A legally valid contract requires six essential elements: (1) Offer - a clear proposal from one party to another; (2) Acceptance - unconditional agreement to the offer's exact terms; (3) Consideration - something of value exchanged by each party (money, services, goods, or a promise); (4) Capacity - each party must have the legal ability to contract (adults of sound mind, not under duress); (5) Legality - the contract's purpose must be lawful under applicable local, state, and federal law; and (6) Signatory Awareness - each party must knowingly and willingly agree to be bound. Missing any one of these elements renders the contract void or voidable. A seventh element - mutuality - is often cited as a bonus requirement: both parties must be bound to perform, or neither is. These elements apply to contracts governed by US common law; contracts for goods may also be subject to the Uniform Commercial Code.
Every valid contract - regardless of industry, value, or complexity - must include all six of the following elements. If any element is missing, the agreement may be unenforceable or void entirely.
|
|
Element |
Key Question |
|
1 |
Offer |
Has a clear, specific proposal been made? |
|
2 |
Acceptance |
Has the offer been unconditionally agreed to? |
|
3 |
Consideration |
Has each party exchanged something of value? |
|
4 |
Capacity |
Do all parties have legal ability to contract? |
|
5 |
Legality |
Is the contract's purpose lawful? |
|
6 |
Signatory Awareness |
Does each party knowingly consent to be bound? |
Whether you’re closing a deal or developing an agreement, a contract serves to lay the foundation for the rights of each party, as well as what they are contractually obligated to deliver upon.
While contracts vary in scope, term length, and party involvement, every contract must include the following six required elements:
With the presence of these six requirements, a document goes from an abstract agreement to a legally binding contract. If you miss one of these requirements, you will end up with a null contract.
Every contract begins with an offer, encompassing the responsibilities of each party and the exchange of a product, good, or service. An offer exists once the requesting party receives the offer, but keep in mind, that the offer can be modified and even terminated before acceptance. The party extending the offer can also provide a counteroffer. In this case, the beginning offer is canceled and the parties will negotiate a different result.
Every contract begins with an offer - a clear, specific proposal from one party (the offeror) to another (the offeree) that encompasses the responsibilities of each party and the exchange of a product, good, or service. An offer exists once the requesting party receives it. Until acceptance, the offer can be modified, countered, or terminated.
Key offer rules:
Example: A software vendor sends a written proposal to a business offering to provide a SaaS platform for $2,000/month for one year. This is a valid offer once received by the business.
After an offer is provided, the recipient can accept or reject the offer. In the case the recipient desires to accept the offer, they can make their acceptance known via verbal acceptance or written acceptance. In the context of a counteroffer, the counteroffer serves as a termination of the initial offer. However, some scenarios allow a conditional acceptance where new conditions are considered valid so long as the conditions are made clearly known to each party.
Failing to act upon the offer does not mean the offer is accepted, and contract acceptance must be clear to each party. An acceptance will demonstrate the willingness of one party to follow contracted terms and conditions. Each offer will contain parameters and actions that determine an official acceptance. In order for an offer to be accepted, the offeree must have awareness of exactly what is contained in the offer. The offeree must also demonstrate their intention to formally accept the offer, and then they must express the acceptance in accordance with the guidelines provided in the offer.
After an offer is provided, the recipient (the offeree) can accept or reject it. Acceptance can be made via verbal or written communication. Under the mirror image rule, acceptance must match the offer exactly - any changes create a counteroffer rather than valid acceptance.
Key acceptance rules:
Example: The business sends a signed contract back to the software vendor, agreeing to all terms as stated. This is valid acceptance.
Learn how to build accurate and compliant contracts with the assistance of a contract template library and a library full of preapproved clauses by reading these blogs.
To consider a contract valid in a court of law, each party must be fully aware of the intent to agree. Each party must be a willing and active participant in the contract at hand, recognizing the existence of the contract and agreeing to be legally bound to the obligations and responsibilities.
In the case that signatory awareness is not established, then a contract can be voided. If one party signs a contract under circumstances that compromise their awareness, then the agreement will be discarded and invalidated. To prevent this phenomenon, each party entering the contract must ensure that they establish a mutual and consensual agreement to the contents of the contract.
To be valid in a court of law, each party must be fully aware of the intent to agree. Each party must be a willing and active participant, recognizing the existence of the contract and agreeing to be legally bound by its obligations and responsibilities.
If signatory awareness is not established, the contract can be voided. If one party signs under circumstances that compromise their awareness - such as fraud, misrepresentation, or duress - the agreement can be discarded and invalidated.
Common reasons signatory awareness is compromised:
Basically, know what you’re getting into before signing the dotted line. Moreover, legal principles such as privity and rights of third parties act to limit the responsibilities of everyone involved.
In the context of contracts, consideration includes an agreed value (item, action, etc.) Some common examples of contractual consideration are services and property. It’s also necessary to understand that a financial element is not required for valid contract consideration, and simply agreeing to the exchange of products or services meets the legal requirements of consideration. The most important factor to keep in mind is that consideration includes a mutually agreed upon value between the contract’s signatories.
Consideration is the "something of value" exchanged by each party to the contract. It is what distinguishes a contract from a gift. Consideration does not have to be money - it can be a service, property, a promise to act, or a promise to refrain from acting.
Key consideration rules:
Example: The business pays $2,000/month (consideration) in exchange for the software vendor providing the SaaS platform (consideration). Both parties are exchanging value.
The signing party must sign the agreement without signing off their rights. This means that according to contract law, each signer must understand the terms, consequences, and responsibilities of each contract prior to signing. This understanding is known as the “legal capacity” of the signatory – a requirement of any contract to be considered valid.
People who might not possess legal capacity include the following:
There are a few steps that can be taken to support these individuals on a case-by-case basis. For example, the court may appoint a representative to assist a minor.
Each party signing a contract must have the legal capacity to do so - meaning they must understand the terms, consequences, and responsibilities of the agreement prior to signing.
Parties who may lack legal capacity:
Important nuances:
Every contract is subject to the laws and regulations of the jurisdiction they are located in, including laws on the local, state, and federal level. If an agreement does not align with local laws for example, the contract will not be considered legally valid. However, the legality principle is very nuanced. Contracts must adhere to the laws within the jurisdiction of where the contract is signed. And if federal and state laws clash, then the Constitution’s Contract Clause will guide the contract in question.
There are a few scenarios that invalidate a contract’s legality:
Every contract is subject to the laws and regulations of the jurisdiction where it is formed and performed, including local, state, and federal laws. If an agreement's purpose is illegal or contrary to public policy, the contract is void and unenforceable.
Scenarios that invalidate a contract's legality:
Jurisdictional note: When federal and state laws conflict, the US Constitution's Contract Clause (Article I, Section 10) guides which law governs. Courts apply the law of the jurisdiction specified in the contract's governing law clause, or the jurisdiction most closely connected to the contract if no clause exists.
Mutuality refers to the manner in which each party agrees to being legally bound to carrying-out the obligations contracted to them. Without mutuality of parties, then the law determines that neither party can be held legally responsible to the agreement. Both parties must be bound to the contract to ensure that the agreement isn’t one-sided. A contract without the element of mutuality will be considered void.
This is particularly critical when one party to the contract isn’t provided the opportunity to terminate and cancel the contract. In some of these scenarios, one party can fulfill their contracted obligations without taking away the opportunity for the other party to perform upon contracted requirements. The court oftentimes voids these contracts, as they fail to contain mutuality of contracted obligation. In order to prevent your contract from being considered invalid due to a lack of mutuality, then you should take steps to restrict each party’s ability to void the agreement.
Mutuality (also called "mutuality of obligation") refers to the requirement that both parties are bound to perform under the contract - or neither is. If only one party has obligations while the other can walk away freely, courts often find the contract lacks mutuality and may void it.
Example of missing mutuality: A contract where Company A must provide services on demand, but Company B has the absolute right to cancel at any time with no penalty, may be voided for lack of mutuality - Company A is bound while Company B is not.
To ensure mutuality, contracts should:
|
Missing Element |
Effect on Contract |
|
No offer |
No contract exists - there is nothing to accept |
|
No valid acceptance |
No contract - the offer was never bound |
|
No consideration |
Contract is void - no exchange of value |
|
Lack of capacity |
Contract is voidable by the incapacitated party |
|
Illegal purpose |
Contract is void - courts will not enforce it |
|
No signatory awareness |
Contract may be voided due to fraud, duress, or mistake |
|
No mutuality |
Contract may be void or voidable |
Contracts are an essential tool for any business. In this way, it’s critical that you establish legally valid contracts with clearly defined responsibilities and terms, ensuring that each party is willing and able to enter agreements with a clear conscience. We recommend reviewing your contracts through the lens of theses six required contract elements to support you in developing legally valid and enforceable agreements.
For more information, we would like to welcome you to schedule a free demo with us today.
