4.2 Formation and Validity of Contracts

Offer

An offer is a definite, unequivocal statement of the terms on which the offeror is willing to be bound. It can be made to one person, to a class of people, or to the world at large (as in Carlill v Carbolic Smoke Ball Co [1893]). The key test is whether, on an objective reading, the offeror has shown a readiness to be bound without further negotiation.

Offer vs Invitation to Treat

Many preliminary communications look like offers but are not. An invitation to treat is an invitation to others to make offers or enter negotiations; it does not itself create legal relations if accepted.

The distinction matters because only an offer, once accepted, creates a binding contract. Accepting an invitation to treat does nothing more than produce an offer that the other party may or may not accept.

Acceptance

Acceptance is the unqualified assent of the offeree to the terms of the offer. Two long-standing rules govern it:

• The mirror image rule. Acceptance must correspond exactly with the offer. Any variation, however small, is a counter-offer that destroys the original offer and itself becomes a new offer. (Hyde v Wrench [1840] remains the classic illustration.)
• Communication. Acceptance must be communicated to the offeror. Silence is generally not acceptance, and the offeror cannot impose acceptance by saying "unless I hear otherwise, I will treat you as having accepted."

The postal rule is an important exception: where it is reasonable to use the post, acceptance takes effect when the letter is posted, not when it is received. The postal rule does not apply to instantaneous forms of communication (telephone, email, electronic platforms); for those, acceptance is effective when and where it is received.

Consideration

Consideration is something of value that moves from the promisee to the promisor in return for the promisor's promise. English law, unlike many civil-law systems, will not enforce a bare promise unless consideration supports it (subject to the doctrine of promissory estoppel in limited cases).

Two key tests:

• Sufficient but need not be adequate. Consideration must have some real value in the eyes of the law (it is sufficient), but it does not need to be commercially equivalent to the promise (it need not be adequate). A peppercorn rent can be good consideration.
• Past consideration is not good consideration. An act done before the promise was made cannot be the consideration for that promise.

Consideration in Insurance

In an insurance contract the insured's consideration is the premium (or the agreement to pay the premium), and the insurer's consideration is the promise to indemnify (or to pay a fixed sum on a specified event). Both parties must provide consideration for the contract to be enforceable. If the insured never pays the premium and has not promised to, the insurer's promise may be unenforceable for want of consideration.

Intention to Create Legal Relations

Even with offer, acceptance, and consideration, there is no contract unless the parties intend their agreement to be legally binding.

• Commercial agreements carry a presumption that the parties intend legal relations. The presumption can be rebutted, but only by clear evidence.
• Domestic and social agreements carry the opposite presumption — the parties generally do not intend legal consequences (for example, an arrangement to share lifts to work). This too can be rebutted on the facts.

Insurance contracts are clearly commercial, so the presumption of intent to create legal relations applies.

Capacity

Capacity is the legal ability to enter into a binding contract. Certain categories of people have limited or no capacity:

• Minors (under 18 in England and Wales). Contracts with minors are generally voidable at the minor's option, with certain statutory exceptions (necessaries, contracts of employment that are on the whole beneficial).
• Persons of unsound mind. A contract made by a person who, through mental incapacity, cannot understand the nature of the transaction is voidable, provided the other party knew of the incapacity.
• Intoxicated persons. Similar rules apply where a party is so drunk that they cannot understand the transaction and the other party is aware of it.

Effect on Insurance

A minor's insurance contract is generally voidable by the minor. In practice, insurers avoid contracting with minors except for specific permitted products, and most proposal forms require the proposer to confirm they are at least 18 years old. Contracts made through an agent acting for a person lacking capacity are subject to the same rules.

Void, Voidable, and Unenforceable Contracts

These three terms are frequently confused and regularly tested.

The distinction has practical consequences. A void contract confers no rights on anyone. A voidable contract confers rights until rescinded, and rescission may require restoring the parties to their pre-contract position. An unenforceable contract still has legal effects between the parties — for example, money paid under it may not be recoverable — but neither party can compel performance through the courts.

Application to Insurance Contracts

Insurance contract formation follows the same pattern as any other contract, but with a few characteristic features.

The Proposal Form

A proposal form is the document (paper or electronic) on which the prospective insured supplies information about the risk. As a matter of general contract law, the completed proposal is normally treated as the insured's offer to enter into a contract on the insurer's standard terms, not as an invitation to treat. The insurer is then free to accept, decline, or offer cover on modified terms.

Cover Notes and Binding Authority

• A cover note is a temporary document issued by the insurer confirming that cover is in force before the full policy is issued. The issue of a cover note is normally the insurer's acceptance of the insured's offer, creating a binding contract immediately, even though the full policy wording is not yet prepared.
• A binding authority is an agreement under which one party (typically an intermediary acting for the insurer) is granted authority to enter into contracts of insurance on behalf of the insurer within defined parameters. Contracts made within the binding authority are binding on the insurer from the moment they are concluded, even if no policy document has yet been issued.

These mechanics reinforce a key practical point: in insurance, cover can be effective before the policy document is produced, because the basic elements of contract formation have already been satisfied.