6 Essential Elements of a Contract
Ensure your agreement is valid and enforceable
At the heart of most professional relationships is a contract. If you’re striking a bargain, coming to an agreement, or closing a deal, a contract is what cements the obligations, rights, and duties of all parties involved.
And even though contracts are infinitely varied in length, terms, and complexity, all contracts must contain these six essential elements.
When these six elements are present, a contract evolves from a simple agreement to a binding legal document. But if you lack just one of them, a contract may not be enforceable at all.
Let’s take a look at each element.
All contracts start with desire and responsibility. Someone wants (desires) something, and someone can fulfill (take responsibility for) that want. Known as “the offer,” this first essential element encompasses the duties and responsibilities of each party, but must also demonstrate an exchange of value. That value can be money, or it can relate to a desired action or outcome.
Technically, an offer does not exist until it is received by the requesting party (the offeree). After the offer has been received, it can still be revoked, altered, or terminated at any time before acceptance.
The offeree is also free to extend a counter-offer. When a counter-offer is made, the original offer is terminated, and the parties are now in the process of bargaining for a new desired outcome.
Once the offer is presented, the offeree can decide whether to accept or reject the proposal. The offeree can communicate acceptance either verbally or in writing (including mail or email)*.
Acceptance can take many forms, including:
- Conditional Acceptance
- Acceptance by Action
- Option Agreement
In general, a counter-offer is considered a termination of the original offer, but some circumstances allow for conditional acceptance. For example, the Universal Commercial Code (UCC) acknowledges the validity of new conditions to an offer, as long as those conditions are made known to both parties and do not cause surprise or hardship.
Inaction is not considered acceptance for the purposes of a contract. This goes back to a legal tenant established in 19th Century Britain. In that contract case, a man offering to buy a horse declared that he would consider the horse purchased unless he heard otherwise from the seller. The court determined that assumption cannot create a contract. Acceptance must be explicit; merely taking action on one side (for example, shipping unsolicited materials) is not enough. Both sides must act, but if the actions are explicit and declarative, they will rise to the level of acceptance for the purposes of the contract.
*In most states, an offer is considered accepted once it has been placed in a mailbox. The “mailbox rule” applies even if the acceptance is never received by the offeror. The main rule of validity for an acceptance is that it must be a clear and direct statement that all terms and responsibilities in the contract are accepted.
For a contract to be binding, both parties must first be aware that they are entering into an agreement. Often called “a meeting of the minds,” both parties to a contract must be active participants. They must recognize the contract exists and are freely agreeing to be bound by that document’s obligations.
In fact, contracts can be voided if awareness is not adequately established. For example, if one of the parties signed an agreement under duress or can prove undue influence, fraud, or misrepresentation, the contract will be invalidated. As a result, it is crucial for all parties entering into a contract to clearly and decisively establish that the agreement is genuine, mutual, and all parties consent to its contents.
In short, it’s crucial that both parties know what they’re getting into.
Ultimately the purpose of the contract relates to what it provides: the consideration. For contractual purposes, consideration includes the value that has been agreed upon, whether that be an action or an item. Property, services, even protection from harm, are all examples of contractual consideration.
It’s important to note that there does not need to be a financial component for consideration to be valid. An agreement of an exchange of services, for example, is enough to meet the legal burden of consideration. The key is that the consideration has an agreed-upon value between the signatories to the contract.
In simplest terms, an individual cannot sign away their rights. Of course, the reality is a bit more complicated, which is why contract law requires that all signatories demonstrate that they clearly understand the obligations, terms, and consequences of the contract before they sign.
The court defines that understanding as “legal capacity,” and each party signing a contract must demonstrate this legal capacity for the contract to be valid.
Generally speaking, people who fall into one or more of these categories may not have legal capacity to validate a contract:
- Someone with a brain disorder (e.g., dementia)
- Someone under the influence of drugs or alcohol
- Someone without sufficient understanding of the language used in the contract
There are, of course, ways to overcome these capacity hurdles. A minor may have a court-appointed representative, for example. In the case of a foreign language, a translated copy of the contract could suffice. The final determination on capacity ultimately rests on understanding: does each party fully comprehend the contract’s words and meaning?
Finally, all contracts are subject to the laws of the jurisdiction in which they operate, including any applicable federal, state, and local laws and ordinances. Obviously, a contract for an illegal action or product cannot be enforced. Even if the parties initially had no knowledge, if their agreement runs afoul of local laws, that lack of awareness is insufficient to overcome the legality burden. It also goes without saying that a contract that involves criminal activity is not valid.
As always, there are nuances. In general, the contract must adhere to the law in the jurisdiction where it’s signed. Sometimes state and federal laws are not in alignment, and in those cases, the Contract Clause (Article I, Section 10, Clause 1 of the United States Constitution) will be the guiding authority.
In addition, there are certain instances where a contract is no longer legal, including:
- Undue Influence, Duress, Misrepresentation: When any party to the contract signs as a result of coercion, threats, false statements, or improper persuasion
- Unconscionability: When the result of a contract triggers oppressive obligations or produces results that “shock the conscience of the court.”
- Public Policy and Illegality: When a contract violates public policy or jeopardizes public welfare
- Mistake: When an error in the contract has a “material effect” upon the obligations and responsibilities initially agreed to
- Force Majeure: When circumstances beyond the control of the parties make it impossible to satisfy the obligations of the contract
Contracts are critical business tools. That means establishing a valid contract is crucial, as is ensuring all the terms and conditions are clear and that both parties are aware, competent, and able to enter into a legally binding agreement.
Reviewing contracts with an eye towards these six key elements will help ensure that your document meets all the legal requirements and will be enforceable and actionable. ‘