What is a “contract”?
A contract is a legally enforceable promise or an exchange of promises. To be enforceable, the contract must meet certain elements. There must be an offer, acceptance of that offer, and then an intended exchange of value between the parties. These elements demonstrate a “meeting of the minds” between the parties. That is, the parties have a common understanding of the material terms of the agreement. A contract does not have to be a formal, written document. It can be a verbal agreement or it can arise through the conduct of the parties. Those who make a contract do not have to use the word contract or even recognize that they have made a legally enforceable promise. Each state develops its own contract law. Contract law provides confidence and promotes productivity by making private agreements between individuals legally enforceable. Plainly stated, it helps make buyer and seller willing to do business together.
• Example: One individual offers to purchase a widget from another person for $1. The other person agrees. This is a contract, as there is an offer and acceptance of that offer, a planned exchange of value, and a meeting of the minds as to these primary terms of the agreement.
• Note: As you can see, a contract does not necessarily have to be formal or in writing. A simple conversation or even actions of two or more individuals can be a contact.
• Discussion: Does it surprise you how easy it is to form a contact? Why or why not? Why do you think it is so easy to form an enforceable contract? Are there any negatives to this? How do you judge whether there is a meeting of the minds between the parties? How do you account for the subjective nature of one person’s understanding?
• Practice Question: Mark goes to an antiques auction. A nice painting comes up for auction and Mark love it. The auction provides extensive background on all of the items being offered. The auctioneer begins taking bids and Mark the winning bidder. Has a contract been formed in this situation?
What are the sources of contract law?
States create their own contract law. They pass statutes and allow courts to develop common law. In doing so, state legislators and judges rely upon model laws in developing the statutory and common law. These model laws are known as the Restatement of Contracts and the Uniform Commercial Code. These model laws influence judges who interpret contract law and legislators who draft statutes that resemble (or copy exactly) these model laws. As such, you can study model laws to acquire a broad understanding of how contract law works. You can then look to the specific laws of your state to determine the exact law that applies to a given situation.
• Restatement of Contract – The Restatement of Contracts (Restatement) is a model law that deals primarily with contracts that do not involve the sale of goods or when goods are not the primary subject of the contract. Most state common law generally tracks closely the provisions of the Restatement.
• Article 2 of the Uniform Commercial Code – Article 2 of the Uniform Commercial Code (UCC) governs contracts for the sale of goods. It has been uniformly accepted by nearly every state in the United States. A sale of goods includes any manufactured product, crops, timber, livestock, attachments to land, exchanged currencies, mined minerals, etc. It does not include intellectual property, securities, non-commodity currencies, and un-mined minerals.
To be subject to the provision of the UCC, goods must be the primary purpose of the contract. If services are the primary purpose of the agreement, the incidental inclusion of goods is not covered by the UCC or corresponding state statutes.
• Discussion: What are some of the advantages and disadvantages of model codes of laws? Why do you think states more readily adopt a uniform code of contracts covering the sale of goods, but are less apt to adopt a uniform code covering services?
• Practice Question: Jill approaches an interior designer about designing and purchasing furniture for her home. Jill owns a large mansion. The designer quotes Jill a price of $10,000 for her services and $1 million for all of the furniture. If Jill’s state adopts the Restatement of Contracts and UCC, which model law will primarily govern the contract?
What are “unilateral contracts” and “bilateral contracts”?
Contracts are divided into unilateral and bilateral agreements based upon the duty of performance and how an offer to contract is accepted.
• Bilateral Contract – A bilateral contract consists of two promises between individuals that form a contract. Specifically, one party makes a promise to another party that she will do something (or forgo doing something) in exchange for the other party’s promise to do something (or promise to forgo doing something).
⁃ Example: Eric promises to wash Julia’s car if she promises to pay him $20. The both activities will occur at some point in the future, so you have two promises of future performance.
• Unilateral Contract – A Unilateral contract is an agreement with only one promise. That is, one party promises a future action if the other party performs whatever is requested of her. The promising party does not want a return promise. As such, a contract is formed or comes into exists once the other party begins to perform the requested services.
⁃ Example: Suppose Eric tells Julia that he will pay her $20 if she washes his car. Eric does not want a promise to wash the car. Julia can accept Eric’s offer by beginning to wash his car. Julia is not obligated to wash the car unless or until she begins doing so. Further Eric is not obligated to pay Julia until she begins washing the car.
• Note: The common characteristic between unilateral and bilateral contracts is that it entails a promise of performance and a demand from the offeree. This is critical to the requirement that a contract contain an offer, acceptance, and exchange of value.
• Discussion: Why do you think it is important to distinguish and recognize these two types of contracts? Do you think each type of contract is more applicable in either sales of goods or services? Why or why not?
• Practice Question: Jennifer is looking for someone to paint her house. She sends out an email to several painters in the neighborhood that she has purchased the paint and will pay $3,000 to anyone who paints her house. She also includes some detailed requirements for the painting process and states that project must be completed by the coming weekend. Rob shows up the next morning with all of his equipment and ready to paint. Is there a contract in this situation? Why or why not?
What are “express contracts”, “implied-in-fact contracts”, and “implied-in-law contracts”?
• Express Contract – An express contract arises from interactions in which parties actually discuss the agreement and the promised terms. The contract does not have to be formal or in writing, but it requires that the parties express their intentions in an agreement.
⁃ Example: One person expressly offers to sell a widget to another person. The other person accepts the offer by saying the she will buy it. The parties have an expressed contract because they have stated an offer, stated an acceptance, and identified consideration. These expressions can be verbal, as in this situation, or written.
• Implied-in-Fact Contract – An implied-in-fact contract arises from the conduct of the parties, rather than from words. That is, the parties interact in a manner that constitutes a legally enforceable contract. This means that all of the elements of an enforceable contract can be inferred from the actions of the parties.
⁃ Example: Ellen asks Albert, an attorney, for professional advice. Ellen knows that Albert is an attorney and charges for his advice. Asking Albert for his professional advice implies a promise from Ellen to pay the going rate for that advice. This is true even though Ellen and Albert did not make an express promise to pay for it.
• Implied-in-Law or Quasi-Contracts – An implied-in-law contract is a contractual relationship ordered by the court. It lacks the mutual asset element of a contract, but the court deems the interactions between parties to be a contract under the law. This court action is generally taken to avoid an unjust result, such as when one party is unjustly enriched at the expense of another. The court will hold that the law implies a duty on the first party to pay the second, even though the elements to find a legally enforceable contract between the two parties are absent.
⁃ Example: Bell routinely rakes leave in the neighborhood for extra money. She rakes leaves for lots of houses and sometimes forgets which houses have requested her services. She begins raking James’s yard, having forgotten that she never worked out an agreement to do so. James often pays individuals to rake his yard and has plenty of money to do so. At the end of the job, Bell asks James for $20 for her effort. If James refuses to pay the court may hold that it would be unfair for James to receive this value and not pay something for it. As such, the court could hold that an implied-in-law contract to pay for Bell’s services.
• Discussion: How do you feel about implied contracts? Should all contracts be required to be expressed? What are some arguments for and against this approach? What do you think is the justification for recognizing implied contracts?
• Practice Question: Kyle agrees to purchase building material from Anna, a new employee of a construction materials company. Anna executes a contract but makes an error when pricing the material. Per the terms of the agreement, Kyle will pay far less than the cost of the material. Kyle realizes this, but he stays quiet. Kyle uses the material before Anna catches the error. She sends Kyle an additional bill to cover the cost of the material, but not profit. Kyle refuses to pay the additional amount. What might a court do in this situation?
What elements are required to form a valid contract?
As previously discussed, a contract is a specific promise to another and also a specific demand of that person. The demand could be a promise of future action (bilateral contract) or immediate performance of an act (unilateral contract). The promise and demand is an “offer”. Meeting with the offeror’s demand is known as “acceptance”. Both parties must give or exchange something of value with the other. The thing of value is known as “consideration”. Consideration is the promise to give, or actual giving, of a requested benefit or the incurring of a legal detriment (i.e., doing something one does not have to do.). Both parties must be of a legal age and sound mind, and the purpose of the agreement cannot be illegal or against public policy.
• Example: One person offers to sell a product, service, or offers something of value (money, goods, etc.) in exchange for someone else’s product, service, or other thing of value. This constitutes a valid offer. The things of value constitute consideration. A second person accepts the offer by either agreeing to the offeror’s request to trade things or actually trading those valuables.
• Note: An important thing to remember is that each party must provide something of value to the other. It does not matter how much value or even whether anyone else in the world would consider it valuable.
• Discussion: Why do you think that the law requires an agreement to have all of the elements to be enforceable? Can you think of situations where any of these elements are not present, but you believe the agreement should be enforceable anyway?
What are “valid contracts”, “enforceable contracts”, “void contracts”, and “voidable contracts”?
There are several common characteristics of contracts that dictate whether a contract actually exists and whether it is enforceable in a court of law. The following vocabulary is important for characterizing these aspects of a contract.
• Valid and Invalid – A contract is valid when all of the elements essential to forming a legal contract are present. Conversely, a contract is invalid (or rather, there is no contract) if any of the essential elements of a contract are missing. The elements to forming a valid contract (offer, acceptance, consideration, and a meeting of the minds) are discussed further below.
⁃ Example: One person announces that she will sell her cell phone for a reasonable price. Another person quickly says, “I will buy it”. In this case there is not a valid contract because there is not enough specificity in the consideration. As such, a critical piece of the contract is missing. While the parties might think they have a contract, if a challenge to the contract arises, a court is likely to hold it to be invalid.
• Enforceable and Unenforceable Contract – An enforceable contract is one that can be enforced in court of law. That is, the law allows for enforcement of the contract. An enforceable contract must always be valid. A valid contract may, however, be unenforceable. That is, even though all of the essential elements of a contract are present, a court will not enforce the contract.
⁃ Example: An oral contract may be valid, but the court will not enforce it because that specific type of contract is required to be in writing under the state’s law. Contracts that are required to be in writing are discussed further below.
⁃ Discussion: Why do you think there is a distinction between a invalid contract and contract that is unenforceable against a party? Are there any reasons or justifications for treating them as one in the same?
⁃ Practice Question: Gayle arrives at work one morning and says to all of her colleague, “I am tired of my piece of junk car. I would sell it right now for $500.” Bert thinks about Gayle’s statement and determines that it would be a good buy. After lunch, Bert approaches Gayle and says, “I will buy your car” and extends $500 in cash. Gayle, surprised by Bert’s actions, replies that she is not willing to sell her car. If Bert sues Gayle for breach of contract, what will be the likely result?
Void and Voidable Contracts
An otherwise valid contract may be void pursuant to the law. That is, state law identifies certain types of contracts that are deemed void from the outset. These include contracts that violate public policy or have an illegal purpose. A voidable contract is an agreement where either one or both parties has the right to make the contract void. That is, the contract is valid and enforceable until one party elects to void it.
⁃ Example: A contract to purchase illegal drugs is void. A party to a contract who is below the legal age of mental capacity may void the contract at any point before she reaches the age of mental capacity. Various situations where contracts are deemed valid, enforceable, void, or voidable are discussed further below.
⁃ Discussion: What do you think are the justifications for deeming a contract voidable? Can you think of scenarios where you think one party should be allowed to get out of the contract, but not the other party? Can you think of scenarios where both parties should be allowed out of the contract?
⁃ Practice Question: Amy is extremely angry at David. She hires Laura to pour sugar into the gas tank of David’s car. Laura loses her nerve and backs out of their agreement? Can Amy enforce her agreement with Laura?
What is “mental capacity” to contract?
To enter into a contract, a person must have mental capacity sufficient to understand the nature and consequences of her actions. If mental capacity is absent, the contract is voidable by the person lacking capacity. There are three classes of persons commonly understood to lack capacity to be bound by contractual promises:
• Minors – A minor is someone below the statutory age of mental capacity within a jurisdiction. Generally, a person must be 18 years old or older to have the requisite mental capacity to contract. As such, a minor who enters into a contract can void the contract at any time prior to reaching the age of majority. The exception to this rule is when the contract involves goods or services necessary for the child’s survival. This could include food, water, shelter, etc. In the case of necessities, the child will be obligated to pay the reasonable value of the goods or services received. If the child fails to disaffirm the contract by this time, she thereby ratifies the contract and is bound going forward.
⁃ Example: Jane is 17 years old. She goes to a local gym and signs up for a year-long membership. This is not a contract for a necessity. Jane will be able to void the contract at any time before she turns 18 years old. She will, however, have to pay the reasonable cost of any value she receives from the gym.
• Intoxicated Person – An intoxicated person may lack the mental capacity necessary to contract. Generally, this will require extreme intoxication. If the intoxicated person enters into a contract, she must disaffirm the contract within a reasonable time of regaining capacity and learning of the contract. If she fails to do so within a reasonable time, she has ratified the contract and will be bound.
⁃ Example: Don gets incredibly drunk in a bar. He does not know where he is and asks a stranger for a ride home. He offers to give the stranger, Gary, his Rolex watch in exchange for a ride home. Gary takes him home and takes the Rolex. When Don sobers up, he can immediately demand return of the Rolex. He was too intoxicated to appreciate the nature of his actions. As such, he can void the contract. He must act within a reasonable period to void the contract upon becoming sober.
• Mentally Incompetent Person – A mentally incompetent person generally lacks the ability to enter into a contract. If the mental incompetency is temporary, the individual must disaffirm any contract entered into during incapacity within a reasonable time of regaining capacity. If the person is permanently incapacitated, the contract is either void or voidable at the insistence of a legally appointed guardian.
⁃ Example: Ernie is having psychotic delusions. He goes to a security firm and hires a private security guard. Ernie’s legally appointed caretaker will be able to void the contract based upon Ernie’s lack of mental competence to enter into the agreement.
Each state may pass additional situations in which it deems an individual mentally incompetent to enter into contractual relations.
• Discussion: How do you feel about the requirement for mental capacity to contact? Do you agree with arbitrarily setting an age at which a person is deemed to have mental capacity? Why or why not? How should a person’s level of intoxication be measured to determine whether she has mental capacity to contract?
• Practice Question: Phyllis is in a bar and drinking heavily. She realizes that she cannot drive in her state, so she solicits a ride from Harriet. She does not have any money, so she offers Harriet her new Rolex watch in exchange for a ride. Harriet accepts and drives Phyllis 3 miles to her home. The next morning Phyllis realizes that she traded a very expensive watch for a 3-mile ride. What are Phyllis’ options?
What is the requirement that a contract have a “lawful purpose”?
A contract must have a lawful purpose to be enforceable. That is, the contract cannot violate or cause others to violate the law or public policy.
• Crimes and Torts – Contracts that require commission of a crime or tort or violate accepted standards are void. If a contract has both legal and illegal provisions, a court will often enforce the legal provisions and refuse to enforce the illegal ones.
• Unconscionable Contracts – An unconscionable contract is one that is so unfair that it is said to “shock the conscience”. Unconscionability is broken down into “substantive unconscionability” and “procedural unconscionability”.
⁃ Substantive Unconscionability – This means that the terms of the agreement are so extremely unfair or one-sided in favor of a party that it is unlikely that the other party to the agreement understood its terms.
⁃ Procedural Unconscionability – This refers to the conditions under which the contract was formed. The terms of the contract may indicate that one party was taken advantage of by another party with greater bargaining power. Such a contract may be void as against public policy if the circumstances indicate that a reasonable person would not have entered into the agreement without the existence of an undue hardship. In some situations, the undue hardship must have been brought on by the party unduly benefited by the contract.
• Contracts that Restrain Trade – Contracts that restrain trade may be illegal and thus void. This is true for contracts that create a monopoly, fix prices, and divide up markets. This is generally the area of antitrust law. A court may also find a contract void if it serves to frustrate economic activity in a manner not covered by antitrust law or it intentionally interferes with contractual relations or unfairly competes.
⁃ Example: An example of a contract that directly prohibits competitive business activity is a “covenants not to compete”. This type of contract restricts an individual from carrying on a trade or practice. These contracts are held to be void when they are unduly burdensome in their restrictions regarding the time and geographic locations for doing business. A covenant not to compete that has a limited time frame (3-6 months) and a limited jurisdiction (up to 50 miles) is generally enforceable if there is good reason for the restriction.
States are free to pass statutes or develop common law that protects the public interest. A contract that runs afoul of what is deemed necessary for the public good may also be void.
• Discussion: How do you feel about the requirement that a contract have a lawful purpose? Can you think of any situations where this requirement may cause an unfair result for parties? Should there be a sliding scale for determining enforceability of contracts that violate public policy or are illegal? Why or why not?
• Practice Question: Carter lives in New Orleans, Louisiana. The state is in a state of emergency based upon an approaching hurricane. Carter, along with thousands of other people, attempts to flee the city. The traffic is horrible and folks are running out of gas on the roadway. Carter is low on gas and pulls into a gas station. The gas station is charging $250 per gallon of gas. Carter is outraged, but purchases the gas and continues to flee the city. What are his legal options?
What common situations give rise to a voidable contract?
• Fraud – Fraud involves an intentional misstatement of the material (important) fact that induces one to rely justifiably to his or her injury. If a person is defrauded into entering a contract, the defrauded party may void the contract upon learning of the fraud. Voiding the contract is at the option of the defrauded party, as she may wish to remain in the contract. The party committing fraud may not void the contract. If the defrauded party fails to void the contract upon learning if the fraud, she is deemed to have ratified it and is bound.
• Misrepresentation – Misrepresentation is a material misstatement of fact that induces one to rely on the statement. The difference with misrepresentation and fraud is that misrepresentation does not involve the intent to mislead. As in the case a fraud, a party who enters a contract as a result of a material misrepresentation may void the contract upon learning of the false representation. The misrepresenting party may not void the contract. If a party fails to void the contract upon learning of the misrepresentation, she is deemed to ratify the agreement.
• Duress – Duress means the use or threat of force to convince a person to act according to one’s wishes. If a party enters into a contract due to the physical or economic duress imposed by the other party, the contract is voidable at any time by the party subject to duress.
• Undue Influence – Undue influence arises when one party unfairly takes advantage of another party by using a position of trust, influence, or confidence.
⁃ Example: A psychiatrist who enters into a contract with her patient that is not related to medical services may be deemed to have exercised undue influence. The influenced party may have been pressured to enter into the agreement or felt unduly obligated to enter into the agreement for fear of destroying the doctor-client relationship.
• Mutual Mistake – A mistake by both parties regarding “material” facts or circumstances relevant to the contract may make a contract voidable. In such a situation, either party may void the contract upon learning of the mutual mistake. The standard for whether the mistake of fact is material is whether a reasonable person would have entered into the agreement if the true facts were known. A mutual mistake of law may make a contract voidable if it caused the parties to not have a “meeting of the minds” with regard to the core aspects of the contract. If no meeting of the minds exists, there is never a valid agreement between the parties.
• Unilateral Mistake – Generally, unilateral mistake by one party to the contract does not make the contract voidable. A unilateral mistake about the basic assumptions of the contract will only make the contract voidable when the non-mistaken party knew or had reason to know of the other party’s mistake. In such a case, the effect of enforcing the contract against the mistaken party must be unconscionable and the non-mistaken party would not suffer a substantial hardship by voiding the contract. If the non-mistaken party did not know about the other party’s mistake, the standard for voiding the contract is even higher. In such a case, the contract must not yet have been performed or the parties must be easily restored to their pre-performance positions. The mistake must be substantial, and the mistake must directly relate to some computational or clerical error in the construction of the terms of the agreement.
⁃ Note: No defense exists if the mistaken party knowingly assumed the risk of the mistake; is grossly negligent in making the mistake; violates a legal duty; fails to act within her duty of good faith and fair dealing; or intentionally fails to read the contract.
• Discussion: How do you feel about the idea that both parties may hold the right to void a contract? Is there any justification for holding that the contract is void rather than voidable? Do you agree with the scenario under which a unilateral mistake if voidable? Why or why not?
• Practice Question: Constance enters into an agreement to purchase Gerald’s business. The contract contains a calculation for the business’s cash on hand at the time of sale to be added to the purchase price. Constance and Gerald did not pick up on the calculation error at the time of signing the agreement. The week prior to closing, Constance’s attorney caught the error, which causes a huge increase in the calculated value of the business. Gerald wants to hold Constance to the dramatically increased price, as she signed the contract containing the calculation error. What are Constance’s options?