1. Be Able to Apply the Requirements for a Valid Contract

1. Be able to apply the requirements for a valid contract

Definition of contract

A business contract is an agreement or set of promises enforceable by law made between two or more persons or businesses. There must be an intention to create a legally binding agreement between the parties and they must intend to give something of value as consideration to add worth to the contract.

Types of contract

A contract can exist in many different ways:

n They can be verbal where two people agree through the spoken word to be bound.

n They can be written where the details of the contract are included in a document signed by each person. (Some contracts must be in writing such as contracts for the sale of land, consumer credit and employment.)

Verbal and written contracts

Not every business transaction will require a contract, but it is important that you can recognise when a contract is needed and when it is not. It is just as important, however, to recognise the need for a written or verbal contract. Consider why certain contracts can be quite informal whilst others require formal procedures to be in place.

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Verbal or written contracts?

Consider the examples in the table below and decide whether or not a contract is required, what type of contract is required, and the reasons for your answers.

Type of activity / Contract required
Yes/No / Type of contract
Verbal/written / Reason
Employing a new member of staff
Selling a car on credit
Borrowing £10 from your parents
Selling a car privately
Applying for a credit card
Borrowing £1000 from a friend and agreeing to pay back £1100
Buying and selling a house

Standard form contracts

Businesses may choose to use their own standard form contracts. These forms contain terms that amount to ready-made contracts that suit individual business needs.

points for discussion

The problems with standard form contracts

g Discuss the problems associated with standard form contracts in business. Issues that might be considered are as follows:

§ They are one-sided and obviously favour the party writing them.

§ Non-business parties may not understand the term. They should be written in plain English.

§ Terms written should be ‘fair and reasonable’ and standard form contracts may struggle with this.

§ Over-reliance on pre-written contracts means that businesses lose the skill of negotiation.

Offers

Business contracts will consist of a series of offers and acceptances. An offer is a promise from one of the parties made with the idea that it shall become legally enforceable upon the person making it as soon as it is accepted by the person receiving it.

Invitation to treat

Many statements that appear to be offers are not binding and are in fact invitations to treat. These are statements showing an indication that a person is prepared to receive offers from another person. These can be accepted or rejected until the final moment of acceptance. Examples are:

n The display of goods with a price ticket attached in a shop window or supermarket.

n Products displayed in advertisements, catalogues, brochures and the Internet.

n The value of shares of a business issued in the Company Prospectus.

points for discussion

Invitation to treat- the contractual position

There have been many examples of mistakes being made by businesses about the price of their products. In 2003 the online retailer Amazon gave details on its website of a HP pocket computer on sale for £7! It was on the US Amazon website for $299 so it looked like a real bargain. The site was flooded with consumers buying in bulk. The site was closed and Amazon said the price was a mistake and that they would not honour any of the orders placed. They said that no contract had been formed and that a contract was only in existence when they send the consumer an e-mail saying their goods had been sent.

g What important contractual issue does this raise?

g Why were Amazon able to get out of honouring the contracts?

g From a business point of view were Amazon correct to do this?

Counter-offer

Offers should be accepted in exactly the same way as they are offered. If they are accepted differently the acceptance forms a counter-offer which can invalidate the original offer.

Communication of offer

An offer must be communicated to the other party so that they can accept it. It has to be certain and not too vague so that the person accepting it knows what they are agreeing to.

Acceptance

For a contract to exist, a valid offer (made by the offeror) must be accepted by the other side (the offeree). Several important factors should be considered when looking at acceptance. Acceptance must be communicated to the person making the offer, so that silence to an offer will not be acceptance of that offer. Acceptance must be in the form (if any) specified in the offer. If the offer is silent as to the method of acceptance, then only written or oral acceptance will be allowed. Acceptance does not have to be in the specified form laid down in the offer provided the method of acceptance used satisfies the offer. Acceptance of an offer must be without condition. The effect of a change in acceptance will have the effect of cancelling the original offer.

Acceptance by post is an exception to the above rule that acceptance must be communicated to the person making the offer. The so called ‘postal acceptance rules’ state that acceptance is considered to be effective as soon as a correctly addressed, stamped envelope is posted in a letter-box.

The Battle of the Forms

Legal difficulties have arisen in business law when companies deal with one another using standard form contracts, as businesses may make an offer and acceptance on their own forms. These standard form contracts often contain terms that conflict with the other side’s contract. These disputes are known as ‘The Battle of the Forms’. Unfortunately, often if a dispute arises, the only way to resolve the dispute is by going to court.

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The Battle of the Forms

Bell Computers had been supplying computers to the local council for many years. They offered to supply computers to the council for £173,000. The quotation included a term in a standard form contract called a variation clause that would allow the sellers to increase the price of the quotation. The council defendants accepted the offer on their own standard form contract that did not allow such a price variation. An agreement was made, and on delivery Bell had increased the delivery price to £200,000 because of transport costs and a weak exchange rate. The council is refusing to pay the extra money.

g What issues does this problem raise?

g Can you argue a business case for Bell increasing their prices?

g How would you settle the dispute?

Consideration

For a valid contract there must be some form of consideration between the parties.

Consideration is defined as something given, promised or done in exchange by each party to the agreement. It simply adds value to the set of promises in the contract.

Consideration can exist in two ways:

n Executed consideration where an act is completed in exchange for a promise such as a reward case.

n Executory consideration where the promise is yet to be fulfilled. Most business contracts begin in this way; for example, the promise of a seller to deliver to a buyer is consideration for the buyer's promise to buy at the agreed price on completion.

There are various rules of consideration that have to be considered:

n Consideration can never be past, so that something already completed by a party can never be deemed to be consideration for a promise later made by the other party.

n Consideration must not be illegal; a contract will not be valid if the consideration involved is illegal or considered immoral.

n In all valid contracts consideration must have some value, but there is no requirement for that consideration to be adequate, it should be merely sufficient. The value of consideration is agreed by the parties and the court will not help parties who agree consideration and then complain of making a ‘bad bargain’.

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Adequate or sufficient consideration

The rule that consideration need not be adequate but must be sufficient means that things that might be considered inappropriate might be classed as consideration on a contract.

Look at the following scenarios and discuss in groups whether you think sufficient value has been placed on the consideration in the contract.

Activity / Adequate or sufficient consideration?
Collecting 1p vouchers from sweet wrappers in exchange for free music downloads
Using a new slimming drink for the prescribed amount of time and losing weight to claim a slimming prize being offered by the company
Looking for a lost cat to try to claim a reward for finding it
Spending five hours of your time as a finance broker trying to find a business loan for your client

points for discussion

Contracts – a personal view

g Consider situations when you may have entered into a contract recently. It might have been buying a sandwich from your centre shop, buying a new MP3 player or booking a holiday with friends. Whatever the situation, you will have formed a contract. List the key contractual points in the table below.

Scenario / How was the offer made? / How was the offer accepted? / What consideration was given? / Did both parties have capacity?

The Contracts (Rights of Third Parties) Act 1999

This Act creates the law that allows third parties to have rights in a contract that affects them.

To gain rights under the Act, the third party must be clearly identified by name, class or description, and all remedies will be available to a third party as if he was a party to the original contract made between the original parties.

Capacity as applied to business situations

A person or business must have legal capacity (or power) to enter into an agreement. This is vital if a contract is to be created. There are certain groups that only have limited capacity to enter into legal agreements.

Minors

Legal rules have been developed to protect minors (those under 18) from contractual liability and to allow them to also enter into agreements in limited circumstances. Generally, there are two types of contract that will bind a minor when dealing with adults or businesses: contracts for the supply of necessary goods and services and beneficial contracts of service.

points for discussion

The problem of minors entering into a contract

g Try to think of examples when minors might be able to enter into valid business contracts. Why are minors excluded from making business contracts? How can they get round this problem? For example, they might be able to get somebody to stand as guarantor for them on the contract.

Incapacitated persons

Incapacitated persons cannot enter into a valid contract as they do not have sufficient mental capacity to understand what they are doing.

Organisations have varying capacity depending on the type of organisation.

Registered companies

Companies are created by registration under the Companies Act 1985 (as amended).

The company in law has a legal identity of its own and can sue and be sued on contracts made in its name. The company's power or capacity to contract is limited and defined in the Objects Clause of its Memorandum of

Association. Companies cannot form contracts before they are legally created.

Unincorporated associations

These are groups of people joined together in a common interest such as a sporting, social or political group. These groups are not considered legal bodies and capacity to contract belongs to members personally or jointly and not with the group. The group cannot make contracts in its name.

Partnerships

Partnerships are governed by the Partnership Act 1890. Under this Act each partner has capacity to contract on behalf of all the partners, and therefore each is liable jointly on any contract entered into on behalf of the partnership.

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Acceptable contracts

Consider whether it is acceptable for your business to make a contract with the following people:

§ John is 17, learning to drive and wants to buy a sports car using car finance.

§ Alan, who has a severe mental illness and is in a secure hospital, wants to buy a shotgun from you.

§ A company is about to be set up, but before it is registered they order a supply of office equipment from you.

§ A local amateur dramatic society has entered into a contract with you to provide lighting at their theatre.

§ The senior partner in a firm of solicitors has ordered 12 new computers from you.

2. Factors which invalidate or vitiate a contract

A binding agreement between two or more parties will form a valid contract. A binding contract will only be formed when there is consent between the parties and the agreement is genuine. There are a number of factors that will invalidate or vitiate (corrupt) an agreement.

Misrepresentation

Before business contracts are made, there may be a series of negotiations or talks between the parties. These talks will be a series of representations forming the agreement that is the basis of the contract. If these representations are in fact wrong or they are misrepresentations, then the contract may be in doubt.

A misrepresentation is a false declaration of fact made by one party to the other before the contract is made and is aimed at attracting or inducing the other to agree to the contract.

A misrepresentation is a positive statement made by a party. There is, however, no legal duty to disclose facts, and silence will not normally amount to a misrepresentation unless the contract is made in good faith where one party alone is in the possession of all the facts that form the basis of the contract. Here there is a legal duty to disclose relevant information.