In business law, the formation of a contract refers to several conditions which must be met before a contract will be enforced by a court of law. These include that all parties are capable of entering into a contract, they do so in a legal way and for a lawful purpose, they do so intentionally and they consent to the terms of the agreement. It is extremely important for businesses to understand legal issues surrounding the formation of a contract because these will determine a firm’s legal responsibilities as well as the options which it may have when a contract has been breached.
A contract is any form of agreement which has several basic elements, including an offer to provide a good or service, acceptance of this offer, compensation for whatever is being provided (technically known as “consideration”) and an intention that the exchanged promises will be legally binding. In common law systems like the United States and the United Kingdom, courts will only find contracts to be legally valid and issue orders enforcing their terms if several specific factors, known as the formation of a contract, can be established. In theory, the same requirements and obligations apply to contracts which are signed in writing or merely negotiated orally, but courts typically give greater weight to agreements when they are in writing.
As a result, when contract disputes go to court, one or both parties may attempt to escape their contractual obligations by arguing that no valid contract actually existed in the first place. The specific tests which a court will use to determine whether a contract was properly formed differ based on the legislation and case law present in different jurisdictions. As a result, companies should seek qualified legal advice regarding the specific obligations and legal options which may exist in the places where they do business.
The first step in evaluating a contract is to determine whether all of the involved parties had what is known as the “capacity to contract.” In the United States, legal contracts cannot be entered into by minors (except in certain circumstances), the mentally ill or the obviously intoxicated. In addition, businesses are bound only by contracts which are entered into by corporate officers who have the proper authority to do so. Ensuring that a corporate officer has the authority to enter into a contract may be an important consideration when dealing with business law issues.
Second, Washington, DC, attorney Kamal Nawash explains, the contract must contain the necessary elements in an offer by one party, acceptance of this offer by the second party, and acceptance of promised consideration from the second party to the first. The consideration need not be in the form of money. However, says Nawash, it does have to be a “legally adequate benefit” of some kind.
Third, the exchanges which are being promised in the contract must be lawful. A court will not attempt to uphold an agreement which involves promises relating to the provision of goods or services which are illegal, like a sale of illegal drugs or a promise to commit a crime against a third party.
Fourth, even if the exchange itself is lawful, the form of the agreement itself must take the form prescribed by law. In addition to general requirements for how contracts are prepared, his aspect of contract formation will differ depending upon what restrictions (if any) a particular jurisdiction places on contracts pertaining to particular goods and services. For instance, many governments have passed legislation mandating how a contract must be drawn up, and what minimum terms it must contain, with respect to landlord-tenant leases, home mortgages and credit cards. In New York City, for instance, a residential lease must be written in readable print and everyday language, and there are certain obligations which landlords may not require of tenants.
Fifth, all of the parties to a contract must intend that by reaching these terms they are entering into a legally binding relationship with the other parties. This is usually presumed.
Sixth, the parties to a contract must give voluntary consent to all of the above terms. When the contract is drawn up in writing, this typically takes the form of signatures at the end of the agreement. A corporation consents to a contract when an authorized officer of that corporation signs the agreement on its behalf.
It is important for businesses to understand issues surrounding the formation of a contract because they may need to demonstrate that all of these factors were present in order to get a court to enforce a contract with another party who is trying to breach the contract – or they may need to defend their own actions in court who is arguing that the business has breached a contract. Common defences in legal disputes surrounding a contract are typically objections that the contract was not properly formed because it was signed by mistake, under duress, by someone who lacked the legal capacity to enter into a contract, due to fraudulent misrepresentations made by the part of the other party or because the terms are so unconscionable that no reasonable person would have agreed to them knowingly and voluntarily.