Contracts: The Basics
What goes into a legally binding agreement?
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Contracts are legally binding agreements, and they pervade almost every aspect of our personal and business lives. If you own or manage a business, you contend with contracts all the time in your dealings with employees, contractors, vendors, commercial landlords, banks, utilities, insurance companies, and, of course, customers and clients.
What makes a contract special -- and essential for business dealings -- is that it is binding on the parties. If one party doesn't hold up its end of the bargain, the other party has legal remedies for any resulting damages. This article looks at the basic requirements for a legally binding contract, the contract as a document, and the process of "contracting." (For more basic tips on contracts, read Nolo's article Contracts 101: Make a Legally Valid Contract.)
To be enforceable by a court, every contract (whether written or oral) must meet several requirements. Let's take a look at each of them.
- Consideration. As Cole Porter wrote in the song, True Love, "You give to me and I give to you." That sums up consideration. Each party has to promise or provide something of value to the other. Without this exchange, there is no contract. (Learn more in Nolo's article Consideration: Every Contract Needs It.)
- Offer and acceptance. There must be a clear or definite offer to contract ("Do you want to buy this?") and an unqualified acceptance ("Yes!").
- Legal purpose. The purpose of the agreement must not violate the law. For example, you won't be able to enforce a loan agreement that charges interest in excess of what is allowed by usury laws or a service agreement to hire someone to rob a bank or kill your mother-in-law.
- Capable parties. To be "capable" of making a contract, the parties must understand what they're doing. For example, there is a presumption that minors and insane people usually don't know what they're doing and, for that reason, contracts they enter into won't be enforced under certain circumstances. (Learn more in Nolo's article Who Lacks the Capacity to Contract?)
- Mutual assent. This is also sometimes referred to as a "meeting of the minds." The contracting parties must intend to be bound by their agreement and must agree on the essential terms.
In addition to these general rules, federal and state laws may impose more requirements on particular types of contracts. For example, certain consumer contracts must meet additional requirements, and some contracts must be in writing.
The Contract as a Document
The term "contract" often refers to a written agreement, typically including some or all of the following elements:
- introductory material (sometimes known as "recitals" or "whereas provisions")
- definitions of key terms
- a statement of the purpose or purposes of the agreement
- the obligations of each party (and conditions that may trigger obligations)
- assurances as to various aspects of agreement (sometimes phrased as warranties, representations, or covenants)
- boilerplate provisions (see examples of these in Nolo's article Common Boilerplate Provisions in Contracts)
- a signature block, and
- exhibits or attachments.
The Contract as a Process
"Contract" is a noun, but it can be used as a verb, too. When you contract with somebody, you participate in a process that typically involves three phases.
- Phase 1: Contemplating the deal. The parties each assess the prospective arrangement and its risks ("Can I trust her?") and attempt to predict the future ("Will I regret paying this price for the computer next month? Will it be outdated?").
- Phase 2: Reaching an agreement. During this phase the parties negotiate and agree on the terms, usually formalized in a written contract or some other documented evidence of the arrangement (such as a receipt or purchase order, for example).
- Phase 3: Performance and enforcement. Once the contract is in place, the parties are legally required to perform their mutual obligations. If one party fails to perform, the other can sue to enforce the deal.
For practical tips on getting your agreement in writing, read Nolo's article 10 Tips for Making Solid Business Agreements and Contracts. If you're looking for an A to Z guide on everything you need to know about contracts, get Nolo's new book Contracts: The Essential Business Desk Reference, by attorney Rich Stim.