Contracts form a key part of the commercial world. Buyers and sellers bind themselves to transactions through Sale and Purchase Agreements (SPAs). Employees and employers set out their respective duties and responsibilities in employment contracts. Lenders and borrowers set out their rights and obligations in loan agreements. Arrangements discussed later in this handbook such as licensing, franchising and outsourcing are governed by contracts. Without contracts (and the law governing the enforcement of contracts), the commercial world would have to function solely on trust, which would likely discourage people from transacting with one another.
- Sale And Purchase Agreement (SPA): a legal contract that describes the outcome of key commercial and pricing negotiations and when signed, obligates a buyer to buy and a seller to sell a product or service. Examples include agreements to buy products and agreements to buy companies.
- Share Purchase Agreement: contractual agreement to buy shares in a company.
How Is A Contract Formed?
Contracts can be formed in a number of different ways. Contractual terms are typically set out in a document and signed by the relevant parties. However, contracts can also be created by any number of other means (e.g. through oral agreement and electronic communication) so long as the basic elements required to create a contract exist. The key elements are:
- One party must make a clear offer to the other party. The terms of the offer must be certain and the offer should indicate that the offeror (the person making the offer) is genuinely prepared to proceed with the transaction if their offer is accepted.
- You probably make ‘offers’ on a daily basis, although you may not realise that this is what you have been doing. For instance, when you go into a shop and approach the cashier with a product that you wish to buy, this constitutes an ‘offer’ to buy that product (assuming that you do not try to negotiate the price).
- The offer must be unconditionally accepted by the offeree (the party that received the offer) and acceptance must correspond completely with the terms of that offer. ‘Acceptance’ has not occurred for these purposes if the offeree specifies qualifications/conditions to their acceptance or introduces different terms (e.g. a different price, delivery date or quantity). Instead, this would likely constitute a ‘counter-offer’, which the law dictates will void the original offer.
- Acceptance must be communicated (by words or conduct) and must take place before the offer in question is withdrawn by the offeror or lapses. An offer will lapse if (a) the offeror specifies a time limit during which acceptance must take place and this time limit expires; or (b) if no time limit is specified by the offeror, after a ‘reasonable’ period of time.
- There are complex rules governing the precise time at which acceptance is deemed to have taken place (timing can depend on the method by which acceptance is communicated, for instance by post or fax), but further discussion of this is outside the scope of this handbook.
- The ‘consideration’ requirement in this context means that something of value must flow from each party to the other. If I promise to give my laptop to a friend for free, that friend has not given any consideration for my promise. My friend therefore cannot sue me for breach of contract if I do not then give him/her the laptop. However, if I promise to give my laptop to a friend in exchange for that friend promising to (for instance) give me money, give me their car or paint my house, then this would satisfy the ‘consideration’ requirement. It does not matter if the goods/services to be exchanged are of different value.
Intention to create a legal relationship
The parties to a contract must be shown to have had the requisite intention to be legally bound to perform their obligation(s) under the contract. In commercial agreements (e.g. agreements between two businesses or agreements between businesses and customers), the presumption is that where (a) an offer is made; (b) acceptance has occurred; and (c) consideration exists, the parties intend to be legally bound.
- In contrast, in social arrangements (e.g. where a husband promises to clean the kitchen in exchange for his wife doing the shopping), the presumption is that neither party intends to create a legally binding agreement and thus no intention to create legal relations exists.
To place this in context, let’s use the example of buying a chocolate bar in a supermarket. There is no signed document setting out a contract, however a contract is formed once the purchase is complete.
- Offer: a valid offer is made if you offer to buy a chocolate bar in a supermarket at the price advertised.
- Acceptance: acceptance has occurred once the cashier scans the product and accepts your money.
- Consideration: the ‘consideration’ requirement is satisfied as you are paying (or promising to pay) money, whilst the supermarket is promising to transfer the chocolate bar to you.
- Intention: the presumption is that you and the supermarket intended to enter into a legally binding contract, as the transaction is taking place in a commercial context (although you may not be thinking this explicitly at the time!).
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By Jake Schogger - City Career Series