A contract is a binding agreement between two or more parties.  This agreement creates one or more obligations.  Each party to a contract is legally bound to do, or to refrain from doing, certain acts.  The essence of a contract is that by mutual agreement, parties create obligations that can be legally enforced.

The elements of a contract are:

• an agreement;
• between competent parties;
• based upon the genuine assent of the parties;
• supported by consideration;
• made for a lawful objective; and
• in the form required by law.

A contract may relate to virtually any type of transaction.  Contracts may relate to performance of a service, sale, or transfer of ownership of property, or a combination of these types of transactions. Parties to a contract may be individuals, partnerships, corporations, or even governments.  There may be more than two persons to a contract.  With some exceptions, only the parties making a contract have rights or duties under the contract.

It is possible for other persons to have rights and duties with respect to a contract other than the original parties to the contract.  For example, rights under a contract may be assigned to a third person.  Also, a contract may be made for the benefit of a third person as in a life insurance contract.  A life insurance contract involves the insurance company, the insured, and the beneficiary.

A valid contract is a legally-binding contract that is made in accordance with all legal requirements. A voidable contract is an agreement that would be binding and enforceable except the circumstances surrounding its execution, or the fact that one of the parties lacks “capacity,” makes the contract voidable at the option of one of the parties.  For example, a person who has been forced to sign an agreement may avoid being bound by the agreement. A void agreement is an agreement which is without legal effect.  For example, an agreement which deals with the performance of an illegal act is void.

An executed contract is a contract that has been completely performed.  Nothing remains to be done by either party.  For example, if you go into a furniture store and agree with the sales­man to pay $400.00 for a chair and then pay the salesman cash and take delivery of the furniture, the contract has been completely executed. In an executory contract, something remains to be done by one or both of the parties.  If a contract is executed between a seller and a buyer regarding the purchase of land, and both parties agree that the sale will be consummated after the buyer obtains his loan and the seller gives a certificate of title (showing no defects), the contract is enforceable, but it is said to be executory.

An option contract is a contract that gives the right to one party to enter into a second contract with the other party at a later date.  One of the most common forms of option contracts deals with the sale of real estate.  In this type of contract, the prospective buyer will be granted an option to purchase the property within a specified period of time.  The prospective buyer will pay the seller a sum of money since the seller is, in effect, taking the property off the market during the option period.  If the prospective buyer exercises his option during that time, a second contract is entered into regarding the sale of the property.  If the option period expires, then neither party has any obligation to the other. The money paid to the seller for the option is retained by the seller.

Agreement

One of the essential elements of a contract is an agreement.  An agreement shows that the parties have bound themselves to act or refrain from acting in a manner specified by the contract.  It is essential to a contract that there be an offer and, while the offer is still in existence, it must be accepted without qualification.  An offer expresses the willingness of the offeror to enter into a contract agreement regarding a particular subject. A contract is based upon an agreement.  An agreement arises when one person, the offeror, makes an offer and the person to whom is made, the offeree, accepts.  There must be both an offer and an acceptance.  If either is not present, there is no contract. An offeror may make an offer to a particular person or it may be made to the public at large (for example, a reward offered to the public for return of lost property).

To constitute an offer, the offeror must intend to create a legal obligation, or he must appear to intend to create a legal obliga­tion.  This intent can be shown by conduct.  For example, when one party signs a written contract and sends it to the other party, this action is obviously an offer to enter into a contract on the terms of the writing.  Again, the offeror must intend to create a legal obligation.  No contract comes into being when an offer is made jokingly, or under any other circumstances that would cause a reasonable person to believe there was no intent to enter into a binding agreement.

An invitation to negotiate is not an offer.  An invitation to negotiate is merely a preliminary discussion or an invitation by one party to the other to negotiate or make an offer.  For example, a school asking a teacher whether or not the teacher wishes to continue teaching at the school the following year is a preliminary discussion and not an offer that could be accepted.  If the teacher indicated that he would like to continue teaching, then a formal offer could be made.

Generally, newspaper advertisements, price quotations, and catalog prices are just invitations to negotiate and cannot be accepted in a contractually-binding manner.  No seller has an unlimited supply of any commodity and therefore cannot possibly be deemed to have intended to make a contract with everyone who sees the advertisement or seeks to accept the price offered.

Assuming that an offer is made with intent to be bound, it still is not a legal offer unless it is communicated to the offeree.  This offer may be communicated by the offeror or at his direction.  If the offeree hears about the offer indirectly, through the grapevine so to speak, he cannot accept the offer until it is communicated to him by the offeror or at the offeror’s direction.

An offer can be withdrawn before acceptance and therefore prevent a contract from arising.  If an offer is terminated, an attempted acceptance after the termination has no legal effect.  Ordinarily, an offer may be revoked at any time by the offeror.  All that is required is the showing by the offeror of his intent to revoke the offer and communication of this intent to the offeree.

Offers may be terminated in any one of the following ways: Revocation of the offer by the offeror; counteroffer by offeree; rejection of offer by offeree; lapse of time; death or disability of either party; or performance of the contract becomes illegal after the offer is made.

The general rule is that the revocation is effective only when it is made known to the offeree.  Until it is communicated to the offeree, directly or indirectly, the offeree has reason to believe that there still is an offer that may be accepted.  The offeree may rely on this belief. If the offeror seeks to revoke the offer, but the offeree accepts the offer before notice of the revocation, a valid contract is created.

A conditional acceptance is a counteroffer.  For example, if Jones accepts the $10,000.00 price, but adds a term by stating that new tires must be put on the car, this is a conditional acceptance and therefore a counteroffer.

A rejection terminates an offer.  A rejection is an offeree’s communication that an offer is unacceptable.

When an offer states that it will be open until a particular date, the offer terminates on that date if it has not yet been accepted.  This is particularly clear when the offeror declares that the offer shall be void after the expiration of a specific time. If the time passes, and the offeree attempts to accept the offer, this is in effect a counteroffer from the offeree and can be accepted or rejected by the offeror.

If the offer does not specify a time, it will terminate after a reasonable period of time has passed.  What constitutes a reasonable time depends on the circumstances of each case.  For example, if the commodity to be sold or purchased is a perishable commodity, such as food, the reasonable time would be shorter than if the matter to be sold is machinery.

If either the offeror or the offeree dies or becomes mentally incompetent before the offer is accepted, the offer is auto­mati­cally deemed to be terminated.

If the performance of the contract becomes illegal after the offer is made, the offer is deemed to be terminated.  For example, if there is an offer made to sell alcoholic beverages to a store, but a city ordinance is passed prohibiting the sale of alcoholic beverages before the offer is accepted, the offer is terminated.

If the offeror does not otherwise specify, a mailed accep­tance takes effect when the acceptance is properly mailed.  This is known as the “Mailbox Rule.”  If the offeror specifies that an acceptance shall not be effective until received, there is no acceptance until acceptance is received.  The Mailbox Rule also would not apply in a situation where the offeror requires receipt of a payment to accompany an acceptance. Improper mailing of an acceptance can cause the acceptance to take effect only when received.

Smith owned land. Jones mailed an offer to Smith to buy his land.  Smith agreed to this offer and mailed back a contract signed by him.  While this letter was in transit, Smith orally notified Jones that his acceptance was revoked.  Was Smith bound by a contract?  Yes, since the acceptance was effective when mailed.  Subsequent revocation had no effect.

 Competent Parties

The law generally presumes that everyone has the capacity to contract.  But if a party does lack capacity, then the contract is usually voidable and the party without capacity may avoid the contract.

Parties to an agreement must have contractual capacity before the agreement will be binding on both parties.  Contractual capacity is the ability to understand that a contract is being made and to understand its general nature.  The fact that a person does not fully understand the full meaning and all ramifications of a contract does not mean that the person lacks contractual capacity.

Some classes of persons such as people under the age of 21, or in most states, under the age of 18, are deemed by law to lack contractual capacity. The common law rule was, and is, that anyone under the age of 21 years is a minor.  However, many states have reduced the age limit from 21 to 18 years.  Some states have the age of majority as 19.

With some exceptions, a contract made by a minor is voidable.  The minor, in other words, may avoid the legal liability under a contract.  Upon reaching the age of majority, a minor may affirm or ratify the contract and therefore make it contractually binding on him.  Any expression of the minor’s intention to avoid the contract will accomplish avoidance.

A minor can only avoid a contract during his minority status and only for a reasonable time after he reaches the age of majority.  After a reasonable period of time, the contract is deemed to be ratified and cannot be avoided.

When a minor avoids a contract, there are certain rules of law regarding the effect on any property received by the minor under the contract.  If the minor still has what he received from the other party, he must return it to the other party upon seeking to avoid the contract.  If he does not return the property in such a situation, he cannot avoid the contract.  If the minor cannot return what he has received pursuant to the contract because it has been spent, damaged or destroyed, he still can avoid the contract.  He can avoid the contract and is only required to return that part of the consideration he still has.  Even if he has nothing left, or what he has is damaged property, he still can avoid the contract.

Helen, age 17, wanted to buy a motorcycle.  She did not have the money to pay cash but persuaded the dealer to sell a cycle to her on credit.  The dealer did so partly because Helen said that she was 22 and showed the dealer an identification card that falsely stated her age as 22.  Helen drove the motorcycle away.  A few days later, she damaged it and then returned it to the dealer and stated that she avoided the contract because she was a minor.  The dealer said that she could not do so because (a) she had misrepresented her age and (b) the motorcycle was damaged.  Can she avoid the contract?  Yes.  In a state that follows the common law rule, neither the damage to the property nor Helen’s misrepresentation of her age will prevent her from avoiding the contract.  Some states would hold that because of the misrepresentation of age, Helen must pay for the damage that she has done, but she can avoid the contract.  A few states would hold that Helen cannot avoid the contract because she misrepresented her age.

After a minor reaches the age of majority, he can ratify the contract.  Once the contract has been ratified, the ex-minor cannot change his mind and avoid the contract.  Ratification consists of any words or conduct of the minor which shows an intent to be bound by the contract.  For example, Smith buys a car from Jones Ford Company for $10,000.00 when Smith is 17 years of age.  Smith finances the car with Jones for 5 years making installment payments each month.  Smith reaches his 18th birthday and continues to make payments for two months to Jones and then has a wreck.  Smith decides that he is going to avoid the contract and get his $10,000.00 back.  However, the fact that Smith reached the age of 18 and continued to make payments on the car and use the car would keep him from being able to avoid the contract.  Smith’s conduct constituted a ratification of the contract.  However, many Courts refuse to recognize payment as ratification unless further evidence is given of an intent to ratify a contract or an understanding by a minor that payment might constitute a ratification.  In the situation with Smith and Jones, Jones would argue that Smith continued to use the car after he reached 18 as well as made payments on the car.

Parents of a minor are not liable regarding the contracts made by the minor merely because they are the parents of the minor.  However, if a minor makes a contract and a parent or any other adult signs along with the minor as a co-signer, the parent or other adult can be held liable.  For example, if Smith, who is a minor, buys a car from Jones Auto and Smith’s father co-signs the loan documents with Smith, Smith’s father can be held liable on the loan even if Smith seeks to avoid the contract.

A person who is mentally incompetent (non compos mentis) lacks the capacity to make a contract.  The cause of the mental incompetency is immaterial.  It can be the result of a mental illness, excessive use of drugs or alcohol, a stroke, etc.  If the person does not have the mental capacity to understand that a contract is being made or the general nature of the contract, the person lacks contractual capacity.  A person who is mentally incompetent may ordinarily avoid a contract in the same manner as a minor.  If the person later becomes competent, he can ratify or avoid the contract at that time.

Consent

The third element of contract deals with the consent or understanding of the parties regarding the proposed contract.  The consent or assent of a party to an agreement must be genuine and voluntary.  This assent will not be genuine or voluntary in certain cases of mistake, deception or undue pressure

The agreement of parties may be affected by the fact that one or both of them made a mistake.  A unilateral mistake is a mistake made by one party to the agreement.  A mistake that is unknown to the other party usually does not affect the enforceability of the agreement.  A unilateral mistake regarding a fact does not affect the contract.  For example, if a customer orders a water-resistant coat thinking that this means waterproof, the customer cannot get out of the contract unless the sale was made with some sort of misrepresenta­tion as to the meaning of those words.  An exception to this would be if the seller knew that the buyer misunderstood those terms, but went ahead and sold the coat anyway.

Adam claimed that Bill owed him money.  Adam was under the impression that Bill did not have much money.  On the basis of this impression, Adam made a settlement agreement with Bill for a nominal amount.  When Adam later learned that Bill was in fact reasonably wealthy, Adam sought to set the agreement aside.  Was Adam entitled to do so?  No.  A unilateral mistake of fact does not affect the binding character of an agreement.  Bill made no misrepresentation and therefore was not guilty of fraud.  There was no obligation on Bill to volunteer any information as to his financial condition.

Failure to read a document before signing it can cause the signer to be liable under the terms of the document.  For example, suppose the president of ABC Corporation signs a promissory note in two places without reading it.  In one place he was signing as president of the corporation.  However, in the other place, he signed under a statement that said that if the corporation defaulted on the loan, the president would personally pay for the debt.  In such a situation, unless there was misrepresentation involved, the president could be held personally liable due to his negligence in not carefully reading the document.

A person who has the ability and the opportunity to read a document before signing it is contractually bound by the terms of the document even if the person signed it without reading it.  The signer cannot avoid liability based on the argument that no explana­tion was given to him as to the terms of the contract.

Even if a person is unable to read or understand the terms of the agreement, he is still bound by the terms of the agreement since he should have tried to obtain an explanation of the agree­ment.  The exception to this rule is that if the other party knows, or has reason to know, that the signer cannot read nor has a limited education, some courts would hold that the contracting party should have read the document to the other party or explained the terms.

If a party relies on the explanation of another party as to the contents of the agreement, the contract may be avoided under two circumstances:

• The party was justified in relying on the explanation of the other party; and
• The explanation was fraudulent.

The party making the explanatory statements does not have to be a lawyer, but can be any person who handles this type agreement on a regular basis and therefore has a greater knowledge of the content than the other person.  This rule would not apply if the agree­ment was negotiated between the two parties and therefore both parties had an understanding of the terms as evidenced by the negotia­tion.

If both parties to an agreement make the same mistake regarding a key factual matter, the agreement is void.  For example, a contract is void if both parties mistakenly believe that the contract can be performed when, in fact, it is impossible to perform it.  For example, suppose Smith promises over lunch to sell Jones an antique car in Smith’s garage.  Assume both parties believe the automobile is in Smith’s garage.  However, the car had been destroyed by fire an hour before the agreement and Smith had not learned of this.  Since this fact was unknown to both parties, there is a mutual mistake as to the possibility of performing the contract.  The agreement is therefore void.

When parties to an agreement make a mistake as to the legal effect of the contract, the contract is still binding.  For example, suppose Smith sold Jones a vacant lot and Jones planned to build an office on the lot.  Both Smith and Jones assume that this would be a lawful use of the property.  However, if after pur­chasing the property and applying for a building permit, Jones is told that the property is zoned for residential use, the contract is still binding.  However, if the contract had represented that the property could be used for the building of an office, it could be rescinded by Jones.

Rescission of a contract means to put the parties back in the same circumstances they were in before making the agreement.  If the agreement involved the sale of goods, the goods would be returned to the seller and the money for the goods would be returned to the buyer.

When one party to a contract knows of a fact that has a bearing on the transaction, the failure to disclose this informa­tion to the other party is called nondisclosure.  Generally, the law does not attach any significance to nondisclosure.  The theory is that it is preferable that the party lacking the knowledge ask questions of the party with the knowledge rather than imposing some sort of duty on the party with the knowledge to volunteer the information.  Thus, generally, an agreement of the parties is not affected by the fact that one party did not disclose material information to the other party.

Ordinarily there is no duty on a party to a contract to volunteer information to the other party.  The nondisclosure of information that is not asked for by a party does not hurt the validity of the contract.  For example, Jones wants to buy Smith’s house.  Jones, prior to signing the contract, makes an inspection of the house and sees several cracks in the roof and walls.  He assumes that these cracks are just the result of the house settling.  Smith makes no disclosure one way or another about the cracks.  Jones buys the house and later discovers that the house has severe foundation problems.  He sues Smith for the damages incurred in repairing the foundation problems.  Under the general rule, Smith would have been under no duty to disclose the foundation problems to Jones

There are some exceptions to this general rule regarding nondisclosure. In some instances, the failure to disclose information that was not requested can be regarded as fraudulent, giving the party harmed by the nondisclosure the same remedies as if a  statement were fraudulently made. These exceptions fall generally into one of four categories:

• Unknown defect or condition;
• Confidential relationship;
• Fine print; and
• Active concealment.

Many courts would hold that there is a duty for one party, who knows of a defect or a harmful condition, to disclose this information to the other party if:

• the defect or harmful condition is obviously unknown to the other party and
• is of a nature that the other party would be unlikely to discover or inquire about the defect or condition.

Going back to the other hypothetical about Jones buying Smith’s house, assume that Smith, while not a professional engineer or building contractor, did have some knowledge about foundations. Smith also knew that several of his neighbors had foundation trouble due to the type of soil in their neighborhood.  He therefore had reason to know that the cracks in his wall and roof were the result of foundation problems and not the result of the house simply settling.  Assume that Jones did not know that the neighbors of Smith had foundation problems.  In this situation, Jones would have a strong argument that the contract should be rescinded or that Smith should pay Jones damages for the cost of repairs to the foundation.

If two parties have a confidential relationship, such as that of attorney and client, the attorney has a duty to reveal anything that is material to his client when dealing with this client in a business matter.  The attorney’s silence has the same legal consequences as knowingly making a false statement of a material fact to his client.

Courts may find an intent to conceal when a printed contract contains clauses in such fine print that it is reasonable to believe that the other party will not take the time to read the provisions.  Of course, no relief will be granted if the fine print is not material.  In other words, if the provisions in fine print are such that the party reading the contract would have entered into the contract in any event, the provisions in the fine print would not cause the contract to be invalid.

Active concealment can cause a contract to be invalid or result in liability to the concealing party.  This is more than a failure to volunteer information.  Active concealment consists of hiding information from the other party by concealment.  For example, using the Smith and Jones house transaction as an example, suppose that Smith had painted over the cracks in the wall and the ceiling in order to hide the foundation problem. He would be guilty of active concealment and the contract could be rescinded, or Jones could recover damages from Smith in the amount of the foundation repair costs.

Fraud consists of five elements:

• The making of a false statement;
• With knowledge that the statement is false or with reckless disregard as to whether or not the state­ment is false or true;
• With the intent that the listener rely on the statement;
• With the result that the listener relies on the statement;
• With the consequence that the listener is harmed.

Smith was thinking of buying the house of Jones.  Smith noticed watermarks on the ceiling, but Jones stated that the roof had been repaired and was in good condition.  Smith was not told that the roof still leaked and that the repairs had not been able to stop the leaking.  Smith bought the house.  Some time later, heavy rains caused water to leak into the house.  Smith claimed that Jones was guilty of fraud.  Was he correct?  Yes.  The statement that the roof had been repaired would suggest to the ordinary person that the repairs had been successful.  This conclusion was reinforced by the statement that the roof was “in good condition.”  The net result was that what was said and what was not said had the effect of representing an untrue condition of the roof and therefore misled Smith and caused him to be harmed.  Because this was done with knowledge of the true facts, Jones had committed fraud.

An essential element in proving fraud is to prove that one relied on the statement which is alleged to be fraudulent.  If the alleged victim had the same knowledge of the true facts as the alleged wrongdoer, no fraud is present.  If the victim should have known the facts or if a reasonable person would have known that the statement was not true, there is no fraud.  If false statements are made after a contract has been signed, it is obvious that there was no reliance on the false statements and therefore there is no fraud.

Smith offers to sell Jones a car and represents that the car has never been in a wreck.  Jones, who has worked on cars for many years, notices some dents underneath the car that could only have been made by a wreck.  Jones buys the car anyway.  Even if Smith knew this statement was false and was trying to deceive Jones, there is no fraud since Jones did not rely on Smith’s representation.

Ordinarily, a statement of opinion cannot be the basis for fraud liability.  The theory is that a person hearing the state­ment should recognize it as merely the speaker’s personal viewpoint.

Les was buying a car from Acme. He asked the salesman if the car had ever been in a wreck. The salesman said:  “No, it has never been in a wreck.”  In fact, the auto had been seriously damaged in a wreck and, although repaired, was worth much less than it would have had it not been in a wreck.  When Les learned the truth, he sued Acme and the salesperson for damages on the basis of fraud.  They raised the defense that the salesperson did not know that the statement was false and had not intended to deceive Les.  Did the conduct of the salesperson constitute fraud?  Yes. The salesperson making the statement did not know whether the car had been in a wreck or not.  Nevertheless, the salesperson made the statement as though it was true and as though he knew that the statement were true.  This constituted reckless indifference as to whether or not the statement was true.  The reckless indifference as to the truth of a statement satisfies the mental state element of fraud.  The salesperson was therefore guilty of fraud.

An agreement may be set aside if it was not in fact entered into voluntarily by both of the parties.  If either party entered into the agreement because of undue influence or physical or emotional duress, it may be set aside.

Undue influence arises in a situation where a confidential relationship exists and one party has such influence over the other party that the other party’s free will is dominated to the benefit of the influencing party.  Confidential relationships which may result in undue influence can be such things as the relation­ship of an elderly parent and an adult child, a physician and patient, an attorney and client, or any other relationship of trust and confidence in which one party exercises a significant amount of control or influence over another.  Because of the possibility that a person in such a confidential relationship may dominate the will of another and take unfair advantage of that person, the law presumes that undue influence has occurred if the dominating party obtains any benefit from a contract made with the person alleged to have been unduly influenced.  The contract is then voidable and may be set aside unless it can be proven that no such undue influence took place.

Smith, upon reaching the age of 75 and being in ill health, decided to move in with his oldest adult son.  He lived with his oldest adult son for several years prior to his death.  Upon his death, it was discovered that he deeded all of his property to his oldest son.  The younger son contested the deed, stating that his older brother exercised undue influence over their father in getting him to give all of his property to the oldest son.  A presumption of undue influence would arise which would have to be overcome by the oldest son.  One way to overcome this presumption would be to show that the father consulted a disinterested third party, preferably an attorney, without the older son being present, and was counseled by the third party.  This is not absolute proof of the lack of undue influence, but it is a very important element of proof.

Persuasion and argument are not in themselves undue influence.  An essential element of undue influence is that the person making the contract does not exercise his free will.  Unless there is a confidential relationship, such as that between a parent and child, Courts are most likely to take the attitude that the person who claims to have been dominated was merely persuaded.

An agreement made under duress may be set aside if the duress took the free will of the person seeking to avoid the contract away.  In a duress situation, a party enters a contract to avoid a threatened danger.  This threat may be a threat of physical harm to person or to the property of someone.

A person makes a contract under duress when there is violence or the threat of violence to the extent that the person is deprived of his free will and makes the contract to avoid harm.  The threatened harm may be directed at a relative of the contracting party as well as against the contracting party.  If a contract is made under duress, the agreement is voidable.

Consideration

Another of the elements needed to make an agreement binding is consideration.  Even though there has been an offer and an acceptance, an agreement may not be enforceable if there is no consideration. Consideration is what the promisor demands and receives as the price for the promise. The promisor is the person making the promise, and the promisee is the person to whom the promise is made.  Consideration consists of something that the promisor is not otherwise entitled to.  It is not necessary to use the word consideration in a contract.

Consideration is the price paid for the promise.  When thinking of consideration, think in terms of legal value as opposed to economic value.  While economic value (e.g., money) is the most common form of consideration, consideration does not have to involve money. In order for a contract to be enforceable, each party to the contract must change his or her legal position in some way.

If an agreement lacks consideration, it is generally not a binding and enforceable contract.  There are a few exceptions to this rule.  A person sued for breaking a promise generally will not be held liable when no consideration was received for the promise.  Smith signs an agreement with his employer, Acme, stating that he will not compete with Acme should he leave the employ of Acme.  This promise by Smith is not binding unless it is supported by consideration.  If Acme tells Smith that he will be fired unless he signs this agreement, that is adequate considera­­tion; or, if at the time Acme is considering hiring Smith, Acme states that it will not hire Smith unless he agrees to enter a covenant not to compete, this covenant would then be binding.  The consideration would be the hiring of Smith.

A promise to do something that is illegal is not considera­tion.  Neither is a promise not to do something that is already prohibited by law.  These types of promises will not form a valid contract.

Ordinarily, Courts do not consider the adequacy of the consideration given for a promise.  Smith agreed to provide janitorial service to Acme for six months at $400.00 per month.  After three months, Smith decided that $400.00 was not enough money, and he sought to get out of his contract, stating that the consideration for the services was inadequate.  Is there a binding contract?  The contract is binding since, again, the law is not normally concerned with the value or quantity of consideration that the promisor demands and receives for the promise.  The employment contract was binding even if the compensation to be paid was in fact low.

Lawful Objective

The fourth element of a contract is that it must be made for a lawful objective. Courts will not enforce contracts that are illegal or violate public policy.  Such contracts are considered void. For example, a gambling contract would be illegal in many states.

If the illegal agreement has not been performed, neither party has the right to sue the other for damages or to require performance of the agreement.  If the agreement has been performed, neither party can sue the other for damages nor did to have the agreement set aside.

Jones was asked by Smith to find a buyer for his restaurant in exchange for a payment of 15% of the sales price if Jones found a buyer. Jones did not have a real estate license nor did he claim to have one.  Jones obtained a buyer and was paid one-half of the commis­sion.  Smith refused to pay any more commission saying that he did not have to since Jones did not have a realtor’s license as required by state law. Is Smith correct? Smith also said that Jones had to return the part of the commission that he had already paid to Jones. Is this correct?

Smith is correct about not having to pay Jones the rest of the commission since the state licensing statute was violated by Jones acting as a realtor without a license.  Smith’s agreement to pay Jones a commission was void and can not be enforced.  However, Smith is incorrect regarding his contention that Jones has to pay back the part of the commission Smith paid to Jones. A court will not help either party enforce an illegal contract. In most cases, parties to an illegal agreement are denied remedies of any nature.  A Court will not require parties to perform an illegal agreement, and a Court will not award damages because a party fails to perform.

An agreement may involve the performance of several promises, some of which are legal and some illegal.  The legal parts of the agreement may be enforced if they can be separated from the parts that are illegal.  However, if the illegal parts would be such as to affect the whole agreement, the legal parts of the agreement will not be enforced.  When possible, an agreement will be interpreted as being lawful.  In other words, if an agreement is susceptible to two interpretations, one legal and the illegal, the Court will generally use the legal interpretation unless it is clear that the interpretation as to illegality is very clearly indicated.

An agreement which calls for the commission of a crime is illegal and therefore void.  For example, a person could not enforce an agreement with another party to burn a house down.  Also, an agreement that calls for the commission of a civil wrong (such as a tort) is illegal and void.  For example, an agreement to slander a third party is void.

Ordinarily, a Court will not consider whether a contract is fair or unfair, wise or foolish.  However, in some instances, Courts will hold that a contract will not be enforced because it is too harsh or oppressive to one of the parties.  For example, a clause in a contract which provides that a party will pay a large penalty if he breaks the contract may be unenforceable, depending upon the circumstances.  Another example would be a situation where one party agreed that the other party would not be liable for the consequences of gross negligence.  This type of agreement would usually be void as against public policy.

Agreements that may harm the public welfare are contrary to public policy and are not binding.  An agreement may not violate a statute, but it still may be so offensive to society that courts will rule that to enforce it would be contrary to public policy.  Whether or not a contract is contrary to public policy is difficult to determine because the term “public policy” is difficult to define.  The concept of public policy has to do with protecting the public from something that tends to be injurious to the public, or contrary to the public good, or which violates an established interest of society. Contracts which violate public policy frequently relate to the protection of the public welfare, health or safety; to the protection of the person; or the protection of recognized social institutions.  For example, a contract that would prohibit some­one from marrying would be unenforceable as violating public policy.

An agreement which would require a person to lose some sort of statutory protection would be in violation of public policy.  For example, state insurance statutes frequently provide that policies of a certain type (e.g., medical) must contain certain benefits.  An insurance policy which fails to supply such benefits would violate public policy as declared in the statute.

An agreement which interferes with the proper performance of a duty of a public officer is contrary to public policy and void.  An example would be an agreement between a mayor and a private citizen where the private citizen agreed to pay the mayor $10,000.00 if the mayor would hire the citizen’s son as his executive assistant.

Agreements involving conflicts of interest can be void as violating public policy such as when a purchasing officer of a government buys from a company that the officer privately owns.

Any agreement intended to obstruct the process of law is void as being contrary to public policy.  Suppose for example, in a medical malpractice case, an attorney offered to pay his expert witness, a physician, and $10,000.00 for testifying and an additional $15,000.00 if the attorney’s client wins the case. This agreement would be void.  The danger is that a witness might lie in order to help win the case.

Most states provide that gambling contracts are illegal.  Lotteries which involve the element of a prize, chance, and consideration are also held to be held illegal.  Of course, a state may allow a lottery run by the state or may legalize gambling in general, such as in Nevada. In some states, bingo games, lotteries, and raffles are legal if the proceeds go to charity. Giveaway plans and games are lawful as long as it is not necessary to buy anything or give anything of value in order to participate.  If participation is free, the element of considera­tion is not present and therefore there is no lottery.

Statutes frequently require that a person obtain a license or certificate before practicing certain professions such as law or medicine, or before carrying on a particular business such as that of a real estate broker or stock broker.  If the license is required to protect the public from unqualified persons, such as an unlicensed physician, any contract made by the unlicensed person in the course of his medical practice would be void.  In a North Carolina case, a statute required that contractors be licensed.  An unlicensed contractor entered into a contract to make repairs.  The Court held that the contractor could not recover from the owner either the price agreed to in their contract or the reasonable value of the services actually performed since the contractor was unlicensed.

If a license is strictly a revenue raiser, such as a privilege license to conduct a store at a particular location, it would be rare for an agreement made in violation of the licensing statute to be held invalid.  Someone operating a store without a permit would not have its entire sales declared void, but it might be fined for failure to obtain the appropriate license.

When a businessman sells his business, he may compete with the buyer of his business unless there is a valid restrictive covenant or covenant not to compete.  The same is true when an employee leaves the employ of a company and begins soliciting customers of his former employer.

When an ongoing business is sold, it is commonly stated in the sales contract that the seller shall not go into the same area or a similar business again within a certain geographical area or for a certain period of time or both.  Such an agreement is valid and enforceable.

Restrictions to prevent competition by a former employee are held valid when they are reasonable and necessary to protect the interests of the employer.  For example, a provision in an employ­ment contract which prohibited an employee for two years from calling on any customer of the employer called on by the employee during the last six months of employment would generally be valid.  Courts will closely examine covenants not to compete signed by individuals in order to make sure that they are not unreasonable as to time or geographical area.  For example, suppose a company only operated within a certain city and the covenant not to compete provided that an employee of the company could not solicit business in the city or within 100 miles of the city if he ever left the employ of the company. Such an agreement would be unreasonable as to its geograph­i­cal area.  The company had no need to be protected regarding such a large geographical area.

An agreement between a doctor and a clinic that if the doctor leaves the employ of the clinic, he will not practice within the city in which the clinic is located for the remainder of the doctor’s life would be unrea­sonable as to time.  Courts may also look to public welfare.  If the city needed more than one doctor (assuming there was just one), the Court might declare the restriction as contrary to public policy.

When a restriction of competition is invalid because it is too long or covers too great a geographical area, Courts will generally do one of two things.  Some Courts will trim the restrictive covenant down to a period of time or geographical area that the Court deems reasonable.  Other Courts refuse to enforce the restrictive covenant at all and declare it void.

Proper Form

The fifth element of a contract is that it must be in the form required by law.  Do all contracts have to be in writing?  No – oral contracts can be just as valid and enforceable as written contracts.  How­ever, state statutes require that certain contracts must be in writing in order to be enforceable by a court.  These statutes are called statutes of fraud.  Statutes of fraud require that either the contract itself be in writing and signed by the parties or there must be a sufficient memorandum of the agreement signed by the party being sued for breach of contract.

The statute of frauds normally does not apply if it is possible under the terms of the agreement to perform the contract within one year.  If no time for performance is specified in the oral agreement and the performance will not necessarily take more than one year, the statute of frauds would not apply.

Smith claimed that he and Jones had made an oral contract (i) to start a business under the name of Acme Textile Mill, Inc., (ii) to incorporate the business, and (iii) to divide the stock equally.  The alleged contract was not performed.  Smith sued Jones for breach of contract.  Jones raised the defense of the statute of frauds, asserting that it was not specified that the contract should be performed within one year. Was this defense valid?  No.  The contract could have been performed within one year. Writing was therefore not required.  The statute does not apply if the contract contemplated performance within one year or if in fact it could be performed within one year.

Contracts involving the sale of land must be evidenced by writing.  This would include deeds and mortgages, as well as the contract between the buyer and the seller setting forth the terms of the sale.  This statute applies only to the agreement between the owner and purchaser of the real property.  It does not apply to collateral agreements such as between a real estate agent and one of the parties to the sales contract regarding the real estate agent’s commission.

Another type of contract that must be in writing is the promise to answer for the debt of another person.  For example, an oral promise by the president of Acme Company to pay the debt owed by Acme to Tenth National Bank would not be enforceable.

A promise by the executor or administrator of an estate to use personal funds to pay a debt of the estate must be in writing.  An executor of a deceased person’s estate has a duty to pay the debts of the person from the person’s estate.  If the executor promises to pay a debt of the decedent from his personal funds, this must be in writing.  However, if the executor makes a contract on behalf of the estate, like hiring an attorney to represent the estate, this type of agreement could be enforceable even if it is not in writing.

A promise made in consideration of marriage must be in writing.  An example of this would be a prenuptial agreement. If a contract provides for the sale of goods with a price of $500.00 or more, this type of contract must ordinarily be in writing.

The statute of frauds requires a writing to evidence the contracts which it states must be in writing.  This does not neces­sarily have to be a formal contract signed by both parties.  It can be a letter signed by only one party setting forth the terms of the oral agreement.  However, the writing, whether it be a letter or memorandum, must be signed by the person “to be charged.”  This means it must be signed by the person against whom you are seeking to enforce the contract.  The writing must contain all of the material terms of the contract so that a Court can determine what has been agreed to.  A letter from the seller of real estate to a potential buyer which did not adequately describe the property involved in the sale would not be enforceable.  The description of the land must be adequate in order to allow the Court to know exactly what land is being referred to.

In a telephone conversation, Smith agreed to buy Jack’s house.  All the details of the transaction were agreed to in the conversation.  The next day Jack wrote Smith a letter stating: ”This confirms the agreement we made last night that I should sell you my home.”  Later, Jack refused to go through with the transaction.  Smith sued Jack.  Will Smith recover?  No. Because the subject matter of the contract was the sale of an interest in land, the statute of frauds required that the contract be evidenced by a writing.  The letter written by Jack did not satisfy the statute of frauds, since such a letter must set forth all the material terms of the contract so that there is no need to resort to outside evidence to establish any of the terms of the contract.

The letter, memorandum, or other writing may consist of more than one writing if there is a sufficient link between them.  For example, two or three letters from a seller of land to the potential buyer describing the terms would satisfy the statute of frauds even if one of the letters alone would not be sufficient.  It is not necessary that the writing be made with the intent to create a writing to satisfy the statute of frauds.  A letter or memorandum signed by a seller of land to the potential buyer could satisfy the statute of frauds even if the seller did not intend for this letter to be used against him should he renege on his agreement.

In dealing with the statute of frauds, the first question is whether the contract is one that has to be in writing.  The second question is whether or not there is a sufficient writing that can be enforced.  With the parol evidence rule, there is already a written contract, and the question is whether evidence outside of the written contract is admissible in court.  If a contract is in dispute, often a question arises as to whether or not the writing evidencing the contract represents all that the parties agreed to.  The general rule is that spoken words (i.e., parol evidence) will not be allowed to modify or contradict the terms of the written contract that is complete on its face.  Exceptions to this rule are made in cases of fraud, accident, or mistake, or it can be shown that the writing is not the complete or true contract.

The parol evidence rule prevents a party from avoiding liability on a written contract by presenting evidence that the writing does not mean what it says.  The reason for the rule is to give stability to written contracts and to prevent someone claiming that there were oral terms that never found their way into the written agreement.  Parol evidence will be allowed when:

• the writing is incomplete;

• the writing is ambiguous;
• the writing is not a true statement of the agreement of the parties because of fraud,
• accident or mistake; or
• the existence, subsequent modification, or ille­gality of a contract is in question.

If the written contract is obviously incomplete or if the parties admit that it is incomplete, Courts will allow evidence as to what was orally agreed to, in addition to what was agreed upon in writing.  If the terms of the contract are ambiguous, parol evidence will be allowed to explain the contract so as to make it not ambiguous.  For example, if a written contract might have two different meanings, parol evidence may be admitted to clarify what the contract really means.  However, the fact that the parties disagree as to the meaning of the contract does not mean that it is ambiguous.

A contract which looks complete on its face may have omitted a provision that should have been included.  Parol evidence may be admitted to show that this provision was omitted due to a mistake or because of fraud of the party drawing up the contract.  Parol evidence is, of course, admissible to prove fraud.  For example, if the seller of property orally represented that the land was zoned to permit commercial use, and the land in fact was not zoned for commercial use, this evidence can be admitted in seeking to avoid the contract.

Interpretation of Contracts

If there is a dispute as to the interpretation of a contract, Courts seek to enforce the intent of the parties to the contract.  The intent which will be enforced is what a reasonable person would believe that the parties intended.  The intent that will be enforced is the intent as it reasonably appears to a third person (e.g., the judge or jury).

In interpreting contracts, ordinary words are to be inter­preted according to their ordinary meaning.  Trade terms and technical terms are to be interpreted according to their trade or technical meaning.  Software, when referring to a computer, does  not mean something that is soft, but it means the actual program.

The way parties have used terms in their prior relationships can also be used to determine what the parties meant by the words they used in a contract.

Sometimes a written contract is sent with additional printed material.  The question arises whether the additional material is part of the contract.  For example, when goods are purchased, the buyer often receives a manufacturer’s manual or various pamphlets.  When a worker gets a new job, the worker oftentimes gets an employee handbook.  Sometimes the original written document provides the answer as to whether or not the printed material is part of the contract.  Sometimes the contract will expressly refer to and incorporate into the contract the terms of the other written material.  For example, a contract for the sale of the inventory of a business may state that the seller does hereby sell to the buyer the goods described in Exhibit “A” attached hereto.  Exhibit “A” will then list specifically the items of inventory.  In that case, Exhibit “A” would be a part of the contract.

The provisions of a contract must be construed as a whole.  Provi­sions are not to be read out of context and interpreted out of context.

If an occurrence or a nonoccur­rence of an event has an effect on the existence of a contract, the event is called a condition. A condition precedent is the occurrence of an event that precedes the existence of an obligation to perform or the existence of a contract.  For example, in a fire insurance policy, there is no obligation on the insurance company to make a payment until there is a fire loss.  The occurrence of such a loss is therefore a condition precedent to the duty of the insurer to make payment.

The parties may agree that the contract will terminate if a particular event occurs or does not occur.  Such a provision is called a condition subsequent.  For example, in a contract for the purchase of land, the contract may contain a condition subsequent that cancels the contract if the zoning board turns down a buyer’s application to obtain a zoning permit to use a building for a particular purpose.  The contract may state something to the effect that this contract will be void if the buyer is unable to have the property rezoned from residential to commercial  within 90 days from the date of the agreement.

In some cases, a conflict can be solved by considering the form of the conflicting terms.  If a contract is partly printed or typewritten and partly handwritten, the handwritten part would prevail if it conflicted with the typewritten or printed part.  If there is a conflict between the printed part and a typewritten part, the typewritten part would prevail.  If there is a conflict between an amount or quantity expressed both in words and figures, as on a check, the amount or quantity expressed in words prevails.

A contract is ambiguous when it is uncertain what the intent of the parties was and the contract is capable of more than one reasonable interpretation.  Sometimes ambiguous terms can be explained by the admission of parol evidence.  Also, Courts abide by the rule that an ambiguous contract is interpreted against the party who drafted it.  In other words, the party who did not draft the contract will be given the benefit of the doubt so to speak.  Also, sometimes the background or circumstances surrounding the contract can eliminate ambiguity.  For example, in a Minnesota case, suit was brought in Minnesota on a Canadian policy of insurance.  The question arose as to whether the dollar limit of the policy referred to Canadian dollars or American dollars.  The Court concluded that Canadian dollars were intended since the insurer and the insured were both Canadian corporations, the policy was entered into in Canada, and over the years premiums had been paid in Canadian dollars, and a prior claim on the policy had been settled by using Canadian dollars.

Again, if two interpretations are reasonably possible, the contract will be interpreted in favor of the person who did not draft the contract and against the person who did draft it.  An example of this would be preprinted insurance policies.  Any clause which is capable of two interpretations will usually be interpreted against the insurer and in favor of the insured.

Sometimes a Court may imply a term to cover a situation where the parties fail to provide the term.  The Court may also imply a term if it’s necessary to give a contract a construction or meaning that is reasonable.  For example, if a contract does not state its duration, the Court may imply that the contract is to be performed or continue for a reasonable time — reasonable in relation to the type of contract that it is.  However, a term will not be implied in a contract when the Court concludes that the parties intended for the contract to be silent on a particular point.

In every contract there exists an implied covenant of good faith and fair dealing.  For example, when a contract to purchase a house is made subject to the condition that the buyer can obtain financing, the buyer must make a reasonable good faith effort to obtain the financing or be held in breach of the contract.  The implied duty to act in good faith means an honest, good faith effort to satisfy the condition of the contract.

As a general rule, a party is bound by a contract even if it proves to be a bad bargain.  However, if a court is called upon to interpret a contract, if possible, the court will interpret it in such a way as to avoid hardship, particularly when the hardship would hurt the party who had the weaker bargaining position.

When a contract has contacts with more than one state, it is a contract in interstate commerce, and it is necessary to determine which state’s law governs the contract.  The rules that govern that decision are called the law of conflicts of law.  The parties may specify the jurisdiction whose law is to govern.  If that jurisdic­tion bears a reasonable relationship to the contract, the choice will be given effect by the Court.

Assuming there is no choice of law in the contract, the law of the state where the contract is made determines whether or not the contract is valid.  Matters regarding the performance of the contract, for example, damages for nonperformance or defenses for nonperformance, are generally governed by the law of the state where the contract is to be performed.  An example of performance would be where a contract was made in Mississippi to sell cotton to a Tennessee merchant.  If the contract provided that delivery was to be made in Tennessee with payment made in Tennessee, the contract would be performed in Tennessee.

The state in which the contract is made is determined by finding the state in which the last act essential to the forma­tion of the contract was performed.  For example, if I send a contract signed by me to someone in Tennessee with the request that they sign the contract if the terms are acceptable, the signing of the contract in Tennessee would be the last act necessary for the formation of the contract and would therefore be considered a Tennessee contract.

The modern trend, when no provision is stated in the contract as to which state’s law will apply, is to apply the center of gravity rule.  Under this rule, the court will choose to follow the law of the state which has the most significant relationship to the parties, the contract, and its performance.  The courts consider the place where the contract was made, where the negotiations occurred, where the performance was made, the location of the subject matter of the contract (e.g., land location), the residence of the parties, and the states of incorporation and principal place of business if a corporation is involved.

Third Parties and Assignments

Ordinarily, only the parties to contracts have rights and duties with respect to the contracts.  However, exceptions are made in the case of third-party beneficiary contracts and assignments.

When a contract is intended to benefit a third person, this person is a third-party beneficiary and may enforce the contract.  A life insurance contract is a third-party beneficiary contract.  The insurance company promises the insured person to make payment to the beneficiary.  Suppose you have a life insurance policy with Metropolitan Life Insurance Company and your wife is the beneficiary.  If you die, Metropolitan Life will pay the insurance proceeds to your wife.  If the Company refuses to pay in accordance with the terms of the policy, your wife has the right to bring a lawsuit against the Company in her name. She may do this even though she was not a party to the contract.

The beneficiary does not have to be specifically named, but may be described as a class of people.  For example, a union contract is between the union and the employer.  However, an employee, one of the class of individuals covered by the union contract, can bring suit on the contract even though he is not specifically named in the contract.

Not everyone who benefits from the performance of a contract between other persons is entitled to sue as a third-party benefici­ary.  In order to be a third-party beneficiary, the contract must clearly show an intent to give direct benefits to the third person.  Anyone else who might benefit by the contract is called an inci­dental beneficiary and has no rights under the contract.  An incidental beneficiary may not sue to enforce the contract.  A Court would hold that such a beneficiary did not have “standing” to sue for breach of the contract.  For example, if a private employer makes a contract with the U. S. Government to employ and train disadvantaged unemployed persons, these unemployed persons are merely incidental beneficiaries of the contract.  They cannot sue for damages if the contract with the government is broken by the employer.

An assignment is a transfer of rights that a party has under a contract to another person, called an assignee.  The assigning party is called the assignor.  An assignee of a contract may generally sue directly on the contract rather than suing in the name of the assignor.  The other party to the original contract is called the obligor.  For example, suppose I sell my car to Larry for $10,000.00.  He does not have $10,000.00 in cash, but executes an agreement stating that he agrees to pay me $500.00 a month for 20 months.  I then assign this contract to Peggy.  Larry is the obligor, I am the assignor, and Peggy is the assignee.

Unless there is a statute that requires that certain language be used in an assignment or that the assignment be in writing, there are really no formal requirements for an assignment.  Any words which show the intent to transfer rights under a contract are sufficient to constitute an assignment.

If there is no considera­tion for the assignment, this does not affect the validity of an assignment.  This is so because an assignment is not a contract, but is the transfer of a property right.  An assignment may therefore be made as a gift, although it is usually part of a business transaction and does involve consideration.

Any right to money may be assigned.  This is true in cases where the assignor is entitled to the money at the time of the assignment or will be entitled to the money at some point in the future.  My assigning my contract with Larry to Peggy is an example of an assignment of future rights to money. Any contract may be assigned with permission of the obligor. Personal service contracts cannot be assigned without the permission of the parties, such as a contract between an employee and an employer.

A contract may prohibit the assignment of any rights arising under the contract.  Some Courts hold that this type of prohibition is binding, and any assignment in violation of the prohibition has no effect.  However, as far as an assignment of a right to money is concerned, any contract which would prohibit the assignment of a right to money is invalid and would not prevent the making of such an assignment.  This is the general rule.

A right to a performance may be assigned with certain exceptions.  For example, suppose I have my car repaired and the repairman guarantees the repairs for 30 days.  Unless the guarantee states that it will not apply to a purchaser of the car, if I do sell the car, the purchaser could also receive the guarantee.

If the assigning of a right would increase the burden of the obligor in performing the contract, an assignment is ordinarily not permitted.  Lee contracts to paint Sally’s two-story house for $1,000.  Sally realizes that she will not have sufficient money, so she transfers her rights under this agreement to her neighbor Karen, who has a three-story house.  Karen notifies Lee that Sally’s contract has been assigned to her and demands that Lee paint Karen’s house for $1,000.  Is Lee required to do so?  No.  The right called for the performance of personal services.  Such a right cannot be assigned without the consent of the person who is to render the personal services.  This is particularly true in this case, because this type of assignment, if allowed, would increase the burden of performance; it is a greater burden to paint a three-story house than a two-story house.

Contracts involving personal satisfaction cannot be assigned without the permission of the obligor.  For example, if a contract involves goods to be furnished that must be satisfactory to the buyer, this type of contract could not be assigned since the buyer’s judgment may be different than the assignee’s.

If a party to a contract has certain duties to perform under that contract and then transfers these duties to another person who is to perform them, there is a delegation of duties.  In such a case, the original person who is to perform the duties remains liable if the person to whom he transfers the duties fails to adequately perform the duties.  In other words, the party to the contract who delegated the duties remains liable in case of default of the person doing the work just as if no delegation had been made.

In some instances, a delegation of duties cannot be made unless consented to by the party entitled to the performance.  An example of this would be when a personal element of skill or judgment of the original contracting party is involved.  If I contract with a particular mechanic to repair my car because this mechanic is known for his expertise regarding the particular problem I am having, the mechanic would breach his contract with me if he delegated these duties to another mechanic without my permission.

An assignment does not relieve the assignor of any obligation under the contract. An assignor continues to be bound by the obligations of the original contract unless the other party to the contract releases him. For example, the fact that a buyer assigns the right to goods under a contract does not terminate the buyer’s liability to make payment to the seller.

An obligee is someone owed an act or deed, such as paying money on a promissory note or contract. Ordinarily, the assignee is not subject to a suit by the obligee by virtue of the fact that an assignment has been made.  For example, if someone assumes a loan in purchasing a house, the lender ordinarily cannot sue the assignee (i.e., purchaser and assumer of the loan) unless the assignee/assumer agreed, not only with the seller, but with the lender, to pay the loan.

The rights of the assignee regarding the assigned contract are no greater than those of the assignor.  If the other party to the contract could have successfully defended against a suit brought by the assignor, that party (the obligor) will also prevail against the assignee.

Mack did plastering work in Nick’s home.  He did not have a license to do the plastering work, and by statute, he was barred from suing for the contract price for this work.  Mack assigned his claim against Nick to Will, who then sued Nick for the amount due for Mack’s work.  The Court held in favor of Nick.  The Court ruled that by virtue of the statute, Mack’s lack of a license was a defense to the recovery on the contract from Nick.  Will, as assignee of Mack, had no greater right than Mack to sue.

A valid assignment takes effect the moment it is made regardless of whether notice of the assignment is given to the other party to the contract.  If the obligor is notified that there has been an assignment and that any money due must be paid to the assignee, the obligor’s obligation can only be discharged by making payment to the assignee.  In other words, payment to the assignor would not satisfy the contract after notice.  If the obligor does not know of the assignment and makes payments to the assignor who does not turn the money over to the assignee, the assignee cannot sue the obligor, but does have a remedy against the assignor.  However, if the obligor both knows of the assignment and has been notified to make future payments to the assignee, any payments made by the obligor to the assignor have no effect and do not reduce the debt of the obligor.  If Acme Furniture sells furniture to Smith on a retail installment contract, and Acme then assigns this contract to Tenth Bank, Acme is the assignor, the buyer is the obligor, and Tenth Bank is the assignee.  When Tenth Bank  and Acme notify the buyer that future payments are to be made to Tenth Bank, the buyer must make these payments to Tenth Bank.  If he makes payments to Acme, the payments will not reduce the debt unless Acme forwards the money on to Tenth Bank.  If the buyer did not know of the assign­ment and continued to make payments to Acme, and Acme pocketed the money and did not turn it over to Tenth Bank, Tenth Bank  could not recover from the buyer, but could sue Acme to recover the payments.

When an assignment is made for consideration, the assignor warrants:

• That the right assigned is valid;
• That the assignor owns the claim assigned; and
• That the assignor will not interfere with the assignee’s enforcement of the obligation.

The assignor does not warrant that the other party will pay or perform as required by the contract.  In other words, this is not impliedly warranted.  However, it can be warranted by contract.  In other words, the assignor can agree to pay the assignee if the obligor does not pay.

Discharge — Performance

A contract is discharged by performance of the terms of the agreement.

An offer to perform is a tender.  If a person offers to perform the contract pursuant to its terms and the other party refuses to allow performance, the contract is discharged. A tender of payment is an offer to pay the amount due when it is due–for example, on a note. The tender must be legal tender–for example, by cash, a check (if allowed), or a bank wire.

Payments must be applied in the manner stated by a debtor.  If a debtor does not specify how payments are to be applied, the creditor can apply payments to any legal debt that is owed.  State law may require application of payments to the oldest debt. If no time is specified, payment must be in a reasonable time.

A payment by a check is a conditional payment.  The debt is revived if the check bounces.  The payee can sue on the check or on the debt.

The phrase time is of the essence is a phrase sometimes used in a contract.  This phrase in effect means, “the specified time and dates in this agreement are vital and thus, mandatory.” Therefore, any delay, reasonable or not, slight or not, will be grounds for cancelling the agreement. An example of this would be in the case of the sale or purchase of perishable property or property that fluctuates rapidly in value.  If a contract states that time is of the essence, but it obviously is not, courts will ignore this clause. When time is not of the essence, courts generally permit parties to perform their obligations within a reasonable time.

If a party acts in good faith, and substantially performs a contract, he will be allowed to recover to the extent he has performed.  He may have to pay any damages the other party has suffered.  Good faith is important.  For example, if a contractor does not follow building specs on purpose (e.g., trying to cut costs), he will not recover anything.

Greg contracted to build a house and garage for Bill for $50,000.00.  The job was completed according to the specifications in all respects except that Greg forgot to put a tool shed next to the garage as was required by the contract specifications.  Bill refused to pay Greg.  Greg sued Bill.  Bill raised the defense that Greg was not entitled to any money until the contract was completely performed and that the performance was incomplete because the tool shed had not been constructed.  Was Bill correct?  No.  Under the doctrine of substantial performance, Greg can recover $50,000.00 less such amount as would be required to complete the performance, that is to build the tool shed.  The court reached this conclusion to avoid the hardship that would be imposed on Greg if he should lose everything because of a relatively minor breach of the contract.

The doctrine of substantial performance will not be applied when the contract makes it clear that a literal and exact compliance is required.  The doctrine of substantial performance does not apply to a condition precedent.  Example: Say a lender is obligated to lend money if a specific number of leases are signed (like on a loan to build a building).  The Bank will have no obligation if the specific number of leases are not signed.

Dick contracted to build a house for Mike.  When it was approximately 25 to 40 percent completed, Mike would not let Dick work any further because he was not following the building plans and specifications, and there were many defects.  Mike hired another contractor to correct the defects and finish the building.  Dick sued Mike for breach of contract, claiming that he had substantially performed the contract up to the point when he had been discharged.  Was Dick correct?  No. There was no substantial performance because the substantial performance of a building contract implies that the building be usable for the purpose for which it was intended.  Because a performance that is only 25% to 40% complete would not produce a usable building, the substantial performance doctrine could not be applied.

With regard to a contract requiring performance to the satisfaction of the other party, the courts are divided as to:

• Whether the promisor must perform the contract to the satisfaction of the promisee; or
• Whether it is sufficient that the performance would satisfy a reasonable person under the circumstances.

When personal taste is an important element, the courts generally hold that the performance is not sufficient unless the promise is actually satisfied. Personal satisfaction is generally required when a person promises to make clothes or paint a portrait to the satisfaction of the other party. With respect to things mechanical, courts are more likely to hold that the performing party has performed satisfactorily if a reason­able person should be satisfied with what was done. In most instances, the courts require that the dissatisfaction be shown to be in good faith rather than the “dissatisfied” customer just trying to avoid paying for the work that has been done.

It is common for a person to guarantee the performance of a contract.  For example, a builder may guarantee for one year that certain work will be satisfactory.  Such a guarantee may also be made by a third person.  For example, a surety company may guarantee to the owner that a contractor will perform a contract.  In such a case, the obligation of the surety is in addition to the liability of the contractor, but the contractor is also still liable.  However, a plaintiff cannot recover twice.  He can recover only the amount of the liability. For example, a plaintiff can recover part from contractor and part from surety, or all from surety. However, the plaintiff cannot recover all from surety and all (again) from contractor.

A contract may be discharged pursuant to a provision in the contract or by a subsequent agreement.  For example, there may be a discharge by the terms of the original contract when it says it will end on a certain date.  There may be a mutual cancellation when both parties agree to end their contract.  There may be a mutual rescission when both parties agree to annul the contract and return to their original positions as if the contract had never been made.  This would require returning any consideration (for example, money) that had changed hands.

Sometimes parties may decide that their contract is not the one they want.  They may want to replace it with another contract.  If they do, the original contract is discharged by substitution.  It is not necessary for the parties to state that they are making a substitution.  If they make a new contract that is clearly inconsistent with a former contract, a court will hold that the earlier contract has been superseded by the later contract.  It is preferable, however, to expressly state in the later contract that the earlier one has been superseded.

The fact that a second contract has been made does not always mean that the original contract has been canceled.  The second contract may merely supplement or modify the original contract.  In order for the later contract to take the place of the first, the parties should put language similar to the following in the second agreement: “This contract completely supersedes and replaces that certain contract entered into by the under­signed on March 5, 1989, dealing with the sale of the materials referred to in Exhibit “A.”

The parties may agree to a different performance.  This is called an accord.  When the accord is performed, this is called an accord and satisfaction.  The original obligation is discharged.

In order for there to be an accord and satisfaction, there must be a bona fide dispute; an agreement to settle the dispute; and the performance of the agreement.

An example would be settlement of a lawsuit for breach of contract. The parties might settle for less than the amount called for under the contract.

Circumstances beyond the control of the contracting parties may discharge the contract. Impossibility of performance refers to external conditions as opposed to someone’s personal inability to perform the contract.  For example, the fact that a debtor does not have the money to pay a debt, and therefore cannot pay the debt, does not discharge the debt.  This is not a case of impossibility. Even riots and shortages of raw materials, even though external factors, do not necessarily excuse the failure to perform a contract.

What if a seller cannot obtain the goods he needs from any supplier to meet his contractual obligation to sell the goods to a buyer?  This will not discharge the seller’s obligation unless the inability to obtain the goods was a condition subsequent to the contract. What if a road contractor is unable to obtain gravel from his usual source and would have to get it from a supplier at a much higher price?  The contractor would not be discharged.  If there is nothing in the contract requiring that the gravel be obtained from the usual source, there is no “impossibility of performance.”  Just because performance would be more costly or burdensome than originally planned, this does not mean that the obligation is discharged.

When the parties expressly refer to particular subject matter in a contract, the contract is discharged if the subject matter is destroyed through no fault of either party (assuming there is no insurance on the subject matter).  When a contract calls for the sale of a wheat crop growing on a specific parcel of land, the contract is discharged if the crop is destroyed.

A farmer made a contract to sell and deliver 10,000 bushels of soybeans.  A flood destroyed his entire crop.  He claimed that he was discharged from his obligation under the contract.  Was he correct?  No.  The contract obligated the farmer to deliver a stated quantity of soybeans.  It did not require the delivery of the soybeans that were grown on the farmer’s land.  Therefore, the fact that the beans on his land were destroyed did not discharge the contract.  The fact that the farmer probably intended to fill the contract by using the crop grown on his land had no signifi­cance because that intent was not made a term of the contract.

A contract is discharged when its performance is made illegal by a subsequent change in the law.  For example, suppose there is a contract to construct a three story  building at a particular place.  Prior to beginning construction, a zoning law is passed which prohibits such a building in this area.  The contract would be discharged.

However, a change of law that merely increases the cost of one of the parties is not a “change of law” that discharges the contract. For example, Mack made a contract with Richard to build an apartment house for a specific price.  A number of serious apartment house fires later occurred in the city, and an ordinance was adopted by the city council increasing the fire precautions that had to be taken in the construction of a new building.  Compliance with these new requirements would make the construction of the apartment house for Richard more expensive than Mack had originally contemplated.  Is Mack discharged from the contract to build the apartment house?  No.  Mack must perform the contract even though it has been made more expensive to do so because of the change of law.  Mack is not discharged from the contract, because the change of law did not prohibit the construc­tion of the building but merely made it more expensive to build.

If a contract obligates a party to perform an act that requires personal skill of a particular person, the death or disability of that person would discharge the contact. For example, if an all pro NFL quarterback was killed in a car accident, the contract would be discharged. However, if the act called for by the contract could be performed by others, or by the estate of the decedent (e.g., executor hiring some­one), this rule does not apply.

In every contract, there is an implied covenant of good faith and fair dealing.  One party to a contact is under an obligation to do nothing that would interfere with the performance of the other party.  If one party makes the other party’s performance impossible, the obligation to perform is discharged.  For example, if  a contractor refuses to allow his subcontrac­tor access to the property where the subcontractor is to do the work, the contract is discharged as to the subcontractor.  The subcontractor would have a cause of action against the contractor, but the contractor would not have a cause of action against the subcontractor.

If the conduct of the other contracting party does not make performance impossible, but only more difficult or expensive, or causes a delay, the contract may not be discharged, but the injured party will be entitled to damages for any loss he incurred.  In our example, if the contractor eventually allowed the subcontractor on the work site, the contract would not necessarily be discharged, but the subcontractor could get damages for any loss he incurred.

Acts of God, such as tornadoes, lightning, and floods, usually do not terminate a contract, even though they make performance more difficult and delays in performance occur.  Weather conditions constitute a risk that is assumed by a contracting party in the absence of a contrary agreement.  Construction contracts commonly contain a weather clause, which either expressly grants an extension for delays caused by weather conditions or expressly denies the right to any extension of time or additional compensation because of weather condition difficulties.

Most insolvent debtors may voluntarily file for bankruptcy or be compelled to do so by creditors.  The trustee in bankruptcy then takes possession of the debtor’s property and distributes it as far as it will go among the creditors.  After this is done, the bankruptcy court grants the debtor a discharge if it concludes that the debtor has acted honestly and has not attempted to defraud creditors.  Even though all creditor have not been paid in full, the discharge by a bankruptcy court discharges ordinary contract claims against the debtor.

Statutes provide that after a certain number of years have passed a contract claim is barred.  The time limitations provided by state statutes of limitations vary widely.  Three years is a commonly use time in statute of limitations for breach of a contract.

A contract may also require that notice of any claim be given within a specified time.  A party who fails to give notice within the time specified by the contract may be barred from bringing a suit against the other party.

Breach and Remedies

A breach of contract is a failure to perform the contract in the manner called for by the contract.  A party is entitled to contractual remedies if the other party breaches a contract. A breach does not always result in a lawsuit or mean the end of a contract.  One party may be willing to waive or ignore the breach.  A waiver can be made by words or by conduct.  Accepting a late payment on a note would be an example of a waiver by conduct.  It is possible to make a waiver by silence.  For example, failure to object to the manner of performance in a timely manner would be a waiver by silence.

A party who waives a breach gives up the right to damages or remedies regarding such breach, and cannot use the breach as an excuse to keep from performing the contract.

A waiver may be express or implied.  An example of an implied waiver would be accepting a defective performance without objection.  A waiver only applies to the specific matter waived.  A party is entitled to require the other party to strictly perform all other contractual obligations set forth in the contract.

A party may retain the right to recover damages caused by another party’s breach if the party expressly reserves the right to damages at the time the party accepts a defective performance.  This reserva­tion of rights should be, but does not have to be, in writing.

A contracting party is entitled to damages if the other party breaches a contract.  Generally, damages are the sum of money necessary to put a party in the same or equivalent financial posi­tion as the party would have been had the contract been performed. A party may recover compensatory damages for any actual loss that the party can prove with reasonable certainty.

Compensatory damages include direct damages and consequential damages.  An example of direct damages would be in a situation where the plaintiff has paid $10,000.00 for a truck, but the defendant refuses to deliver the truck.  The direct damages would be $10,000.00. Consequential damages would arise in a situation where the failure to deliver the truck harmed the business of the plaintiff (e.g., the plaintiff lost a delivery contract).  In this situation, the plaintiff could possibly get consequential damages for loss of the delivery contract.

Punitive damages are designed to punish.  A Court uses punitive damages to make an example of a defendant in order to keep others from committing a similar wrongful act.  Punitive damages are rare in a breach of contract case except bad faith insurance claims (e.g., when an insurance denies a claim for an invalid reason).

A non-breaching party has a duty to mitigate damages.  In other words, a non-breaching party has the duty to take reasonable steps to minimize damages.  The failure to mitigate damages may cause the victim to only be allowed to recover damages that would have resulted if mitigated.  In our truck example, say the truck was purchased and was to be delivered on January 5, to allow the buyer to perform a delivery job for $500.00.  Delivery was late. The delivery contract was lost.  However, suppose the buyer could have rented a truck for $150.00.  However, he failed to do this. His damages would therefore only be $150.00.

An appropriate remedy for a breach may be rescission of the contract.  This places the parties in the position they would have been had the contract never been entered into.  For example, money is returned to the buyer and the buyer returns the merchandise to the seller.  If performance has been involved, the performing party may get the reasonable value of his performance under an unjust enrichment theory.  Suppose that pursuant to a contract for the sale of land, a buyer has taken possession and made substantial improvements.  If the contract is rescinded, the buyer will return the land and the seller will return the money.  However, the seller may have to pay the buyer the reasonable value of the improvements.

Specific performance is an action to compel a party who breached a contract to perform the contract as promised.  The subject matter of the contract must be unique, or an action for damages would be the proper remedy.  Actions for specific performance are usually allowed with regard to a contract involving the sale of particular real estate; and a contract for sale of a particular business. Specific performance is not allowed regarding a contract for the sale of personal property unless the property is unique in some way like an antique, coin collection, or art objects.

Generally, a party cannot obtain specific performance of personal service contracts or employment contracts.  This is because of the Thirteenth Amendment barring involuntary servitude.  However, breach of a service or employ­ment contract can subject the breaching party to a suit for damages.

In general, a contract may limit the remedies that a non-breaching party may obtain.  For example, Johnston purchases a new truck from Acme Truck Sales.  The contract may limit Johnston’s remedies to having Acme repair the truck or replace the truck if it is defective.

A contract may state the amount of liquidated damages to be paid if the contract is breached.  Upon a party’s breach, the other party will recover this amount of damages whether actual damages are more or less than the liquidated amount.  For example, the parties to a construction contract may stipulate that damages are to be paid of $1,000.00 for each day that the construction exceeds its contracted completion date.  Another example would be with regard to a contract for the sale of land where the contract provides that the earnest money paid will be the sole remedy upon breach of contract by the buyer.

Courts will honor liquidated damage provisions if:

• Actual damages are hard to determine (e.g., breach of a restrictive covenant).
• The amount is not excessive when compared with probable damages.

If the agreed-upon liquidated damage amount is unreasonable, the Court will hold the liquidated damage clause to be void as a penalty.  In such situations, the plaintiff would have to prove the actual damages.

In general, an exculpatory clause (i.e., a limitation of liability clause) that eliminates a party’s liability for damages caused by a breach of contract is valid and enforceable.  For example, in a construction contract, it may be provided that the contractor will not be liable for damage caused by delays of third parties (subcontractors, for example).

There is a trend in the law to invalidate an exculpatory clause if:

• The parties have unequal bargaining power and the clause is unfair;
• The clause eliminates liability for negligence, particularly if a negligent party is a public utility or the contract involves a fundamental good or service; or
• The exculpatory clause was obtained by fraud or other wrongful conduct.

Exculpatory clauses are typically upheld if agreed to by businesses with equal bargaining power.

A common type of exculpatory clause involves limiting liability on a loan to the collateral.  In other words, if there is a default, the contract says that the damages will be limited to execution on the collateral (i.e., foreclosure on the property covered by the mortgage or deed of trust).

What happens if a limitation of remedies clause or a limita­tion of liability clause is not valid?  In this situation, the plaintiff may sue pursuant to any other valid remedy, such as actual damages.

Author: William Glover

I received my B.B.A. from the University of Mississippi in 1973 and his J.D. from the University of Mississippi School of Law in 1976. I joined the firm of Wells Marble & Hurst in May 1976 as an Associate and became a Partner in 1979. While at Wells, I supervised all major real estate commercial loan transactions as well as major employment law cases. My practice also involved estate administration and general commercial law. I joined the faculty of Belhaven University, in Jackson, MS, in 1996 as Assistant Professor of Business Administration and College Attorney. While at Belhaven I taught Business Law and Business Ethics in the BBA and MBA programs; Judicial Process and Constitutional Law History for Political Science Department; and Sports Law for the Department of Sports Administration. I still teach at Belhaven as an Adjunct both in the classroom and online. In 2004 I left Belhaven for a short stay at Wells Marble & Hurst, PLLC, and then joined the staff of US Legal Forms, Inc., 2006 where I draft forms, legal digests, and legal summaries. My most recent publications and presentations include: • Author: Sports Law Handbook for Coaches and Administrators, Sentia Publishing, 2017. • Co-Author: In the Arena published by the New York State Bar Association in 2013; • Co-Author: Criminal Justice Communications - Corinthian Colleges, Inc. in 2014. • Co-Author: Business Law for People in Business, Sentia Publishing, 2017. View all posts by William Glover