30 Jan 2023
8 Jan 2020
The defining feature of contracts is that they are legally binding agreements. As a business owner, there is no doubt you will have to deal with contracts in all aspects of your business, whether it is for dealing with employees, other businesses, clients, etc. Whilst you do not need a legal professional to assist you in drafting a contract per se, there are basic requirements that must be fulfilled for there to be a legally enforceable and binding contract. If you do not want to miss out on any important requirements, you’ve come to the right place - we will be covering all the requirements for a legally binding and enforceable contract below.
Technically, any agreement between two parties can constitute a legally binding contract, so far as it is executed correctly. There can be written or oral agreements (a contract in writing has an evidentiary advantage) that can involve goods, services, money, employment contracts, and real estate deals. The law governing this area is contract law, which is derived from the common law. You should note that a party signing a written contract is bound by its terms, whether or not he/she has read them or has understood them.
Online contracts are simply agreements between two parties that are made electronically without a physical signature. So long as the essential elements of a contract are present, an online agreement can be valid and legally binding (whether it is created through an online legal template provider such as DocPro or executed electronically). As such, under contract law, the long terms and conditions on websites would still apply and be enforceable after the user clicks “I agree”. This is the case whether or not the user actually reads or understands the terms.
Contracts can be oral or partly oral; written or partly written. They can also be made informally. However, you should note that some legislation imposes requirements for contracts to be in writing or in a certain form. These include contracts for the sale or disposition of an interest in land, some consumer credit agreements and some requirements relating to employees.
There are essential elements of a valid contract that must be fulfilled in order for a contract to be legally binding. These are offer, acceptance, consideration, and intention to create legal relations.
If you want to learn more about these essential elements in detail, you can refer to our article, 6 Essential Elements of a Valid Contract with Examples.
Normally, a contract cannot confer rights or impose obligations that arise under the contract to anyone other than one of the parties to the contract.
Privity of Contract is a common law doctrine that provides that a contract cannot confer rights or impose obligations that arise under the contract on anyone other than one of the parties to the contract.
As such, only parties to the contract should be able to sue to enforce their rights or claim damages under a contract.
As such, only parties to the contract can sue to enforce their rights or claim damages under a contract. This makes it problematic for third parties, however.
For example, Andrew and Ben enter a contract under which Andrew agrees with Ben to give a valuable diamond to Carrie. Both Andrew and Ben fully intend for Carrie to benefit from Andrew’s promise. Under the doctrine of privity of contract, if Andrew for some reason does not give the diamond to Carrie, Carrie cannot sue Andrew as she 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:
(i) expressly provides that the third party may enforce a term of the contract; or
(ii) purports to confer a benefit on that third party.
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 upon the meeting of a condition.
The law presumes that parties who intend to contract to have the capacity to contract.
Minors (children under 18) and mentally disordered people do not have the full capacity to contract. This incapacity, however, is for the person claiming it to bring evidence and prove it.
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), organizations and charities.
Joint liability arises when two or more people jointly agree to do something.
If either (or any) of the joint obligors (i.e. the people who have the obligation) perform the obligation, the others are discharged from their obligations. There are strict technical rules of law that apply to joint liability and liability can also be joint and several.
Joint liability also occurs when 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.
The most obvious terms are those that the parties have expressly set out in their agreement. The parties may record their agreement, and the terms of their contract, in more than one document.
There is no duty on parties to negotiate in good faith. This means that the parties can negotiate or bargain as hard as possible, so long as it does not constitute fraud or misrepresentation (please see below). Note that a one-sided agreement does not necessarily make the contract unenforceable.
The terms may be incorporated by reference into the contract; (for example, where a contract is made subject to standard terms of sale). Once the express terms have been identified, the question of interpretation arises.
The document setting out the parties' agreement must be interpreted objectively. This asks what a reasonable person in the position of the parties would have understood the words to mean. The starting point is that words are to be given their ordinary and natural meaning, but technical words are usually given their technical meaning.
Commercial contracts are construed in a business fashion. Certain words have a statutory meaning - month, person, the singular includes the plural and the masculine includes the feminine.
If the wording of an instrument is ambiguous, it will be construed against the person who drafted the provision or for whose benefit the provision was drafted for.
This is particularly relevant in guarantees, exclusion clauses and indemnities. There may also be an express reference to a person or something particular to show an intention to exclude everything else. That is why many agreements have a definition and interpretation section to cater for any special usage of words.
Some terms are not expressly stated but are implied; these are known as implied terms. Normally these terms are fairly obvious to both parties to the contract, or the parties intended not to expressly write it, or by operation of law, or by custom or usage.
The law will imply terms in a contract in some cases. For example, this would happen where it is necessary to give efficacy to the contract; and where it is obvious from the contract that the parties would, as reasonable men, have agreed to it if it had been suggested when the contract was made.
In the context of an employment contract, implied terms may include things like the right to equal pay, not to be discriminated against, or a certain duty of care. Take a look at an example here: https://docpro.com/doc285/employment-agreement-junior-employee-without-share-options-neutral
Terms implied in law are terms imported by operation of law, meaning that they are enforceable regardless of whether the parties intended to include them or not. For example, in a contract for the sale of goods, it is an implied term that the goods will be of a certain quality and, if sold for a particular purpose, will be fit for that purpose.
Further significant terms may be implied from the nature of the relationship between the parties – for example, contracts for professional services require the professional to act with reasonable standards of competence. See here.
A misrepresentation is an untrue or misleading statement of fact made during negotiations by one party to another, in which a statement was made that induced that other party into the contract. There are three categories of misrepresentation:
This is misrepresentation made by someone who had genuinely thought or had reasonable grounds for believing that the false statement was true;
This is a misrepresentation in which the person making the statement should have known, or had a duty to know, that it was false and therefore failed to exercise a duty of care in not finding out; and
This is a misrepresentation by a person acting in bad faith by lying or making a false statement of fact that causes or induces someone to enter into a contract. The misrepresentation can be in the form of a lie, half-truths, or silence when there is a duty to speak. This is done to deceive the other party.
A person can always rescind the contract for fraudulent misrepresentation. If the misrepresentation is negligent or wholly innocent, the court has the discretion to refuse to allow the person to whom the misrepresentation was made to rescind the contract but to award him damages instead. It used to be the case that if someone was induced to enter a contract by a misrepresentation, he could rescind the contract subject to certain conditions but could only claim damages if the misrepresentation was fraudulent.
The misrepresentation can be a misstatement of a fact.
For example, if a representation is made about a dishonest opinion or intention, this can also be actionable.
Furthermore, if a statement that is true when made becomes untrue later on, a failure to notify the change can constitute misrepresentation.
Note that the general rule in contract law/misrepresentation is that mere non-disclosure is not a misrepresentation as there is generally no duty on a party to a contract to disclose material facts to the other party.
The law on misrepresentation is a complex mixture of the rules of common law, equity, and statute law. It may be possible to bring an action in tort for misrepresentation, as well as in contract, leading to the number of damages awarded being different.
To obtain relief, a person must be able to show that the misrepresentation was made to him or his agent, or that the person making it expected it to be passed on or made to the public at large. The person must also show that he relied on it or was affected by it.
The main remedies for misrepresentation are damages or rescission.
The amount of damages for fraudulent misrepresentation differs from the normal damages for breach of contract. Damages for negligent misrepresentation can be reduced if the person claiming was contributorily negligent.
Rescission means that the parties can rescind or cancel the contract. This means that the parties would go back to the original position as if the contract was never entered into.
There are bars to rescission, however. These include:
(i) if it is not possible to put the parties back to their original positions,
(ii) if the party has affirmed the contract,
(iii) because of the lapse of time, or
(iv) because a third party has acquired rights.
A mistake occurs when there is an erroneous belief at the time of contracting that certain facts are true. In common law, there are three different types of mistakes in contracts:
A unilateral mistake is a mistake made by one party – e.g. the party has not fully considered the circumstances when making the contract.
Normally, a unilateral mistake does not render a contract void. The common law principle of Caveat Emptor (buyers beware) applies when a party enters into a contract.
However, a party shall not take advantage of the other party if it is a clear clerical mistake, or 'snatch up' a bargain that one did not intend to make, resulting from arithmetic error etc.
An objective standard will be applied - that is, whether a reasonable person would be able to know that the mistake would not make sense to one of the parties. The court may also not uphold a contract if the unilateral mistake makes it unconscionable.
A mutual mistake occurs when the parties to a contract have the same erroneous beliefs about the same material fact within their contract.
This constitutes a meeting of the minds (at cross-purposes); both parties are mistaken, making the contract voidable.
Collateral mistakes will not afford the right of rescission. A collateral mistake is one that 'does not go to the heart' of the contract. For a mutual mistake to be void, the thing the parties are mistaken about must be material.
A common mistake is where both parties hold the same mistaken belief of the facts at the time of entering into the contract.
The distinction between the 'common mistake' and the 'mutual mistake' is important. For common mistakes, an agreement can be set aside from the beginning if there is a mistake relating to a fundamental assumption as to the existence or identity of the subject matter.
If the effect of a mistake is that the misunderstanding in the communications between the parties prevents there from being an effective agreement, then the contract would be rendered void Ab Initio (i.e. there was never any contract between the parties).
However where, at common law, the court decides that the mistake was not enough to make the contract void ab initio (does not go to the heart of the contract), then it may then consider whether to make the contract “voidable”. This amounts to a void agreement.
A voidable contract is a contract that is originally perfectly enforceable but it can be rendered unenforceable. The party who made the mistake would have the opportunity to reject the contract after the fact.
If a party with the power to reject the contract chooses not to reject the contract despite the defect, the contract remains legally binding and enforceable. The court may also consider other grounds that exist for relief or remedy in equity.
Where a contract has been entered into under duress, the party who was subject to the duress can choose not to be bound by the contract provided he has not affirmed or ratified the contract.
The same applies if a contract has been entered into under undue influence. Undue influence refers to the circumstances in which one party has abused his influence over the other or betrayed a position of confidence.
Equitable relief may also be granted for unconscionable bargains or where there was inequality of bargaining power. These do not apply to commercial transactions.
"Freedom of contract" refers to the process by which individuals and businesses are free to enter into a contract with whoever they want and on the terms they choose. It is not usually possible for absolute freedom of contract. This is due to the existence of government regulations such as unfair contract laws; sales of goods laws, minimum wage laws, competition laws, economic sanctions, price-fixing, or other restrictions to protect consumers, workers, and the general public.
A contract may not be legally binding or enforceable if it contravenes these regulations. As such, most contracts include a standard "severability" clause:
If and to the extent that any provision of this Agreement is held to be illegal, void, or unenforceable, such provision shall be given no effect and shall be deemed not to be included in this Agreement but without invalidating any of the remaining provisions of this Agreement.
If you need boilerplate clauses for a standard contract, please see here.
Once you have negotiated and agreed on the terms of a contract with your counterparty, here are some of our top tips for ensuring that it is legally binding and enforceable:
Check the terms to ensure that they are clear, unambiguous, and without any mistakes. You should always include specific definitions for any technical terms which may not be easily understood.
Clarify any unclear issues with your counterparty to avoid claims of misrepresentation, mistake, duress, or undue influence, which would render the contract void or voidable.
Ensure that the essential elements of a valid contract like offer, acceptance, consideration, and intention to create legal relations have been included in the contract.
Although a contract can be verbal, you should try to put the contract in writing as it serves as better evidence to show what the parties have agreed upon. Where possible, include more expressed terms so as to limit the number of implied terms.
Once the parties are in agreement that the contract is final, they should sign and date the contract. Where possible, this should be done at the same time as you may be inadvertently giving some optionality away by signing first. Finally, all parties should keep a copy of the contract for reference.
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 lawyer.
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