What Must a Contract Contain to Be Legally Binding?

By | Small Business

To be legally binding, a contract needs two essential components: 1) an agreement, and 2) consideration. Within the agreement and consideration lies an assortment of provisions that add to the legality of a contract. These include the offer, performance, terms, conditions, obligations, payment terms, liability, and default or breach of the contract.

The agreement component involves offers, counter-offers, and eventually what contract law calls the "meeting of the minds." An agreement can be either oral or written, depending upon the contract. If you hire a taxi to drive you to the airport, then it is an oral agreement that you will pay the driver a certain sum when you reach your destination. Contracts whose agreements must be in writing include real estate contracts and contracts that last more than a year. Every state has its own legal requirements and you should consult these requirements to find the specific regulations that pertain to your type of contract.

The agreement process involves one party offering terms and conditions that are either accepted or rejected by the other party. If the other party changes any term or condition of the offer, then the offer becomes a counter-offer. At this point, each party negotiates the terms and conditions of the offer until they have a meeting of the minds. This is when an agreement has been met and a contract can be drawn up.

Both parties must be competent enough to enter into the contractual agreement. They may not be minors (under 18 years of age), under the influence of drugs or alcohol, or of unsound mind. They also must have the legal power to enter into the agreement; this particularly pertains to people representing an outside interest, such as a company or third party. The main question becomes, "Do they have the legal power to carry out the terms of the agreement?"

For an agreement to be legal and binding, it must have some form of consideration. This means that all parties involved must receive consideration or something of value. Otherwise, it is considered a gift rather than a contract. The promise of a gift is not necessarily binding, depending upon the circumstances. Usually consideration involves one party giving something such as a product or service, and in exchange the second party gives some form of monetary compensation.

The consideration component of the contract brings up several other provisions that should be addressed. These provisions include:

  • Obligations and Conditions of the Contract -- what each party needs to do to fulfill the terms of the contract
  • Performance -- how well each party performs the terms of the contract
  • Payment Terms -- a schedule that specifies when all payments are to be made
  • Liabilities -- defines the liability of each party in terms of the contract
  • Breach of Contract -- what will happen should either party fail to fulfill their end of the agreement

When compiling the agreement and consideration of a contract, the agreement must be clear as to what is specifically expected of each of the contracting parties. An ambiguity or confusion in any part of the contract can lead to problems when trying to enforce the provisions of the contract.

Although not legally required, each contract should contain several provisions known as "boilerplate" provisions. These include:

  • Arbitration Clause -- makes allowances so that disputes are handled by an independent arbitrator
  • Entire Agreement Clause -- states that what is written in the contract is what the agreements and conditions of the contact are, and no previous agreements or conditions are applicable
  • Force Majeure Clause -- states that should something happens beyond the control of either party (such as a tornado destroying a house while it is still in escrow), then the contract is no longer valid

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