You have been talking about the terms of a possible deal for a long time but you are not quite sure at what point your discussions turn from contract negotiations into a legally binding agreement. In this article, Nick Guinness, corporate law solicitor with Forrester Sylvester Mackett explains the essentials of contract formation.
What needs to happen for a contract to be created?
For a legally binding contract to exist you need four things to happen:
- you need someone to offer to do something;
- you need someone to accept the offer;
- you need the person accepting the offer to agree to pay for what is being provided or to offer some other type of reward as consideration; and
- you need the offeror and acceptor to intend to enter a legally binding arrangement.
What constitutes an offer?
An offer, in the context of contract formation, is one made with the intention that it will become binding once it has been accepted, with no need for any further discussion or negotiation. This intention is what differentiates an offer from what is known as an ‘invitation to treat’, which occurs where an offer to negotiate the terms for a possible agreement is made. The display of goods in a shop, requests for the submission of tenders, or an advertisement for a property auction, are all examples of invitations to treat.
How is an offer accepted?
An offer can be expressly accepted orally or in writing. It can also be accepted by conduct, for example by the person to whom the offer was made acting in accordance with the contract terms.
Importantly, for an offer to be accepted, it must be accepted on the terms proposed by the person who made the offer. If the person to whom the offer was made attempts to negotiate the terms, then the offer will not have been accepted; instead what will have happened is that a new offer will have been made to contract on different terms to those initially proposed and which the person who made the original offer is free to either accept or decline.
At the time of acceptance, the terms of the contract must be certain and there must be agreement on all the major elements, with nothing left to be agreed upon later.
What is consideration?
Consideration in the form of payment or some other reward is what makes the contract mutually beneficial and therefore enforceable. The person accepting the offer will receive goods or services that are of value to them, and the person offering to supply them will be paid or rewarded for their trouble.
The amount of consideration must be sufficient for the goods or services being provided but does not have to be adequate. The concept of consideration becomes more complex in cases in which one or both people who have signed up to the contract agree to act or pay in the future.
When will there be an intention to be legally bound?
There needs to be an intention to enter a legal relationship. This is what distinguishes contracts from other types of agreements, such as those made socially between friends. An offer to cook a meal for your flatmates if they bring the wine is clearly not intended to be legally binding.
In a commercial context, there is a presumption that there will have been an intention to create legal relations. Whether such an intention did in fact exist however will always depend on the context.
While all legally binding contracts share the four attributes discussed in this article, the contents of every contract will differ depending on the nature of the business relationship and the specific circumstances of the transaction. If you are about to enter a contractual relationship and wish to ensure that you are doing so on favourable terms, or if you have a query about an existing contract, it is worth seeking advice at the earliest opportunity to avoid costly disputes and potential litigation later.
For further information on contracts, or any other commercial law matter, please contact our experienced team.