What are the Four Elements of Forming a Commercial Contract?

You will frequently enter into commercial contracts with your customers and other businesses as a business owner. A contract is essential for conducting business, as it formalises your business relationships. Knowing when you have a valid contract is essential for understanding your legal relations with other parties. This can be useful if you ever end up in a dispute. We will outline the four key elements of contract formation in commercial contracts you should keep in mind. 

What are the Elements of a Contract?

To create a binding contract, there are four essential elements. These must all be present for a legally binding agreement to exist. Without the elements, you will not have created a valid contract. Therefore, the contract may not be enforceable and you may not be able to take the other party to court for breach of contract. For this reason, knowing the contractual elements is highly important. 

The four key elements are:

• offer;
• acceptance;
• consideration; and
• intention to create legal relations.

Importantly, while most business contracts are written, parties can also form an oral or implied contract that holds the same legal validity.

What is an Offer?

An offer is a proposal of the agreement and its terms. You must clearly think through the offer, ensuring it is specific, complete, and capable of acceptance. The party making the offer must also intend to create a legally binding agreement when the offer is accepted. More importantly, an offer differs from an advertisement or ‘invitation to treat,’ which some people may also refer to as an ‘invitation to negotiate.’

For example, when a grocery store places apples on its shelf, it invites customers to make an offer. This kind of invitation is known as an invitation to treat, or in other words, an advertisement. The customer makes the offer by taking the apple to the cashier and proposing to buy it. Another example of an offer is if you are looking to enter into a contract with a marketing agency. They may make an offer when providing you with a quote to provide marketing services. 

If a person makes an offer but then decides to revoke it, they must clearly tell the other party about the withdrawal. The offer remains valid until the person withdrawing it informs the other party.

What is Acceptance?

Acceptance is the agreement to the proposed terms of the contract, as made through an offer by the other party. You form a legally binding agreement when your acceptance is communicated to the person who makes the offer. 

Acceptance can be communicated in various ways, such as in person, over the phone or in writing. This can be important because the exact time and date you form your contract can significantly affect a dispute. In e-commerce, acceptance often occurs when a customer clicks ‘Place Order’ or a similar button, agreeing to the terms of sale. This could also include having other ways for users to indicate acceptance, such as a checkbox or an ‘I accept’ button.

Importantly, if your response does not agree to the exact terms proposed by the other party, it will not amount to an acceptance. Instead, it will constitute a counter-offer. The other party must then accept your counteroffer for the contract to be formed. 

What is Consideration?

Consideration requires that both parties give each other something of value as part of the contract. Consideration can take various forms, including money, services or shares. For example, suppose you buy an apple from a grocery store. The consideration from the grocery store is the apple, and from you, it is your money.

Usually, a contract will only be valid with consideration. Consideration must be given in exchange for a promise in the present or future. Generally, if consideration is made before the contract is valid, it will not be valid. Contracts made in a deed are a notable exception to this, as a deed does not require consideration. This is because a deed is usually a more formal document with more formal signature requirements, which typically indicates an intention to be bound by its terms.

Consideration is significant as it shows both parties have made a commitment and they must follow through with their obligations. In commercial contracts, courts will look to see whether valid consideration has changed hands. It is important to note that consideration does not need to be adequate, meaning that the exchanged promises do not need to be of equal value. It is also important to note that a past promise is not valid consideration for the formation of a new contract.

What are Intentions to Create Legal Relations?

The intention to create legal relations is the final element of contract formation. This is the requirement that both parties intend to create a legally binding relationship by entering into the contract. When assessing this, the court will look at the context in which the contract was made. 

For example, if you agreed on a napkin in a pub as a joke, a court will be less likely to find that you intended to create legal relations. Conversely, in a business context, there is usually a presumption that parties intend to create legal relations. For example, if two companies sign a detailed service agreement, it is assumed they intend it to be legally binding unless explicitly stated otherwise.

Other Elements

Some further conditions are necessary beyond the four key elements. For example, the:

• parties must have the mental capacity to make a legally binding agreement; and
• contract terms must be clear and unambiguous.

Ensuring the parties have legal capacity before signing a new contract is essential. Contracts can be intimidating. As such, it is important that whoever signs on behalf of your company can demonstrate that they are capable of understanding the obligations, terms and consequences of the contract before agreeing. 

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The terms of the contract must be clear and certain. They should include the crucial terms of the agreement. This might include aspects such as the services the business provides, the price, the delivery date and any other essential terms the parties need to agree on to carry out the contract.

Additionally, having clearly written terms is important from a practical perspective. This allows the parties to refer back to the agreement and clearly understand what they agreed on. Having clear terms tends to reduce the amount of disputes. Each party can clearly see what they have agreed to. Contracts also typically explain how the parties should handle certain situations.

Key Takeaways

If you are entering into commercial contracts, you may wish to rely on your legal rights as part of the contract at some point. To be able to do this, you need to have a valid and legally binding agreement. This requires the four elements of contract formation. There are four essential elements of forming a contract: offer, acceptance, consideration, and intention to create legal relations. Beyond this, the terms of the contract must also be unambiguous, and the parties must have the mental capacity to agree.

If you have any questions regarding contract formation, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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