Part 1: Offer

The crucial first steps of forming a valid contract involve an offer and acceptance. The basic definition of an offer provides that it is an expression of willingness to contract made with the intention to create legal relations once accepted (see Australian Woollen Mills Pty Ltd v The Commonwealth (1954) 93 CLR 546). Offers can be written or verbal, and can be directed to individuals, groups or even the ‘world at large’ (see Carlill v Carbolic Smoke Ball Co [1893] 1 QB 256).

Whilst this appears to be straightforward, grey areas arise when we consider what kinds of statements or representations may constitute an offer. Does an advertisement which offers rewards for customers who buy their goods constitute a contractual offer? Does the display of goods in a retail store express a valid offer?

Australian Courts have considered the following factors when determining these issues:

  1. Whether the alleged offer is sufficiently clear and precise;
  2. Whether the person making the offer (offeror) demonstrates an intention to be bound by the offer without any further discussion or negotiations upon acceptance;
  3. The factual context of the alleged offer; and
  4. Whether the recipient of the alleged offer would reasonably interpret it as an offer.


Invitations to Treat

In situations where the offeror is merely approaching the other party to start negotiations or offering information such as quoting prices, it is unlikely that a valid offer will be established. These situations are generally viewed as an ‘invitation to treat’ rather than an offer because they often lack the offeror’s intention to be bound, or the required certainty and specificity in contractual terms.


Mere Puffery

Blurred lines also arise in situations where exaggerated statements may appear to be an offer. For example, in the American case of Leonard v Pepsico, Inc. 88 F. Supp. 2 d 116 (Leonard), the Court considered the issue of whether an advertisement which showed a customer receiving a fighter jet as a prize for purchasing a certain number of Pepsi drinks could be viewed as a contractual offer. The Court held that this was not an offer because no reasonable person would believe that a fighter jet was a viable prize in this context. Australian Courts have taken a similar approach to distinguish whether exaggerated representations can be a contractual offer.

Although cases like Leonard can help with differentiating between offers, invitations to treat and mere puffery, there is no hard and fast rule which can be applied mechanically. The question of whether a valid contractual offer is established must be answered by evaluating the specific facts of the alleged offer by reference to the key factors that Courts have considered in these situations, particularly the intention of the offeror.

 

Part 2: Acceptance

The second essential element to create a binding contract after an offer is made is acceptance. An offer must be accepted to create a valid contract. If an offer is made by the offeror (the party making the offer) and it is rejected by the offeree (the party responding to the offer), there is no contract. Acceptance is a ‘meeting of the minds’ where the parties agree to shared terms of a contract.

There are several other details that ensure a contract is validly entered into to have effect. We have listed a few with some examples below.

  1. Silence does not constitute acceptance. Acceptance must be communicated to the offeror.
    In Felthouse v Bindley (1862) 142 ER 1037, a man offered to buy his nephew’s horse and stated in his offer that if he did not hear back, he would take that to mean the horse was sold to him. The nephew did not communicate any acceptance, hence was not bound to sell the horse.
  2. The offeree must notify the offeror of their acceptance.
    For example, if an agreement is signed internally within an office, this does not constitute acceptance. If the parties to the agreement do not communicate the terms of their offer and acceptance, such as if the parties sign different contracts, there is no valid contract.
  3. Acceptance can be communicated in many ways.
    Acceptance is typically achieved by performing the act asked for by the offeror, however there is no given way of how to accept an offer. There does not necessarily have to be a handshake to “seal the deal”. Each case is contextual and depends on the offer and the conduct itself. For example, if an offeror made an offer to provide a train ticket to Melbourne, and the offeree printed the ticket and boarded the train, this could constitute acceptance of the offer.
  4. Acceptance must refer to the offer.
    The offeree must be aware of the offer and accept the said offer. In Crown v Clarke (1927) 40 CLR 227, a prisoner tried to claim a reward for information he provided in order to discharge himself.  He could not claim this offer however, because at the time that he provided the information, he was unaware of the reward.
  5. Acceptance must be made by someone that has the authority to communicate the acceptance.
    For example, if an offer was made by a company to a board of directors, and an employee overhears the discussion and communicates the board’s acceptance of the offer to the company, this would not constitute valid acceptance as the employee did not have the authority to do so (see Powell v Lee (1908) 99 LT 284).
  6. A counter-offer is not acceptance.
    If the offeree responds to the offeror with an alternative offer, they have not accepted the offer and there is no contract. The offeree has made a new offer. If there was an error in the offeree’s statement of acceptance, this does not constitute a counter-offer. If there was an error but it is clear the offeree intended to accept the terms of the offer, this may still constitute a valid contract. If someone makes an offer and it does not correspond with what the offeree is accepting, it does not constitute acceptance.

The technicalities of contracts can be complicated and result in unintended legal consequences.

Part 3: Consideration

For a valid contract to exist, there must be consideration on the part of each party that enters the contract.


What is Consideration?

In simple terms, where a promiser has made a promise to a promisee, the latter must in return give the promisor something in order to make the promise binding. That is, consideration is the mutual exchange of promises (see Eastwood v Kenyon (1840) 113 ER 482). For example, if Hugh promises to do renovations on Neil’s house, Neil might give Hugh $10,000.00 as consideration to make the promise binding on Hugh. 


What does Consideration do?

It makes a promise enforceable.


What constitutes Consideration?

The Australian Courts have applied the following elements when determining whether there has been consideration.

  1. Benefit/Detriment Requirement
    Consideration may consist either in some right, profit or benefit accruing to one party or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other (see Currie v Misa (1875) LR 10 Ex 153). In Harmer v Sidway (1891) 124 NY 538, the Court considered whether an uncle’s promise to pay his nephew $5,000.00 for refraining from drinking liquor, using tobacco, swearing and playing cards or billiards for money until the nephew turned 21 was consideration. The Court held that this was not consideration because the uncle received no benefit from the nephew’s performance (and arguably the nephew received no detriment).
  2. Bargain Requirement
    The promisee’s undertaking to incur a detriment or confer a benefit must correspond to the promise made by the promisor. In Australian Woollen Mills Pty Ltd v Commonwealth (1954) 92 CLR 424, the Court held that the plaintiff could not enforce statements of policy as a promise. This case demonstrates that there is a crucial difference between an act performed by a promisee as part of the bargain for the promisor’s promise and an act that is merely done in reliance of some vague promise.
  3. Movement from Promisee
    Consideration must move from the promisee. This requirement is still satisfied if the promisee confers a benefit upon a third party at the behest of the promisor (see Coulls v Bagot’s Executors and Trustee Co Ltd (1967) 119 CLR 460).


What if the Consideration is disproportionate?

Generally, the law does not intervene with respect to the value of the consideration exchanged unless the two promises are so disproportionate in value as to demonstrate unconscionability in the bargaining process. While consideration need not be adequate, it must be legally sufficient (see Woolworths Ltd v Kelly (1991) 22 NSWLR 189).


When is Consideration not required?

Consideration is not required when:

  1. One of the parties was already legally obliged to perform, for example by public duty or an existing contract in which the promisee is already bound;
  2. The promise amounts to a gift, not a contract;
  3. The exchange is for “past consideration”; or
  4. The bargained-for promise is illusory (or contrary to law).


What if the contract does not have Consideration?

The contract may be unenforceable. However, this relies on the unique circumstances of the situation. Whenever there is uncertainty of whether a contract has sufficient consideration, it is crucial that you obtain proper legal advice.

Part 4: Past Consideration

The general rule that past consideration is not good consideration is important to remember when determining whether adequate consideration has been provided to formalise contractual relations.

This means that consideration must be provided either during or after the formation of the contract. For instance, if Isabelle sells a book to Nicole and Nicole informs Isabelle that her payment to Isabelle for a different purchase few years ago would count towards the purchase of this book, this would constitute past consideration, and therefore, not valuable consideration with respect to the agreement regarding the sale of the book.

In the landmark case of Roscorla v Thomas (1842) 3 QB 234, the plaintiff purchased a horse from the defendant and after this transaction, the defendant promised the plaintiff that the horse was sound and free from vice. When the plaintiff later determined that the horse was in fact not sound, the plaintiff commenced proceedings against the defendant for breach of contract. Lord Denman ultimately held that the plaintiff did not provide consideration for the defendant’s promise that the horse was sound, and the sale of the horse previously would be deemed to be past consideration, and therefore, not good consideration. This was confirmed in the Australian case of SAS Realty Developments Pty Ltd v Kerr [2013] NSWCA 56.

There is however an exception of when past consideration will be held to be proper consideration (see Pao On v Lau You Long [1980] AC 614). This will be the case where:

  1. The act of consideration was provided at the request of a party;
  2. Both parties reached an understanding that some form of remuneration would be provided for this act; and
  3. From the evidence, it is clear that this remuneration would be enforceable if it had been promised in advance.

The issue of consideration or past consideration can have a significant impact on a party’s obligations and liability under a particular contract.

Part 5 – Intention

The next requirement of forming a valid contract is intention. This means that the parties must have intended for an agreement to be legally binding between them. To determine if this element has been satisfied, an objective approach must be taken (see Ermogenous v Greek Orthodoc Community of SA Inc [2002] HCA 8).

It does not matter if a party to an agreement secretly did not intend to be legally bound. It also does not matter if a party denies an intention by simply saying that he or she did not intend to be legally bound by an agreement. What matters here is what the parties have said and done. You must ask, would a reasonable person regard the agreement as intended to be binding on the parties? (see Merritt v Merritt [1970] 1 WLR 1211).

Generally, the Court will consider the following factors when determining this issue:

  1. Content of an agreement;
  2. Language and conduct of the parties to an agreement;
  3. The relationship between parties and the presumption arising out of that relationship;
  4. The context in which the agreement was made; and
  5. Other relevant surrounding circumstances.

The traditional approach taken by the Courts was to apply various presumptions to different situations. For example, there was presumed to be an intention in a commercial context and presumed not to be intention in a family or social context. However recently, the High Court of Australia has proposed that these presumptions should simply indicate which party has the onus of proving the intention.


Commercial Transactions

Where a party denies that they are legally bound by an agreement in a commercial context, that party has the onus of proving that all parties have manifested an intention not to create a legally binding agreement.

A party will often rely on an express or ‘honour’ clause in an agreement. In the English case of Rose & Frank Co v J R Cromption & Bros Ltd [1925] AC 445, the Court considered such a clause in an agreement between a manufacturer and a distributer. The clause provided that the agreement was not a legal agreement between the parties but was simply a record of the parties’ purpose and intention to ‘which they honourably pledge themselves’. The Court held that the agreement was not legally binding, however the Court also held that each individual order made by the distributor would have created separate contract when each order was accepted by the manufacturer.


Agreement between Family Members

There have been some circumstances where the Courts has been prepared to find that there is an intention to be legal binding between family members and spouses where:

  1. The spouses have separated or are about to separate;
  2. Where a transaction between family members is essentially commercial in nature; and
  3. Agreement relates to housing.

The critical factor in these cases is the degree of reliance and the serious consequences on either party to an agreement. In the case of in Todd v Nichol [1957] SARS 72, one party promised to provide a right in real property if the other party moved from Scotland to Australia. The Court held that an intention to be legally bound ought to have been inferred because the agreement contemplated a permanent arrangement and involved valuable property rights.

While these cases provide some guidance on understanding when there may be an intention to be legally bound by an agreement, the question can only be answered by considering the specific facts of each case.

 

Part 6 – Capacity

When determining the parties to a contract, it is important to consider if the parties have contractual capacity to enter into legal relations. If a party falls within a category of persons that lack the legal qualification or capacity to enter into a contract, it is likely that the contract will not be enforceable against them.

On a preliminary basis, it is important to remember the presumption of capacity, which states that where a party enters into a contract, it is presumed that the party has legal capacity to do so. Such a presumption may however be rebutted by evidence showing that the party lacks capacity. In this regard, different rules apply for different categories of people, for instance – minors, people with mental disabilities or those who are intoxicated, corporations (including partnerships and unincorporated associations), the Crown and bankrupts. This article will focus on a couple of these classes of people.


Mental Disabilities

Typically, a contract will be voidable if a party can put forward evidence that:

  1. Due to them having a certified mental disorder, they were unable to understand the nature and consequences of entering into the contract; and
  2. The other party had knowledge, or ought to have had knowledge, about this mental disability (Knowledge Criterion).

This means that even if the contract entered was ‘unfair’ to the party alleged to have been lacking capacity, the presumption of capacity will not be rebutted until the Knowledge Criterion has been satisfied (see Hart v O’Connor [1985] 1 AC 1000).

In Gibbons v Wright (1954) 91 CLR 423, the High Court of Australia was required to determine if the plaintiff would become the sole registered proprietor of a property after she argued that her two sisters (who were co-owners) lacked capacity when they executed documents to change the ownership of that property from joint tenancy to tenants in common. The Court stated the threshold regarding the soundness of the parties’ minds, being that, the parties ought to have had the capability to understand the general nature of their participation in the contract and the capacity to understand the nature of the transaction when explained. Here, the plaintiff’s sisters had already died and the criteria for capacity was not met, which means that unless the plaintiff’s sisters sought to avoid the contract during their lifetime, the contract would remain valid.

It is also noteworthy that the degree of a party’s incapacity may also become relevant to determine if the other party acted unconscionably during the negotiation of the contract’s terms (see Blomley v Ryan (1954) 99 CLR 362). Here, even if capacity has been satisfied, the contract may nevertheless become unenforceable if unconscionable conduct is present.


Bankrupts

Whilst bankrupts are not prohibited from entering into contracts, some sections of the Bankruptcy Act 1966 (Cth) (Act) may classify it as an offence if the bankrupt entered into certain transactions. For example, a bankrupt will commit an offence and be liable to penalty pursuant to section 269 of the Act if they obtain credit greater than $5,881.00 without disclosing that they are a bankrupt.

The key takeaway is that it is extremely important to check that the party you may be entering into a contract with has the requisite capacity to enter into legal relations. If the other party is successful in arguing that you ought to have known about them lacking capacity, this may render the contract unenforceable.