23/03/2014

1
Contract formation: Creating legally
binding contracts
Business Law
! Objectives: To distinguish the processes of negotiation
and reaching agreement; to illustrate the importance of
legally enforceable agreements; to explain the nature of
contractual obligations; to explain limitations on
contractual capacity; to explain the doctrine of privity; to
understand how and when contractual obligations arise;
to identify the essential elements of contract formation:
agreement, intention to be bound and either formal
execution or exchange of consideration.
23/03/2014
2
! "#$%&'( ) *+ &#' &',&-**.
! /'0'0-'(1 2.3% *4'( $56 7$2' 2800$(3'2 5*& 932&': 35 &#'
/'$:35; <83:' +*( 6*8 &* ('$: = 3+ &#'6>(' 5*& 932&':? &#'6 $(' !"#
',$035$-9'@ A*8 2#*89: 2&399 ('$: $56 35&(*:87&*(6 %$($;($%#2
-'+*(' &#' 7$2' 2800$(6? #*B'4'(@
! A*8 B399 !"# -' ',$035': *5 &#' !"#$%&'()$ +&,(-,$%)'(- .$% /000
12.3 %(*4323*52 2'& *8& 35&#' &',&-**.@ C52&'$:? -' +$0393$( B3&#
&#' 293:' *5 &#32 &*%37 35 &#32 9'7&8(' = &#32 32 $99 6*8 5'': &*
.5*BD
! "*5289& &#' /'$:35; <83:' +*( *&#'( 2'7&3*52 *+ &#' 7#$%&'( &#$&
$(' 5*& ',$035$-9'
! A contract is a legally enforceable agreement between two or more persons who
are called the parties to the contract.
! Contracts create legal obligations. Legal obligations consist of correlative rights
and duties.
! Contractual rights and duties can be discharged by voluntary performance. If there
is a failure to perform the contract, a breach of contract may arise. A breach of
contract provides the legal basis for bringing an action in court to enforce the
agreement. In other words, a breach of contract is a cause of action.
! In most cases, people tend to do what they have bound themselves by contract to
do, because it is convenient, it builds trust and it avoids lawsuits. Generally,
therefore, contracting parties can rely on their agreements, making them a useful
and reliable planning tool.

23/03/2014
3
! Adult persons (over the age of 18) who are of sound mind, and artificial persons
such as corporations, have full contractual capacity.
! Minors may also be bound by contracts:
! for necessities
! for things that give a benefit
! Persons with a mental disability are bound by agreements reached in lucid
periods, but not otherwise.
! Contractual obligations only exist between those who have agreed to undertake
them.
! It follows that only parties to the contract have the right to bring an action to
enforce it. This is called privity of contract.
! Price v Easton (1833) 4 B & Ad 433.
! Coulls v Bagot's Executor & Trustee Co Ltd (1967) 119 CLR 460
23/03/2014
4
! Contracts come into existence when (and only when) three elements are all
present. These are:
! Intention to be legally bound; and
! Sufficient agreement (consensus); and
! Either (a) formal execution in a deed or (b) consideration
! An agreement is only legally enforceable if the parties intended to be legally
bound.
! Intention is to be judged objectively. The court asks whether, in the circumstances,
a reasonable person would regard the agreement as intended to be binding.
! Carlill v Carbolic Smoke Ball Co [1893] 1 QB 256
23/03/2014
5
! Domestic arrangements and social agreements
! Balfour v Balfour [1919] 2 KB 571
! Cohen v Cohen (1929) 42 CLR 91
! Merritt v Merritt [1970] 2 All ER 760
! Commercial or business agreements
! Esso Petroleum Ltd v Commissioners of Customs and Excise [1976] 1 All ER
117
! Ermogenous v Greek Orthodox Community of SA Inc (2002) 209 CLR 95
23/03/2014
6
! Agreement means a meeting of the minds (consensus) on at least those essential
terms needed for a workable transaction.
! For example, in a sale contract, there must at least be agreement as to: what is
being bought and sold; the price that is payable; and that the transaction is a sale
(rather than, say, a lease).
! Agreement can be reached in different ways, e.g.
! After long and complex negotiations
! By accepting standard terms set out, or referred to, in a document or on a
notice or ticket
! Without expressly stated terms
! When one party offers to do something in exchange for a act
! The general process of reaching agreement can often be usefully described or
analysed as involving an offer and an acceptance. In other words if, on the
facts of a case, you can identify an offer and an acceptance, then you can
conclude that sufficient agreement has been reached for a contract to be created.
23/03/2014
7
An offer must be:
! Promissory, i.e. an undertaking to give or do; or an undertaking of liability:
! Placer Development Ltd v Commonwealth (1969) 121 CLR 353
! Sufficiently complete, that is, setting out all the necessary aspects of a
workable transaction
! Intended to result in a contract if accepted
! Partridge v Crittenden [1968] 2 All ER 421
! Addressed to a particular person or to an identified group of persons
! Carlill v Carbolic Smoke Ball Co [1893] 1 QB 256
Acceptance must be:
! In the same terms of the offer

! Not still subject to a condition

- Masters v Cameron (1954) 91 CLR 353

! Made while the offer is still in existence
! Made by the person to whom the offer was addressed
! Made in an acceptable form.
23/03/2014
8
! When communication is instantaneous (eg between persons present) acceptance
takes effect as soon as it is received by the offeror.
! Acceptance made or by fax or telex is considered instantaneous as long as the
message is actually received at the offerees end.
! Brinkibon Ltd v Stahag Stahl und Stahlwharenhandelsgesellschaft [1983] 2 AC
34; [1982] 1 All ER 293
! When acceptance is made by post, it is effective when the letter of acceptance is
posted.
! Henthorn v Fraser [1892] 2 Ch 27
! Continued.
! Please note that the Electronic Transactions Act 2000 (SA) in your textbook
is not examinable dont memorise it!
! Instead, all you need to know is this (ie. this is examinable):

! Legislation determines when receipt of an electronic communication takes place,
and each state has similar legislation on this point. The general rule is this:
! If the offeror specified an email address as a way in which to accept the offer,
then receipt takes place when the email reaches that system.
! If not (ie the offeror has an email address, but didnt actually specify that they
wanted the offer to be accepted by email), the receipt takes place only when
the email comes to the attention of the addressee (ie the offeror actually opens
the email).
23/03/2014
9
! Agreements can be formally executed in a deed in which case there is no doubt
that they should be treated as enforceable.
! Deed requirements expressed as a deed, sealed and witnessed
! The courts treat informal agreements differently, and apply the bargain theory of
contract. This gives rise to the requirement of consideration in informal
contracts.
! informal agreement can still be in writing!
! Consideration is something given in exchange for a promise received.
Continued..
Consideration may be anything of value to the person receiving it.
! It may be a thing, money or a promise to give or do something, or a promise not to
give or do something.
! Thomas v Thomas (1842) QB 851
! Consideration cant consist of something previously promised or done, which is
known as past consideration: Stilk v Meyrick (1809) 2 Camp 317; 170 ER 1168
! However, there is an exception to the past consideration rule: if it can be shown
that a practical benefit was obtained as a result of promise of the past
consideration, then this can constitute good consideration: Musumeci v
Winadell (1994) 34 NSWLR 723
! Note that an act performed with the intention of receiving a promised counter-
performance is good consideration. It is called executed consideration to
distinguish it from past consideration.
! Carlill v Carbolic Smoke Ball Co [1893] 1 QB 256
23/03/2014
10
Reaching agreement
! The seller has advertised a car for sale. The car is a red Ford Falcon. The
seller has papers that show the car was manufactured and first registered in
2006. The odometer shows that the car has done 50,000 kilometres. The car
appears to be in good condition with no dents or scratches. The engine starts
without difficulty. A new Ford Falcon would cost $38,000.
! The buyer has seen the advertisement and contacted the seller. Now they are
meeting to see if they can reach agreement on a sale.
! Consider the discussion that takes place between the buyer and seller. Try to
identify and discuss the various aspects of contract formation that are illustrated
by this conversation.
23/03/2014
11
! Buyer: Hi. I see you have a car for sale.
! Seller: Yeah. Its over there the red one. Check it out if you like.
! Buyer: OK, thanks. How much are you expecting to get?
! Seller: Im looking for $15,000, but Ill consider reasonable offers around that
price. It depends on whos interested.
! Buyer: $15,000 seems a bit high to me. And the paintwork is a bit dull.
! Seller: Well, I agree, it needs a good polish, but this is a wonderful car it is the
best car I ever owned.
! Buyer: Well, heres the thing: I have to go to Sydney tomorrow and Id like to drive
there. That means Im only interested in a car thats completely roadworthy.
! Seller: Thats no problem. Ive had this car checked out last week and I can
promise you its in roadworthy condition.
! Buyer: In that case, would you accept an offer of $12,000? And could I have it
tomorrow?
! Seller: You can have the car tomorrow, no worries, but I cant let it go for $12,000.
What about $14,000?
! Buyer: No. Thats still too much. But look, Im prepared to split the difference: Ill
pay you $13,000.
! Seller: OK, thats good. Its a deal. Bring $13,000 tomorrow and you can take
the car. Ill have all the papers ready for you.
! Buyer: Thats great, thanks. Ill see you around 10am. Bye for now.
! Seller: Bye.
23/03/2014
12
Consider these questions in the light of the buyers and sellers conversation:
! What process was involved in trying to reach agreement? Is this the only way that
agreements are reached?
! How much discussion and compromise was involved? At what point did
discussion end and a final agreement come into existence? What signified the final
reaching of agreement?
! What things were clearly agreed on? This agreement was unwritten. How would
you prove what was agreed if the case came to court?
! Did the parties have the capacity to enter into a legally enforceable agreement
! Is this particular agreement legally enforceable? Why is this important?
! Who is entitled to enforce the terms of a binding agreement?
! Did the agreement cover everything that might be important? What happens if
there are gaps in the agreement?
! Remember that PBL Test one is available for you to
undertake this week on the LMS (under the PBL Test
One tab)
! It is a 60 minute timed test, with 40 multiple choice
questions to answer