What Does it Take to Make a Binding Contract?
Contracts are the building blocks of business. This article addresses the basics of the necessary “elements” to create a legally binding contract.
When boiled down to the bones, there are really only three elements to a binding contract. A contract consists of an offer, an acceptance, and “consideration” on the part of each party. The problem with boiling contract law down is the possibility that the reader will simply interpret what they think an offer is, what constitutes an acceptance, and what consideration means. The truth is that each of these elements can arise in almost an infinite number of different ways that raise questions as to when they are satisfied. At the risk of discouraging the enthusiastic business person, some words of caution are appropriate. First, it is the courts of each jurisdiction that decide when each element is met, and each court may interpret these requirements at least slightly differently. Second, the past decisions of courts on a particular issue are not always a guarantee that a court will decide that the facts of a particular case are the same as past cases and the reader may be surprised by an outcome that appears to be a change from decisions.
With that massive disclaimer, the following is a general outline of some commonly-held legal principles in understanding offer, acceptance, and consideration.
1. Offer
An offer is when one party expresses or “manifests” its willingness to enter into a bargain, which then justifies another party to believe that his agreement will conclude the bargain.
Many problems arise in figuring out whether a particular manifestation or statement is truly an “offer” within the law, meaning that another party may bind the first by accepting. For example, consider a situation in which you and I are friends who have come together for a barbeque. You take the opportunity to show me your beautiful new luxury car and I tell you how much I would love to have it. You laugh and say, “I’ll sell it to you for $20!” Can I bind you to a contract by quickly accepting your offer and handing you a $20 bill? Probably not. But why? After all, an offer was clearly expressed. Contract law follows the objective theory of contracts. In other words, a party’s intent is what a reasonable person in the shoes of the other party would believe about the offering party’s intent. So, if a reasonable person would believe that the person making the offer intended to create a binding contract by his statement, then the accepting party was justified in believing they could create a contract by accepting. If a reasonable person would believe that the offer was a joke based on the circumstances, an accepting party may not bind the joker.
2. Acceptance
Simply defined, acceptance is a manifestation of agreement to the terms made by the person making the offer. Just as in offers, problems in acceptance arise often because there is such a wide array of ways in which the acceptance arises in the real-world of business and can be much more complex than one may think.
One common problem with understanding acceptance is the idea that it is only an acceptance if it is an agreement to the exact terms of the offer. If any change is made to the terms of the offer it is NOT an acceptance. Instead, it is a rejection of the initial offer, and a counter-offer. This is very significant because there is no binding contract at that point. Instead, the process has begun again and the contract is only made if the other party accepts the terms of the counter-offer.
3. Consideration
With some exceptions, contracts generally require consideration to be binding. This essentially means that each party gives something of value in the bargain. The courts look at two things that a party must be able to point to in establishing consideration.
- “Detriment”: The party who receives a promise must give up something of value, whether in money or in limiting his/ her liberty in some way.
- Exchange: The party who makes the promise makes it in exchange for the thing of value or detriment given by the other party.
This requirement means that promises to make a gift are usually unenforceable, because they generally do not meet the bargain requirement. However, this does not always hold when the parties can fulfill the bargain requirement in their agreement.
One element that some people get confused about in contracts, is whether a contract must be in writing to be legally binding. The answer is no, unless it falls within the “statute of frauds” which outlines the kinds of contracts that must be in writing to be binding.
The world of contracts can be fraught with contradictions. In an effort to create agreements that people can depend on, our courts have created many rules and concepts that govern contracts. Although in reality these rules add to the confidence a business person can have in a properly constructed contract, there are many pitfalls that the unwitting fall into if they are not careful.