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Elements of a contract

Offer and acceptance

A contract is formed when an offer by one party is accepted by the other party.

An offer must be distinguished from mere willingness to deal or negotiate. For example, X offers to make and sell to Y calendars featuring Australian paintings. Before any agreement is reached on size, quality, style or price, Y decides not to continue. At this stage, there is no legally binding contract between X and Y because there is no definite offer for Y to accept until the essential terms of the bargain have been decided.

An offer need not be made to a specific person. It may be made to a person, a class of people, or to the whole world.

An offer is a definite promise to be bound, provided the terms of the offer are accepted. This means that there must be acceptance of precisely what has been offered. For example, a used car dealer offers to sell B a Holden panel van for $1,000, without a roadworthy certificate. If B decides to buy the Holden panel van, but insists on a roadworthy certificate being provided, then B is not accepting the used car dealer’s offer. Rather, B is making a counter offer. It is then up to the used car dealer to accept or reject the counter offer.

A person can withdraw the offer that has been proposed before that offer is accepted. For withdrawal to be effective, the person who has proposed the offer must communicate to the other party that the offer has been withdrawn. To continue the example above, the used car dealer may say to B that he’ll check with his supervisor and maybe a roadworthy certificate can be provided. If, while waiting for a reply, B decides he does not want to buy the Holden panel van and he tells the used car dealer of his change of mind, then there is no binding contract.

Acceptance occurs when the party answering the offer agrees to the offer by way of a statement or an act. Acceptance must be unequivocal and communicated to the offer or: the law will not deem a person to have accepted an offer merely because they have not expressly rejected it. Some modifications to the rules of offer and acceptance have been made to protect consumers by sections 18 and 41 of the Competition and Consumer Act 2010 (Cth) schedule 2 Australian Consumer Law (“ACL”); for example, invitations or offers to purchase cannot be misleading or deceptive (see Chapter 12.2: Consumer Guarantees).

Intention to create legal relations

A contract does not exist simply because there is an agreement between people. The parties to the agreement must intend to enter into a legally binding agreement. This will rarely be stated explicitly but will usually be able to be inferred from the circumstances in which the agreement was made. For example, offering a friend a ride in your car is not usually intended to create a legally binding relation. You may, however, have agreed with your friend to share the costs of travelling to work on a regular basis and agree that each Friday your friend will pay you $20 for the running costs of the car. Here, the law is more likely to recognise that a contract was entered into.

Commercially based agreements will be seen as including a rebuttable intention to create a legally binding agreement. However, the law presumes that domestic or social agreements are not intended to create legal relations. For example, an arrangement between siblings will not be presumed to be a legally binding contract. A person who wants to enforce a domestic or social agreement will need to prove that the parties did intend to create a legally binding agreement.

Consideration

Consideration is the price paid for the promise of the other party. The price must be something of value, although it need not be money. Consideration may be some right, interest or benefit going to one party or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other party.

So long as consideration exists, the court will not question its adequacy, provided that it is of some value. For example, the promise to pay a peppercorn in return for the lease of a house would be good consideration. Of course, the consideration must not be illegal or impossible to perform.

There is an exception to the rule: documents under seal (deeds) do not require consideration for there to be a binding contract. However, since few contracts between people are made in this way, it is not discussed further in this chapter.

Legal capacity

Not all people are completely free to enter into a valid contract. The contracts of the groups of people listed below involve problematic consent, and are dealt with separately, as follows:

  • people who have a mental impairment;
  • young people (minors);
  • bankrupts;
  • corporations (people acting on behalf of a company); and
  • prisoners.
People who have a mental impairment

Generally speaking, people are free to enter into contracts even though they may have a mental impairment, or are temporarily disabled by drugs or alcohol. They are, however, sometimes vulnerable to being bound by contracts they do not fully understand. The question of capacity to make the contract often arises only after the contract is in place.

People with disabilities and their advocates will find some protection in the rule that a contract is not valid and enforceable unless there was genuine consent to its making.

Capacity to give consent involves a general understanding of the nature of the contract (not necessarily its fine details). A person with a mental impairment, for example, may have the capacity to understand some contracts (e.g. buying a loaf of bread), but not to understand other, more complicated contracts (e.g. buying a car on credit).

Where a person with a disability did not understand the general nature of the contract, a court can intervene to set aside the contract only if:

  • the other party knew (or ought to have known) of the disability or lack of capacity and it would be unfair for them to take advantage of that; and
  • the benefit received by the other person has not been sold to a third party who did not know the previous transaction might not be valid. Generally, to escape the consequences of a contract, the other party should be notified of the intention not to be bound by the contract within a reasonable time.

Some people with disabilities (temporary or long-term) are assisted by an administrator appointed by the Guardianship List of the Victorian Civil Administration Tribunal (VCAT). For further information on the role of an administrator, see Chapter 16.6: Guardianship and Administration. People with disabilities who have an administrator appointed to act on their behalf are generally not free to enter into contracts, unless this is approved in writing by their administrator or an order of the Guardianship List of VCAT.

A person with an intellectual or psychiatric disability will be liable to pay only a reasonable price for necessaries sold and delivered (s 7 Goods Act 1958 (Vic)). “Necessaries”, and the rules applicable here, are dealt with in “Young people”, below (because the definition is the same for both groups).

Young people

The term young person is used here to refer to anyone under the age of 18 years (s 3 Age of Majority Act 1977 (Vic)). Sometimes legal writing refers to minors or infants.

The exact capacity of young people to bind themselves and be bound by contract is limited but also unclear, because no Act of Parliament completely covers this area of law. The Supreme Court Act 1986 (Vic) in sections 49 to 51, “Contracts of Minors”, is the most useful reference on this question.

Binding contracts and young people

Contracts for the supply of “necessaries” will generally be binding. There are no hard and fast rules to identify what is “a necessary”, but it does include the sorts of things the young person needs to live a reasonable lifestyle. It includes basics such as:

  • food;
  • clothing;
  • a place to live;
  • medicine,

and so on.

It will also include any contracts relating to the young person’s education, apprenticeship or something very similar, if it can be shown to be of benefit to the young person. While a court has not yet considered the issue specifically, mobile phones are probably not necessaries.

The young person contracting in this situation will be held bound to pay a reasonable price (although that may not be the contract price) for necessaries actually sold and delivered. (“Delivery” is a technical term. Generally, delivery takes place when the seller has given the buyer the power to take the goods away.) Where necessaries have been sold but there has been no delivery, the young person does not have to take delivery or pay for the goods.

Non-binding contracts and young people

Two classes of contracts are not binding on a young person, namely:

  • contracts that are not for necessaries; and
  • contracts for the repayment of money lent or to be lent (that is, any form of credit contract).

Where a young person has already paid money under a non-binding contract, that money will not be recoverable unless no benefit has been received by the young person. The young person can, however, refuse to make any further payments under the contract. It is not certain who then owns goods that are not necessaries. It appears that they become the property of the young person unless the young person has fraudulently misrepresented their age.

Even after turning 18, a person cannot confirm a prior contract and then become bound by it. Any money paid by a young person under such circumstances may be recovered.

Bankrupts

Bankrupt people are not deprived of their general capacity to contract. However, there are provisions of the Bankruptcy Act 1966 (Cth) (“Bankruptcy Act”) that relate to dealings and contracts by bankrupts. For example, obtaining credit of $3,000 (as at 20 May 2013) or more without disclosing your bankruptcy is an offence and liable to penalty under section 269 of the Bankruptcy Act (see “The effect of bankruptcy on debts”, in Chapter 8.3: Bankruptcy).

Corporations

A corporation is an artificial body created by law. The corporation has a legal existence separate from the individual people who comprise it. However, a company has the legal capacity of a natural person and therefore has the capacity to enter contractual relations (see s 124 Corporations Act 2001 (Cth)). This is so even if there is an express prohibition contained in the company’s constitution. Such transactions are not deemed void and beyond the company’s powers simply because the exercise of such powers is in breach of the restrictions placed in the company’s constitution (s 125(1)).

A company has the capacity to enter contractual relations, but such relations are only binding on the company if those acting on behalf of the company do so with the company’s express or implied authority (s 126(1)). The courts have been quite liberal in their interpretation of implied authority. It has been found that in cases where directors with express authority have acquiesced and allowed a director with no authority to frequently enter contractual relations on behalf of the company, that such directors have implied authority and therefore can contractually bind the company.

Prisoners

During their imprisonment, prisoners may enter contracts, including contracts to buy and sell property. The usual restrictions about supervision and censorship of anything coming into the prison still apply, so that the permission of Corrections Victoria is required before a prisoner may sign for, deliver or receive any document. (For further information, see “Employment and money” and “Communication with prisoners”, in Chapter 4.5: Prisoners.)

Consent

Entering into a contract must involve the elements of free will and proper understanding of what each of the parties is doing. In other words, the consent of each of the parties to a contract must be genuine. Only where the essential element of proper consent has been given is there a contract that is binding upon the parties. The ultimate consequences of establishing that no proper consent was given to enter the contract are matters dealt with when considering remedies for breach of contract (see Chapter 12.4: Consumer Remedies).

Proper consent may be affected by any of the following matters:

  • mistake;
  • false statements;
  • duress; and
  • undue influence or unconscionability.
Mistake

Only a few types of mistakes will cause the contract to be non-binding on the parties to it: they must be mistakes that go to the very basis of the agreement. For example, where there is a contract for the sale of a car that both parties assume to exist, although in reality it has been destroyed by fire, this contract is non-binding on the parties. By contrast, where the parties are only mistaken about the model of the car, then this contract would be binding.

Another example is when a person signs a written document mistakenly believing that it relates to something entirely different from what in fact it does relate to, in this case the person will not be bound by it. This means that if X is told to sign a document that X reasonably believes to be something like a character reference to assist Z to obtain a loan from a finance company, and the document is later discovered to have been a guarantee of the loan contract, then the guarantee will not be binding on X.

A third example is when Y cannot read, due to blindness or illiteracy or other disability. Someone else tells Y what is in the document and Y signs it. The document Y signed is not what Y was told it was. The document Y signed would not be binding on Y.

By contrast, if a person who signs a document believing it to be a contract does not read the terms and conditions that person will be bound by the contract and will not be entitled to plead mistake.

Other factors may also be relevant to a successful plea of mistake. For instance, whether or not the defence of mistake will be allowed often depends on whether an innocent third party will be adversely affected by a decision that the contract is non-binding. Again, if the signer was careless and failed to take reasonable precautions, the defence will not be allowed to succeed. For these reasons, it is wise to seek legal advice about whether or not a court would hold the contract binding on these grounds.

False statements

There are serious false statements and minor false statements that might be made by parties contracting with each other. Different consequences flow, depending on the seriousness of the false statement made.

False statements might be made where either:

  • the parties come to agree and contract because one of them has been motivated to agree by a statement of fact (something said or written) that is not true. Commonly, these types of statements have not actually been included in the contract itself but were an encouragement to enter into the contract. For this reason, they are viewed as though they were part of the contract; and/or
  • the parties have agreed and there is a contract, but the statements or terms in the contract exist only because one of the parties has made a false statement.

False statements affect the question of whether or not a contract exists. Very serious false statements mean a court would view the contract as void (see Glossary) and unenforceable. The consequence is that monetary damages sufficient to place the wronged party back to their original position must be paid.

In other (less serious) instances, the court will find the contract valid but the wronged party will be entitled to reject the contract or to treat it as at an end. Here, monetary damages sufficient to place the wronged party in the position they would have been in, had the contract been properly completed, must be paid.

Where a false statement has put the wronged party at a disadvantage or caused some loss, but not enough damage has been done to justify ending the contract, then the contract will be valid and the wronged party will be bound to the contract, but entitled to sufficient monetary damages to make up for the loss suffered as a consequence of the false statement.

The two most important factors considered to determine the level of seriousness at which a false statement will be viewed are as follows.

The false statement: a condition or a warranty?

“Conditions” of a contract are so important that without them one or other of the parties would not enter the contract. If a false statement amounts to a condition of the contract, the wronged party is entitled to rescind (see Glossary) the contract. A court may view the condition so seriously that without it the contract is void; that is, with the false statement taken out of the contract, there is no contract.

Less important statements are called “warranties”. Where the false statement amounts to a warranty, the wronged party will only be permitted to receive sufficient monetary damages to make up for any loss suffered; the contract will continue to exist and the parties will continue to be bound by it.

For further details about conditions and warranties, see “The terms of a contract”, below.

What type of false statement was made?

There are three types of false statements:

  • fraudulent misrepresentation;
  • innocent misrepresentation; and
  • negligent misrepresentation.
Fraudulent misrepresentation

To prove fraud, it is necessary to show that the person making the statement knew it was false, had no belief in its truth, or knew it might be false and recklessly went ahead and made it anyway, not caring whether it was true or false. It is very difficult to prove fraud. Once proved, however, the innocent party can rescind the contract, sue for damages for deceit, or both.

Innocent misrepresentation

An innocent misrepresentation will be made where the false statement is made with no intention to deceive. An innocent misrepresentation could nevertheless be a serious false statement (being a condition of the contract), or a breach of warranty. The level of seriousness will be determined by an appraisal of all the circumstances of the contract. If innocent and without negligence, the only available remedy is rescission (see Glossary for meaning).

Negligent misrepresentation

A negligent misrepresentation will arise where a party to the contract is under a special duty of care to the other party. This special relationship will be held to exist where the person making the false statement claimed to have some special skill not generally possessed by an ordinary member of the community, and where that person was prepared to exercise this special skill on behalf of the person to whom the false statement was made. The wronged party must be able to show that:

  • the person making the false statement could reasonably be expected to foresee that the false statement would be relied upon;
  • in the circumstances it was reasonable to rely on the statement;
  • the statement was made without due care; and
  • the statement was false.

Once again, the level of seriousness of a false statement made in these circumstances can vary. Where there is a serious breach, the innocent party can rescind the contract and recover damages for negligence.

Duress

Proper consent may be affected by duress. Duress is held to have occurred where there has been actual or threatened violence either to the other contracting party directly or to their immediate family, near relatives or close associates. The duress may be made by someone acting under the instructions of the party to the contract. The net effect, though, will have been that a party has been forced into the contract by being deprived of their free will to act.

Duress now extends to contracts entered into as a result of threats to a party’s economic well being, that is, a threat to a person’s business or trade. This form of duress is called economic duress.

The consequence of establishing duress is often that the contract is voidable at the election of the wronged party. Where the wronged party elects to have the contract declared void, monetary damages sufficient to place the wronged party in their original position must be paid. Where the wronged party elects to continue with the contract, monetary damages to cover any loss suffered because of the duress must be paid.

Undue influence or unconscionability

Proper consent may be affected by undue influence. Undue influence is exercised by taking unfair and improper advantage of the weakness of the other party, to the extent that it cannot be said that that party intended voluntarily to enter into the contract.

The main reason for the rule against the use of undue influence is to correct abuses of trust and confidence. It is applied where the parties are in a relationship where one party may be able to exercise considerable influence over the other party.

There are two categories of undue influence.

The first is where no special relationship exists, but the stronger party will have used some fraud or wrongful act expressly to gain an advantage from the weaker party. The weaker party will have to prove that undue influence was actually exerted.

The second is where the parties are in a confidential relationship; most cases of undue influence fall into this category. A confidential relationship exists when one party’s position towards the other’s involves a dependency or trust, in the form of authority or an expectation to give fair and independent advice to the weaker party. Where a confidential relationship is found to exist, a presumption of undue influence will arise. It is then necessary for the stronger party to show that the contract was not the result of any undue influence.

A confidential relationship and the presumption of undue influence can be established in either of two ways.

First, the parties may be in a well recognised special relationship, for example, solicitor and client, doctor and patient, religious or spiritual adviser and devotee.

Second, the confidential relationship, although not falling within any well recognised relationship, is such that the complaining party is able to show that the other party was in a position of influence. For example, it could be the relationship between a bank and its customer, because of a special position of trust that the bank had come to occupy in connection with the conduct of this customer’s affairs. (It has been stressed, however, that in ordinary circumstances no presumption of undue influence arises out of a banker-customer relationship.) See, for example, Commercial Bank of Australia v Amadio[1983] HCA 14 (for a summary of Amadio’scase, see “Unconscionable conduct”, in Chapter 12.3: Consumer Protection Legislation).

The consequence of establishing undue influence is that the contract may be held voidable at the election of the wronged party.

For details of complaints of undue influence in relation to some types of loan contracts and related complaints of unjust contract, unconscionable dealings, harsh and oppressive contracts, etc., see “Unjust contracts, changes and charges”, in Chapter 13: Credit and Finance.

Corporations are prohibited from engaging in unconscionable conduct in relation to the provision of goods or services by virtue of sections 20, 21 and 22 of the ACL (see “Unconscionable conduct”, in Chapter 12.3: Consumer Protection Legislation).

Unfair contract terms and standard form contracts

The ACL regulates unfair contract terms. A term is unfair when it:

  • causes a significant imbalance in the parties’ rights and obligations arising under the contract; and
  • it is not reasonably necessary to protect the legitimate interests of the supplier; and
  • it causes detriment to another party.

In determining whether a contract term is unfair, a court must consider the transparency of the term as well as the operation of the contract as a whole. For example, certain highly advantageous terms might need to be counterbalanced against other disadvantageous terms. 

Certain terms cannot be determined to be unfair, for example the price of a good or service or the main subject.

Unfair contract terms are discussed in more depth in Chapter 12.3: Consumer Protection Legislation (see “Unfair contract terms”).

Illegal and void contracts

The law will not enforce all contracts. There are some categories of contract to be wary of.

Where a contract is illegal, this may affect its enforceability. Contracts that are illegal by statute will be regulated as to enforceability by the statute; thus the statute will need to be read and interpreted. Contracts absolutely prohibited by statute will be void, whether the parties know of the illegality or not. However, where one party performs an otherwise legal contract in a manner that breaches legislation, the other party, if having no knowledge of the facts giving rise to the illegality, can still enforce the contract or recover damages for breach of it. They may also recover money or other property transferred under the contract.

Contracts made void by statute are treated differently; while they remain valid contracts, the courts will not enforce them. Again, the precise extent of the enforceability of, or the recovery of any money paid under, a void contract will depend on the particular statute.

Certain types of contracts are illegal at common law, because they are contrary to the public good. These include contracts:

  • to commit a crime, a tort or a fraud;
  • that are sexually immoral;
  • that prejudice public safety, including good relations with other states or countries;
  • that prejudice the administration of justice;
  • that tend to promote corruption in public life; and
  • to defraud the revenue.

Illegally formed contracts are generally void and unenforceable by either party at common law. Therefore, property or money transferred cannot be recovered.

Where legally formed contracts are performed in an illegal manner (i.e. the illegal conduct was not an intended or required part of the contract but merely incidental to the way it happened to be performed) then the contract is not void, but:

  • no remedies are available to the guilty party; and
  • the innocent party retains all rights and remedies (provided they did not know the contract was to be performed illegally).

Certain types of contracts are void at common law, being contrary to the public good. These include contracts:

  • to oust the jurisdictions of the courts;
  • prejudicial to the status of marriage;
  • in restraint of trade (unless the restraint is reasonable both between the parties and in the public interest). The courts here will look at the relative bargaining power of the parties. Restraint imposed between equals is viewed with more favour than, for instance, a contract between an employer and employee in unequal bargaining positions.

The general rule is that the contract is void only so far as it is contrary to the public good; it is not void entirely. That is, the offending part can be removed provided that the rest of the contract continues to make sense. However, contracts illegal at common law are not “severable”; that is, the “illegal” parts of the contract cannot be removed or severed from the “legal” parts.

Money paid or property transferred under a contract that is void at common law may be recoverable because the effect of the contract being void is that there is no contract, so that the parties should be put back to their original position.

Other kinds of conduct that might or might not affect the enforceability of a contract are covered by the ACL, which include prohibitions against:

  • misleading or deceptive conduct;
  • unconscionable conduct; and
  • misrepresentation in particular matters,

all of which are discussed in Chapter 12.3: Consumer Protection Legislation (see “Misleading and deceptive conduct”, “Unconscionable conduct” and “Prohibition of misrepresentations”).

Elements of a contract :: Last updated: Sun Jun 30th 2013