At PandaDoc, we’re huge believers of developing a deep understanding of contract elements and contract law if you deal with contracts daily.
And the reasoning for this is to ensure the documents our users draft are valid and legally enforceable.
Keeping up with that philosophy, in this article, we’ll teach you:
- Elements a valid contract must contain
- What makes contract elements important
- The relationship between the terms you use and the legality of the contract
- Real-life examples of legally valid contracts
- Requirements of a valid contract (aka what makes a contract legal)
- How PandaDoc can help you store contracts
What are the essential elements of a contract?
There are seven essential elements an agreement must have to be considered a valid contract.
The elements of a contract include identification, offer, acceptance, consideration, meeting of the minds, competency and capacity, and contract legality.
Preferably, the document will be in writing (electronic or on paper).
All parties involved in the agreement must identify who they are in the identification stage.
The law states that a contract requires updated information in the following categories, so the parties involved can locate one another if a dispute arises:
- Full legal name
- Registered office address
- Registration number
- Country of practice
- Full legal name
- Full address
- Trading name
- ID number
Since a basic contract is made up of two parties, you’ll probably identify the parties by name at the beginning of the document, followed by their titles and address, like so:
“This agreement is between John Jane, hereby referred to as “Homeowner,” and Construction Company, hereby referred to as “Company,” for the purposes of remodeling the Homeowner’s home on 444 Jamieson Street, Anytown, USA.”
The above example is also called a “contractual parties clause” and is used to organize the information of the parties and reduce redundancies.
An offer acts as a promise to do or not do something in exchange for something else.
Your offer should be firm, not ambiguous or vague, and include the duties and responsibilities of each party.
These duties may be explained further in the terms and conditions of the agreement.
An offer doesn’t technically exist until it’s received by the requesting party. When it’s received, the offer can be accepted, altered, revoked, or terminated.
If a counter-offer is made, the original offer is terminated, and the parties will have to enter into negotiation once more.
An invitation to treat, while it looks like an offer, isn’t.
An invitation to treat is an invitation to another party to make an offer and is common in real estate, marketing, and auto sales.
After an offer, acceptance of the offer comes shortly after.
You can accept the terms of a contract either verbally (also known as an oral contract) or in writing (also known as a written contract), and inaction cannot be considered acceptance.
Most states follow the “mailbox rule,” meaning any offer that’s accepted via email or snail mail is considered “officially accepted” the moment a person sends the email or puts the acceptance letter in the mailbox.
For valid acceptance to occur, the parties must:
- Agree to all of the contract’s terms without any changes or conditions
- Wait until all the recipients of the offer mutually agree
- Have the capacity to enter the contract
- Accept the terms within a reasonable time frame
- Understand the risks they’re incurring when they sign
Certain vitiating factors can void a contract, so you have to make sure the terms of your contract are agreed upon. You can streamline this process by doing the following:
- Check the document for proper grammar and spelling
- Restate the terms of your contract and receive a verbal acceptance
- Place the acceptance statement at the beginning of the agreement
- State verbally what the parties need to do to accept the agreement
- Seek help from a law firm that can guarantee everyone’s acceptance
Remember that a written document is more enforceable and clear. It can be referred to if anyone claims to misunderstand the terms of your contract.
Plus, the courts take a contract more seriously when it’s in writing, so opt for a professional document when asking for acceptance.
If you want to implement contract risk management across your company, all of your agreements must be written.
To have a valid legal agreement, one party must exchange something of value with another party.
A contract may offer things like products, protection, property, or services in exchange for money. Basically, the offer being made has to come with a price tag, or it lacks legality.
In instances where neither party is exchanging money, the parties must ensure the court would view what they’re trading (their consideration) as valuable.
5. Meeting of the minds
At this stage, both parties have recognized the contract, and both have agreed to enter into its obligations.
The “meeting of the minds” may also be referred to as a genuine agreement, mutual assent, mutual agreement, and consensus ad idem.
Regardless of what you call it, you can only reach this stage if all parties pass the consideration, acceptance, offer, and identification stages.
Once the meeting of the minds is complete, the contract can only be voided via discharge, vitiating factors, or a mutual amendment.
6. Competency and capacity
Before entering into a contract, the parties involved must have the capacity to do so.
Also known as “consideration capacity,” a person who knowingly enters into a contract with a person who doesn’t have the capacity to sign the document could receive legal repercussions.
The courts may take a “consideration capacity” breach on a case-by-case basis, especially if the person who drafted the contract couldn’t guarantee the signer was incapacitated.
Examples of this include a person signing a document online while they’re inebriated or under some undue influence.
However, the courts will be less generous if they conclude a person used the signer’s incapacitated state to coerce one of the parties to sign the document.
One of the most essential elements of a contract is its legality.
The whole point of contract law is to protect others from contracts that could be considered unconstitutional or illegal.
Since contracts require all participating parties to take on some degree of risk, it’s vital that the law protects those that mistakenly enter an agreement.
A person can’t enter into a deal with minors under the age of 18 or break any other laws in the process of forming the contract.
Otherwise, it becomes void.
To protect your own rights, you should always use a written contract and include a dispute resolution clause in case a disagreement arises between the parties.
Why are contract elements important?
It’s crucial for business owners to understand all of the required elements of a contract because it helps them create valid agreements.
With a valid agreement, you can mitigate legal liability.
Besides protecting your business from potential harm, formal contracts also make agreements between parties legally binding.
While used interchangeably, contracts are enforceable, while an agreement isn’t.
Why? Because they lack the essential elements that make them legal!
To make a contract legal, you must:
- Identify all of the parties involved
- Present an offer
- Confirm that the other party accepts your offer
- Offer something of value
- Ensure all parties are capable of signing the contract
- Have a meeting of the minds to legally accept the terms
- Create a dispute resolution clause if the deal falls through
With these elements present, you can use most business agreements to enforce your rights, improve your processes, and hold the other party legally accountable.
In fact, users from fast-growing companies like Sproutloud have used PandaDoc to improve their processes and reduce downtime too.
Here’s what they had to say about our software: “We’ve seen at least a 50% reduction in time to create and send out contracts. The PandaDoc team has been great to work with and we couldn’t be happier with our decision.”
This frees you up to focus more on how to negotiate your contracts rather than worrying about the technical stuff.
Does the legality of your contract depend upon the terms you use?
Although the 7 elements we discussed are important, there’s a lot of misinformation on the internet that may make you believe other elements are necessary when they aren’t.
Some business owners make the mistake of adding certain terms or legal mumbo-jumbo to add emphasis, but they don’t exaggerate the enforceability of your contract.
In fact, there’s a higher possibility that using terms you’re unfamiliar with will make your contract less enforceable!
Although the use of legal language is necessary to remove doubt, most contracts are legally enforceable as long as they contain the 7 contract elements we’ve highlighted here.
For example, saying that the parties “expressly” agree to the contents in your contract doesn’t make the topic before the “expressly” more important.
If you want the parties involved to take certain terms more seriously, you should go into detail as to why these terms are important to you in the contract.
You could also state that specific terms of the contract carry more weight if they’re broken.
Are there any examples of a legally binding contract?
Contracts are a common and ever-present document in daily life.
You’ve probably had to sign a cell phone contract when you traded in your old smartphone or filled out a rental agreement before moving into your first apartment.
If you’re a business owner, you may have to create dozens of contracts for your employees,
clients, and partners. You can use templates to simplify the contract creation process.
One quick and easy way to do that is to browse the PandaDoc template library to check out commonly-used templates like:
- employment contracts
- business sale agreements
- real estate agency agreements
- car leasing agreements
- royalty agreements
- promissory notes
- non-disclosure agreements.
Important note: Agreements can still be considered contracts if they contain the essential elements of a contract. Contracts referred to as agreements can be binding agreements.
What are the requirements of a valid contract?
You cannot just create a contract with the necessary elements and call it a day.
You also have to follow the law (more specifically, contract law) to ensure that your contract adheres to the necessary rules set in place.
Contract law principles regulate the obligations established by a legally binding agreement. In the United States, these laws vary from state to state.
For example, the Iowa State Court will have different court procedures and codes than California.
Similarly, a business from Iowa and a business from California, even if they operate in the same industry, will have to draw up different terms and conditions to ensure that the requirements of the law are met.
For example, if you deliver a product, the terms and conditions of different states will outline what your rights are.
In this instance, as per Iowa laws, inbound freight delivery charges are taxable, but in California, shipping charges, for the most part, are non-taxable.
Now that we’ve discussed all the need-to-know elements to make a contract valid, here are the elements that can make a contract voidable (aka invalid):
- The contract hides crucial details that may make one of the parties reconsider the agreement.
- It was signed by the parties when they were under duress, legally incapacitated, or convinced under a false pretense.
- The contract is extremely one-sided, unjust, or contrary to good conscience.
- It asks someone to do something impossible or illegal, or something that would restrict their rights under the U.S. law.
Under contract law, neither a person nor a business can make you do something written in an agreement if it’s voidable or unconstitutional, even if you sign it.
Alternatively there’s another way all parties can be free from all the obligations in a contract. This “way” is called “discharge.”
A discharge typically occurs in one of four ways:
- Discharge by agreement: All parties agree to terminate the contract.
- Discharge by performance: All parties fully performed their contractual obligations.
- Discharge by breach: One or more parties breached the terms of the contract. During a breach, the affected party can choose to dissolve the contract and claim damages.
- Discharge by frustration: If the situation has changed and one of the parties cannot fulfill their obligations because they’ve become impossible, the contract is dissolved.
If you don’t wish to go forward with the discharge route, you can agree to a contract amendment instead, which means that an enforceable contract can be changed or modified at any time.
Most types of contracts allow for pre-signature and post-signature amendments.
Before entering into a contract, one party can outline in the agreement whether a contract amendment is possible.
However, acceptance must be provided by both parties for an amendment to occur, regardless if the legal contract states it could occur.
In the end, contract law ensures that both laborers and business owners are safe from shady deals and power imbalances.
Create and store legally binding contracts with PandaDoc!
If you’re responsible for writing out contracts, use our advice to ensure all of your agreements include the essential elements of a contract.
You can make this contract creation process even easier when you use our contract management software.
With over 750+ legally binding templates to choose from, you won’t have to worry about compliance issues in your business ever again!
However, that’s not the only benefit PandaDoc offers.
With our solution, you can keep track of documents, integrate with your favorite solutions, create valid contracts in a few minutes, organize your document lifecycle, and collaborate with team members easily.
To learn more about the product, take a two-minute product tour.
Originally published June 23, 2022, updated May 8, 2023