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Most assume that once one party has made an offer and the other party has accepted, a contract has been formed. In reality, however, there are six elements that must be fulfilled for a valid, legally binding contract to exist.
A contract is valid and legally binding if the following six key elements are present:
(i) Offer
(ii) Acceptance
(iii) Intention to create legal relations
(iv) Consideration
(v) Capacity
(vi) Certainty
Each will be explored in turn below.
(i) Offer
An offer is a specific proposal by one party, which if unconditionally accepted by the other party, can result in a valid, legally binding contract. For example, if a company tells you that they are willing to sell you 10 bags of rice in exchange for $1,000, the company is making an offer to you. An offer can be made orally or in writing.
It is important to distinguish between an offer and an invitation to treat. An invitation to treat is an invitation made by one party to another for the latter party to make an offer. The former party can then elect either to accept or reject this offer. An invitation to treat does not constitute an offer.
In order to create a valid contract, an offer must be made, which is then subsequently accepted. Accepting an invitation to treat will not lead to the creation of a valid contract. Invitations to make tender offers, advertisements of goods in newspapers and displaying goods in shops are all examples of invitations to treat and not offers.
(ii) Acceptance
Acceptance is an agreement to the terms of an offer. Until the person to whom the offer is made accepts the offer, there is no valid, legally binding contract.
Normally, acceptance must be communicated to the offeror. Ordinarily, contracts are accepted orally or in writing. Generally, silence cannot be treated as an acceptance.
In some cases, acceptance can be by conduct.
Example: Let’s say you draft a contract for the supply of certain goods and send it to your supplier. This constitutes the offer. Your supplier then starts supplying the goods to you, without explicitly communicating their acceptance of your offer. In this instance, the conduct of the supplier may be regarded as constituting acceptance.
To avoid any uncertainty regarding whether there has been accepted, the method of acceptance should be agreed to and specified by the parties to a contract.
When considering whether there has been accepted, and when acceptance has occurred, a few important rules should be borne in mind:
- Postal Rule: If the post is used for acceptance, then acceptance is said to occur at the point in time at which the letter is posted.
- Receipt Rule: If oral communication is used to accept an offer, acceptance is said to occur when the oral communication is received by the other party. If a fax is used for acceptance, acceptance is deemed to occur when the message is delivered to the other party, even if that party does not in fact read the message until much later. The same rule also applies to e-mail messages.
If someone purports to accept an offer but does so on different terms, that will be a counteroffer rather than an acceptance. To put it another way, if a person accepts only some of the terms of an offer or accepts the terms of an offer subject to some specified conditions, that person is not considered to be accepting the offer but making a counteroffer to the other party.
(iii) Intention to create legal relations
The parties must have an intention to create a legally binding contract. ‘Legally binding’ means that should a party not fulfil any of their obligations stated in the contract, the other party can sue them.
When two parties enter into a commercial transaction, it is presumed that the parties have the intention to create a legally binding contract. This presumption can, however, be rebutted, if the parties expressly state that they do not intend to make a legally binding contract.
(iv) Consideration
Consideration refers to a detriment to the person making a promise or benefit conferred on the other party.
Example: Let’s say Company A agrees to sell 10 bags of rice to Company B for $500 HKD. Company A’s consideration is the 10 bags of rice. Company B’s consideration is the $500 HKD.
It is important to note that there is no need for the consideration offered by a party to be adequate. In practical terms, this means there is no requirement for the buyer of goods or services to offer consideration commensurate to the fair market value of the items being purchased.
Example: If Company A agrees to sell 10 bags of rice to Company B for $1 HKD, Company A cannot go to court and claim the shortfall between the fair market value of the 10 bags of rice and the $1 HKD.
A promise by one person to gift something to another party will not constitute a legally binding contract. This is because there will be a lack of consideration – only the donor has consideration, and the recipient is not offering any payment in exchange for the gift and is not offering any consideration.
If consideration is clearly not going to be offered by one party, the promise can be made legally binding by using a special type of contract called a deed.
(v) Capacity
Certain persons are considered, by the law, to lack the capacity to enter into contracts. Contracts entered into by persons who lack capacity are voidable – the contract can be annulled by the person who lacks mental capacity.
Lunatics (people who suffer from mental disorders or who are intoxicated) and minors (people under the age of 18) lack the capacity to enter contracts under Hong Kong Law.
Minors can enter into contracts for the purchase of “necessaries”. This is an exception to the above general rule that minors lack the capacity to enter into contracts. “Necessaries” is a legal term which refers to goods suitable to the condition in life of a minor and to his actual requirements at the time of the sale and delivery. Examples of “necessaries” include drinks, food, or clothes.
In practical terms, this exception means that should a minor enter into a contract to purchase certain “necessaries”, they can be sued if they fail to pay for those goods or services.
(vi) Certainty
A valid contract requires that it be certain. It should not be vague or unclear. A valid contract should also be complete. It should not lack certain essential terms.
If the parties fail to reach an agreement that is both certain and complete, the agreement might be void even if all other essential elements are present.
