Contracts are the lifeblood of commerce, brining order and stability to the marketplace. Without contracts, there would be no credit – no sale of goods and services – and no commerce.
Contracts affect every business, big and small. Because of their importance, every business owner should have a fundamental understanding of contract law.
This article, and two following over the next two months, will provide a basic review of that law. Each column with address a different part of the contract process: (1) Forming a contract, (2) construction and enforceability of contract terms, and (3) performance by the parties.
Creating a contract
Most people think a contract is created when people read and sign a formal written agreement. That concept, though true, is outdated. In our modern world of communication, contracts can be created in many different formats – and without any signatures. Contracts can arise from verbal exchanges on a cell phone, from documents exchanged by fax, or by emails. They can also be created through gestures, like a nod of the head or the raise of a hand.
Through contracts come in various formats, all have the same essential components: offer, acceptance and valid consideration. Each element plays an integral role in forming every contract.
An offer is basically a solicitation to buy or sell. For example, when people solicit you to buy their products or service, they make an offer. In doing so, they have the right to define the terms and conditions of the proposed sale. They can demand you accept the offer by a certain date. If the offer has no date, you have the right to accept within a reasonable period.
However, the seller still has the authority to withdraw the offer at any time, even when it provides for a final acceptance date. To effectively revoke an offer, the seller must give you notice of the revocation before you accept. If you’ve already accepted, it’s too late.
Unless otherwise instructed in the offer, you can accept an offer through any form of communication. Once you accept, a contract is created, and the offering party must honor the proposed transaction.
To effectively accept an offer, you must ensure that:
- The offering party actually receives your acceptance.
- Your acceptance is the “mirror image” of the offer. If your acceptance contains terms or conditions not reflected in the offer, it will be treated as counteroffer. In that case, a contract will not arise until the other party accepts your proposed terms and conditions.
- The offering party receives your acceptance before and final acceptance date, if given. Mailing your acceptance by that date may not be effective unless the offer permits it. But once you mail that notice, you can’t withdraw your acceptance. You’re on the hook.
Valid consideration is the value received by the contracting parties under a transaction. Without it, there is no contract, but the value doesn’t have to be much. It can be a nominal amount, something received by a third party or even forbearance of detriment.
For example, there is valid consideration when you agree to pay $5 for a $1000 asset, buy a car for your spouse from a dealer or pay a friend to quit smoking.
But there is no valid consideration when you agree to pay for a nonexistent thing or promise to give someone a gift or reward for past performance. In these instances, you haven’t received any legal value for your promise.
No turning back
Once a contract is created, the terms will be enforced no matter how onerous or preposterous they may be. A judge will presume the contracting parties knew what they were doing, and will enforce the contract in accordance with its terms.
Judges can’t save people from their own stupidity. So before you accept an offer, make sure you understand the terms and conditions.
Printed in Four Rivers Business Journal (Paducah Sun), August 2009.