If you own a service-based business, then you know that your services are your bread and butter. They’re what you sell to your clients, and they’re what generates revenue for your business. But what happens if something goes wrong with one of those services?
That’s where service contracts come in. Whether you’re a small business or large corporation, in this blog post, we’ll discuss five reasons why service-based businesses need a contract.
1. Service contracts protect your business from liability.
If something goes wrong with a service that you provide to a client, and that client suffers damages as a result, they could sue your business for those damages. A well-drafted service contract will help to protect your business from liability in those situations by specifying what types of damages are not covered by the contract.
For example, let’s say your business provides on-site repair services for a solar technology company. If a wildfire or other natural disaster prevents you from conducting your repair services, the company could claim that you’ve breached the agreement by failing to perform your obligations. However, if the service contract is well-drafted, it will contain a force majeure clause, which protects you against situations outside of your control that prevent your performance.
As another example, if you’re an accountant, you can’t do your job well unless your clients provide you with certain financial information. If your client provides you with information that’s incorrect and you make a mistake as a result (i.e., your profit and loss for the company is wrong), they could sue you for negligence and seek recovery for any resulting fines or regulatory penalties. However, if you have a service contract in place that requires the client to provide you with that information, and limits your liability for incorrect information, it will help to protect you against such claims.
In short, service contracts can help to protect your business by specifying the types of damages you can’t be held responsible for and, with some specificity, sets the expectations for both parties as to what services are to be provided.
2. Service contracts can help you to avoid disputes with clients.
Disputes between businesses and their clients are always costly—in terms of both time and money. By spelling out the terms and conditions of your service, you can minimize the chances of a legal dispute arising.
For example, all service contracts should include a detailed description of the services to be provided, any project deadlines or milestones, the price of the services, and the payment terms. If a client later claims that you didn’t provide the services that they expected, or that you missed an important deadline, you can point to the service contract to show that either your performance is clearly within the expectations contained in the agreement or that there was never any agreement as to those specific services or deadlines.
Small Business Owners
Safeguarding against financial loss in your service contracts is especially critical if you’re a small business owner. For many small businesses, your livelihood and ability to put food on the table are tied to your business succeeding and avoiding any major losses.
Spending the time (and investment) to ensure you, as a small business owner, have less risk, will avoid major setbacks that could ultimately force you to lay off employees, dip in your personal savings to make ends meet, or, worst of all, close your doors forever.
Recommended Reading: 10 Legal Documents Every Business Must Have
If you’re operating your business as a sole proprietorship, you may think a service contract isn’t necessary or that sending them a legal document might scare away your clients.
In reality, in the absence of an agreement, you’re foregoing important legal protection and risking your personal assets in the process.
Even if you’re using a business name, sole proprietorships are not separate legal entities from their owners, which means that the owner of a sole proprietorship is personally liable for all debts and liabilities incurred by the business and the owner’s personal assets are at risk. This includes service-related disputes with clients.
For example, if you’re a web designer and you create a website for a client but they don’t like the final product, they could ultimately pursue you personally in small claims court.
Besides putting your own property and other assets at risk, a public filing of this nature isn’t a good look and could tarnish your business name.
For these reasons, legal counsel often recommend individuals form a limited liability company or corporation to shield against personal liability. A legal entity can not only separate your personal assets from your business liability, but it can also ensure debts incurred remain solely business debts.
Whether you choose a corporation or a limited liability company, the benefits related to your business remain the same.
When Disputes Happen
If a dispute does occur, having a service contract in place will help to prove that you acted in good faith and followed the agreed-upon procedures. This can help to reduce or even eliminate any financial damages that may be awarded in a lawsuit or through alternative dispute resolution.
3. Service contracts can help you to get paid on time.
If you don’t have a written contract in place, then it can be very difficult to get paid for the services that you’ve provided. This is especially true when a client tries to claim that the amount owed to you is different than what was previously agreed.
This is why it’s critical that your pricing and payment terms are included in the service contract with some level of specificity. Simply put, your agreement needs to spell out in simple terms how your customers or clients will pay you or your company.
Things to consider:
Should you be paid in advance or 30 days after services have been rendered?
What forms of payment do you accept? Check? Credit card?
What happens if payment is late? Will you charge a late fee? Will you send late bills to collection?
Are you able to terminate the agreement for any reason with a certain number of days’ notice? If not, does your contract include language that allows you to terminate in the event your client fails to ever pay?
4. Service contracts can provide clarity for everyone involved.
The fundamental idea of every contract is that a “meeting of the minds” must take place before a binding agreement can be formed. This means that both parties should have a common understanding of the contract language and agree to be bound by them.
When there’s an unclear interpretation of the contract phrases, issues arise in the interpretive process and on-time performance. Make sure you know exactly what you’re signing and what you’re agreeing to. And while form contracts may be useful as a starting point, you’ll want legal advice for anything more complex than this example.
One of the benefits of having a written contract is that it can provide clarity for both you and your client about the terms of the agreement. This can help to avoid misunderstandings and miscommunication down the road.
Services to be Provided
For example, if you include a detailed description of the service to be provided, including the type of services that are deemed “out of scope”, then it would be difficult for a client to claim you or your company failed to provide certain services that were never previously agreed upon. In essence, you want to make clear what are your contractual obligations.
While no one expects to have their customers and clients act unreasonably, it’s important to prepare for the worst thereby mitigating legal issues.
Other major areas of concern that a service contract typically addresses include the following:
Your service agreement should include a provision about insurance coverage. Typically, the agreement will stipulate that each party must maintain its own business insurance (i.e., general liability, worker’s compensation, etc.) with an insurance company that meets a certain rating level.
Requiring each party to maintain their own liability insurance ensures that no matter when something goes wrong, the costs will be mitigated. One thing to keep in mind with liability insurance is that it typically works in tandem with indemnification.
Indemnification is a contractual provision that essentially says, “You scratch my back, I’ll scratch yours.” It’s a way of spreading the risk around so that each party has some skin in the game.
For service-based businesses, it’s typical for the service provider to indemnify (or agree to defend and hold harmless) the client against losses that arise from its negligence or willful misconduct.
However, it can be important for the business to try and obtain some level of indemnification in return to avoid being held responsible for wrongful actions the client may take.
In many cases, a business will either create deliverables or be given access to proprietary information in order to perform its services. Whether the intellectual property created as a byproduct of the services can be retained by you and your business or is immediately owned by your client is an important distinction that should be made in the agreement.
For small businesses, retaining ownership of their own intellectual property, even when it’s incorporated into products or deliverables ultimately provided to the client, is important and must be accounted for and carved out from any work-made-for-hire provisions.
Recommended Reading: Work Made For Hire: What Is It and How Does It Affect Your Business?
5. Service contracts can be customized to fit your specific needs.
No two businesses are alike, which means that no two service contracts should be alike either.
For example, a service contract for a financial advisor might protect him or her from a client saying they didn’t give them the right professional advice about long-term investments, while a service contract for an IT company might protect them from a customer claiming their computer stopped working properly because of the in-home set-up service they provided.
If your company handles sensitive information or is given access to a customer’s computer systems, your contract must address data breaches.
Even with top-notch security software, companies may still fall victim to phishing scams that ultimately put client information at risk, which is why your contract must adequately address this issue.
As you can see, there are many legal challenges that can be addressed in advance in a service contract.
Our experienced contract attorney will work with you to tailor the terms of your service contract to fit the specific needs of your business and take into account any local laws that might govern your relationship as an independent contractor.
Overall, service contracts are an important part of any service-based business. They provide protection against liability, help to avoid disputes, and can ensure that you get paid on time.
Service contracts can also provide clarity for all involved parties, and can be customized to fit your specific needs. If you are a service-based business, it is strongly recommended that you create and use service contracts.
It’s important to be aware of the fact that service contracts can be complex documents and you may need an experienced lawyer to ensure that your interests are fully protected. However, the time and money spent on drafting a service contract will be well worth it in the long run.
Our Arizona commercial contract attorney will work with you to determine the most important provisions to include based on your industry and the type of services you intend to provide.
If you have any questions about service contracts or need help drafting one, please contact our office. We would be happy to assist you.