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What Makes a Contract Legally Binding?

Updated: August 11, 2023
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What is a Legal Binding Contract?

A contract is a legally binding document between two or more parties which defines and governs the rights, duties and responsibilities of all parties involved in an agreement. It becomes legally binding when all parties sign on to the agreement. It can involve an exchange of goods or services and will provide legal remedies to either party that is impacted by a breach of contract.

Here is an article where you can learn more about contracts.

Requirements For a Legally Binding Contract

There are two types of contracts:

  1. Bilateral : A bilateral contract is an agreement where all parties make a promise or set of promises to each other.
  2. Unilateral : A unilateral contract is an agreement where only one party makes a promise/set of promises. An example of a unilateral contract is a reward contract where one party may promise a reward for some sort of service or good.

In order for a contract to be legally binding it needs to satisfy the following elements:

  1. Offer and acceptance : All parties involved in the exchange should agree upon the value of the item exchanged. When one party presents their assessed value of a good or service, the other party/parties must accept or decline this offer.
  2. Consideration/Agreement : In a contract, both parties will gain or receive something and this benefit is called consideration . It can be money, goods, services or anything that is of value to the parties. Both parties need to agree upon this consideration or value.
  3. Mutuality or intention : A contract needs to be mutual and intentional for all parties involved.
  4. Legality : The contract cannot contain unlawful promises or considerations in order to be valid. A promise to do or exchange something that violates the law will make the contract invalid.
  5. Capacity and competence : Capacity means that the parties signing a contract need to have the legal ability to do so. A minor will not have the legal capacity to sign a contract.

Only when these five elements are present, a contract is a binding contract and enforceable.

Here is an article about different elements of a binding and non-binding contract.

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Basic Parts of a Contract

Any contract contains some basic parts:

  • Title : The document title is present in all contracts and it defines the type of document.
  • Preamble : The preamble is used to highlight important details of the document. This can include the name of the agreement, the date of execution and party information.
  • Purpose of the agreement : This outlines the subject matter of the agreement.
  • Parties : Any contract will provide all information regarding the parties involved. This would be the name, contact and other details of the parties. In case the parties are businesses, this would list their business information.
  • Recitals : These are often optional forms used to include background information to the agreement. This can provide an important guide to reading and interpreting the contract.
  • Agreement : Any contract is not complete and binding without agreement of all parties. The parties need to agree on terms of the contract as well as the value of exchange before signing the contract. Once signed, it will be a legally binding document if it meets all other elements and rules of a valid contract.
  • Description of consideration : A written contract should outline and define all promises being made in a contract which are agreed upon by all parties.

Beyond basic parts of any contract, they can also include additional terms like the following:

  • Special terms and conditions: This includes any special promises, warranties and guarantees relevant to the contract.
  • Non-disclosure: A contract can have parties sign a non-disclosure to protect information or intellectual property rights.
  • Force Majeure : Force Majeure frees involved parties from liabilities arising for special circumstances or events beyond their control.
  • Statute of Limitations : This provides a time limit for filing lawsuits or other claims in the case of a breach.
  • Choice of jurisdiction : A contract can define the choice of law and jurisdiction in advance where any disputes pertaining to the contract would be resolved.
  • Additional clauses : These can include an integration or merger clause, arbitration clause, indemnification clause, severability clause, termination clause, non-compete/non-solicitation clause etc. These cover special caveats to any part of the contract.

Written Contracts vs. Oral Contracts

Contracts do not always need to be written to be a binding contract. Oral contracts can be binding contracts. Oral contracts are generally made in speech between parties. It doesn’t have a formal written record. Handshake deals can also be legally binding if there is a witness involved. Oral contracts are generally harder to prove. Written contracts provide certainty, clarity and definiteness to the agreement that oral contracts do not.

Oral contracts have three main elements:

  1. Offer : Just like written contracts, the agreement needs to have an offer by one party to other/others.
  2. Acceptance : The party/parties receiving the offer either need to accept or reject the offer.
  3. Consideration : Consideration is the same under written and oral contracts. This defines the agreed upon value of the exchange.

Oral contracts are not considered valid if they fall under the category of statue of frauds. Most states have the statute of frauds – a law that requires some types of contracts to be in writing to be enforceable. These generally involve land exchanges or exchanges of high value. Contracts involve large sums of money also require to be written down. These are some of the agreements that require written contracts under statute of frauds:

  • Land
  • Paying off another person’s debt
  • Marriage
  • Property transfers
  • Contracts that have over one year to finish
  • Contracts lasting longer than the lifespan of the participants
  • Agreements regarding a certain amount of money (varies by state)
  • Real estate leases that last over a year
  • Real estate sales involving executors of a will

However, even if the contract falls under these categories under the statue of frauds they can be enforceable in two unique situations:

  1. If one party partly complied to the terms.
  2. If one party relied on the other party’s promise and suffered/was injured in that course of reliance.

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