What Makes a Contract Legally Binding?
Introduction
Businesses enter into contracts every day — and, no doubt, you will want to rely on those arrangements being enforceable against the other party. On the other hand, you need to watch out for the opposite risk — that you might accidentally enter into a contract before you’re ready.
What Constitutes a Legally Binding Contract?
It’s, therefore, important for businesses to know what makes a contract legal and when a contract becomes binding. Let’s look at the elements of a legally binding contract:
Offer;
Acceptance;
Consideration;
Intention to create a legally enforceable agreement.
A few other factors can also prevent a contract from becoming enforceable. These concepts might all seem a bit technical, so let’s examine each one in more detail.
Offer
A promise made by one party to another to engage in a contract on particular terms is called an offer. The offer must be sufficiently specific, complete, and acceptable to the other party.
The other party is free to accept or decline the offer. If the other party says they accept the offer but try to modify the terms or add new conditions, this takes effect as a new counteroffer. The roles are then reversed, and it’s up to the first party to decide whether to accept this new offer.
There is also a distinction between an offer and an “invitation to treat.” An invitation to treat is simply an invitation to somebody else for them to make an offer or to open negotiations. For example, publishing an advertisement or displaying goods for sale in a store would usually be considered an invitation to treat, not an offer.
Acceptance
For a legally binding contract to be formed, the other party must accept the offer. The acceptance must be communicated to the person who made the offer. It must exactly match the terms of the offer — without trying to vary, qualify, delete, or supplement any of the offer terms. And, if the person who makes the offer has specified a particular method for the offer to be accepted, then that method must be respected for the acceptance to be binding.
A person receiving the offer might try to accept it but with additional terms or conditions. In this case, there is no acceptance. Instead, it is treated as a counter-offer that the first party can choose to accept or decline. This can lead to a situation called the "battle of the forms." During negotiations, each party tries to impose its standard form terms and conditions on the other party.
For example, a customer may issue a purchase order that states its terms and conditions apply. The supplier might then acknowledge receipt of this purchase order but respond that delivery will be made subject to its terms and conditions. This can require some investigation to work out which party’s terms will ultimately apply.
Consideration
Legally binding documents are based on the concept of a reciprocal obligation. For a party’s obligation to be treated as binding, each party must have promised or exchanged something of value with the other. This is the concept of “consideration.”
A court is not concerned as to whether the consideration is adequate in the sense of whether a party got a good deal or not. This means the consideration can even be nominal — and the contract will still be enforceable. However, if there is no consideration (for example, as is the case with a gift), the promise won’t be treated as binding.
Intention to create a legally enforceable agreement
The parties must also have intended for their agreement to be legally binding. It’s, therefore, a good idea for a contract to specify whether the parties intend to be bound (or not, in the case, for example, of a non-binding letter of intent).
Other Factors That Make a Contract Legally Binding
Several other factors can cause issues when you want to define legally binding contract:
Certainty of terms — The main terms of the contract must be sufficiently specific for the contract to be enforceable. Which terms are essential will depend on the contract type.
A contract must be unconditional — If the parties have agreed that the contract is subject to any conditions, those conditions must be satisfied before the contract will become legally binding.
Contractual capacity — The parties to the contract must have the capacity to understand the nature of the transaction they are agreeing to. For individuals, this might include issues such as whether the person can contract as a minor in that jurisdiction or whether the person was mentally incapacitated or under the influence of drugs or alcohol.
Authority — a person who agrees to a contract on behalf of another party must have sufficient authority to do so. For example, a manager in a company must have been given the authority to sign up for that particular type of contract. Likewise, they might have their authority limited to only those transactions under a financial limit.
No other factors would make the contract void or voidable — a contract might not be enforceable if certain factors are present — for example, where the contract has been entered under duress, illegality, or breach of public policy under duress.
Form requirements — the form in which a contract is agreed does not usually affect its enforceability (even an oral contract can be binding). However, for some purposes, the contract form can be an issue. For example, some jurisdictions impose minimum requirements that stipulate that the contract must be in writing or even in the form of a deed for real estate transactions.
Does the Contract Need To Be Signed?
In many common law jurisdictions, contracts do not need to be put into writing to be binding. The existence and terms of a contract can be implied from the parties’ words and behavior. This sometimes causes confusion — is a signed contract legally binding?
A signature can serve different functions, for example:
For evidence purposes — As proof that the other party saw and consented to the written terms of the contract. For this reason, signatures are often required to be witnessed, providing one more layer of evidence.
As a formality requirement — For example, a contract in the form of a deed needs to be “signed, sealed and delivered.”
So, although a contract does not need to be signed to be binding, requiring a signature from the other party can be considered good practice — and one that might save your relationship from disputes in the future.
Conclusion
To fulfill the criteria of legally binding contract requirements, a fascinating interplay of elements must occur. There must be a harmonious exchange of mutual offers and acceptance, a clear manifestation of the intention to foster a legal relationship, and a beautiful dance of value exchange, referred to as “consideration.” All parties should be legally competent, and the contract's subject must be legal. Some contracts must be in writing to be valid. Due to their complexity, it's advisable to seek legal advice when forming contracts.