Contract law I: formation

Contracts are the legal backbone of business. Every sale, lease, loan, employment relationship, software subscription and supply chain rests on agreements that the law will enforce. A contract is a legally enforceable agreement: a promise or set of promises that the law will recognize and for whose breach it gives a remedy. This lesson covers how contracts are formed: offer and acceptance, consideration, intention, capacity, legality and form, including contracts made online. Lesson 4 covers what contracts mean and what happens when something goes wrong in their making or performance, and lesson 5 covers remedies and the special rules for sales of goods.

Contract law in the common law provinces is mostly judge-made, supplemented by statutes such as the sale of goods acts, consumer protection acts and electronic commerce acts. Quebec contract law is set out in the Civil Code of Québec, which shares many concepts with the common law but expresses them differently, for example by requiring good faith in the formation, performance and termination of every contract. This lesson focuses on the common law, with notes on Quebec where it differs sharply.

The elements of a contract

A valid contract requires an offer, an acceptance of that offer, consideration (something of value exchanged by each side), an intention to create legal relations, parties with legal capacity and a lawful purpose. Some contracts also require a particular form, such as writing. If an element is missing, there is no contract, and a party who performed may be limited to recovering the value of what it provided. Courts judge formation objectively, by asking what a reasonable person in the position of the other party would have understood from words and conduct, not what a party secretly intended.

Offer

An offer is a proposal that shows a willingness to be bound on definite terms as soon as the other party accepts. It must be communicated to the offeree and must be sufficiently certain: the essential terms, such as the parties, the subject matter and the price or a way to determine it, must be clear enough for a court to enforce. An offer must be distinguished from an invitation to treat, which invites others to make offers. Advertisements, catalogues, price lists, goods displayed on shelves and websites showing products are usually invitations to treat, because a seller does not intend to be bound to sell to everyone who responds, perhaps beyond its stock.

The classic Canadian authorities follow English cases. In Pharmaceutical Society of Great Britain v. Boots Cash Chemists (1953), goods on a self-service shelf were held to be an invitation to treat: the customer makes the offer at the till and the cashier accepts. In Carlill v. Carbolic Smoke Ball Co. (1893), however, an advertisement promising £100 to anyone who used the company's smoke ball as directed and still caught influenza was held to be an offer of a unilateral contract, because it was specific, and the company had deposited £1,000 in a bank to show its sincerity. Mrs. Carlill accepted by performing the conditions, without needing to notify the company. A business that promises a reward or bonus in specific terms can be bound in the same way.

Offers do not last forever. An offer ends when it is revoked by the offeror before acceptance (revocation must be communicated, though it can come from a reliable third party), when it is rejected, when the offeree makes a counter-offer, when it lapses at the end of a stated time or, if no time is stated, after a reasonable time, and on the death or incapacity of a party in some situations. An offeror may revoke even after promising to keep the offer open, unless the offeree paid for that promise (an option contract) or the law provides otherwise.

Canadian common law has no general firm offer rule: a promise to keep an offer open is binding only if the offeree gave consideration for it, creating an option, or if the promise was made under seal. In tendering, however, the Supreme Court of Canada in R. v. Ron Engineering & Construction (Eastern) Ltd. (1981) held that submitting a compliant bid in response to a call for tenders can create Contract A, under which the bidder cannot withdraw its bid and the owner must treat bidders fairly, separate from Contract B, the construction contract itself.

Acceptance

Acceptance is the offeree's unconditional agreement to all the terms of the offer, communicated to the offeror. Under the common law mirror image rule, a reply that adds or changes terms is not an acceptance but a counter-offer, which rejects the original offer. Acceptance must normally be communicated; silence is generally not acceptance, because one party cannot impose an obligation on another by saying that silence will count as agreement. Acceptance can be by words or conduct, such as shipping goods in response to an order. In a unilateral contract, acceptance is by performing the requested act.

The method of communication matters for timing. For instantaneous methods, such as telephone or in-person conversation, acceptance takes effect when the offeror receives it. Under the traditional postal acceptance rule, an acceptance sent by mail takes effect when it is posted, if mail was a reasonable method. For email and online communication, provincial electronic commerce statutes, such as Ontario's Electronic Commerce Act, 2000, address when an electronic message is sent and received, and courts generally treat email acceptances as effective when they reach the offeror's system. Offers that specify a method of acceptance must be accepted in that way.

The battle of the forms arises when businesses exchange standard purchase orders and acknowledgements with conflicting fine print. Canadian courts generally apply the traditional approach from Butler Machine Tool Co. v. Ex-Cell-O Corp. (1979): each form that changes terms is a counter-offer, and the last form sent before performance, often the seller's acknowledgement accepted by the buyer taking delivery, usually wins. Courts sometimes look at the whole course of dealing instead. The practical lesson is to read the other side's forms and to negotiate key terms such as warranties and limitations of liability rather than rely on the fine print.

Consideration

In the common law, a promise is enforceable only if it is supported by consideration: something of value given in exchange for the promise. Consideration can be money, goods, services, a promise to do something or a promise not to do something one is entitled to do, such as forgo a legal claim. Courts do not ask whether the bargain was fair; consideration need only have some value in the eyes of the law, so a peppercorn can support a promise. What matters is that the consideration was bargained for. A promise to make a gift is not enforceable, and neither is past consideration, something already done before the promise was made, such as a promise to pay an employee a bonus for work completed last year without any earlier agreement.

A promise to perform an existing contractual duty is traditionally not good consideration for a new promise. If a contractor demands more money to finish a job it is already bound to complete, the owner's promise to pay more is unenforceable under the classic rule. Canadian courts have softened this. In Greater Fredericton Airport Authority Inc. v. NAV Canada (2008), the New Brunswick Court of Appeal held that a variation of an existing contract can be enforced without fresh consideration if it was not procured under economic duress. Promissory estoppel can also help: if a party makes a clear promise to alter legal relations and the other party relies on it, the promisor may be prevented from going back on the promise (Maracle v. Travellers Indemnity Co. of Canada, 1991 SCC). In Canada, promissory estoppel is traditionally a shield, a defence, not a sword that founds a new cause of action. A promise made under seal is enforceable without consideration, a formality still used for some guarantees and real estate documents.

Intention, capacity and legality

Courts presume that parties to commercial agreements intend to create legal relations, and that family and social arrangements do not. The commercial presumption can be rebutted by clear words, such as a letter of intent stated to be non-binding or a statement that an agreement is subject to a formal contract. Letters of intent and memoranda of understanding are a common source of disputes: they should say clearly which provisions are binding (often confidentiality, exclusivity and costs) and which are not.

Minors, people under the age of majority, have limited capacity. The age of majority is 18 in Alberta, Manitoba, Ontario, Prince Edward Island, Quebec and Saskatchewan, and 19 in the other provinces and the territories. A contract with a minor is generally voidable at the minor's option, except for contracts for necessaries (such as food, clothing and shelter suited to the minor's situation), for which the minor must pay a reasonable price, and beneficial contracts of service. British Columbia's Infants Act makes most contracts with minors unenforceable against them unless a court approves. Adults who lack the mental capacity to understand a contract, because of illness or intoxication, may avoid it if the other party knew or ought to have known of the incapacity. Corporations have the capacity of a natural person under the Canada Business Corporations Act and provincial statutes, but individuals acting for them must have authority (lesson 8).

A contract with an illegal purpose, such as an agreement to fix prices or to pay a bribe, is void and courts will not enforce it. Contracts that offend public policy are also unenforceable. The most important category for business is restraint of trade: covenants not to compete or solicit, which are enforced only if reasonable in scope, duration and geography and necessary to protect a legitimate interest such as trade secrets or customer goodwill. Courts are stricter with employment restrictive covenants than with those in the sale of a business, and several jurisdictions now prohibit most employee non-competes outright. Lesson 10 covers these rules.

Form and electronic contracts

Most contracts can be made orally or by conduct, but writing makes proof far easier. Ontario's Statute of Frauds still requires a signed writing for guarantees of another person's debt and for contracts creating interests in land, and other provinces have similar rules; British Columbia's Law and Equity Act requires writing for land contracts and guarantees. Consumer protection statutes require written agreements with specific disclosures for many consumer contracts, such as internet agreements and future performance agreements. Electronic commerce statutes in every province confirm that electronic documents and signatures satisfy writing and signature requirements, with some exceptions such as wills and certain land documents.

Online, contracts are formed in several ways. In a clickwrap agreement, the user must click "I agree" after being shown the terms or a clear link to them; courts generally enforce these. In a browsewrap agreement, terms are posted somewhere on the site and the user is said to agree by using it; courts often refuse to enforce browsewrap terms because users may never see them. Sign-in-wrap agreements, which say that by creating an account the user agrees to linked terms, are generally enforced if the notice is clear and conspicuous. A business that wants its online terms to hold should require an affirmative act, display the terms clearly, keep records of acceptance and highlight unusual terms such as arbitration clauses.