What is the purpose of a contract and why are contracts important?

Contracts are finalised every second of every day. For businesses in particular, contracts act as a vital tool for building new relationships, extending existing ones and closing transactions.

However, formalising relationships is just one of many purposes performed by contracts. The widespread use of contracts means that there are now countless ways in which a contract can help a business (if managed correctly).

According to the IACCM, there are multiple purposes behind contracts, and these can often become confusing as a result.

Fear not, though. This page explores why contracts are important in business, what they are used for, and our advice on how to optimise your contract process to ensure you are receiving the most value from your contracts.

What is a contract?

A contract is a legally binding agreement between two or more parties. Once signed, this contractual agreement creates a promise that certain rights and obligations will be fulfilled by each party. In essence, a promise is at the heart of every contract.

Whilst the definition of a contract is simple, those promises can be complicated in practice.  At Juro, we try to simplify and explain these processes wherever we can:

• What makes a promise a contract? (Elements of a contract)
• When is a promise not a promise? (Agreement vs contract - what’s the difference?)
• How can we understand the whole universe of promises we’ve made? (How to create a contract repository)
• What if we need to change the promise we’re making? (How to amend a contract)
• How do we know when it’s time to make good on all those promises? (How to manage contract renewal)

However, before becoming waylaid by the headaches caused by contract processes, it is important to understand precisely what the purpose of a contract is, and why they have become an essential tool for all businesses.

What is the purpose of a contract?

The main purpose of a contract is to formalize new relationships and outline the various legal obligations each party owes to the other.

Today, most contracts are agreed between businesses, not people. Whilst individuals will sign basic contracts occasionally - to sell a house, or accept a job offer - businesses sign legal agreements in the masses, with partners, customers, and suppliers. The truth is, contractual agreements form the backbone of every commercial relationship.

Why are contracts important?

As recognised in a report by the IACCM, contracts perform various important business functions, making them critical business documents for many organisations. The importance of signing a contract stems largely from the fact that it performs the following purposes:

1. Contracts serve as a record of rights, responsibilities, and obligations

Foremost, contracts function as a reliable record of the rights, responsibilities, and obligations of the parties who have signed it.

An effective contract will describe, in detail, what duties each party has to one another, how these ought to be performed, what they will be measured against, and when. As a result, contracts act as a useful document for each party to refer to when reminding themselves of the responsibilities they owe and are owed.  

By using contracts in this way, businesses can apportion and minimise risk, since there is a degree of predictability and clarity surrounding who is responsible for doing what, and on what terms. This fundamental knowledge can then be relied on by a business to inform subsequent business decisions.  

2. Contracts make private promises legally enforceable

The intention to be legally bound is a core component of any contract, and it requires that for a contract to exist and be enforceable by law, both parties must share this intention.

This means that, unlike other, less formal promises, a promise in a contract is one that you have a legal right to enforce in court, typically where another party has breached the terms originally agreed and caused you loss of some sort.

For all businesses - big and small - a contract will protect you in the event of wrongdoing. Not only will a contract empower you to take legal action if the terms you agreed to are violated, but it will also explain which jurisdiction you can take this action under, and what steps to take to do so.

3. Contracts formalise a relationship between parties

Before the contract process even begins, two or more parties will have agreed to work together in a mutually beneficial way.

Contracts are a way of formalising a relationship between businesses, as well as outlining how you’ll maintain this relationship, what obligations you need to fulfil, how long you will fulfil them for, and for what price.

Fast-growth companies that are scaling will need to enter these relationships frequently and nurture them well, so understanding what is expected of each other and being accountable for the promises made is essential to developing a more fruitful relationship in the coming years.

4. Contracts ensure you get paid

Another purpose of a written contract is to stipulate the payment process and capture revenue. When a SaaS company offers to deliver their service to another business, for example, there is almost always a cost attached. A contract will explain this cost, along with other details, like:

• The exact amount of money due to be paid
• How frequently payments will be made
• The payment method to be used
• The costs associated with late payment
• Terms and dates relating to auto-renewal

Therefore, a contract also acts as a safeguard to guarantee your business’ right to payment on a certain date.

5. Contracts provide an opportunity to increase revenue

Many businesses can also use contracts as an opportunity to generate higher revenue. This is commonly achieved in two ways:

A. By negotiating contract terms to increase value

It’s simple. By negotiating contract terms that work in their favour, like increasing the price paid for a certain software subscription, or upselling a certain service, a business can increase their revenue. Contract negotiation is the perfect opportunity to make the deals being agreed upon more valuable.

B. By making the contract process more efficient

Contracts are designed to make a deal official, which results in revenue. Therefore, any barriers that prevent fast and frequent agreement are also barriers to revenue.

For example, if your legal team is blocking a contract due to constraints on their time, your business team could miss opportunities to close deals. This is a problem easily resolved by software that enables business teams to self-serve, yet many businesses continue to lose potential revenue by following age-old, inefficient contract workflow processes.

Making the contract process as seamless, simple, and efficient as possible will eliminate these missed opportunities and costly wasted time. To ensure that contracts serve you better as a route to revenue, discover a more efficient way to use them - hit the button below to find out more about all-in-one contract automation with Juro.

6. Contracts prevent disputes between parties

At a basic level, contracts are a tool that helps businesses to agree more. Since contracts are a collection of terms that parties have reached a consensus on, they are very effective at preventing conflict and contractual disputes in the future.

In fact, that’s what our mission is built upon at Juro: helping the world agree more. What businesses want when entering a new relationship is a win-win situation, and a contract represents that being achieved.

In any successful contract process, there will already have been opportunities for parties to discuss, edit and suggest terms, meaning that there is little (if anything) for them to disagree about in the future - particularly where the process has been truly collaborative.

7. Contracts guarantee confidentiality

Another essential purpose of a contract is that it can grant you specific rights and requests that are important to your business, and confidentiality is a prime example of this.

It is not uncommon for parties to a contract to be exposed to sensitive information about one another, or at the very least, have information about the transactions involved in their relationship.

Where parties are reluctant for this information to be shared, contracts serve as a perfect opportunity to ensure that the client or business they are dealing with holds these in secrecy using non-disclosure provisions and confidentiality clauses within the written contract.

Access our free Non Disclosure Agreement (NDA) template and Confidentiality Agreement template.

8. Contracts enable formal collaboration between teams

If managed well, contracts can also facilitate formal collaboration between teams and departments.

In business, a contract is rarely approved by just one person or department. Rather, contracts are often passed between departments, typically (and often painfully) via email for input and approval, which is an incredibly time-consuming but also very important stage in the contract lifecycle.

With so many parties involved in the contract review process, contractual agreements provide the perfect opportunity for departments to collaborate and discuss the business direction and how to achieve the best results from an emerging contractual relationship.

In some cases, parties may even enter into exclusive contracts that prevent them in entering into relationships with other providers, or competing companies. Establishing important details like these early on is key to ensuring all parties know how they're expected to work together.

Given that the benefits of cross-functional teams include better insight, innovative ideas, and better relationships, finding and implementing an efficient, collaborative contract process can be hugely beneficial - as our customer, Cazoo, can tell you.

Want to get more out of your contracts?

To ensure that contracts perform well for you and your team, you should first address your contract process and any pain points you are regularly experiencing. Juro is an all-in-one contract automation platform that helps visionary legal counsel and the teams they enable to agree and manage contracts in one unified workspace. Fill in the form below to get in touch and find out what Juro can do for your business.