What makes an agreement legally binding?

The legal position

Offer. An offer is a definite statement of willingness to be bound on specified terms, made with the intention that it will become binding as soon as it is accepted. It must be distinguished from a statement of the lowest price at which a person might be prepared to sell, which is a mere supply of information, not an offer.

Acceptance. Acceptance must be unqualified and must correspond with the terms of the offer. A purported acceptance that introduces new or different terms is a counter-offer. It operates as a rejection of the original offer, which cannot thereafter be accepted. Acceptance must ordinarily be communicated to the offeror. Silence does not amount to acceptance, and an offeror cannot impose a contract by stipulating that silence will be treated as assent.

Consideration. Each party must give or promise something of value in exchange for the promise of the other: a price, a service, or a promise to act or to refrain from acting. Consideration must have some value in the eyes of the law, but it need not be a fair price; the courts do not inquire into whether the bargain was a good one. A gratuitous promise, that is, a promise for which nothing is given in return, is not enforceable as a contract unless it is made by deed.

Intention to create legal relations. In commercial dealings, the law presumes that the parties intended to be legally bound. In domestic and social arrangements, it presumes the contrary. Either presumption may be rebutted by evidence.

Certainty. The terms must be sufficiently certain for a court to determine what was agreed. Where an essential term, such as the price or the subject matter, has been left for future agreement, there may be no concluded contract at all.

The objective test. The question in each case is not what a party privately intended, but what a reasonable person would conclude from that party's words and conduct.

Practical implications

A great many everyday transactions are contracts, although nothing is written down. The purchase of goods over a counter, the provision of transport or other services, and supply arrangements concluded by telephone are all examples, and none of them requires a formal document. A contract for the sale of goods of the value of one hundred dollars or upwards may be enforced by action if the buyer has accepted and actually received part of the goods, has given something in earnest to bind the contract, or has made a part payment. Writing is necessary only where none of those conditions has been satisfied. In that event, the contract is enforceable only if there is a note or memorandum of it in writing, signed by the party against whom it is to be enforced (Sale of Goods Act, s 6).

In practice, contractual disputes seldom turn on whether a contract exists. More frequently, the contest is over what its terms were and how those terms are to be proved.

Arrangements expressed in vague terms, or which leave essential matters to be settled later, are liable to fail for uncertainty.

A contract containing all five elements may nonetheless be set aside where it was induced by misrepresentation, duress (illegitimate pressure) or undue influence, and certain kinds of mistake may prevent a contract arising at all. Many contracts entered into by persons under the age of eighteen cannot be enforced against them, and a court will not enforce an agreement to do something illegal.

Recommended steps

Before relying on an agreement, the parties should confirm that its essential terms have in fact been settled: the price, the subject matter and the time for performance.

The terms should be recorded in writing at the time of agreement. A written confirmation sent on the same day, setting out the terms agreed, is valuable evidence if a dispute later arises.

Certain contracts must be in writing, or evidenced in writing, before a court will enforce them. These include contracts for the sale or other disposition of land, and guarantees. A sale of goods of the value of $100 or upwards requires signed writing only where none of the statutory alternatives described above has been satisfied. See Must a contract be in writing, signed or witnessed?

Where there is doubt as to whether a binding contract exists, legal advice should be obtained before acting upon the agreement or withdrawing from it. A refusal to perform a binding contract is a breach, for which the other party may recover damages.