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What is a Contract?

Updated on August 17, 2014

A contract, in United States law, is a promise or set of promises creating a legal duty of performance. Society has largely left to the courts the responsibility for creating and developing the law of contracts, although there is much legislation concerned with particular aspects of contract, such as usury, labor law, and unreasonable restraint of trade.

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Basic Concepts

Persons often make promises, which are assurances or undertakings that something shall or shall not happen- for example, a promise to build a house or a promise not to assert a claim. Business transactions depend upon such promises. (Although often used, the word "promise" is not actually required.) But unless society creates a legal duty to perform a promise, there is no legal compulsion to do so.

Thus, a person's promise to pay $100 to another as a gift does not create a legal duty, while a promise to pay $100 for a service subsequently rendered in reliance on the promise creates a legal duty to pay the $100.

A promise can ask for only three things in return: an act, a forbearance (refraining from doing something ), or a return promise. A contract is unilateral if the promise requests an act or a forbearance. If the promise requests a return promise, the contract is bilateral, consisting of mutual promises. A promises to pay $50 for B's services, which B then renders; or C promises to pay $50 to D for services and requests D's return promise to render such services, which D promises.

A's promise is a unilateral contract, although both A and B are parties to it. The mutual promises of C and D constitute a bilateral contract.

When one or more of the parties has the right to avoid his duty to perform the contract, the contract is voidable. Thus, a contract fraudulently induced is voidable at the discretion of the party defrauded. However, he may waive his power to avoid, keep the contract in force, and hold the defrauding party liable for deceit. When there is no legal remedy to enforce a contract, it is unenforceable. Thus, a contract provable only by a writing (the written contract or a signed memorandum) is unenforceable without such a writing; an oral contract to transfer land would be unenforceable.

Formation

A promise creates a contract when, with some exceptions, four things are present: two or more parties with legal capacity to contract, agreement between the parties, sufficient consideration, and a legally valid transaction.

Parties

Most persons have legal capacity to contract, although anyone adjudged by a court to be incompetent cannot do so. Enemy aliens often cannot contract. Neither can convicts serving long terms of imprisonment. A "person" may be either a juristic person created by law (such as a corporation) or a human being. An infant, that is, a person under 21 years of age, can contract.

However, in the absence of statute or judicial decision to the contrary, an infant may avoid his contracts (1) during his infancy or (2) within a reasonable time after he becomes an adult, unless the contract is one involving land.

Where land is concerned, he can avoid only within a reasonable time after he becomes an adult.

Because an infant may avoid, businessmen often require an adult as an additional party to the contract. In any case, while under 21, an infant cannot waive his power of avoidance.

Parties are jointly liable as a legal entity when they together promise to render the same performance to the same third person. Also, parties are severally liable if they make separate promises to render the same performance to the same third person. Parties may be jointly and severally liable. They may also have joint, several, or joint and several rights.

Agreement

The parties must agree on what is to be done, and this they do by offer and acceptance.

An offer, made by an offeror, is a promise requesting in exchange another's act, forbearance, or return promise. It is more than a mere negotiation or an inducement inviting an offer. For example, a statement that an article is for sale is not an offer; it simply invites an offer to buy. Price lists are not offers, and likewise quotations, estimates, and trade inquiries usually are not offers. Bids a re offers, with the exception of a bid at an auction where the auctioneer has not reserved the right to accept or reject any bid. In that case a bid is an acceptance of the auctioneer's offer to sell.

An acceptance is made by the offeree (the person to whom the offer has been made) and is his manifestation of assent to the offer in compliance with and in reliance on it. However, if goods are being sold, provided there is an acceptance of a part of the offer thereby effecting a bargain, there is an agreement. Silence generally is not a manifestation of assent, although the offeree's silent exercise of dominion over the item, as by use, sale, or destruction, implies an acceptance.

Also, the parties may agree that silence is an acceptance.

If the offer does not expressly indicate how or when acceptance is to occur, then the offeree can use any proper channel of communication and must assent within a reasonable time. Usually in business transactions time is important, and the acceptance must be made promptly. If the offer requires the offeree to send his acceptance, the sending of it creates an agreement; but if the offer requires that the offeror receive the acceptance, only receipt creates agreement. An offeree's written confirmation, sent within a reasonable time, of an offer to buy or sell goods is an acceptance.

An offer is terminated by an acceptance, and both merge into an agreement. Termination may also occur by expiration, revocation, or rejection of the offer. An offer may expire either by its express or implied terms; or by operation of law, as by death of the offeror or the offeree, or by destruction of the thing contemplated by the offer, before acceptance has occurred.

An offeror may revoke his offer before acceptance, but the revocation is effective only when received by the offeree. The offeror's promise to keep the offer open for a time in exchange for consideration (something to be done) by the offeree, which the offeree renders, causes the offer to become an option, which is an irrevocable offer.

If the promise to keep the offer open is gratuitous (without consideration), then the promise is not binding on the offeror and the offer is not an option. However, a merchant's signed writing offering to buy or sell certain goods and assuring that the offer will be held open is a firm offer and is irrevocable, without consideration, for a maximum period of three months. An offeree may reject the offer before acceptance, thereby terminating the offer, by manifesting an intent not to accept the offer.

If the offeree requires a change in the terms of the offer, the offeree makes a counteroffer. An offeree's inquiry whether the offeror would change the terms of his offer is not a rejection.

When an agreement has been induced by an intentional misrepresentation, called fraud, or an innocent material misrepresentation of a contracting party, resulting in a contractual mistake, the contract is voidable by the party to whom the misrepresentation was made. Unless otherwise agreed and in the absence of statute or judicial decision to the contrary, contracting parties have no duty to disclose fully what each knows to the other, unless there is a fiduciary relationship between them. That relationship creates a duty to disclose fully and failure to do so makes the contract voidable by the party to whom disclosure should have been made. A fiduciary relationship exists when one party has a duty to act primarily on behalf of another, such as an agent for his principal.

With some exceptions, mistake does not preclude the formation of a contract. When a contract is in writing any oral or written agreement made previously, and any oral agreement made contemporaneously with the written contract, that varies or adds to the contract, are not admissible in evidence.

Sufficient Consideration

A promise is unenforceable as a contract unless it is supported by sufficient consideration. Consideration is the price exacted by a promise; it is the act, forbearance, or return promise requested in exchange for the promise. The consideration must have value, in that the person rendering it was under no previous legal duty to do so.

For example, A promises $100' to B if B will dig a ditch, which B then does. B's work is the consideration for A's promise, and since B was not under any previous legal duty to A to dig the ditch, B's work was sufficient consideration for A's promise, which is now enforceable. If A and B had a prior contract for B to dig, and later A promised B $20 extra if B would perform his contract (which B then does), A's new promise of $20 is not a contract.

It was not supported by sufficient consideration, as B had a previous contractual legal duty to A to dig the ditch. Thus, a promise to pay a debt is not sufficient consideration because the promise does not request anything in return. However, under the Uniform Commercial Code such a promise usually is enforceable as a contract because of the mercantile nature of the transactions covered by it. A creditor's promise to accept a lesser sum from the debtor in full satisfaction of a larger debt is unenforceable when the lesser sum is paid because the debtor was under a previous legal duty to pay the debt. An exception is made when an insolvent or financially embarrassed debtor agrees with some or all of his creditors that, on his payment of a part of his debt to each of them, each shall discharge him of the balance.

Often a claim is disputed because it is honestly and reasonably believed not to be valid by the party against whom it is asserted. A party's promise to discharge his disputed claim, on payment of a compromised lesser amount, is supported by sufficient consideration. Similarly, payment of an unliquidated claim-one which exists when the amount is neither fixed by the parties, certain, nor ascertainable mathematically or by law-is sufficient consideration for a promise discharging the payor's obligation.

There are important occasions when, as exceptions, a promise is enforceable without consideration and without agreement. The statute of limitations limits the time in which a claim may be enforced in the courts. One exception to the consideration rule is a promise, express or implied, to pay money on a debt barred by the statute of limitations.

Such a promise is implied from (1) the debtor's mere acknowledgement or part payment of a debt; or (2) his issuance of a negotiable instrument, such as a promissory note or check, or giving collateral security for the debt or interest thereon.

Other exceptions are:

(1) a promise to pay part or all of a debt discharged or dischargeable in bankruptcy, made after bankruptcy proceedings have begun; and

(2) a promise to waive the power to avoid a contract.

Valid Transaction

The contract must involve a legally valid transaction. An agreement is illegal when its formation or performance is contrary to law, by being opposed either to statute or to public policy as declared by the courts. Legal relief is denied to a wrongdoer. Thus, an agreement to commit a crime or a tort is void.

Statute of Frauds

In order to prevent fraud, statutes require proof by a writing that certain kinds of contract exist. Unless so proved, these contracts are unenforceable. The writing may be either the contract itself or a memorandum of an oral contract. Examples of contracts when a writing is required are: one for the sale of land or an interest in land; one not performable within one year; and one to answer for the debt, default, or miscarriages of another person.

Nonperformance

When the performance required under the contract is not rendered, the legal effect varies. If the nonperformance is material, that is, if the main purpose of the contract is not performed or is defeated, the innocent party is discharged from his contractual obligation. If the nonperformance is not material, there is substantial performance and so the innocent party must perform his part of the contract, less the harm he has sustained by the other party's nonperformance. However, nonperformance may be excused or legally justified.

A breach on contract is wrongful nonperformance of a contractual duty; unless excused or legally justified, nonperformance is wrongful. Generally, the alternative legal remedies available to the innocent party for breach of contract are (1) the right to damages; (2) in proper cases, the right to have the contract specifically performed; or (3) restitution of what he has previously delivered to the materially nonperforming party.

Discharge

The termination of a contractual duty is called a discharge, which may occur by act of the parties or by operation of law. Any of the following events causes a discharge: performance; material nonperformance; mutual agreement; assignment; exercise of a power of avoidance; intentional and fraudulent material alteration of a contract by one party without the other's assent; or a judgment, an arbitration award, or an excusable impossibility of performance.

Have you ever had a contract that you've declined to sign?

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