While it may seem like a simple answer, at times many people do not truly know whether they have a legally binding agreement with another party, or what basic principles are actually required for contract formation. Have you thought there was a contract in place but the agreement was not binding? Have you been party to a binding contract when you thought you were still trying to reach an agreement? Misunderstandings around the basics of how and when a contract is created can lead to numerous and potentially severe consequences for parties doing business together.
The following are typically the key elements that must be present for a contract to be legally formed:
Offer and Acceptance: There must be an offer by one party that is accepted by the other. Although this may appear like common-sense, problems can arise when parties are involved in frequent negotiations, with each party making numerous offers and counteroffers to the other. Until one of those counteroffers are fully accepted by the party receiving the offer – acceptance meaning a final, unqualified agreement to the offer (i.e., no variation to the terms) – there will be no contract.
Consideration: Many parties can easily meet the “offer and acceptance” element of contract formation, but some fail to provide consideration. In essence, consideration is the exchange of either money or some kind of value that is given by the parties to one another (e.g., a service or goods). It is the “bargained-for exchange” that occurs between the parties. In a real estate transaction, the consideration would be the deposit provided by the buyer as well as the remaining funds required on closing to purchase the property from the seller. In other contracts however, love and affection could be considered adequate consideration.
A “Meeting of the Minds”: There needs to also be a genuine intention to establish legal relations. Although an intention to create a legal relationship is generally presumed in commercial situations, if any documents are marked subject to contract (or something similar), there will be no binding contract as this would be an indication that the parties do not yet intend on being legally bound.
Certainty of Terms: Although not every term need be agreed upon before a contract can be considered binding, all essential terms of a contract (e.g., parties, price, term, etc.) must be agreed upon and none of these can be ambiguous, vague or uncertain. If a key term is missing, there must at least be a method of determining or implying it (e.g., no specified price, but a formula to calculate the price). Nonetheless, it is recommended that all terms are agreed upon to prevent later disputes.
Competency and Capacity: There may not be a contract if one or all of the parties do not have the mental capacity or competency to understand and appreciate all that they are agreeing to in the contract. Such cases can include making agreements with minors, people with mental disabilities, people under the influence of alcohol or other drugs, and unregistered businesses.
Consent: The parties must be entering into the agreement voluntarily, without undue influence, duress or misrepresentation.
It should also be noted that a contract can be in writing, be made orally, be inferred by conduct or formed using a combination of all three. In certain circumstances, however, a contract must be in writing (e.g., agreements of purchase and sale for property). It is also preferable to have an agreement in writing, especially for evidencing all the essential elements of contract formation.
Some other suggestions are to try to ensure all key terms are agreed upon before performing under the contract, to mark all documents “subject to contract” if you’re still negotiating, and, of course, to read the contract in its entirety before signing.
Even if you believe you have met all the above key elements to form a legally binding and enforceable contact, it is always highly advisable to have the contract reviewed or prepared by a lawyer. Your lawyer can recommend beneficial modifications to the terms and conditions of the agreement and assist you in understanding your specific obligations, liabilities and rights, which may not be clearly evidenced by the words (or lack thereof) on the page.
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