To illustrate what a legally binding contract is like, this image depicts two hands in agreement bound by a rope.

What is a Legally Binding Contract?

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Have you been asked to sign or have you signed a piece of paper that another person is claiming to be a “contract”? What constitutes a legally binding contract is more complicated than you might think.

At Gardner Employment Law, we provide guidance to make sure you understand what you are asked to sign. If you need advice before signing a contract, feel free to give us a call.

What is a Legally Binding Contract in the Workplace?

At its essence, a contract is a bargained-for exchange between two parties.  It is an agreement where Party A offers Party B something of value in exchange for something that Party B possesses.  As we explained in a previous blog post, “Are Company Policies Legally Binding – Or What’s in Your Contract?”, a contract can be based on an exchange of promises.  It can be as simple as – “If you take me to the grocery, I will pay you $10.”  Whether a contract is legally binding depends primarily on whether the agreement satisfies the essential elements of a contract, which we discuss in more detail below.

A legally binding contract can be verbal, written, or based on the parties’ conduct.  Often parties’ promises are reduced to written agreements, especially in the employment context.  But to be a binding contract, the writing is not legally required unless the parties understand that one of the terms is that the agreement must be in writing. The primary problem that arises with verbal agreements is the parties’ inconsistent memories of the terms to which they agreed.  Having the agreement in writing assures that the material terms are clear and understood by the parties.

There are many different types of contracts in the workplace. These contracts typically dictate the actions of the employer and employee pertaining to terms and conditions of employment. Examples include contracts governing severance payments, non-competition, or non-disclosure of trade secrets. Upper level managers and executives often sign employment contracts governing compensation, benefits, job duties, duration of employment, and other aspects of the employment relationship.

What Makes Up a Legally Binding Contract?

For a contract to be legally binding, it must have 4 essential elements:

  1. An offer
  2. Acceptance of material terms of the offer
  3. Consideration by both parties
  4. Mutual assent (called a “meeting of the minds”)

Using our example above, Party A says, “If you take me to the grocery, I will pay you $10” [the offer].  Party B agrees [acceptance].  They both agree to the terms, [mutual assent], and both parties give and receive value, i.e., Party A pays $10 and gets a ride to the grocery, and Party B gets $10 by driving to the grocery [consideration]. All of these elements must be satisfied for an agreement to qualify as a legally binding contract. A verbal agreement may contain these elements, but there is fertile ground for disagreement about what was offered and what was accepted.  A written contract avoids this problem.

Contract law tends to be rather black and white. Either you did or did not comply with the terms of the contract.  There is even a rule known as the “four corners rule.” This rule says that any evidence outside of what is written within the four corners of a legal document is not admissible to prove what was meant by the parties involved.  Everything that is needed is inside the four corners of the document. Of course, as with most rules, there are exceptions, such as when the terms of the agreement are vague. In that instance, an explanation of what the parties meant by their wording may be needed.

Company Policy vs. Legally Binding Contract

It is important to distinguish the difference between a legally binding contract and company policy. Texas courts do not recognize either an implied or express contract arising from an employee handbook, especially when the handbook contains a disclaimer that it does not constitute a contract. If you read your employee handbook, you almost certainly will find that disclaimer.

Company policies are guidelines and expectations that an employee should follow. The guidelines govern proper behavior at work.  They often dictate conduct such as ethics, sexual harassment, discrimination, cybersecurity, and more. Employees can be terminated for insubordination for engaging in the prohibited behavior. It follows that failure to follow a company policy can lead to a legitimate termination (so long as the reason for the termination is not illegal).

Company policies can be changed at any time by the employer. Contracts, on the other hand, are less fluid. Unless the contract is amended, parties who agree to the terms of a contract are bound by those terms and conditions as stated in the contract. A failure to perform according to the material terms results in a breach of contract.

What Problems Can Arise with Employment Contracts?

Before entering into a legally binding contract, you should be on alert for potential problems. Even if a binding contract is created, whether it is legally enforceable can be a complex issue.

Here are several factors worth considering when you contemplate making a contract:

1. Ambiguous Language

If a contract has language that is too broad or susceptible to more than one reasonable meaning, the contract will be difficult to enforce. The question becomes – what did the parties agree to do?  Contracts should be stated very clearly. When you read a proposed contract, make sure that you understand what each party will be obligated to do.

2. Illegal Activity

An agreement to undertake Illegal activity is void. That means that a contract was never created.  In the employment setting, an example of illegal activity might be an agreement to commit fraud. When it comes to criminal activity, a contract does not supersede the law.

3. Insufficient Consideration

Consideration is the value that the parties exchange. As mentioned earlier, consideration is a required element in any contract.  If one party makes a promise but knows at the time he is not going to perform his promise, the promise did not constitute any value.  There was no consideration provided.  As a result, there is no valid contract.

4. Power Imbalance

A contract that is extracted under duress traditionally can be voided. If a party’s consent to the contract terms is induced by an improper threat by the other party that leaves the victim no reasonable alternative, the contract is voidable by the victim.  However, in the employment setting Texas courts have resisted recognizing duress as a defense, favoring instead the doctrine of “employment at will.”  If, for example, an employee is forced to sign a non-compete agreement or suffer termination, courts rely on the at-will doctrine.  The employee could have been terminated at will in any event, whether he signed the non-compete agreement or not.  Therefore, there is no duress.

5. Legal Capacity

Whether one party has the authority to enter into a contract raises the question whether that party has the “legal capacity” to make a binding contract. A manager might sign a contract for a company when he did not have the authority to do so. There are cases in which one party might be in the early stages of dementia, for example, causing him to lose his legal capacity to make a contract. A person cannot understand the contract terms if he does not have a sound mind.

Can I Back Out of an Employment Contract?

Once a contract is made and the essential elements are met, you are bound by the terms of agreement. Also, under Texas law you are presumed to have understood the terms of any contract that you sign. It is imperative that you fully understand the terms and consequences before you enter into a contract. Understandably so, contracts and contract laws confuse many people. It is best to have a law firm on your side to help you understand the fine print and make a well-informed decision.

Don’t Worry About Contracts Alone – We Can Help!

At Gardner Employment Law, we know firsthand how tedious and overwhelming it can be to study the “legalese” in a contract. However, you don’t have to navigate these complicated waters alone. If you need clear, understandable legal advice so you feel comfortable in your decision about a contract, don’t hesitate to contact us.

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