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Formation of contracts

Overview

Men shaking handsAgreementConsiderationIntentionCapacityFormalities

We all make contracts almost every day. Whenever we buy a coffee, do the grocery shopping, fill the car up with petrol or purchase a ticket for public transport we are entering into a contract. We are often unaware we are contracting (or at least don't turn our minds to that fact) and we almost certainly don't break down our transaction into the various 'components' necessary to give rise to contractual rights and obligations. Nevertheless, these are contracts every bit as much as the detailed written and signed contract for purchasing houses or cars or engaging contractors to do building work.

In most cases we have no need to turn our mind to the specific components of contractual formation; most contracts are made and performed instantly (or almost instantly). However, should something go wrong (eg, one party fails to perform (eg, deliver goods) or goods delivered or services performed are defective in some way), it is important to be able to assess when and whether a valid contract was entered into and the nature of its terms and obligations.

In this section we focus on the first part - whether there is a valid contract in the first place upon which to found a claim. Other parts will consider how we determine the terms (rights/obligations) under the contract, whether contractual obligations may be avoided because of the conduct of the other party (like misleading conduct) or some external factor (some unanticipated event preventing the contract being performed), how we know if there has been a breach and what remedy (or remedies) might flow from that breach.

In order to make a valid contract there are generally five things ('components' or 'elements') that need to be established:

  • Agreement between the parties
  • Consideration (that something be given in exchange for a contractual promise)
  • Intention to create legal relations
  • Capacity to contract
  • Compliance with any formalities
    (there is no requirement at common law to have a contract in writing or signed, but in some cases legislation requires this.

 

Agreement

The first requirement for a valid contract is an agreement. An agreement normally consists of an 'offer' and an 'acceptance' (although the parties may not articulate their arrangement in these terms) and involves a 'meeting of the minds' - or consensus - between two or more parties. Complex rules exist to determine when an offer and acceptance are valid.

To be effective an agreement must also be certain in all material respects. Thus, an agreement which is 'vague or ambiguous', incomplete or constitutes a mere 'agreement to agree' will not be enforceable.

 

Consideration

Consideration is the price that is asked by the promissor in exchange for their promise and is an essential requirement in Australia before a contract will be binding (save for agreements made under seal). Consequently, gratuitous promises are generally not enforceable.

Consideration is a complex requirement containing many rules and qualifications. In addition, the doctrine of promissory estoppel now operates to permit the enforcement of agreements even absent the existence of valid consideration.

 

Intention to create legal relations

For a contract to exist the parties to an agreement must intend to create legal relations. Usually, the presence of consideration will provide evidence of this, but not always, so that this requirement must be separately proved in each case. The onus is on the party seeking to prove the contract to demonstrate intention and the nature of the relationship between the parties, while relevant, no longer carries with it any presumption about the contractual intention of the parties involved.

 

Capacity

There are certain persons and classes of persons that lack the capacity to enter into a contract with the consequence (normally) that resulting contracts will not be enforceable against them.  Lack of capacity now often stems form a fear of vulnerability to exploitation. This area has become more complex as a result of statutory developments at a state level (calls for national law reform have not yet met with success) which result in a variety of different rules.

 

Formalities

In most cases there is no requirement for a contract to comply with any formalities (such as that it be in writing or that it be signed by one or more parties). However, statute does impose such a requirement in a limited range of contracts - most commonly, those relating to the sale or disposition of land or guarantees.