A contract is an enforceable agreement between two or more persons or entities pursuant to which the parties undertake binding obligations. The vast majority of all business — both personal and commercial — is conducted pursuant to contracts, either oral or written, and courts of law decide disputes between parties to contracts. The four basic elements necessary for formation of a valid contract are capacity, offer and acceptance, consideration and compliance with law and public policy. Also, implicit in every contract is a duty to act in good faith and deal fairly with the other party.
CapacityEach person or entity must have legal capacity or authority in order to enter into an enforceable contract. Examples of persons who lack capacity are minors, those adjudged legally incompetent, and persons under the influence of mind altering drugs or alcohol. For a company to have capacity to enter into a contract, it must be duly existing and organized under the laws of a state, and the person signing on its behalf must have authorization to do so from the board of directors or management of the company. Note that the law presumes that every person or entity who enters into a contract has capacity, and the party alleging lack of capacity will be faced with the heavy burden of proving otherwise.
Offer and AcceptanceEvery valid and enforceable contract involves an offer followed by an acceptance. There is no contract unless the offer is accepted. Thus, if John offers to sell his collection of baseball cards to Joe for $500, and Joe’s response is to offer $250 instead, Joe has not accepted John’s offer. Instead, he made a counter-offer that can be accepted or rejected by John. Both the offer and the acceptance should be clear and unambiguous; once the offer has been accepted, the parties are said to have had a “meeting of the minds.”
ConsiderationThe third necessary element of a contract is consideration. Consideration is defined as something of value in exchange for something else of value. It can take the form of payment of money for property, goods or services,; the exchange of property or goods for other property, goods or services, or the exchange of services for services. In addition, consideration can take the form of a promise for a promise—a promise to do or not to do something, so long as the promise is not illusory and there is a benefit for or detriment to each party. Note, however, that potential or accidental benefit or detriment will not constitute valid consideration; and a party’s promise to do something he or it is already legally obligated to do would not constitute valid consideration.
Legal Purpose and Public PolicyThe fourth and final essential element of an enforceable contract is that its object must be both legal and consistent with public policy. Contracts for prostitution or for the sale or use of illicit drugs are invalid and unenforceable. Similarly, some states will not enforce contracts relating to horse racing or gambling, or contracts in furtherance of restraints of trade, price-fixing and monopolies.