Part 1: What Is a Contract?

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What is a contract, anyway? You may first think of a document about a deal written by a lawyer in a language that is maybe English. But really, a contract is broader than that—it’s an agreement that is legally binding—and it can take different forms.

A Real Contract Has Certain Basic Elements.

A contract has a few components. First, one party makes an offer. For instance, I say, “I will sell you my widgets for $5.00 each.” Second, the other party must accept for there to be a contract. You say, “Yes, I will buy your widgets for $5.00 each.” Or you can start the game over by making a counter-offer. You say, “I will buy your widgets for $4.00 each.” I say, “Okay, I will sell my widgets for $4.00 each, but you must buy 10,000 of them.” Now we have offer and acceptance.

A contract must also have what is called consideration. This doesn’t mean the parties being thoughtful. It means that there must be value involved. If your grandmother says she will give you her antique china, that may be considerate, but it is not consideration. It is not a deal, just a gift. However, if she says she will give you her antique china for looking after her while she recovers from surgery, that might be an offer with consideration. If she is not going to give you anything and you promise to look after her, and you don’t do it, you haven’t breached your contract, because there was no consideration. You are just a jerk, not a contract-breaker.

A few other points. Both parties in a contract must have something they must do, also called mutuality of obligation. In the contract with your grandmother, she must give you her china, and you must look after her. Both of you must be competent to make the decision and you must have the capacity to carry out your part of the offer. If she has dementia, or you live in China and can’t get home, you don’t have a valid contract. And in some types of contracts, such as the sale of land, you must have a written instrument. A “written instrument” is just lawyer-speak for saying you have to write down what you agreed on.

Verbal Contracts Exist, but Can Sure Cause Problems.

Wait—does that mean there are contracts that don’t have to be written down? Yes, of course. If you tell your teenage son, “I offer you $20.00 to vacuum the house,” and he accepts your offer, you have a valid contract (assuming that he has the skills to vacuum the house and your wife agrees you were not out of your mind to ask). This contract could be enforceable. The problem with verbal contracts is not that they aren’t valid, but that they are hard to prove. The whole family could be arguing about aspects of the deal. For instance, by when did he have to finish the vacuuming? Before he graduates? Does he get paid before or after? Lawyers like to say that verbal contracts aren’t worth the paper they are written on.

Contracts in Less Formal Forms of Writing May Also Have Problems.

What if we just wrote our deal down in an email? I could email you and offer my widgets, and you could accept by return email. Is that a contract? Perhaps so. If we took it to court, the court would analyze whether we had a real agreement. Was there was enough there to be legally binding or to show we intended to be legally bound? For instance, how many widgets did you agree to buy? When were you going to pay? How was I supposed to deliver them? Not including the important details not only increases the risk that you don’t have a contract at all, but that the court may add in some ordinary, reasonable terms of its own (that you may not want). Or what if one person says she was just negotiating and it wasn’t intended to be legally binding? There have been many fascinating and profitable lawsuits around contract disputes like this—fascinating and profitable to the lawyers, that is, not to you as the businessperson.

Be Clear If You Are Negotiating or Sealing the Deal.

What is the practical takeaway here? When you aren’t ready to be in a legally enforceable deal, make clear that this discussion is preliminary. When you want to be in a legally enforceable deal, create a contract that includes all the important elements of the deal. In part 2, we’ll talk about some important contract clauses, what they mean, and why you might want to have them.