Welcome to basic training in contract formation. When we think of contracts, we think of lengthy written agreements containing fine print and legal mumbo-jumbo. Most of us don’t even read through all the terms, almost as a matter of convention! When you rent a car, do you sit there and read through all the terms and conditions before signing the document and getting into your car? Probably not. When you open a bank account, do you read through all the fine print pertaining to your new account before you sign? Unlikely.
And, practically-speaking, this ultimately doesn’t affect many of us. We return the rented car, undamaged, filled with the same amount of gas that it had when we picked it up. We deposit and withdraw money into and from our bank account and pay our monthly account fees. Etcetera. Life goes on.
But, when things go wrong, we end up having to look at the terms of the contract. And we end up learning (oftentimes the hard way) after-the-fact the terms we agreed to.
So, the terms of a contract are important. But what exactly is a contract? And how and when is one even formed? There are all sorts of rules that can get quite complex, but let’s try to get a hold of the basics in contract formation.
Contract Formation – What’s a Contract?
A contract is a binding agreement between two or more people that gives rise to an enforceable obligation.
The Canadian Encyclopedic Digest defines a contract as: “an agreement free from vitiating factors such as mistake or misrepresentation, and constituted by the unconditional acceptance of an outstanding offer involving a reasonably precise and complete set of terms between two or more contractually competent parties, who intend to create mutual and reciprocal rights and duties that may be the subject of judicial sanction, if they are expressed in any required form, and are free from the taint of illegality or immorality, and are not subsequently discharged by law, by agreement, by breach, or by sufficient supervening circumstances.” What a mouthful!
Contract Formation – Components
There are four components to contract formation:
(1) Authority, Capacity, and Power;
(2) Mutual Assent (an Offer and Acceptance);
(3) Consideration; and
(4) Free from Vitiating Factors.
Authority, Capacity, and Power
This refers to the person signing the contract, usually on behalf of a company.
Authority is exactly what is sounds like – for example, does the person/representative have authorization to bind the company? This usually involves the powers that are delegated by a company to its representative, and the authority can be express or implied. Even if a company employee lacked actual authority, he or she may have had apparent authority (based on an appearance of authority) to bind the company.
Capacity refers to the legal capacity of a person to enter into a contract – for example, a person who is mentally incompetent, a minor, etc., cannot enter into a contract.
Power refers to a company and whether that company has the power to enter into a contract. A company’s power to enter into a contract may be limited by its bylaws or by any special business licence, etc.
Mutual Assent (an Offer and Acceptance)
You need the following two components to form mutual assent:
(1) An Offer; and
(2) An Acceptance of the Offer;
An Offer is: a willingness by one party (the Offeror) to enter into a contract for goods or services (or both), communicated in a way that the other party (the Offeree) understands the terms of the offer, verbal or written. Beware because the Offeree can become the Offeror if the Offeree doesn’t agree to the terms of the offer and makes a counter-offer.
The offer must then be accepted. Acceptance means the other party responds in a way that the first party clearly knows that the other has accepted and agrees to the essential terms that were being proposed.
Consideration means that the parties must exchange something of value. Basically, the act or promise of one party must be “bought” or “bargained for” by the act or promise of the other party. Consideration can be in the form of a promise to perform an act . . . or not to act; it can be cash or cash equivalent; or it can be an action or performance. The important thing is that the consideration exchanged matches what the parties bargained for and agreed to (the exchange doesn’t need to be of equal value).
Consideration has been defined as “some right, interest, profit or benefit accruing to the one party, or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other.”
No Vitiating Factors
There’s also legislation – like the Statute of Frauds – that makes certain contracts enforceable only if they’re in writing. Many contracts are verbal, but some legislation protects parties from verbally negotiating and unintentionally entering into a contract by oral agreement. Generally-speaking, contracts for the sale of goods over $500 must be in writing. Contracts that can’t be performed in one year must be in writing. Contracts involving marriage or real estate must be in writing. And so on and so forth.
When something is “in writing,” the written correspondence (like email) must identify the parties, identify the essential terms, and demonstrate that the parties wanted to enter into a contract. Some legislation even makes it a requirement that a document be signed. But a signature can be any symbol, including a typed name at the end of an email (i.e. an electronic signature meets the legal threshold).
Besides the signature requirement, some contracts can be unenforceable because of the situation. If there’s a mistake on the part of either party that doesn’t match up with the terms, that can render the contract unenforceable. If there’s misrepresentation (a false or partially false assertion or, sometimes, non-disclosure/concealment), that can render the contract unenforceable. If there’s duress or undue influence (where one party doesn’t act freely of their own volition or is improperly forced), that can render the contract unenforceable. Finally, if the contract is illegal or contrary to public policy, that can render the contract unenforceable.
So, to form a contract, you need a binding offer by one person that’s accepted by another person, with the parties possessing authority, capacity, and power to bind, and with the parties each having exchanged something of value as part of the bargain. Sometimes (but not always) the agreement must be in writing. And the agreement can’t otherwise be unenforceable because of a mistake, misrepresentation, duress or undue influence, or illegality or a public policy reason.