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  • 1. Chapter 7: Basic Contract Law David Baumer, Spring 2003
  • 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: E-commerce
        • Lawyers and legislators are scrambling to provide a universally accepted contract law of E-commerce
  • 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
  • 4. 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
  • 5. 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
  • 6. 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
  • 7. 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 directors- Coming to America
          • Quasi contract is sometimes used by small firms to try to salvage an inadvertent or bungled knowledge transfer to a larger firm
  • 8. 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
  • 9. 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
  • 10. 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
  • 11. 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
  • 12. 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).
  • 13. 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
  • 14. 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
  • 15. 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
  • 16. 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
  • 17. 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
  • 18. 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
  • 19. 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
  • 20. 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
  • 21. 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
  • 22. 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
  • 23. 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
  • 24. 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
  • 25. 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
  • 26. 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
  • 27. 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
  • 28. 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
  • 29. 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
  • 30. 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
  • 31. 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
  • 32. 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
  • 33. 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
  • 34. 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
  • 35. 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
  • 36. 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
  • 37. 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
  • 38. 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
  • 39. 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
  • 40. 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 = (P m - P k )Q k 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
  • 41. 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
  • 42. 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
  • 43. 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
  • 44. 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