In the first of a six-part blog series from Pannone’s dispute resolution team, we take a closer look at commercial contracts, focusing at those elements which give rise to the risk of disputes, and how best to navigate those challenges.
Parties may believe that they are embroiled in a contract dispute, but the first question for the court will be “is there a legally binding contract in the first place?” In this blog, we examine the requirements for the formation of a legally binding and enforceable contract.
The five requirements for a legally binding contract
A contract gives rise to legally enforceable rights, obligations and remedies. It’s therefore important to consider whether or not a legally binding contract has been formed.
It’s not necessary for a contract to be documented in order to be legally binding. A contract can be formed whether made in writing or verbally.
However, there are five key requirements which must be present to form a legally binding agreement. These are:
- an offer
- acceptance
- consideration
- a mutual intention to create legal relations
- certainty of terms.
Let’s take a closer look at each of these.
1 Offer
What is an offer?
An offer is defined as “an expression of willingness to contract, made with the intention that it shall become binding upon the person making it, as soon as it is accepted by the person whom it is addressed”. In other words, an offer is a promise made to enter into a contract.
When is an offer not an offer?
It’s important to distinguish between an offer to contract from what is commonly known as an ‘invitation to treat’. Parties need to consider whether the proposal which is made is intended to give rise to a legally binding contract (an offer), or whether it’s made with the intention of entering into negotiations (an invitation to treat). An example commonly given for an invitation to treat are goods displayed in a shop window. An invitation to treat will not amount to an offer to contract.
Can an offer be withdrawn?
An offer can be withdrawn before acceptance has taken place. This can happen in a number of ways. For example, an offer may give a deadline for acceptance. If the offer expires, the offer may not be capable of acceptance. If there’s no specific deadline for acceptance, the courts deem the offer to remain open for a reasonable amount of time. A ‘reasonable amount of time’ will depend on the particular circumstances of the case.
2 Acceptance
When is a contract formed?
A contract is typically formed, and therefore becomes legally binding, at the point of acceptance. Acceptance is the final confirmation that the terms of an offer are agreed. Acknowledging receipt of an offer will not constitute an acceptance. Instead, acceptance should clearly signal an intention to be bound by the terms of the offer. When assessing this, the court will apply the reasonable person test, i.e. would a reasonable person standing in the shoes of the person making an offer find that there is a clear intention to accept the terms of the offer and subsequently form the contract.
Acceptance of an offer can also be demonstrated by way of conduct which evidences an intention to accept the offer.
Is it an acceptance or is it a counteroffer?
In order for an acceptance to give rise to a binding contract, it’s important that the specific terms of the offer have been accepted. If alternative terms are proposed, this will not amount to an acceptance of the offer, but will instead amount to a counteroffer. A counteroffer amounts to a rejection of the original offer so that no contract exists. Querying something, or seeking clarification about the terms of the offer, will not, however, amount to a counteroffer.
3 Consideration
What is consideration?
The requirement for consideration is in essence the principle that you cannot get something for nothing. It’s centres on the idea that a party cannot enforce a promise unless it has given or promised something in exchange for it. The law does not interfere with the bargain struck between two parties and so will not test whether consideration is adequate, so long that the consideration has a value, even if that is a pound.
Who must the consideration move between?
Consideration must move from the party who seeks to enforce a promise, as this is in line with the doctrine of privity to a contract, i.e. only those privy to the contract can enforce the rights under the contract. However, the consideration does not necessarily have to move to the person who makes the promise.
Does past consideration count?
Consideration which is given at some time in the past is not a valid form of consideration, this being an act which has come before the promise was made and therefore not something of value.
4 Intention to create legal relations
Why is this important?
If the courts determine an agreement was reached without a mutual intention to create legal relations, that agreement will not be legally binding.
What is required?
When considering whether the parties had the necessary intention to create legal relations, the courts will consider the conduct of the parties and all the relevant circumstances. If an intention is disputed, the onus is on the party who claims there was no intention to prove this allegation. In order to avoid any ambiguity, it’s beneficial for parties to clearly identify their intentions from the outset.
The business presumption
Businesses should be aware that there is a presumption that there is an intention to create legal relations in commercial circumstances. In the event a party objects to there being a presumed intention, the onus is on that party to prove otherwise.
5 Certainty of terms
Are the terms clear?
For there to be a legally binding contract, there must also be certainty of terms. This requires all the essential terms that form the contract to be complete and free from ambiguity. If an agreement omits a material term or is uncertain, this may lead to the agreement not being capable of being enforced.
The court’s approach
In assessing whether essential terms have been agreed, the court will assess whether an honest and reasonable businessperson would have concluded from the parties’ communications and conduct that they had agreed all the terms they considered to be a precondition to creating legal relations.
Generally speaking, the court will not wish to interfere with agreements reached between two commercial parties. However, in certain circumstances, the court does have the ability to fill in gaps in a contract to give effect to the parties’ intentions. This will depend on all the circumstances of the case.
What’s next…
Our next blog post in this series will examine the ‘battle of the forms’ and how to ensure that your contract terms govern your business relations.
If you would like to discuss this blog, please contact Paul Jonson on 07737571147 or by email to paul.jonson@pannonecorporate.com