What Is a Contract? What Makes One Binding, and What Does Not

Most people arrive at this question in one of two moments. Either somebody has sent over a document with signature lines at the bottom and it needs to be understood before Friday, or something has already gone wrong and the question is whether the thing that was agreed actually counts for anything. Both moments turn on the same underlying test, and that test is a great deal shorter than the documents it applies to.

What follows is general information about how contracts work in the United States rather than legal advice. Contract law is mostly state law built on judicial decisions, so individual elements are read differently in different states, and agreements for the sale of goods are governed by Article 2 of the Uniform Commercial Code rather than by common law alone. Where a specific agreement matters, a lawyer licensed in the relevant state is the right person to ask.

What makes an agreement a contract

A contract is an agreement that a court will enforce. That is the entire distinction. Some agreements are not contracts, and a great many arrangements that never looked like contracts turn out to be exactly that. The test has four parts, and the things people expect to see on the list are mostly absent from it.

• Mutual assent. An offer from one side, and an acceptance of that same offer from the other.
• Consideration. Something of value moves in both directions.
• Capacity. Both parties are old enough and of sound mind.
• A lawful purpose. Courts will not enforce an agreement to do something illegal.
• No writing, for most agreements. A short list of categories has to be written down. Everything outside that list can be binding spoken.
• No notary, witness or lawyer. None of the three appears anywhere in the test.
• No formal language, and no requirement that the price be fair. Plain sentences bind, and courts rarely second guess the bargain itself.

The practical consequence of that figure is the single most useful thing to understand about contracts. An email thread in which one person sets out a price and a scope and the other replies that it sounds good can satisfy all four elements at once. So can a phone call followed by somebody starting the work. Nobody printed anything, nobody signed anything, and there is a contract.

Which reverses the question most people ask. It is rarely worth asking whether a contract exists. The useful question is what its terms turn out to be, and who gets to prove them.

1. Mutual assent is judged by what you did, not what you meant

Courts look at what each side outwardly said and did, not at what either side was privately thinking. Believing a document was a draft does not make it one if you signed it and started performing. Assuming a term would be renegotiated later does not put a renegotiation right into the agreement.

Two mechanics follow from this. Under common law, a reply that changes the terms is usually a counter-offer rather than an acceptance, which puts the original offer off the table and hands the choice back to the other side. Sales of goods work differently: section 2-207 of the Uniform Commercial Code treats a definite expression of acceptance as an acceptance even where it adds or changes terms, which is why a purchase order and an order confirmation that do not match still form a contract. In both settings silence is generally not acceptance, so an email saying you will be charged unless you object does not by itself create an obligation.

What to look for: any language saying the document is a draft, or that neither side is bound until a definitive agreement is signed. If that language is there, it changes the picture considerably. If it is absent, do not assume there is a later stage at which the terms get settled.

2. Consideration is why some promises cannot be enforced

Consideration means each side gives up something. A promise to make a gift is not enforceable as a contract because nothing moves the other way. Neither is a promise to pay for work that was already finished with no expectation of payment at the time, which is the past consideration problem. And under the pre-existing duty rule, promising extra money for work somebody was already contractually obliged to do generally does not create a new enforceable bargain. That last rule is one of the places the Uniform Commercial Code parts company with common law: section 2-209 says a modification to a contract for the sale of goods needs no consideration at all.

What consideration does not have to be is fair. Courts are reluctant to weigh whether the exchange was a good deal, on the view that the parties are better placed to decide that than a judge is. Gross inadequacy can be evidence of fraud or mistake, but a bad bargain on its own is usually still a bargain. The doctrine that catches the extreme cases is unconscionability: under UCC section 2-302 and its common law equivalent a court can refuse to enforce a contract, or strike a single clause, that it finds unconscionable, and many states layer consumer protection statutes on top of that. It is a high bar rather than a general fairness review.

What to look for: whether what you are receiving is actually specified. A commitment to pay amounts the parties may agree on later is a very different thing from a price, and the difference tends to become visible only when somebody wants out.

3. Capacity and lawful purpose are the two nobody checks

Capacity is about age and sound mind. An agreement signed by someone who lacked capacity may be void or voidable rather than enforceable, depending on the state and the circumstances. The operationally useful detail is who holds the choice. In the ordinary case the agreement is voidable at the option of the person who lacked capacity, so a minor can generally disaffirm while the adult on the other side stays bound. Outright voidness is largely reserved for cases where a court has already declared someone incompetent.

Lawful purpose cuts two ways. An agreement to do something illegal will not be enforced at all. More commonly, one specific clause is void by statute while the rest of the agreement stands, which is what happens to a non-compete copied out of a generic template into an employment agreement in California. A severability clause in the boilerplate says the rest survives, and in several states a statute does that job whether or not the clause is present. California Civil Code section 1599 severs the unlawful object and leaves the remainder standing on its own.

What to look for: the severability clause, and whether the party named on the other side is an entity that actually exists. Signing on behalf of a company that was never properly formed can leave a person on the hook individually.

4. Whether it has to be in writing at all

Every state has a statute of frauds: a short list of agreements that cannot be enforced unless they are in writing and signed by the party you are trying to enforce against. Real estate is on every version of it, which is why in most states a residential or commercial lease running longer than a year has to be written down, though the exact threshold is set state by state. So is a promise to answer for somebody else's debt, which is what a personal guaranty is, and anything that by its own terms cannot be completed within a year of the day it was made. Sales of goods priced at $500 or more come under section 2-201 of the Uniform Commercial Code, which every state except Louisiana has adopted.

Two things in that figure are worth carrying away. The first is that electronic counts. Under the federal ESIGN Act a record cannot be denied legal effect solely because it is electronic, forty nine states plus the District of Columbia and the US Virgin Islands have adopted the Uniform Electronic Transactions Act, and New York, the one holdout, has its own equivalent statute. A clicked button, a typed name and an email can all be signatures.

The second is that the writing does not have to look like a contract. Section 2-201 asks only for something sufficient to show that an agreement was made, signed by the party being sued, and it holds only up to the quantity that writing states. A signed quote or a purchase order can carry the day.

What to look for: if your agreement falls into one of the writing categories, whether the document you actually hold contains the essential terms and carries a signature from the side you would need to enforce against. A written agreement signed by only one of two parties is a common and unwelcome discovery.

5. A written contract earns its keep even when the law does not require one

An oral agreement outside the statute of frauds is perfectly valid. The problem with it is never validity, it is proof. Two people who remember a conversation differently, eighteen months later, with money at stake, will remember it in the directions that suit them. A document is not a legal formality in that situation. It is the evidence.

Writing also changes what counts. Most commercial contracts contain an entire agreement or integration clause saying the document is the complete agreement between the parties. Once that clause is in, assurances made in the sales call or in an earlier email generally stop being part of the deal unless somebody wrote them into the document. The promise that persuaded you to sign is worth checking against the page.

What to look for: the entire agreement clause, and then whether the specific thing you were told during the negotiation actually appears anywhere in the text.

6. The clauses that decide what happens when it goes wrong

Most of a contract describes the deal working. A small number of clauses describe it failing, and those are the ones that decide how expensive failure is. They sit at the back, in the section most readers skip, and they are frequently the only part of the document that was not negotiated.

• Governing law and forum. Which state's law applies, and which courts hear a dispute. A clause sending you to another state can make a modest claim uneconomic to bring.
• Arbitration. Whether you go to arbitration instead of court, and whether class actions are waived.
• Legal costs. Under the American Rule each side pays its own attorney fees unless a statute, a narrow judicial exception or the contract says otherwise. A fee shifting clause changes that. Whether a one sided clause stays one sided depends on where you are: California Civil Code section 1717 makes any fee clause in a contract reciprocal, and several other states do the same.
• Limitation of liability. Any cap on what either side can recover, and whether the cap applies to both.
• Indemnity. A promise to cover somebody else's losses. Indemnities are commonly carved out of the liability cap, so the thing to establish is whether this one sits inside the cap or outside it.
• Termination and renewal. Whether it renews on its own, the deadline for giving notice, and what exiting early costs.

What to look for: all six, and whether each one runs in both directions or only one. Mutuality is the fastest tell in any agreement.

The five minute version, if you are about to sign something

When there is no time for a full read, this order finds the most risk per minute spent.

1. Check who the parties are, and whether you are signing personally or on behalf of a company.
2. Find the money: the total, what is excluded from it, and when it is due.
3. Find the end: the term, whether it renews automatically, and the notice deadline if it does.
4. Find any personal guarantee, uncapped indemnity or missing liability cap.
5. Read the governing law, forum and arbitration clauses.
6. Check that whatever was promised verbally appears in the document.

Anything that cannot be ticked because the agreement is silent is itself a finding. Silence in a contract is not neutral. It usually means a default rule applies, and the default rule was not written with you in mind.

Where RateMyContract fits in

Reading a contract properly is slow, and the reason people sign without doing it is almost never carelessness. It is that the document is long, the language is unfamiliar, and there is no obvious place to start. RateMyContract exists to remove that first barrier. Upload the agreement and it explains in plain English what each section says, flags the clauses that are unusual or one sided, and points at the parts most worth a second look, including the back-of-the-document clauses in section six above.

What it does not do is give legal advice, tell you whether to sign, or predict how a court would read a particular clause in your state. It is a reading tool. Its job is to get you from not understanding the document to understanding it, so that whatever you do next, including a conversation with a lawyer, starts from a much better place than page one.

When to talk to a lawyer

A few situations are worth paying for advice on rather than working through alone. Anything involving real estate or a personal guarantee, because both put assets outside the deal at risk. Anything where the amount at stake would genuinely hurt to lose. Employment agreements with restrictive covenants, since the enforceability of those turns entirely on state law that has been changing quickly. Anything you are being pressed to sign quickly, since urgency is usually the other side's problem rather than yours. And any agreement that has already gone wrong, where the question is no longer what the document says but what can be done about it, which is covered separately in when to hire a contract breach attorney.

The short version

A contract is an agreement a court will enforce, and four things make one: mutual assent, consideration, capacity and a lawful purpose. Nothing on the list requires paper, a notary, a lawyer or formal language. A short list of agreements does have to be written and signed, electronic signatures count almost everywhere, and everything outside that list can bind you from an email thread. So the question worth asking is not whether you have a contract. It is what is in it, and whether the parts describing failure were written by somebody thinking about you.

If you have a document in front of you now, run it through RateMyContract and read the plain English version before you read the original. For a fuller pass once you know what it says, the contract checklist works through it point by point, and if the document came out of a generic template, what to change in a contract template covers the parts a template cannot get right on its own.

Frequently asked questions about contracts

Is a verbal contract legally binding?

Usually yes. An oral agreement with mutual assent, consideration, capacity and a lawful purpose is a contract in most situations. The exceptions are the categories in your state's statute of frauds, such as real estate, guarantees and agreements that cannot be performed within a year. The real weakness of an oral agreement is not validity, it is proving later what the terms actually were.

Does a contract have to be signed to be valid?

Not generally. Signatures are the clearest evidence of agreement, but agreement can also be shown by conduct, such as starting work or accepting delivery. Where the statute of frauds applies, a signature is needed from the party you want to enforce against, and under the ESIGN Act and state electronic transactions laws an electronic signature is as good as ink for nearly all agreements.

What makes a contract void or unenforceable?

An unlawful purpose, a missing element such as consideration, or a party who lacked capacity. Agreements can also be voidable for fraud, misrepresentation, duress or mutual mistake, which means the affected party can choose to undo them. And a single clause can be void by statute while the rest of the agreement survives, which is what happens to non-competes in the states that ban them.

Can I get out of a contract after signing it?

Sometimes, but there is no general right to change your mind. Some agreements contain a termination clause you can use. Some sales carry a cooling off period: the Federal Trade Commission's Cooling-Off Rule gives three business days to cancel certain personally solicited sales, at $25 or more when made at the buyer's home and $130 or more elsewhere, with a long list of exclusions including real property, insurance and anything conducted entirely by mail or telephone. Outside those, exit usually depends on a defect in how the agreement was formed.

Do I need a lawyer or a notary for a contract to count?

No. Neither appears among the elements of contract formation. Notarization proves who signed rather than making an agreement binding. A deed, to take the usual example, is generally valid between the parties without one. The notary's acknowledgment is what allows it to be recorded in the public land records, which is a separate question from whether it works. Whether to involve a lawyer is a question about the stakes and the complexity of the deal, not about whether the document will be valid.

What is the difference between an agreement and a contract?

Every contract is an agreement, but not every agreement is a contract. An agreement becomes a contract when it has the elements a court needs to enforce it. Arranging to meet a friend for dinner is an agreement with nothing of value moving either way, so there is no consideration and no court will enforce it. American law does not add a separate requirement that the parties intended to be legally bound, which is one point where it differs from English law. Agreeing a price for work, in writing or otherwise, generally is a contract.