What is a contract and what is required for them to be valid?

Question

What is a contract?

What elements are required for validity?

Answer 1

The following answer is based on general common law jurisdictions; many jurisdictions have statutes that will change some of these. In particular, consumer contracts, real estate contracts and employment contracts are typically heavily regulated and may have additional requirements.

What is a contract?

A simple definition of a contract [Guest, AG (ed), Chitty on Contracts, Sweet and Maxwell, 27th ed, 1994, p 1] is:

A contract is a promise or set of promises that the law will enforce.

Such promises must be between different people; you can't contract with yourself. Note, however, that you and a company you own are different people; so you can form a contract with your company.

So at least two people must be parties to a contract but there can be more, in fact, as many as you like. So long as the requirements are met by each of the parties they will be legally bound by their promises.

Contracts are ubiquitous

Most of us engage in contracting many, many times a day. Almost every transaction where something of value passes from one person to another in return for something of value going the other way is part of a contract. Buy a coffee. Use some electricity. Get a haircut. Sell something on Ebay.

What elements are required for validity?

To form a contract, all parties must have:

• Intention to create legal relations
• Agreement
• Consideration
• Legal Capacity
• Genuine Consent
• Legality of Objects

Intention to create legal relations

The mere fact of mutual promises does not create a contract. The law requires some evidence (express or implied) by the parties that they intend to make their promises legally binding. Two presumptions, both of which may be overcome by the evidence, have developed to help determine this:

1. an agreement in commerce or business is presumed to be a contract,
2. an agreement of a family, domestic, social or voluntary nature is presumed not to be contract.

In addition, a transaction with a public authority carrying out a statutory function is not normally contractual, even if a fee is paid. In contrast, government commercial activities such as buying or selling goods or services (that are not statutory obligations) are contractual.

Agreement

The parties, having decided they wish to be legally bound, have to agree on what they will be bound to. The most common way this is determined is by the concept of offer and acceptance, however, a global approach can be taken by looking at the acts and conduct of the parties to determine if they have reached an agreement.

Offer

An offer is a definite undertaking with the intention that it shall become legally binding when the person to whom it is made accepts it. In working out if a communication is an offer or not, the following are considered:

• An invitation to treat is not an offer. An invitation to treat can include putting goods on display in a shop (but putting them on display in a vending machine is an offer), publishing a catalogue or price list, advertising an auction or putting a "For Sale" sign on your house or car.

• An offer can be made to a specific person or persons, a class of persons or the whole world. The offer can only be accepted by someone to whom it was made. For example, if I offer to sell my car for $5,000 to Jim then only Jim can accept it, if Tony "accepts" it there is no contract.

• An offer must be communicated to the person(s) for whom it is intended. Duh.

• An offer can be revoked before it is accepted.

Acceptance

Once an offer is made there are rules used to determine when (and if) it has been accepted:

• Acceptance must be in reliance of the offer; that is, the person "accepting" the offer must know that it exists. For example, if B find's A's lost wallet and returns it out of kindness, not knowing that A has offered a reward, B cannot claim the reward when he learns of it.

• Acceptance must be complete and unqualified. If there is anything further to be negotiated then a contract has not been formed.

• Conditional assent is not acceptance. An agreement to buy "subject to bank finance" for example is not a contract.

• Acceptance must be clear and certain. The exact terms of the contract must be agreed with sufficient certainty, if the terms are indefinite there can be no contract. Note, however, that common usage or past dealings can provide sufficient certainty.

• Acceptance may be express or implied. That is, you can accept an offer by word or action.

• Acceptance may be retrospective. Where parties have acted on the basis that a contract will be formed in the future then if and when that contract comes into existence, those acts form part of it.

• A counter-offer is a rejection of an offer. If you make a counter offer then that kills the original offer; you cannot subsequently accept that offer unless it is re-made.

• Acceptance must be communicated (unless it is communicated by conduct). Again, duh!

• The offeror may prescribe the manner of acceptance. If the offer says it can only be accepted by post for example, then an email is not an acceptance.

Example 1

B walks into A's convenience store. A has on display a chocolate bar with a price tag of $1; this is an offer to treat. B can now make an offer on said chocolate bar by:

1. Saying, "I will give you $1 for this chocolate bar",
2. Saying, "I will give you 50 cents for this chocolate bar",
3. Saying, "I will give you $2 for this chocolate bar; but you must accept my offer in writing",
4. Saying, "I will massage your left foot for 1 minute for this chocolate bar",
5. Saying, "please give me this chocolate bar for free" (Note: this is not an offer that can lead to acceptance due to absence of consideration, see below),
6. Picking it up and putting it on the counter (this is implicitly saying what No 1. said explicitly). Needless to say this is the most common method.

Now that B has made the offer (by whatever method) it is open to A to accept it. Ignoring the silly offers and focusing on 1./6., this is typically done by A saying "$1, please" (explicit) or holding out his hand (implicit and slightly rude). At that point (but not before) B is legally committed, the offer has been accepted; he can't put the chocolate bar back, however, A is unlikely to sue for breach if he does.

Consideration

A contract must be an exchange of promises. If A says to B "I will give you $100" and B says "Thank you" there is an agreement but no contract; quite possibly there is no intention to create legal relations but B has given no consideration to support A's promise. Consideration is the price and a price must be paid for every promise to form a contract. Some examples of consideration are:

• A promise for a promise: A promises to work for B in return for B's promise to pay A. C promises to fix D's leaking tap in return for D's promise to fix C's car.

• A promise for an Act: E promises to give F a car if F gets a certain grade at university. G promises to pay H's debts in return for I withdrawing a suit against H. J promises to shop in K's supermarket in return for K supplying a trolley.

The following rules apply to consideration:

• Consideration is required for a contract to exist
• Consideration can be "executed" (a promise for an act) or "executory" (a promise for a promise) but cannot be "past". If the act or promise has already happened, it cannot be consideration for a contract. For example, if A promises to pay B for work already done, there is no contract.
• Consideration need not be adequate; that is, the deal does not have to be "fair".
• Consideration must be sufficient - this is different from adequacy. Insufficient consideration falls under: performance of a duty imposed by law, performance of a duty imposed by an existing contract, acceptance by a creditor of part payment by a third party, composition with creditors, moral obligation (i.e. you can't do it for love), illusionary or uncertain promises.
• Consideration must move from the promissee but need not move to the promisor. For example, if A promises to pay B if C will fix A's car, B cannot enforce A's promise because B has offered no consideration for A's promise. Alternatively, if B had promised to organise C to fix the car then that would be good consideration.

Legal capacity

A contract may not be valid if one or both of the parties is legally incapacitated. At least six classes of persons are (or were) subject to degrees of incapacity (I won't go into details):

• Minors
• the mentally ill
• the intoxicated
• married women (archaic)
• corporations
• capital felons.

Genuine consent

Consent may not have been given due to:

• Mistake, however, remedies are restricted, narrow and technical,
• Misrepresentation
• Undue influence
• Duress
• an Unconscionable contract

Legality of Objects

You can't make a contract where the law says you can't.

Is there anything else?

A great deal, however, these are the basics.

As previously mentioned, the common law may have been changed in your jurisdiction by statute; either to contracts as a whole or to certain types of contract. In addition, statutes may require some contracts to be in writing and/or witnessed; contracts to do with real estate and employment are a favourite for this.

Other than this there is no need for a contract to be in writing, be signed, be witnessed or have any other special mumbo-jumbo. Indeed the vast majority of contracts are verbal with implied terms (or terms read in by statute) and are formed and completed without the parties even realising there was a contract.