Contracts are essential components of the business world. They help manage employment, partnerships, sales, and more.
If your business regularly handles agreements and contracts, you need to develop a deep understanding of contract elements to ensure the documents you draft are valid and legally enforceable.
One of the reasons why PandaDoc offers a large library of legally binding templates is to make the contract drafting process easier, but that doesn’t let you off the hook.
You still need to recognize if the documents your clients or partners ask you to sign are valid and enforceable, and that can only come with knowledge.
Why are contract elements important?
It’s crucial for business owners to understand all of the required elements of a contract because it helps them create valid agreements. With a valid agreement, you can mitigate legal liability.
Besides protecting your business from potential harm, formal contracts also make agreements between parties legally binding.
While used interchangeably, contracts are enforceable, while an agreement isn’t.
Why? Because they lack the essential elements that make them legal!
To make a contract legal, you must:
- Identify all of the parties involved
- Present an offer
- Confirm that the other party accepts your offer
- Offer something of value
- Ensure all parties are capable of signing the contract
- Have a meeting of the minds to legally accept the terms
- Create a dispute resolution clause if the deal falls through
With these elements present, you can use most business agreements to enforce your rights and hold the other party legally accountable.
Now, you can focus on how to negotiate your contracts rather than worrying about the technical stuff.
Although the 7 elements we discussed are important, there’s a lot of misinformation on the internet that may make you believe other elements are necessary, when they aren’t.
Some business owners make the mistake of adding certain terms or legal mumbo-jumbo to add emphasis, but they don’t make the contract any more enforceable.
In fact, there’s a higher possibility that using terms you’re unfamiliar with will make your contract less enforceable!
Although the use of legal language is necessary to remove doubt, most contracts are legally enforceable as long as they contain the 7 contract elements.
For example, saying that the parties “expressly” agree to the contents in your contract doesn’t make the topic before the “expressly” more important.
If you want the parties involved to take certain terms more seriously, you should go into detail as to why these terms are important to you in the contract. You could also state that specific terms of the contract carry more weight if they’re broken.
Are there any examples of a legally binding contract?
Contracts are a common and ever-present document in daily life.
You’ve probably had to sign a cell phone contract when you traded in your old smartphone or filled out a rental agreement before moving into your first apartment.
If you’re a business owner, you may have to create dozens of contracts for your employees,
clients, and partners. You can use templates to simplify the contract creation process.
Here are a few contract examples your business may use:
- Employment Contracts
- Business Sale Agreement
- Real Estate Agency Agreement
- Car Leasing Agreements
- Royalty Agreement
- Promissory Note
- Non-Disclosure Agreement
Remember that agreements can still be considered contracts if they contain the essential elements of a contract. Contracts referred to as agreements can be binding agreements.
What are the requirements of a valid contract?
You cannot just create a contract with the necessary elements and call it a day; you also have to follow the law, more specifically, contract law.
Contract law regulates the obligations established by a legally binding agreement. In the United States, these laws vary from state to state.
For example, the Iowa State Court will have different court procedures and codes than California.
Some jurisdictions in Iowa will even have unwritten rules for how you should conduct yourself in court. That’s why it’s important to speak to a lawyer if you plan to seek legal action.
Fortunately, the laws governing transactions around the sale of goods have become mostly standardized thanks to the adoption of the Uniform Commercial Code (UCC).
However, you’ll still find variants between contracts depending on how often a state will refer to the UCC, so watch out for that.
Summed up, contract law governs the formation of a contract, the terms and conditions of a contract, and the discharge of the contract.
Formation of a contract
To make sure all contracts are balanced and fair for all parties, contract law is the only set of government rules and regulations about legal agreements.
That means that your freelance contract, payment agreement, and license agreement are all governed by the same laws regardless of what category they fall into. A business agreement will include the exact same procedures and protections as a rental agreement.
However, the contents of a contract will vary based on the contract type. For example, a mortgage will contain information about your interest rate, but a rental agreement won’t.
Contracts are also at the mercy of other laws if the parties who create them don’t form a legal agreement.
A contract becomes voidable in a court of law if:
- The contract hides or doesn’t disclose, either by accident or on purpose, crucial details (material facts) that may make one of the parties reconsider the agreement.
- The contract was signed by one or more of the parties when they were under duress, legally incapacitated, or convinced under a false pretense.
- The contract contains unconscionable terms. To be considered unconscionable, a contract has to be extremely one-sided, unjust, or contrary to good conscience.
Agreements are considered “void” or “unconstitutional” if:
- The agreement asks one or more of the parties to do something impossible.
- The agreement suggests or outright asks the parties to do something illegal.
- The agreement restricts a person’s individual rights under other US laws.
Under contract law, neither a person nor a business can make you do something written in an agreement if it’s voidable or unconstitutional, even if you sign it.
Terms and conditions
The terms and conditions of an agreement ensure that all parties understand their contractual rights and obligations.
Parties will draft terms and conditions into a contract in accordance with state and federal contract laws.
Businesses use terms and conditions to set up rules both the business and customer will play by.
For example, if you deliver a product and it’s damaged during shipment, the terms and conditions will outline what your rights are and what you’ll do to remedy the situation.
You’ll need terms and conditions whenever you form a formal relationship with another party. Otherwise, you could leave yourself open to legal disputes or broken promises you can’t prove.
The terms and conditions of an agreement are only lawful if they’re fair. It has to strike the right balance and respect both parties’ relevant interests.
Terms and conditions can include the following clauses:
- Termination Clause
- Intellectual Property Rights
- Limitation of Liability
- DMCA Notice Clause
- Confidentiality Clause
- Enforceability Clause
- Governing Law Clause
- Severability Clause
Depending on the size of your business, you may need all of the included clauses, but most contracts will discuss what the parties can do if the agreement falls through.
They will also offer guidance to courts regarding the intent and the purpose of the document at the time it was created.
Discharge, vitiating factors, and amendments
A contract cannot be considered legal under contract law unless one of the parties can void it, either willingly or due to one or more vitiating factors.
Vitiating factors
A vitiating factor prevents an otherwise valid contract from being enforced.
The main vitiating factors under contract law are misrepresentation, undue influence, mistake, duress, illegality, incapacity, frustration, and unconscionability. We already discussed most of these vitiating factors earlier on.
Some businesses will take advantage of a person’s lack of contract knowledge, economic difficulties, or emotional state to make others sign unfair agreements.
However, they won’t hold up in court. A person who signs an unlawful agreement can choose not to follow the clauses in their contract without facing legal repercussions.
Discharge of contract
A discharge frees one or all parties from the obligations presented in a contract.
A discharge typically occurs in one of four ways:
- Discharge by agreement: All parties agree to terminate the contract.
- Discharge by performance: All parties fully performed their contractual obligations.
- Discharge by breach: One or more parties breached the terms of the contract. During a breach, the affected party can choose to dissolve the contract and claim damages.
- Discharge by frustration: If the situation has changed and one of the parties cannot fulfill their obligations because they’ve become impossible, the contract is dissolved.
Contract amendment
Instead of discharging the contract, the parties can agree to a contract amendment. An enforceable contract can be changed or modified at any time.
Most types of contracts allow for pre-signature and post-signature amendments.
Before entering into a contract, one party can outline in the agreement whether or not a contract amendment is possible.
However, acceptance must be provided by both parties for an amendment to occur, regardless if the legal contract states it could occur.
In the end, contract law ensures that both laborers and business owners are safe from shady deals and power imbalances.
What are the essential elements of a contract?
There are 7 essential elements an agreement must have to be considered a valid contract.
The elements of a contract include identification, offer, acceptance, consideration, meeting of the minds, competency and capacity, and legality. Preferably, the document will be in writing.
1. Identification
All parties involved in the agreement must identify who they are in the identification stage.
The law states that a contract requires updated information in the following categories, so the parties involved can locate one another if a dispute arises:
For businesses:
- Full legal name
- Registered office address
- Registration number
- Country of practice
For individuals:
- Full legal name
- Full address
- Trading name
- ID number
Since a basic contract is made up of two parties, you’ll probably identify the parties by name at the beginning of the document, followed by their titles and address, like so:
“This agreement is between John Jane, hereby referred to as “Homeowner,” and Construction Company, hereby referred to as “Company,” for the purposes of remodeling the Homeowner’s home on 444 Jamieson Street.”
The above example is also called a “contractual parties clause” and is used to organize the information of the parties and reduce redundancies.
2. Offer
An offer acts as a promise to do or not do something in exchange for something else.
Your offer should be firm, not ambiguous or vague, and include the duties and responsibilities of each party. These duties may be explained further in the terms and conditions of the agreement.
An offer doesn’t technically exist until it’s received by the requesting party. When it’s received, the offer can be altered, revoked, or terminated.
If a counter-offer is made, the original offer is terminated, and the parties will have to enter into negotiation once more.
An invitation to treat, while it looks like an offer, isn’t. An invitation to treat is an invitation to another party to make an offer and is common in real estate, marketing, and auto sales.
3. Acceptance
After an offer, acceptance of the offer comes shortly after. You can accept the terms of a contract either verbally or in writing, and inaction cannot be considered acceptance.
Most states follow the “mailbox rule,” meaning any offer that’s accepted via email or snail mail is considered “officially accepted” the moment a person sends the email or puts the acceptance letter in the mailbox.
For valid acceptance to occur, the parties must:
- Agree to all of the contract’s terms without any changes or conditions
- Wait until all the recipients of the offer mutually agree
- Have the capacity to enter the contract
- Accept the terms within a reasonable time frame
- Understand the risks they’re incurring when they sign
Certain vitiating factors can void a contract, so you have to make sure the terms of your contract are agreed upon. You can streamline this process by doing the following:
- Check the document for proper grammar and spelling
- Restate the terms of your contract and receive a verbal acceptance
- Place the acceptance statement at the beginning of the agreement
- State verbally what the parties need to do to accept the agreement
- Seek help from a law firm that can guarantee everyone’s acceptance
Remember that a written document is more enforceable and clear. It can be referred to if anyone claims to misunderstand the terms of your contract.
Plus, the courts take a contract more seriously when it’s in writing, so opt for a professional document when asking for acceptance.
If you want to implement contract risk management across your company, all of your agreements must be written.
4. Consideration
To have a valid legal agreement, one party must exchange something of value with another party.
A contract may offer things like products, protection, property, or services in exchange for money. Basically, the offer being made has to come with a price tag, or it lacks legality.
In instances where neither party is exchanging money, the parties must ensure the court would view what they’re trading (their consideration) as valuable.
5. Meeting of the minds
At this stage, both parties have recognized the contract, and both agreed to enter into its obligations.
The “meeting of the minds” may also be referred to as a genuine agreement, mutual assent, mutual agreement, and consensus ad idem.
Regardless of what you call it, you can only reach this stage if all parties pass the consideration, acceptance, offer, and identification stages.
Once the meeting of the minds is complete, the contract can only be voided via discharge, vitiating factors, or a mutual amendment.
6. Competency and capacity
Before entering into a contract, the parties involved must have the capacity to do so.
Also known as “consideration capacity,” a person who knowingly enters into a contract with a person who doesn’t have the capacity to sign the document could receive legal repercussions.
The courts may take a “consideration capacity” breach on a case-by-case basis, especially if the person who drafted the contract couldn’t guarantee the signer was incapacitated.
For example, a person may sign a document online while they’re drunk or under the influence of drugs.
However, they’ll be less generous if the courts can prove a person used the signer’s incapacitated state to coerce one of the parties to sign the document.
7. Legality
One of the most essential elements of a contract is its legality.
The whole point of contract law is to protect others from contracts that could be considered unconstitutional or illegal.
Since contracts require all participating parties to take on some degree of risk, it’s vital that the law protects those that mistakenly enter an agreement.
A person can’t enter into a deal with minors under the age of 18 or break any other laws in the process of forming the contract. Otherwise, it becomes void.
To protect your own rights, you should always use a written contract and include a dispute resolution clause in case of a disagreement between the parties.
Store your contracts with PandaDoc!
If you’re writing a contract, use our advice to ensure all of your agreements include the essential elements of a contract.
But, you can make the contract creation process even easier when you use our contract management software! With over 750+ legally binding templates to choose from, you won’t have to worry about compliance issues in your business ever again!
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