Contracts - Chapter 10 Nature & Terminology

The key points in this chapter include:

1. The function of contract law.

2. The definition of the term contract and the basic elements that are required for contract
formation.

3. The objective theory of contracts.

4. The types of contracts.

5. The rules that govern the courts’ interpretation of contracts.

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 chapter introduces the basic terms and concepts of contract law, including the rules for interpreting contract language.

I. FUNCTIONS OF CONTRACT LAW

A. ENFORCE PROMISES
Contract law assures the parties to private agreements that the promises they make will
be enforceable. Without the framework that the law provides, businesspersons could rely
only on the good faith of others to keep their promises.

B. AVOID PROBLEMS
The rules of contract law are often followed in business agreements to avoid potential
problems.

C. SUPPORT THE EXISTENCE OF A MARKET ECONOMY
Businesspersons can usually rely on the good faith of others to keep their promises, but when
price changes or adverse economic factors make it costly to comply with a promise, good
faith may not be enough.

II. FREEDOM OF CONTRACT AND FREEDOM FROM CONTRACT

A. FREEDOM OF CONTRACT
Generally, everyone may enter freely into contracts. This freedom is a strongly held
public policy, and courts rarely interfere with contracts that have been voluntarily made.

B. FREEDOM FROM CONTRACT
Illegal bargains, agreements unreasonably in restraint of trade, and unfair contracts between
one party with a great amount of bargaining power and another with little power are
generally not enforced. Contracts are not enforceable if they are contrary to public
policy, fairness, and justice.

III. THE BASIC REQUIREMENTS OF A CONTRACT

A. THE ELEMENTS OF A CONTRACT

1. Agreement
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
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 ENFORCEMENT 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).

IV. THE OBJECTIVE THEORY OF CONTRACTS
Intention to enter into a contract is judged by objective (outward) facts as interpreted by a
reasonable person, rather than by a party’s subjective intention. Objective facts include (1)
what the party said when entering into the contract, (2) how the party acted or appeared,
and (3) the circumstances surrounding the transaction.

V. TYPES OF CONTRACTS

A. BILATERAL VERSUS UNILATERAL CONTRACTS

1. Bilateral Contract
A promise for a promise—to accept the offer, the offeree need only promise to perform.

2. Unilateral Contract
A promise for an act—the offeree can accept only by completing the contract performance.
A problem arises when the promisor attempts to revoke the offer after the promisee has
begun performance but before the act has been completed.

a. Revocation—Traditional View
The promisee can accept the offer only by performing fully. Offers are revocable until
accepted.

b. Revocation—Modern View
The offer becomes irrevocable once performance begins. Thus, even though it has
not yet been accepted, the offeror cannot revoke it.

B. EXPRESS VERSUS IMPLIED CONTRACTS

1. Express Contract
The terms of the agreement are fully and explicitly stated in words (oral or written).

2. Implied-in-Fact Contract
Implied from the conduct of the parties.

C. QUASI CONTRACTS—CONTRACTS IMPLIED IN LAW
In the absence of an actual contract, a quasi contract is imposed by a court to avoid the
unjust enrichment of one party at the expense of another. Cannot be invoked if there is an
actual contract that covers the area in controversy.

D. FORMAL VERSUS INFORMAL CONTRACTS

1. Formal Contract
Requires a special form or method of creation to be enforceable (such as a contract under
seal, a formal writing with a special seal attached).

2. Informal Contract
All contracts that are not formal. Except for certain contracts that must be in writing, no
special form is required.

E. EXECUTED VERSUS EXECUTORY CONTRACTS

1. Executed Contract
A contract that has been fully performed on both sides.

2. Executory Contract
A contract that has not been fully performed by one or more parties.

F. VALID, VOID, VOIDABLE, AND UNENFORCEABLE CONTRACTS

1. Valid Contract
Has all the elements necessary for contract formation.

2. Void Contract
Has no legal force or binding effect (for example, a contract is void if its purpose was
illegal).

3. Voidable Contract
Valid contract that can be avoided by one or more parties (for example, contracts by
minors are voidable at the minor’s option).

4. Unenforceable Contract
Contract that cannot be enforced because of certain legal defenses (for example, if a
contract that must be in writing is not in writing).

VI. INTERPRETATION OF CONTRACTS
Rules of contract interpretation provide guidelines for determining the meaning of
contracts. The primary purpose of these rules is to determine the parties’ intent from the
language of their agreement and to give effect to that intent.

A. THE PLAIN MEANING RULE
When the writing is clear and unequivocal, it will be enforced according to its plain terms.
The meaning of the terms is determined from the written document alone.

B. OTHER RULES OF INTERPRETATION
When the writing contains unclear terms, courts use the following rules—

1. A reasonable, lawful, and effective meaning is given to all terms.

2. A contract is interpreted as a whole; individual, specific clauses are considered subordinate to the contract’s general intent. All writings that are part of the same transaction are interpreted
together.

3. Terms that were negotiated separately are given greater consideration than standard terms
and terms that were not negotiated separately.

4. A word is given its ordinary, common meaning, and a technical word its technical meaning,
unless the parties clearly intended otherwise.

5. Specific, exact wording is given greater weight than general language.

6. Written or typewritten terms prevail over preprinted ones.

7. When the language has more than one meaning, it is interpreted against the party who
drafted the contract.

8. Evidence of trade usage, prior dealing, and course of performance may be admitted to
clarify meaning.

C. PLAIN-LANGUAGE LAWS
The federal government and most states require an agreement to be written clearly,
coherently, and in words of common, everyday meaning.