This guide contains a list of components that form a valid contract – and what they mean.
A contract is a legally binding agreement between at least two parties. Contracts are routine in commerce.
It is therefore important to understand how contracts work. Every contract has a set of terms on which the parties agree (although some terms – implied terms – will apply even if they are not mentioned). These terms set out the parties’ rights and responsibilities.
Does a contract have to be written?
In general, there is no requirement that a contract must be in writing.
Contracts can be made in various ways, including:
- In writing (either in a formal document or in correspondence);
- Orally; or
- By conduct or acts of the parties.
Most commercial contracts are in writing to maintain a proper record of the agreement, however they do not have to be.
Written contracts do not need to be signed. Drafts of formal contracts are not usually sufficient to be binding. Unwritten contracts do not require any formalities.
What elements form a valid contract?
There are five elements which, taken together, make a contract valid:
- Capacity; and
- Intention to create legal relations.
An offer is a promise to enter into a contract on certain terms, where one party promises to do something in exchange for another party’s performance.
The offer requires some act that gives another person to create a contractual relationship between the parties. Then the other party has the power of acceptance.
An offer must be specific, complete, capable of acceptance and intention to bound.
Also note that offers can be withdrawn before acceptance, by lapse, withdrawal, death of the offeror or failure of a condition or precedent.
Acceptance of an offer forms the ‘agreement’ – the contract – between the parties.
The following requirements are needed for acceptance to be valid:
- The offer must remain open
This means that acceptance of the offer must happen whilst the offer is still open for acceptance.
One cannot accept an offer than is no longer open.
- Mirror the offer
One cannot accept an offer which is different to the original offer made.
For example, if an offer was made and the offeree varied the terms, they could not then accept the original offer. This is because the original offer has become a counter-offer.
Acceptance must mirror the exact terms of the original offer.
- Be unequivocal
This means that there cannot be doubt that the offer has been accepted.
- Be unconditional
The acceptance cannot be subject to a further condition being satisfied.
- Must be communicated to the offeror
The offeror must know that their offer has been accepted. Usually, acceptance is made known by words or writing.
Or, acceptance could be made known by conduct of the parties.
Other communications – voice, letter, email, SMS message or text message – are all valid forms of acceptance.
Note that silence is very rarely accepted as acceptance. In order for silence to be considered acceptance, there are usually previous dealings which demonstrate that it is usual for both parties to treat silence as acceptance. Alternatively, silence may be deemed as acceptance if both parties have agreed that is possible.
- Comply with the conditions of acceptance in the offer
An offer can be accepted through any way of acceptance, such as vocally, written or by conduct. It does not have to be communicated in a certain way unless stated so in the offer.
For example, if an offer says acceptance must be communicated by email, email will be the only sufficient mode of acceptance.
Other points to note:
An invitation to treat is not an offer, meaning they cannot be accepted. A definite offer capable of acceptance has not been made. An example of an invitation to treat is an advert in a shop window.
Consideration is another component of a contract. Consideration is a form of payment or other benefit, and both parties must give consideration to the other in order to be valid.
The only way a contract without consideration will be enforceable is if a contract is made by deed – which is a written document executed with the necessary formality.
Examples of consideration include in a B2B relationship, where one business supplies good or services in exchange for money.
Key points about consideration:
- Consideration is a promise, or a promise not to act
This means that some value must pass from each party to the other for the agreement to become a legally binding agreement.
- Need not be adequate, but must be sufficient
The value of the consideration is not relevant.
For example, a contract could agree to sell Bentley car for £1. Although the value £1 seems far too small, the courts will not take this into account. This is because consideration was given by both parties, making it valid.
- Must not be historic
Consideration must not be historic, i.e the performance of a pre-existing obligation cannot be good consideration, unless the party does more than what was originally contracted.
However, where the performance of a pre-existing duty provides a practical commercial benefit to the promisor, such as saving of time or inconvenience in securing replacement performance, it can be valid consideration.
- Must move from the person making the promise
Consideration must move from the person making the promise, meaning that the person to whom a promise is made can only enforce the promise if they have provided consideration for it.
4. Intention to create legal relations
The parties must intend to create a legally binding agreement, or there is no contract – also known as ‘contractual intention’.
In a commercial context, the court will usually assume there was an intention to create legal relations. The burden is on the party claiming that a binding contract has been made to prove the intention to create legal relations. Equally, however, where there is any express agreement the burden of proving that there is no contractual intention is a heavy one.
Contracting parties must also have the capacity to be bound. Examples include; companies, LLPs and individuals of at least 18 years old.
Contracting parties must also be to fully comprehend at the time of their agreement what their obligations will be.
There are certain persons that lack the capacity to enter into a contract, with the consequence that resulting contracts will not be enforceable against them.
Examples of those who do not have capacity to contract:
- Intoxicated people
Intoxicated people lack the capacity to enter into an contract because they cannot fully understand the obligations that they are undertaking.
For example, if a party is aware that the other is mentally incapacitated, even temporarily, so that they are incapable of understanding the nature of the transaction, the contract will be voidable at the option of the other person.
There are also special rules for minors – those under 18. They lack contractual capacity, with the exception to this rule being if the contract is in regard to a necessity, such as food, clothing or shelter. In these cases, under 18s are able to contract.
- Mentally disabled
If the person doesn’t have the mental capacity to understand the meaning and effect of the contract, they lack the capacity to enter a contract.
Mentally disabled people can void most contracts or have their guardian void it for them.
This does not include individuals who fail to understand the document for no legitimate reason. For example, someone cannot claim they did not have the capacity to sign a contract simply because they did not understand a word used in the document,
Illegal and void contracts
The law will not enforce all contracts.
A contract that involves illegal conduct may be void and unenforceable.
Contracts prohibited by statute will be deemed to be void, whether the parties know the legality or not.
However, where one party performs a legal contract in an illegal manner, the other party may still enforce the contract or recover damages for breaching it.
Freedom of contract
Autonomy is crucial. Businesses are free to agree on terms they choose, allocating risks within their contracts as they wish.
It is up to the parties to decide what risks they will accept and on what terms. Courts will respect their decision and enforce the deals that they sign up to.
Creating your next contract
A contract is not just a signed document, there are components required to create a valid one.
If you need help drafting a contract for a commercial arrangement, contact us here. Our expert lawyers can help.