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Deal or no deal?
Accountants’ daily work on financial transactions will often involve contracts. But what are their key features and what can be done if they are not fulfilled?
Words Gill Myers, Evolve
For a contract to be valid, i.e. legally enforceable by the courts, it must meet five requirements:
Agreement
To have an agreement, an offer must be made and accepted.
Imagine you work for a construction company that is asked by a customer to provide a quote for a building job. By your company (the offerer) providing a detailed quote to the customer (the offeree), it has communicated an offer.
Until an offer is accepted it can be terminated. Your company could revoke its offer, as long as it tells the customer. The customer could also make a counter offer, maybe to change the specifications or negotiate the price, which rejects the original and replaces it with a new one.
When a definite and unequivocal statement of willingness to be bound by specific terms without further negotiation is reached, and its acceptance is communicated, the requirements of agreement will be met.
It is important not to confuse an offer with an invitation to treat. An offer must include specific terms – perhaps that a job will be completed by a given date and cost a stated amount. However, an invitation to treat is when a seller does not make an offer for a customer to accept but instead invites the customer to make an offer (usually of an advertised amount) that they will accept, often at the point of sale. The prices displayed at a builders’ merchants would be examples of invitations to treat.
Consideration
Valid contracts require both parties involved to have agreed to provide something of value to the other. For consideration to exist, a number of criteria need to be considered:
In our example, consideration is sufficient because the customer will gain a building and the construction company will generate income. It is also legal and likely to be paid for on completion, meaning the payment will be executory.
Intention to create legal relations
A simple contract exists once there is acceptance and consideration. However, to be legally enforceable there must be intention. If something goes wrong and one of the parties wishes the courts to enforce the terms of the agreement then they must show that both parties intended to be legally bound by the contract. It is generally accepted that legal relations are intended in commercial transactions, but not in relation to agreements for social reasons or between family members.
Capacity and legality
These final requirements mean that a contract cannot be legally enforced if it is illegal or made with someone who does not have sufficient abilities to do so. There are three groups of people considered to have limited capacities to enter contracts, so they would not be bound by an agreement:
- Under-18s
- Those of unsound mind
- Anyone under the influence of alcohol or drugs
Valid, void, voidable
Judged against the five requirements, our example contract is valid. If the building job included something illegal then the contract would be void. If the customer turned out to be under the age of 18 then the contract would be voidable.
Discharge of contracts
Once a valid contract has been made, it can be ended or ‘discharged’ in a variety of ways. Two common methods are:
When a contract is discharged by performance then that’s the end of the matter. However, when there is a breach of contract the aggrieved party will want the problem sorted out. This can often be achieved by both parties agreeing between themselves. When this is not possible, an aggrieved party can take the other party to court to seek a remedy.
Consequences of being in breach of contract
Courts can award two categories of remedies:
Legal damages
If, in our example, the construction company failed to complete the building on time, resulting in the customer having to delay opening a new retail outlet, they may be awarded monetary damages to compensate for lost revenue.
Equitable remedies
Equitable, or fair, remedies are only available at the discretion of the court and are usually either:
- Specific performance, which requires contractual obligations to be performed. For example, if the construction company only partly completed the building, it could be required to complete the work.
- Injunction, which requires something to happen or stop happening. For example, if the customer had been making excessive negative postings on social media about the construction company then it could seek an injunction to force the posting to stop.
KEY TAKEAWAYS
While contract law can be complicated, you should have some basic knowledge and understanding of it as we enter into contracts regularly, both on a personal and professional basis. Knowing that a valid contract requires agreement, consideration, the intention to create legal relations, capacity and legality is an important part of working in the accounting profession.
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