Whether your agreement is through email, or drafted by a team of contract lawyers, a legally binding contract will depend on these three key components.

If you need legal advice from a small business lawyer, book your free legal consultation with Supply Law today.

*Disclaimer: this guide is for informational purposes only. It does not constitute legal advice nor create a solicitor-client relationship between the author and reader. As with all legal matters, a lawyer should be properly retained and consulted where legal advice may reasonably be considered necessary.

This blog post covers what makes a contract legally binding, including:

What is a Legally Binding Contract?

In its most basic sense, a contract is a promise to perform some undertaking. Aside from illegality, the obligations parties may agree to perform are almost limitless. The promise could be as simple as closing a residential real estate transaction by delivering the keys and vacant possession to the purchaser by a certain date, or can be as complex as a capital injection in the form of a share subscription agreement backed by multiple layers of security. Regardless of the complexity of the contractual relationship, and whether the agreement involves two individuals or multiple corporate parties, the existence of a legally binding contract will depend on the same three elements being present.

The 3 things you need for a binding contract

Any first year law school student should be able to tell you a binding agreement depends on:

  1. Offer
  2. Acceptance, and
  3. Consideration

Whether or not your contract is in writing, if the agreement contains all three of these components, and is legally capable of being performed (meaning the subject matter isn’t contrary to law i.e. an agreement to purchase counterfeit goods, or only a licensed real estate brokerage may trade in real estate) a valid contract will be found.

Because these 3 components will often come up in a contract dispute, we’ll need to take a closer look.

A. What is an offer?

An offer is a statement of the complete terms of the contract, open for acceptance by the party it is directed towards. There are two main components of an offer. First, the offer must contain all of the terms the party is willing to deal under, and second, the party delivering the terms must have intended the terms to constitute an offer (these components will often be open to interpretation).

An offer can be made in writing, or orally. An offer can be made to a specific party, or generally, so that it is open for anyone willing to accept. Where an offer is made specifically, the offering party must ensure the person the offer was delivered to was capable of accepting the terms in order to create a binding agreement. This issue usually arises where an organization like a partnership or corporation seeks to avoid its obligations by claiming the person that accepted the offer (by signing the agreement) had no authority to bind the organization. Offers can be for a fixed time i.e. open until acceptance by a specific date and time, or remain open until the offer is accepted or otherwise revoked. There are countless other rules that have developed in the common law system to govern offers, including what happens in the event the offering party dies before an offer is accepted, or what happens when a counteroffer is made. Entire books could be written on this requirement alone.

B. What is acceptance?

Like an offer, there are two main rules governing acceptance. First, acceptance has to be unequivocal, meaning without further qualification. As explained below, there is no binding agreement if there is no meeting of the minds. There can be no meeting of the minds if the terms of the agreement remain unresolved.  In such case, the parties could be considered to still be in the stage of negotiations.

The requirement for unequivocal acceptance will normally take the form of executing a formal agreement or, where no agreement is prepared, can be made through a simple statement such as, “I accept your terms”. It should be noted that silence (meaning no words or actions are taken towards conveying acceptance) cannot bind a party. For instance, the offering party cannot present an offer and state, “If we do not hear from your further, we will presume you have accepted these terms”. There must be some act or acknowledgement on behalf of the recipient of an intention to be bound by the contractual terms.    

Second, acceptance must be communicated back to the offering party. Whether a party has communicated their acceptance will be decided by what a reasonable outsider would consider to be the case. This means acceptance can be inferred from the words or actions of the party that has allegedly accepted the agreement (or conversely, not inferred due to a party’s inaction). Communication of acceptance must occur by the time specified in the offer (if any) or if no time is given, within a reasonable amount of time considering the nature of the agreement. There is a presumption that an offer should be replied to promptly.

Acceptance can become complicated where the parties continue to negotiate even after a valid contract has clearly come into existence. In this situation, the parties may continue the negotiations with the understanding the agreement has been rescinded, or may attempt to turn to the courts to argue a valid agreement was finalized, and seek to enforce the terms.

Note: offer and acceptance and consensus ad idem

The requirement for an offer and acceptance stems from the long-standing legal theory that contracts come into being when they are given mutual assent by the parties to them. Mutual assent occurs where there is “consensus ad idem” a Latin phrase meaning, a meeting of the minds, or wills, of the parties. That is all to say, there must be an offer, acceptance of that offer, and the intention for the parties to be legally bound. These factors are not determined by what the parties themselves believe to be the case, but by what a reasonable person viewing the situation would perceive.

Note: who is this reasonable person?

The reasonable person is a fictional character created by the courts. This person is adapted and applied to a variety of litigation claims from contract disputes to negligence. This person is presumed to be ordinary, fair minded, lacking special knowledge, and not unusually suspicious or naive. The question in a contractual dispute is ultimately whether, in the mind of this fictional person, offer or acceptance has occurred.

C. What is consideration?

Although the concept of consideration has mostly fallen to the wayside (for reasons explained below) it nonetheless remains a vital part of any binding contract. In essence, the requirement for consideration comes from the theory that there should be some value or benefit given in exchange for the obligations the parties agree to undertake to perform. The reason being, that only a party providing consideration should be able to seek to enforce the agreement in the event of a breach.

The requirement for consideration is why contracts frequently include a provision stating, “in consideration of the sum of $1.00 the parties agree as follows:”. Providing for consideration in this form is a technique known as “peppercorning”. This nominal consideration being akin to a waiter coming over to your table to grind pepper on top of the main dish. Peppercorning is often present where obligations are exchanged without monetary compensation.

Peppercorning is common where one party agrees to release another from multi-party litigation. In such case, the real consideration is that the defending party is released from the action and in exchange, agrees they won’t hold the plaintiff liable for their legal costs incurred defending against the action. As the payment of $1.00 can hardly be satisfactory consideration for these obligations (and never actually exchanged in practice) there has been much debate about the continued necessity of consideration as a governing principal of contract law.

Throughout the history of the English Common Law system, the courts have readily intervened to find consideration wherever they can, simply to fulfill the requirement that consideration be present. The uncanny ability of judges to find consideration in nearly all cases (often coming just short of conjuring it out of thin air!) has led many legal theorists, and the courts, to question the continued necessity of this third requirement. Nonetheless, the requirement remains (at least in theory) and may be found in a range of creative forms such as care and affection.

Conclusion

Regardless of whether your agreement is made verbally, in writing, via text message exchange, or downloaded from the internet, if the three factors are present: offer, acceptance, and consideration, a legally binding contract may be found. Because attacking these three core components will often be the first place a contract lawyer will look when litigating a contract dispute, it is important to understand when your words may legally bind you.

If you need legal advice from a small business lawyer, book your free legal consultation with Supply Law today.