A Formation of a Contract Requires 4 Important Elements

A formation of a contract requires 4 important elements, namely an offer, an acceptance, an intention to create legal relations and consideration.

Section 2(a) of the Contract Act 1950 (hereinafter referred to as CA 1950) states that ‘when one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to the act or abstinence, he is said to make a proposal.’

In the case of Preston Corporation Sdn Bhd v Edward Leong [1982] 2 MLJ 22, the respondents sued the appellants for the sum of $28, 052. The appellants rejected the claim. The Federal Court stated in this case that the quotations made were a mere supply of information or an invitation to enter into a contract.

Section 26 states that an ‘agreement made without consideration is void’ unless they belong to one of those categories of agreements listed in the same section as being exempted from the rule. The definition of consideration can be found in section 2(d) as ‘when, at the desire of the promisor , the promise or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration of the promise.’

In the case of Osman bin Abdul Ghani & Ors.v.United Asian Bank Bhd [1987] 1 MLJ 27, the Supreme Court affirmed the decision of the High Court. In this action, the appellants were directors of a company and were granted overdraft facilities by the bank. The first, second and sixth appellants executed a guarantee. Two years after the execution of the first guarantee, the company executed a further debenture for $1 million and all the appellants executed a guarantee for the same. The respondent bank claimed on the second guarantee. Lee Hun Hoe C.J. concluded that ‘The respondent bank was on the verge of suing the company but was willing to forbear suing the company when the appellants gave the second guarantee. Clearly, the second guarantee was given for the benefit of the company by giving the company time to arrange for the payment of the debt … The authorities are clear that forbearance could either be expressed or implied … The consideration is the forbearance to sue. This may be implied from the nature of the transaction as between businessmen …’

Consideration may be categorized as executor, executed or past. It is an executor consideration when one promise is made to another for the return of another promise. A consideration is executed when a promise is made in return for the performance of an act. Finally, where a promise is made subsequent to and in return for an act that has already been performed, the promise is made on account of a past consideration.

In the case of K.Murugesu v. Nadarajah {1980} 2 MLJ 82, the appellant agreed to sell a house to the respondent and the agreement was written on a scrap of paper. Specific performance was ordered at trial and the appellant took the matter to the Federal Court. The Federal Court rejected the appeal.

The principle of past consideration was applied in Kepong Prospecting Ltd& S.K. Jagatheesan & Ors. v. A.E. Schmidt & Marjorie Schmidt [1968] 1 MLJ 170. Schmidt, a consulting engineer, had assisted another in obtaining a prospecting permit for mining iron ore in the State of Johore. He also helped in the subsequent formation of the company, Kepong Prospecting Ltd, and was appointed Managing Director. After the company was formed, an agreement was entered into between them under which the company undertook to pay him one per cent of the value of all ore sold from the mining land. The Privy Council concluded that it did constitute a valid consideration and Schmidt was entitled to his claim on the amount.

There are exceptions to the general rule that an agreement without consideration is void. These exceptions are provided in section 26 of CA 1950.

In the case of Phiong Khon v Chonh Chai Fah , a Chinese woman upon the death of her husband, set up a home with the appellant until her death. The appellant alleged that the respondent had executed a document which transferred the land to him. The court held the terms of the document to be vague and uncertain and that it must be seriously be doubted whether there was any intention to create a legal relationship.

Parties to agreements sometimes label their agreement in a manner to make sure that there is no intention to create legal relations. It is the law that determines the relationship between the parties.. In Sia Siew Hong v Lim Gim Chian , it was held that the court is not bound by the label of a document but has to construe the nature and purport of a document from is language and other admissible evidence.

Cases in the area are divided into two classes:

(1) Social, family or other domestic agreements- where the presence or absence of an intention to create legal relations depends upon the inference to be drawn by the court from the language used by the parties and the circumstances in which they use it.

(2) Commercial agreements- where the intention to create legal relations is presumed and must be rebutted by the party seeking to deny it.

The final expression of assent to the terms of a proposal is known as an acceptance. By virtue of section 2(b) of the Contract Act 1950, ‘when a person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted: a proposal, when accepted, becomes a promise. The person accepting the proposal is called the “promise” or the “acceptor”.’ In the case of Ayer Hitam Tin Dredging Malaysia Bhd v YC Chin Enterprise Sdn Bhd [1994] 2 MLJ 754, the Supreme Court held that they must be an agreement between the parties and the existence of such an agreement depends on their intention. The court may assume this from the conduct of the parties, the object of the contract and the language used.

In the case of Chia Foon Tau v Lim Pey Lin [1998] 7 MLJ 762, the deceased and the respondent entered into a partnership agreement. The agreement was that as long as the respondent was the senior partner, he need not pay rent for usage of the premises. If was held that the deceased had made a contract with himself. A covenant between one person and himself is unenforceable and void.

Under section 7 (a) of CA 1950, in order to convert a proposal into a promise the acceptance must be absolute and unqualified. When the promise in the contract states his acceptance as ‘subject to contract’, the court will hold that there is no contract as there are not strong and exceptional circumstances. It is merely a conditional contract. This is based on two reasons. First, it negatives the intention to create legal relations. Secondly, an acceptance which does not correspond with the terms of the proposal because of an introduction of a new condition, as per the case of Chilling Worth v Esche [1] . Section 7(a) of CA 1950 provides that in order to convert proposal into a promise the acceptance must be unqualified.

The Supreme Court held in the case of Ayer Hitam that when an arrangement is made subject to contract, the court will take it to mean that negotiations are still on going and they do not intend to be bound by the contract until a formal contract is exchanged. An agreement to enter into an agreement is not a contract as per the case of Low Kar Yit v Mohd Isa. The defendant in this case gave an option to the plaintiff as to buy a piece of land. The agent of the plaintiff operated the option but the defendant refused to sign the sale agreement. The plaintiff sued for specific performance for breach of contract. It was held that the option subject ‘to a formal contract to be drawn up and agreed upon’ the parties, therefore it was a conditional option. The option was merely an agreement to enter into an agreement. Therefore, there was no legal binding contract between the parties.