Formation of a Contract — SQE1 FLK1 Contract Law

A vintage amplifier sits in a shop window, price tag £2,500. A customer walks in, counts out £2,500 in cash on the counter, and says he will take it. The owner refuses. She promised it to a friend last week. Is she obliged to sell? No. She never made an offer, and until she accepts one, she owes him nothing.

That distinction, between an offer and an invitation to treat, is the first thing formation questions test. And formation is among the most commonly tested areas on the paper. This is Formation of a Contract, the first topic in Contract Law. Every element except consideration, which is the next episode. Keep the amplifier in mind. We come back for it.

Here is the route. Offer first, and the line between an offer and an invitation to treat. Then how offers die. Then acceptance, and the mirror image rule. Then the part that decides most questions, when acceptance actually takes effect. Then intention to create legal relations, with its two presumptions. Then certainty of terms. And finally capacity: minors, mental incapacity, and companies.

Start with the checklist, because it never changes. A valid contract needs four things. Agreement, meaning offer and acceptance. Consideration. Intention to create legal relations. And certainty of terms. On top of those, both parties must have the legal capacity to contract. Consideration has an episode of its own, so today it is the other three, plus capacity.

So what is an offer? A clear and definite statement of willingness to be bound on specified terms, made with the intention that it becomes binding the moment the person it is addressed to accepts. The one making it is the offeror. The one it is made to is the offeree. Fix those two words now. Every rule that follows turns on which one you are.

An invitation to treat is not an offer. It is a willingness to negotiate, or to receive offers. One question settles it. Did that party intend to be bound immediately by the other side's response, or was it merely inviting others to make offers? So. Our amplifier in the window, with its price tag. Offer, or invitation to treat?

Invitation to treat. A flick knife displayed in a shop window with a price tag was held to be an invitation to treat, not an offer for sale. That is Fisher v Bell, from 1961. The customer makes the offer when he puts his money down, and the shop can accept it or refuse it. Which is why our owner keeps the amplifier for her friend.

Goods on a self-service shelf work the same way. You make the offer at the checkout, and the cashier accepts or rejects it. Advertisements are usually invitations to treat too. But not always, and the exception is one every candidate meets.

An advertisement promised £100 to anyone who caught flu after using the company's smoke ball, and the company had deposited £1,000 with a bank to show it was sincere. That was a unilateral offer to the world at large. Carlill v Carbolic Smoke Ball Co, from 1893. You accept by performing the act, and no prior notice of acceptance is needed.

Two more classifications. At auction, the call for bids is an invitation to treat. Each bid is an offer, accepted by the fall of the hammer, so a bidder may withdraw before it drops. An invitation to tender is usually an invitation to treat too. But undertake to accept the highest or lowest tender, and that promise is itself a unilateral offer. In 1986 the House of Lords held a vendor to exactly that.

Communication next, and it is short. An offer must reach the offeree before it can be accepted. You cannot accept an offer you know nothing about. Which is why cross-offers fail. Two parties who post identical offers to each other on the same morning have no contract, because neither letter answered the other.

Offers do not last forever. Five ways one ends. Revocation, lapse of time, death, rejection, and counter-offer. Revocation first. An offeror may revoke at any time before acceptance, even having promised to keep the offer open. But revocation only bites when it is communicated. It is not effective until received, and it need not come from the offeror. A reliable third party passing on the news will do.

Lapse is next. An offer lapses at the end of any period stated for acceptance, and where none is stated, after a reasonable time. Shares offered in January and purportedly accepted in July are far too late.

Death is messier. If the offeree learns of the offeror's death before accepting, the offer lapses. If he does not know, the position is uncertain, though the offer may survive where no personal performance is needed. And the offeree's estate can never accept.

Now the one that decides most questions. A counter-offer destroys the original offer, which cannot then be accepted. A seller offered his farm for £1,000. The buyer came back at £950. That was refused, so the buyer tried to accept the original £1,000. Too late. Hyde v Wrench, from 1840. His own counter-offer had killed it.

But watch the near miss. In one case the offeree asked whether delivery could be spread over two months. Counter-offer, or something else? Something else. A request for information proposes no new terms, so the original offer stayed open and could still be accepted. Read the words, not the tone.

One last rule on revocation, and it applies only to unilateral offers. Once the offeree has begun performance, the offeror cannot revoke. A father promised to convey a house to his son and daughter-in-law if they paid all the mortgage instalments. They started paying. The Court of Appeal held he could not withdraw. They were never obliged to finish, but if they did, he was bound.

Acceptance now. It is the final and unqualified expression of assent to the terms of the offer, and it must correspond exactly. That is the mirror image rule. Vary a single term and you have not accepted. You have made a counter-offer, and destroyed the offer you were reaching for.

It need not be in words. Acceptance can be inferred from conduct. In one case the parties acted on a draft agreement for years, and that was acceptance by conduct, though nobody ever signed it. Contrast an acceptance expressed to be subject to contract. That binds nobody. Those three words say further negotiation is coming.

Which brings the battle of the forms. Both sides send their own standard terms. Traditionally, the last shot wins. The final set sent before performance is a counter-offer, accepted by conduct. In one case a seller quoted on its terms, the buyer replied on its own, and the seller signed and returned a tear-off acknowledgement slip. The buyer's terms governed.

Now the part candidates lose marks on. When does acceptance actually take effect? The general rule is on receipt. The offeror must actually receive it. Face to face, or on the telephone, that means when he hears it.

Then the exception. The postal rule. A properly stamped and addressed letter of acceptance takes effect the moment it is posted, not when it lands. Adams v Lindsell, from 1818. It applies where post is a reasonable or contemplated method between these parties. Post it, and the contract exists, even if the letter is slow.

The rule is fenced in, though. It does not apply to revocation of an offer. Not to instantaneous communications. Not where the offer requires that acceptance be received. Not where posting would produce manifest inconvenience and absurdity. And not to acceptance of an option.

That first limit is where the marks are, so hold it. Acceptance flies on posting. Revocation counts only on arrival. In one case the offeror posted a revocation, but the offeree had already posted an acceptance. The revocation was worthless. The contract was made when the acceptance went into the postbox.

For instantaneous communications the ordinary rule returns. A telex acceptance was effective where and when it was received, not where and when it was sent. And a message received outside business hours may take effect only when the office reopens. Treat email the same. Effective on receipt, in business hours.

And silence? Silence cannot be acceptance. An uncle wrote to his nephew offering to buy his horse. If he heard no more about him, he would consider the horse his. The nephew said nothing. No contract. Felthouse v Bindley. An offeror cannot impose on an offeree a duty to reject.

Two smaller rules close acceptance. Prescribe a method and acceptance by that method works, but an equally advantageous alternative may serve just as well. And in a unilateral contract the offeror waives communication altogether. Performing the act is the acceptance. The offeror is master of the offer, and sets the conditions for acceptance.

Third element. Intention to create legal relations, and it runs on two rebuttable presumptions. Domestic and social agreements are presumed not to be intended to create legal relations. Commercial agreements are presumed to be. A husband promised his wife £30 a month while she remained in England for health reasons. Not enforceable. Balfour v Balfour, from 1919.

The same fate met a mother's promise to support her daughter while she studied for the Bar. But the presumption can be rebutted. A separated husband and wife agreed in writing that he would transfer the house once she finished paying the mortgage. Enforceable. Separated spouses deal at arm's length.

Commercially the presumption runs the other way, and the burden of rebutting it is heavy. An employer promised a redundant pilot an ex gratia payment. Binding. Ex gratia meant only that the employer was not admitting it already owed the money. What does rebut it is an honour clause. An agreement stating it was not subject to legal jurisdiction was held not to be a contract, though individual orders under it were.

Fourth element. Certainty. If the terms are too vague or too incomplete, the court cannot tell what was agreed, and the agreement is void. An agreement to buy a van on hire-purchase terms was void, because the hire-purchase terms were never specified.

Three qualifications. A meaningless clause can be severed. A reference to the usual conditions of acceptance meant nothing, so out it went and the rest of the contract stood. An agreement to agree fails, and an agreement to negotiate in good faith is unenforceable, because it sits badly with the adversarial nature of negotiation. But a lock-out agreement, a promise not to negotiate with anyone else for a definite period, may bind.

And machinery can cure uncertainty. Where the contract supplies a way to fix the missing term, an arbitration clause, a market price, a third party valuer, the court will hold the parties to it.

Last, capacity. Four groups have limited capacity. Minors, people with mental incapacity, intoxicated people, and companies acting outside their powers. Minors first, meaning anyone under 18. Contracts for necessaries bind, and the minor must pay a reasonable price, not necessarily the contract price. That is s 3 of the Sale of Goods Act 1979.

Necessaries are goods or services suitable to the minor's condition in life and to his actual requirements at the time of sale and delivery. So. A tailor sells 11 fancy waistcoats to an undergraduate already adequately supplied with clothing. Necessaries? No. The tailor recovered nothing. Actual requirements decides it.

Beneficial contracts of service, apprenticeship, education or training bind a minor if the contract as a whole is for his benefit. The whole, not the individual terms. A boxer's contract forfeiting his purse if disqualified was binding, because overall it gave him professional opportunities. Oppressive apprenticeship terms were not.

Shares, leases and partnerships are voidable, valid until the minor repudiates, during minority or within a reasonable time of turning 18. Everything else does not bind him unless he ratifies on reaching 18. That is the Minors' Contracts Act 1987.

Mental incapacity next. Section 2 of the Mental Capacity Act 2005 is the test. A person lacks capacity if an impairment of, or disturbance in, the functioning of the mind or brain stops them making a decision. The contract is then voidable at their option, but only where the other party knew or ought to have known. A reasonable price for necessaries is still payable, under s 7.

The burden of proving both the incapacity and the other party's knowledge sits with the person claiming it. Intoxication mirrors this exactly. Voidable where the person was so intoxicated they did not understand what they were doing, and the other party knew.

Companies last. A company once could act only within its objects clause, the ultra vires doctrine. Under s 31 of the Companies Act 2006 its objects are unrestricted unless the articles limit them. And s 39 says an act cannot be questioned for lack of capacity by reason of anything in the company's constitution. Ultra vires is effectively dead against a third party dealing in good faith.

A word on how SQE1 tests this. You are not asked to recall case names or section numbers. You get a scenario, five answers, and one instruction: pick the best one. So learn the rules, and how they decide facts. The names in this episode are memory pegs, nothing more.

If you keep only three pegs. Fisher v Bell, for the default: a priced display is an invitation to treat, and the customer makes the offer. Hyde v Wrench, for the rule that a counter-offer kills the offer it answers. And Adams v Lindsell, because the moment acceptance takes effect decides more formation questions than anything else.

Four traps the examiners set. One: a request for information is not a counter-offer. Asking whether the seller could deliver differently keeps the offer alive. Proposing a different price kills it.

Two: the postal rule does not run in reverse. A posted revocation does nothing until it lands. And the rule switches off for instantaneous communications, where the offer says acceptance must be received, and where posting would produce an absurd result.

Three: separate a lock-in from a lock-out. A promise to negotiate in good faith is unenforceable. A promise not to negotiate with anyone else, for a definite period, may well bind. The word definite is doing the work.

Four: never treat the domestic presumption as unanswerable. Look for parties who have separated or deal at arm's length, a written agreement, real reliance or financial sacrifice, and precision in the terms agreed.

Quick check, and it turns on that asymmetry. Monday: a wine merchant posts a letter offering a restaurant owner 200 cases at £120 a case, the offer open until Friday. These two have always dealt by post. Wednesday: the restaurant owner posts a properly stamped and addressed acceptance. Thursday morning: the merchant posts a withdrawal. It arrives on Friday. The acceptance arrives on Saturday. On which day, if any, was a binding contract formed?

Three candidate answers. One: Saturday, because a postal acceptance takes effect only when it reaches the offeror. Two: Wednesday, because a properly posted acceptance takes effect at the moment of posting. Three: no contract at all, because the merchant posted the withdrawal before the acceptance arrived. Pause here if you want a moment.

The answer is two. Wednesday. Where post is a reasonable means of acceptance, acceptance takes effect on posting, and these parties had always dealt by post. The contract was two days old before the withdrawal was communicated at all.

Why the others fail. One applies the general rule and forgets the exception. The postal rule displaces the ordinary requirement that acceptance be received. Three uses the wrong comparison. The question is never whether the withdrawal was posted before the acceptance arrived. It is whether it was communicated before the acceptance was posted. It was not.

Five things to take away. One: a price on a display, an advertisement, an auctioneer's call for bids, an invitation to tender. All invitations to treat, unless the words promise to be bound on performance. Two: a counter-offer destroys the offer, a request for information does not, and revocation works only once it reaches the offeree.

Three: acceptance must mirror the offer and, as a rule, must be received. The postal rule is the exception, and never covers revocation or instantaneous communications. Four: two presumptions on intention, domestic against and commercial in favour, both rebuttable. Five: terms must be certain, and capacity is the last box to tick.

And our shop owner still keeps the amplifier, because she never made an offer to sell it. Next time, Consideration and Promissory Estoppel.

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