As a business owner, it’s in your interests to make sure that all contracts that you enter into on behalf of your business are legally binding and enforceable. However, you may never have assessed ‘what actually constitutes a legally binding contract’.
As this is such a fundamental matter, it’s worth taking the time some time to consider this question. In this article, we’ll be discussing the constitution of a contract and the key role that the concept of consideration in contract law plays.
What are the key elements of a contract?
A contract requires five elements which must all be present for it to be legally binding. These five elements are as follows:
- Offer – there must be a clear offer capable of acceptance, including all the terms.
- Acceptance – there must be clear acceptance of all the terms of the offer.
- Certainty – there must be sufficient certainty in the terms of the deal for it to be capable of forming a binding contract. All the agreed terms should be certain and unambiguous.
- Intention to create legal relations – the parties must intend for the deal to be legally binding upon them. There is a rebuttable presumption against this in the case of arrangements between family members, but a rebuttable presumption in favour of this when the two parties are entering into a commercial arrangement.
- Consideration – sometimes called the ‘price for the promise’ – see below for a more in-depth explanation of the role of consideration.
What is consideration?
One way to think about consideration is that it represents what each party is offering up (or giving up) to the other to make the deal happen. This is why it has sometimes been described as the ‘price for the promise’ – what is each party offering up in return for the promise from the other party. In this sense, it’s somewhat like the ‘glue’ that holds the deal together.
To give a very simplistic example to demonstrate the concept, if you walk into a shop and buy a chocolate bar for £1, in this scenario the consideration passing is the £1 in return for the chocolate bar.
However, the consideration doesn’t necessarily have to be monetary. To keep with the same example, if the shopkeeper and the customer were to strike a deal that in return for the chocolate bar the customer is to spend some time helping stack shelves, then the consideration passing would be the labour time spent stacking shelves.
The concept of consideration helps distinguish genuine contractual bargaining from mere gifts or informal/one-sided arrangements that are not truly capable of contractual enforceability.
It has sometimes been argued that if you look long and hard enough in any commercial arrangement you’ll find consideration passing. However, the takeaway point for those keen on ensuring contractual enforceability is to remove the guesswork and make sure that the contract drafting states clearly the consideration passing.
Consideration in a commercial context
In commercial terms, if the deal involves outright financial payment, then the precise amount should be clearly stated. If the deal involves more of a ‘quid pro quo’ or exchange of services, then likewise this should be recorded for reasons of certainty, and to ensure there is no later dispute on whether or not there was an absence of consideration and legal enforceability.
In certain circumstances, if there is any doubt about the terms of the consideration passing, it may be in both parties’ interests to execute the contract as a Deed, which generally does not require consideration to be enforceable.
However, before doing this, it’s important you take legal advice as there are special rules applicable to the signing of Deeds that must be followed.
Wrapping up
If you’re entering into a contract with another business and wish to ensure that it’s legally binding, then you should take legal advice so you can ensure the terms are professionally drafted and enforceable. By appointing solicitors, the parties can set out the fine details with clarity and certainty, which is absolutely critical to the success of the contract.
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Author: Ashley Gurr. Ashley is one of the many expert contract lawyers at LawBite. Ashley has over 15 years of experience in private practice helping SMEs and in-house for an international consultancy group advising on commercial agreements and a multi-national utility giant in a contract strategy role.
