If you are in business, it is important that you are aware of the basic elements of a contract to ensure that you do not find yourself in the unfavourable position where you cannot properly enforce what you understood to be the binding promise of another.
In Australia, there are six basic elements that must be satisfied for the formation of a contract. In the absence of one or more of these elements, a court may find that a contract is not binding on the parties.
Six basic elements of a contract
The first element of a contract is agreement between parties. Usually the question of whether an agreement exists will be determined by considering whether what is commonly referred to as “offer and acceptance” has occurred.
For offer and acceptance to have occurred, there must be an offer communicated by one party (the offeror) to another setting out the terms on which the offeror agrees to be bound.
That offer must then be accepted (and that acceptance must be communicated to the offeror) by the other party prior to any withdrawal of the offer by the offeror.
Examples that do not constitute offer and acceptance:
- “An invitation to treat”: This is basically a request from others to make offers or an expression by one party that they are willing to negotiate over a particular matter. Most advertising constitutes an invitation to treat and it is only at the point of sale that offer and acceptance occurs.
- Counter offers: If one person makes an offer and another person makes a different offer back, this will constitute a counter offer and will make the first offer incapable of acceptance by the party proposing the counter offer. For instance, if you make an offer to purchase a house for $750,000 and the vendor sends back a contract with an amended purchase price of $800,000, if you reject the counter offer of $800,000, that Vendor cannot go back and accept the initial offer of $750,000. The counter offer of $800,000 effectively cancels your offer of $750,000. If the vendor wanted to sell for $750,000, they would need to make a new offer to you for that amount.
The next element of a contract is that there must be consideration for a person’s promise. What this means is that there must be an exchange of something of value (not necessarily money) between the parties. The courts generally will not enforce a promise by one person to another unless something of value has flowed between the parties at the time of the agreement. The values need not be equal but there must be something given by each party. Some examples of consideration include:
- Money (which can be a nominal sum of $1.00);
- A promise to do something (eg A agrees to paint B’s house for $5,000. A’s promise is to do something which is paint B’s house. B’s promise is to make payment); or
- A promise to refrain from doing something (eg A and B are neighbours and in dispute over a fence line. B claims it is built on their property. They agree A will pay B $5,000 and B will not litigate. B’s promise is to not do something which is not litigate. A’s promise is to make payment).
The other important point with this element is that past consideration will generally not suffice. Prior to a contract being formed, if consideration has already been provided by one person in the past, that consideration may be insufficient to “buy” the promise of another person.
The parties to the contract must have the legal capacity to enter into a binding contractual relationship. This can mean that people such as minors, people with mental impairment or people with diminished capacity may not be in a position to enter into a legally binding contract.
4. INTENTION TO BE LEGALLY BOUND
The fourth element is that both parties to a contract must intend that their agreement is the type of agreement which will create a legally binding contractual relationship. For instance, it is usually presumed that parties to commercial arrangements intend for legal consequences to arise, while parties to social or domestic agreements are presumed not to want to create a legally binding contract.
This is not to say that this will always be the case, it just creates a presumption which the party asserting the opposite must disprove. That is, the onus of proof would be on a party to a commercial agreement to prove that the parties did not intend for an arrangement to be legally binding while a party to a domestic arrangement would need to prove that the parties intended to enter into a binding contract.
Other issues which can mean that there is no intention to be bound can be if a contract is made “subject to agreement”. In that case, the court will need to determine whether the parties intended:
- to be immediately bound and subsequently formalise all of the exact terms;
- to be immediately bound to the promise but that neither party need perform their promise until the exact details are formalised; or
- that the parties did not intend to be bound until the final agreement is prepared and signed.
A court will usually presume that (c) applies unless there is evidence to the contrary.
The contract must meet any standards set out in statute for it to be legally binding.
The most common issue is that contracts for a transfer of an interest in land need to be in writing. An oral contract for sale of land in Australia will not be enforceable. Variations of a contract for sale of land should also be in writing.
A contract must be sufficiently certain and sufficiently complete to properly identify the rights and obligations of both parties. All of the relevant matters necessary to give practical effect to the agreement need to be completed and there should be sufficiently certain timeframes for performance of each key obligation.
Reasons that a court may find a contract void for uncertainty include indefinite timeframes; missing a key issue (such as who must pay a particular large cost); and vague conditions that allow one party to avoid their promise; or inclusion of an “agreement to agree” where the parties do not resolve an issue at the time of contract but include a clause saying they will agree closer to completion and then fall out over the terms of that condition.
This list sets out the basic elements of a contract and should serve as a good checklist for anyone entering or considering entering into a contract and to make sure their contract includes, at the very least, these six elements.
That being said, there is a huge amount of law on each of these issues and there is no substitute for proper legal advice, especially if you think you may have an issue with one or more of these elements.
If you would like to discuss contracts or require other legal support for your mining and resources business, please contact me, Ian Hillhouse, on 61 (0)7 3007 2000 or firstname.lastname@example.org
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