Imagine this. You’ve spent months negotiating a deal. Today, you and your counterparty agreed the last of the important terms. Your lawyers still need to finalise the written document but you and your counterparty shook hands on the deal at the end of a meeting. Have you got a contract?
The answer is “depends”. There are certain thresholds you must meet to form a contract. This article explores when a contract is likely to have been formed.
When is a contract made?
At a minimum, a contract requires:
- all the essential terms to be both agreed and are sufficiently clear and certain;
- both parties to intend to enter into binding legal relations; and
- the parties have given each other something of value (‘consideration’).
Each of these is explored below.
Essential terms
“Essential” in this context means both:
- everything needed for the contract to work; and
- everything the parties require to be agreed before entering a contract.
Essential is not just about contractual mechanics. It’s also about the terms each party values and needs to be agreed.
This involves an objective review of the situation, rather than what any party actually thought in the moment. “Objective” means what a reasonable third person would think if they knew all the facts. This is a very fact heavy investigation. Factors to consider include what was said by each party, any emails exchanged and how the parties conducted themselves after the alleged agreement.
In our example, the parties have agreed on all of the important terms and shook hands on the deal. This may be a good indication that the essential terms have been agreed. But there may be contrary indicators. For example, if in the meeting the counterparty had said such as “We are happy with this deal subject to seeing the contract” or sent an email shortly after the meeting stating “Here is what we agreed today but we still need to agree on X and Y before signing”. These would tend to indicate that all the essential terms have not been agreed.
Intention to enter into binding legal relations
Not only do the parties need to agree to the terms of the deal, the parties must also intend to be legally bound by the terms of the deal. A gentlemen’s agreement or a social agreement are not sufficient to form a contract.
Whether the parties intended to be legally bound is once again an objective test. What a party actually thought is not the point. The question is what a reasonable third person would think if they knew all the relevant facts.
The factors that are relevant to determining whether all the essential terms have been agreed will also be relevant to this question.
The fact that the parties have not signed a written contract does not determine whether the parties have agreed to be legally bound but can be indicative. Words such as “subject to contract” are also not decisive but can be indicative.
In our example, assuming all the essential terms have been agreed, we do not have enough information to be able to say whether the parties intended to be legally bound by their handshake agreement.
A very telling indication will be how the parties acted after the meeting. Did the parties begin to implement the deal? For example, making purchases of materials, submitting applications or demolishing structures? Specific acts done by the parties to further the agreement are a good indication that the parties intended to be immediately and legally bound.
Consideration
The last factor is consideration. Consideration is the giving of something valuable to the other party. Consideration can include a promise. The exchange of promises can be sufficient for a contract to be formed. Consideration is also not essential if the relevant contract is recorded in a deed.
In our example, if the essential terms have been agreed and the parties intend to be bound by legal relations, it is likely that a Court will consider consideration has been given. The consideration would be each party’s promise to perform the deal.
Legislation
The above is also impacted by legislation which in respect of some contracts require the agreement to be in writing and signed.
If you’d like to discuss this article and your circumstances further, contact our Victoria Caldwell, Commercial Associate or our Senior Legal Consultant, Petar Vladeta
This publication is for general information purposes only and does not constitute legal advice. You should seek legal advice regarding your particular circumstances.