6 Essential Elements of a Valid Contract with Examples

An agreement does not need to be worked out in meticulous detail to become a contract. However, an agreement may be incomplete where the parties have agreed on essential matters of detail but have not agreed on other important points. 

The question of whether the parties have reached an agreement is normally tested by asking whether a party has made an offer which the other party has accepted. Agreements may not give rise to a binding contract if they are incomplete or not sufficiently certain. There will usually be no contract if the parties agree ‘subject to contract’ but never quite agree on the terms of the contract.

If the agreement is a stepping stone for a future contract or is an agreement to agree, then the agreement might be void for a lack of intention to create legal relations. Moreover, a domestic contract is presumed not to be legally binding in common law jurisdictions. 

For an example of a memorandum of understanding (MOU) concerning a joint venture, please see the link below: https://docpro.com/doc189/memorandum-of-understanding-mou-joint-venture-neutral

4. Consideration

Consideration constitutes something of benefit to the person who has the obligation or who makes a promise to do something (the promisor). It can also be something detrimental to the person who wants to enforce the obligation, or who has the benefit of the promise (the promisee). There is no need for an 'adequate' value: if some value is given for the promise, it would be sufficient consideration.

Where the consideration of one party is not absolutely clear, the agreement will generally include language such as ‘FOR GOOD AND VALUABLE CONSIDERATION, the receipt of which is hereby acknowledged’ in the recital. 

Alternatively, one can make the document in a deed without the need for consideration.  

What is a deed? 

If there is a promise to do something but the agreement lacks any consideration, then the agreement must be made in a deed. A deed is a document under seal that either (i) transfers an interest, right or property or (ii) creates an obligation which is binding on someone or some persons or (iii) confirms an act that transferred an interest, right or property.

Not all documents under seal are deeds. There are special requirements for the execution and delivery of deeds. For instance, a contract under seal is a deed. A contract contained in a deed does not require considerations. A person identified in the deed as someone to benefit from a promise can enforce a promise to pay money or can seek damages if the promise is not performed. 

However, equitable remedies (e.g. specific performance of obligations other than to pay money) are not available if there is no consideration.

For example, where a party would like to join an existing agreement without clear consideration, the party would enter a deed of adherence: https://docpro.com/doc379/deed-of-adherence-to-agreement-general

5. Legality and Capacity 

What would render a contract illegal?

A contract is illegal if the agreement relates to an illegal purpose. For instance, a contract for murder or a contract to defraud the Inland Revenue Department is both illegal and would therefore void contracts that are unenforceable. 

Certain contracts may also be unenforceable because they are immoral and against public policy. For example, contracts for sexual services may be unenforceable or even illegal contracts in certain jurisdictions: https://docpro.com/doc1137/relationship-contract-consent-short-term-sexual-open-relationship  

Severability

To avoid the whole contract being rendered unenforceable due to illegality, a boilerplate severability clause can be added to say that if and to the extent that any provision of the contract is held to be illegal, void or unenforceable, such provision shall be given no effect and shall be deemed not to be included in the contract but without invalidating any of the remaining provisions of the contract.

For examples of a boilerplate clause, please see below:

https://docpro.com/doc303/general-boilerplate-document-standard-agreement

Whether the other party has the capacity to contract? 

The law presumes that a party to a contract has the capacity to contract. However, minors (children under 18) and mentally disordered people do not have the full capacity to contract. It is for the person claiming the incapacity to prove their incapability to enter a contract. 

There are special rules which apply to corporations (including companies), unincorporated associations (including clubs and trade unions), the government (including any government department or officer), public authorities (including local government bodies, state-owned enterprises), organisations and charities. 

In what circumstances can a minor enter into a contract? 

A minor is capable to enter a contract for 'necessaries' (goods or services that are suitable to the condition of life of a minor). A minor who fails to pay for the goods or services can be sued for a breach of contract.

How about a mentally incapable person? 

In general, an agreement entered by a mentally incapable person will be void. 

However, a person that becomes mentally incapable later on can authorise another person to make legal decisions on behalf of them by granting the other person the power of attorney (POA).

For an example of a POA document, please see the link below:

https://docpro.com/doc1302/enduring-lasting-continuing-durable-power-of-attorney-medical-personal-care-3-attorneys

6. Certainty 

A valid contract requires reasonable certainty for the essential terms. If the parties fail to reach an agreement on the essential terms with reasonable certainty, then it may be contract void even if all other essential elements are present. 

What is an essential term? 

The definition of essential terms depends on what the parties have set out to achieve. In general, under common law, there are two essential terms: (i) consideration or price of a bargain, and (ii) price to be paid for the promised obligation.

Whether the term is essential is determined by asking whether the term is so important and fundamental to the contract that any breach of such a term will justify termination.

For commercial contracts, provided that the parties have shown an intention to be legally bound, the court can fill in the gaps through five special rules: 

• Constructing an essential term by referencing the agreed mechanism

• Constructing an essential term by referencing the contract as a whole 

• Imply an essential term by referencing to prior course of dealings 

• Imply an essential term by referencing the parties' post-contractual conduct 

• Imply an essential term by law 

For example, a sales and consignment agreement is a commercial contract : 
https://docpro.com/cat51/commercial-sales-and-marketing/sales-and-consignment-agreement

Above are the six essential elements of a valid contract. You should note, however, that the classic doctrine of contract formation has been modified by developments in the law of estoppel, misleading conduct, misrepresentation, unjust enrichment, and power of acceptance.

Since contractual obligations are only binding to the parties of the contract, the issue of third-party contractual enforcement raises the topic of privity of contract. This will now be discussed.

B. Privity of Contract

What is the Privity of Contract?

Privity of Contract is a common law doctrine that provides that a contract cannot confer rights or impose obligations that arise under the contract on anyone other than one of the parties to the contract. As such, the only parties who should be able to sue to enforce their rights or claim damages are the parties to the contract.

However, there are issues associated with contracts made for the benefit of third parties who are unable to enforce the contractual rights as they are not the contracting parties under the contract.

For example, Andrew and Ben entered a contract under which Andrew agreed with Ben to give a valuable diamond to Carrie. Both Andrew and Ben fully intended for Carrie to take the benefit of Andrew’s promise. Under the doctrine of privity of contract, if Andrew for some reason does not give the diamond to Carrie, Carrie cannot sue Andrew as she is not a party to the contract. Ben can sue Andrew for breach of contract, but Ben will only be entitled to nominal damages as Ben has not suffered any actual loss.

Right of Third Parties

In certain common law jurisdictions such as England, some states in Australia, New Zealand, Hong Kong, Singapore, and some provinces in Canada, the parties to a contract can agree that someone who is not a party to the contract can enforce a term of the contract.

This will apply to give a third party a statutory right to enforce a contract term where the term of the contract:

• Expressly provides that the third party may enforce a term of the contract; or

• Purports to confer a benefit on that third party

It is also possible to expressly contract out of such statutory right in these jurisdictions by including a term along the line of:

"No Rights under Contracts for Third Parties

 A person who is not a party to this Agreement shall have no right under any law to enforce any of its terms."

It is not possible to use a contract to impose an enforceable obligation on someone who is not a party to the contract. However, a similar effect may be achieved by conferring a benefit subject to the third party meeting a condition.

Joint and Several Liability

Joint liability arises where two or more people jointly agree to do the same thing. If either (or any) of the joint obligors (i.e. the people who have the obligation) perform the obligation, the others are discharged from their obligations.

There are strict technical rules of law that apply to joint liability. Liability can also be joint and several. This is where two or more people jointly promise to do the same thing or severally agree to do the same thing.

Performance by one will discharge the liability of all of them. It is presumed that liability is joint where a promise is made by two or more people. If this is not the intention, express wording should be included to make the obligation several.

For further tips on drafting a valid and enforceable contract, you can learn more here: https://docpro.com/blog/valid-enforceable-contract