A function of contract is the legal recording of transactions between individuals or business entities. It usually exists because the two parties are each gaining a value and want to formalize the terms of their agreement.

A contract can be as simple as an oral agreement between two people that is settled with a handshake or as complex as a deal between two companies that takes months to negotiate, involves teams of lawyers on both sides, and consists of page after page of legal terms and conditions. One is just as binding in a court of law as the other, and in fact many written contracts begin with an oral commitment between two parties.

Key Elements of a Contract

The primary benefit of a contract is its enforceability. In the event that one party fails to fulfill its obligation as spelled out in the contract, called a breach of contract, the other party can bring a lawsuit to receive compensation for the damages incurred by the breach.

There are, however, several components of a contract that must exist for it to be considered valid in a court of law:

  • Offer. One party makes a promise to perform (or not perform) a task or provide goods to the other party.
  • Acceptance. In return, the other party gives their assent to the offer, and in doing so establishes a promise between the parties.
  • Capacity. The parties must establish that they have the ability to fulfill both the offer and acceptance.
  • Consideration. This is an obligation created by the offer being made and accepted.
  • Intention to create a legal document. Both parties enter the agreement understanding that it will be enforceable in a court of law.
  • Certainty. There must be no ambiguity as to the intention of the two parties.
  • Free consent. Both parties are entering the agreement of their own free will.

Of these elements, the first two, offer and acceptance, are the most important and form the basis for the existence of the other conditions. Back in the very early days of contracts, the agreement was proven to be legally binding through the presence of both parties’ legal seal on the document, hence the term “stamp of approval.” Today, all that is required to make a written contract valid is the signatures of both parties.

The Need for Contracts in the Business World

Without contracts, it would be difficult for companies to transact business. Companies are only willing to enter into agreements because they trust that established contract law has provided legal assurances that the assets exchanged are not in jeopardy should obligations not be fulfilled. In fact, it is the presence of these obligations, as well as the details of what will happen should one party not live up to their side of the bargain, that forms the backbone of most contracts.

In the US, the legality of contracts has been developed through both legislation and precedence. In other countries, the law has derived from religious texts, dictates by tribal leaders, decrees by political parties, and even the command of one individual. Depending upon their basis for existence, the laws may favor the rights of the consumer entering into a contract or tend to side with corporations in business dealings. In the US for example, many businesses choose to set up shop in states that are deemed to be “business friendly” in matters of contract law.

Regardless of the foundation of a country’s contract law, all contracts share a commonality. Contracts:

  • Allow businesses to plan for the future by providing a sense of normalcy in all business transactions.
  • Establish the relative value placed upon goods and services.
  • Establish expected standards of performance whenever transactions occur.
  • Provide assurance that obligations will be met.
  • Apportion risk between parties to a contract so that one party is not subject to onerous conditions.
  • Provide ways for parties to an agreement to seek remedies if obligations are not met.

With contracts in hand that provide fixed prices for materials and labor over an extended period of time, businesses can confidently make decisions they would otherwise be hesitant to make in an uncertain business climate. Avoiding risk is, after all, the ultimate goal of most businesses, especially those that have a fiduciary duty to act wisely on behalf of their shareholders.

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