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Do you really know what a contract is?

Written by Kate Legg on Friday, 08 April 2016. Posted in Legal

Entering into a contract doesn’t necessarily mean signing on the dotted line. That’s why it’s important to understand what constitutes a legally binding contract

Do you really know what a contract is?

What comes to mind when you think of a legal contract? You may imagine thick paper signed in fountain pen or pages of small print that never get read. But you may be surprised to learn that most contracts don’t even have to be in writing. In fact, forming legally binding agreements may be easier than you think.

The principles of contract formation were established over a hundred years ago and, whilst they have been augmented by statute, the basic requirements haven’t really changed. When lawyers look to see whether there is a contract in place, they look for five basic elements. If all five elements are present, then there is a contract – even if it’s not written down.
 
Offer and acceptance

The first two requirements are that there must be an offer made by one party and an acceptance by another. Legally speaking, an offer is a promise to enter into a contract on the terms provided. This means that the terms of the contract must be clear in the offer, otherwise it is essentially just an invitation to negotiate and thus not legally binding.

Once an offer has been made, the other party must then do something to indicate that they accept it. Traditionally, offers are accepted by signing the contract; however, this is not strictly necessary. An offer could be accepted verbally or by any act that indicates that the party is doing so.

Often, a supplier will start work on a contract before the papers have been signed and whilst negotiations on the finer points are continuing. Although it’s understandable that a supplier will want to get stuck in as soon as possible, this approach certainly isn’t without risk. When the supplier starts work on the contract, this could actually be seen as an indication that the supplier accepts the offer as it stands and is bound by a contract on those terms.

Occasionally the second party will state that they want to accept the offer but propose some slightly different terms. This often arises when the buyer and seller each have their own standard terms and conditions. Typically, the seller makes an offer that is subject to their standard terms of sale; the buyer then ‘accepts’ the offer but subject to the their standard terms of purchase. In this particular scenario, the buyer hasn’t actually accepted the seller’s offer at all but instead has made a counter-offer. This is commonly known as a ‘battle of the forms’ and can be fruitful ground for litigation lawyers.

Consideration

The third requirement is consideration. Put simply, this is the price that the customer has agreed to pay in return for the seller’s goods and services. Usually this will be an amount of money, although anything with a value is sufficient. What’s more, it doesn’t matter what the actual value of the consideration is: it could be something worth significantly less than the other part of the bargain. For example, a packet of crisps could constitute consideration for the sale of a Ferrari and be capable of forming a legally binding contract, even though the crisps are worth significantly less than the market value of the car. This principle was illustrated in a franchise case in 2010. 

In franchise agreements, the franchisee will usually agree to various obligations – including the obligation to pay fees – in return for the rights to use the franchisor’s brand and to operate the franchise. However, in the 2010 case, a pack of posters given to the franchisee by the franchisor was found to be sufficient consideration for the obligations that the franchisee entered into in the franchise agreement.

Intention

The fourth requirement is intention. A contract can only be formed in circumstances where the parties intended to create a legally binding agreement. However, this is not a ‘get out of jail free’ card for someone who wants to avoid a contract. The law presumes that in commercial contracts there is an intention to create a binding agreement. This means that the party who wants to avoid the agreement must provide very clear evidence that they did not intend to be bound. In practice, this is very difficult to prove.

Certainty

The final requirement is that the terms of the contract must be certain. However, in some circumstances, the law will imply terms into contracts even if the exact terms haven’t been agreed. Occasionally, terms will be implied that are fundamental to the contract; for example terms may be implied relating to price, delivery and quality.

The existence of implied terms doesn’t mean that written contracts are redundant or that the courts will write a contract for you. On the contrary, it is far better to have a written contract where the agreed clauses are clearly set out, rather than leave it to hoping and guess work as to whether a particular term will be implied. Otherwise you risk being bound by a contract on terms that you didn’t choose but which are imposed upon you by the courts.

Putting it altogether

From a legal perspective, if the five elements are present, then there is a legally binding contract, regardless of whether the parties have signed an agreement or even whether there is anything at all in writing.

From a practical perspective, if you don’t intend to form a contract and are still negotiating, it is important that you make this very clear to the other party. Conversely, once an agreement has been reached, make sure that it is documented. A written agreement is much easier to enforce if things go wrong and helps to reduce the risk of disputes in future.

About the Author

Kate Legg

Kate Legg

After more than a decade advising other business owners, Legg has recently fulfilled a long held ambition and become one herself. Now the founder, director and CEO of Komerse, a legal practice specialising in commercial law and franchising, Legg is clearly practising what she preaches.

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