OVERVIEW
Contracts are the backbone of our system of commerce; the legal rules and principles governing contracts determine whether our agreements are legally binding and what remedies are available if a contract is breached. Since many contracts are entered into without the involvement of a lawyer, a basic understanding of contract law will help avoid many potential legal problems.
CONTRACTS DEFINED
A contract is an agreement that the law will enforce. Contracts can be oral or written, although in certain cases, the law requires the contract to be in writing to be enforceable. The ‘Common Law’, that is, rules made by judges in the course of deciding cases (as opposed to statutes enacted by legislatures) is the source of most contract law. For certain types of transactions, the Common Law has been incorporated into state statutes. A valid contract must represent a ‘meeting of the minds’, that is, an understanding on the essential terms of the agreement.
Agreements to Agree
An ‘agreement to agree’, that is, a preliminary agreement that does not contain all essential terms and does not represent a true ‘meeting of the minds’, will generally not constitute a valid contract. The courts are reluctant to add missing terms to an agreement that is indefinite.
Uniform Commercial Code
In every state other than Louisiana, Article 2 of the Uniform Commercial Code governs the sale of goods. The code, sometimes referred to as the ‘UCC’, was adopted throughout the United States with some variations, in order to simplify and clarify the law of sales. The rules of law incorporated in the Uniform Commercial Code will be utilized in this article in analyzing contract law.
Legal Capacity
In order to enter into a binding contract, both parties must have the necessary legal capacity to do so; the law requires that contracting parties be capable of understanding the nature of the contract and have the capacity to form an intention to be bound by it. Persons who are insane or are otherwise suffering from a severe mental disorder or disease are legally incapable of entering into a contract. Contracts entered into while intoxicated can be voided or revoked within a reasonable time after becoming sober. Contracts that are the product of fraud or duress will not be enforced.
Minors
Minors, individuals who are either under 18 or 21 depending on their state of residence, can enter into contracts, however they are voidable. A voidable contract is one that a party may at his/her option either enforce or reject. Except as regards contracts for necessaries (food, medical care, clothing, shelter), a minor can disaffirm a contract at any time until adulthood. If the contract has not been cancelled shortly after reaching the age of majority, it can no longer be voided. Any benefits received by the minor must ordinarily be returned at the time the contract is voided.
Illegality
Contracts that require either party to perform an illegal act are unenforceable.
Agents
Parties can appoint agents to enter into contracts on their behalf. In those cases where the contract must be in writing, the authority from the principal to the agent to act on his/her behalf must also be in writing.
Modification
Contracts can be modified or amended at any time if the parties mutually agree to do so. Contracts that are required to be in writing generally require the modifications to be in writing as well.
ELEMENTS OF A CONTRACT
The basic elements of a contract are an ‘offer’, an ‘acceptance’ and ‘consideration’. Each of these elements will be discussed separately.
Offers
An offer is an expression of willingness to enter into a contract. It differs from preliminary negotiations; the offer must be clear and definite as to its terms and it must invite an acceptance immediately or within a defined period.
Duration of Offer
Unless the offeree (person to whom the offer is communicated) has an option contract (see below), the offer is open until (1) it expires by its own terms, (2) the offeror withdraws it (before acceptance by the offeree), or (3) a reasonable time has passed- what is reasonable depends on the circumstances.
Options
An option contract is a legally binding agreement that allows a party to exercise a right in the future; it is an agreement to keep an offer open for a certain period of time.
Unilateral and Bilateral Contracts
The offer may be for a unilateral or bilateral contract. A unilateral contract requires the acceptance to be in the form of an act, e.g., “I promise to pay you $1,000 if you build me a table”; to accept the offer, the offeree merely performs the act. A bilateral contract is one in which a party promises to do something in return for a promise from the offeree. Acceptance is indicated by making a return promise, e.g., “I promise to pay you $1,000 if you will promise to give me a deed to your property”. The distinction is often important in determining whether a valid contract has come into existence.
Acceptance
An acceptance is the offeree’s agreement to be bound to a contract under the terms and conditions of the offer. An acceptance must be unconditional- if conditions are attached, it may constitute a counter-offer from the offeree. A bilateral contract is accepted when the offeree makes a responsive promise to the offer. A unilateral contract is accepted when the required act is performed, although some courts require that the offeree also give the offeror notice that the act has been performed.
Method of Acceptance
If the offer does not specify the mode of acceptance, acceptance may be given by any reasonable method. Where the mode is specified (e.g., telegram, certified mail, etc.), the method must be followed. Where acceptance is required by mail, it is usually effective when posted.
Acceptance of Benefit
With respect to contracts for services, acceptance of the benefit of the service generally constitutes an acceptance. This means that a property owner cannot watch a workman mistakenly lay a patio at one’s home, and after the service is complete advise the workman that he installed it at the wrong property and attempt to avoid payment.
Acceptance Varying from Offer
If the terms of acceptance vary from the offer in a way that is not material and does not change the essential character of the contract, the courts will generally find that a contract exists.
Consideration
Generally, a contract will not be enforceable unless it is supported by consideration- something that a party gives up or does in return for something else. Consideration is any promise or act that induces a party to enter into a transaction. Both parties to the transaction must give consideration- this is referred to as ‘mutuality of obligations’. If the parties enter into a contract whereby the seller agrees to sell airline tickets for $100 to a purchaser, the seller’s consideration is the agreement to transfer the tickets; the purchaser’s consideration is payment of $100. The consideration must be real, and not illusory. If either party can back out of a contract at will, any consideration recited in the contract is illusory since it can be cancelled at any time.
Adequacy of Consideration
The courts will generally not examine the adequacy of the consideration as long as it has some value. The consideration can be non-economic, e.g., the promise to refrain from some activity, such as smoking, is adequate consideration. Nominal consideration, e.g., $1.00 to support an agreement to sell an apartment building worth $1,000,000, may be considered by the court to be no consideration at all.
Agreement to Make a Gift
A promise to make a gift is generally unenforceable because it lacks consideration. Once the gift has been made, however, it need not be returned.
Contracts Enforceable Without Consideration
Under certain circumstances, a contract may be binding even in the absence of consideration. Modifications to sales contacts, promises to pay debts discharged in bankruptcy or to pay for services that were received previously are generally enforceable without new consideration.
A promise that would reasonably cause reliance on the part of the promisee may be enforceable without consideration if the promisee actually relies on the promise to his/her detriment. A promise by a rich uncle to pay for college tuition if his nephew quits his job and enrolls in school is enforceable if the nephew actually quits his job and enrolls. Promises to make charitable contributions are often enforced by the court on principles of promissory estoppel- the promisor is estopped or prevented from claiming that the promise is not supported by consideration.
CONTRACTS THAT MUST BE IN WRITING
While most contracts are binding even if oral, certain contracts must be in writing to be enforceable. Because certain types of contracts are more susceptible to fraud than others, all 50 states have adopted some version of the ‘Statute of Frauds’.
Statute of Frauds
Contracts that must be in writing pursuant to the Statute of Frauds include
- Promises to pay the debts of another
- Contracts for the sale or purchase of land, other than for leases of less than a year
- Contracts that cannot be fully performed within one year from its making
- Contracts for the sale of goods valued at more than $500
- Contracts made in consideration of marriage, such as premarital agreements or marital settlement agreements
Memorandums
A signed memorandum or summary, of a contract may be sufficient to satisfy the ‘writing’ requirement of the Statute of Frauds if they contain the essential terms of the agreement and indicate that a contract was entered into between the parties. If the memorandum is signed by one party only, it may be enforceable only against that party.
Memorandums between Merchants
Under the Uniform Commercial Code (UCC), a confirmation of an order or contract sent to a party may be enforceable against such party even if it is not signed if no objection is made to the confirmation within 10 days.
INTERPRETING CONTRACTS
If there is a disagreement between the parties to a contract as to its meaning, the courts will generally allow introduction of evidence to show what the parties intended. All terms in the contract will be interpreted in a way that gives them meaning.
The courts will not allow parties to introduce evidence of preliminary agreements or discussions in order to contradict or vary the terms of a contract that appears to be in final form on its face.
Custom and Usage
As between merchants, the court will consider the past dealings of the parties as well as what is customary in the trade in interpreting the provisions of a contract.
BREACH OF CONTRACT
When a party fails to perform obligations required under a contract, he/she is said to have breached it. A breach of contract gives the injured party a variety of potential remedies. The party who failed to perform may claim that some act or omission relieved him/her from performance as a defense in a lawsuit.
Anticipatory Repudiation
If a party clearly has clearly indicated that he/she will not or can not perform under a contract before the time that performance is due, that party is said to have committed an ‘anticipatory repudiation. Under such circumstances, the injured party can sue immediately.
Remedies
The parties injured by a breach of contract can sue upon the contract for damages. In a suit for breach of contract, the court will attempt to put the plaintiff in the position he/she would have been in had the contract been fully performed. The damages include any lost profits that the plaintiff would have realized and any other losses that were reasonably foreseeable and incidental to the breach. The plaintiff may be able to recover any expenses incurred to cover, reduce or mitigate his/her damages; e.g., if the seller breaches a contract to sell a car and the purchaser is forced to buy a similar vehicle for a higher price, the seller is generally responsible for the increased cost as well as the expense of a rental vehicle while looking for a replacement.
Mitigation of Damages
A party who has sustained losses or damages as a result of a breach of contract must take reasonable steps to mitigate and keep such damages or losses at a minimum. Mitigation in the case of breach of a contract to sell a car, for example, may include purchasing a substitute vehicle so that automobile rental expenses do not continue for an excessive period.
Equitable Relief
Often, the plaintiff cannot be made whole through an award of money damages alone. Under these circumstances, and particularly in contracts for the purchase of real property (land, house, etc.) or some other unique item, the court may order specific performance- that is, direct the defendant to perform under the terms of the contract, e.g., to convey the land.
If the contract itself provides for a specified amount of damages in the event of breach through a ‘liquidated damage clause’, the court will generally award the specified amount.
Intended Beneficiaries (Third Party Beneficiaries)
Often, a third person, not a party to the underlying breached contract, would have benefited directly from its performance and is injured as a result of the breach. In such cases, the law gives the injured ‘intended beneficiary’ a right to sue the breaching party. If A and B enter into a contract whereby A is to perform services for B in return for B paying A’s debt to C, C can maintain a direct action against B as an intended beneficiary in the event of a breach. An incidental beneficiary, one who might have derived an indirect benefit from performance, but was not an intended beneficiary, cannot bring such an action.
Defenses
There are a variety of possible defenses to an action for breach of contract. These defenses include fraud, duress, illegality, lack of consideration, mistake, that the contract violates the Statute of Frauds, and impossibility of performance.
Mistake
If there was a mutual mistake by both parties as to an essential term or condition of the contract, the contract can be avoided or rescinded. The mistake must have had a material effect on the nature of the contract (e.g., the parties thought they were buying and selling a diamond and it turns out to have been glass). In order for a unilateral mistake (mistake by one party to the transaction) to be the basis for rescission, it must be shown that enforcement of the contract would be unconscionable (grossly unfair) or that the other party had reason to know of the mistake or caused or contributed to the mistake.
Impossibility of Performance
If performance under a contract has been rendered impossible by the occurrence of an event not within a party’s control, that party is relieved from any duty to perform. Impossibility of performance may result from destruction of the subject matter of the contract (e.g., destruction by fire of a house that was to be painted under a contract) or an act of god, war or strike.
Duress
In order for contracts to be valid and binding, they must be entered into voluntarily. Threats, coercion or duress used to force a person to enter into a contract are valid defenses to an action (lawsuit) for breach of contract if they are such that they would have deprived a reasonable person of the ability to exercise free will.