Contracts are essential to growing your business. They mark exciting milestones, including building new business relationships, extending existing ones, and closing transactions.
The World Commerce & Contracting organization found the average Fortune 1000 company has 20,000-40,000 active contracts at any given time. Of these, written contractual agreements govern 60-80% of business transactions.
Unlike contract signing, creating new contracts can be a lengthy, time-consuming, and tedious process—especially if your business still uses a manual contract generation processes.
A well-drafted contract with a solid customer experience can mean the difference between closing a deal and losing one—that’s why you need to master the contract creation process.
This article shares the elements of a valid contract, types of contracts, and how to create one from scratch.
Elements in a Valid Contract
No matter what industry you’re in, there are key elements shared in every contract. Without certain elements, a contract would not be legally binding and may not be enforced by the courts. So, knowing what to include is essential for protection.
Let’s review the seven key elements that must be present for a contract to be valid, binding, and legally enforceable.
Offer and Acceptance
Before forming a contract, one party (the offeror/business owner) must make an offer that another party (the offeree/client) either accepts, revokes, alters, or terminates.
An offer has two parts:
- The expression: When the two parties express a desire to enter into a legally valid contract through a verbal discussion, written formal letter, or other forms.
- The intention: A presumption by the two parties that the contract will be legally binding and enforceable, and they intend to uphold its obligations.
If the offeree accepts the offer—which involves signing the contract through a wet signature or eSignature—the two parties will exchange products and/or services. In some cases, the offeree can extend a counter-offer, which terminates the initial offer, leaving the parties free to negotiate the new proposal’s terms.
Offers can also be deemed accepted without physical signatures. A party can use conditional acceptance, where the offeror must meet certain contract terms or take certain actions before the other party finalizes the acceptance. For example, if the offeree orders goods at a set price and the offeror ships them, it may be perceived as acceptance with or without signatures.
However, under most contract laws, silence and inaction don’t constitute acceptance. So, not rejecting an offer doesn’t necessarily mean acceptance.
Consideration
Consideration is what the offeree agrees to give up or pay in the contract to get what they want out of it and meet their obligation or commitment to the offeror.
Money is the most common form of payment, but parties don’t need to exchange money for consideration to be valid. In practice, anything else of value, such as services, a promise to act or promise to refrain from acting, or personal or real property which the offeror receives as part of the contract can be a consideration.
Without clear consideration, a court might consider the contract invalid. Some examples of what doesn’t qualify as consideration include:
- Promises of future gifts
- Illusory promises that a party isn’t obligated to fulfill
- No mutual agreements between the parties on consideration
Capacity
To enter a contract, both parties must have legal capacity. This means the offeror and offeree both understand the contractual terms, obligations, and consequences that flow from the contract before signing it.
If the parties lack contractual capacity, then the agreement will be invalid or void. And, if either party breaches the contract, they could face legal action and a range of remedies for failing to honor its obligations or business rules.
A person without contractual capacity either lacks:
- Mental ability: The individual is incapable of understanding the contract and its consequences. Such people include minors, people suffering from certain psychological conditions or mental illnesses, or those under severe intoxication.
- Signatory authority to contract: The person signing the contract wasn’t an authorized signatory or isn’t empowered to sign on behalf of the offeror (another individual or business).
Legality
A contract needs to be legally enforceable for the courts to impose it on both parties.
Legality is a key element for contracts in certain jurisdictions. However, if you’re in the US, you might find disagreement between federal and state contract laws—in which case the Contract Clause of the US Constitution will prevail.
A contract may no longer be legal if:
- A party used threats, coercion, unsuitable persuasion, or false statements to get the other party to sign the agreement
- The contract triggers oppressive obligations or results
- There’s a violation of public policy or danger to general welfare
- An error in the contract has material effect on the initial contract terms
- Circumstances beyond the parties’ control render performance impossible
Certainty
A contract is legally enforceable when it has enough certainty and both parties agree to the terms required to carry out the contract. Parties to a contract often dispute in a newly formed agreement or where there’s no consensus around their rights or responsibilities.
To check for certainty, the courts will consider whether:
- The parties can consensually agree to enter into a legally binding relationship
- The contractual terms are unclear, vague, or ambiguous
For example, if the contract is for sale of goods but the parties disagree on what “goods” are, then it’s an uncertain contract and the courts may not enforce it based on its vagueness or uncertainty.
Genuine Consent
For a contract to be legally binding, both parties must agree or genuinely consent of their own free will to contract.
Several issues can affect genuine consent during contractual negotiations, such as:
- Undue influence by one party over another
- Mistakes on the contractual terms or a person’s identity
- Misrepresentation before making the contract
- Duress, unconscionable/harsh conduct, or threats of violence to one party to obtain a contractual promise
These or other issues may mean consent wasn’t genuinely or freely given by one of the parties, meaning they may avoid their contractual obligations.
Types of Contracts
Written Contracts
A written contract is a printed document detailing what parties can or cannot do. This legally binding and enforceable agreement protects the terms of the agreement between the parties who wish to exchange something of value.
Verbal Contracts
Verbal or oral contracts are agreements between two or more parties made through spoken words but aren’t written down. A verbal contract can be made in person, over the phone, or other spoken methods, carries as much weight as a written one, and is legally binding and enforceable.
Express vs. Implied Contracts
An express contract is a legally binding agreement made in writing or verbally and contains clearly stated terms between the parties to the agreement.
Implied contracts are more ambiguous because they’re not verbal or written, don’t explicitly state the agreed upon terms, and have no signatures. Instead, implied contracts are inferred by how a person behaves or acts that suggest they’d like to enter into a contract. While these traits make implied contracts harder to enforce, they’re still legally binding if they satisfy the essential contract requirements.
Unilateral and Bilateral Contracts
A unilateral contract involves only the offeror, who makes a promise or agrees to do something, legally binding that person, while a bilateral contract involves at least two parties agreeing to do something.
Unilateral and bilateral contracts differ based on:
- Number of people promising to do something: Unilateral involves only one person while bilateral involves at least two parties.
- When the exchange happens: In a unilateral contract, the exchange happens when a certain action is complete. In a bilateral contract, parties can exchange upfront.
- When it’s used: In a unilateral contract, there’s no guarantee something will be completed compared to a bilateral contract, where both parties have that guarantee based on the legally binding terms of the contract.
Executed and Executory Contracts
A fully executed contract has been signed and completed/fulfilled (not just formalized) without objections from any of the relevant parties to the agreement.
An executory contract is one where the parties have signed and agreed to its terms and is in progress but hasn’t been fully executed (completed/fulfilled).
Contract Creation Process
You know the elements of a contract and the different types available for your business. But you’re still unsure of how to start the contract creation process to develop a valid document you can share with other parties before closing a deal.
Here’s our 10-step guide to the overall process of creating valid, legally binding, and enforceable contracts.
1) Identifying the Parties Involved
Outline and clarify the parties to the contract who will be legally bound by the agreement, be responsible for different obligations, and consent to its terms. Include necessary information, such as:
- Legal business name (exactly as written on legal documents)
- Main contact (for each party)
- Physical and billing addresses
- Client and service provider’s contact information
Use the names of the parties throughout the contract—not “service provider”, “third party”, or “client”.
2) Defining the Scope and Purpose
Discuss the deliverables of the contract—what each party promises to do for the other and how they’ll fulfill their obligations. Be as specific as possible about what each party is going to do, how they’ll do it, and the expectations on both sides.
3) Establishing Terms and Conditions
Include all the details of what’s being exchanged in the contract, such as each party’s rights and obligations, descriptions of products and/or services provided, financials, and more. If you forget to include something, you can write an amendment or handwrite the change into the contract—if it hasn’t been signed.
4) Payment Terms and Conditions
When establishing payment terms or details, include:
- How you’ll be paid: It can be hourly or project-based
- Minimum/maximum hours: If paid hourly, include the minimum and maximum number of hours to prevent scope creep and ensure fair compensation
- Deliverables: If paid per project, outline deliverables you’re responsible for and what the rate covers
- Billing and payment schedule: Outline when you’ll be billing the other party (weekly, monthly, or after hitting certain milestones) and how long they have to pay you after receiving the invoice (e.g., on receipt, within 15, 30, or 45 days)
- Payment methods: Include the acceptable payment methods depending on how you receive payment (by check, wired payment, cash, or digital payments)
5) Performance and Delivery Obligations
Outline the associated project deadlines, including milestones and deliverables. Specify what you need from the client and when you need them to provide it to meet your obligations.
6) Confidentiality and Data Protection
When parties agree to do business, they often become privy to each others’ sensitive business information. Include mutual promises in the contract that will bind each party to keep strictly confidential information they learn while performing the agreement. Alternatively, add a non-disclosure agreement (NDA) separately to expand on the protection of confidential information and trade secrets.
7) Force Majeure Clauses
Include a force majeure clause to remove liability for any unforeseeable/unavoidable, external, and irresistible situations beyond the parties’ control and render their performance impossible or illegal or change the contract’s purpose.
Such events or situations interrupt the expected course and prevent fufillment of each party’s obligations, and may include natural disasters or human actions like diseases or conflicts. Failure to include this clause may mean limited remedies for both parties.
8) Termination and Breach of Contract
To protect either party from a breach and get paid for what you’ve already completed, include a stipulation that clearly states that any payments received are non-refundable in case the contract is terminated.
You may include a kill fee for early termination. Alternatively, add verbiage that states you’ll bill for what’s completed up to a certain point in case a project is delayed and the invoice will need to be paid based on the company-specific terms.
9) Governing Law and Jurisdiction
According to the Cornell Law School, the main laws that govern contracts are state statutory and common law and private law. Select the laws that apply to the contract based on your location. If you’re both in different locations, choose one of the state’s laws for the contract to avoid legal wrangles later on.
Specify where to mediate, arbitrate, or bring legal actions under the contract to simplify things in case a dispute arises.
10) Signatures and Execution
Once both parties sign the contract, it’s legally binding. Sign and collect a signature from the other party along with the date the contract was signed, before moving forward with the project. You can use a wet signature or eSignature.
Does a Contract Have to Be Written to Be Valid?
According to the University of New Mexico, there’s no requirement that a contract be in writing. It just needs to include the essential elements of a contract. So, it can be verbal/oral or inferred by behavior or actions as with implied contracts.
However, some contracts must be written in a designated format to be legally binding and enforceable, and give the parties security, particularly where there’s something of significant value with a high purchase price.
How Are Contracts Interpreted by the Court?
In the courts, a judge will consider the ordinary meaning of the language and the parties’ intentions for entering the agreement. If the intention is unclear, they’ll consider usage and custom in the business and region in question. There’s no specific expression required for a party to enter the agreement.
What is Contract Automation and How It Can Benefit your Legal Team?
Contract automation involves using contract creation software or tools for contract generation through contract templates. It eliminates the rote, mundane administrative tasks of managing paper documents in Microsoft Word or other programs.
Legal contract automation helps businesses build and execute repeatable contract management workflows with minimal manual data entry. Instead of using the traditional wet signature, you can create an electronic signature and save you and your clients time and unnecessary back-and-forth.
Automation also eliminates unnecessary friction in the contract lifecycle, ensures contract documents reach signing faster, allows employees to focus on higher-value tasks, and helps you get revenues faster.
Get Started With Docubee Digital Contract Management
Inefficient contract creation and management processes cost businesses thousands.
With Docubee’s digital contract management, you and your legal department will spend less time, effort, and finances by automating the mundane aspects of contracting.
Our contract management software makes the process easy by automating document generation, improving the client experience through a secure document-sharing process, and streamlining collaboration during review and approval.
Get in touch and find out what Docubee’s valuable tool can do for your business.
