, etc.

A Worst-Case Scenario

Two partners run a thriving healthcare business. It is discovered that one of the partners is instructing the staff—without the knowledge of the other partner—to engage in fraudulent billing practices. The defrauding partner is able to divert millions of dollars in payments on fraudulent billing. The innocent partner never knows and never profits from these diverted funds. Nonetheless, a Federal audit is triggered and the missing funds identified. A series of criminal and civil trials might ensue that will be very expensive to both parties and may lead to jail time for one or both of the partners.

If there are no governing contracts in place, the fraudulent party may try to settle the case out of court and to repay the defrauded amounts at a fraction of the face value to a third-party payer, such as Medicare, Medicaid, a private insurer, or to the other partner. However, in the eyes of the courts, the fact that one partner has committed fraud may reduce the value of the business to zero. In this case, the innocent partner faces potential prosecution and possibly potential jail time. This outcome will be outside the control of the business partners and will rest with the lawyers and the courts because the proper documents were not constructed in advance.

Fraud Anyone?

While no one goes into business with a partner who they know to be intent on committing fraud, people do end up in unfortunate situations. A law-abiding partner can yield to temptation if he or she succumbs to financial pressure, is presented with the opportunity to commit fraud, or believes that the fraud will not be discovered. This sort of scenario can arise at many points in the life cycle of a business.

If partners agree at the outset of their business dealings to a set of rules that will govern their conduct, they can avoid many types of future disagreements and even illegal activities. For instance, in the case of the fraudulent business described above, if the partners had signed a partnership agreement stating that either partner would be immediately and completely disenfranchised upon proof of fraud, there would be a significant financial disincentive to commit fraud. If a partner realizes that he may automatically lose 100% interest in his business if he commits fraud, he will find another way to overcome his financial challenges.

Similarly, the partnership agreement could cover partners’ interactions with employees, investors, vendors, clients, and others. While these types of agreements can provide a mechanism to make an innocent partner, an employee, or an injured business, whole again after legal or civil damages, they can also help to prevent people from making bad choices in the first place.

In the best-case scenario, two people who are considering entering business together will sit down with their respective attorneys and design the parameters of an optimal working relationship. They will then commit these parameters to paper in the form of partnership agreements and other types of contracts. These agreements will then provide the foundation for a successful business venture.

If you do not have legal counsel of your own please contact us and we will provide you with referral options. Dan Fredenberg, Esq., is Partner at Fredenberg Beams Legal Group in Phoenix, Arizona.

Kevin B. Perlberg, Donald (Trace) W. Tendick, Tom Kueht and Christopher Nei are registered representatives offering securities through United Planners Financial Services, member FINRA, SIPC. Advisory services offered through Blackhawk Capital Partners. Susan Brousseau and Mike Miller offer Advisory Services Only. Blackhawk Capital Partners and United Planners Financial Services are independent companies.

 

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