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CHAPTER
7
Basic Contract Law
1-2
Contract Law
Contracts evolved from the common law
Each state has its own common law precedents
Dissatisfaction with differences across state led to the
Uniform Commercial Code (UCC)
– UCC has been adopted by all 50 states and will be discussed next
chapter
Currently we are dealing with another watershed event: Ecommerce
Lawyers and legislators are scrambling to provide a
universally accepted contract law of E-commerce
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1-3
Contract Law
A contract is:
A promise or set of promises, the breach of which the
courts will provide a remedy for
When the two parties agree to a contract, it creates a
legally recognized duty to perform
Not all agreements are recognized as legally binding
A promise to make a gift is not binding
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Elements of a Contract
Valid contracts possess the following:
An agreement between the parties: an offer and
acceptance
Consideration--each party must do something that
they were not previously obligated to do
Both parties have capacity to contract
Formation and performance of the contract are legal
and not against public policy
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Contractual Nomenclature
Valid, void, voidable and unenforceable
– A valid contract is one recognized as binding in law
– A void contract is not recognized at all such as a gambling contract
– In a voidable contract one of the parties can not perform without
liability--a victim of fraud
– A contract is unenforceable if there are no legally enforceable
remedies--an oral real estate agreement
In a bilateral contract, both parties exchange promises
In a unilateral contract a promise is made for
performance--e.g., reward contracts
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Types of Contracts
Executory and executed
– A executory promise is a promise for future performance
• If the contract has been executed, both parties have performed
Express and Implied
An express contract can be written or oral
– In an express contract the duties of the parties are clearly
elucidated
An implied contract is implied by conduct
– After receiving treatment from a doctor, you will be asked to make
arrangements for payment
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Quasi Contracts
– The plaintiff is suing for quantum meruit (the fair market
value of her services)
• The plaintiff performed valuable services
• The defendant knowingly received these services
• The plaintiff expected to get paid if the services were
used by the def.
• The def. was unjustly enriched
– Quasi contract has been used by writers who claim
movies were made based on ideas they told directorsComing to America
– Quasi contract is sometimes used by small firms to try to
salvage an inadvertent or bungled knowledge transfer to a
larger firm
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Elements of a Contract
Agreement
Offer and Acceptance
The offeror must have intent to make an offer
– Intent is judged under an objective standard--What would
a reasonable person believe under the circumstances?
– Most advertisements are an invitation to bargain as are
items submitted for auction
• If the offer is very specific, then maybe it will be
termed an offer
– Many advertisements made on the Internet are offers
• Customers can make an immediate contract
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Offer and Acceptance
The terms of the offer must be clear and definite
– Under the common law of contracts, at a minimum the offer must
contain Price, Quantity, the Parties and the Subject Matter of the
contract.
– Must contain all material terms
The offer must be communicated to the offeree
– and the offeree knows of the offer before performing
– If an offer is made to the offeree, a third party cannot accept the
offer
– Offers can be directed to classes of offerees
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Acceptance
Just like an offer, the acceptance must have:
– Intent to be bound by the offeree
• Again judged by objective standard
• In general, silence is not deemed an acceptance unless the
parties had prior dealings
– Acceptance must be complete and unconditional
• An acceptance that contains conditions or additional terms is a
counteroffer and thus a rejection of the offer
– Acceptance must be communicated to the offeror
• Offeree should use the same medium used by the offeror to
make the offer if nothing is said in the offer
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Acceptance
An acceptance must be timely
If the offeror accepts in the manner invited by the
offer or uses the same medium if there is no specified
method
The acceptance is effective upon dispatch by the offeror
Mailbox rule has been made irrelevant generally by faxes
and E-commerce
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Termination of an offer
The offeror can revoke the offer at any time (with some
limited exceptions)
– Thus an offeror can make an offer that is good for 10 days and
then revoke it after 5 days
– Revocations must be communicated to the offeree
– Offers and revocations are effective when received
Among the exceptions to the common law rule that an
offeror can revoke an offer at anytime are:
– promissory estoppel and the
– UCC firm written offer by merchants rule (discussed in next
chapter).
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Promissory Estoppel
An offer is irrevocable if the conditions for
promissory estoppel take place:
(1) offeror knows or should know the offeree will rely on
the offer made by the offeror
(2) the offeree does rely and
(3) relies to his detriment and
(4) injustice can only be avoided by enforcing the promise
Damages under P.E. are based on costs of reliance
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Termination of the offer
If the offeree rejects the offer or makes a
counteroffer, the offer is terminated
Will occur when the offer is deemed lapsed after a
reasonable period of time
What is reasonable depends upon the industry
An offer could expire by operation of law
Death or incapacity of offeror or offeree
Supervening illegality
Destruction of the subject matter
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Consideration
Consideration
Is the exchange element in a contract
In order to support a promise made by the promisor,
the other party (the promisee) must do something that
constitutes consideration
The promisee must incur a legal detriment
Examples of consideration:
– Make a promise in exchange for a promise
– Transfer something of value
– Give up something of value such as a legal claim
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Consideration
Generally the courts do not consider the adequacy of
consideration
unless they decide the bargain is unconscionable
Consideration does not exist if the other party has a
preexisting duty to perform by law or contract
– In general past consideration is not consideration
Consideration does not exist if the promise made by the
promisee is illusory
– If the promisee maintains an unlimited right to cancel at any time
for any reason, the promise is illusory
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Consideration
There are some promises that are enforceable without
consideration
A promisor is liable under the theory of promissory
estoppel (PE)
Note with PE it is not a contract and therefore the damages
are based on reliance costs of the promisee and are
generally less than if the negotiations had resulted in a
contract
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Capacity
Both parties to a contract must have capacity to
contract
There are three categories of people who do not have
capacity
Minors--under 18
Intoxicated people--must not comprehend the transaction
Mentally deficient either due to age or disease
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Capacity
Minors can enter into a contract but
The contract is voidable at the option of the minor
When a minor voids a contract it is called disaffirming a
contract
Upon turning 18 the minor has a limited right to disaffirm
or else the contract is deemed ratified
– If the minor makes a payment after turning 18 the contract is
ratified
– A minor cannot ratify a contract while still a minor
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Capacity
If a minor disaffirms, the minor must return the
consideration if he has it
There are an increasing number of contracts that are
binding on minors, though these exceptions vary from state
to state
– Contracts with the army, insurance contracts, educational loans,
bank account agreements are examples
– A minor is liable for the FMV of necessaries: food clothing and
shelter and tools etc for an emancipated minor
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Capacity
A contract is voidable if at the time the contract was
agreed to, a party was too intoxicated to understand
the terms of the contract
If a person has been judged incompetent, then all contracts
with the person are void
If the person is, in fact, insane, the person can claim lack of
capacity even though the courts have not ruled the person
is incompetent by appointing a guardian
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Legality
Contracts can be illegal by statute or by public policy
– In either event, the agreement is void
– There are a number of agreements that have been ruled illegal by
statute in various states:
• Gambling, illegal drug sales, usurious loan agreements,
contracts with unlicensed professionals
• Increasingly, illegal contracts are taking place in cyberspace-e.g., prescriptions drugs sold online.
– Under public policy a number of bargains are void
• Exculpatory agreements such as agreements not to sue
employers under workmen’s compensation
• Contracts to excuse intentional actions
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Legality
Public policy constraints
The contract is unconscionable
Look at superior education and legal representation
one side and relative ignorance on the other side
A contract by a third party to pay a governmental
employee is illegal
Contracts in restraint of trade
– Covenants not to compete agreed to in employment
contracts must be reasonable
– Must be reasonably limited in time and space
– Cyberspace may make spatial obsolete
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Taints on an Agreement: Mistake
An agreement is voidable if there is a mutual
mistake of a material fact
A fact is material if knowledge of the true fact
would have changed the decision of the parties to
contract
If one party knows or should have known the other
party was mistaken, then the agreement is voidable
Often occurs when bids are submitted and there is a
typo
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Taints on an Agreement: Fraud
If a contract is fraudulent, it is voidable at the option of the
victim
Fraud in contract has the same elements as fraud in tort:
–
–
–
–
–
Misrepresentation of an important fact
Scienter
Intent to defraud
Justifiable reliance by the victim
Damages are caused by the fraud
An innocent misrepresentation of a material fact makes the
contract rescindable
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Genuineness of Assent
A contract is voidable if
It is the product of duress
A party signed a contract because of threat of force,
criminal prosecution, or blackmail
It is the product of undue influence
The victim is either in a weakened mental state or the other
party has a confidential relationship
The bargain is objectively unfair
There was no consultation with outside counsel
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Writing requirements
Oral contracts in general are enforceable
For certain contracts, the contract must be in writing
–
–
–
–
–
–
Contracts involving real estate
Contracts that cannot be performed within one year
Surety contracts
Marriage contracts
Contracts for the sale of goods where the value exceeds $500
Contracts where an executor is personally liable for the debts of
the deceased
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Writing Requirements
There are some exceptions to the exceptions
Oral promises of sureties to obligors are enforceable
by obligees
In some states there are part performance exceptions
for oral real estate agreements,
where the buyer takes possession, makes improvements,
and pays some or all of the purchase price
Promissory estoppel
UCC exceptions--discussed in next chapter
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Writing Contracts
Sufficiency of the writing
The agreement must have all material terms
Must be signed by the defendant
Names of the parties, consideration, and the subject matter
of the contract are required terms
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Parol Evidence Rule
Excludes prior or contemporaneous evidence that
conflicts with a written agreement
If the written agreement is incomplete, oral evidence
may be introduced
The corporate party often tries to negate an inference that
the agreement is incomplete by putting in an integration
clause
A party can always introduce evidence of fraud or
misrepresentation or mistake
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Performance, Discharge and Breach
of Contracts
Most contractual obligations are discharged by
performance
If performance fails in its essential purpose, it is
material breach
A material breach relieves the non-breaching party from
the obligation to pay the breaching party
By inserting a time is of the essence clause, late
performance becomes a breach
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Delegations of Duties
If the promisor is a company, it may delegate responsibility
for performance to employees
– If the contract performance is inadequate, the business, not the
employee, is liable for breach of contract
– Most contracts can be delegated except if the personality or talents
of the promisor are unique
• In some cases there are statutory or public policy constraints
on delegations
• Delegations are a very common event
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Assignments
Many contracts can be assigned
Once the assignment takes place the assignee can enforce
the contract against the obligee
– The assignee takes the benefits of the contract subject to the
defenses the obligor has against the assignor
– Assignments are common in car loans. The car dealer is the
assignor, the customer is the obligor and the bank is the assignee
In general, contracts can be assigned unless the assignment
or delegation would make performance by the third party
more difficult or disagreeable
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Third Party Beneficiaries
If your parents pay a soccer camp to provide soccer
training for you
You are the 3rd party beneficiary
– The purpose of the contract is to benefit you
If the soccer camp did not perform, you or your parents
could sue
If you are an incidental beneficiary, you have no right to
sue if the promisor breaches
– A garden store has no right to sue if a supplier of a beekeeper fails
to deliver
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Material Breach and Obligation to
Perform
If a promisor materially breaches a contract, the promisee
is absolved of her obligation to perform
– Same is true if there is an anticipatory breach-• contractual obligations of the non-breaching party are
eliminated, but
– If a party announces it will not be able to perform,
• the other contracting partner need not pursue legal action
immediately,
• but instead could continue performing in hopes that the
anticipatory breacher will in fact perform
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Discharge by Agreement
The parties can decide to rescind the contract
Each party agrees not to perform and neither party is liable
A novation occurs when a new party is substituted
– If A and B have a contract, and A agrees that C can fulfill B’s
obligations under the contract, a novation takes place
Satisfaction and Accord
– The same parties change the agreement
– The accord is the new agreement and the satisfaction occurs when
the new consideration is received
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Discharge Due to Impossibility
Impossibility
If performance is objectively impossible due to war
or embargoes, the promisor is discharged without
liability
If there is a subjective impossibility due to events that
are foreseeable, the obligation to perform is not
discharged
If the promisor made a bad bid, he cannot claim he cannot
perform because he is not making any money
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Discharge Due to Operation of Law
and Conditions
By Operation of Law
Bankruptcy, death of a party, destruction of the subject
matter
Discharge by condition
– Condition precedent--if the condition does not take place the
promisor does not have to perform
– Condition subsequent--if the condition takes place the obligation
to perform ceases
– Most executory bilateral contracts have concurrent conditions
• If one party does not perform, the other party’s obligation to
perform ceases
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Impracticability and Compensatory
Damages
The UCC equivalent of impossibility
It is more liberal and allows for more excuses for
nonperformance
– Strikes and bad weather may qualify
Remedies
Generally the remedy in contract law is money damages
The theory of compensatory damages is to put the
nonbreaching party in the position he would have occupied
if the contract had been performed
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Remedies
Damages: Compensatory
– In sale of goods contracts, damages are often calculated as the
difference between the market price and the contract price time
quantity:
• Damages = (Pm - Pk)Qk in this case, the seller is likely to be
the defaulting party
In addition reliance and restitution costs are sometimes
recoverable
– Reliance: Costs associated with relying on promises of the
promisor
– Restitution: Recovering consideration
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Consequential Damages
Consequential damages
Damages that are the result of the contract breach but are
unusual in some way
– Lost profits are an example of consequential damages
– The non-breaching party must apprise the breaching party of the
consequential damages in order to recover
– In some cases there is an obligation to notify the breaching party
before the breach of the possibility of consequential or unusual
damages
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Liquidated Damages
Liquidated Damages
– In many contracts damages are difficult to calculate so the parties
agree in advance what damages are
• If the parties provide a reasonable estimate of damages,
liquidated damages clauses are enforceable
• If the liquidated damages clause is judged excessive it will not
be enforced as a penalty
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Remedies
Punitive damages in contracts are very rare
The nonbreaching party is expected to mitigate
damages
Landlords whose lease has been breached cannot
refuse to lease to another tenant
Wrongfully discharged employees cannot turn down
comparable job offers from 3rd parties
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Equitable Remedies
Specific Performance
The remedy is appropriate if the promisee attaches great
value to the consideration
– The consideration must be unique
– Jewelry, works of art, real estate, family heirlooms
Injunctions
– The courts will freeze the action if irreversible damage may occur
with a continued breach
– The plaintiff generally has to demonstrate that he will likely
prevail in trial that the defendant is breaching the contract
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