Recent Articles

What is a Contract?

shoveling snow

Article 1 of the Uniform Commercial Code copyrighted by the American Law Institute is considered the primary source for the definition of a contract.  All of the 50 states have incorporated all or most of the definition of this code as statue.  A contract is defined as a legal obligation between two or more parties.  A contract has to have four elements for it to be binding on the parties.  These are 1) an offer, 2) acceptance, 3) consideration and 4) performance.  This is the core definition.  It does get more complicated as you move towards business agreements and I will reiterate a very important belief; THERE IS NO SUBSTITUTE FOR GOOD LEGAL ADVICE AND COUNSEL.  I am not an attorney and this article is written to assist you in understanding a basic tenet of business. 

Contracts are most often verbal between two parties.  A very common type is between an owner of property and someone doing a small job of some sort.  As an example, after a snowstorm, the neighbor’s kid comes to your door and says ‘I’ll shovel your driveway for $15’ and you agree.  So he makes the offer – element one; you accept – element 2; there is consideration of $15 – element three; and once he performs – element four you owe him $15.  This is the simplest example of a contract between two parties.  But in business, it isn’t that simple.  Oral agreements are not a good idea, because nothing is as simple as shoveling the driveway.  And even with something as simple as shoveling the driveway, there can be a lot of misunderstanding.  The boy may not realize how wide your driveway is.  Or it keeps on snowing and after he is done, the part where he started has another ¼  inch of snow accumulated.  So you can see that having a legal document between you and the other party is important in the business world.

From a vendor agreement to a franchise agreement, many business contracts can be as short as one page long to over 200 pages in length.  So you need to fully grasp the concept.  But always remember the four essential elements of a contract and make sure you identify them before you agree and sign on the bottom line.

OFFER

What is an offer?  This is basically a statement of what one party is willing to do in the due course of business.  Just as the boy offered to shovel your driveway, both parties need to understand what the offer includes.  With vendor suppliers, what exactly are you providing, when would you provide the items, what level of quality are we talking about.  How are you going to provide this and what is included in the offer.  Note that this one element asks the questions of who, what, when, where, and how of the transaction between the two parties.  It is important for both to fully grasp the offer.

ACCEPTANCE

Acceptance gets a little more complicated.  This is due to misinterpretation between parties.  Often the party making the offer can misunderstand the response from the second party.  So in any legal proceeding acceptance can be express, conditional, or implied. 

· Of the three types of acceptance the best for any contract is the expressed acceptance, in our simple example above, the homeowner accepts the offer by the boy by just saying ‘OK’.  In business agreements, it can be this simple or acceptance is done by signing the contract.  Express acceptance is clearly interpreted and explicitly understood between the two parties.

· Conditional acceptance is sometimes referred to as a qualified acceptance, like a counteroffer.  I’ll agree to you shoveling the driveway, if you include the sidewalk.  Notice that this puts the onus back onto the boy to decide now if he wants to accept the new terms of the contract.  Common conditional issues are related time constraints, third party approvals, or the consideration amount is modified.

· Implied acceptance is where much confusion starts.  The person receiving the offer doesn’t expressly state acceptance but makes acts as if he is accepting the deal.  An example would be instead of saying to the boy that ‘NO’ do not shovel the driveway, you instead wave the boy away but you wave him towards the driveway with a backward wave of your hand which can be interpreted as ‘Go Ahead’ from the boy’s perspective.  After about 5 minutes of him shoveling the driveway, you look out the window and both of you see each other and smile.  It is at this moment that you can either go out and stop the boy from continuing the service because of the misunderstanding or by doing nothing you implicitly accept the terms of the deal.

CONSIDERATION

Once acceptance is made, consideration is required.  An agreed amount of financial implication is essential to a deal.  For our deal, it is $15 to shovel the driveway.  But in the business world, it gets a lot more complicated.  Often the product or service isn’t exactly 100% of what we agreed to in the offer and acceptance portion.  Many written contracts account for this possibility.  Terms such as ‘like’ or ‘similar’ are used to describe substitution in the agreement thereby negating the full compliance to the agreement.  So the question becomes do you pay the full amount.  The answer in the business contract is generally yes and you will be held to that standard.  

PERFORMANCE

The final element is performance.  If the offeror completes the task or provides the product, than one side of the contract is now complete and you must pay the consideration as negotiated.  But sometimes there is a misunderstanding between the two parties and so the question becomes, did he perform his side of the contract?  So in our example, the boy shovels the driveway, but puts the snow onto the side of your car whereby you can’t get the door open to get inside!  So the question becomes, did he do his job as offered?  Well, he shoveled the driveway so technically he fulfilled his side of the bargain.  But common sense tells everyone that you don’t shovel the snow in such a way as to block the door of the car.  It defeats the purpose of shoveling the driveway. 

In a court of law, any reasonable judge would most likely say that he failed to perform as agreed.  It is implied that you will shovel the snow a reasonable distance away from the driveway.  So thereby you do not have a fully completed contract.  However, he would probably say that the boy has partially fulfilled the contract and award some consideration to the boy for that partial fulfillment of the contract.  In addition, the judge would be lenient because the plaintiff is a boy and award him a good portion of the consideration.  Naturally, nobody would go to court over $15.  You would counsel the boy on his error and award him the $15 and move along or have him shovel the snow away from the door.

So using the example of the verbal agreement to have the driveway shoveled we can see that there are essential elements involved in a contract.  An offer, acceptance, consideration, and performance are all required to make a contract enforceable.  Use the Uniform Commercial Code as your guide in negotiating a contract.  Review what your state statues are for contracts and gain a true understanding of what is required before proceeding in business.  Act on Knowledge.

If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org.  I would love to hear from you. If interested in my services as an accountant/consultant; click on My Services in the footer of this article.

 

If you found this article helpful, please consider a donation to the site.  The donation button is just to the right.  Even if you don’t make a contribution, I encourage you to read more articles on the website to help you become a better business entrepreneur.

 

About David J Hoare (386 Articles)
I spent 12 Years as a Certified Public Accountant, Over 20 Years of Practice in Accounting and Consulting, Controller in Management of Closely Held Operations, Masters of Science in Accounting, Prepared over 1,000 Business Tax Returns and Hundreds of Individual Returns

Leave a comment