Contracts form the backbone of modern society by establishing trust and minimising risks between parties. Contracts are not necessarily money related, but they can also relate to the specific performance of certain obligations or not to carry out certain acts (e.g. non-compete undertakings). Contracts create legal obligations recognised by law, and a party can make a civil claim (or even criminal if fraud is involved) against another party to the contract for breach of contract.
To provide a full picture of what makes a valid contract, this entry covers two important areas in contract law: (A) essential elements of a contract, and (B) privity of contract.
Most people assume that once one party has made an offer and the other party has accepted, a contract has been formed. However, there is more to a valid contract than what meets the eyes, and it has nothing to do with the formalities of a contract.A contract can be formal or informal, written or even oral.
A contract is valid and legally binding so long as the following six essential elements are present:
Offer and acceptance analysis is a traditional approach in contract law. Developed in the 19th century, the offer and acceptance formula identifies a moment of formation when the parties are of one mind i.e. a meeting of minds.
An offer is a specific proposal by one party to enter into an agreement with another party, which is essential to the formation of an enforceable contract.
It is important to distinguish between an offer and invitation to treat. A valid contract requires an acceptance of offer, but an invitation to treat is not an essential element to a contract. Whilst an offer can be accepted, an invitation to treat is an invitation to someone to make an offer in which the first party can then accept.
An invitation to treat gives the party who issues the invitation control over when (and if) the contract is made. An invitation to treat only constitutes an offer when the wordings are clear, definite and explicit, which leaves nothing open for further negotiation.
In general, an invitation to tender is an invitation to treat. However, if the invitation is addressed to everyone that are known to the inviter , and the invitation contains an agreement to accept the most competitive bid or states that at least one of the tender will be considered, then such an invitation can be regarded as an offer.
Another example of an invitation to treat would be restaurant menu that display prices.
Below is an example of internship opportunity offer:
An acceptance is an agreement to the terms of an offer. Offers can be accepted by conduct. If someone purports to accept an offer but does so on different terms, that will be a counter-offer rather than an acceptance. The acceptance must normally be communicated to the offeror. Generally, silence cannot be treated as an acceptance.
In exceptional circumstances (for example, where the offeree has been given terms of dealing and the offeree proceeds with the dealing without formally communicating acceptance) silence may be treated as an acceptance.
Below is an example of a letter to accept an employment offer:
An agreement does not need to be worked out in meticulous detail in order to become a contract. However, an agreement may be incomplete where the parties have agreed on essential matters of detail but have not agreed other important points.
The question of whether the parties have reached an agreement is normally tested by asking whether a party has made an offer which the other has accepted. Agreements may not give rise to a binding contract if they are incomplete or not sufficiently certain. There will usually be no contract if the parties agree ‘subject to contract’ but never quite agree on the terms of the contract.
If the agreement is a stepping stone for future contract or is an agreement to agree, then the agreement might be void for a lack of intention to create legal relations. Connecting to this, a domestic contract is presumed to be not legally binding in common law jurisdictions.
For an example of a memorandum of understanding (MOU) in relation to a joint venture, please see the link below:
Consideration can be something of benefit to the person who has the obligation or who makes a promise to do something (the promisor). It can also be something detrimental to the person who wants to enforce the obligation, or who has the benefit of the promise (the promisee). There is no need for an 'adequate' value: as long as some value is given for the promise it would be sufficient consideration.
Where the consideration of one party is not absolutely clear, the agreement will generally include languages such as ‘FOR GOOD AND VALUABLE CONSIDERATION, the receipt of which is hereby acknowledged’ into the recital.
Alternatively, one can make the document in a deed without considerations.
If there is a promise to do something but the agreement lacks any consideration, then the agreement must be made in a deed. A deed is a document under seal which either (i) transfers an interest, right or property or (ii) creates an obligation which is binding on someone or some persons or (iii) confirms an act which transferred an interest, right or property. Not all documents under seal are deeds. There are special requirements on the execution and delivery of deeds. For instance, a contract under seal is a deed. A contract contained in a deed does not require considerations. A person identified in the deed as someone to benefit from a promise can enforce a promise to pay money or can seek damages if the promise is not performed.
However, equitable remedies (e.g. specific performance of obligations other than to pay money) are not available if there is no consideration.
For example, where a party would like to join an existing agreement without clear consideration, the party would enter into a deed of adherence:
A contract will be illegal if the agreement relates to an illegal purpose. For instance, a contract for murder or a contract to defraud the Inland Revenue Department are both illegal and unenforceable.
The law presumes that a party to a contract has the capacity to contract. However, minors (children under 18) and mentally disordered people do not have full capacity to contract. It is for the person claiming the incapacity to prove one’s incapability to enter a contract.
There are special rules which apply to corporations (including companies), unincorporated associations (including clubs and trade unions), the government (including any government department or officer), public authorities (including local government bodies, state-owned enterprises), organisations and charities.
A minor is capable to enter a contract for 'necessaries' (goods or services that are suitable to the condition of life of a minor). A minor who fails to pay for the goods or services can be sued for a breach of contract.
In general, an agreement entered by a mentally incapable person will be void.
However, a person that later on become mentally incapable can authorise another person to make legal decisions on behalf of them by granting the other person the power of attorney (POA).
For an example of a POA document, please see the link below:
A valid contract requires reasonable certainty for the essential terms. If the parties fail to reach an agreement on the essential terms with reasonable certainty, then the agreement might be void even if all other essential elements are present.
The definition of essential terms depends on what the parties have set out to achieve. In general, under common law there are two absolutely essential terms: (i) consideration or price of a bargain, and (ii) price to be paid for the promised obligation.
Whether the term is essential is determined by asking whether the term is so important and fundamental to the contract that any breach of such a term will justify termination.
For commercial contracts, provided that the parties have shown an intention to be legally bound, the court can fill in the gaps through five special rules :
For example, a sales and consignment agreement is a commercial contract :
Above are the six essential elements of a valid contract. This classical approach to contract formation has been modified by developments in the law of estoppel, misleading conduct, misrepresentation, unjust enrichment, and power of acceptance.
One should note that a contractual obligation is only binding to the parties of the contract. The issue of a third party contractual enforcement gives rise to the topic of privity of contract.
Privity of Contract is a common law doctrine which provides that a contract cannot confer rights or impose obligations which arise under the contract on anyone other than one of the parties to the contract. As such, the only parties to contracts should be able to sue to enforce their rights or claim damages under a contract are the parties to the contract.
However, there are issues associated with contracts made for the benefit of third parties who are unable to enforce the contractual rights as they are not the contracting parties under the contract.
For example, Andrew and Ben entered into a contract under which Andrew agreed with Ben to give a valuable diamond to Carrie. Both Andrew and Ben fully intended for Carrie to take the benefit of Andrew’s promise. Under the doctrine of privity of contract, if Andrew for some reasons does not give the diamond to Carries, Carrie cannot sue Andrew as it is not a party to the contract. Ben can sue Andrew for breach of contract, but Ben will only be entitled to nominal damages as Ben has not suffered any actual loss.
In certain common law jurisdictions such as England, some states in Australia, New Zealand, Hong Kong, Singapore, and some provinces in Canada, the parties to a contract can agree that someone who is not a party to the contract can enforce a term of the contract. This will apply to give a third party a statutory right to enforce a contract term where the term of the contract :
It is also possible to expressly contract out of such statutory right in these jurisdictions by including a term along the line of:
A person who is not a party to this Agreement shall have no right under any law to enforce any of its terms."
It is not possible to use a contract to impose an enforceable obligation on someone who is not a party to the contract. However, a similar effect may be achieved by conferring a benefit subject to the third party meeting a condition.
Joint liability arises where two or more people jointly agree to do the same thing. If either (or any) of the joint obligors (i.e. the people who have the obligation) performs the obligation, the others are discharged from their obligations. There are strict technical rules of law that apply to joint liability. Liability can also be joint and several. Two or more people jointly promise to do the same thing and also severally agree to do the same thing. Performance by one will discharge the liability of all of them. It is presumed that liability is joint where a promise is made by two or more people. If this is not the intention, express wording should be included to make the obligation several.
For further tips on drafting a valid and enforceable contract, please see our other entry:
Please note that this is just a general summary of the position under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your local lawyer.
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