13
Nov

How is a legally binding contract formed?

Is somebody claiming that you have breached the contract or do you want to enforce an agreement?

Either way, the first step is ascertaining whether you actually entered into a binding and enforceable contract.

A contract is legally enforceable if, and only if:

  • agreement is reached between the parties;
  • consideration has been given by at least one of the parties;
  • the parties have legal capacity and intend for the contract to be legally binding; and
  • formalities are complied with.

Agreement

An agreement is reached when:

  • a party makes an offer (a promise to perform an act if the other party promises to do something in return); and
  • another party accepts the offer.

Offer

An invitation to deal, for example, a request for a tender for a building project, is not an offer. Rather, the tender itself will be treated as an offer.

An offer will expire if a counter-offer is made; the offer is revoked, not accepted on time or rejected; or alternatively, a condition precedent is not met.

If the terms are incomplete or refer to future matters that are to be agreed (which are referred to as agreements to agree) an agreement may not be legally binding.

Acceptance

Acceptance of an offer can be by words or conduct. If a party does not read or understand all of the offered terms, but nonetheless accepts the offer, the agreement will be binding regardless of the actual intention of the parties.

Consideration

Consideration is usually the payment of money, but can be anything from a right, interest, profit or benefit accruing to the offeror, which is transferred in exchange for the performance (or non-performance) of an act. The value of the consideration does not need to be fair or adequate compensation for the promise for the agreement to be binding.

There will be no consideration, however, where there is no detriment in the event that the party has the right not to perform the act or is exempt from liability, if the act is not performed. For example, if the terms contain an exemption clause that excludes a party’s liability for breach of contract, the agreement may not be formed and be binding on the parties.

Intention

There is a presumption that parties to commercial agreements intend them to be legally binding. Courts have found that agreements to agree are not legally binding, however, some exceptions may apply.

Formalities

Whilst a contract can generally be formed orally, in writing, by conduct (or by a mixture of these means) statutory exceptions apply to contracts relating to interests in land or guarantees, which must be in writing and signed by the party against whom proceedings are being brought.

The parol evidence rule, provides that where a written contract exists, the parties are bound by the terms of the contract and no extrinsic evidence can be relied upon to support the allegation that the terms of the contract are different from the written terms. There are exceptions to the parol evidence rule of course, the most prominent of which are where there is fraud, misrepresentation, mistake and duress. Furthermore, terms may be implied into a contract by:

  • law (for example, pursuant to the Competition and Consumer Act 2010 (Cth) contracts for services contain implied guarantees that the services will be rendered with due skill and care and that materials used will be fit for the purpose for which they are required and that supply will occur within a reasonable time);
  • to give effect to what is custom in a relevant trade or in line with a previous course of dealings between the parties; or
  • to bring business efficacy to the contract.

 

In BP Refinery (Westernport) Pty Ltd v Hastings Shire Council (1977) 180 CLR 266, the Court determined that the test for whether a term can be implied “in fact” into a contract in writing, it must:

  • be reasonable and equitable;
  • be necessary to bring business efficacy to the contract;
  • be so obvious that “it goes without saying”;
  • be capable of clear expression; and
  • not contradict any express term of the contract.

 

Construction of the meaning of the terms of the contract is determined by adopting the test of what a reasonable person in the position of the party to the contract would have understood them to mean. Accordingly, the Court will look not only at any written documents but also the surrounding circumstances known to the parties, and the purpose and object of the transaction.

If you need help deciphering whether you have a contract or the terms of your agreement, we encourage you to contact us for a free consultation.