Marshall Q&A – Topic 8: Contracts 101

Question: When does a contract become binding? 

Short Answer: Contracts have fundamental elements – once they are established, an enforceable contract exists.

Key Takeaways

  • Contracts require key elements to be binding
  • They can be binding even without a signature or written terms
  • Other legal avenues might prevent ‘legal loopholes’ creating unfair results

Contracts are an everyday part of modern life.  From purchasing items from a supermarket to ordering a coffee, we enter into ‘binding’ contracts every day.

 For a contract to be legally effective, it needs to display six fundamental elements:

  • An Intent by all parties to create binding legal relations;
  • An Offer of terms;
  • Acceptance of those terms;
  • Consideration from all parties (i.e. quid pro quo - an exchange of something of value);
  • The Capacity (i.e. competency and authority) of all parties to willingly enter the contract; and
  • The Legality of the contract.

Note that the Form that a contract takes (for example written v ‘handshake’ agreements) is NOT considered a fundamental element.

Intent

The test for Intent by-passes agreements which the parties did not intend to have legal ramifications.  Situations such as a parent bribing their child to do their homework or household chores are not supposed to create legal obligations. 

Depending on the nature of the agreement, courts will either presume that the parties DID intend to be legally bound (for business/commercial agreements) or DID NOT intend to be bound (familial/domestic agreements).  This is not definitive, and it is possible to rebut the presumption.

Offer

An ‘offer’ outlines specific terms to a specific party.  It covers everything from simple exchanges (such as basic purchases) to very complex transactions (which are likely to be written in detail).

What constitutes an ‘offer’ has been refined by centuries of case law.  Advertisements (including price tags on items at a shop or supermarket) are considered to be ‘invitations to treat’ rather than ‘offers’.  This means that they themselves create no legal obligations. Rather, they supply customers with information which allows them to make an offer of their own.

Acceptance

Acceptance of an offer represents a ‘meeting of the minds’ – that is, the parties have identified common terms which constitute the agreement.

Whilst some contracts might specify how they must be accepted (for example, in writing or by performing a specific action), in general, to accept a contractual offer, you must:

  • be responding to the terms of the offer (as opposed to a superseded or different set of terms);
  • accept the terms as they are (as even minor variations might constitute a ‘counter-offer’ which renders the original offer ineffective); and
  • communicate your acceptance to the appropriate person.

A contract is (generally) binding and enforceable from the moment that an offer has been validly accepted.

Consideration

Consideration is the value behind the agreement.  For a contract to be enforceable, every party must provide something of value to the exchange.  Consideration does not have to be monetary (for example contracts of employment) and it does not always have to represent a fair exchange.

Where the parties do not each provide consideration (for example, an agreement to gift money), the agreement will not be legally binding as a contract.  In such cases, it might be beneficial to formalise the transaction in a deed.

Capacity

Each party must have the requisite competency and authority to enter a contract.  There are many categories of people who might not satisfy these requirements.  For example, people with mental impairments and intoxicated people are unlikely to comprehend (or intend to be bound by) the relevant contractual obligations whilst bankrupt people do not have the legal authority.

There are many misconceptions around capacity. For example, children CAN (and frequently do) enter into binding contracts, although depending on the type and seriousness of the contract it may become ‘voidable’ (i.e. the child may elect for the contract to no longer be binding).  

Corporations also have special rules about which individuals have authority to enter binding contracts on the corporation’s behalf, and what assumptions an outside party is entitled to make in relation to a corporation’s apparent representatives.

Legality

Contracts which are against the law or public policy are not enforceable.  For example, transactions involving illicit drugs or illegal acts.  In general, courts will not assist parties who have suffered loss due to an illegal contract. 

Form

General contracts have no formal restrictions and can be enforceable whether they exist in writing, by verbal agreement, or even just by the conduct of the parties.  Some types of contract though (e.g. for the sale of land), must exist in writing in order to be enforceable.  (For further information, see our article on electronic signatures.)

Equity

Where a legally binding (and otherwise valid) contract has an unfair effect against one party, they may be able to seek assistance through ‘equity’ (legal principles of fairness).  This might be because the contract has created unfair ‘loopholes’, because the party was vulnerable in some way, or because the benefitting party secured the contract through unconscionable means. 

Whilst equity can help rectify an unfair situation, it is not a perfect cure.  It is always preferable to (where possible) pre-emptively avoid disputes.

Conclusion

Contracts are a fundamental pillar of law and as such there are complex considerations which underpin well-drafted contracts.  This summary provides a very general overview of the basic elements which make a contract enforceable.  For complex transactions or important agreements, obtaining legal advice is highly recommended as a well-drafted contract can save both headaches and money.