Contract Types An Overview For Businesses

Contract Types: An Overview For Businesses

Contracts are essential for businesses to maintain relationships and run their operations. From vendor agreements to NDAs, there’s a host of documents that organizations depend on to ensure results and mitigate risks. This post will analyze the main contract types that every business owner should know.


Businesses enter contractual relationships for a wide variety of reasons. Every contract, from vendor agreements to employment contracts, is essential in determining how a business operates and how its relationships play out. Organizations must weigh the pros and cons of each type to choose the one that aligns with their project needs and risk tolerance.

Understanding which kind of contract would suit them in each circumstance can ensure results. It enables businesses to negotiate better terms, minimize risks, and ensure successful project outcomes. This awareness also helps to build strong relationships with clients, employees, and vendors. Consequently, they can foster trust and collaboration in the business environment.

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Fixed-price contract

In this type of agreement, the buyer agrees to pay a set price to the seller for a product or service. This price is determined and agreed upon before the project or work begins. It remains fixed, regardless of any unforeseen circumstances. It provides both parties with a clear understanding of the costs involved and helps mitigate financial risks.

One of the key benefits of a fixed-price contract is that it provides predictability in terms of costs. The buyer and the seller know exactly how much the project will cost from the outset, which can help with budgeting and financial planning. Fixed-price contracts typically outline the scope of work in detail, including deliverables, timelines, and milestones. It prevents scope creep and ensures that both parties are on the same page throughout the project.

However, they have their limitations, such as a lack of flexibility. If there are any changes to the project scope or requirements, it can be challenging to negotiate additional costs or adjustments to the contract. They put the onus on the seller to deliver the project within the agreed-upon budget. The seller might have to pay the extra expenses if the project encounters difficulties or unanticipated events.

Cost-reimbursement contract

According to the agreement, the contractor will get payment for all reasonable expenses incurred while completing the work. It includes direct costs (such as materials and labor) and indirect costs (such as overhead and administrative expenses). The contract offers the contractors financial security because it guarantees payment for their out-of-pocket expenses. 

Cost-reimbursement agreements are flexible and helpful when the nature of the work is uncertain or subject to change over time. Since they receive payments for their costs, contractors are motivated to find cost-effective solutions that can help them maximize their profit margins. Also, the contractor and the client can share the contractual risks. Contractors are not solely responsible for any unforeseen expenses that may arise during the project. 

However, since the buyer is responsible for reimbursing all allowable costs incurred by the seller, there is a lack of incentive for the seller to control costs effectively. It can lead to cost overruns and budgetary issues for the buyer. They bear the brunt of any unforeseen expenses or cost increases.

Time and materials contract

It’s a legal agreement between a client and a contractor in which the client pays for the actual time spent on a project and the materials used during the project. Unlike fixed-price contracts, where the total cost is predetermined, these contracts provide more flexibility for both parties. The final charge depends on the actual hours worked and materials used.

Clients can alter the project scope or requirements during the project without having to renegotiate the entire contract. This flexibility can be especially beneficial in projects where the scope is likely to evolve. The contracts may not have a fixed total cost, but clients can still exercise some level of cost control. They can impose restrictions on the quantity of materials or hours worked.

However, since the final project cost depends on the time spent and materials used, businesses can’t accurately estimate the total cost upfront. It can lead to budget overruns and disputes between the parties involved.

Unilateral contract

In this agreement, one party promises something in return for the other party carrying out a specific action. In simpler terms, it is a one-sided agreement where one party is obligated to fulfill their promise only if the other party performs the required action.

Unilateral contracts are an effective way to incentivize employees or partners based on performance metrics. For example, a sales team might receive a bonus if they meet a predetermined sales goal within a given time. By structuring the incentive as a unilateral contract, the employees are motivated to work towards the goal.

Bilateral contract

These agreements are between two parties where both parties make promises to each other. In a bilateral contract, each party is both an offeror and an offeree, meaning that each party is making a promise in exchange for the other party's promise. This mutual exchange of promises forms the basis of the contract, and each party is obligated to fulfill their promises.

Bilateral contracts are legally enforceable, meaning that if one party fails to fulfill their promise, the other party can seek legal remedies. Like all contracts, bilateral contracts require some form of consideration, which is the value exchanged between the parties. It could be money, goods, services, or anything else of value.

Unconscionable contract

These agreements are so one-sided and unfair that they shock the conscience. They often contain terms and conditions that are highly unfavorable to one party, taking advantage of their weaker bargaining position or lack of understanding. Unconscionable contracts may involve excessive fees, hidden clauses, or unreasonable terms that make it nearly impossible for the disadvantaged party to fulfill their obligations.

It is challenging for the parties to completely comprehend their rights and obligations due to ambiguous or hidden terms in the fine print. One party holds significantly more bargaining power than the other, leading to unfair terms favoring the stronger party. The contract includes exorbitant fees, penalties, or consequences that far outweigh the value of the goods or services. The terms can be unfair or oppressive, such as waiving essential rights or imposing harsh restrictions.

Bill of sale

It serves as proof of a transaction between a buyer and a seller. It outlines the details of the sale, deliverables, the purchase price, the date of the transaction, and the identities of both the buyer and the seller. Essentially, it acts as a receipt and provides a record of the transfer of ownership from the seller to the buyer.

A bill of sale can help protect both the buyer and the seller in case any disputes arise in the future regarding the ownership of the item. It can help establish the value and potentially be used to calculate any applicable taxes.

Licensing agreement

A licensing agreement is a legal contract between two parties that grants one party the right to use the intellectual property for a specific purpose, typically in exchange for a fee or royalty. Intellectual property can include trademarks, patents, copyrights, or trade secrets.

The contract terms may include the duration of the agreement, the territory, the specific rights granted, and the payment structure, among other details. For example, a software company may license its technology to another company for use in a specific market segment. The licensing agreement would specify the terms of use, royalties, and any restrictions on the use of technology.

Equipment lease agreement

It’s a contract between a lessor (the equipment owner) and a lessee (the business or individual using the equipment) that allows the lessee to use the equipment for a specified period in exchange for regular payments. Essentially, it is a rental agreement for equipment rather than real estate.

Lease agreements offer flexibility for upgrading equipment as technology advances or business needs change. Some lease agreements include maintenance and support services, relieving businesses of the burden of equipment upkeep. They are a more cost-effective option compared to purchasing them outright. It allows organizations to access high-quality equipment without tying up capital.

Purchase order

A purchase order (PO) is a legally binding document outlining the details of a transaction. It’s a formal offer to purchase goods or services at a specified price, quantity, and delivery date. Essentially, a PO acts as a contract between the buyer and the seller, providing clarity and protection for both parties. 

A purchase order helps avoid misunderstandings and disputes between buyers and sellers by clearly outlining the terms of the transaction. It allows businesses to track their expenses and manage their budgets. 

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Dock 365 contract management software

In short, businesses require various contract types to carry out their business operations. They need them to onboard vendors, customers, and employees. If the legal team has to draft these contractual agreements from scratch each time, it can delay the business considerably. Businesses must, therefore, rely on automated solutions to expedite the process. 

Dock 365 contract management provides pre-approved templates and clause libraries to streamline drafting. These templates cover various business scenarios, from sales to non-disclosure agreements, and can be easily customized to suit specific needs. Clause libraries enable businesses to build custom contracts. These libraries typically include commonly used clauses 

Disclaimer: The information provided on this website is not intended to be legal advice; rather, all information, content, and resources accessible through this site are for purely educational purposes. This page's content might not be up to date with legal or other information.
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Written by Deepti Gopimohan

As a creative content writer, Deepti has spent years assisting brands to share their unique voice with audiences, complying with the latest marketing trends and strategies. Her educational background in Literature & Journalism has helped her research and publish content for diverse industries & mediums.
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Reviewed by Naveen K P

Naveen, a seasoned content reviewer with 9+ years in software technical writing, excels in evaluating content for accuracy and clarity. With expertise in SaaS, cybersecurity, AI, and cloud computing, he ensures adherence to brand standards while simplifying complex concepts.

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