What makes a contract: the four essential elements

How does a contract form?

A contract is a legal agreement between two or more parties that can be legally binding. A contract can only be formed and be legally binding if it has four essential elements:-

Offer

Acceptance

Consideration

Intention to create legal relations

It is important to note that if any one of the four elements is missing, then a contract cannot not be formed or be legally binding.

An offer is a proposal and becomes legally binding if it is accepted provided it also fulfils the other elements of consideration and intention. The person who makes an offer is called an offeror, and to whom it is made is known as offeree. A proposal is only regarded as an offer if the offeror intends to be bound by it. The offer has to be certain, clear and without any ambiguity. For example, if someone says “I am thinking of selling my car for a reasonable price”, it will not be considered an offer as it lacks certainty in terms of thinking, and it is also not clear what price the person might be considering. But if the same person says “I will sell my car to you for £1999”, then it will be regarded an offer by law.

An acceptance is saying yes to an offer made. Acceptance can be described as “unqualified assent to the terms of the offer”. Here the word assent means that the offeree must be willing to agree to the terms of the offer, and the word unqualified means that the offer is being accepted on the terms of its proposal. So if there is an offer of selling a car for £1999 and the offree agrees, it means the offeree is accepting to buy it on the exact term of the price of £1999 – an unqualified assent to the offer. Once an acceptance has been communicated to the offeror, it becomes a legally binding agreement.

Consideration is the price that one party pays for the promise of the other. Consideration can also be a detriment which means that in an agreement both parties lose to gain in return. Suppose you bought a pc for £299 from a computer shop, you paid the shop £299 and in return the shop handed over the pc to you. Here £299 was the consideration (or detriment) that you exchanged for the pc and likewise the shop had a detriment (or consideration) when it sold you the pc but in return it gained £299. Another rule about the consideration is that it must be sufficient but not adequate. What it means by it that it does not matter what is the real value of the consideration as far as there was something given in return. For example if someone offers to sell his very expensive sports car just for a few quids, then it would not matter if the money paid was not sufficient if the buyer and seller are happy to exchange on that price. This rule is also known as the peppercorn rule.

Intention to create legal relationship is the forth essential element of a contract. A contract can only be legally binding if the contracting parties have intention to be legally bound. Whether two parties have intention to be legally bound will depend on individual circumstances. Most commercial agreements whether business to business, or business to individual would be regarded by law as created with intention to be legally bound. However there might be some other groups of people which may be considered as having to create an agreement with the intention to be legally bound. For example, if you agree to mow the lawn if your partner does the dishes in return – and forgets! –  by law it won’t be regarded as an agreement that had the intention to be bound. Or you cannot force your partner to fulfil the promise. In circumstances where it is difficult to determine whether an agreement was created with the intention to be legally bound, the law applies what is known as the objective test. An objective tests tries to look at the situation from the perspective of a reasonable person.

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