What is a contract?
A business contract is a legally binding agreement between two or more parties to do or not to do certain things. For example, a business contract could be for the sale of goods or supply of services at a certain price.
There are many different types of contracts including:
- the sale and purchase of a business agreement;
- partnership agreements;
- leases of business premises;
- leases of plant and equipment; and
- employment agreements.
The process for creating a contract generally includes information exchange, discussion, negotiation and employment agreements.
What are the essential elements of a contract?
To be legally binding a contract must contain four essential elements. These four elements are:
- offer;
- acceptance;
- intention of legal consequences; and
- consideration.
Offer
There must be a definite, clearly stated offer to do something. For example: A quotation by sub-contractor to the main contractor and an offer to lease.
An offer does not include ball park estimates, requests for proposals, expressions of interest, or letters of intent.
An offer will lapse:
- when the time for acceptance expires;
- if the offer is withdrawn before it is accepted; or
- after a reasonable time in the circumstances (generally the greater the value of the contract, the longer the life of the offer).
- Invitation to treat
An invitation to treat is a mere declaration of willingness to enter into negotiations; it is not an offer, and cannot be accepted so as to form a binding contract. An agreement is not created if there is an acceptance of the invitation to treat.
An invitation to treat is part of the preliminaries of negotiation, whereas an offer is legally binding once accepted, subject to compliance with the terms of the offer. For example: Invitations to treat are advertisements, price lists, circulars and catalogues.
Acceptance
Only what is offered can be accepted. This means that the offer must be accepted exactly as offered without conditions. If any new terms are suggested this is regarded as a counter offer which can be accepted or rejected.
There can be many offers and counter offers before there is an agreement. It is not important who makes the final offer, it is the acceptance of that offer that brings the negotiations to an end by establishing the terms and conditions of the contract.
Acceptance can be given verbally, in writing, or inferred by action which clearly indicates acceptance (performance of the contract). In any case, the acceptance must conform with the method prescribed by the offerer for it to be effective.
Intention of legal consequences
A contract requires that the parties intend to enter into a legally binding agreement. That is, the parties entering into the contract must intend to create legal relations and must understand that the agreement can be enforced by law.
The intention to create legal relations is presumed, so the contract doesn't have to expressly state that you understand and intend legal consequences to follow.
If the parties to a contract decide not to be legally bound, this must be clearly stated in the contract for it not to be legally enforceable.
Consideration
In order for a contract to be binding it must be supported by valuable consideration. That is to say, one party promises to do something in return for a promise from the other party to provide a benefit of value (the consideration)
Consideration is what each party gives to the other as the agreed price for the other's promises. Usually the consideration is the payment of money but it need not be; it can be anything of value including the promise not to do something, or to refrain from exercising some right.
The payment doesn't need to be a fair payment. The courts will not intervene where one party has made a hard bargain unless fraud, duress or unconscionable conduct is involved.
The four essential elements of a contract can be briefly explained as follows; a contract is formed when one party makes an offer and that offer is accepted by another party for an exchange of some benefit or something of value by the parties (this is the consideration element). The intention of the parties is that they are legally bound by the contract.
An agreement must contain four essential elements to be regarded as a contract. If any one of them is missing, the agreement will not be legally binding.
When can a contract be invalid?
Even if the four essential elements are present a contract could in be invalid if:
- It is an illegal contract. Examples of illegal contracts are an agreement to commit a crime and an agreement that breaches legislation, such as unconscionable conduct under the Competition and Consumer Act 2010.
- The person or entity lacks the capacity to enter into the contract. Examples of persons lacking capacity are minors and bankrupts.
- The contract involves misleading or deceptive conduct, mistake, duress, undue influence, unconscionable conduct or other categories that at law can cause the contract to be avoided.
Can a contract be verbal or written?
Contracts can be verbal or written, provided they contain the four essential elements of a contract. However, a verbal contract is much more difficult to prove. Some types of contract such as those for buying or selling real estate and credit must be in writing.
A written agreement is recommended as it:
- becomes your proof of what was agreed upon;
- prevents ambiguity or misunderstanding;
- prevents either party forgetting or changing the terms later; and
- makes the parties focus on the essential issues and come to a definite agreement.
Unless you're a lawyer nobody expects you to write your own contracts. However, as a business owner you're expected to be able to read a contract and understand what it means.
What general matters are covered in a contract?
Some of the general matters that a business contract can cover include but are not limited to:
- parties to the contract
- date of the contract
- definitions used in the contract
- description of the goods and services that your business will provide or receive
- payment amount and details of payment dates
- interest on late payments
- delivery dates of goods and performance dates for services
- insurance provisions
- guarantee provisions
- termination dates of the contract
- renewal terms
- damages for breach of contract
- termination conditions
- special conditions.
Standard contracts and obtaining legal advice
The Small Business Development Corporation (SBDC) is frequently asked for standard business contracts for a variety of purposes such as buying a business, leasing commercial premises, partnerships or employment contracts.
We do not provide standard contracts or templates, although some 'standard contracts' may be available through industry associations. We recommend contracts are drafted to reflect the unique commercial circumstances of the parties negotiating the agreement. The lawyer drafting the contract will take into account their client's concerns, commercial risks and matters agreed during negotiations.
Keep in mind that you should always get legal advice before signing a significant contract.
Get the right advice
In business it is particularly important to get the right advice before entering into a business contract, or you could face significant and far-reaching consequences.
Legal advice will ensure your rights are protected and favorable terms are negotiated on your behalf - terms that better suit your business and allow you to trade profitably, which means the likelihood of costly disputes in the future is reduced.
Furthermore, the underlying transaction of a contract can have GST, taxation and stamp duty consequences and this aspect of the contract could also require professional advice.
It is strongly recommended you consult your lawyer before entering into any contract where a substantial amount of money is involved or the potential liability under the contract is substantial.
A lawyer can:
- explain the terms of a contract if you are unsure of the meaning;
- explain your rights and obligations under that contract;
- negotiate more favorable terms in the contract;
- prepare a contract for you to enter into with another party;
- explain the consequences of entering into the contract before you commit to it; and
- advise and assist you if the other party breaches the contract, or if you are accused of breaching the contract.