Published: July 28, 2022
Updated: July 18, 2024
When looking to improve your contract management processes, it helps to know the contract fundamentals before diving into advanced topics like best practices. Although you are likely knowledgeable about the types of agreements your organization currently uses, there might be others you have not executed — those that could better define your relationships with suppliers, customers, partners, and other parties with whom you do business.
What is a contract?
A contract is a binding agreement between parties, such as businesses, individuals, or multiple people. It defines the obligations of each party to the other, including:
- Delivery of products and/or services
- The quality of those products or services
- The beginning and end date of the agreement and any renewal terms
- Requirements for relationships, like employment, partnerships, mergers, or acquisitions
Contracts also define the remedies available if one or both parties fail to meet their obligations, like contract termination, legal action, or financial ramifications.
Why are contracts important?
Contracts are important because they provide a legal record of an agreement between two or more parties — as to their understanding of their obligations and expectations. When individuals or authorized business or institutional representatives apply their ink or digital signatures to a contract, they — or the business they represent — are legally bound to fulfill the terms of the agreement. Procurement Tactics reports that nearly one-third of the entire workforce is engaged in contract management.
It does not matter whether an organization’s legal department, contract management team, senior executive, or virtual legal AI assistant has reviewed a contract — and understands its terms — in its entirety or not. In the eyes of the law, a fully signed and delivered contract means all parties to the agreement are required to comply with the terms of the agreement. (Of course, we hear about situations where one party doesn’t comply – that’s called “breach”, and it’s the source of many lawsuits.)
10 Different Types of Contracts
Better define your relationships with suppliers, customers, partners, and other parties with these types of contracts:
| Type of Contract | Everyday Use | Benefits | Drawbacks |
|---|---|---|---|
| Sales Agreements | Used in B2B transactions for goods and services. | Clear terms, predictable revenue recognition. | May require complex negotiations. |
| Non-Disclosure Agreements | Common in joint ventures and employee onboarding. | Protects sensitive information. | Can be difficult to enforce. |
| Fixed-Price Contracts | Frequently used in construction and government projects. | Predictable costs for clients. | High risk for contractors if costs exceed expectations. |
| Time and Materials Contracts | Popular in software development and consulting. | Flexibility for changing project scopes. | Potential for cost overruns. |
| Retainer Agreements | Common among legal professionals and consultants. | Steady income for service providers. | This may lead to underutilization of time. |
| Adhesion Contracts | Used in software licensing and website terms of service. | Simplifies transaction processes. | Little to no negotiation for terms. |
| Cost-Plus Contracts | Common in construction projects with unknown conditions. | Covers all costs, ensuring profitability. | This can lead to cost overruns if not managed properly. |
| Unit Price Contracts | Used in projects with repetitive tasks like road construction. | Clear payment structure for repetitive tasks. | Requires accurate estimation of units. |
| Bilateral Contracts | Standard in most business agreements. | Mutual promises provide security. | Breach by one party affects both. |
| Unilateral Contracts | Seen in reward-based offers and promotions, common in everyday transactions like dining out. | Only binding if the action is performed. | It can be difficult to prove performance. |
| Implied Contracts | Common in everyday transactions like dining out. | Formed through actions, often simple. | Ambiguity can lead to disputes. |
| Express Contracts | Standard in formal business agreements. | Clear, documented terms. | Time-consuming to draft. |
| Simple Contracts | Used for straightforward services or transactions. | Easy to create and understand. | May lack detailed terms. |
| Unconscionable Contracts | Often challenged in court for fairness. | Usually not enforceable, protecting the vulnerable party. | It may be difficult to prove unconscionability. |
“A contract is a binding agreement between parties, such as businesses, people, or two or more people. It defines the obligations of each party to the other.”
1. Sales Accords
Generally, sales agreements govern the sale of products between businesses, such as raw materials, supplies, or equipment. They can, however, include services, such as a Statement of Work, as an addendum. Companies need to ensure their contract terms are followed by the letter to recognize revenue for a fiscal period. Using approved templates is a best practice.
Terms of Sales Agreements include:
- Pricing, including volume-based discounts
- Payment terms, such as incentives for early payment
- Return policies, including return merchandise authorization terms
- Delivery terms, including free on-board or point of origin
- Warranty, including repair or replacement options
Example: A company selling manufacturing equipment may use a sales agreement to outline the machinery’s price, delivery schedule, and warranty terms.
2. Non-Disclosure Agreements (NDAs) and Intellectual Property Management
NDAs can be used to create many types of relationships. For example, joint venture partnerships are when two companies bid on a government tender together, with the commitment that they will not divulge each other’s methods or industry secrets. Employees and contractors often sign NDAs during their onboarding process. Companies typically maintain NDA templates that cover their most sensitive information and the circumstances that put it at risk.
Example: Two tech companies entering into a collaboration on a new software product may use an NDA to protect proprietary information shared during the project.
In this digital age, industries — like manufacturing, software companies, and pharmaceuticals — are just a few in which intellectual property protection is crucial to growth and competition. Management of copyright, trademark and patent-related portfolio data empowers your legal team to mitigate risks, like brand reputation damage, loss of revenue, and frivolous lawsuits.
3. Professional Service Agreements – Fixed-Price, Time and Materials, and Retainer-Based Contracts
Fixed Price:
“Contracts provide a legal record of an agreement between two or more parties —as to their understanding of their obligations and expectations.”
A fixed-price contract is a type of agreement commonly utilized in government consulting and construction projects, where the contractor is obligated to complete the specified work for a set amount of money. This contract type requires contractors to submit “all-in” bids, meaning the bid must cover all expenses, costs, and efforts necessary to deliver the complete set of specified deliverables. Such contracts are designed to provide a clear and predictable cost framework, mitigating the risk of budget overruns by establishing a firm price from the outset.
The fixed-price model benefits clients by ensuring financial predictability and limiting the risk of unforeseen expenses during the project lifecycle. Contractors, on the other hand, bear the full responsibility for managing costs effectively within the agreed-upon budget. This necessitates careful planning, accurate estimation, and efficient resource management to maintain profitability while fulfilling contractual obligations. However, the rigidity of fixed-price contracts can also pose challenges, as any unforeseen issues or scope changes may not be easily accommodated without renegotiation. This structure emphasizes the importance of thorough initial project assessments and detailed contract specifications to minimize potential disputes and ensure project success.
Example: A construction company may use a fixed-price contract for building a new office complex, agreeing on a set price for the entire project
Time and Materials (T&M):
T&M contracts allow service providers to bill clients based on the actual time spent on a project, typically calculated on a per diem or hourly basis, in addition to the costs of materials and other expenses incurred during the work. This type of contract offers flexibility in project execution, making it suitable for projects where the scope is not well-defined or is expected to evolve.
Under a T&M contract, the client assumes the majority of the risk related to cost increases, as the total expenditure can exceed the initial estimate if the project requires more time or materials than initially anticipated. This arrangement benefits the service provider by ensuring they are compensated for all efforts and resources expended, but it requires the client to closely monitor the project’s progress and budget to avoid significant cost overruns.
Example: A software development firm might use a T&M contract for a project where the scope may change, billing the client based on the actual time spent and materials used.
Retainer Agreements:
Retainer Agreements are commonly adopted by professionals such as consultants and attorneys to secure their services for a specified period. Under this arrangement, the client pays a predetermined fee upfront, granting them access to the professional’s expertise and services as needed over the term of the agreement. This fee, often paid monthly or annually, ensures that the professional is available to the client for a set number of hours or specific tasks, fostering a continuous working relationship.
Retainer agreements offer clients the benefit of having prioritized and readily available support without negotiating terms for every individual service. Meanwhile, professionals gain financial stability and a predictable income stream, allowing them to allocate their time and resources more effectively. This type of contract is particularly useful in ongoing advisory roles or where consistent, on-demand expertise is crucial for the client’s operations.
Example: A marketing consultant may have a retainer agreement with a client, providing a set number of service hours each month.
4. Adhesion Contracts
Adhesion contracts, often referred to as “take-it-or-leave-it” agreements, are standardized contracts drafted by one party, typically a business with stronger bargaining power, and presented to the other party, usually a consumer or weaker party, on a non-negotiable basis.
These contracts contain pre-determined terms and conditions that the accepting party must either agree to in full or reject entirely, with no room for negotiation or modification. This type of contract is designed to streamline and expedite transaction processes by using templates, which simplifies the process of entering into agreements.
While they facilitate efficiency and consistency, adhesion contracts can sometimes raise concerns regarding fairness and imbalance in the parties’ respective bargaining powers, leading to potential scrutiny under contract law to ensure they do not exploit the weaker party.
Example: Software installation agreements where users must accept the terms and conditions to proceed.
5. Cost-Plus Contracts
Cost-plus contracts are agreements where the client reimburses the contractor for the actual costs of work performed, such as labor and materials, and pays a fixed percentage as profit.
According to the Federal Acquisition Regulation, the fee may not fluctuate according to the exact cost of the work, but it can be modified depending on changes in the work scope.
These contracts are frequently employed in construction projects where the scope and requirements are subject to change, allowing for greater flexibility and adaptability. This arrangement ensures that contractors are fairly compensated for any unexpected increases in project costs while also incentivizing them to maintain efficiency and cost control.
By covering both the direct costs and a predetermined profit margin, cost-plus contracts help manage the financial uncertainties and complexities often encountered in large-scale construction endeavors.
Example: A construction company may use a cost-plus contract for a project involving unknown site conditions, allowing them to cover costs and make a profit.
6. Unit Price Contracts
Unit price contracts are agreements in which payment is based on a fixed amount per unit of work, making them particularly advantageous for projects involving repetitive tasks or quantities that can be precisely measured.
Under this contract type, the total cost is determined by multiplying the unit price by the number of units completed, allowing for flexibility in the overall project cost depending on the actual work performed. This arrangement is beneficial for both parties: the contractor gains clarity and predictability regarding payment per unit, while the client can manage and forecast expenses more accurately based on the project’s progress.
Additionally, unit price contracts can adapt to changes in project scope or quantities, reducing the risk of disputes and ensuring fair compensation for variations in work volume. They are commonly used in construction and engineering projects, where tasks such as laying bricks, pouring concrete, or installing fixtures can be easily quantified.
Example: A road construction project may use a unit price contract to pay for each mile of road completed.
7. Bilateral and Unilateral Contracts
Bilateral Contracts:
Bilateral contracts are agreements in which both parties exchange mutual promises to perform certain obligations, making this type of contract the most common in business transactions. In a bilateral contract, each party is both a promisor, committing to fulfill a particular duty, and a promise, receiving the benefit of the other party’s commitment. This mutual exchange of promises creates a binding obligation for both parties, ensuring that each side is legally bound to uphold their end of the agreement.
Bilateral contracts are fundamental to various business dealings, such as employment agreements, sales contracts, and service agreements, where reciprocal promises form the basis of the contractual relationship. This type of contract contrasts with unilateral contracts, where only one party makes a promise that the other party can accept by performing a specific act.
Example: A sales contract in which one party agrees to deliver goods and the other party agrees to pay for them.
Unilateral Contracts:
Unilateral contracts are characterized by one party making a promise that the other party can accept by performing a specific act. Unlike bilateral contracts, where both parties exchange promises, unilateral contracts rely on the performance of an action by the offeree (the party to whom the offer is made) to create a binding agreement. These contracts are less common in business contexts but are often found in scenarios involving rewards or public offers. For instance, in a reward scenario, a person might promise a reward to anyone who finds and returns a lost item. The contract becomes binding and enforceable once someone finds the item and performs the act of returning it, fulfilling the condition set forth by the promisor (the person offering the reward). Unilateral contracts are structured to motivate performance by offering a benefit upon completion of the specified task, aligning incentives while ensuring clarity and enforceability in the agreement.
Example: A reward offer for finding lost property is a unilateral contract, accepted when the property is found.
8. Express and Implied Contracts
Express Contracts:
An express contract is a clear and explicit agreement between parties, whether written or spoken, where the terms and conditions are directly stated and agreed upon by all involved. These contracts leave little room for ambiguity as they outline the obligations, responsibilities, and rights of each party in detail. Express contracts are commonly used in business transactions and formal agreements, providing a solid foundation for legal enforceability and dispute resolution if necessary. They are preferred for their clarity and specificity, ensuring that all parties understand their roles and expectations from the outset.
Example: A written employment contract outlining job responsibilities and salary.
Implied Contracts:
Implied contracts arise from the actions, conduct, or circumstances of the parties involved.
On the other hand, implied contracts arise from the actions, conduct, or circumstances of the parties involved rather than from explicit statements or writings. These contracts are not expressly stated in words but are inferred from the parties’ behavior or the nature of their relationship. Implied contracts often occur when one party provides a service or goods expecting payment, and the other party accepts and uses those services or goods without objection. The terms of the contract are implied by the circumstances surrounding the transaction and are legally enforceable to protect the reasonable expectations of both parties. Implied contracts can be implicit in various situations, such as routine business practices or ongoing relationships where parties have a history of mutual understanding regarding transactions and obligations.
Example: Paying for a meal in a restaurant implies a contract to pay for the service and food provided.
9. Simple Contracts
Simple contracts refer to straightforward agreements between parties that do not necessitate formalities such as seals or notarization to be legally binding. These contracts are typically based on mutual promises or exchanges of goods or services where the terms and conditions are clearly defined and agreed upon by both parties.
Unlike more complex contracts that may involve extensive negotiations or legal formalities, simple contracts are often used in everyday business transactions, leases, employment agreements, and sales of goods or services. The simplicity of these contracts lies in their ease of creation and understanding, fostering efficiency in legal transactions while ensuring that both parties are aware of their rights and obligations. Despite their straightforward nature, simple contracts still require offer, acceptance, consideration, and an intention to create legal relations to be enforceable, providing a foundational framework for agreements that are clear, concise, and legally recognized.
Example: A basic agreement between a freelancer and a client for graphic design services.
10. Unconscionable Contracts
Unconscionable contracts are agreements that exhibit such extreme inequality or unfairness in terms that they shock the conscience of the court and are deemed unenforceable under the principles of contract law. These contracts typically arise when one party, often the stronger or more knowledgeable party, takes advantage of the other’s vulnerability, lack of bargaining power, or limited understanding of the terms.
The unfairness may manifest in various forms, such as grossly unequal exchange of value, oppressive terms, or clauses that are unduly favorable to one party and excessively detrimental to the other. Courts intervene in cases of unconscionability to prevent exploitation and to uphold fairness in contractual relationships. This concept is particularly relevant in consumer protection laws where certain clauses or practices in contracts may be invalidated if they are found to be unconscionable, ensuring that individuals are not unfairly burdened or exploited in their commercial dealings.
Example: A loan agreement with extremely high interest rates and unfair terms may be deemed unconscionable.
Leverage an Intelligent CLM to Manage Your Contracts
These are some of the most common contract types which your business is likely already using. An AI-enhanced contract lifecycle management (CLM) platform can help your organization streamline workflows for authoring, negotiating, approving, storing, and finding business agreements.
ContractPodAi helps many organizations worldwide address difficult challenges in their contract workflows. Contact us today.
