How do I correctly form and enter into a binding Contract?

Article Scope: This article will discuss the basic legal requirements to form an enforceable or binding legal contract, including (1) Offer, (2) Acceptance, and (3) Consideration. This is contracts 101.

Disclosure: This information is provided for educational purposes only and cannot be construed as legal advice or to create an attorney-client relationship. You should seek legal advice from a qualified attorney to determine whether and how your specific facts apply to a specific area of law.

An Introduction to Contract Formation

Diverse facts and circumstances lead parties to enter into agreements, but in all cases, contracts are only formed where both parties intended to enter into a binding agreement. Contracts can be formed through documents, verbal agreements, or even actions. Documents, photos, and testimony based on memories are all evidence and a basis of fact for a judge to find that the parties intended to enter into an agreement and, therefore, a contract existed.

Courts are called on to determine whether a contract was indeed formed, valid, and enforceable. Whether a contract exists is an issue of law and fact. The court must follow specific standards when reviewing the evidence to determine if a reasonable objective person would believe the contract had been agreed to based on the circumstances known at the time. If, based on the circumstances known to them at the time, an objectively reasonable person would believe that a contract has been (1) offered, (2) accepted, and (3) consideration existed, then a court will find that a contract exists. If not, no contract existed, and a party may be able to avoid all or some responsibilities alleged under the contract.

Contract Formation Process

Contract creation or formation is a process that often occurs after hours, days, or weeks of negotiation, but, it can also happen in seconds.

Contracts are intentional agreements entered into between two or more parties (including qualified individuals, legal entities, or government agencies) that create a legal obligation to perform a legal duty. There are two main classifications of contracts, Unilateral Contracts and Bilateral Contracts. Bilateral contracts are the most common and the focus of this article. Bilateral contracts are created when both parties provide a promise to perform specific legal duties for the benefit of the other party in exchange for compensation or the promise of the other party. These contracts can be formed through a few different means: verbal agreement, separate actions (based on reasonable expectations and prior communications), or signed written agreement. Using a writing is the most common way to enter into an agreement/contract.

The parties that are directly connected and obligated to perform under the contract are the “Parties.” The Parties have separate legal roles and act as either the offeror (the party presenting a potential contract) or the offeree (the party receiving the offered contract).

The Offeror is the party presenting or outlining the essential terms and conditions of the potential contract (the “Offeror“) to the Offeree.

The Offeree is the party that receives the offer and either accepts, rejects, or allows the offer to expire (the “Offeree“)(possibly also a counter offeror).

For a contract to be created (and later enforced), three elements must be present: Offer, Acceptance, Consideration (later defined). Establishing these three elements occurs through the contract formation process. Where a valid offer was made, and acceptance was given, and bi-lateral consideration was present, then a valid and enforceable contract was formed (“Formation“).

A contract that is missing one or more of these elements is considered legally “void” (i.e., never properly formed from the outset) and, therefore, “unenforceable” (i.e., no party is not obligated to perform duties under the contract, because the contract lacked the essential terms or elements of a contract). Note: some contracts may be “voidable”  (i.e., a party may later elect to either enforce or void the contract) after formation due to other problems that occurred during the formation like a mistake of law or fact).

Once a contract is formed, it cannot be canceled, terminated, or modified without mutual consent or new consideration, otherwise, the other party may take action under the contract and seek to enforce it in a court of law.

Offer, Acceptance, and Consideration Defined

Consideration.

Consideration is the element that initially motivates or incentivizes each party to enter into the contract.  If one party isn’t getting anything under the contract, there is nothing motivating them to participate in the agreement, and therefore, the contract lacks a necessary component to be enforceable. Therefore, consideration must be given for a contract to be valid and enforceable, and without it, the contract is “void” (no contract exists) from the outset.

Consideration is legally defined as any “‘benefit received’ or ‘detriment suffered’ (including a legal right given up) by one party in exchange for the other parties action or inaction which the one party ‘would not have otherwise received, suffered, or been entitled to’ without the contract.” (“Consideration“).  Consideration must be two sided, meaning both parties must receive something there would not have otherwise gotten without of the agreement.

Offeror makes an Offer.

An Offer is generally defined as a presentation of terms and conditions by the Offeror to the Offeree. No contract formation can occur without a valid offer.

For an offer to be valid and acceptable, it must (1) be made by the Offeror or their agent, (2) include all the essential terms and conditions of the potential agreement, (3) be communicated in a method and manner that an Offeree could reasonably interpret as having the opportunity and power to accept it (a valid or enforceable “Offer“). Without the above elements, an offer is not legally considered an offer because it is missing essential terms (e.g., a price), unclear, equivocal (noncommittal), illusory (a promise open to be canceled/withdrawn/terminated at the election of one or both sides at any time), subject to or conditional upon continued negotiations, or other valid reasons.

An offer need not contain all terms and details for it to be valid and enforceable, only the “essential” or “necessary” terms and conditions. Price is considered an essential term, but it need not always be stated in an exact number, yet, the contract must state a method for determining price.

At any time prior to acceptance, the Offeror may limit the time for the Offeree to respond to the offer (i.e. set a specific deadline); similarly, the Offeror may dictate a specific method for the Offeree to respond to the offer (i.e., only respond by phone, fax, mail, email, signing, etc.). If a specific method of acceptance is not designated, any reasonable method that is sufficiently to timely notify the Offeror may be used to accept the offer. A reasonable method of acceptance is generally defined as the method used by the Offeror to present the offer is sufficient or any other method similar in form and at least as timely.

Offeror may Revoke an Offer.

Generally, Offerors may be revoked (i.e., rescinded/withdrawn) any offer at any time before being accepted by an Offeree. Similarly, all offers are considered open to acceptance by an Offeree until rescinded/revoked/withdrawn by the Offeror. The main exception to this rule is where, respectively, an Offeree or Offeror has given or accepted money (or other consideration) to hold the offer open for a specific time. An Offeror may make and revoke as may offers as they wish. A New Offer is an offer made by an Offeror after any previous offer and often constitutes a revocation of the previous offer. If not a revocation, the new offer may only be a modification to an existing offer. A modification is any change to an exiting offer and may be seen as a completely new offer. Similar to revocation, an Offeror may modify any offer at any time prior to acceptance. The legal outcome is likely always the same in the context of an offer.

Acceptance of the Offer by Offeree.

Prior to acceptance, the accepting party must have the a reasonable opportunity to hear/read, understand, all the terms and conditions offered, and, thereafter, either (a) accept the offer, (b) reject the offer, (c) present a counteroffer, or (d) allow the offer to expire.

Acceptance of an offer occurs (and the contract is formed) the moment the Offeree (or their agent) unequivocally communicates acceptance of all the terms and conditions of the offer (the “Acceptance“). Unequivocal communication is a communication by work or act  that the Offeror may reasonably interpret as unwavering intent to be bound by the terms offered.

The manner and method of acceptance, by the Offeree, must be done in a way that would timely and adequately notify the Offeror that the offer has been accepted by the Offeree/accepting party. A signature on a written contract is the most common way to accept a contract and a presumption of intent to enter into the agreement, once signed, the contract must be delivered to the Offeror to be considered accepted. A verbal offer may be accepted by stating, “I agree to your terms.” An offer may be accepted through actions if explicitly allowed or presumed (common for unilateral contracts). For example: If you mow my law, I will pay you $20, neither party has a legal obligation until the Offeree says I agree to your terms or until the Offeree initiates the lawn mowing.

(Note: an agent is an individual authorized to act on behalf of the principal, in this case, the Offeree.) Once an offer is accepted, the offer becomes an enforceable contract, the acceptance cannot be rejected, and the offer cannot be revoked.

Rejection of the Offer by the Offeree.

Rejection of an offer occurs when the Offeree (or their agent) either (a)unequivocally declines the offer, (b) allows the offer to expire, or (c) proposes a counter offer. Once rejected, the offer is dead and cannot be later accepted.

Expiration of the Offer.

Expiration of an offer occurs either (a) after an acceptance deadline was given by the Offeror (prior to acceptance) or when a reasonable time has passed since the offer was made.

A Counteroffer made by the Offeree.

Counteroffer is a new offer made in response to a previously received but unacceptable Offer. A Counteroffer constitutes a rejection of the previously made Offer. A Counteroffer is made when an Offeree does not accept all the terms as presented in the original offer and presents terms that differ from the original offer (e.g. “I accept, but you must also do X . . . .”). In this case, the Offeror and Offeree switch roles. The Offeree becomes the new offeror by presenting a Counteroffer. The Offeror becomes the new Offeree and must decide whether to accept, reject, allow the new offer to expire, or again counter (and the cycle continues).

Common Errors and Clauses in Contract Formation.

Missing Contracts

I can’t tell you how many times clients have come to me with the intention to hold a party accountable for not complying with the agreement and they cannot find it either because they didn’t receive, lost, or allege bad acts leading to missing contracts. Make sure you get a signed version from the other party and store it in a secure place. If you don’t have a signed contract and the other party claims no contract existed, it is a very long and expensive road to prove it existed.

Entire Agreement, Integration, or Merger Clauses

Watch out for “entire agreement clauses” and unenforceable promises by business or sales agents that conflict with the written contract terms. DO NOT SIGN a contract based on these promises. If you do, and a problem arises (as they often do), you will likely be left feeling frustrated, angry, and taken advantage of.

An “entire agreement” clause (sometimes called an “integration clause” or a “merger clause”) is common and included in most commercial contracts. It provides that the agreement contains all of the terms and conditions that will govern the parties’ relationship. The clause promotes certainty, and prevents a party from asserting incorporation of statements or representations made before execution of the contract to the extent not incorporated.

Often a salesperson will make representations regarding how a contract will be handled differently from what the written contract states, or they may also promise to “help you out” if any problems arise regarding the contract. Always be wary of such promises and statements. Where the contract excludes such statements and promises, they are likely unenforceable.

In these cases, at a minimum, include all such promises in an addendum and make sure the addendum controls if conflicts arise under the contract and addendum.

Personal Guarantees

It may seem obvious, but you must understand what kind of personal obligations you may have to a contract. If the contract references a cosigner or personal guarantee, you may be personally liable for all the obligations of the contract signed on behalf of the business or another person.

Joint and Several Liability Clause

Similar to a personal guarantee, if you sign a contract with numerous other people or entities, you may be obligated to pay for all the other parties debts or unfulfilled obligations under the contract, even if you personally haven’t breached the agreement.

Mandatory Arbitration or Mediation

You generally have the right to take a party to court for a violation or breach of the contract, however, if an arbitration or mediation provision is included, you may have waived that right and be forced to spend time and money mediating first. Conversely, if you prefer to avoid costly litigation up front, it may be to your advantage.

Conclusion

Understanding when a contract is formed will help you know if a contract is enforceable. Never sign an agreement unless you intend to be bound the all the terms contained therein because you can’t change the terms later unless you negotiate or pay for the changes.

This is just a general list of rules for formation of contracts. Exceptions exist, and almost always apply, based on other laws and on the specific facts. So never make a legal conclusion as to whether a contract has been formed, legal duties to perform exist, or a contract is enforceable without first consulting with a licensed attorney.