A contract is a binding agreement between two or more parties. This agreement creates one or more obligations. Each party to a contract is legally bound to do, or to refrain from doing, certain acts. The essence of a contract is that by mutual agreement, parties create obligations that can be legally enforced.
The elements of a contract are:
• an agreement;
• between competent parties;
• based upon the genuine assent of the parties;
• supported by consideration;
• made for a lawful objective; and
• in the form required by law.
A voidable contract is an agreement that would be binding and enforceable except the circumstances surrounding its execution, or the fact that one of the parties lacks capacity, makes the contract voidable at the option of one of the parties. For example, a person who has been forced to sign an agreement may avoid being bound by the agreement.
A void agreement is an agreement which is without legal effect. For example, an agreement which deals with the performance of an illegal act is void. A gambling contract in many states is void.
An executed contract is a contract that has been completely performed. Nothing remains to be done by either party. For example, if you go into a furniture store and agree with the salesman to pay $400.00 for a chair and then pay the salesman cash and take delivery of the furniture, the contract has been completely executed.
In an executory contract, something remains to be done by one or both of the parties. For example, if a contract is executed between a seller and a buyer regarding the purchase of land, and both parties agree that the sale will be consummated after the buyer obtains his loan and the seller gives a certificate of title (showing no defects), the contract is enforceable, but it is said to be executory.
An option contract is a contract that gives the right to one party to enter into a second contract with the other party at a later date. One of the most common forms of option contracts deals with the sale of real estate. In this contract, the prospective buyer will be granted an option to purchase the property within a specified period of time. The prospective buyer will pay the seller a sum of money since the seller is, in effect, taking the property off the market during the option period. If the prospective buyer exercises his option during that time, a second contract is entered into regarding the sale of the property. If the option period expires, then neither party has any obligation to the other.
One of the essential elements of a contract is an agreement. An agreement shows that the parties have bound themselves to act or refrain from acting in a manner specified by the contract. It is essential to a contract that there be an offer and, while the offer is still in existence, it is accepted without qualification. An offer expresses the willingness of the offeror to enter into a contract agreement regarding a particular subject.
To constitute an offer, the offeror must intend to create a legal obligation, or he must appear to a reasonable person to intend to create a legal obliga¬tion. This intent can be shown by conduct. For example, when one party signs a written contract and sends it to the other party, this action is an offer to enter into a contract on the terms of the writing. Again, the offeror must intend to create a legal obligation. No contract comes into being when an offer is made jokingly, or under any other circumstances under which a reasonable person would not regard such an offer as an intent to enter into a binding agreement.
Hypothetical: Richard discusses selling a farm to Lucy. After a 40-minute discussion of the first draft of a contract, Richard signs a second draft stating: “I hereby agree to sell to Lucy the Richard Family Farm for $50,000 with title satisfactory to buyer.” Lucy agrees to purchase the farm on these terms. Thereafter, Richard refuses to transfer title to Lucy claiming that he had made the contract as a joke and there was no contract. Was Richard correct? No. There was a binding contract because it would appear to a reasonable person that there was a serious transaction in which the parties made an agreement with contractual intent. The long discussion on the first draft and the execution of a second draft contradicted any claim that the transaction was not serious. The agreement was therefore binding; that is, a contract existed.
Hypothetical: The Smith Music Company advertised a television set at $22.50 in the Sunday paper. Ehrlich ordered a set, but the company refused to deliver it on the grounds that the price in the newspaper was a mistake. Was the Company liable? No. The newspaper ad was merely an invitation to the public to make offers. It was not an offer that could be accepted by placing an order with the company. Consequently, a purported “acceptance” by a customer did not result in a binding contract, but was merely an offer that did not become a contract until accepted by the advertiser.
An invitation to negotiate is not an offer. Newspaper advertisements, price quotations, and catalog prices are ordinarily just invitations to negotiate and cannot be accepted in a contractually-binding manner. No seller has an unlimited supply of any commodity and therefore cannot possibly be deemed to have intended to make a contract with everyone who sees the advertisement or seeks to accept the price offered.
Assuming that an offer is made with intent to be bound, it still is not a legal offer unless it is communicated to the offeree. This offer may be communicated by the offeror or at his direction. If the offeree hears about the offer indirectly, through the grapevine so to speak, he cannot accept the offer until it is communicated to him by the offeror or at the offeror’s direction.
An offer can be withdrawn before acceptance and therefore prevent a contract from arising. If an offer is withdrawn or terminated, an attempted acceptance after the termination has no legal effect. Ordinarily, an offer may be revoked at any time by the offeror prior to acceptance. All that is required is the showing by the offeror of his intent to revoke the offer and communication of this intent to the offeree.
Offers may be terminated in any one of the following ways:
• Revocation of the offer by the offeror;
• A counteroffer by offeree;
• A rejection of the offer by offeree;
• Lapse of a sufficient amount of time;
• Death or disability of either party; or
• Performance of the contract becomes illegal after the offer is made.
The general rule is that the revocation is effective only when it is made known to the offeree. Until it is communicated to the offeree, directly or indirectly, the offeree has reason to believe that there still is an offer that may be accepted. The offeree may rely on this belief.
If the offeror seeks to revoke the offer, but the offeree accepts the offer before notice of the revocation, a valid contract is created. Say, for example, Smith promises to sell 100 widgets to Jones. Smith then changes his mind. Smith mails a letter of revocation to Jones. Jones, in the meantime, sends a fax to Smith accepting the offer before Jones receives Smith’s letter. There is a binding contract.
If Smith makes an offer to Jones to sell Jones a car for $10,000.00, and Jones replies the he will purchase it for $7,500.00, the original offer is terminated. Jones in effect is refusing the original offer and making a counteroffer. The original offer of $10,000.00 cannot be accepted. A new offer of $10,000.00 can later be made, but the original offer is no longer effective.
A conditional acceptance is also a counteroffer. For example, if Jones accepts the $10,000.00 price, but adds a term by stating that new tires must be put on the car, this is a conditional acceptance and therefore a counteroffer.
A rejection also terminates an offer. A rejection is an offeree’s communication that an offer is unacceptable.
When an offer states that it will be open until a particular date, the offer terminates on that date if it has not yet been accepted. This is particularly true when the offeror declares that the offer shall be void after the expiration of a specific time. If the time passes, and the offeree then attempts to accept the offer, this is in effect a counteroffer from the offeree and can be accepted or rejected by the offeror.
If the offer does not specify a time, it will terminate after a reasonable time has passed. What constitutes a reasonable time depends on the circumstances of each case. For example, if the commodity to be sold or purchased is a perishable commodity, such as food, the reasonable time would be shorter than if the commodity to be sold is machinery.
If the performance of the contract becomes illegal after the offer is made, the offer is deemed to be terminated. For example, if there is an offer made to sell alcoholic beverages to a store, but a city ordinance is passed prohibiting the sale of alcoholic beverages before the offer is accepted, the offer is terminated.
If the offeror does not otherwise specify, a mailed accep¬tance takes effect when the acceptance is properly mailed. This is known as the “Mailbox Rule.” If the offeror specifies that an acceptance shall not be effective until received, the Mailbox Rule would not apply and there is no acceptance until acceptance is received.
Hypothetical: Thompson owns 100 acres of land. Morrison mails an offer to Thompson to buy his land. Thompson agrees to this offer and mails back a contract signed by him. While this letter was in transit, Thompson orally notifies Morrison that his acceptance is revoked. Is Thompson bound by a contract? Yes, since the acceptance was effective when mailed. Subsequent revocation had no effect.
Improperly mailing an acceptance can destroy the acceptance. Improper mailing can cause the acceptance to take effect only when received.
The law generally presumes that everyone has the capacity to contract. However if a party does lack capacity, then the contract is voidable and the party without capacity, or his representative, may avoid the contract.
Parties to an agreement must have contractual capacity before the agreement will be binding on both parties. Contractual capacity is the ability to understand that a contract is being made and to understand its general nature. The fact that a person does not fully understand the full meaning and all ramifications of a contract does not mean that the person lacks contractual capacity.
Some classes of persons, such as people under the age of 18 in most states, are deemed by law to lack contractual capacity. With some exceptions, a contract made by a minor is voidable. The minor, in other words, may avoid the legal liability under a contract. Upon reaching the age of majority, a minor may affirm or ratify the contract and therefore make it contractually binding on him. Any expression of the minor’s intention to avoid the contract will void the contract. A minor can only avoid a contract during his minority status and only for a reasonable time after he reaches the age of majority. After a reasonable period of time, the contract is deemed to be ratified and cannot be avoided.
Parents of a minor are not liable regarding the contracts made by the minor merely because they are the parents of the minor. However, if a minor makes a contract and a parent signs along with the minor as a co-signer, the parent can be held liable.
A person who is mentally incompetent (NCM) lacks the capacity to make a contract. The cause of the mental incompetency is immaterial. It can be the result of a mental illness, excessive use of drugs or alcohol, a stroke, etc. If the person does not have the mental capacity to understand that a contract is being made or the general nature of the contract, the person lacks contractual capacity. A person who is mentally incompetent may ordinarily avoid a contract in the same manner as a minor. If the person later becomes competent, he can ratify or avoid the contract at that time.
The third element necessary to form a contract is the consent or understanding of the parties regarding the proposed contract. The consent or assent of a party to an agreement must be genuine and voluntary. This assent will not be genuine or voluntary in certain cases of mistake, deception or undue pressure. If the apparent agreement does not reflect the true intention of the parties, it is possible to have the agreement set aside.
The agreement of parties may be affected by the fact that one or both of them made a mistake. A unilateral mistake is a mistake made by one party to the agreement. A mistake that is unknown to the other party usually does not affect the enforceability of the agreement. A unilateral mistake regarding a fact does not affect the contract. For example, if a customer orders a water-resistant coat thinking that this means waterproof, the customer cannot get out of the contract unless the sale was made with some sort of misrepresenta¬tion as to the meaning of those words.
Failure to read a document before signing it can still cause the signer to be liable under the terms of the document. For example, suppose the president of ABC Corporation signs a promissory note in two places without reading it. In one place he signed as president of the corporation. However, in the other place, he signed under a statement that stated that if the corporation defaulted on the loan, the president would personally pay for the debt. In such a situation, the president could be held personally liable due to his negligence in not reading the document.
Even if a person is unable to read or understand the terms of the agreement, he is still bound by the terms of the agreement since he should have tried to obtain an explanation of the agreement. The exception to this rule is that if the other party knows, or has reason to know, that the signer cannot read or has a limited education. Some Courts would hold in such a situation that the other contracting party should have read the document to signer or explained the terms to him
If a party relies on the explanation of another party as to the contents of the agreement, the contract may be avoided under two circumstances:
the party was justified in relying on the explanation of the other party; and
the explanation was fraudulent.
The party making the explanatory statements does not have to be a lawyer, but can be any person who handles this type of agreement on a regular basis and therefore has a greater knowledge of the content than the other person. This rule is applicable to a situation where the agreement is on a preprinted form, and the person who explains the agreement handles these types of forms on a regular basis.
If both parties to an agreement make the same mistake regarding a key factual matter, the agreement is void. For example, a contract is void if both parties mistakenly believe that the contract can be performed when, in fact, it is impossible to perform it. Suppose Smith promises over lunch to sell Jones an antique Mercedes in Smith’s garage. Assume both parties believe the automobile is in Smith’s garage. However, the car had been destroyed by fire an hour before the agreement and Smith had not learned of this. Since this fact was unknown to both parties, there is a mutual mistake as to the possibility of performing the contract. The agreement is therefore void.
When parties to an agreement make a mistake as to the legal effect of the contract, the contract is still binding. For example, suppose Smith sold Jones a vacant lot and Jones planned to build an office on the lot. Both Smith and Jones assume that this would be a lawful use of the property. However, if after pur¬chasing the property and applying for a building permit, Jones is told that the property is zoned for residential use, the contract is still binding. However, if the contract had represented that the property could be used for the building of an office, it could be rescinded by Jones.
When one party to a contract knows of a fact that has a bearing on the transaction, the failure to disclose this information to the other party is called nondisclosure. Generally, the law does not attach any significance to nondisclosure. The theory is that it is preferable that the party lacking the knowledge ask questions of the party with the knowledge rather than imposing some sort of duty on the party with the knowledge to volunteer the information. Thus, generally, an agreement of the parties is not affected by the fact that one party did not disclose information to the other party. This is the general rule. Ordinarily there is no duty on a party to a contract to volunteer information to the other party. The nondisclosure of information that is not asked for by a party does not hurt the validity of the contract. For example, Jones wants to buy Smith’s house. Jones, prior to signing the contract, makes an inspection of the house and sees several cracks in the roof and walls. He assumes that these cracks are just the result of the house settling. Smith makes no disclosure one way or another about the cracks. Jones buys the house and later discovers that the house has severe foundation problems. He sues Smith for the damages incurred in repairing the foundation problems. Under the general rule, Smith would be under no duty to disclose the foundation problems to Jones. Of course, one way to avoid any question whatsoever is to state in the contract that the buyer has inspected the premises and is purchasing the premises in their as is and present condition.
There are some exceptions to this general rule of no liability for failure to disclose. In some instances, the failure to disclose information that was not requested can be regarded as fraudulent, giving the party harmed by the nondisclosure the same remedies as if a known false statement were intentionally made. These exceptions fall generally into one of four categories:
• Unknown defect or condition;
• Confidential relationship;
• Fine print; and
• Active concealment.
There is developing in the law a duty for one party who knows of a defect or a harmful condition to disclose this information to the other party if the defect or harmful condition is obviously unknown to the other party and is of a nature that the other party would be unlikely to discover or inquire about the defect or condition. Many manufacturers and distributors of asbestos products are being, and have been, sued for selling these products without disclosing the information that asbestos products can cause cancer.
Courts may find an intent to conceal when a printed contract contains clauses in such fine print that it is reasonable to believe that the other party will not take the time to read the provisions. Of course, no relief will be granted to the party reading the contract if the fine print is not material. In other words, if the provisions in fine print are such that the party reading the contract would have entered into the contract in any event, the provisions in the fine print would not cause the contract to be invalid.
Active concealment can cause a contract to be invalid or result in liability to the concealing party. This is more than a failure to volunteer information. Active concealment consists of hiding information from the other party by concealment. For example, using the Smith and Jones house transaction as an example, if Smith had painted over the cracks in the wall and the ceiling in order to hide the foundation problem, he would be guilty of active concealment and the contract could possibly be rescinded, or Jones could possibly recover damages from Smith in the amount of the foundation repair costs.
Fraud consists of five elements:
• The making of a false statement;
• With knowledge that the statement is false or with reckless disregard as to whether or not the state¬ment is false or true;
• With the intent that the listener rely on the statement;
• With the result that the listener relies on the statement; and
• With the consequence that the listener is harmed.
An essential element in proving fraud is to prove that one relied on the statement which is alleged to be fraudulent. If the alleged victim had the same knowledge of the true facts as the alleged wrongdoer, no fraud is present. If the victim should have known the facts or if a reasonable person would have known that the statement was not true, there is no fraud. If false statements are made after a contract has been signed, it is obvious that there was no reliance on the false statements and therefore there is no fraud.
Hypothetical: Smith offers to sell Jones a car and represents that the car has never been in a wreck. Jones, who has worked on cars for many years, notices some dents underneath the car that could only have been made a wreck. Jones buys the car anyway. Even if Smith knew this statement was false and was trying to deceive Jones, there is no fraud since Jones did not rely on Smith’s representation.
Ordinarily, a statement of opinion cannot be the basis for fraud liability. The theory is that a person hearing the statement should recognize it as merely the speaker’s personal viewpoint.
A statement of the law that is false is ordinarily treated in the same manner as an opinion and cannot be treated as fraud. The theory behind this is that the listener has an opportunity of discovering what the law is. However, if the speaker has an expert’s knowledge of the law or claims to have such a knowledge, the statement can be the basis for fraud liability. Of course, an obvious example of this would be a statement of law made by a lawyer to a non-lawyer which the lawyer knew was false. The other elements of fraud would also have to be present.
Lester purchased a used automobile from Moore Motors. He asked the seller if the car had ever been in a wreck. The Moore salesperson had never seen the car before that morning and knew nothing of its history, but quickly answered Lester’s question by stating: “No. It has never been in a wreck.” In fact, the auto had been seriously damaged in a wreck and, although repaired, was worth much less than the value it would have had if there had not been any wreck. When Lester learned the truth, he sued Moore Motors and the salesperson for damages for fraud. They raised the defense that the salesperson did not know that the statement was false and had not intended to deceive Lester. Did the conduct of the salesperson constitute fraud? Yes. The salesperson making the statement that there were no prior wrecks did not know whether that statement was true or false. Nevertheless, the salesperson made the statement as though it were true and as though he knew it were true. This constituted reckless indifference as to whether the statement was true. The reckless indifference as to the truth of a statement satisfies the mental state element of fraud. The salesperson was therefore guilty of fraud.
An agreement may be set aside if it was not in fact entered into voluntarily by both of the parties. If either party entered into it because of undue influence or physical or economic duress, it may be set aside.
Undue influence arises in a situation where a confidential type relationship exists and one party has such influence over the other party that the other party’s free will is dominated to the benefit of the influencing party. Confidential relationships which may result in undue influence can be such things as the relationship of an elderly parent and an adult child, a physician and patient, an attorney and client, or any other relationship of trust and confidence in which one party exercises a control or influence over another. Because of the possibility that a person in such a confidential relationship may dominate the will of another and take unfair advantage, if such a confidential relationship exists, the law presumes that undue influence has occurred if the dominating party obtains any benefit from a contract made with the person alleged to be dominated. The contract is then voidable and may be set aside unless it can be proven that no such domination took place.
Hypothetical: Smith, upon reaching the age of 75 and being in ill health, decided to move in with his oldest adult son. He lived with his oldest adult son for several years prior to his death. Upon his death, it was discovered that he deeded all of his property to his oldest son. The younger son contested the deed, stating that his older brother exercised undue influence over their father in getting him to give all of his property to the oldest son. A presumption of undue influence would arise which would have to be overcome by the oldest son. One way to overcome this would be to show that the father consulted a disinterested third party, preferably an attorney, without the older son being present, and was counseled by the third party. This is not absolute proof of the lack of undue influence, but it is a very important element.
Persuasion and argument are not in themselves undue influence. An essential element of undue influence is that the person making the contract does not exercise his free will. Unless there is a confidential relationship, such as that between a parent and child, Courts are most likely to take the attitude that the person who claims to have been dominated was merely persuaded.
An agreement made under duress may be set aside if the duress took the free will of the person seeking to avoid the contract away. In a duress situation, a party enters a contract to avoid a threatened danger. This threat may be a threat of physical harm to person or to the property of someone (physical duress) or it may be a threat of severe financial loss (economic duress).
A person makes a contract under duress when there is violence or the threat of violence to the extent that the person is deprived of his free will and makes the contract to avoid harm. The threatened harm may be directed at a relative of the contracting party as well as against the contracting party. If a contract is made under duress, the agreement is voidable.
Another of the elements needed to make an agreement binding is consideration. Even though there has been an offer and an acceptance, an agreement may not be enforceable if there is no consideration.
Consideration is what the promisor demands and receives as the price for the promise. Remember, the promisor is the person making the promise, and the promisee is the person to whom the promise is made. Consideration consists of something that the promisor is not otherwise entitled to. It is not necessary to use the word “consideration” in a contract.
Consideration is the price paid for the promise. When thinking of consideration, think in terms of legal value as opposed to economic value. While economic value (e.g., money) is the most common form of consideration, consideration does not have to involve money. In order for a contract to be enforceable, each party to the contract must change his or her legal position in some way.
Ordinarily, Courts do not consider the adequacy of the consideration given for a promise. Suppose Smith agreed to provide janitorial service to Acme for six months at $400.00 per month. After three months, Smith decided that $400.00 was not enough money, and he sought to get out of his contract, stating that the consideration for the services was inadequate. Is there a binding contract? The contract is binding since, again, the law is not normally concerned with the value or quantity of consideration that the promisor demands and receives for the promise. The employment contract was binding even if the compensation to be paid was in fact low.
The fourth element of a contract is that it must be made for a lawful objective. Courts will not enforce contracts that are illegal or violate public policy. Such contracts are considered void. If the illegal agreement has not been performed, neither party can sue the other for damages or to require performance of the agreement. If the agreement has been performed, neither party can sue the other for damages or have the agreement set aside. For example, a gambling contract would be illegal in many states.
Hypothetical: Knight did not have a real estate license nor did he claim to. However, Johnson asked Knight to find a buyer for Johnson’s car wash in exchange for Johnson paying Knight a 15% commission if Knight could find a buyer. Knight obtained a buyer and was paid one-half of the commission. Johnson refused to pay any more commission. Knight sued Johnson for the remaining commission. The Court ruled in favor of Johnson as to the unpaid commission since the licensing statute was violated by Knight acting as a broker without a license. The agreement to pay him commission was therefore void and could not be enforced. Johnson also claimed that Knight should not be entitled to keep the commission he had received. The Court held that although Knight had no right to the commission, he had been paid and the Court would not aid either party to the illegal contract. Therefore, Johnson could not recover from Knight the commission that had already been paid.
In most cases, parties to an illegal agreement are denied remedies of any nature. A Court will not require parties to perform an illegal agreement, and a Court will not award damages because a party fails to perform.
An agreement which calls for the commission of a crime is illegal and therefore void. For example, a person could not enforce an agreement with another party to burn a house down. Also, an agreement that calls for the commission of a civil wrong (such as a tort) is illegal and void. For example, an agreement to slander a third party is void. An agreement to infringe another’s trademark or copyright is also void.
Ordinarily, a Court will not consider whether a contract is fair or unfair, wise or foolish. However, in some instances, Courts will hold that a contract will not be enforced because it is too harsh or oppressive to one of the parties. For example, a clause in a contract which provides that a party will pay a large penalty if he breaks the contract may be unenforceable, depending upon the circumstances. Another example would be a situation where one party agreed that the other party would not be liable for the consequences of gross negligence. This type of agreement would usually be void as against public policy.
A provision in a contract or a contract which a Court believes gives too much of an advantage over a consumer can be held to be void as unconscionable. This situation would arise when one party has a gross disproportionate bargaining power over another party, such as an inexperienced or financially weaker party. If the terms of an agreement in such a circumstance were deemed to be grossly unfair, the contract could be held to be void as uncon¬scion¬able and therefore contrary to public policy. Unconscion¬ability means that the actions of a party to a contract are so outrageous and oppressive as to shock the conscience of the Court and invalidate a clause or provision of the contract or the whole contract itself.
The fact that a contract is a bad bargain does not make it unconscionable. Unconscionability is to be determined in light of the circumstances existing at the time when the contract was made. The fact that later events show that the contract was unwise or undesirable does not make it unconscionable. For example, if the market price of goods sold pursuant to a contract increased dramatically, this increase in market value as compared to the sales price does not make the contract unconscionable. The concept of unconscionability is frequently used by Courts to protect consumers.
Agreements that may harm the public welfare are contrary to public policy and are not binding. An agreement may not violate a statute, but it still may be so offensive to society that Courts will rule that to enforce it would be contrary to public policy.
An agreement which would require a person to lose some sort of statutory protection would be in violation of public policy. For example, state insurance statutes frequently provide that policies of a certain type (e.g., medical) must contain certain benefits. An insurance policy which fails to supply such benefits would violate public policy as declared in the statute.
Any agreement intended to obstruct the process of law is void as being contrary to public policy. For example, in a medical malpractice case, if I offered to pay my expert witness, a physician, $10,000.00 for testifying in any event, and $25,000.00 if I win the case, would be void. The danger here is that a witness might lie in order to help win the case.
Most states provide that gambling contracts are illegal. Lotteries which involve the element of a prize, chance, and consideration are also held to be held illegal. Of course, a state may allow a lottery run by the state or may legalize gambling in general, such as in Nevada. In some states, bingo games, lotteries, and raffles are legal if the proceeds go to charity.
Giveaway plans and games are lawful as long as it is not necessary to buy anything or give anything of value in order to participate. If participation is free, the element of considera-tion is not present and therefore there is no lottery.
Statutes frequently require that a person obtain a license or certificate before practicing certain professions such as law or medicine, or before carrying on a particular business such as that of a real estate broker or stock broker. If the license is required to protect the public from unqualified persons, such as an unlicensed physician, the contract made by the unlicensed person is void. In a North Carolina case, a statute required that contractors be licensed. An unlicensed contractor made a contract to make repairs. The Court held that the contractor could not recover from the owner either the price agreed to in their contract or the reasonable value of the services actually performed since the contractor was unlicensed.
If a license is strictly a revenue raiser, such as a privilege license to conduct business from a store at a particular location, it would be rare for an agreement made in violation of the licensing statute to be held invalid. Someone operating a store without a permit would not have all of its sales declared void, but he might be fined for failure to obtain the appropriate license.
The fifth element of a contract is that it must be in the form required by law. Do all contracts have to be in writing? No – oral contracts can be just as valid and enforceable as written contracts. How¬ever, the law requires that certain contracts must be in writing in order to be enforceable by a Court. The state statutes that require certain contracts to be in writing are called statutes of fraud. Statutes of fraud require that either the contract itself be in writing and signed by both parties or there must be a sufficient memorandum of the agreement signed by the party being sued for breach of contract.
The statute of frauds normally does not apply if it is possible under the terms of the agreement to perform the contract within one year. If no time for performance is specified in the oral agreement and the performance will not necessarily take more than one year, the statute of frauds would not apply.
McLarty claimed that he and Wright made an oral contract to start a business under the name of DeKalb Textile Mill, Inc., to incorporate the business, and to divide the stock equally. The alleged contract was not performed. McLarty sued Wright for breach of contract. Wright raised the defense of the statute of frauds, asserting that it was not specified that the contract should be performed within one year of making. Was this defense valid? No. The contract could have been performed within one year of making. A writing was therefore not required. It is not necessary that the contract state expressly that it is to be performed within one year in order to avoid the statute of frauds applicable to contracts that cannot be performed within one year. The statute does not apply if the contract contemplated performance within one year or if in fact it could be performed within one year.
An agreement that cannot be performed within one year after the agreement is made must be in writing in most states to be enforceable. Hypothetical: Armored Motor Service made an oral contract to supply First Federal Savings with courier service. The contract was to run for two years. First Federal failed to make the payments required by the contract and was sued by Armored Motor. First Federal raised the defense that the oral contract could not be enforced because of the statute of frauds. The Court held in favor of First Federal. One key element was that the contract was to run two years.
Contracts involving the sale of land must be evidenced by a writing. This would include deeds and mortgages, as well as the contract between the buyer and the seller setting forth the terms of the sale. This statute applies only to the agreement between the owner and purchaser of the real property. It does not apply to collateral agreements such as between a real estate agent and one of the parties to the sales contract regarding the real estate agent’s commission.
Another type of contract that must be in writing is the promise to answer for the debt of another person. For example, an oral promise by the president of Acme Company to pay the debt owed by Acme to Trustmark would not be enforceable.
A promise by the executor or administrator of an estate to use personal funds to pay a debt of the estate must be in writing. An executor of a deceased person’s estate has a duty to pay the debts of the person from the person’s estate. If the executor promises to pay a debt of the decedent from his personal funds, this must be in writing. However, if the executor makes a contract on behalf of the estate, like hiring an attorney to represent the estate, this type of agreement could be enforceable even if it is not in writing.
A promise made in consideration of marriage must be in writing. An example of this would be a prenuptial agreement.
If a contract provides for the sale of goods with a price of $500.00 or more, this type of contract must ordinarily be in writing.
The statute of frauds requires a writing to evidence the contracts which it states must be in writing. This does not neces¬sarily have to be a formal contract signed by both parties. It can be a letter signed by only one party setting forth the terms of the oral agreement. However, the writing, whether it be a letter or memorandum, must be signed by the person “to be charged.” This means it must be signed by the person against whom you are seeking to enforce the contract. The writing must contain all of the material terms of the contract so that a Court can determine what has been agreed to. A letter from the seller of real estate to a potential buyer which did not adequately describe the property involved in the sale would not be enforceable. The description of the land must be adequate in order to allow the Court to know exactly what land is being referred to.
The letter, memorandum, or other writing may consist of more than one writing if there is a sufficient link between them. For example, two or three letters from a seller of land to the potential buyer describing the terms would satisfy the statute of frauds even if one of the letters alone would not be sufficient. It is not necessary that the writing be made with the intent to create a writing to satisfy the statute of frauds. A letter or memorandum signed by a seller of land to the potential buyer could satisfy the statute of frauds even if the seller did not intend for this letter to be used against him should he renege on his agreement.
In dealing with the statute of frauds, the first question is whether the contract is one that has to be in writing. The second question is whether or not there is a sufficient writing that can be enforced. With the parol evidence rule, there is already a written contract, and the question is whether evidence outside of the written contract is admissible in Court. If a contract is in dispute, often a question arises as to whether or not the writing evidencing the contract represents all that the parties agreed to. The general rule is that spoken words (i.e., parol evidence) will not be allowed to modify or contradict the terms of the written contract that is complete on its face. Exceptions to this rule are made in cases of fraud, accident, or mistake, and it can be shown that the writing is therefore not the complete or true contract.
The parol evidence rule prevents a party from avoiding liability on a written contract by presenting evidence that the writing does not mean what it says. This rule is based on the theory that either there was never an oral agreement involved, or, if there were, the parties abandoned their oral agreement when they executed the written contract. The reason for the rule is to give stability to written contracts and to prevent someone claiming that there were oral terms that never found their way into the written agreement.
Parol evidence will be allowed when:
• the writing is incomplete;
• the writing is ambiguous;
• the writing is not a true statement of the agreement of the parties because of fraud,
• accident or mistake; or
• the existence, subsequent modification, or ille¬gality of a contract is in question.
If the written contract is obviously incomplete or if the parties admit that it is incomplete, Courts will allow evidence as to what was orally agreed to, in addition to what was agreed upon in writing. If the terms of the contract are ambiguous, parol evidence will be allowed to explain the contract so as to make it not ambiguous. For example, if a written contract might have two different meanings, parol evidence may be admitted to clarify what the contract really means. The fact that the parties disagree as to the meaning of the contract does not mean that it is ambiguous.
A contract which looks complete on its face may have omitted a provision that should have been included. Parol evidence may be admitted to show that this provision was omitted due to a mistake or because of fraud of the party drawing up the contract. Parol evidence is, of course, admissible to prove fraud. For example, if the seller of property fraudulently represented that the land was zoned to permit commercial use, and the land in fact was not zoned for commercial use, this evidence can be admitted in seeking to avoid the contract.
Interpretation of Contracts
If there is a dispute as to the interpretation of a contract, Courts seek to enforce the intent of the parties to the contract. The intent which will be enforced is what a reasonable person would believe that the parties intended. The intent that will be enforced is the intent as it reasonably appears to a third person (the judge or jury).
Hypothetical: A contract was made for the sale of a farm. The contract stated that the buyer’s deposit would be returned “if for any reason the farm cannot be sold.” The seller later stated that she had changed her mind and would not sell, and she offered to return the deposit. The buyer refused to take the deposit back and brought suit to enforce the contract. The seller defended on the ground that the “any reason” provision extended to anything, including the seller’s changing her mind. Was the buyer entitled to recover? Yes. The condition of “cannot be sold” referred to some condition or circumstance independent of the parties.
In interpreting contracts, ordinary words are to be inter¬preted according to their ordinary meaning. Trade terms and technical terms are to be interpreted according to their trade or technical meaning. Software, when referring to a computer, doesn’t mean something that is soft, but it means the actual program.
The way parties have used terms in their prior relationships can also be used to determine what the parties meant by the words they used in a contract.
The provisions of a contract must be construed as a whole. Provi¬sions are not to be read out of context and interpreted out of context.
If an occurrence or a nonoccur¬rence of an event has an effect on the existence of a contract, the event is called a condition. A condition precedent is the occurrence of an event that precedes the existence of an obligation to perform or the existence of a contract. For example, in a fire insurance policy, there is no obligation on the insurance company to make a payment until there is a fire loss. The occurrence of such a loss is therefore a condition precedent to the duty of the insurer to make payment.
The parties may agree that the contract will terminate if a particular event occurs or does not occur. Such a provision is called a condition subsequent. For example, in a contract for the purchase of land, the contract may contain a condition subsequent that cancels the contract if the buyer is not able to obtain a zoning permit to use a building for a particular purpose. The contract may state something to the effect that this contract is contingent upon buyer being able to have the property rezoned from residential to commercial within 90 days from the date of the agreement.
Sometimes the provisions of a contract are contradictory. In such a situation, a Court will try to reconcile the provisions and eliminate the conflict. However, if this cannot be done, the Court will declare that there is no contract. For example, I make a contract to sell 100 acres of land to John. One paragraph of the contract states that the purchase price is $100,000.00. Another paragraph states that the purchase price is $1,100.00 per acre, which would produce a total price of $110,000.00. Which amount would be binding? Neither amount would be binding if the conflict in the terms could not be reconciled by parol evidence.
In some cases, a conflict can be solved by considering the form of the conflicting terms. If a contract is partly printed or typewritten and partly handwritten, the handwritten part would prevail if it conflicted with the typewritten or printed part. If there is a conflict between the printed part and a typewritten part, the typewritten part would prevail. If there is a conflict between an amount or quantity expressed both in words and figures, as on a check, the amount or quantity expressed in words prevails. For example, if a check is written for $1,000.00, yet the check states it is for One Hundred and 00/100 Dollars, the words would prevail over the figures.
A contract is ambiguous when it is uncertain what the intent of the parties was and the contract is capable of more than one reasonable interpretation. Sometimes ambiguous terms can be explained by the admission of parol evidence. Also, Courts abide by the rule that an ambiguous contract is interpreted against the party who drafted it. In other words, the party who did not draft the contract will be given the benefit of the doubt so to speak. Also, sometimes the background or circumstances surrounding the contract can eliminate ambiguity. For example, in a Minnesota case, suit was brought in Minnesota on a Canadian policy of insurance. The question arose as to whether the dollar limit of the policy referred to Canadian dollars or American dollars. The Court concluded that Canadian dollars were intended since the insurer and the insured were both Canadian corporations, the policy was entered into in Canada, and over the years premiums had been paid in Canadian dollars, and a prior claim on the policy had been settled by using Canadian dollars.
In every contract there exists an implied covenant of good faith and fair dealing. For example, when a contract to purchase a house is made subject to the condition that the buyer can obtain financing, the buyer must make a reasonable good faith effort to obtain the financing or be held in breach of the contract. The implied duty to act in good faith means an honest, good faith effort to satisfy the condition of the contract.
As a general rule, a party is bound by a contract even if it proves to be a bad bargain. However, if a Court is called upon to interpret a contract, if possible, the Court will interpret it in such a way as to avoid hardship when the hardship would hurt the weaker of the two parties to the contract.
When a contract has contacts with more than one state, it is a contract in interstate commerce, and it is necessary to determine which state’s law governs the contract. The rules that govern that decision are called the law of conflicts of law. The parties may specify the jurisdiction whose law is to govern. If that jurisdic¬tion bears a reasonable relationship to the contract, the choice will be given effect by the Court.
Assuming there is no choice of law in the contract, most states apply the “center of gravity” rule. Under this rule, the Court will choose to follow the law of the state which has the most significant relationship to the parties, the contract, and its performance. The Courts consider the place the contract was made, where the negotiations occurred, where the performance was made, the location of the subject matter of the contract (e.g., land location), the residence of the parties, and the states of incorporation and
principal place of business if a corporation is involved.
Suppose a contract requires performance to the satisfaction of the other party. The courts are divided as to:
• Whether the promisor must perform the contract to the satisfaction of the promisee; or
• Whether it is SUFFICIENT that the performance would satisfy a reasonable person under the circumstances.
When personal taste is an important element, the courts generally hold that the performance is not sufficient unless the promise is actually satisfied. However, in most instances, the courts require that the dissatisfaction be shown to be in good faith and not just to avoid paying for the work that has been done. Personal satisfaction is generally required when a person promises to make clothes or paint a portrait to the satisfaction of the other party
When a building contract requires the contractor to perform the contract to the “satisfaction” of the owner, the owner generally is required to pay if a reasonable person would be satisfied with the work of the contractor.
It is common to guarantee the performance of a contract. For example, a builder may guarantee for one year that certain work will be satisfactory. Such a guarantee may be made by a third person. For example, a surety company may guarantee to the owner that a contractor will perform a contract. In such a case, the obligation of the surety is in addition to the liability of the contractor, but the contractor is also still liable. However, a plaintiff cannot recover twice. He can recover only the amount of the liability.
• Part from contractor and part from surety
• or all from surety,
• but not all from surety and all (again) from contractor.
A contract may be discharged pursuant to a provision in the contract or by a subsequent agreement. For example, there may be a discharge by the terms of the original contract when it says it will end on a certain date. There may be a mutual cancellation when both parties agree to end their contract. There may be a mutual rescission when both parties agree to annul the contract and return to their original positions as if the contract had never been made. This would require returning any consideration (e.g., money) that had changed hands.
Other examples of discharge by agreement are:
• accord and satisfaction
• a release
• a waiver.
The parties may agree to a different performance. This is called an accord. When the accord is performed, this is called an accord and satisfaction. The original obligation is discharged.
In order for there to be an accord and satisfaction, there must be
• a bona fide dispute;
• an agreement to settle the dispute; and
• the performance of the agreement.
An example would be settlement of a lawsuit for breach of contract. The parties might settle for less than the amount called for under the contract.
Circumstances beyond the control of the contracting parties may discharge the contract. Impossibility of performance refers to external conditions as opposed to someone’s personal inability to perform the contract. For example, the fact that a debtor does not have the money to pay a debt, and therefore cannot pay the debt, does not discharge the debt. This is not a case of impossibility.
What if a seller cannot obtain the goods he needs from any supplier to meet his contractual obligation to sell the goods to a buyer? This will not discharge the seller’s obligation unless the inability to obtain the goods was a condition subsequent to the contract.
When the parties expressly refer to particular subject matter in a contract, the contract is discharged if the subject matter is destroyed through no fault of either party. When a contract calls for the sale of a wheat crop growing on a specific parcel of land, the contract is discharged if the crop is destroyed.
A contract is discharged when its performance is made illegal by a subsequent change in the law. For example, suppose there is a contract to construct a non-fire¬proof building at a particular place. Prior to beginning construction, a zoning law is passed which prohibits such a building in this area. The contract would be discharged. However, a change of law that merely increases the cost of one of the parties is not a “change of law” that discharges the contract.
When the contract calls for the payment of money, the death of either party does not affect the obligation. The estate (executor) of the person who was to pay the money is responsible to make payment. Likewise, the estate (executor) of the person who was to collect the money can collect it.
In every contract, there is an implied covenant of good faith and fair dealing. One party to a contact is under an obligation to do nothing that would interfere with the performance of the other party. If one party makes the other party’s performance impossible, the obligation to perform is discharged. For example regarding a contract between a contractor and a subcontractor, if the contractor refuses to allow the subcontrac¬tor access to the property where the subcontractor is to do the work, the contract is discharged as to the subcontractor. The subcontractor would have a cause of action against the contractor, but the contractor would not have a cause of action against the subcontractor.
If the conduct of the other contracting party does not make performance impossible, but only more difficult or expensive, or causes a delay, the contract may not be discharged, but the injured party will be entitled to damages for any loss he incurred. In our example, if the contractor eventually allowed the subcontractor on the work site, the contract would not necessarily be discharged, but the subcontractor could get damages for any loss he incurred.
Acts of God, such as tornadoes, lightning, and floods, usually do not terminate a contract, even though they make performance difficult. Weather conditions constitute a risk that is assumed by a contracting party in the absence of a contrary agreement. Extra expense because of weather conditions is a risk that the contractor assumes in the absence of an express provision for additional compensation in such case.
Modern contracts commonly contain a “weather” clause, which either expressly grants an extension for delays caused by weather condi¬tions or expressly denies the right to any extension of time or additional compensation because of weather condition difficulties.
Breach and Remedies
A breach of contract is a failure to perform the contract in the manner called for by the contract. A party is entitled to contractual remedies if the other party breaches a contract.
An anticipatory repudiation occurs when one of the parties to a contract makes it clear that performance will not be carried out as required by the contract when the time for performance arrives. This can be done by words or conduct. An example of such conduct would be to sell goods covered by a contract to another party. An anticipatory repudiation may be treated as a breach of contract prior to the time performance is actually due.
A breach does not always result in a lawsuit or mean the end of a contract. One party may be willing to waive or ignore the breach. A waiver can be by words or by conduct. Accepting a late payment on a note would be an example of a waiver by conduct. It is possible to make a waiver by silence. For example, failure to object to the manner of performance in a timely manner would be a waiver by silence.
A party who waives a breach gives up the right to damages or remedies regarding such breach, and cannot use the breach as a reason for not performing the contract.
A party retains the right to recover damages caused by another party’s breach if the party expressly reserves the right to damages at the time the party accepts a defective performance. The reservation of right should be, but does not have to be, in writing.
A buyer and seller enter into a contract regarding the purchase and sale of machinery. The buyer of the machinery may need the it badly and accept defective machinery, but reserves his right to sue for any damages suffered. In this situation, the buyer is not waiving his right to sue for the breach if the defective machinery causes damages.
If a party makes an anticipatory repudiation, the other party has the following options:
• Do nothing – wait until the time for performance, and then sue if performance is not made;
• Treat the repudiation as a definite breach and sue immediately; or
• Treat the repudiation as an offer to cancel the contract, and accept the offer, thereby terminating the contract.
A contracting party may be entitled to damages if the other party breaches a contract. Generally, damages are the sum of money necessary to put a party in the same or equivalent financial posi¬tion as the party would have been had the contract been performed. A party may recover compensatory damages for any actual loss that the party can prove with reasonable certainty. Compensatory damages include direct damages and consequential damages. An example of direct damages would be in a situation where the plaintiff has paid $10,000.00 for a truck, but the defendant refuses to deliver the truck. The direct damages would be $10,000.00.
Consequential damages would arise in a situation where the failure to deliver the truck harmed the business of the plaintiff since the plaintiff lost a delivery contract. In this situation, the plaintiff could possibly get consequential damages for loss of the delivery contract.
Punitive damages are designed to punish. A Court uses punitive damages to make an example of a defendant in order to keep others from doing a similar wrong. Punitive damages are rare in a breach of contract case except bad faith insurance claims. Consumer protection laws sometimes permit consumers to recover punitive damages for breach of certain types of contracts.
A non-breaching party has a duty to mitigate damages. In other words, a non-breaching party has the duty to take reasonable steps to minimize damages. The failure to mitigate damages may cause the victim to only be allowed to recover damages that would have resulted if mitigated. In our truck example, say the truck was purchased and was to be delivered on January 5, to allow the buyer to do a hauling job for $500.00. Delivery was late. The hauling contract was lost. However, the buyer could have rented a truck for $150.00. However, he failed to do this. Therefore, his damages would only be $150.00.
An appropriate remedy for a breach may be rescission of the contract. This places the parties in the position they would have been had the contract never been entered into. For example, money is returned to the buyer and the buyer returns the merchandise to the seller. If performance has been involved, the performing party may get the reasonable value of his performance under an unjust enrichment theory. Suppose that pursuant to a contract for the sale of land, a buyer has taken possession and made substantial improvements. If the contract is rescinded, the buyer will return the land and the seller will return the money. However, the seller must pay the buyer the reasonable value of the improvements.
Specific performance is an action to compel a party who breached a contract to perform the contract as promised. The subject matter of the contract must be unique, or an action for damages would be the proper remedy. Actions for specific performance are usually allowed with regard to:
• A contract involving the sale of particular real estate; and
• A contract for sale of a particular business.
Specific performance is not allowed regarding a contract for the sale of personal property unless the property is unique in some way like an antique, coin collection, or art objects.
Generally, a party cannot obtain specific performance of personal service contracts or employment contracts. This is because of possibly violating the Thirteenth Amendment regarding involuntary servitude. However, breach of a service or employment contract can subject the breaching party to a suit for damages.
In general, a contract may limit the remedies that a non-breaching party may obtain. For example, Johnston purchases a new truck from Acme Truck Sales. The contract may limit Johnston’s remedies to having Acme repair the truck or replace the truck if it is defective.
A contract may state the amount of liquidated damages to be paid if the contract is breached. Upon a party’s breach, the other party will recover this amount of damages whether actual damages are more or less than the liquidated amount. For example, the parties to a construction contract stipulate that damages are to be paid of $1,000.00 per day that the construction exceeds its contracted completion date. Another example would be with regard to a contract for the sale of land where the contract provides that the earnest money paid will be the sole remedy upon breach of contract by the buyer.
Courts will honor liquidated damage provisions if:
• Actual damages are hard to determine (e.g., breach of a restrictive covenant), and
• The amount is not excessive when compared with probable damages.
If the agreed-upon liquidated damage amount is unreasonable, the Court will hold the liquidated damage clause to be void as a penalty. In such situations, you have to prove the actual damages if the clause were declared to be void.
What happens if a limitation of remedies clause or a limita¬tion of liability clause is not valid? In this situation, the plaintiff may sue for actual damages. For example, if a liquidated damage clause is held invalid, the plaintiff may sue for actual damages.