Contracts

What Makes a Contract Legally Binding?

June 28, 2021

Put yourself in the shoes of a property developer. You have acquired land to develop and are in negotiations with a construction company to build your development. Your lawyers and their lawyers agree on almost everything, but there are a few terms they are still trying to negotiate. Time is money and you want construction to begin ASAP, but you do not want to risk going forward before the contract is ready. Maybe you don’t have to.

  • Not every contract has to be signed before it can be executed.
  • Under certain conditions, unsigned contracts are enforceable.
  • Understanding more about contracts saves your business time and money, and it protects you from accidentally agreeing to something that you never intended.

A contract is a legally-binding agreement that holds parties accountable for fulfilling the terms that they agreed to in the contract. When does a contract become binding? Most people assume only when it is signed by both parties. However, this is not always the case, especially in contracts concerning construction.

A watertight contract should stipulate what “acceptance” will look like. In other words, it should say that a contract is accepted when both parties sign, in writing. If a contract does not say this, and many don’t, then it leaves the door open for acceptance of a contract to take other forms, such as beginning to fulfill the terms.

How do draft contracts become binding?

Draft contracts can become binding through something called “Acceptance by Performance.” Acceptance by performance, as the name suggests, is when one or more parties to a contract begin to fulfill their contractual obligation and no party objects to those actions being performed. In this instance, the parties have accepted the terms of a contract, even though it has not been signed and even though not all of the terms are agreed to. This is a bad practice as terms outside of payment and performance will not necessarily be enforceable.

Why does this exist?

This is allowed because in some industries, such as in construction, both parties may be invested in fulfilling the contract while yet still trying to negotiate changes to specific terms. In this case, the parties may want to begin fulfilling the contract, i.e., begin construction, before finishing the negotiation process. Acceptance by performance, in such a case, would indicate that the parties agreed in general on what would be constructed and for how much money while still negotiating some of the finer points. In this case, if the construction is completed, then the purchaser is still bound to pay the company for the work, even if the contract itself was never signed.

This is important to note because it means that completion of the terms of the contract in good faith constitutes enforceability and means that a judge will likely rule that the company must be paid in the event of a lawsuit.

Are there other applications?

While less concrete, the same principle can be applied to other agreements made without a contract. For example, if two parties have an agreement that one will buy a house from the other for a certain amount of money, and there is an exchange of emails demonstrating that both sides have agreed to the sale, that can be enough to make a case for acceptance, even if there is no formal contract. This can be enough to put a lien on the property if the seller tries to back out of the agreement and go with a new, better offer. The ruling on this is uncertain, but such an agreement can be enough to get the buyer’s foot into the door of a courtroom, which may be enough to preserve the sale.

Two conditions need to be met to establish Acceptance by Performance.

In order for an acceptance by performance argument to hold up, it does need to meet a few criteria.
  • First, the performer must be able to demonstrate that they knew of the agreement and were performing with the expectation that they would be compensated.
  • Second, as mentioned earlier, the contract must not have specifically indicated that acceptance could only take place through signature and written acknowledgement. If a contract indicates that it can only be accepted through signature, and one of the parties begins fulfilling their terms without signing, then the other party is not obligated to fulfill their end of the agreement.

An acceptance by performance agreement can be revoked if one of the parties changes their mind and notifies the other before performance begins. The key bit here is that the party needs to notify the other that they no longer wish the agreement to continue, and that it occur before performance begins. If the performing party completes the work completely or substantially before receiving notification, the agreement may be binding.

What’s the bottom line?

The main takeaway for those involved in contracts is, as always, to make sure that the contract and all communication between parties is clear so that misunderstandings, and ensuing litigation, can be avoided. In this light, whether or not draft contracts are binding depends on circumstances. It is important to know how your circumstances interact with your contract, and as always this is best understood with the help of an attorney.