Business Law Contract Law Unit Textbook

Business Law Contract Law Unit Textbook Contract Law 1

UNIT OUTLINE 1. Introduction 2. Elements of a Contract A. Capacity B. Offer C. Acceptance D. Consideration E. Legality F. Writing 3. Types of Contracts 4. Breach of Contract A. Contract Enforcement Contract Law 2

INTRODUCTION A CONTRACT is a legally enforceable agreement between two or more parties that creates an obligation to do or not do particular things. The term party can mean an individual person, company, or corporation. A contract is created any time things of value are exchanged. Contract law gives reasonable assurances to all parties that agreements will be fulfilled. The law provides remedies for those who suffer losses due to otherʼs failures to keep contractual promises. Mention of the word contract often conjures up terrifying visions of endless pages of obscure and detailed legal jargon. Nothing could be further from the truth. Of all the areas of law, none is encountered more frequently in day-to-day living than the law of contracts. Contracts are everywhere. Youʼve probably made at least ten contracts this week without even thinking about it. You made a contract when you bought groceries at the supermarket. If you ate at a restaurant last night, you had a contract; you paid money in return for food. Your cell phone services are provided under a contract: you have agreed to pay them the going rate for the services they furnish. In addition, you will make more serious contracts throughout your life. When you take a job, youʼll make a contract with your employer to do certain work in exchange for a certain amount of money. When you buy or rent a place to live, youʼll make a contract with the seller or landlord. If you buy insurance or take out a loan, youʼll make a contract with the insurance company or bank. If you get married, you may make a marriage contract with your spouse. What is it about the word contract that intimidates the average person? Perhaps it is because we usually reserve its use for more significant things buying real estate or cars, for instance, or employment contracts. But the general rules of contract law that govern your relationship with the person who delivers your daily newspaper are the same as those that protect your rights when you, say, hire a company to do extensive and costly home improvement work for you. The law of contracts, as youʼll soon discover, is one of the most systematic areas of the law. It flows logically and chronologically from the time an offer is made until the contract is breached or successfully concluded. This unit gives you the information you need to understand your basic rights when making an agreement. After reading the following material, youʼll never again cringe upon hearing the word contract. First, several introductory words about contracts are in order. A common myth is that a contract must be written to be enforceable, but this is not true. Except for a few types of contracts, an oral contract is just as good as a written contract. But it is always preferable to have the contract in writing and signed by each party. The terms of the contract should always be spelled out with specificity so the other party canʼt claim that there wasnʼt a contract or that the terms were different from what they thought. If it comes down to a lawsuit even if itʼs only in small claims court itʼs much easier to prove the terms of a written contract than those of an oral one. Weʼve all been warned never to sign a contract without reading it. This can be very important. Suppose you sign a contract without reading it and later discover that some of the provisions are different from those you thought you had agreed to. Can you get out of it? Generally not. You normally are bound by the terms of the contract you signed. So before you sign your next contract, take whatever time you need to read it carefully, and ask for explanations if you donʼt understand something. And if you donʼt get a satisfactory explanation, talk to a lawyer first. Above all, donʼt feel pressured into signing a contract without being given the chance to read it. Contract Law 3

ELEMENTS OF A CONTRACT Four things are essential for a contract to be legally binding: both parties must have the legal capacity and authority to make a contract; there must be an offer; there must be an acceptance of that offer; and there must be consideration something you give (money, for instance) or do (such as provide a service) in return for something else. In addition, contracts must always be legal in nature and sometimes put in writing to be enforceable. CAPACITY CAPACITY is the legal ability to enter into a contract. Having legal capacity to contract often means in part to be old enough to make a contract. A minor (in most states, a person under 18) is legally incapable of making a binding contract. This rule is designed to protect minors from being taken advantage of because of their age and lack of experience. A minor who enters into a contract with an adult really has the best of both worlds. The adult cannot enforce the contract against the minor, but the minor can enforce it against the adult. The minor can reap the benefits of the contract while avoiding any obligations. If an adult sues a minor for breach of contract, the minor can simply assert his or her minority as a complete defense. One exception is that a minor is usually liable for the reasonable value of any necessities of life food, clothing, shelter, and medical care given directly to him or her. What happens after the minor comes of age? The contract can be enforced against the minor if he or she does not disaffirm (cancel) it within a reasonable time after reaching the age of majority. In a few states, however, the only way a minor can ratify (affirm) a contract after coming of age is in writing. When a minor cancels a contract, he or she ordinarily must return what was received (or what is left of what was received) from the other party. For protections, most businesses require minors to have a parent or other adult cosign any major contract. The adult cosigner is responsible for making payments if the minor does not honor the deal. Legal capacity to contract also means that there must be a sufficient mental ability to understand what the contract is all about. A person who is insane, mentally incompetent, or suffering the effects of Alzheimerʼs disease, for instance, ordinarily lacks the mental ability to enter into a contract. If a guardian has been appointed for a person, only the guardian can make contracts on his or her behalf. Contracts made by insane persons are usually void and unenforceable. A number of courts, however, hold that if you donʼt know that a person is mentally incompetent (and the person doesnʼt exhibit bizarre conduct or do anything else to indicate a problem), and you fulfill your part of the agreement, you can enforce the contract against him or her. And, like a minor, a mentally deficient person can still be liable for the necessities of life that he or she receives. A person who is so drunk or high on drugs that they donʼt understand the nature and effect of the contract is generally not bound by it. When the person sobers up, they usually have the option of canceling or ratifying the contract. If the person chooses to cancel the contract in this situation, they must return any money or property received from the other party. The courts donʼt like to let a voluntarily intoxicated person revoke a contract with innocent parties but if that person appeared to be under the influence when the contract was made, then the other party probably wasnʼt so innocent. On the other hand, if the person didnʼt appear to be intoxicated when making the contract, then he or she probably will have to abide by it. Contract Law 4

OFFER The first step in making any contract is the OFFER a proposal to buy, sell, or do something. The person who makes the offer is the OFFEROR; the person to whom it is made the OFFEREE. The most important thing to know about an offer is that the proposal must be sufficiently clear and definite as to its terms. Four things should be spelled out in the offer: the names of the parties, the subject matter of the contract, the price, and how soon the contract must be performed. These details (who, what, how, how much, when and so on) of the contract are called its provisions or terms. In order to avoid problems of fraud or misrepresentation, which can give the other person a way out of the contract, the offer should accurately and honestly describe what is being sold or promised to do. In addition, contractual intent must be present in an offer; thus, offers that appear to be made in jest are not valid. ACCEPTANCE Once there is an offer, a contract is made only if the person to whom the offer was made accepts it while it is still open. So an ACCEPTANCE occurs when an offeree agrees to a proposal. Normally, only the person to whom the offer is made has the power to accept the offer. But when an offer is made to the public in general, anyone has the right to accept it. The person receiving an offer must accept all the terms of the offer before a valid and binding contract exists. Therefore, an acceptance must be unconditional and unequivocal that is, with no strings attached. Suppose Tom says to George, I offer to sell you my sailboat for $5,000, and George replies, You have a deal, but only if you outfit it with a new mainsail first. Has George accepted Tomʼs offer? No. George has changed the terms of the offer by adding a new condition. Georgeʼs conditional acceptance has the same legal effect as a counteroffer. A COUNTEROFFER terminates an original offer and acts as a new offer, which can be accepted or rejected by the new offeree. Acceptance must also be voluntary that is, both parties must agree to the contract on their own free will, with full knowledge of what they are doing. A court will not allow anyone to be forced or tricked into making a contract. In deciding whether a contract is mutual and voluntary, a court looks at more than just the words of the contract. It looks at how the contract was made. With the help of witness testimony and written evidence, the court tries to reconstruct the steps that led to the contract. CONSIDERATION The final thing a contract needs in order to be legally binding and enforceable is consideration. CONSIDERATION is the exchange of things of value that creates the legal bond between the parties to the contract. Simply put, it is something given in return for something; it is the heart of the contract, the very reason for its existence. In order to get something, something must always be given up. Suppose you buy a sofa for $750. Your consideration is giving $750; the other personʼs consideration is giving you the sofa. Or suppose you get your car washed. Your consideration is paying money and the other personʼs consideration is washing your car. Money is frequently one partyʼs consideration in a contract, but bartering goods or services is just as valid. Contract Law 5

The amount of the consideration given is generally not important, except to the extent it bears on whether the offer was made in jest or whether it wasnʼt a contract at all but really a gift. For example, if you pay $1,000 for a painting worth $15,000, the contract is binding, unless the other person claims to have been only joking when they made the offer. In some states, contracts in writing are presumed to be supported by consideration and are therefore enforceable. LEGALITY Only contracts for legal activities can be enforced by contract law. Any agreement for illegal activity cannot be enforced in a court of law and does not constitute a binding contract. For example, contracts to buy illicit drugs for a certain price cannot be enforced by either party in a court of law. These types of agreements are void by the nature of their subject matter. WRITING To be enforceable, some agreements must be in writing. A written agreement becomes proof of what was agreed upon and prevents someone from forgetting or changing the story later. The situations in which an agreement must be in writing can differ from state to state, but usually include the following: Contracts dealing with interests in real estate, except for leases of less than a year; Contracts for the sale of goods priced at more than $500; Contracts that cannot be performed within one year from the date when the contract is made or that require services for the lifetime of either party; Contracts in consideration of marriage, such as premarital agreements and property settlement agreements; and Promises to pay anotherʼs debts. Most contracts are actually made through spoken words or possibly nonverbal actions. An oral contract is just as valid as a written contract but itʼs always preferable to have a contract in writing and signed by each party. This way itʼs much easier to prove the terms of the contract with specificity. To be enforceable, the written contract need contain only the bare requirements: the names of the parties, the subject matter, the price, and when the contract is to be performed. If there is much at stake or if the matter is complex, using a lawyer may be a wise decision. The best money may be spent up front in preventing any potential legal problems, rather than battling it out in a lawsuit later on. Contract Law 6

TYPES OF CONTRACTS The law recognizes contracts that arise in a number of different ways: A BILATERAL CONTRACT is the type of agreement most people think of as a traditional contract a mutual exchange of promises among the parties. In a bilateral contract, each party may be considered as both making a promise, and being the beneficiary of a promise. A UNILATERAL CONTRACT is one in which the offer requests performance rather than a promise from the person accepting the offer. A unilateral contract is formed when the requested act is complete. A classic example of a unilateral contract is a reward advertisement, offering payment of money in exchange for information or the return of something of value. An EXPRESS CONTRACT is formed by explicit written or spoken language, expressing the agreement and its terms. An IMPLIED CONTRACT is formed by behavior of the parties that clearly shows an intent to enter into an agreement, even if no obvious offer and/or acceptance were clearly expressed in words or writing. BREACH OF CONTRACT Disputes can arise over contracts, and one party (or both) may accuse the other of breaking their obligations under the agreement. In legal terms, a partyʼs failure to fulfill an end of the bargain under a contract is known as breaching the contract. When a breach of contract happens (or at least when a breach is alleged) one or both of the parties may wish to have the contract enforced on its terms, or may try to recover for any financial harm caused by the alleged breach. CONTRACT ENFORCEMENT The most common method used to resolve contract disputes and enforce contracts (if informal resolution methods fail) is through lawsuits and the court system. If the amount at issue is below a certain dollar figure (usually $3,000 to $7,500 depending on the state), the parties may be able to use small claims court to resolve the issue. Courts and formal lawsuits are not the only option for people and businesses involved in contract disputes. The parties can agree to have a mediator review a contract dispute. The parties are not bound by a mediatorʼs decision, but may be convinced to avoid a costly court battle by how the mediator rules. The parties can also agree to binding arbitration of a contract dispute. In arbitration, a neutral party listens to the arguments from both sides and issues a decision that is binding on the parties. This is cheaper and less time consuming than a court battle. When attempting to enforce a contract, an individual or business should always consider the effect any dispute will have on any long-term business relationship between the parties involved. Contract Law 7