Formation of Contract: Everything You Need to Know

Formation of a contract requires several important elements, including the goal of creation of a legal relationship between two parties.

Formation of Contract Basics

The easiest way to understand a contract is as a legal agreement between two parties. Several elements go into the formation of contract, but the initial step is one party making an offer and the other party accepting. At least two parties are required for a contract to be formed, as there must be both an offeror and an offeree. 

Another important factor in forming a contract is a meeting of the minds. This is when the two parties negotiate the terms of the contract, which they intend to be legally binding, and then agree on those terms.

If there is a dispute between the two parties, such as a breach of contract lawsuit, courts will examine multiple elements to determine if the agreement was valid, including the:

• Offer.
• Acceptance.
• Consideration.

Additional elements that can be examined include:

• Whether formalities were observed.
• The legal capacity, or lack thereof, of the parties.
• Whether the parties intended to create a legal relationship.

What is an Offer?

Making an offer is the first step in the formation of contract. With an offer, one party proposes to another that they will enter a legal contract with defined terms. The intent of the offer must be serious, and it should be easily understood by all parties involved.

An offer can also be understood as the inclination to enter into a legally binding contract as soon as the offeree accepts. It's important to understand that an invitation to treat is different from an offer. An invitation to treat means a party is open to hearing offers, which they will then decide whether to accept or not.

Offers can be made to individuals and even the world at large, meaning the scope of an offer can vary widely.  When an offer is made, it should include language that indicates the offeror is willing to enter into a contract without any additional negotiations taking place upon acceptance. 

Auctions are the perfect example of how offers work. When the auctioneer opens bidding, it would be considered an invitation to treat, as they are ready to hear offers. In this case, the offers are the attendees' bids. If the auctioneer accepts the bid, a contract is formed.

What is Acceptance?

Acceptance occurs when the party who was made an offer accepts it without qualification.

Acceptance can take place in many forms. For example, a person can accept an offer either verbally or orally and can also accept an offer through their conduct.  A contract cannot be legally binding unless the offer and acceptance match.

Several requirements must be met for an acceptance to be legal:

• The acceptance needs to mirror the offer.
• The offeree must have full knowledge of the offer before accepting.
• The offeree must clearly communicate their acceptance to the offeror. Once the acceptance has been communicated, the contract becomes binding.

If there is a condition that accompanies the acceptance, the contract is not binding. 

Making a Counter Offer

It's possible that the offeree can make a counter offer instead of accepting the original offer. With a counter offer, the offeree would propose new terms or a change in the original terms. The party that originally made the offer has the ability to either reject or accept the counter offer. Once a counter offer is made, acceptance of the original offer is no longer possible, as a counter offer is considered a rejection of the first offer.

Communicating Acceptance

As a rule, the offeree must clearly communicate their acceptance to the offeror. Contracts do not become legally binding until this communication occurs. The offeree can either communicate their acceptance themselves, or they can authorize a representative, such as an attorney, to alert the offeror that their offer has been accepted.

If someone accepts an offer without the authorization of the offeree, the acceptance is not considered legal.  Additionally, offerors cannot hold the offeree to contracts if no response is given. If the acceptance occurs via an instant form of communication, such as an email or telex, the contract becomes binding as soon as the offeror receives the notification. 

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