Bus311: Essentials of Business Law Tutorial - Week Two - Ashford Bus 311

 Contract law concerns the formation and keeping of promises, the ex­cuses our society accepts for breaking such promises, and what promises are considered contrary to public policy and therefore legally void. This learning block introduces the basic terms and concepts of contract law.

A. Sources of Contract Law - Contract law is common law, which governs all contracts except when statutes or administrative regu­lations have modi­fied or replaced it. Statutory law—particularly the Uniform Commercial Code (UCC)—governs all contracts for sales of goods.

B. The Function of Contract Law - Contract law ensures compliance with a promise and entitles a nonbreach­ing party to re­lief when a con­tract is breached. All contractual relationships involve promises, but all promises do not establish con­tractual relationships. Most contractual promises are kept, because keep­ing a promise is generally in the mutual self-interest of the promisor and the promisee.

C. Definition of a Contract - A contract is a promise for the breach of which the law gives a remedy or the performance of which the law recognizes as a duty (that is, an agreement that can be enforced in court). A contract may be formed when two or more parties promise to perform or to refrain from performing some act now or in the fu­ture. A party who does not fulfill his or her promise may be subject to sanctions, including damages or, in some circumstances, being required to perform the promise.

D. The Objective Theory of Contracts - Intent to enter into a contract is judged by objective (outward) facts as in­terpreted by a reasonable per­son, rather than by a party’s subjective inten­t. Objective facts include:

1. what a party says when enter­ing into a contract
2. how a party acts or appears
3. circumstances sur­rounding a deal.

A. Requirements of a Valid Contract

1. Agreement - This requirement includes an offer and an acceptance. One party must offer to enter into a legal agreement, and an­other party must accept the offer.

2. Consideration - Promises must be supported by legally sufficient and bargained-for con­sideration.

3. Contractual Capacity - This includes characteristics that qualify the parties to a contract as competent.

4. Legality - A contract’s purpose must be to accomplish a goal that is not against public policy.

B. Defenses to the Enforceability of a Contract

1. Genuineness of Assent - The apparent consent of both parties must be genuine.

2. Form - A contract must be in whatever form the law requires (some contracts must be in writing).

Each category signifies a legal distinction regarding a contract’s formation, performance, or en­forceability.

A. Contract Formation

1. Bilateral versus Unilateral Contracts - Bilateral contract—a promise for a promise (to accept the offer, the offeree need only promise to per­form). Unilateral contract—a promise for an act (the offeree can accept only by completing performance).

2. Formal versus Informal Contracts - Formal contract—a special form or method of creation is required for enforcement. Informal contract—a contract that is not formal (certain contracts must be in writing, however).

3. Express versus Implied-in-Fact Contracts - Express contract—the terms of the agreement are fully and explicitly stated in words (oral or writ­ten). Implied contract—implied from the con­duct of the parties.

B. Contract Performance - Executed contract—a contract that has been fully performed on both sides. Executory contract—a con­tract that has not been fully performed by one or more of the par­ties.

C. Contract Enforceability - Valid contract—has all elements necessary to entitle at least one party to en­force it. Void con­tract—produces no legal obligations on the part of any of the parties. Voidable contract—valid con­tract that can be avoided by one or more of the parties. Unenforceable contract—contract that cannot be enforced because of certain legal defenses.

Consideration is the value given in return for a promise.

A. Elements of Consideration

1. A Bargained-for Exchange - The promise must induce the value, and the value must induce the promise. Situations that lack this element include “past” consideration (promises made with respect to events that have already taken place are unenforceable).

2. Something of Legal Value - Something of legal value must be given in exchange for a promise. It may be a return promise. If it is performance, it may be:

1. an act (other than a promise)
2. a for­bearance (refraining from action)
3. the creation, modification, or destruction of a legal relation.

a. Adequacy of Consideration - Generally, a court will not evaluate adequacy (the fairness of a bargain), unless its absence in­dicates fraud, duress, incapacity, undue influ­ence, or a lack of bargained-for ex­change.

b. Preexisting Duty Rule and Past Consideration - A promise to do what one already has a legal duty to do does not consti­tute consideration. A promise made in return for an event that has already occurred also lacks consideration.

B. Promissory Estoppel - Under the doctrine of promissory estoppel (detrimental reliance), a person who relies on the promise of another may be able to recover in the absence of consideration if—

1. The promise was clear and definite.

2. The reliance is justifiable.

3. The promisor knew or had reason to believe that the promisee would likely rely on the promise, and the reliance induced a change of a substantial and definite character.

4. Justice will be better served by enforcement of the promise.

Persons who are minors, intoxicated, or mentally incompetent but not yet adjudi­cated officially as such, have capacity to enter into a contract; but they can normally avoid liability under the contract.

To be enforceable, a contract must not violate any statutes or public policy. A covenant not to compete, for example, to be enforceable, must be no more restric­tive than necessary to protect a legitimate business interest.

A. Mistakes - It is important to distinguish between mistakes made in judgment as to value or quality and mistakes made as to facts. Only the latter have legal significance.

1. Bilateral (Mutual) Mistakes - When both parties make a mistake as to a ma­terial fact, either party can rescind the contract. The same rule applies if the parties attach materially different meanings to a word or term in the con­tract that may be subject to more than one reason­able interpretation.

2. Unilateral Mistakes of Fact - A unilateral mistake as to a material fact does not afford a mistaken party relief. Exceptions: in­clude (1) if the other party knows or should know of the mistake or (2) if the mistake is due to a mathematical error and is done in­advertently and without gross negligence.

B. Fraudulent Misrepresentation - If an innocent party is fraudulently induced to enter into a contract, the con­tract normally can be avoided. Fraud consists of:

1. misrepresentation of a material fact
2. an intent to deceive
3. the innocent party’s justifi­able reliance on the misrepresentation. To collect damages, a party must also have suffered an injury.

C. Nonfraudulent Misrepresentation

1. Innocent Misrepresentation - Occurs when a person misrepresents a material fact without an intent to defraud (be­lieves a state­ment to be true). One relying on the statement to his or her detriment can rescind the contract.

2. Negligent Misrepresentation - Occurs when a person misrepresents a material fact by failing to exer­cise reasonable care in uncov­er­ing or dis­closing the facts, or not using the skill and competence that his or her busi­ness or profession requires. In ef­fect, this is treated as fraudulent misrepresentation.

D. Undue Influence - Occurs when a contract enriches a party at the expense of an­other dominated by the enriched party. The contract is voidable. Essentially, the party taken advantage of does not ex­ercise free will.

E. Duress - Involves forcing a party to enter into a contract by threatening the party with an act that is wrongful or illegal. Threatening to exercise a legal right or taking advantage of another’s economic need (unless the party exact­ing the price also creates the need) does not give rise to duress.

F. Adhesion Contracts and Unconscionability - To avoid a contract, an adhering party must show that the parties had sub­stantially unequal bargain­ing positions and that enforcement would be un­fair or oppressive.

The Statute of Frauds stipulates what types of contracts must be in writing to be enforceable. If a contract is not in writing, it is not void but the Statute of Frauds is a defense to its enforcement.

A. Contracts That Must Be in Writing to Be Enforceable - Contracts involving interests in land, contracts that cannot be performed within one year of formation, collateral ($500 or more under the 2003 amendments to the Uniform Commercial Code—Chapter 11).

B. Exception - An oral contract may be enforced if:

1. a promisor makes a promise on which the promisee justifiably relies to his or her detriment
2. the reliance was foreseeable to the promisor
3. injustice can be avoided only by en­forc­ing the promise.

A. Assignments - The transfer of a contract right to a third person is an assignment.

1. Rights That Cannot Be Assigned - Rights cannot be assigned if a statute prohibits assignment, a contract is personal (unless all that re­mains is a money payment), the assignment materially increases or alters the risk or duties of the obligor, or the contract provides that it cannot be assigned.

2. Exceptions - A contract cannot prevent an assignment of

1. a right to receive money
2. rights in real property
3. rights in negotiable instruments (checks and notes)
4. a right to receive damages for breach of a sales con­tract or for payment of an amount owed under the contract (even if the contract prohib­its it).

B. Delegations - Duties are not assigned; they are delegated. A delegation does not relieve the delegator of the obliga­tion to perform if the delegatee fails to perform.

1. Duties That Cannot Be Delegated - Any duty can be delegated unless:

1. performance depends on the per­sonal skill or talents of the ob­ligor
2. special trust has been placed in the obligor
3. performance by a third party will vary materially from that expected by the obligee
4. the contract prohibits it.

2. Effect of a Delegation - The obligee must accept perfor­mance from the delegatee, unless the duty is one that cannot be dele­gated. If the delegatee fails to perform, the delegator is still liable.

C. Third Party Beneficiaries - There are two types of third party beneficiaries: intended and incidental. An intended beneficiary is one for whose benefit a contract is made; if the contract is breached, he or she can sue the promisor. The benefit that an in­cidental beneficiary receives from a contract be­tween other parties is unin­tentional; an incidental beneficiary cannot enforce the contract.

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