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We’ve mentioned before that contracts are the engine that makes businesses run. So it stands to reason that if a contract is just like an engine, then a contract must be composed of various parts and components that allow it to do its job. This begs the question: If the elements of an engine are a block, pistons, a crankshaft, a camshaft, and a cylinder head, then what are the elements of a contract?
There are seven key elements to each contract. But before we delve into each of them, first let’s refresh the definition of a contract.
Contract definition
At the heart of most professional or business relationships is a contract. A contract can be defined as an agreement between parties that creates a set of specific obligations that must be fulfilled by the parties involved in accordance with the law. To put it another way, it’s the official document that cements all the obligations, rights, and duties of the parties involved.
Contracts constantly vary in length, terms, and complexity. But for an agreement to be legally valid and enforceable, several elements must be fulfilled: Legality, Capacity, Offer, Consideration, Intention, Certainty, and Acceptance. When all elements are met, simple informal agreements become legally binding contracts. And if one element isn’t completed, it’s possible that the contract becomes unenforceable.
Legality
What laws apply?
Chances are this is the starting point for most contracts. Legality establishes the set of laws and regulations that apply to a contract, which varies by state and country. Since states and countries have different laws and methods to mediate disputes, this affects how contracts are executed and written.
As an example, some countries permit e-signatures while others don’t. If the contract’s legality is a country that allows digital signatures, then both parties can sign digitally. But if the legality requires handwritten signatures on a physical paper document, then the contract must be signed by hand on a physical paper document.
Capacity
Can all parties legally enter an agreement?
Capacity is a person’s ability to satisfy the elements required to enter into a binding contract. Common capacity rules relate to age, soundness of mind, consciousness, language, mental disabilities, duress, undue influence, and intoxication (or being under the influence of some substance). These rules may differ by country, state, or even city.
This is why establishing a contract’s legality is paramount. For instance, the age of majority (the age when a minor legally becomes an adult capable of entering any contract) is 18 years old in most U.S. states. However, some states like Nebraska (19) and Mississippi (21) have different ages of majority, and, as a result, they have different rules and responsibilities that might preclude them from certain contracts.
In the case of contracts being signed by individuals on behalf of companies, it’s essential that the persons who are signing have the correct authority to sign. For example, a junior data analyst at Twitter doesn’t have the authority to sign the contract selling Twitter to Elon Musk.
While this element is often considered a formality, it is just as important as all other elements. Individuals who lack the appropriate capacity are presumed to not know what they’re doing, and thus can’t establish a contract. In other words, if capacity is not set, a contract can’t be created. Not to mention, after a contract is signed, if it’s later proven that one of the signatories lacked the necessary capacity, the contract can be declared null and void.
Offer
What’s the proposal?
A contract starts because somebody wants something, and there’s someone who can deliver that something. At both ends of the offer, there are duties and responsibilities to be fulfilled. There must also be an exchange of value, such as money, assets, or some desired action.
Ultimately, contracts need to explicitly state the offer in sufficient detail. This is because the contract indicates what’s being exchanged and how.
If you’re drafting a contract offer, try to answer these questions:
- What’s being exchanged?
- How will it be exchanged?
- When will it be exchanged?
- What is the cost?
- Who is responsible?
- What happens if someone doesn’t fulfill their obligations?
Make sure your proposal addresses each of these factors. If it doesn’t, one of two things may happen: 1) if the contract’s legal jurisdiction contains a law pertaining to the situation, then the jurisdiction’s law takes effect; 2) nothing can be legally enforced. To simply say that some action was intended but was accidentally omitted is not a defensible position in court.
Example: Employment contracts often stipulate a notice period in the event the employee decides to leave the company. A two-week notice is considered fairly standard by most in the U.S. and other countries. However, if the contract doesn’t explicitly state this notice period, and the state doesn’t have a law addressing notice periods, then there is nothing legally stopping you from leaving the day you notify your employer.
Consideration
How does each party benefit?
It goes without saying that there can be no contract if there’s nothing in it for each party. Legal consideration allows all who read the contract to see the benefits each party receives. Benefits can be money, valuable items, services, assets, or even protection.
Although we often associate contracts with financial value, there needn’t be a financial element for consideration to be met. Take, for example, two tutors: If one teaches the other math and, in return, is tutored in history, this is perfectly valid to meet consideration.
If no consideration exists, the contract becomes “voluntary”, and parties have limited to no right to legal action if an obligation isn’t performed.
Intention
Are the parties interested in working together?
Also known as mutuality, intention simply means that all parties wish to do business together. For a contract to be legally binding, all parties named must provide consent.
The easiest way to prove intention is by having the contract in writing. This ensures that a record is kept of the terms that were agreed upon.
Certainty
Is the contract clear and understandable?
Contracts should explicitly state the essential (and optional) terms and conditions, as well as the key parties involved. These commitments form the backbone of the agreement, and the clearer they are, the less likely an incidental breach of contract can occur. And by naming parties, this simply means contracts can only be enforced by or against the parties named.
To improve certainty, commitments can include the descriptions of the goods or services being provided by each party to the other. Certainty is further improved when additional identifying details, such as an individual’s date of birth, tax identification number, or passport number, are included in the contract.
Acceptance
Do all parties agree?
Commonly, acceptance is shown by all parties adding their signatures to the document. But in situations when a contract is verbal, acceptance can be shown by one or more of the signees fulfilling their contractual obligations.
There are several types of acceptance. Here are a few examples:
- Conditional acceptance
- Acceptance by action
- Option agreement
In any case, it’s critical that the contract’s terms and conditions are clearly accepted by the parties involved. Otherwise, if one party proves that assent was not mutual, the contract can become unenforceable.
Conclusion
Contracts are an essential element of businesses, so making sure they are compliant and in order is critical to the organization’s success. Keeping all seven of these elements in mind while reviewing a contract will go a long way towards ensuring all legal requirements are met, so that all contracts are binding and actionable.
Like we mentioned in the beginning, if one of these elements is missing, there’s a strong likelihood that the contract will fail, costing your organization considerable sums of wasted money and time. To avoid such problems, it helps to use a contract management platform that can alert you to any major issues. Book a demo to find out how AXDRAFT can support you.
Interesting Related Posts
- Binding vs. Non-Binding Contracts: What’s the Difference?
- Addendum vs. Amendment: What’s the Difference?
- What is Contract Compliance?
- What is a Breach of Contract?
- Types of Contracts: Learn About the 13 Main Options