Back to the Basics – What Is a Contract?

It is a basic understanding between parties to a contract that they are bound to the terms of their agreement, whether that contract is written (ideally, and in some cases required) or unwritten. Court decisions, however, remind us that parties continue to have a misunderstanding of precisely what is necessary to have an enforceable agreement.   

While it is possible to unintentionally find yourself in a binding contractual relationship, perhaps it is more likely that parties find themselves in a misunderstanding where one party believes a contractual arrangement has been formed and the other does not. In a legal sense, we say that such misunderstandings are a failure of two parties to reach a “meeting of the minds.” Courts evaluating the existence of an enforceable contract will judge that meeting of the minds by an objective standard looking at the parties’ expressed words and visible acts, not their subjective states of mind. Absent a meeting of the minds, an essential element of contract formation fails. 

So, what are the essential elements of a contract?   

Competency 

First, both parties must be competent to contract. For individuals, this generally means adults suffering from no disability that impairs their ability to comprehend the deal at hand. For entities, this typically means a properly formed corporation or limited liability company, for example, with the individual(s) executing the agreement on behalf of such entities having authority to do so under the entity’s governing documents or otherwise under state law.  

Proper Subject Matter 

Second, the contract must be for “a proper subject matter.” In short, illegal activity cannot be the subject of an enforceable contract. Can you imagine arguing your case before a judge, attempting to enforce a contract for the purchase of narcotics or other illicit materials or activity? 

Consideration 

Third, there must be legal consideration, that is, something must be given in exchange for something else. Consideration can be cash in exchange for a product or service, or trading one item or service for another. The exchange simply cannot be gratuitous – there is generally no consideration, for instance, when you give someone a gift card because it is his or her birthday. I am careful to couch examples with “generally” or “typically” because often there are exceptions. 

Mutuality of Agreement  

Finally, as discussed above, there must be mutuality of agreement – a meeting of the minds. Before a contractual relationship is established, there must be an offer and an unambiguous acceptance.   

An offer is the manifestation of willingness to enter into a bargain, so made as to justify another person in understanding that his assent to that bargain will conclude it. In other words, it is not something said in jest along the lines of “I’ll sell you the moon,” or a hedge like “maybe I’ll paint your house if you pay me.” On the other hand, one can conclude an offer is being made if you were to say, “I’ll paint your house if you supply the paint and pay me $100 when I am done.”  

If an offer is made, acceptance of the offer is then required. Sufficient acceptance arises when the individual to whom the offer is made voluntarily manifests an intent to be bound by that offer and the legal consequences flowing from that offer. In the above scenario, acceptance would be communicated perhaps by verbally acknowledging the offer to paint the accepting party’s house, but certainly by the accepting party supplying the paint as well pursuant to the terms of the offer. Verbally acknowledging the offer but failing to supply the paint quite likely would be found not to be proper acceptance.  

As suggested above, ideally all contracts should be reduced to writing, not simply those which are required to be in writing by statute or otherwise (e.g., contracts related to real estate). Handshake deals certainly still happen and may never be an issue between two long-term partners. But memories can fade and parties need to plan for the consequences if, for example, only two individuals know the terms of that unwritten deal and unfortunate circumstances befall one of them. What then? 

If you are currently a party to an arrangement or are contemplating an arrangement with another party, the business attorneys at Kreis Enderle are here to provide guidance and to protect your interests by formulating an enforceable contractual arrangement. Don’t hesitate to contact us.

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