Contract law: the essentials - Business Environment

All businesses enter into contracts, whether with suppliers or employees or financiers or customers, and these contracts will be important and possibly crucial to the firm’s operations. Such contracts are essentially agreements (oral or written) between two or more persons which are legally enforceable, provided they comprise a number of essential elements. These elements are: offer, acceptance, consideration, intention to create legal relations and capacity.

Offer
An offer is a declaration by the offer or that they intend to be legally bound by the terms stated in the offer if it is accepted by the offer (e.g. to supply component parts at a particular price within a specified time period). This declaration may be made orally or in writing or by conduct between the parties and must be clear and unambiguous. Further more it should not be confused with an ‘invitation to treat’, which is essentially an invitation to make an offer, as is generally the case with advertisements, auctions and goods on display. Tenders are offers; a request for tenders is merely an invitation for offers to be made.

Termination of an offer can happen in several ways. Clearly an offer is ended when it is accepted but, that apart, an offer may be revoked at any time up to acceptance. It is of no consequence, legally, that an offer may be kept open for a certain time. It is only when some consideration is paid for ‘buying the option’ that the time factor is important and this ‘buying the option’ would generally be a separate contract in any case. If an offer is for a certain length of time, then later acceptance is ineffective, and even where there is no specified time limit, the courts will imply a reasonable time. Thus, in Rams gate Victoria Hotel v Montefiore (1866), shares in the hotel were offered for sale. After several months the offer was ‘accepted’ but the court held that too much time had passed, bearing in mind that the purpose of the shares offer was to raise money.

Another way for an offer to come to an end is by the failure of a condition. Although a genuine offer is always held to be firm and certain, sometimes it may be conditional and not absolute. Thus, should A wish to buy a model car from B, B may agree but impose conditions on the deal, such as stating that A must collect at a specific time on a certain day at a particular place and must pay in cash. This is known as a ‘condition precedent’ and failure to complete the conditions will nullify the agreement. There is another type of condition, called a ‘condition subsequent’ where there is a perfectly good contract which runs until something happens. For instance, a garage may have a good contract with an oil company to buy petrol at £x per 1000 litres until the price of oil at Rotterdam reaches $x per barrel. It is only when oil reaches the stipulated price that the contract ends.

Acceptance
Just as an offer must be firm and certain, the acceptance of an offer by the person(s) to whom it was made must be unequivocal and must not contain any alterations or additions. Accordingly, any attempt to alter the terms of an offer is regarded as a counter-offer and thus a rejection of the original offer, leaving the original offer or free to accept or decline as he or she chooses.

While acceptance of an offer normally occurs either in writing or verbally, it may also be implied by conduct. In the case of Brogden v Metropolitan Railways Co. (1877) MrBrogden had supplied the company for many years without formalities. It was then decided to regularize the position and a draft agreement was sent to him. He inserted a new term, marked the draft ‘approved’ and returned it to the company where it was placed in a drawer and forgotten about, although both parties traded with each other on the terms of the draft for more than two years. Following a dispute, MrBrogden claimed there was no contract. The House of Lords decided differently, saying that a contract had been created by conduct.

Inferring the acceptance of an offer by conduct is quite different from assuming that silence on the part of the offeree constitutes acceptance: silence cannot be construed as an acceptance. Equally, while the offer or may prescribe the method of acceptance (although this is regarded as permissive rather than directory), the offeree may not prescribe a method by which he or she will make acceptance. For instance, an offer may be made by fax, thus implying that a fast response is required; therefore a reply accepting the offer which is sent by second-class mail may well be treated as nugatory.

There are some rules about acceptance which are important. Postal acceptance, for example, is a good method of communication and one which is universally used by businesses; but to be valid for contractual purposes a communication must be properly addressed and stamped and then placed into the hands of the duly authorized person (i.e. the post box or over the counter). An acceptance sent to a home address may be nullified if there has been no indication that this is acceptable. Similarly, acceptance of the offer must be effectively received by the offer or where modern, instantaneous methods of communication are used. Thus if a telephone call is muffled by extraneous sound, then the acceptance must be repeated so that the offer or hears it clearly.

Consideration

Together, offer and acceptance constitute the basis of an ‘agreement’ or meeting of minds, provided the parties are clear as to what they are agreeing about (i.e. a consensusad idem exists). Central to this agreement will be a ‘consideration’ which has been defined as some right, interest, profit or benefit accruing to one party or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other. In commercial contracts, the consideration normally takes the form of a cash payment in return for the goods or services provided (i.e. the ‘price’ in a contract of sale). In contracts involving barter, however, which are sometimes used in international trade, goods are often exchanged for goods or for some other form of non-pecuniary consideration (e.g. information or advice).

Intention to create legal relations
Not every agreement is intended to create a legally binding relationship. For example, most domestic agreements such as the division of household chores would not constitute a contract recognized in law. In commercial agreements, however, it is generally accepted that both parties intend to make a legally binding contract and therefore it is unnecessary to include terms to this effect. Should such a presumption be challenged, the burden of proof rests with the person who disputes the presumption.

Capacity
A contract may be valid, voidable or void and one of the factors which determines this is the contractual capacity of the respective parties to the agreement. Normally speaking, an adult may make a contract with another adult which, if entered into freely and without any defects, and which is not contrary to public policy, is binding upon them both (i.e. valid). However, the law provides protection for certain categories of persons deemed not to have full contractual capacity (e.g. minors, drunks and the mentally disordered); hence the practice by firms of excluding people under the age of 18 from offers of goods to be supplied on credit.

Concentrating on minors those below voting age the law prescribes that they can only be bound by contracts for ‘necessaries’ (e.g. food, clothing, lodging) and contracts of employment that are advantageous or beneficial, as in the case of a job which contains an element of training or education. In most other instances, contracts with minors are void or voidable and as such will be either unenforceable or capable of being repudiated by the minor.

In the case of business, legal capacity depends on the firm’s legal status. Unincorporated bodies (e.g. sole traders, partnerships) do not have a distinct legal personality and hence the party to the agreement is liable for their part of the bargain. Limited companies, by contrast, have a separate legal identity from their members and hence contractual capacity rests with the company, within the limits laid down in the objects clause of its Memorandum of Association.

Other factors
To be enforceable at law a contract must be legal (i.e. not forbidden by law or contrary to public policy). Similarly, the agreement must have been reached voluntarily and result in a genuine meeting of minds. Consequently, contracts involving mistakes of fact, misrepresentation of the facts, or undue influence or duress may be void or voidable, depending on the circumstances. In insurance contracts, for instance, the insured is required to disclose all material facts to the insurer (e.g. health record, driving record), otherwise a policy may be invalidated. In this context a ‘material fact’ is one which would affect the mind of a prudent insurer, even though the materiality may not be appreciated by the insured.


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