Contracts 101: Make a Legally Valid Contract

Many business owners base their profits on well-crafted business agreements. Moreover, owners often need to enter into agreements just to operate their business. It's important to know when you're working with a legally valid contract and what mistakes to avoid when creating your contract.

Elements of a Legally Valid Contract

A contract must contain the following six elements to be legally valid:

• Offer. Contracts start with an offer. An offer to contract must be intentional, definite, and communicated to the other party.
• Acceptance. The party that receives the offer must accept the offer. If the offer is revoked, expires, or is altered (as in, the receiving party counteroffers), then there's no acceptance.
• Consideration. In a contract, a party exchanges one thing for another. This exchange of value is called "consideration." Every contract must exchange something of value, whether it be money, goods, services, or something else.
• Legal purpose. Put simply, your contract can't violate the law. You can't agree to do something illegal.
• Legal capacity. Both parties must have the capacity to enter into an agreement. Typically, minors, individuals who lack mental capacity, and intoxicated persons lack the legal capacity to enter into a contract.
• Mutual assent. Contracts require a "meeting of the minds." Both parties must intend to be bound by the terms of the contract. The parties must also agree on the essential terms of the contract.

If a contract satisfies these six elements, the contract is legally valid. But if a contract lacks any of these elements, then you can raise a defense against the enforcement of the contract.

When a Contract Isn't Legally Valid

If a contract doesn't meet one of the required elements, you can argue that the contract is unenforceable or voidable. If a contract is unenforceable or voidable, then you don't have to fulfill your end of the contract. Typically, a party will argue that the contract shouldn't be enforced after that party has broken the contract and breached the agreement.

The breaching party will argue that they're not obligated to perform their end of the contract because the contract isn't valid. You can raise one of the following contract defenses to prove your contract is voidable or unenforceable and excuse nonperformance:

• One of the parties lacked the capacity to contract.
• One of the parties was under physical or economic duress (threat) when they made the agreement.
• One party had authority over the other party and put pressure (undue influence) on the susceptible party to enter the contract.
• One or both sides lied or didn't disclose (misrepresented) a material fact during negotiations.
• One or both parties made a mistake about a present material fact that one or both parties relied on when entering the contract.
• The contract should've been in writing.
• The contract is indefinite (in other words, incomplete).
• The contract is unconscionable or shockingly unfair—for example, the bargaining power between the parties is grossly unfair or the terms of the contract were unfair (a rip-off).
• The contract is illegal or against public policy.
• The contract becomes impossible or impracticable to perform because of some unexpected event.

If you want to create a legally enforceable contract, then you need to make sure your contract meets the required elements and that the other side can't raise a viable defense. But if one side breaches (breaks) the agreement and there's no valid defense, then the nonbreaching side can end the contract, sue for money damages, or ask the court to make the other side perform their end of the contract.

Does a Contract Have to Be in Writing?

It depends. In a few situations, contracts must be in writing to be valid. All states have adopted at least part of the Uniform Commercial Code (UCC), a set of model rules that govern commercial contracts. The UCC has specific rules about when contracts must be in writing.

Under the UCC, the following types of contracts must be in writing to be valid:

• contracts for the sale of goods of more than $500
• lease contracts for personal property more than $1,000 (excludes commercial real estate leases), and
• agreements that create a security interest (where a creditor has a legal claim over the debtor's collateral).

It's important to note that Louisiana hasn't adopted Articles 2 and 2A of the UCC, which govern the sale and leasing of goods. So if you're in Louisiana, you'll need to take a closer look at your state's laws about written contracts.

In addition, state laws often require written contracts for real estate transactions or agreements that will last for more than one year. You'll need to check your state's laws to determine exactly which contracts must be in writing.

Even if you're not legally required to have a written contract, it's a good practice to use written contracts. Oral (verbal) contracts can be difficult or impossible to prove.

Can You Amend a Contract?

Yes, as long as your contract doesn't explicitly prohibit amendments. But most contracts have a provision that allows for amendments as long as both parties consent to the change.

You can change the terms of a contract as long as both sides agree to the changes. It's recommended that you create a separate document, called an "amendment to contract" to record the alteration.

In your amendment, you should make sure to include:

• the names of the parties to the amendment
• a reference to the agreement being amended
• the details of the amendment
• the date the amendment will take effect, and
• the signatures of both parties.

In some cases, you don't need to draft a separate amendment to contract. Sometimes parties just want to waive a particular requirement of the contract.

For example, suppose you run a catering business. You sign a contract to cater a wedding in which you're required to provide two entrees, three sides, rolls and biscuits, and tea and lemonade. However, when the wedding day comes around, you experience a shortage of supplies for biscuit making. The wedding couple doesn't care for biscuits anyway and agrees to double up on rolls. While you don't necessarily need to draft a contract amendment, you should still get the couple's waiver of the biscuits in writing.

But you might want a separate amendment for a more substantive change to the contract. Let's look at the above example again. Now, suppose the couple has a lower RSVP rate than expected and no longer needs as much food at their nuptials. They ask if they can order one entree and two sides instead of two entrees and three sides for a lower price. You agree to the change of plans. Because there's a significant change in the scope of work and price, you should have the couple sign an amendment to the contract.

Tips for Making a Legally Valid Contract

When creating a contract, you usually want to make sure that the contract is legally valid and enforceable. Below are some quick tips to help you create a valid contract.

Offer and Acceptance

You must meet a set of requirements to create a valid offer and to accept that offer.

A valid offer must:

• include specific and definite terms
• be intended to be an offer to contract, and
• be communicated to the other party.

On the other side, you can accept an offer either expressly (through your words or by a written acceptance) or implicitly through your actions.

To create a valid contract, the acceptance must match the offer. If you introduce new terms in your acceptance, then you haven't accepted the offer. You've created a counteroffer. The original offeror must now choose to accept or reject those terms or present their own counteroffer.

In some cases, you can introduce new terms in your acceptance that become part of the final agreement. Specifically, your ability to introduce new terms in your acceptance applies to the sale of goods between merchants under the UCC. The new terms will become part of the final agreement unless:

• the offer limits acceptance to only its own terms
• the responding party objects to the additional or different terms within a reasonable time, or
• the additional or different terms materially alter the terms of the offer.

(You can find out more about which terms make it into the final agreement in our article about the battle of the forms under the UCC.)

It's best to have a written offer and acceptance. The offer and acceptance should be as specific as you need them to be. If you want to make sure specific details become part of your contract, include those details in your offer (or your acceptance or counteroffer). Ideally, you'll want to agree on all of the major details before you sign the final contract so you don't have to amend the agreement later.

Consideration

For a contract to be valid, you need to make sure you provide consideration. Typically, courts see any consideration as being adequate to satisfy this contractual requirement. If contracts are made and consideration is exchanged in good faith, the contract will be enforceable.

Typically, consideration consists of a promise to either:

• do something you're not otherwise legally obligated to do, or
• not do something you have the right to do.

While this contractual element isn't heavily scrutinized, it's still in your best interest to explicitly address it. Your contract should expressly state what each party is offering under the contract. If you're providing services, list out those services. If you're making a payment, the contract should say that you're responsible for that particular payment.

Agreeing on Contract Terms

As mentioned earlier, to create a valid contract, both parties need to agree:

• to create a legally binding contract, and
• on the essential terms of the contract.

If the parties don't agree on the essential terms of a contract, the contract is voidable. One side can argue that they don't have to perform their end of the contract because the contract is indefinite and missing important terms.

Sometimes parties can agree on the essential terms but disagree or leave out less important terms. In these situations, the contract will usually stand. Courts sometimes fill in the gaps of an agreement with what the court considers to be reasonable terms. The court can determine what a reasonable term is based on the parties' intentions, industry standards, previous dealings, and current performance.

You don't want to go through all the effort of negotiating a contract or performing your obligations under the contract just for the other side to say that there was never an agreement as to the essential terms of the contract. Think through all the terms that you'd need to agree on to complete the contract.

Determine whether you need to establish or specify:

• definitions for terms to be used in the contract (or other industry terms)
• payment terms (including the amount, method, and due dates)
• timelines for performance
• delivery methods
• performance reviews, and
• licensing or other intellectual property ownership details.

You don't want to leave room for ambiguity or interpretation. It's beneficial to both sides if both parties know what to expect upfront.

In addition to agreeing on the terms that govern the contract, you'll also want to include provisions governing contract disputes. Even if you've put your best effort into creating a legally valid contract that's essentially free from interpretation, unexpected issues can always arise.

You should include clauses in your contract that detail what happens when the parties encounter a conflict, including:

• a mediation clause or arbitration clause, which requires the parties to try to work out the issue through mediation or arbitration instead of through the court
• a choice of law provision, which establishes which state's laws will govern the agreement
• a liquidated damages provision, which specifies a predetermined amount of money the harmed party can recover if the other side breaches the agreement
• an attorneys' fees provision, which clarifies which side will be responsible for the attorneys' fees if the dispute goes to court, and
• an indemnification provision, which protects the parties against losses from third-party claims related to the contract.

The final piece of advice is to be overprepared rather than underprepared. If you need help crafting or reviewing a business agreement, talk to a business lawyer. They can help you avoid any pitfalls that might invalidate your agreement.

If you'd like to learn more about contracts on your own, you can read Contracts: The Essential Business Desk Reference, by Richard Stim (Nolo). This book has a breakdown of contract terms and includes sample contract provisions and contracts for your use. You can also check out our business section of books and forms for more general information on running a business.