Business Basics: What Makes a Contract?

Business Basics What Makes a Contract

Recently, a business owner sought an investor to fund a capital infusion for his 5-year-old company. In exchange for some stock from his company, he contracted with another company. However, it was soon apparent that the potential investor didn’t have the capital necessary to make the investment. Instead of letting the deal go, they found a third-party investor. They wanted to modify the buy-sell agreement for company stock in order to make room for this third-party investor. Due to American law’s flow of contract construction, an amendment to the buy-sell agreement wasn’t the right vehicle to “bootstrap” a third-party investor. We now have to ask the bigger question: What makes a contract in American law?

Meeting of the Minds

A contract can only exist if there is an agreement between two or more people about a specific subject matter. The contract under consideration (the original buy-sell agreement between my client & the errant investor) has an introductory paragraph and signature lines at its bottom. The body of the document outlines the rights and obligations. A mere agreement between two parties on a subject matter is not sufficient to make it enforceable.

Take into account

An agreement between identified parties must be an actual contract. It must include an exchange of legal rights. This is usually in the form of either a promise for an action (e.g., if I do this, then I promise that I will do it) or a commitment to something (e.g., if I promise to do this, then you promise to do that). The consideration that makes a contract binding is this exchange of legal rights.

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Binding Third Parties Not Related

The third-party investor is not a party to the buy-sell agreement. The third-party investor is not an intended beneficiary or a party to the underlying contract and has no rights, duties, or obligations. The original investor and the business owner cannot look to the third party for their obligations under the buy/sell agreement. Additionally, the new third party cannot receive the benefits of the contract.

To hold the third-party investor responsible for the rights and obligations they have under the original buy/sell agreement, both parties must assign the rights, title, and interest of the original investor to the third party and, in turn, must delegate to the new investor all obligations under that agreement. The new, separate assignment and assumption agreement will also include representations and warranties to show that the new third-party investor is authorized to enter into this agreement and that it is capable of performing any duties or obligations that are delegated. Indemnifications will be included in the document to ensure that the other party to the original buy/sell agreement is protected in the event of the investor’s failure to perform.

The original investor was able to resign, and the agreement to assume was amended. The business owner then received a cash injection from the third-party investor, which has allowed it to meet its corporate obligations and expand its business.