1. The Offer
2. Acceptance
3. Consideration
4. Mutuality of Obligation
5. Competency and Capacity
6. Other Considerations
7. Types of Contracts
8. Why Are Contracts Necessary?

The 5 elements of a legally binding contract are made up of:

  • An offer.
  • Acceptance,
  • Consideration.
  • Mutuality of obligation.
  • Competency and capacity.

Sometimes additional components are involved to protect the interests of all the parties.

A contract involves two or more parties who are competent to enter into a legally binding agreement. While a contract can be verbal or implied, it is usually in writing. If a contract is enforceable, a court can compel the parties to follow through on what they agreed to in the contract.

A legally enforceable contract is more than a casual promise between friends. The purpose of a business contract is to place legal requirements on the parties to follow through on the agreement. The legal system is available to mediate if a party breaches the terms of the contract.

The Offer

An offer is a verbal or written promise to take some action or to refrain from acting in exchange for a set of agreed upon terms. Verbal offers can be difficult to prove if the situation gives rise to a court case. This method of contracting should be avoided when possible.

Acceptance

Just as offers can be verbal (though it's not recommended), acceptance can also be done verbally. In business contracts, the terms are almost always handled in writing so that they are clear. In order to make sure everyone understands the terms, the offer should clearly lay out the points that involve acceptance, such as expiration dates, rights of revocation, and the appropriate forms of acceptance.

Consideration

Consideration is the value that each party brings to a contract. This might be monetary, or it may take the form of a promise to carry out a particular act. Performing an act can be defined as something a party is expected to do or something the party is expected to refrain from doing. These expectations should be spelled out clearly rather than left up to the law to interpret.

Mutuality of Obligation

The mutuality of obligation is the binding agreement between the parties to the terms of consideration. If one party holds more leverage, such as a right to cancel, a court may consider whether or not mutuality of obligation has been met. If it is not met, the court can invalidate the contract.

Competency and Capacity

The contract requires that each party be legally competent and have the capacity to agree to the terms. Minors and people with limited mental capacity are not considered competent. A court will usually find that such a party does not have the capacity to enter into a legally binding contract.

Other Considerations

While these aren't part of the five essential elements, certain elements are required for a contract to be legally binding.

  • Lawful purpose: The law requires that a contract serves a legal purpose.
  • Written documentation (usually): Many states require that some types of contracts, usually those involving more than $500, be in writing in order to be enforceable. Some examples are contracts involving the buying or selling of land, those with a life of more than one year, marriage contracts, and those involving one party paying the debts of another.

Types of Contracts

  • Definite quantity contract: This is an agreement that one party will deliver specific amounts and types of goods or services at a specified time and price.
  • Firm-fixed-price contract: This is an agreement in which a contract receives a set amount of money from a customer for providing all goods or services up front. The contractor takes the risk if it's not possible to control the costs of the job.
  • Fixed-price contract: This is an agreement with adjustable pricing, including a maximum price and a target price, subject to the terms of the contract.
  • Time and materials: This is an agreement in which a customer pays a contractor directly for the materials involved in the job and a fixed hourly rate for the labor.

Why Are Contracts Necessary?

Without legally enforceable contracts, society couldn't function as it does. Contracts let people hold jobs, start businesses, attend school, worship as they wish, participate in sports, and more. In many ways, human interaction is largely based on a series of agreements between individuals.

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