The Elements of a Contract
What is a contract?
In a legal sense, a contract is more than just an agreement between two people. There are five basic elements that must be satisfied for a contract to be properly formed; the absence of one or more of these elements may cause a court to find that the contract is not binding on the parties. These elements are:
- Offer and Acceptance
- Consideration
- Capacity
- Intention to Create Legal Relations
- Certainty
Offer and Acceptance
The first element of a contract is agreement between parties. Usually the question of whether an agreement exists will be determined by considering if “offer and acceptance” has occurred.
For offer and acceptance to have occurred there must be an offer communicated by one party to another, setting out the terms on which that party will agree to be bound. That offer must then be accepted by the other party prior to any withdrawal of the offer by the first party.
Some examples of situations that do not constitute offer and acceptance:
- “An invitation to treat”: Essentially this is a request from a party to make offers, or an expression by one party that they are willing to negotiate in relation to a particular matter. A person making an invitation to treat does not intend to be bound as soon as it is accepted by the person to whom the statement is addressed. Most advertising will constitute an invitation to treat and it is only at the point of sale that offer and acceptance will occur.
- Counter offers: If one person makes an offer and another person makes a different offer in response, this will constitute a counter offer and will make the first offer incapable of acceptance by the party proposing the counter offer. For instance, if you make an offer to purchase a house for $500,000 and the vendor sends back a contract with an amended purchase price of $550,000, if you reject the counter offer for $550,000, that Vendor cannot go back and accept the initial offer of $500,000. The counter offer of $550,000 effectively cancels your offer of $500,000.
Consideration
Consideration is the price paid for the promise of the other party. The price must be something of value, although it need not be money. Consideration may be some right, interest or benefit going to one party or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other party.
In Australian law, the court will not question the adequacy of consideration, provided that it is of some value. This accounts for the fact that different things mean differently to different parties. Sufficient consideration may also include abstract exchanges such as ‘love and affection’.
The other important point to note regarding consideration is that past consideration will generally not suffice. If consideration has already been provided in the past by one person prior to a contract being formed, it may be insufficient to “buy” the promise of another person.
Capacity
The parties to the contract must have the legal capacity to enter into a binding contractual relationship. This can mean that people such as minors, people with mental impairment or people with diminished capacity may not be in a position to enter a legally binding contract.
Intention to Create Legal Relations
A contract does not exist simply because there is an agreement between parties; the parties must intend to enter into a legally binding agreement. This will rarely be stated explicitly, but will usually be inferable from the circumstances in which the agreement was made. For example, offering a friend a ride in your car is not usually intended to create a legally binding relation. You may, however, have agreed with a colleague to share the costs of travelling to work on a regular basis, and agree that each Friday your colleague will pay you $20 for the running costs of the car. Here, the law is more likely to recognise that a contract was entered into.
It is usually presumed that parties to commercial arrangements are intending legal consequences, while parties to social or domestic agreements are presumed not to want to create a legally binding contract. A person who wants to enforce a domestic or social agreement needs to prove that the parties did intend to create a legally binding agreement.
Certainty
For contract formation the agreement must be sufficiently certain and sufficiently complete that the parties’ rights and obligations can be identified and enforced. The topic of certainty encompasses three related and often overlapping issues:
- The agreement may be incomplete because the parties have failed to reach agreement on all of the essential elements or have decided that an essential matter should be determined by future agreement;
- The agreement may be uncertain because the terms are too vague or ambiguous for a meaning to be attributed by a court;
- A particular promise may be illusory because the contract effectively gives the promisor an unfettered discretion as to whether to perform the promise.