This is from a Canadian site, but relies on the common law:
Beware the "reasonable man"!
Another important feature of the law of contract is that where there is a dispute as to whether or not a contract exists, the courts will assess the situation not from the perspective of the parties, but from the perspective of a "reasonable man". In other words, the judge will want to decide if, given all the circumstances, a "reasonable man" would believe there to be a contract. An 1871 English case, Smith v. Hughes, summarized this principle as follows:
"If whatever a man's real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to terms proposed by the other party and that other party, upon that belief, enters into a contract with him, the man thus conducting himself would be equally bound as if he had agreed to the other person's terms."
Theoretically, then, both parties could deny having entered into a contract but if a third party brought them to court and asked the court if there was a contract, the judge could decide that there was one based on this objective standard.
In the real world, mere conduct will rarely cause a judge to "make" a contract between the parties. This is particularly true if some type of written document has been prepared or exchanged between the parties. Rather than invent a contract, the judges would then take any written document between the parties and try to make sense of it given it's wording, rather than suppose terms. A 1978 Canadian case (Marquest Industries Ltd. v. Willows Poultry Farms Ltd.) sets out the principle as follows:
"... if the real intention of the parties can be collected from the language within the four corners of the instrument, the Court must give effect to such intention by supplying anything necessarily to be inferred and rejecting whatever is repugnant to such real intention so ascertained."
Furthermore, where a key element of the contract has not been negotiated between the parties, then it makes more sense to conclude that there was no contract rather than a court trying to fill in such a huge blank. Such a situation might be an "agreement in principle," but not a contract (see also Interpretation of Contracts below). Letters of intent are not normally held to be binding.
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