Do you know what you need to form a contract? Have you thought there was a contract in place but the agreement was not binding? Have you been party to a binding contract when you thought you were still trying to reach an agreement?
The process of entering into a legally binding contract may appear straightforward but you must ensure the basics of contract formation are satisfied. If they are not there may be trouble ahead.
How do you form a contract?
Five key elements must be in place before you can have a legally binding contract.
Offer and acceptance
The first two elements can be taken together. A contract is formed when one party has made an offer that another party has accepted.
Acceptance will be the final and unqualified agreement to an offer, acceptance of the exact terms of the offer with no variation.
If an offeree purports to accept an offer but on varied terms, no contract will be formed at that point. That's because the offeree will have made a counter-offer, which, if accepted, will form the terms of the contract.
Consideration must have been provided by both parties. This means that a promisee cannot enforce a promise unless something has been promised or given in return.
Unless the contract is contained within a deed, some sort of payment or value must be provided by both parties.
Intention to be bound
The parties must have had an intention to create legal relations. If there was no mutual intention to create a legally binding arrangement there can be no contract.
An intention to create legal relations is presumed in commercial situations. However, if the parties make it clear that they do not yet intend to be bound by the contractual terms - for example if any documents are marked subject to contract (or something similar), there will be no binding contract.
Certainty of terms
Parties do not have to agree every term of a proposed contract before it can be binding. All essential terms must be agreed and the agreement cannot otherwise be uncertain, vague or ambiguous.
The courts can find that the parties have entered into a binding contract even if some terms are still to be agreed. However, if terms are missing they must be capable of being implied by the court - the court must be able to fill in the gaps. In some cases, the court may be able to infer a standard of reasonableness, either on the basis of common law, or statute.
It is always best to agree all important terms if at all possible, to reduce the chance of a dispute arising.
Does it have to be in writing?
A contract can be in writing, be made orally, be inferred by conduct or formed using a combination of all three.
There must always be offer, acceptance, consideration, an intention to create legal intentions and certainty of terms. This may be better evidenced in a written contract but in many cases if the essential elements are present a binding agreement will be formed, regardless of whether there is anything in writing.
Of course there are some contracts that must be in writing, for example many land / property contracts, deeds and guarantees. However in many general commercial contracts there will be no need for a written contract.
If you do have a written contract, make sure you have read it before you sign it. The courts are reluctant to interfere when commercial parties of equal bargaining power have agreed terms, this is particularly so when the parties are legally represented. Make sure you know what you are signing up to!
Does a written contract have to be signed?
An unsigned written contract can be binding, although a court will look at all of the circumstances before concluding that the parties intended to be bound.
The lack of a signature would normally suggest that the parties had not yet reached the point where they were agreeing to be bound. However, where evidence exists to the contrary, for example if the parties had acted in accordance with an unsigned agreement, the court can hold that the parties are bound by an unsigned written agreement.
For more information on making sure contractual documents are signed properly - if they do need to be signed - see our earlier article.
Heads of terms, letters of intent and other pre-contract documents are often entered into before a formal agreement is reached.
Often pre-contract documents record a non-binding outline of the terms that the parties have agreed in principle, allowing parties to see how close they are to a deal and providing a framework for future negotiations. Pre-contract documents can, however, be used to set out some binding terms, confidentiality being a prime example.
Whether a legally binding agreement has been reached will depend on whether all of the elements of a contractual relationship are present. If they are, the document could be an 'interim' contract in place until a full formal agreement is entered into, or a simple contract as it stands. If all elements are not present, the pre-contract documents may well be simply an agreement to agree, and such an agreement will not be legally binding.
Can I start work before the contract is finalised?
Of course it is always better for a contract to be in place before you start any work, in many cases this will not be possible.
Even if full terms have not been agreed try and set out as many agreed terms as possible in a short form interim contract or put in place binding heads of terms.
If you can record as much agreement as possible that will help if arguments on whether a contract exists arise at a later date.
Remember that even if it is found that no contract exists the party who has undertaken the work may well still have a claim in restitution for the work that has been done. A claim would be made under the quantum meruit principle - in plain English; to be paid a fair and reasonable sum for the service supplied / the work that has been undertaken.
What do I need to remember?
- A contract can be made by conduct or by words or in writing - that can include an email exchange;
- If you are still negotiating mark all documents 'subject to contract';
- Make clear any binding terms in pre-contract documents (for example, confidentiality);
- Try and agree all key terms before delivering under the contract;
- Make sure all terms are clearly defined - and that you stick to those definitions - so there is no uncertainty.
- Read the contract! Make sure the contract reflects the terms you think you have agreed.
Of course this doesn't tell you everything you need to know about contracts but it is a good place to start. If you have the five key elements of a contract in place you will have a binding agreement, but to give yourself the best protection you will still need to think about:
- What the terms of the contract mean for you - do you have to act in good faith and use reasonable/best endeavours?;
- The governing law and jurisdiction of the contract?;
- Is there a need to limit / exclude liability? Any need for an indemnity?;
- Any dispute resolution process to be followed?;
- Damages that may flow in the event of a breach of contract?