What are the components of an enforceable contract? In other words, if you or your business makes an agreement with another person or entity, what makes the agreement enforceable? Let’s review of some of the technical and practical considerations for contract enforcement.
Must it be in writing?
The general rule is that a contract must be in writing, though there are technical exceptions to this rule. But, practically speaking, every contract should be in writing. Not only does it allow the parties to thoughtfully craft the terms of the agreement in a way less ambiguous than speech, but it provides important proof of the exact terms of the agreement. An oral agreement might be sufficient in certain limited circumstances, but the better practice is to put it in writing.
What are the requirements for a contract?
There are three basic parts to an enforceable contract. First, there needs to be an “offer” from one party. Second, there needs to be “acceptance” from the other party. Finally, there needs to be some kind of “consideration.” Consideration is the most difficult concept to grasp, but in basic terms it simply means that something of value must be exchanged between the parties as part of the transaction.
Offer and Acceptance
The first two components, offer and acceptance, are relatively easy to grasp. If Bill offers to do something (and that something can be broad – provide goods or services or act a certain way or refrain from acting a certain way, etc.) and Betty agrees, then we have an offer followed by an acceptance – the first component of an enforceable contract. But, if Betty were to change any of the terms in response to Bill’s offer, even slightly, then Bill would need to accept the modified offer before the first component of an enforceable contract is met.
Consideration
Not only must Bill agree to do something, and Betty accept, but Betty must offer something back – consideration. So, if Bill offers to build a sidewalk for Betty and Betty accepts, there is no enforceable contract yet—even if its in writing. Betty needs to offer something back to Bill. Usually, one might think of money (Betty agrees to pay $1,500) as the normal consideration for a contract. And, maybe that’s true in most cases.
But, consideration can be anything. For example, in exchange for building the sidewalk, Betty might promise to cook dinner for Bill the next seven nights. Or, Betty might promise to take down a yard sign that Bill finds offensive. Or, Betty might agree to compete in a marathon. Or, Betty might promise to allow Bill to participate in her pinochle tournament. As is evident, the concept of “consideration” is broad.
Practically Speaking, Enforcement Requires High Level of Damages
Once you have the offer, the acceptance, and the consideration (and preferably the agreement is in writing), you have an enforceable contract. Regrettably, not every validly enforceable contract is worth enforcing. Our legal system is set up in such a way that the costs of enforcement can be substantial. And, while legal and court costs can vary wildly from case to case, there are some minimum efforts and costs incurred in every case. For example, let’s look at two cases. In the first case, two parties enter into a valid contract for Bill to provide Betty a new concrete sidewalk for $1,500. Betty pays Bill but Bill doesn’t do the job to the contract specifications. Contrast that with the second case where Bill is to provide concrete to all of Betty’s housing development for a cost of $150,000. Again, Bill either doesn’t do the job or doesn’t do the job to the contract specifications. The cost of enforcing either contract with an attorney would be substantial because attorneys charge hundreds of dollars an hour. In the first case, it is not practical for Betty to engage an attorney as the costs of enforcement would likely be higher than the cost of the damages ($1,500). Conversely, in the second case, it would be economically feasible to have an attorney enforce the contract. This example is simplistic and ignores things like small claims court and contractor insurance. Nonetheless, the reality is enforcement costs money so the injured party should weigh that before attempting to enforce.
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* Licensed, not practicing.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.
