If you are involved with managing a business, you need a basic knowledge of the law of contract. You don't need to qualify as a lawyer. A working knowledge of the law of contract can prevent you from falling into many pitfalls.

The law of contract is part of the common law. It has not been codified into a written Act of Parliament in any part of Australia so far. It is interesting to note that contract law has, in fact, been codified and enacted as the Contract Act in India. However, the Commonwealth Parliament and each of the State and Territory Parliaments have passed laws modifying the basic common law. Examples of Acts passed are the Commonwealth Trade Practices law and various State Acts such as the Sale of Goods Act, Fair Trading Act and consumer protection Acts.

A contract is basically an agreement. There are six essentials to the formation of a valid contract. These are:

1. Intention to create legal relations.

2. Offer and acceptance.

3. Consideration.

4. Legal capacity.

5. Consent.

6. Legality of objects.

We shall take a brief look at each of these.

Intention to create legal relations.

There can be no contract unless the parties intend to create legal relations. Domestic arrangements, such as who will do the washing- up etc, are excluded because the parties have no intention of creating legal relations.

Offer and acceptance.

This means that one party must make an offer and the other party must accept that offer. There are some interesting things to note here. It has been decided that a supermarket is not making an offer by displaying its goods. The customer, in fact, makes the offer to the supermarket at the check-out. An offer will lapse if you make a counter- offer. However, a mere enquiry as to whether the other party would accept different terms will not cause the original offer to lapse. Another interesting fact is that a postal offer is accepted once you post the letter of acceptance. In such a case, a valid contract will be formed even before the other party knows that you have accepted his offer! Often these days, when you buy a shrink-wrapped product, you will find a notice on the outside of the packet stating that breaking the shrink-wrap constitutes acceptance of the seller's offer and all the conditions that go with it.

The terms of a contract must be communicated to a person before he accepts them. After the contract has been made, one party cannot unilaterally impose additional terms. For instance, if your company runs a car-park and you do not want to accept liability for damage to vehicles parked on your yard, you must tell the motorist the conditions of parking before he parks his car and not later, after there has been an accident.


"Consideration" is the second half of the bargain. If I offer to sell you a motorcar for $30,000, then the $30,000 is the "consideration". It is often the price paid. It is important to note that consideration does not have to be adequate to form a binding contract. A contract to sell a diamond ring for $1 is a valid and legally binding contract. A mere promise is not legally binding. For example, if I promise to repair your car for free, there is no contract as I do get anything for promising to do the repairs. There is no consideration.

However, there is one big exception to this rule. If the promise is made in a written document called a "deed", then the promise to do something for free is legally binding. A "deed" is a document that is witnessed and says at its end that it is "signed, sealed and delivered". It is interesting to note that a mere promise is legally binding in systems of law that derive from Roman law. These are all continental European systems such as German, French, Italian, Spanish etc. A few English-speaking countries have systems derived from Roman law. These include Scotland, South Africa, Zimbabwe, Sri Lanka, Louisiana.

Legal capacity.

Persons under the age of 18 years are liable only on contracts for "necessities". Necessities would include food, clothing, housing, medical attention etc. These days, it would also probably include a car for getting to and from work. With other types of contracts i.e. for non- necessities, a minor either will not be bound at all or he can repudiate the contract when he reaches the age of 18. If a bankrupt obtains credit for more than $500, he must disclose the fact that he is a bankrupt.


There must be genuine consent to the contract. Often there will not be genuine consent if one person is under a misapprehension as to certain fundamental facts. For instance, if I sign a document thinking that the document is an ordinary letter when it is in fact a Will, then the Will not be validly signed. Or suppose I contract to buy a specific veteran motor-car from someone. However, unknown to both the seller and me, the car had caught fire and had been destroyed. There will be no valid contract in such a case. Or if I am induced to enter into a contract by the fraud of another, I do not have to carry out my side of the bargain if I do not want to. Or suppose that I am threatened with force into signing a contract, then there will be no valid contract.

Legality of objects.

Contracts to commit crimes or to engage in immoral acts are void. Contracts of gambling are void.

Also, contracts in restraint of trade are void if they are too wide. For instance, I sell my business of civil engineering contractor to John. To prevent me starting up in business again and competing with him, John insists that a clause be included in the sale agreement stipulating that I will never again engage in the business of civil engineering contracting. This agreement would be void. If John had insisted on a clause that I would not engage in civil engineering contracting within a radius of 10 kilometres and for a period of three years afterwards, then that agreement would probably be valid and enforceable. The restriction must do no more that protect the goodwill of the business that John bought. Anything beyond that will be unenforceable.

It is important to note that, as a general principle, contracts may be validly formed by word of mouth as well as by writing. The popular conception that writing is necessary to form a valid contract is erroneous. Take for instance contracts of employment. The popular myth is that some employees have contracts and some do not. The truth is that every employee is employed under a contract of employment. Most contracts of employment are by word-of-mouth and are valid contracts. However, the law does require some contracts to be in writing. Some of the more important contracts required to be in writing are 1) sale of land and property, 2) sale of goods having a value of more than $20 (in some States only), 3) a lease for a period of more than three years, 4) transfer of shares in a company, 5) a contract of guarantee. When a written contract is being drawn up, it is very important that all the terms of the contract be included. It is usually very difficult later to rely on any oral terms that are not included in the written contract.

In general, you may assign a benefit under a contract to someone else without the consent of the opposite party to the contract. Also, in general, you may not assign your liability under a contract without the consent of your opposite number. For example, if I am owed a debt of $100 by John, I can assign that debt to Tom without the consent of John. On the other hand, if I owe John $100, I cannot assign my liability to Tom to pay the $100 without the consent of John.

It is most important that you read every word of a contract and understand every word before signing. In general, you will be bound by the written terms of a contract that you have signed. This will be so even though you had not read them.

In most States, the right to sue under a contract lapses after six years. In other words, you must commence legal action within six years of the breach of contract. An aggrieved party can recover compensation for breach of contract. The compensation to be recovered is the foreseeable loss arising from the breach. The Court can also issue a decree of specific performance when appropriate. This is usually only done when the contract is for the sale of land and the seller is refusing to go through with the sale. In such a case, the Court can order the seller to transfer the land.

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Copyright 1994.