Lesson One: Foundations of Contract Law and Formation
In this lesson, you will review the sources of law that govern contracts and the courts and agencies with jurisdiction over contract matters. You will explore the basic requirements of forming a contract and learn about different types of contracts. You will also learn new terminology that is important to understanding the basics of contract law.
Learning Objectives
By the end of this lesson, you should be able to:
-Identify sources of law that govern contracts and agency/contractor relationships
-Identify courts and agencies with jurisdiction over issues that arise in the contract management process
-Explain the basic elements of a contract - offer, acceptance, and consideration
-Differentiate between various types of contracts
Content
What Are Laws?
Laws are enforceable rules governing relationships among individuals and between individuals and their society. American law is based on the English common law legal system. The common law system involves the application of principles applied in earlier cases with similar facts. This use of precedent, known as the doctrine of stare decisis, permits a predictable, quick, and fair resolution of cases. Stare decisis is important because part of the function of law is to maintain stability. If the application of the law was unpredictable, there would be no consistent rules to follow and no stability.
Equity is that branch of unwritten law, founded in justice and fair dealing that seeks to supply a fairer and more adequate remedy than a remedy at law. A court of law is limited to awarding payments of money or property as compensation. A court of equity, however, can order specific performance, an injunction, or rescission of a contract. Today, in most states, a plaintiff may request both legal and equitable remedies in the same action, and the trial court judge may grant either form-or both forms-of relief.
Sources of American Law
During Week One, you read in Chapter 1 of our textbook a review of the sources of the American legal system. We review it here in the context of contracts, since the promise of American law is that of the government to the citizens that have empowered it, to provide mechanisms for ensuring the values that motivated Americans to do so. Contracts lie at the core of that sanctity of the promise, and the courts that enforce them ensure that parties to contracts will live in a society that continues to respect those values. As is true of other segments of that society, businesses are bound by that obligation, and benefit from its observance.
Constitutional Law: The federal constitution is a general document that distributes power among the branches of the government. It is the supreme law of the land. Any law that conflicts with it is invalid. The states also have constitutions, but the federal constitution prevails if their provisions conflict.
Statutory Law: Statutes and ordinances are enacted by Congress, state legislatures, and local legislative bodies. Much of the work of courts is interpreting what lawmakers meant when a law was passed and applying that law to a set of facts (a case). Uniform laws are created by panels of experts and scholars and adopted at the option of each state's legislature. The Uniform Commercial Code (UCC) assists parties involved in commercial transactions by helping to determine their intent and by providing for the enforcement of their agreement. The UCC has been adopted by all the states (only in part in Louisiana), the District of Columbia, and the Virgin Islands.
Administrative Law: Administrative law consists of the rules, orders, and decisions of administrative agencies. Federal agencies are created by Congress through enabling legislation, which specifies the powers of an agency. The powers may include rulemaking, investigation and enforcement, and adjudication. When making rules, an agency gives public notice of the proposed rule, allows time for persons to comment in writing, and considers the comments when drafting the final version of the rule. Using investigatory and prosecutorial powers, an agency can compel individuals or organizations to hand over specified papers, records, or other documents. Agencies may conduct on-site inspections, although a search warrant is normally required. After investigating, an agency may take action against specific parties. The majority of agency actions are resolved at the initial stage. If no settlement is reached, a trial-like hearing may take place before an administrative law judge (ALJ), who may compel the party to pay damages or to cease a specified activity. Either side may appeal the ALJ's decision to a federal court, or the commission that governs the agency may review the case. Court appeals act as a check on the arbitrary use of power. Also, agencies cannot exceed the power granted by Congress, which allocates agency funds. The executive branch can exert control through the president's power to appoint federal officers. The Administrative Procedure Act imposes requirements that must be met when undertaking rulemaking or adjudication.
Case law or common law: Another basic source of American law consists of the rules of law announced in court decisions. These rules include judicial interpretations of constitutional provisions, of statutes enacted by legislatures, and of regulations created by administrative agencies.
Article 2 of the Uniform Commercial Code (UCC)
Article 2 of the UCC applies to contracts for the sale of goods. Virtually all commercial enterprises are the purchase or sale of goods. Under the UCC, a contract is enforceable if parties intend to be bound, though terms are left open for later agreement. An offer signed by a merchant that indicates the offer will be kept open is a firm offer and is not revocable for lack of consideration.
The UCC has several rules for interpreting the meaning of terms in contracts. Actions undertaken during the performance of the contract to which there are no objections are considered to be evidence of the course of performance. Previous transactions between the parties are evidence of course of dealings. Common practices or methods within a particular field are considered evidence of usage of trade. Courts will consider course of performance, course of dealings, and usage of trade to resolve disputes regarding contract terms.
The UCC provides for three types of warranties: express warranty, implied warranty of merchantability, and implied warranty of fitness for a particular purpose. An express warranty is an explicit guarantee by the seller that the goods will have certain qualities. An implied warranty of merchantability guarantees that goods are reasonably fit for the general purpose for which they are sold, properly packaged and labeled. An implied warranty of fitness for a particular purpose guarantees that the goods are fit for the particular purpose the seller recommended.
Agency
We have discussed the nature of principal-agency relationships. Laws pertaining to agency are an essential part of commercial contracts. An agent is a person with the authority to represent and/or bind a principal. Employees and contractors can bind principals in many situations. A principal can be an individual, a group, or an organization. There are several types of agents:
Universal agents have broad or unlimited authority to act on behalf of the principal.
General agentshave transactional authority to act on behalf of the principal.
Special agentshave limited authority, which is generally confined to a specific task or process.
A principal is bound by the actions of his agent only if the agent has not exceeded the scope of the authority given to them. Actual authority is the power given to the agent by the principal. Expressed authority is authority given orally or in writing to the agent by the principal. Implied authority is authority that naturally flows from the expressed authority given to the agent by the principal. Apparent authority is the perception that an agent or employee is acting on behalf of the principal.
Jurisdiction
Jurisdiction is the power to hear and decide a case. Before a court can hear a case, it must have jurisdiction over both the person against whom the suit is brought or the property involved in the suit and the subject matter of the case. Power over the person is referred to as in personam jurisdiction; power over property is referred to as in rem jurisdiction.
Generally, a court's power is limited to the territorial boundaries of the state in which it is located, but in some cases, a state's long arm statute gives a court jurisdiction over a nonresident. A corporation is subject to the jurisdiction of the courts in any state in which it is incorporated, in which it has its main office, or in which it does business.
Subject-matter jurisdiction involves limitations on the types of cases a court can hear. A court of general jurisdiction can hear virtually any type of case, except a case that is appropriate for a court of limited jurisdiction. Courts of original jurisdiction are trial courts; courts of appellate jurisdiction are reviewing courts.
Jurisdiction of the Federal Courts
The jurisdiction of the federal courts is limited by the Constitution. Congress has the power to control the number and kind of federal courts (other than the United States Supreme Court). Congress can also regulate the appellate jurisdiction of the United States Supreme Court and set other limits on federal jurisdiction (although Congress cannot expand it).
Whenever a suit involves citizens of different states, a foreign country and an American citizen, or a foreign citizen and an American citizen, diversity of citizenship exists, and the suit can be brought in a federal court. In diversity of citizenship suits, Congress has set an additional requirement-the amount in controversy must be more than $75,000. For diversity-of-citizenship purposes, a corporation is a citizen of the state in which it is incorporated and of the state in which it has its principal place of business.
Whenever a suit involves a question arising under the Constitution, a treaty, or a federal law, a federal question arises, and the suit can be brought in a federal court.
Exclusive vs. Concurrent Jurisdiction
When both state and federal courts have the power to hear a case, concurrent jurisdiction exists. When a case can be heard only in federal courts or only in state courts, exclusive jurisdiction exists.
Federal courts have exclusive jurisdiction in cases involving federal crimes, bankruptcy, patents, and copyrights; in suits against the United States; and in some areas of admiralty law. States have exclusive jurisdiction in certain subject matters also, for example, in divorce and in adoptions.
Venue
A court that has jurisdiction may not have venue. Venue refers to the most appropriate location for a trial. Essentially, the court that tries a case should be in the geographic area in which the incident occurred or the parties reside.
Standing to Sue
Before a person can bring a lawsuit before a court, the party must have standing. The party must have suffered a harm, or been threatened a harm, by the action about which he or she is complaining. The controversy at issue must also be justifiable (real and substantial, as opposed to hypothetical or academic).
Alternative Dispute Resolution (ADR)
The advantage of alternative dispute resolution (ADR) is its flexibility. Normally, the parties themselves can control how the dispute will be settled, what procedures will be used, and whether the decision reached (either by themselves or by a neutral third party) will be legally binding or nonbinding. Approximately 95 percent of cases are settled before rial through some form of ADR. Forms of ADR commonly seen in contracts include arbitration and mediation.
Contract Law
Contracts are generally covered by common law, and in the case of commercial transactions, by the Uniform Commercial Code (UCC). Contract law shows what promises or commitments our society believes should be legally binding. It shows what excuses our society will accept for the breaking of promises, and what kinds of promises will be considered to be against public policy and, therefore, legally void. The use of contract principles to govern the relationships of those who make promises to one another dates back thousands of years. Early in history the importance of contracts was recognized and given legal effect. Modern capitalist society could not exist without the law of contracts. The foundation for most commercial activity is the contract.
Interpretation of Contracts
The most important principle to keep in mind in considering these rules is that the law attempts not just to enforce a contract, but to enforce the contract the parties made.
The Plain Meaning Rule:When a contract is in writing that is not subject to conflicting meanings, a court will enforce the writing according to its plain meaning. Under this plain meaning rule, the meaning of the words must be determined from the face of the instrument-a court cannot consider evidence extrinsic to the document.
Interpretation of Ambiguous Terms:When the writing is ambiguous, a court will interpret the language to give effect to the parties' intent as expressed in their contract. A court will not make or remake a contract nor interpret the language according to what the parties claim their intent was when they made it. In interpreting ambiguities:
A reasonable, lawful, and effective meaning will be given to all of a contract's terms.
A contract will be interpreted as a whole; individual clauses will be considered subordinate to the contract's general intent. All writings that are part of the same transaction will be interpreted together, although terms that were negotiated separately will be given greater consideration than standardized terms and terms that were not negotiated separately.
A word will be given its ordinary, commonly accepted meaning, and a technical word or term will be given its technical meaning, unless the parties clearly intended something else.
Specific and exact wording will be given greater consideration than general language.
Written or typewritten terms prevail over printed ones.
When the language used has more than one meaning, it will be interpreted against the party who drafted the contract.
When evidence of trade usage, prior dealings between the parties, and previous course of performance under the contract is admitted (typically under the UCC), what each of the parties does in pursuance of the contract will be interpreted as consistent with what the other does and with any relevant usage of trade and course of dealing and performance. In these circumstances, express terms are given the greatest weight, followed by course of performance, course of dealing, and usage of trade, in that order. When considering custom and usage, a court will look at the customs and usage of trade of the particular business and the locale where the contract was made or is to be performed.
What is a Contract?
The foundation for most commercial activity is the contract. Contracts are promises or commitments that are legally binding when they include an offer, acceptance, and consideration and are legally enforceable. The law gives a remedy when a contract is breached, and recognizes its performance as a duty. (In other words, it is an agreement that can be enforced in court.) A contract may be formed when two or more parties promise individually to perform or to refrain from performing some act, now or in the future. A promisor is a person who communicates a promise to another. A promisee is the recipient of such a promise.
A party who does not fulfill his or her promise may be subject to sanctions, including damages or, under some circumstances, being required to perform the promise. The essential elements of a contract are:
Agreement - the offer and acceptance
Consideration
Contractual capacity
Legal purpose
Proper form
The absence of one or more of these elements makes an agreement unenforceable as a contract. However, in certain circumstances where this is the case, there may be equitable relief available to aggrieved parties.
Types of Contracts
Every contract involves at least two parties: an offeror (a/k/a promisor) and an offeree (a/k/a promisee). The offeror promises to do or not to do something. Whether a contract is unilateral or bilateral depends on what the offeree must do to accept.
A unilateral contract is exchange of a promise for an act. If the offeree can accept only by complete performance, the contract is unilateral. (Only the offeror has promised; the offeree must act in order for the contract to exist.)
A bilateral contract is an exchange of a promise for a promise; if the offeree need only promise to perform, the contract is bilateral.
A unilateral contract offer becomes irrevocable once substantial performance has been completed by the offeree. This prevents the offeror from revoking the offer before performance has been completed, or at least for a reasonable period of time.
An express contract is one in which the terms are expressed in words, oral or written. A contract that is implied from the conduct of the parties is an implied-in-fact contract, or simply an implied contract. The parties' conduct reveals that they intended to form a contract, and the parties create and define its terms. To establish that an implied-in-fact contract existed (when such matters result in lawsuits):
The plaintiff must have furnished some service or property;
The plaintiff must have expected to be paid and the defendant knew or should have known that payment was expected; and
The defendant had a chance to reject the service or property and did not.
A quasi-contract or implied-in-law contract is not based on an express promise to pay for a benefit received or on conduct implying such a promise. Quasi-contracts are imposed by courts to avoid unjust enrichment. There are situations in which the recipient of a benefit is not liable. For example, people cannot normally be forced to pay for benefits thrust on them. Also, a quasi-contract will not normally be imposed when there is a contract that covers the matter.
Formal contracts require a special form or method of formation to be enforceable. Formal contracts include contracts under seal, which are writings with a special seal attached. All other contracts are informal contracts, or simple contracts. For these, no special form is required (except for certain types of contracts that must be in writing).
Contracts are also classified according to their stage of performance. A contract that has been performed is an executed contract. A contract that has not been performed is an executory contract. If one party has fully performed but the other has not, the contract is said to be executed on one side and executory on the other, and it is classified as executory.
A valid contract results when all of the elements necessary to contract formation exist-when the parties agree, through an offer and an acceptance, to form a contract; the contract is supported by consideration; the contract is for a legal purpose; the parties had legal capacity to contract; and no other defenses exist that would prevent enforcement of the contract.
A contract that is void is no contract. A void contract gives rise to no legal obligation on the part of any party. For example, a contract for an illegal purpose is a void contract.
A voidable contract is a contract in which one or both of the parties have the option of avoiding his or her legal obligations because there is a defense to its enforcement. If any obligation is avoided, both parties are released. If the contract is ratified, both parties must perform.
An unenforceable contract is a contract that cannot be enforced due to certain legal defenses. For example, an oral contract barred by the Statute of Frauds, which requires certain types of contracts to be in writing, is an unenforceable contract.
Offer and Acceptance
Contract formation commences with an offer that requires satisfaction of three elements:
A demonstrable intent to enter into a contract and not an opinion
Definite language and terms that can be understood by the offeree
Communication of the offer to the offeree
Advertisements are not considered offers as they lack the intent to be bound by a contract and often do not contain definite terms.
Offers an be terminated before acceptance, as long as it is not an irrevocable offer, by any of the following means:
Revocation of the offer by the offeror which must be communicated to and received by the offeree
Rejection of the offer by the offeree
Counteroffer by the offeree
Lapse of time for acceptance specified in the offer
Death of incompetence of the offeror or offeree
Supervening illegality of the contract purpose or terms
Under common law an offeree must accept the contract offer without adding or changing the terms. This is known as the mirror image rule. Acceptance must be by the mode specified in the offer or by any reasonable means, and the offeree must communicate acceptance to the offeror. Under the mailbox rule acceptance takes effect upon communication by the offeree, even if the offeror has not yet received the acceptance. For example, once an acceptance is placed in the mailbox (if mail is the mode for communicating the acceptance) there has been an acceptance and the offeror cannot revoke the offer.
Consideration
An agreement cannot be enforced under contract law unless it is supported by consideration. Consideration requires
Something of legal value given in exchange for a promise such as a promise, an act, or refraining from action
A bargained-for exchange
Consideration cannot be based on a preexisting duty to perform or on acts that already took place in the past. A contract must be based on definite terms for performance or it is considered illusory and without consideration.
When a party has reasonably relied on a promise made by another, but no agreement was reached, a court can use the doctrine of promissory estoppel to form an enforceable contract. The doctrine has the following elements:
A promise has been made
The promisee is justified in relying on the promise
The reliance is of a substantial and definite character
Justice will be served by enforcing the promise
Lesson Two: Defenses to Contract Enforcement and Remedies for Breach of Contract
In this lesson, you will analyze the defenses to contract enforcement and explore third-party contract-based liability. You will also learn about legal and equitable remedies available to aggrieved parties for nonperformance or breach of a contract.
Learning Objectives
By the end of this lesson, you should be able to:
Analyze defenses to contract enforcement including capacity, legality, mistakes, and Statute of Frauds.
Explain third-party rights and contract-based liability in assignments and delegations.
Identify defenses and remedies to breach of contract claims.
Content
Defenses to Contract Enforcement
Although a valid contract may have been formed, it may not be enforceable if there is a defense to enforcement. Defenses include the following and these defenses may result in a voidable or void contract:
Capacity issues in which the contract may be voidable based on the decision of the party with the capacity problem to disaffirm or ratify the contract
Legality issues which results in a voidcontract
Mistakes, misrepresentation, and other contract defects which usually results in a voidable contract that can be disaffirmed or ratified by the innocent party
Statute of Frauds for failing to provide a written contract which results in a contract that is not enforceable unless an exception applies
Capacity
Capacity problems arise when the offeree is a minor (based on state law concerning the age of majority); when a person was intoxicated or under the influence of drugs at the time of acceptance; or when a person lacks mental competence at the time of acceptance, but has not been adjudged as mentally incompetent.
Minors:If a minor disaffirms the contract all goods that have been received must be returned and payment must be made for reasonable use of the goods. Some states do not allow a minor to disaffirm a contract if the minor lied about his or her age. A minor who enters into a contract for necessaries (food, clothing, and shelter) can disaffirm the contract, but must pay for the reasonable value of the goods. Parents are usually not liable for contracts made by their children. A minor cannot ratify a contract until reaching majority age.
Intoxicated and mentally incompetent persons:An intoxicated person or mentally incompetent person who lacked mental capacity when the contract was made can disaffirm or ratify the contract once they are sober or lucid. A person who has been deemed by a court as mentally incompetent cannot enter into contracts and such contracts are considered voidrather than voidable.
Contracts Contrary to Statute
Usury: Usury statutes place a ceiling on rates of interest, but there are exceptions, for example, to facilitate business transactions such as corporate loans. The effects of a usurious loan-whether the lender can recover only the principal, or the principal plus interest up to the legal maximum, or nothing-differ from state to state.
Licensing and Permit Statutes: All states require certain professionals to obtain licenses and certain types of projects to obtain permits. When a person contracts with an unlicensed individual or a company that has not obtained the required permits, the contract may not be enforceable, depending
Reading 3.1.1
Read: Chapters 8, 9, and 10, in your textbook.
Discussion Question:
Look through the "Real-World Case Problems" that appear at the end of the chapters in our textbook that we have read this week (8, 9, 10, 11, 12, 13, 14, 15, and 16).
Select one of the problems. Without conducting any outside research on the case, answer the question(s) asked under the problem you selected. Support your answer with concepts and material you are learning from your readings. Your answer to the question will be your initial response. Before providing your initial response, make sure you list the chapter number and question you are responding to.
Comment to at least one of your classmates' posts that you agree with and at least one of your classmates' posts that you disagree with. Refer to the question or case he/she chose to analyze. Then, offer your comment on his or her discussion, and incorporate new material into your comment.
Once the discussion ends, you can research the actual case. I want you to learn to make arguments based on the law you are learning about, as there is not always a right or wrong answer, and the best argument usually wins the case.
Textbook and Resources
Roger LeRoy Miller and William Eric Hollowell. Business Law Text & Exercises. 7th edition, 2013. South-Western/Cengage Learning.
ISBN13: 978-1133625957.