As a general rule of thumb, I don’t like contracts. Oh sure, I understand their importance. What I don’t like is navigating through paragraph after paragraph of legalese. Unfortunately, as a small business owner I have to wade through my fair share of contracts. Some are innocuous at best, while others make you feel as though you are signing away your first born child if you break the contract.
I have read my fair share of contracts, and while I am not a lawyer or legal expert, I’ve found a way to quickly scan the contract in a way that makes sense to me. I’ll share my tips with you, but before I go further, I will stress that I am not a lawyer, this is not legal advice, if in doubt hire a lawyer, etc, etc, etc.
How to quickly read and understand a contract
The goal with any contract is to ensure that the legal agreement for all parties is clearly represented on paper. That sounds like an easy task, but even an easy to understand concept can be difficult to express on paper – especially when there are many options or variables involved.
The following tips are things I’ve learned from reading dozens of contracts. Keep in mind that each contract is different, and if you are in doubt, seek legal assistance.
1. Determine the scope of the contract
Before you get too far, consider how important this contract is to you and your business. Will it make or break your business? If so, stop here and hire a lawyer. No, seriously. If the future of your business depends on this contract, hire a lawyer. It will be the best money you’ve ever spent.
If the scope of the contract isn’t going to make or break your business, then consider handling it yourself. One good example of this is the “Terms and Agreements” you see on almost every membership website you join, or the cell phone contract you sign when you buy a new cell phone.
2. Read and understand the common terms
Common terms are included in almost every contract, so be sure to go over them before you get too far into the contract so you have a clear understanding of what they mean and which terms represent each party. These are usually found by words such as, “shall mean,” “heretofore known as,” or otherwise wrapped in quotes. An example might look like this:
jingle jangle (“CML” or “Website”) contains a multitude of money management and small business tips (“Content”) available for general information and entertainment purposes only and does not constitute legal advice. CML agrees to try and maintain accuracy for all Content contained in Website, but acknowledges that terms, conditions, and information, (“Terms”) especially in regard to third party products, services or websites (Third Party Offers”) is subject to change without notice. Readers and viewers (“Visitors”) are advised to verify accuracy of Terms or perform appropriate research or contact a financial or legal professional before participating in any Third Party Offers or acting on any information found in Content.
You can see how this “legalese” can quickly get out of hand!
In this example, “CML,” “Website,” and the other words wrapped in quotes are defined, then used throughout the remainder of the contract. They will be capitalized so if in doubt, go back to the beginning of the contract to look up the meaning of the term. You can create a quick reference list if it helps you (and this is a good idea if you are reading a multi-page contract with dozens of defined terms).
Tip: Look out for external references. Some contracts reference additional pages or sources. Make sure all items reference in the contract are in the contract before you sign it, or make sure you review a copy of the referenced source before signing anything.
3. Have some quality alone time with your contract
A contract is best read while you are alone. Otherwise there are too many possibilities for feeling rushed and making mistakes. A good example of this is a making major purchase. You should request a copy your mortgage paperwork in the mail before your signing date, or be prepared to spend several hours in the mortgage broker’s office reading the contract.
For other large purchases, such as a car, you might be expected to sign the paperwork on the spot. This makes it easier for the car dealership to slide in small changes, fees, add-ons, and other expenses that you may not be aware of. Request the time to review the contact and paperwork without distractions and do not succumb to the pressure of signing the paperwork without reading it thoroughly. You are the one spending the money – take the time to ensure you know exactly what you are purchasing and the scope of the contract.
Tip: Ignore legalese when reading for understanding. A simple way to read a contract and understand it is to underline the keywords and ignore the legalese. Focusing on the keywords gets you to the heart of the meaning and will speed up comprehension. You may also consider marking through unnecessary language and reading it that way. Just be sure to review a clean copy after you understand the general meaning.
4. Get a draft copy of the contract, a red pen, and a quiet room
It’s go time. Grab a scratch copy of the contract, a bright pen, and dedicate some alone time with just you and the contract. Be sure to minimize distractions, turn off the music, TV, lock the door, or whatever it takes to eliminate interruptions. No, the pen doesn’t have to be red. You might prefer blur, green, or even a highlighter. Just be sure to go through line by line and write down any questions, comments, or notes you need clarified.
The most recent contract I went through was 6 pages long and had multiple sections that needed clarification. I used a yellow highlighter to highlight sections I needed to clarify/change, a red pen to write questions/comments, and I initialed in red in the sidebar by each section I was good with. Initialing by each section that you are OK with will help prevent reading the sections multiple times and help keep the focus on those sections that need more attention.
If you prefer to review documents on the computer then go through the contract is to use Word and use “track changes” to add your own notes as you go. “Track changes” will show any changes you make to the contract in a different color, making it easy to review online, or in print. Again, it is a good idea to note the sections that don’t need changes so you don’t reread them multiple times.
5. Set up a time to go over the contract with the other party
Now that you have your highlighted sections and your notes, set up a time to go over the contract with your new business partner. Again, be sure to set up a time when you will not have any distractions. Go line by line or section by section until you are good with the agreement.
6. Don’t take a verbal agreement
It’s very easy to make a verbal statement regarding the scope or terms of the contract, but unless it is in writing, or you have a tape recording of the conversation, that statement will be difficult to prove and even more difficult to enforce. Also keep in mind that some contracts contain clauses stating something to the effect of the written contract overwrites all previous agreements, so a verbal contract may be superseded by the newly signed document.
7. Contracts can be rewritten.
If there is something that needs addressed, then have the contract rewritten to encompass the new terms you and the other party agree to. If the change is minor you can probably just scratch through the section on the contract and initial it. But if it is a major change it will probably be best to draft a new copy.
8. NEVER sign anything you don’t understand
Some legalese is designed with the sole intent of tricking the other party into breaking the agreement. No, I’m not cynical and I don’t believe all contracts are designed that way. But I am a realist. Read and understand each line item on the contract before signing it. Otherwise, you have no one to blame but yourself should something go wrong.
9. Know how to recognize a bad contract
Want to see an example of a bad contract? Read this bad contract tutorial, which highlights the sections that are in favor of the company offering the contract, and gives examples of how to rewrite the contract for a more equitable outcome.
This example is specific to a freelance photographer, but many of the principles are applicable to other situations. Be sure that you aren’t giving the other company the benefit and that the contract is equitable to all parties.
10. Take a copy of the signed contract for your records
Don’t leave the only copy of the contract in the hands of the other party. Make sure you receive a signed copy of the contract for your records. There is no reason why the company you are dealing with cannot give you a copy on the spot.
Bonus tip: Consider hiring a lawyer
What? We already covered this in the step1? You’re right. It can be that important!
When in doubt, review or seek counsel
You don’t have to do this alone. Not every contract calls for a lawyer, but a second set of eyes doesn’t hurt. You may find it helpful to ask a relative, friend, neighbor, or someone else to review the contract and give their opinion about it. They may interpret something differently, or find areas that need revised.