In procurement we are often working with current contracts and creating new ones. Sending a purchase order or a response to an RFQ can constitute a contract, as well as a verbal agreement, so it is important to understand the five main elements that are required for a contract to be valid and therefore, understanding a legally binding document.
These elements are:
- Offer
- Acceptance
- Intention
- Capacity
- Consideration
Offer
An offer is often the starting point for creating a commercial contract. It can be made in response to an Request for Quotation (RFQ) or an Invitation to Tender (ITT), or even a supplier coming to visit and asking if you wanted to buy some of their goods. An offer remains open for acceptance only during the period of time in which it is open, so if a quotation has a term stating, “valid until….” this must be adhered to.
It’s important to note an offer can be revoked at any time before acceptance. Once an offer is revoked, no further acceptance can take place, and the opportunity to form a contract is effectively closed.
Acceptance
Acceptance is the act of agreeing to the terms of an offer. It can be communicated in various ways – it can be made verbally, in writing or through a gesture, such as a nod of the head or a shake of the hand of the other party. Once acceptance has occurred it cannot be withdrawn. This signifies that both parties are now committed to the agreement under the specified terms, and the contract can become legally binding.
Intention
In business, it is assumed that people intend to enter into a contract in most cases. However, intention is not demonstrated if one party is forced, coerced or tricked into a contractual situation.
Capacity
Capacity has to be present in a contract for it to be valid and it can take several forms. Firstly, it can relate to authority. Does the person engaging in to the contract have the authority from a business perspective to make agreements on the business’ behalf? Capacity also relates to the parties being of the legal age required to engage in a contract, noting that this is not the same age in all countries.
Capacity also links to whether the parties are of sound mind. Does the party have any mental health issues that may hinder their judgement? Are they free from the influence of drugs and/or alcohol?
Consideration
Finally, consideration. Consideration in contract law refers to the passing of something of value between the parties. Consideration does not have to be sufficient but it has to be adequate. This means that the value passed does not have to be what the contract is worth, as long as there is acceptance from the other party, this is deemed to be valid.
Consideration does not have to be tangible or monetary, it could be a service or another act which constitutes adequate value to the offerer. Without these five elements a contract is not legally binding and could be rescinded by the aggrieved party or within a court of law.
Final Thoughts
Contracts are at the heart of procurement, whether you’re responding to an RFQ, issuing a purchase order, or negotiating a new supplier agreement. Understanding the five essential elements – Offer, Acceptance, Intention, Capacity, and Consideration will ensure that contracts are a legally binding document and enforceable.
Without these elements, agreements may be challenged or even deemed invalid. By keeping these fundamentals in mind, procurement professionals can create clear, fair, and legally sound contracts that protect all parties involved.
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