What red flags should I look for before signing a business contract?

As an owner, you’re going to sign a lot of contracts - at every stage. In the end, a business runs on the contracts that its owners sign. Everything is legally binding, and you need to be careful. What you sign, you live by. So seriously consider going through this with a fine-toothed comb.

Far too many people skim and sign what is marked for them to sign. One line can kill a company, so here is a list of red flags that you need to look out for when signing an agreement.

What Sections You’ll See

Before you get into the meat and potatoes of reading a contract, it’s important to know what sections you’ll see and what they might mean. The breakdown here will help you identify some warning signs, too.

The title should be clear about what the agreement is for, like this: “Independent Contractor Agreement.” Think of a freelancing contract as an independent contractor agreement.

A preamble can act as an introduction to a contract, and it includes the name of the parties to the agreement, the date and place of signing. Confirm the accuracy of these details before moving to the next section.

A recitals section is where you’ll find the what and the why behind the deal, who the people are, and what their goals are. It’s also referred to as the background or whereas section.

According to the VLAA, each side is required to pay the other something of value, called consideration. Without consideration, a contract is not valid. Consideration may be money or a binding promise. It’s not a gift. Say Company B agrees to complete and deliver project for Company A. In return, Company A agrees to pay Company B $5,000.00.

The heart and soul of a contract is usually in the terms of the contract. The terms section of a contract outlines what both parties are agreeing to do, the things being exchanged, and when. For example, if you’re buying a product from a manufacturer, in the section on the terms you might see a description of that product. The price and other terms, like when and how much, will also be in this section. This part of the contract may also include lists of specific duties and responsibilities that each party must fulfill.

The signing section of the contract is where all the thinking about making an agreement becomes a reality. Both parties must sign it to accept its terms. The payments are locked in. The jobs are understood.

Red Flags

Your contracts will contain jargon and small print. But not everyone understands the terms. Many wrongly think they do. Take some time to learn the warning signs that appear here. Here are 10 red flags to watch for.

A non-compete agreement is a legally binding agreement that protects trade secrets and intellectual property. An employee, business partner or client can sign a non-compete agreement.

But you have to understand that a non-compete may not be enforceable unless it meets certain conditions.

To be enforceable, a non-compete agreement must be supported by consideration meant to protect legitimate business interests or trade secrets. It must also be reasonable and limited in time. And it cannot apply to an unreasonable geographic area.

The so-called ‘non-compete clause’ varies wildly from contract to contract, warns business development consultant Joe Bailey of My Trading Skills. In Bailey’s view, you may be able to negotiate the removal or the rewording of these kinds of clauses if you catch them early. In any case, protect your future with similar companies by negotiating the removal of these clauses from your contract.

The parties to a contract may appear obvious, but they can cause a lot of confusion. Because companies can do business under different names, be sure the names on your agreement are the same ones that any payments you are making will be addressed to and paid to. Sometimes that’s the difference between getting paid and not getting paid. Re-read the key parts of the contract, not just the numbers.

The parties signing an agreement with incorrect dates in it may find themselves at the heart of a legal battle over the contract. In fact, failing to check the calendar for correct dates on a contract is a common source of contract litigation, says corporate lawyer Anthony M Kroese at Goldberg Segalla. Often, this is a clerical error, but after the contract is signed, it can cost a company dearly. Instead of falling victim to an avoidable oversight, Kroese suggests you double check the start date against the term sheet, a calendar, and the other parties to a contract.

Be careful what you give away in your contract. If you hire someone to create an original work for you, be clear on what the rights are once it’s finished. For example, say an independent contractor is contracted to develop a software system for a company. If ownership is not spelled out, the company that sells the software may be reselling it to another company. Whatever the case, clarify who owns the IP up front, or risk it later.

Bailey also warns that signing a contract that gives away all rights may be harming your business. Instead, try to keep the rights, ask for joint rights, or gain ongoing access.

You will run into clients who try to expand the scope of your project. Who is responsible when that happens? Unless there are tight rules for asking and granting change orders, both parties are at risk of constantly asking, granting, and paying for work out of scope. The same goes for mistakes: if you don’t define penalties and a cure period for them up front, it will cost you. Look for a cure period clause, which gives a party a period of time to fix a breach of contract before penalties take effect and lawyers get involved. Beware of agreements that do not provide for a cure period.

A cure period can mean the difference between being allowed to fix an error in contract and being sued. Every business has outside variables to make a deal work, says Net Lawman director Andrew Taylor. A cure period can give some breathing space, and the chance to find an amicable solution to a problem. Taylor also advises that you specify the liability for both if there’s a legal action. Otherwise, each side may point fingers at the other to avoid legal fees.

Liability deals with the amount of money owed by a party if something goes wrong. Indemnification refers to whose funds pay for a specific damage. For example, in a construction contract, the indemnification clause can exempt contractors from certain damages that happen by being negligent.

Indemnification clauses can be like landmines. As a small business, you have to be careful of contracts indemnifying only one party, which is often the larger company with more leverage.

Attorney and small business owner Eric J. Proos points out that if a third party does any of the work, indemnity is essential. To Proos, a contract without an indemnification clause is questionable. It makes you wonder about the other side.

For a service or product contract, be very clear on how much, how often, when and how the money will be paid. If you can, come to an agreement on a down payment and interim payments, which will put you much more at ease and make it easier for your business.

According to attorney David K. George, it is usually a good idea to set a fixed time limit for payment, such as 30 to 45 days from the invoice date. Any conditions on the payment should be eliminated as well. Otherwise, payment in advance is probably in your best interest.

Signing a contract can be confusing, but what follows in a dispute can be much more complicated and expensive. The venue clause will set the county and state where a lawsuit over the contract must be filed, and which state’s laws govern the interpretation. Look for an agreement for your home state or another neutral one if the other party suggests theirs.

Stacey A. Giulianti, Chief Legal Officer at Florida Peninsula Insurance Company, points out that the other side could demand that the case against it be brought in a different state, possibly costing you more to prosecute. A Florida business, for example, may be forced to sue a long way from home. The expense can discourage a suit altogether, or you might have to settle for less on the claim.

A trap that vendors often set for their clients is called an auto-renewal clause. That’s a clause that allows the supplier to renew the agreement with you if you don’t actively cancel it after a specified time, which makes it automatically roll over into the next term. This can be buried in the fine print of your vendor contracts, and you might not even need it for the service you are buying.

Many companies are surprised when they discover that they are bound by multi-year agreements for products like uniforms, linen, first aid, fire control, inspections and so on, according to Guy Whitesman, a Florida Bar Board Certified tax expert. Often there is a very short window for cancellation notice, and the buyer of the business may not want to take them over. Don’t let an auto renewal clause sneak up on you and limit the sale of your business later.

Watch out for ‘boilerplate’ provisions. These include jurisdiction, confidentiality, attorney fees, and severability. Though many owners gloss over these as standard, the language used can have a profound effect on your rights and liabilities. Look closely at these clauses.

Whitesman notes that each boilerplate clause is there to benefit one of the parties. Provisions can dictate which state’s laws apply, where you can sue for breach, and whether the agreement passes to the new company if you sell your business. Many sales reps may promise you the moon to sign the deal today. But if you don’t read the merger clause, you could get stuck with something that’s not exactly what you bargained for.

The termination clause needs to be clear and include a payment for work done. Vague grounds for termination can cause problems in a contract later, so spell out the exact grounds for ending it. Make sure you get paid for any work you already completed, or a client can cancel your contract and walk away without paying you for the work you already did.

For Shahara Write Menchan, a business law attorney at The Wright Firm, PLLC, early termination clauses are the biggest worry. Getting out of a contract early can end up costing a lot of money, especially in the first years of a company.

Read the Fine Print

Next time you sign an agreement, read the fine print. Everything is in there for a reason. You need to be aware of all of it. Make sure you understand and agree to every clause before you sign.