This article has been written by Kshitij Pandey pursuing the Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.
A small business may be defined in general terms as a small-scale enterprise involving small capital investment, less labor force and a few pieces of machinery to function. The main characteristics of small businesses are owned by a single person or only very few persons closely related, limited area of operation, less use of technology, labor intensive, use of local resources etc.
Small businesses may deal with manufacturing /supply of goods or providing services e.g. grocery stores, medical stores, tradespeople, bakeries and small manufacturing units. These businesses basically operate on a small scale to serve a local community.
According to the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 the enterprises engaged in the manufacture or production, processing or preservation of goods is a small enterprise if the investment in plant and machinery is more than Rs. 25 lakh but does not exceed Rs. 5 crore. The investment in plant and machinery referred here is the original cost excluding land and building and the items specified by the Ministry of Small Scale Industries vide its notification No.S.O.1722(E) dated October 5, 2006. Further, the Enterprises providing or rendering services and whose investment in equipment (original cost excluding land and building and furniture, fittings and other items not directly related to the service rendered or as may be notified under the MSMED Act, 2006 are small enterprises if the investment in equipment is more than Rs.10 lakh but does not exceed Rs. 2 crore.
For a small business through the priority is to grow the business and maximize profits based on trust and good faith while conducting business with many stakeholders like suppliers, customers, employees etc. The legal aspect in the form of written contracts becomes important so save money and time in litigation. Any loose points or missed out clauses may be detrimental to the business and brand image in case of a legal dispute due to conflict of interest. Some of the important contracts that every small business must have are given below:
In the case of multiple people ownership, a Shareholder Agreement is needed to define the relationship of different shareholders as it aids in defining and adopting a proper business structure. This contract is very helpful to avoid litigation and threats to the business due to differences which arise many times as and when the business expands and earnings increase along with the simultaneous increase of responsibilities. It is useful, even if the shareholders are close relatives in order to have a written document to delineate different roles and responsibilities as well as deal with issues of taxation and many commercial and legal issues during business operations.
A detailed Shareholder Agreement is very vital for the smooth functioning of the company and to deal with the situation of conflict of interests among the shareholders. This agreement should include:
- The clauses related to initial and future contributions by each shareholder;
- Duties and obligations of each shareholder in establishment and operation of the business;
- Issuance of new shares to incoming shareholders and increase or decrease in the share of existing shareholders;
- Dividend policy or sharing of profit policy;
- Accounting policy;
- Exit policy i.e. policy for leaving the business by any partner in case of death, retirement etc.;
- Decision-making policy mentioning by whom & how the business decisions will be taken
- Dispute resolution mechanism.
This is a contract signed between the parties wherein one party agrees to provide services to the other party for some fee or payment. In the case of businesses related to providing a service, a service agreement is required to be executed to delineate the terms and conditions of the relationship between the parties to define responsibilities as a service provider and limits of liability in the event of a third-party claim as well as obligations of the client to whom service is being provided. The service agreement with one client may be used as a model agreement for other clients for an efficient contract management process, at the time of expansion of business. A Service contract should include:
- Scope of the Agreement.
- Obligations of the parties.
- Limitation of liabilities to third parties.
- Details of Fees and Payment Terms.
- Termination of the Agreement.
- Dispute Resolution Mechanism.
In case of a business selling goods a Sales Contract is needed to define the terms and conditions, obligations and liabilities etc. for both parties. Though for very small businesses like grocery stores, a sales contract is not required but in case of significant transactions in high value goods, a Sales Contract may be required. The Sales Contract in small businesses is customized to suit the particular business. The main clauses in Sales Contracts may comprise :
- Specification of Goods,
- Quantum of goods,
- quality of goods,
- Price and price adjustment in certain cases of deficiency,
- Period of delivery,
- Place of delivery,
- Responsibility of taxes & duties,
- Payment terms & conditions.
- Warranties & disclaimers of warranties
- Liability limitations.
This contract is a legal agreement between the employer owning the business and the employees, delineating the terms and conditions of the employment. The employment contract should be executed for the benefit of both the employer and employee to ensure clear understanding of employment conditions as well as expectations and obligations of both parties from each other to avoid future disputes. Generally, employees have access to confidential information about businesses. Further, employees are expected to develop products, business strategies, policies and inventions etc. while working in an organization. There should be a clause in the employment agreement related to Confidentiality to ensure that the employees would not share confidential information to any third party. This may be a separate agreement which may include a clause that the ideas, business strategies, concept papers, documents and other work-related products developed by the employee during his stay with the employer shall be the property of the company, and not of the employee or as agreed between the parties.
Many investors in new ventures demand such types of agreement between employer and employee. Normally, the Employment Agreement should be sent along with an offer letter sent to the new employee. The employment agreement may include:
- Job description e.g. job position, department of work, work profile, responsibilities;
- Type of employment e.g. permanent or contractual;
- Salary and other benefits;
- Working hours ;
- Probation period;
- Reporting details;
- Leave Structure;
- Non-Compete clause for restricting employee to work for other competitors in the same business;
- Confidentiality provisions;
- Termination clause including notice period;
- Dispute Resolution Mechanism.
Non-Disclosure Agreement/ Confidentiality Agreement
The Non -Disclosure Agreement (NDA) is made to protect confidential information from disclosure to a third party in an unauthorized manner and to ensure that the disclosed information must be used by a third party for the specific purposes defined in the NDA. During business operations at different points of time various data, commercial information, technical information, business secrets, marketing strategies, investment information, profit information, customer details, sales details etc. are shared with other parties. This information may be sensitive and crucial for the operation and future growth of the business. To avoid indiscriminate disclosure of such information the NDA is required to be signed before sharing such confidential information. A signed NDA provides protection from the unintended dissemination of confidential information. An NDA contract may include:
- Details of Parties involved i.e. Disclosing and receiving parties.
- Clearly defining and enumerating confidential information.
- The conditions under which the confidential information can be disclosed to a third party.
- The envisioned use of confidential information.
- Treatment of confidential information after intended use e.g. to be returned or destroyed.
- Confidentiality obligations of the parties.
- Consequences of breach of the NDA and the remedies available.
- Period of NDA.
A small business may sometimes need to rent commercial or retail space to run the business. For such cases, a lease agreement with the owner of the property is required. The lease agreement has clauses related to use of the rented property for commercial purposes. Generally, most of the lease agreements are one-sided and are often found to be favoring the owner. However, this may be negotiated for the benefit of the business. This agreement may include:
- The details of the space and location;
- The base rent and additional charges, if any, towards parking, Wi-fi, electricity, water, etc;
- Security Deposit, if any;
- Period of lease and extension;
- Obligations for maintenance of space in good condition;
- The permission for modifications and improvements;
- Termination and notice period.
- Description of Personal Data required to be collected;
- Business Purpose of collecting Personal Data;
- The practice adopted for data storage and security of data;
- Policies for deleting Personal Data after use;
- Policy for Client’s access and request modification in his personal Data;
- Terms of disclosure of Personal Data to third parties;
- Permission to collect information about customer’s IP addresses and Cookies etc.
For financing, business loans from banks or non-banking financial institutions are taken. For taking such loans normally, there is a standard Loan Agreement that the banks and financial institutions offer to sign. Many times these agreements are one-sided and favor the lender by including several clauses for restrictions on borrowers. However, negotiation may be done with the lender on such restrictive conditions. The loan agreements may include:
- Amount of the loan;
- Interest rate and period of loan;
- The repayment plan and timelines;
- Prepayment terms;
- Term and Conditions for using the loan amount;
- Clauses related to breach of the agreement like delay in payment etc;
- Remedy of default;
- The warranties of the borrower.
For running a small business with limited employees, there may be a need for outsourcing certain works to service providers or independent contractors. For such types of arrangements, there should be a written independent contractor agreement to delineate the business relationship between the business owner and the contractor. The objective of getting independent contractors may also be to avoid a direct legal relationship with the third party e.g. an employee of the contractor, who actually executes the work through the independent contractor. Independent contracting may be a suitable option for small businesses, as it is easier to get certain tasks done without any long-term obligations towards employees of the independent contractor. Many independent contractors have their own standard agreement formats. This needs to be modified according to specific needs of the business. An Independent Contractor Agreement should include:
- Scope of the task assigned;
- Timeline for the assignment;
- Cost to be paid and Payment Terms;
- Role and responsibilities of parties;
- Other obligations like insurance etc;
- Indemnity Clause to protect the business from obligations towards employees of the contractor;
- Clause elaborating status of the contractor and its employees e.g. the contractor will not be considered as an employee or legal agent of the company at any point of time.
Website Term of Use Agreement
Many small businesses are nowadays based on e-commerce. They are selling goods or services on online platforms. Websites or portals are one of the most essential parts of today’s businesses for marketing products and business operations. Keeping in view the privacy and cyber security issues, a Term of use agreement for the website /web portal is essential. This agreement is required to define the terms and conditions of the legal relationship between the owner of the websites and businesses and the users of the website as well as any customer buying goods or services using the website. The agreement is very important for facilitating online commercial transactions through websites, winning trust of the customers and saving the website from cyber threats and misuse by miscreants. This contract includes:
- Limitations on using the website;
- Disclaimers for certain contents;
- Liability limitations;
- Indemnity notice to protect from any harm of the third party by unintended use of content of the website;
- Copyright and Intellectual Property Right advices;
- Jurisdiction for any disputes.
A small business must have legal contracts on various business aspects to protect the interests of the company. A general set of contracts have been discussed above in order to provide a roadmap as to what contracts are important for small business owners. The number of contracts entered into by small businesses is dependent on the type of business, location, size, etc. Though many times such legal documentation is neglected as opposed to the financial and technological aspect, for a sustainable and profitable business these agreements are essential to be kept in a written form.
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