When you hear of contracts, you’re most likely to think of written ones, like employment and intellectual property contracts. However, contracts don’t always have to be formal to be valid.
A valid contract is defined by its elements. This means that even an oral agreement, such as asking a plumber to fix your faulty faucet at an agreed price, can be legally binding if it includes the essential elements of a contract.
In this article, we’ll list these contract elements, discuss their importance, and identify common contract mistakes, and strategies to prevent them.
5 Elements of a contract
While the elements of a contract can differ based on legal sources, here are the common ones:
1. Offer
An offer is a definite and explicit proposal by one party (the offeror) to another (the offeree) to form a contract. It’s the initial step in a contract formation and demonstrates the offeror’s willingness to agree on specific terms.
The terms must be clear enough for the offeree to understand and accept them. For example, Company A offers to sell 100 units of product X to Company B at $10 per unit. This offer outlines the quantity, product, and price, making it clear and definite.
Offers can occur in various scenarios, between different types of parties and can be terminated before they are accepted. Here are several ways an offer can be terminated:
- Revocation: The offeror withdraws the offer before it is accepted. The revocation must be communicated to the offeree.
- Rejection: The offeree doesn’t accept the offer and communicates this decision to the offeror. Once an offer is rejected, it cannot be accepted later.
- Counter-offer: The offeree responds with a different set of terms, rejecting the original offer and presenting a new one. For example, if the offeree replies, "I will buy your car for $4,500 instead of $5,000," this counter-offer terminates the original one.
- Lapse of Time: The offer expires after a specified period or a reasonable time if no time frame is stated. For instance, if an offer states it’s open for acceptance for 30 days, it expires after that period.
- Death or Insanity: If the offeror dies or becomes insane before the offer is accepted, the offer terminates.
- Illegality: If the subject matter of the offer becomes illegal before acceptance, the offer is terminated.
2. Acceptance
Acceptance is the expected response of the offeree after receiving an offer. It signifies the offeree's consent to the terms proposed and willingness to be bound by the contract.
For acceptance to be valid, it must be absolute and without any conditions or variations, matching the terms of the offer exactly. For example, if Company B agrees to purchase 100 units of product X at $10 per unit without proposing any changes, this makes unconditional acceptance.
Additionally, acceptance must be communicated to the offeror, verbally or in writing. Silence or inaction may not imply acceptance unless there’s a prior agreement that it does.
3. Consideration
Consideration is a valuable substance exchanged between parties within an agreement, creating a mutual obligation. It can be money, goods, services, profit, interest, a promise to act, or a promise to refrain from acting.
In the agreement between Company A and Company B, Company B's consideration is the payment of $1,000 (100 units at $10 each) while Company A's consideration is the delivery of 100 units of product X.
However, the subject of consideration must be legal and not against public policy; otherwise, the contract will be void and unenforceable. For example, an agreement to sell hard drugs is not a valid contract because the subject matter is illegal.
The consideration doesn’t need to be adequate, fair, or equal in value; it’s subjective to the parties’ agreement. If someone sells a car worth $10,000 for $1, the consideration ($1) is legally sufficient even though it’s inadequate in terms of value. Courts generally don’t assess consideration unless there’s evidence of fraud or undue influence.
4. Intention to create legal relations
Both parties must be willing to be legally bound by the terms of the contract at the time it was formed. This means both parties must agree that the law can intervene if something goes wrong. However, the nature of the agreement—whether social/domestic or business/commercial—determines if there was an intention to create legal relations.
Social/domestic arrangements are informal agreements between friends, or family members that are presumed to lack intention to create legal relations unless evidence suggests otherwise. For example, friends agreeing to go on a road trip together and share expenses typically don’t intend for their informal arrangement to be legally enforceable.
In contrast, business/commercial agreements, where at least one party is a business, are presumed to have an intention to create legal relations unless evidence suggests otherwise.
5. Capacity to contract
For a contract to be valid, the parties must have the capacity to understand the terms and consequences of the agreement. Capacity is generally defined by age, mental competence, and legal authority.
Age: Individuals must be of legal age to enter into a binding contract, typically 18 in most jurisdictions. Contracts involving minors are usually voidable at the minor’s discretion, meaning the minor can choose to enforce or void the contract.
Mental Competence: A person must be mentally competent to understand the contract’s nature, terms, and obligations. Contracts entered into by individuals who are mentally incapacitated (due to illness, intoxication, or other reasons) are voidable.
Legal Authority: Certain entities, such as corporations, can only enter contracts through authorized representatives like the CEO or manager. The corporation may argue that the contract is not binding when an unauthorized employee signs. Additionally, individuals with certain legal restrictions (e.g. those declared bankrupt) may have limited capacity to contract.
Importance of Contract Elements
Some reasons to prioritize contract elements when making agreements are:
Establish legality and enforceability
When a contract is enforceable, you can seek legal intervention if the other party fails to honor their agreed-upon duties. Courts can issue judgments that compel the breaching party to fulfill their outlined obligations in the contract or pay damages for losses incurred. Essentially, a valid contract provides protection and assurance that the agreed terms will be honored, or there will be legal consequences.
Ensure clarity and mutual understanding
A clear offer ensures that all parties involved in a contract understand their rights, obligations, and agreement terms. This prevents misunderstandings and disputes. For example, clearly defining payment terms, delivery schedules, and quality standards in a contract between a buyer and a supplier ensures both parties know exactly what is expected of them.
Promote fairness and protection
Without considering elements of a contract like the intention to enter into a legal relation, parties can later claim the agreement was a mere casual understanding. However, when a contract explicitly outlines the rights and responsibilities of each party, both parties are aware of their commitments and are less likely to take advantage of one another.
Provide proof and accountability
Considering contract elements guides parties towards documenting agreement for reference in case of disputes or misunderstandings. The documents also establish a framework for accountability, outlining each party’s responsibility and remedies if obligations are not met.
Common Contract Mistakes
Here are the common contract mistakes to avoid to ensure the validity of your contract:
Ambiguous and unspecified terms
According to World Commerce and Contracting (WCC), 90% of businesses find contracts difficult or impossible to understand, often due to ambiguous or unspecified terms. Such contracts are prone to misinterpretation, leading to disputes over performance, deadlines, payments, or other contractual obligations. This ambiguity can also make enforcing the contract challenging or seeking remedies in case of a breach.
For example, a contract stating, "Deliver goods promptly," without specifying a deadline or what constitutes "promptly," leaves room for misinterpretation. One party may consider three days prompt, while the other may expect delivery within 24 hours.
Poor documentation
While oral contracts are valid in simple cases, some contracts, such as employment, insurance agreements, or long-term service, must be in writing to be considered valid.
In this case, a lack of proper documentation can cause a dispute over what was agreed upon and courts may hesitate to enforce the agreement.
Overlooking termination and remedies
Contracts without termination conditions and available remedies in case of breach can lead to uncertainty and difficulties in resolving disputes. For example, a lease agreement that doesn’t specify conditions for early termination or the remedies available in case of non-payment can result in prolonged disputes and potential losses for both parties.
How to Prevent Contract Mistakes Using Contract Automation Software
Contract automation software tools are designed to manage the entire contract lifecycle efficiently. They include features that streamline the creation, execution, and management of contracts, thereby minimizing errors and oversights in the contracting process. Here are some key features and their benefits:
Standardize templates
Contract templates offer a structured approach to the contract generation process by providing predefined clauses, terms, and conditions. This empowers team members beyond the contracting staff to generate consistent and accurate contracts, minimizing the risk of language errors and omissions of crucial terms when drafting from scratch. If you’re worried about creating your template, use Docupilot—it allows you to import existing contract templates or choose from the library of premade ones.
Automated reminders and notifications
Let's face it, with the multitude of tasks a business must handle, monitoring contracts for deviations can easily slip through the cracks. Unsurprisingly, the EY 2021 report noted that 71% of contracts are not monitored for deviations.
An automation system can address this by sending notifications whenever changes are made to your contracts. It can also alert you to upcoming renewals, milestones, or obligations, minimizing the risk of missed deadlines or overlooked contractual responsibilities.
Accessibility and searchability
If you can't locate your contract, as many as 90% of businesses admitted in the EY report, what will you reference in case of a dispute? Contract automation tools allow you to store, organize, and retrieve contacts easily at any time. When contracts are readily accessible, managing disputes, updates, renewals, and compliance with terms becomes simpler.
Real-time collaboration and version control
With contract automation software, parties involved in a contract can collaborate in real-time during the contract creation process, reducing negotiation time and increasing the chances of acceptance. It also allows you to build a signature workflow that automatically routes contracts for signing, aiding faster agreement.
Version control features track contract changes and updates, enabling users to revert to previous versions if needed. This prevents confusion from conflicting document versions and ensures everyone works on the latest iteration.
Ensuring Legally Binding Contracts With Docupilot
Whether written or oral, contracts must include elements of validity to be legally binding, protecting the interests of all parties involved. Recognizing common contract mistakes, such as ambiguous terms, poor documentation, and overlooking termination and remedies, enables businesses and individuals to take proactive measures to prevent them.
For those who frequently create contracts, implementing contract automation software like Docupilot is essential to mitigate contracting mistakes. Docupilot supports the creation of standardized templates, organizes and makes contracts searchable, facilitates real-time collaboration, provides version control, and more, ensuring a legally binding and viable contract throughout its lifecycle.
Sign up to create your first automated contract for free, no credit card is required.
