Chapter 9: Contract Formation. Copyright 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning.

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1 Chapter 9: Contract Formation a Copyright part of South-Western 2009 South-Western Cengage Legal Learning. Studies Business,

2 Introduction is a declaration that something will or will not happen in the future. What is a Contract? Contract is an... What law governs? Service contracts -. Sale and lease contracts - ( ). 2

3 1: Function and Definition of Contract Law Designed to provide stability and predictability, as well as certainty, for both, buyers and sellers in the marketplace. Necessary to ensure compliance with a promise or to entitle the innocent party to some form of relief. 3

4 Definition of a Contract A contract is a:.., or The performance of which the in some way recognizes as a duty. Objective of Contacts. Circumstances to determine intent of parties. 4

5 2: Elements of a Contract Agreement (Offer and Acceptance). Consideration. Contractual Capacity. Defense: Legality. Genuineness of assent. Form. 5

6 3: Types of Contracts Bilateral v. Unilateral. Bilateral - Offeree must only promise to perform ( promise for a promise ). Unilateral - Offeree can accept the offer only by completing the contract performance ( promise for an act ). Irrevocable: Offer cannot be revoked once performance has begun. 6

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8 Contract Formation Express v. Implied-in-Fact. Express: Words (oral or written). Implied-in-Fact: Conduct creates and defines the terms of the contract. Requirements: Plaintiff furnished good or service. Plaintiff expected to be paid. Defendant had chance to reject and did not. 8

9 Contract Performance Formal v. Informal. Executed v. Executory. Executed - A contract that has been fully performed on both sides. Executory - A contract that has not been fully performed on either side. 9

10 Contract Enforceability Valid. Elements: Agreement, consideration, contractual capacity, and legality. Void: No contract. Voidable: (unenforceable). Valid contract can be avoided or rescinded. 10

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12 4: Agreement Agreement = offer and acceptance. Parties must show mutual assent to terms of contract. Once an agreement is reached, if the other elements of a contract are present, a valid contract is formed. 12

13 Requirements of the Offer Offeror s serious intention. Definiteness of terms. Communication to Offeree. 13

14 Offer: Intention Contract is judged by what a reasonable person in the Offeree s position would conclude about the offer. Case 9.1 Lucy v. Zehmer (1954). Offers made in anger, jest, or undue excitement are usually not offers. 14

15 Offer: Intention Expressions of opinion are not offers. Statements of Intention or preliminary negotiations are not offers. Advertisements, Catalogues, Price Lists, and Circular are treated as Invitations to negotiate and not as offers. Agreements to Agree. Case 9.2 Basis Technology Corporation v. Amazon.com, Inc. (2008). 15

16 Offer: Definiteness of Terms Terms (Expressed or Implied). Identification of the parties. Object or subject matter of the contract. Consideration to be paid. Time of payment, Delivery, or Performance. Case 9.3 Baer v. Chase (2004). 16

17 Offer: Communication Offeree s knowledge of the offer: Directly by the Offeror. Use of Agents. 17

18 Termination of the Offer An offer may be terminated prior to acceptance by either: Action of the Parties; or by Operation of Law. 18

19 Termination by Action of the Parties Revocation of the offer by the Offeror: Offer can be withdrawn anytime before Offeree accepts the offer. Effective when the Offeree or Offeree s agent receive it. Exceptions: Irrevocable Offers (Detrimental Reliance). Option Contract: Promise to hold an offer open for a specified period of time in return of consideration. 19

20 Termination by Action of the Parties Exceptions (Cont d): Detrimental Reliance or Promissory Estoppel where Offeree relies on offer to his or her detriment, thus Offeror is barred from revoking the offer. Rejection of the offer by the Offeree: Rejection by the Offeree (expressed or implied) terminates the offer. Effective only when it is received by the Offeror or Offeror s agent. 20

21 Termination by Action of the Parties Rejection by Offeree (Cont d). A counteroffer by the Offeree is a rejection of the original offer and making of a new offer. Mirror Image Rule. Offeree s acceptance to match the the Offeror s offer exactly. 21

22 Termination by Operation of Law Lapse of Time. Offer terminates by law when the period of time specified in the offer has passed. If no time period for acceptance is specified, the offer terminates at the end of a reasonable period of time. Destruction of the Subject Matter. 22

23 Termination by Operation of Law Death or Incompetence of the Offeror or Offeree. Supervening Illegality of the Proposed Contract. 23

24 Acceptance Acceptance is the: Voluntary act (expressed or implied), by the Offeree that, shows assent (agreement), to the terms of an offer. Mirror Image Rule. Terms of Offer and Acceptance must be identical, or mirror each other. 24

25 Silence as Acceptance Acceptance of Services by Silence. Sometimes Offeree has a duty to speak. Prior Dealings and Acceptance. Silence can be acceptance if there are prior dealings. Solicited Offers. Offeree has a duty to reject. 25

26 Timeliness of Acceptance Mail Box Rule - becomes effective on, providing that authorized means of communication is used. Offeree accepts by using the means of acceptance. Offeror specifies (expressly or impliedly) how acceptance should be made. Effective when (mailed, shipped). [Revocation effective when ] 26

27 Authorized Means of Acceptance Exceptions: If acceptance is not properly dispatched by the Offeree. If Offeror specifies that acceptance will not be effective until it is received. If acceptance is sent after rejection, whichever is received first is given effect. Unauthorized Means of Acceptance. Not effective until it is received by the Offeror. If timely sent and dispatched it is considered to have been effective on its dispatch. 27

28 Technology and Acceptance Traditional rules provide framework for digital age. But traditional rules may not apply to acceptances via Fed Ex, , or fax. Generally, mailbox rule does not apply to online offers. 28

29 5: Consideration Consideration for a promise must be either: Legally detrimental to the promisee, or Legally beneficial to the promisor. Legal Value is a Bargained for Exchange : Promise, Performance, or Forbearance. 29

30 Adequacy of Consideration A Court will not question the fairness of the bargain if legally sufficient. Law does not protect a person for entering into an unwise contract. In extreme cases, a court may find that a party lacks legal capacity or that contract was unconscionable. 30

31 Agreements That Lack Consideration Preexisting Duty: Promise to to what one already has a legal duty to do does not constitute legally sufficient consideration. Exceptions: Unforeseen Difficulties. Recession and New Contract. Past Consideration is no consideration because the bargained-for exchange element is missing. 31

32 Promissory Estoppel Promissory and Reliance: Must be promise. must justifiably rely on the promise. is substantial. Justice will be served by enforcing. 32

33 6: Capacity Contractual Capacity. The legal ability to enter into a contractual relationship. Full competence. No competence. Limited competence. Legality. The agreement must not call for the performance of any act that is criminal, tortious, or otherwise opposed to public policy. 33

34 Minors In most states, a person is no longer a minor for contractual purposes at the age 18. A minor can enter into any contract that an adult can. A contract entered into by a minor is voidable at the option of that minor. 34

35 Minor s Right to Disaffirm A contract can be disaffirmed at any time during minority or for a reasonable period after the minor comes of age. Minor must disaffirm the entire contract. Disaffirmance can be expressed or implied. 35

36 Intoxication Lack of contractual capacity at the time the contract is being made. Contract can be either voidable or valid. Courts look at objective indications to determine if contract is voidable. If voidable: Person has the option to disaffirm, or Person may ratify the contract expressly or impliedly. 36

37 Mental Incompetence Void. If a person has been adjudged mentally incompetent by a court of law and a guardian has been appointed. Voidable. If the person does not know he or she is entering into the contract or lacks the mental capacity to comprehend its nature, purpose, and consequences. Valid. If person is able to understand the nature and effect of entering into a contract yet lack capacity to engage in other activities. Lucid Interval. 37

38 7: Legality A contract to do something prohibited by federal or state statutory law is illegal and therefore void (never existed). Usury. Gambling. Licensing Statutes. Contract that calls for an act contrary to Public Policy. Contracts in Restraint of Trade. Case 9.4 Stultz v. Safety and Compliance Management, Inc. (2007). Unconscionable Contracts. Exculpatory Clauses. 38

39 8: Voluntary Consent Contract may be unenforceable if the parties have not genuinely assented to its terms by: Mistakes. Misrepresentation. Undue Influence. Duress. 39

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41 Mistakes Only a Mistake of Fact allows a contract to be canceled. Mistake of Value is enforceable. Bilateral (Mutual) Mistakes can be rescinded by either party. 41

42 Mistakes Unilateral Mistakes cannot be canceled unless: If other party to the contract knows or should have known that a mistake of fact was made. If mistake was due to mathematical mistake in addition, summation, subtraction, division, or multiplication and was made inadvertently and without gross negligence. 42

43 Fraudulent Misrepresentation Contract Voidable by Innocent Party. Elements: Misrepresentation of Material Fact. Intent to Deceive. Reliance on Misrepresentation. Injury to the Innocent Party. 43

44 Nonfraudulent Misrepresentation Innocent Misrepresentation. Negligent Misrepresentation. Equal to Scienter. Is treated as fraudulent misrepresentation, even though the misrepresentation was not purposeful. 44

45 Undue Influence Contract is Voidable. Confidential or Fiduciary Relationship. Relationship of dependence. Influence or Persuasion. Weak party talked into doing something not beneficial to him or herself. Presumption of Undue Influence. 45

46 Duress Forcing a party to enter into a contract under fear or threat makes the contract voidable. Threatened act must be wrongful or illegal. Exceptions: Threat to exercise legal rights (criminal or civil suit). Economic. 46

47 Adhesion Contracts and Unconscionability Adhesion Contracts. Preprinted contract in which the adhering party has no opportunity to negotiate the terms of the contract. Unconscionability. One sided bargains in which one party has substantially superior bargaining power and can dictate the terms of the contract. Standard-form. Take-it-or-leave-it adhesion contracts. 47

48 9: The Statute of Frauds 1677 England passed the law An Act for the Prevention of Frauds and Abuses. Certain types of contracts must be in writing and signed by the party against whom enforcement is sought to be enforceable. Today, almost every state has a Statute of Frauds. 48

49 Modern Statutes of Frauds To be enforceable, the following types of contracts must be in writing and signed: Contracts involving interest in land. Contracts involving One Year Rule. Collateral or Secondary Contracts. Promise made in consideration of marriage. Contracts for the sale of goods priced at $500 or more. 49

50 Contracts Involving Interests in Land Land includes all physical objects that are permanently attached to the soil: buildings, fences, trees, and the soil itself. All contracts for the transfer of other interest in land: mortgages and leases. 50

51 The One-Year Rule A contract that cannot, by its own terms, be performed within one year from the date it was formed must be in writing to be enforceable. One-year period begins to run the day after the contract is made. Test: Whether performance is possible (although unlikely) within one year. 51

52 Collateral Promises Primary v. Secondary Obligations. Main Purpose Rule Exception. Estate Debts. 52

53 Promises Made in Consideration of Marriage Prenuptial agreements must be in writing and signed to be enforceable. Contracts must be supported by some consideration to be enforceable. Prenuptial agreements may not be enforceable if the agreement is not voluntary. 53

54 Promissory Estoppel In some cases, an oral contract can be enforced IF the reliance was foreseeable to the promisor, AND if injustice can be avoided by enforcing the promise. 54

55 10: Third Party Rights Only the Parties to a contract have rights and liabilities under the contract. Exceptions: Assignment or Delegation. Third party beneficiary contract. 55

56 Assignments Transfer of rights in a bilateral contract to 3rd party. Obligee/ Assignor Original Contract Formed Obligor Assignment Assignee Duties Owed After Assignment 56

57 Assignments Rights cannot be assigned: If the assignment is contrary to statute. When a contract is personal in nature. Assignment materially changes rights or duties of obligor. If the contract stipulates the right cannot be assigned. Valid notice must be given to all parties. 57

58 Delegation Contractual duties in a bilateral contract that are delegated to a 3 rd party. Obligee Original Contract Formed Obligor Duties Owed After Delegation Delagatee 58

59 Duties That Cannot be Delegated When special trust has been placed on the obligor. When performance requires personal skill or talents. When performance will vary materially from obligee expectations. When the contract expressly prohibits delegation. 59

60 Third Party Beneficiaries Original parties to the contract intend at the time of contracting that the contract performance directly benefits a third person. Intended vs. Incidental beneficiaries. 60

61 Intended: Intended v. Incidental Beneficiaries Promisee intended to confer on the beneficiary the right to bring suit to enforce the contract. Factors: Performance is rendered directly to 3rd party. 3rd party s right to control contract details. 3rd party expressly designated as beneficiary. 61

62 Incidental. Intended v. Incidental Beneficiaries Contract between two parties is unintentional. Incidental beneficiary cannot sue to enforce the contract. 62

Genuineness of Assent

Genuineness of Assent A party who demonstrates that she did not genuinely assent to the terms of a contract may avoid an otherwise valid contract. Genuine assent may be lacking due to mistake, fraudulent