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Contract

A contract is defined as any oral or written agreement between two or more parties that exchange rights and/or duties between the parties.  Every contract has four essential elements.  The first two create ‘mutual assent’ or what is commonly referred to in law as a ‘meeting of the minds’.  They are as follows:

Offer – one party offers up some right or duty to one or more other parties.  Most often the offer comes with terms and/or conditions such as the quality of the product or service, delivery form and date for delivery.  In many more complicated contracts, these terms and conditions can be extensive such as in a contract to build or an insurance agreement.

Acceptance – once an offer is made, the party or parties to the offer must approve to create mutual understanding.  Often, the party to the offer doesn’t like the terms or conditions and counters back with some modifications.  In a construction contract, the counter offer might be the quality of materials used in construction or how the project is inspected for approval. 

The key to these two elements is the creation of mutual understanding between the parties.  Once the understanding is established, the parties must agree to the price involved.  This is referred to as Consideration.  Even though there is a meeting of the minds and the price is set for some dollar amount or time commitment there still is no binding contract.  To bind the parties, one of the parties has to perform. 

Performance legalizes the contract provided the other three elements exist.  If one party puts up the money and the other party has indeed agreed to the offer and agrees to the consideration, then a contract is in place.  This is one of those areas of law where many people misunderstand a contract.  If neither party has performed in accordance to the offer and the consideration, then no contract exists.  Just because there are signatures doesn’t mean you have a contract.  Allow me to provide some examples:

  • A contract exists between a customer and a contractor to build a home.  The customer has not provided any deposit or prepayment as of yet and the builder has done no work to date.  This is a very common example of a non-binding contract.  One of the two parties must perform.  Note that the physical piece of paper has the offer, the acceptance and the consideration set, but neither party has performed.  Therefore, the contract is not binding.  However, if either party performs to any degree, then the contract becomes binding between them.
  • One of the most common forms of contract is an employment agreement.  These agreements stipulate the services to be rendered, the value equated with the service, the commitment levels (hours of day or extended period of time) and often the expected results.  In general, the employer is not obligated to pay if the employee fails to show up to work.  The exception to this exists in sporting contracts.  Often, signing bonuses are offered which then qualifies as performance.  Now the athlete has to perform. 

Sometimes, people believe they have a contract because they performed a service.  The best example of this is in the big city while in your car.  Some guy rushes up to your front windshield and sprays on some cleaner and begins to clean the windshield.  The window cleaner thinks he now is entitled to compensation for a service rendered.  He didn’t go up and make an OFFER, the driver gave no ACCEPTANCE, and there was no agreement to CONSIDERATION.  The driver is not bound to pay any compensation for the service rendered.

Most state codes require a written contract for certain types of transactions.  The most common is real estate transactions.  As a reader, you need to remember that any real estate related transaction requires a written contract between the parties.  This includes the construction of buildings, any modifications to the site, or financing with real estate as collateral.  In most states, for the financing aspect of real estate or the associated construction of facilities, the agreement (Deed of Trust) must be filed with the local circuit court.  Other required written contracts include insurance related agreements, administration of an estate, and contracts for the sale of goods in excess of a certain value (as set by state law).

If you desire to understand a simple illustration of a contract, I have written a short example of an agreement between a boy and the home owner for the service of shoveling snow: What is a Contract? This example illustrates all four of the elements and some variations of the elements involved.  When conducting business, always look for the four elements in every contract or agreement you participate and negotiate.  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 help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.  

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About David J Hoare (395 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

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