Must Have Elements to Create Legally Binding Contracts and Commercial Agreements
Updated: Apr 19, 2021
What are contracts and commercial agreements?
If you try to look it up, you will find multiple definitions of contracts and commercial agreements.
Simply put, they are a legally binding document between two parties.
Contract law in Malaysia is governed and enforced by the Contracts Act 1950.
We interpret the definition of a contract from the Contracts Act 1950, which defines all agreements as contracts when you fulfil the following:
two parties who are of sound mind agree unanimously;
they have made a legal consideration and on a legal matter;
and the agreement is not declared void.
In this Act, specific rules define words and expressions, unless a contrary intention appears from the context.
To put into layman’s terms, the words and definitions are:
When one party shows they are willing to do or refrain from doing anything, in exchange for an agreement from another party, this defines a proposal;
When the party who receives the proposal accepts it, it then becomes a promise;
The person proposing is called the “promisor” and the person accepting the proposal is called the “promisee”;
When the promisee or any other person does or abstains from doing anything at the desire of the promisor, or, gives a promise for the same, it is a consideration for the promise;
Every promise and every set of promises is an agreement;
Promises made as a consideration of another promise or part of the consideration for each other, i.e. party A agrees to do something in return of party B doing something, are called reciprocal promises;
An agreement not enforceable by law is said to be void;
An agreement enforceable by law is a contract;
An agreement which is enforceable by law for only one of the parties is a voidable contract. For example, you make a contract with a minor in Malaysia (a person under 18 years old), and finally;
A contract that ceases to be enforceable by law becomes void when it ceases to be enforceable, i.e. specific laws are changed, nullifying your agreement.
Processes to Execute a Contract
To draw up an “iron-clad” contract, you will have to ensure you conduct full due diligence.
Evaluate the agreement and weigh out the risks and opportunities as well as future implications.
Discuss the main areas you would like in your commercial agreement with your lawyer. Then, they can help put them in the legally binding terms and advise additional information to protect your interest.
This initial step is essential regardless of drafting a contract from scratch or using a template from an existing one.
Once you have completed the above, you enter the negotiation stage to try to develop agreeable terms for both parties. Once agreed, you may draw up a formal contract.
In rare cases, the other party might have no dispute or inputs, and you may proceed accordingly.
Subsequently, the contract will take effect. At this stage, ensure you are performing and enforcing the deal to its full extent to avoid breaching your commercial agreement.
Seek legal advice should there be a breach from the other party.
Essential Elements of a Contract in Malaysia
To create a legally binding contract in Malaysia, one must fulfil these seven essential elements:
Also known as a proposal, an offer is a willingness to contract agreements, with the intention that it will become binding once accepted and agreed.
Acceptance is when there is an agreement to receive the offer.
3. Intention to Create Legal Relation
You fulfil this element when both parties intend to make the agreement legal.
Consideration translates as something of value to either party; promise or promisor.
The value is usually of monetary value when it comes to commercial dealings. The consideration must be a “benefit” that either party is giving or accepting.
The terms of a commercial agreement must be specific, so there will be no ambiguity or vagueness.
If you do not fulfil this element, a contract becomes uncertain. In this case, it then becomes null and void.
The party you enter a contract with must be at capacity to do so.
Section 11 of Contracts Act states that a person is only competent to contract when they are of sound mind,
they do not disqualify from contracting by any law,
and they are of the age of majority. In Malaysia, the age of majority is 18 years old.
7. Free Consent
Finally, both parties must be willing to respond to the agreement made to ensure it is a legally binding contract.
Clauses in Contracts
As mentioned earlier, you want to establish the terms to be included in your commercial agreement from the very beginning.
While drafting the contract, ensure the following clauses are covered to have a positive contractual relationship with your partners.
1. Commencement Date
The date of commencement and duration the contract takes effect.
2. Promise and Promisor Details
Ensure you state full names/business names, company registration number/identification card number/passport number, and addresses in the agreement.
3. Specific Definitions
Should you use any terminology or terms that cannot be defined commonly or is an industry term, ensure to explain them clearly in the contract.
State clearly which party does what, where, when and how.
5. Price and Payment
Specify all payments to be made in your commercial agreement, through which channels, by whom and when.
Also include late payment terms and what happens should there be changes in taxes.
You may even consider a guarantee for payment clause to protect yourself against weak credit or no payment at all.
6. Warranties, Liabilities and Limitation of Liability
Include a warranty for the standard of service, whether you are the supplier or the receiver.
The liability clause will ensure the remedies to be available should there be a breach of warranty.
Additionally, you would want a limitation of liability clause to limit the extent of the liability, in amount and future claims if there are any claims against you.
7. Assignment and Subcontracting
Assignment of contract or subcontract should strictly be prohibited.
Ensure you only deal with the person you are contracting with by covering this clause.
The other party will not be able to re-assign the agreement without your permission.
8. Force Majeure
When listing force majeure, it is best to take into consideration all and every possible occurrence.
You may put into place a term such as “any events beyond the control of either party”. However, if there is a dispute, a force majeure clause may be confined to the type of specific events stated in the contract.
9. Governing law
For any commercial agreements that expand beyond Malaysia, it is crucial that the contract states which country or in some cases, state law would apply in case of any dispute.
State any issues or events that will lead to termination of the contract clearly, followed by how the cessation would occur and each party’s obligations in this case.
It would be best to list how each party deals with issues that would arise after termination, such as non-solicitation, intellectual properties, and confidentiality.
Both promise and promisor are to sign the contract to make it legally binding. Ensure you do not sign a commercial agreement before handing it to the other party to avoid the other party making any changes without your knowledge.
While contracts and commercial agreements may seem like minefields to navigate, understanding the process already gives you a step forward.
Provided you check all the boxes we have mentioned, you are well on your way to protect your business interest.
If presented with a contract or commercial agreement to sign, seek legal advice to fully comprehend the agreement’s extent and avoid any unwitting breach of contracts.
It is always best to include your lawyer from the beginning of your contractual journey to maximise time and efficiency.
Note: This article does not constitute legal advice to any specific case. The facts and circumstances of each case will differ and, therefore, will require specific legal advice. Feel free to contact us for complimentary legal consultation.