What makes a contract legally binding?
Businesses enter into contracts every day – and, no doubt, you will want to rely on those arrangements being enforceable against the other party.
On the other hand, you need to watch out for the opposite risk – that you might accidentally enter into a binding contract before you’re ready.
It’s therefore important for businesses to know how and when a contract becomes binding.
A contract is binding where the following elements are present:
- Intention to create a legally enforceable agreement
There are then a few other factors that can prevent a contact becoming enforceable. These concepts might all seem a little technical, so let’s take a look at each one in more detail.
An offer is where one party promises to another to enter into a contract on certain terms.
The offer must be in a form that is sufficiently specific and complete. It must also be in a form that the other party can accept.
The other party is free to accept or decline the offer. If the other party says that they accept the offer but tries to modify the terms or add new conditions, this takes effect as a new counter-offer. The roles are then reversed and it’s up to the first party to decide whether to accept this new offer.
There is also a distinction between an offer and an “invitation to treat”. An invitation to treat is simply an invitation to somebody else for them to make an offer or to open negotiations. For example, publishing an advertisement or displaying goods for sale in a store would normally be considered as just an invitation to treat, not an offer.
For a binding contract to be formed, the other party must accept the offer.
The acceptance must be communicated to the person who made the offer. It must exactly match the terms of the offer – without trying to vary, qualify, delete or supplement any of the offer terms. And, if the person who makes the offer has specified a particular method for the offer to be accepted, then that method must be respected for the acceptance to be binding.
A person receiving the offer might try to accept it, but with their additional terms or conditions. In this case, there is no acceptance. Instead, it is treated as a counter-offer, that the first party can choose to accept or decline.
This can lead to a situation called the “battle of the forms”. This is where during the back and forth of negotiations, each party tries to impose its standard form terms and conditions on the other party. For example, a customer may issue a purchase order that states its terms and conditions apply. The supplier might then acknowledge receipt of this purchase order but respond that delivery will be made subject to its terms and conditions. This can require some investigation to work out which party’s terms will ultimately apply.
Contracts are based on the concept of a reciprocal obligation. That means for a party’s obligation to be treated as binding, each party must have promised or exchanged something of value to the other. This is the concept of “consideration”.
A court is not concerned as to whether the consideration is adequate, in the sense of whether a party got a good deal or not. This means the consideration can even be nominal – and the contract will still be enforceable. However, if there is no consideration (for example, as is the case with a gift), the promise won’t be treated as binding.
Intention to create a legally enforceable agreement
The parties must also have intended for their agreement to be legally binding. It’s therefore a good idea for a contract to specify whether the parties intend to be bound (or not, in the case, for example, of a non-binding letter of intent).
Other factors that make a contract legally binding
Several other factors can cause issues when deciding whether a contract is legally binding:
- Certainty of terms – the main terms of the contract must be sufficiently certain for the contract to be enforceable. It will depend on the contract type as to which terms are essential.
- Contract must be unconditional – if the parties have agreed that the contract is subject to any conditions, those conditions must be satisfied before the contract will become legally binding.
- Contractual capacity – the parties to the contract must have the capacity to understand the nature of the transaction they are agreeing to. For individuals, this might include issues such as whether the person can contract as a minor in that jurisdiction, or whether the person was mentally incapacitated or under the influence of drugs or alcohol.
- Authority – a person who agrees to a contract on behalf of another party must have sufficient authority to do so. For example, a manager in a company must have been given authority to sign up for that particular type of contract. Likewise, they might have their authority limited to only those transactions under a certain financial limit.
- No other factors that would make the contract void or voidable – a contract might not be able to be enforceable if certain factors are present – for example, where the contract has been entered into under duress, illegality, breach of public policy under duress.
- Form requirements – the form in which a contract is agreed does not usually affect its enforceability (even an oral contract can be binding). However, for some purposes, the contract form can be an issue. For example, some jurisdictions impose minimum requirements that for real estate transactions stipulate that the contract must be in writing or even in the form of a deed.
Does the contract need to be signed?
In many common law jurisdictions, contracts do not need to be put into writing to be binding. The existence and terms of a contract can be implied from the parties’ words and behavior. This sometimes causes confusion – why do contracts need to be signed then, and what happens if they are not?
A signature can serve different functions, for example:
- For evidence purposes – as proof that the other party saw and consented to the written terms of the contract. For this reason, signatures are often required to be witnessed, so providing one more layer of evidence.
- As a formality requirement – for example, a contract in the form of a deed needs to be “signed, sealed and delivered”.
So, although a contract need not be signed to be binding, requiring a signature from the other party can be thought of as a good practice – and one that might just save your relationship from disputes in the future.