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Updated: Jun 01, 2023

How a Contract Works Depends on 4 Essentials

How a contract works depends on 4 essentials.
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Over your lifetime, you’ll be asked to sign lots of contracts -- perhaps agreeing to purchase a home, a car or to join a trendy new gym or online dating service. But have you ever given more than a moment’s thought to how a contracts works and what it must contain? Just in case it's been a while since you've signed on the dotted line, here are the four essentials key to every valid contract.

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1. Competent party (or capacity)

For starters, you can’t make a contract with an insane person. This provision also extends to persons under the influence of mind-altering drugs or alcohol. In other words, you can’t ink a deal with someone who isn’t sober. Whatever promises were made when inebriated, they won’t hold up in court.

A competent party also has to be someone of legal age. Minors (people under 18), for example, can’t contract for real property.

Emancipated minors, however, are allowed to contract. To be emancipated, the minor must be married, widowed or divorced -- an unmarried minor who can contract as unmarried means formerly married (widowed or divorced), be in military service, or have received a declaration of emancipation from the court.

As for prisoners, as long as they’re not under a life imprisonment or death sentence, they can contract. Restrictions, however, can be placed on prisoner contract rights for the security of the prison and to protect the public.

2. Mutual agreement (offer and acceptance)

There must be enough certainty so that a reasonable person -- acting freely and without coercion -- would say there was an actual “meeting of the minds” as to what was agreed upon. So, every valid and enforceable contract involves an offer followed by an acceptance. Thus, if you offer to sell your vintage doll collection for $5,000, but your potential buyer’s response is to offer only $2,500, you don’t have a match. What you have is a counteroffer that you can accept or reject. Generally, acceptance must mirror the terms of the offer.

This "mirror" should be unmistakably clear. For example, if someone offers to clean all the windows in your house for $100, and you reply, "That sounds pretty fair," there's no acceptance, even if the window cleaner completes the task. Your response was too fuzzy. If you say, instead, "We have a deal," or more precisely, "I accept," then there is a binding contract. After the task is completed, the worker has an enforceable contract to collect the $100.

3. Consideration

For a contract to be binding, you and the other consenting party must exchange something of value, be it money, services, or even promises. Interestingly, this exchange doesn’t have to be of equal value. That’s why you’ve probably heard stories of someone agreeing to sell a car for a penny to constitute a binding contact. Some courts, however, may frown on this transaction because of the “nominal” value involved.

The existence of consideration distinguishes a contract from a gift. A gift is a voluntary and gratuitous transfer of property from one person to another, with something of value promised in return.

Sometimes, consideration can be a promise not to do something you have the right to do, such as filing a lawsuit if you feel you or your property has been damaged or injured. For example, let's say you accidentally drove over your neighbor's new power lawn mower and damaged it. Your neighbor is legally permitted to sue you for the damage, but agrees not to if you pay him $500. This agreement provides adequate consideration for the contract, because you and your neighbor are each surrendering something in the exchange -- your money and his right to sue you.

Consideration also applies to current, not past, agreements. For instance, if someone promises to pay you $1,000 for the 50 pounds you lost on your diet last summer, a court will not enforce the promise to make the payment because the performance (shedding the weight) wasn't agreed to in the present. You dropped the weight without knowing someone would later come along and offer to pay you for the weight loss.

4. Legal purpose

Finally, any contract that requires laws to be broken is void. Examples of illegal contracts are those for the sale of illegal drugs or weapons and agreements to commit a crime, such as murder-for-hire, child pornography or human trafficking.

In addition, the purpose of the contract cannot violate public policy. For examples, agreements to work for less than the minimum wage or to forfeit your workman’s compensation rights would be void and thus unenforceable.

In its most basic form, a contract is an agreement upheld and enforced by a court of law. By knowing the four cornerstone essentials that every valid contract must fulfill, you’ll be better equipped to enter and negotiate your future agreements with clarity, confidence and conviction.