Elements
of Effective Contracts Contracts are Promises
Good paper makes
good business. No words have ever been truer.
Contracts, no matter
how large or complex, are nothing more than a promise or a series of
specific promises. No more, no less. In the event that a contractual
promise is broken, the law and the contract itself provide remedies
to compensate the damaged parties. Sometimes even promises that are
not considered contracts are enforceable if one party relied on the
promise and was damaged because the promise was not kept.
From a legal perspective
certain criteria must be met in order for the parties to the contract
to be protected. The parties must be competent and the contract must
be based on something that has a measurable value. This element of value
is referred to in contract language as the "consideration."
A contract also cannot be based on an illegal activity.
Contracts are primarily
governed by state statutory, common law and the contract itself. Parties
to a contract have what is referred to as "the freedom of contract"
which principally allows the parties to establish their own law for
the performance of a specific contract. This private contract law may
override many of the rules otherwise established by state law.
Statutory law may
require some contracts be put in writing and executed with particular
formalities, such as contracts for the purchase and sale of real estate,
guarantees, and contracts of employment in excess of one year. Otherwise,
the parties may enter into a binding agreement without signing a formal
written document. Contracts related to particular activities or business
sectors may be highly regulated by state and/or federal law. In 1988,
the United States joined the United Nations Convention on Contracts
for the International Sale of Goods which now governs contracts within
its scope.
Before taking measures
to enforce a contract it must be established whether or not a contract
actually exists. When deciphering this, the opinion of the involved
parties is ignored and instead the "reasonable man rule" is
the basis for whether or not a binding and valid contract exists. By
viewing the dynamic as a whole, the court will decide if a "reasonable
man" would believe there to be a contract. A binding contract requires
an offer, acceptance and consideration. In addition, the parties must
have an agreement as to the material elements necessary for the performance
of the contract. This understanding and agreement is known as a "meeting
of the minds".
In determining
whether there is a valid contract, in addition to other factors, the
court may consider testimony, written evidence such as notes, e-mails,
letters, as well as any actions taken by or on behalf of either party
in performance of the disputed contract.
The court will
attempt to determine the intentions of the parties. However where a
key element of the contract has not been agreed to by the parties, it
is unlikely that a court will find an enforceable contract, but rather
it would be deemed an unenforceable agreement in principle. A court
will not decide terms of a contract for parties, it will either rule
that such terms were agreed to and what that agreement is or that the
terms were not agreed to and therefore there is no enforceable agreement.
A Letter of Intent
is not a binding contract. However, if a Letter of Intent is written
in such a way that it contains the terms of performance, the consideration
and requires performance, a court may find it to be a valid contract,
especially if one or both parties have fully or partially performed.
Normally only parties
to a contract have the right to enforce its terms. This is known as
the "privity of contract" rule. In some circumstances third
parties who are known beneficiaries to a contract have rights to enforce
and sue for breach of a contract. For example:
Agents, or employees who obviously accept or offer a contract not
in their own personal names but on another person's or a corporation's
behalf. In these situations, the contract is said to be signed by
an "agent". The person employing the agent is called the
"principal" and the principal could sue or be sued under
contracts entered into by his or her agent even though the principal
did not sign the contract directly.
Checks, promissory notes, bearer bonds, and negotiable instruments
transfer are enforceable by their holder and may change hands, from
one bank to another or from one person to another.
Contracts that restrict or impact upon the use of land may be enforceable
upon adjoining landowners, even though they were not privy to the
original contract.
The law of trusts, creates rights in third parties such as beneficiaries
and trustees.
A contract involves
a "meeting of the minds". For this, all parties must be capable
of consent. Accordingly, business legislation gives business entities
cooperatives the ability to contract through authorized persons or groups
of persons.
Minors and mentally-challenged
persons, may void a contract at the minor's or mentally-challenged person's
option. An exception exists if a contract is for necessaries of life,
including such items as food, clothing, and medicine. If a minor ratifies
a contract upon reaching the age of majority, he or she is then bound
to it. A contract with an incompetent person is only voidable at the
option of the incompetent person if the other party knew about the mental
incompetency or ought to have known under the circumstances. Again,
an exception is made for contracts for the delivery of necessaries of
life for which even a mentally incompetent person would be liable.
A drunk or intoxicated
person also lacks the capacity to consent to a contract and has the
option of voiding a contract signed while intoxicated, providing it
is done at the earliest opportunity upon sobriety. A contract accepted
under threat of physical, mental or economic harm, may be voided by
the party so threatened as under "duress". Acceptance must
be freely given. The same is true for contracts entered into between
persons in a relationship of power imbalance. The law calls this "undue
influence" and it will be presumed in some cases such as parent-child,
trustee-beneficiary or doctor-patient contracts.
A contract may
fail for lack of consent when it is deemed "unconscionable".
This is a slippery area of the law which suffers from a lack of judicial
unanimity. In essence, the theory is that the court will rescind contracts
which are totally unfair and, while just short of being fraudulent,
are considered "unconscionable." Although legal academics
try to do so, it is difficult to intellectually differentiate this from
the theory of undue influence discussed above because, in both cases,
it deals with a power relationship imbalance and the taking advantage
of this imbalance. Also, opening up the flood-gates of judicial review
of contracts on the grounds of "unconscionability" could result
in a plethora of contracts being brought to court as every person who
had improperly negotiated a contract would seek judicial relief. Making
a bad deal, will not rise to the level of unconscionability.
Consideration
One of the other
important elements of contract law, which is difficult for the non-lawyer
to understand, is the requirement of consideration. Consideration is
a right, interest, profit or benefit accruing to the one party or some
forbearance, detriment, loss or responsibility given, suffered or undertaken
by the other." As such, a contract differs from a gift.
But consideration
does not necessarily have to be quantified or quantifiable in monetary
terms. Any discernible detriment or the giving up of any right as to
one of the parties could be that party's consideration. The question
is not the adequacy of the consideration but the existence of consideration.
This is the business of the parties and not a matter for judicial interference.
In addition:
The consideration must be reciprocal, each party offering consideration.
Motive is different
from consideration. Your motive for contracting is your personal reason
for contracting. Consideration is objective not subjective.
The consideration
cannot be something or some act which is illegal, immoral or contrary
to public policy. If a certain act is punishable by some law, then
it is "illegal". An example would be a work contract to
an unlicensed electrician.
Offer
Each contract requires
an offer and acceptance of that offer. To constitute a contract, there
must be an offer by one person to another and an acceptance of that
offer by the person to whom it is made. A mere statement of a person's
intention, or a declaration of his willingness to enter into negotiations
is not an offer and cannot be accepted so as to form a valid contract.
An offer must be
a clear, unequivocal and directed at another party to contract. For
this reason, general advertisements, catalogues or store flyers are
not offers. Nor is a "for sale" sign on a used car. However,
if particular terms are included in the advertisement such as $10.00
while supplies last, this can be deemed an offer capable of acceptance.
These advertisements are termed "offers at large".
An offer, once
made, can be revoked before acceptance. An offer can also expire if
a deadline for acceptance passes. If there is no specified deadline,
then the offer expires in a "reasonable time", depending on
the subject-matter of the contract. For perishable goods such as food,
a "reasonable time" would likely be a matter of days. The
"reasonable time" would be longer where the subject matter
of the contract is a building.
Acceptance
Acceptance validates
the contract; it gives it life. It is at that moment that a contract
exists. Acceptance must be clear, unequivocal, and unconditional and
made by the person to whom the offer is intended. It is not enough to
say that you find the offer to be "agreeable"; you must "accept"
the offer although your acceptance can be implied by your conduct. It
must also be brought to the direct attention of the offeror before a
valid contract exists. Conduct can amount to acceptance in the proper
circumstances such as the delivery of the goods mentioned in the offer.
The offeror can
dictate the terms of the acceptance. Offers may set certain conditions
on acceptance and to these, the acceptor is bound. For example, the
offer may require acceptance in writing (if such a requirement has not
been made, then a written offer may be accepted verbally.) However,
an offeror cannot require acceptance by inaction or negative acceptance.
Acceptance most be positive on the part of the accepting party.
A conditional acceptance
is a counter-offer and not an acceptance. A counter-offer must be accepted
to create a contract.
Mistake
A contract requires
a meeting of the minds. If one or both parties have been mistaken about
an element of the contract, then there is no such meeting of the minds.
But that does not necessarily mean that the contract is void. Such a
rule could breed abuse. So the common law has tried to develop a fairly
sophisticated set of rules for dealing with mistake. Unfortunately,
as with so much of contract law, the final determination of what those
rules are is still up in the air, moving with the changing currents
of the courts.
A common mistake,
is where both parties make the same mistake. Each knows the intention
of the other and accepts it but each is mistaken about some underlying
and fundamental fact. In mutual mistake, the parties misunderstand each
other and are at cross purposes. In unilateral mistake, only one of
the parties is mistaken. The other knows, or must be taken to know,
of his mistake.
When both parties
are mistaken on a basic and fundamental element of the contract: the
contract is void from the start if the mistake is of such significance
that, in the words of English case law, it is a "false and fundamental
assumption" of the contract. For example, if the identity of a
contracting party is a fundamental element of the contract, such as
an athlete or artist, a mistake in this regard will void the contract.
Another example is a contract involving something that, unbeknownst
to the parties, has been destroyed.
Sometimes, only
one party will be in error. If the other party is aware of the misperception
or should have been aware of the mistake, the contract may not be enforceable,
even if the enlightened party did not cause the mistake but just took
advantage of it. For example, if you mistakenly believed you were buying
a car but the contract provided for lease and you could not have easily
read the document and determined otherwise.
Misrepresentation
Misrepresentation
is when one of the parties to a contract made a wrong statement about
some material element of the contract and, in reliance of this statement,
the other party entered into the contract. Contract common law treats
fraudulent misrepresentation differently from innocent misrepresentation.
The elements of misrepresentation include: "(1) that the representations
complained of were made by the wrongdoer to the victim (before the contract);
(2) that these representations were false in fact; (3) that the wrongdoer,
when he made them, either knew that they were false or made them recklessly
without knowing whether they were false or true; and (4) that the victim
is damaged thereby.
Misrepresentation
must be distinguished from puffing or sales language. Parties should
know better than to give full credence to commercial aggrandizements.
Silence and omissions can be construed as misrepresentation in certain
circumstances, such as when the omission reasonably results in a misunderstanding
or the omission is of a fact that a reasonable person would want to
know before entering into the contract.
Restraint of
Trade Contracts
In contemporary
commercial environments, restraint of trade contracts in the form of
non-compete and non-circumvent agreements are common. On the face of
it, such contracts, while not illegal, fly in the face of public policy
as it is considered to be "good for the state" that men and
women be free to ply their profession without restriction. Accordingly,
state and common law set forth standards of fairness for such contracts,
such that they must be reasonable in relation to the circumstances,
time period and geographical location, or now, internet marketplace.
Confidentiality
agreements on the other hand are typically enforced in favor of the
restrainer, if the information involves trade secrets.
Assignment and
Novation
A person can transfer
their rights, benefits and liabilities under a contract to another person
unless such assignment rights are limited or eliminated in the contract
itself. Where the original contract stays intact and the party transfers
rights, benefits and liabilities under a contract (the assignor) to
a new party (the assignee), this is called an "assignment".
An assignment must be absolute with no contractual strings to remain
attached between the assignor and the other original contracting party.
However, the law favors assignment and imposes a duty that parties act
reasonable when requested to approve an assignment. However, and obviously,
you cannot assign a contract for personal services. In addition, assignments
can occur by operation of law such as when a person dies or declares
bankruptcy.
Novation is the
replacement of one contract between two parties with another contract,
either between the same parties or others. A novation extinguishes the
original contract.
Frustration
No person can be
held to a contract if, since acceptance, there has been a radical change
which makes performance impossible or illegal. Under certain conditions,
a person can be relieved of their duties under a contract under the
common law heading of "frustration". For example, an act of
God may have destroyed the object of the contract.
However, frustration
cannot be invoked just because the contract has suddenly become more
difficult or expensive for one of the parties, if the party was partly
responsible for the intervening event which destroyed the object of
the contract, or if the event was foreseeable. Severe sickness of one
of the parties is an example where frustration might apply to relieve
one of the parties of their obligations under a contract. In the body
of the contract, the parties may specifically bar a defense of frustration
and make their contract absolute.
Interpretation
of Contracts
The courts are
frequently asked to resolve disputes around the meaning of certain words
in contracts given, as they often are, to drafting by the parties themselves,
and not legal experts. A wide range of general interpretation rules
guide the courts in their inevitable (and unenviable) task of having
to interpret a contract which is, on the face of it, ambiguous:
If both parties
agree on a certain interpretation to be given to a term in a contract,
a court has no reason or justification for pursuing the matter further
and should accept this interpretation.
A court will always try to discover the intentions of the contracting
parties using the plain, ordinary and popular meanings of the words
used. Reference to a common usage dictionary is perfectly in order.
A court will not try to re-write a contract using interpretation rules
but, rather, to use these rules to pinpoint the intentions of the parties
at the moment of contract.
It should be
assumed that no article of the contract is void of any meaning or
superfluous but must have some purpose. It is only where no clear
alternate interpretation is available to remove absurdity or ambiguity
from an article, that the court will void an article of a contract.
A court can
refer to words that have been crossed out, or words in headings, margins,
recitals or preamble for the purposes of interpreting terms of the
contract which are ambiguous.
Where ambiguity
is an issue, a court may refer to the factual circumstances under
which the contract was signed or agreed upon to assist in interpretation.
These could include letters or earlier agreements but not earlier
drafts.
Business customs
may also be considered.
Where a contract
is open to two different but equally probable interpretations, it
is interpreted against the author, especially if there is a power
imbalance between the parties.
Writing is
given greater weight than oral testimony and in some cases evidence
of oral amendments or modifications will not be considered where a
contract provides by its own terms that it can only be amended or
modified in writing.
Certain contracts
are not valid unless in writing executed by the person against whom
enforcement is sought. This law is the Statute of Frauds.
Breach and Remedies
Breach of contract
comes in many forms. You could have a complete breach, where one party
completely refuses to deliver on any part of their undertaking. In other
situations, a person may do most of what the contract requires but omit
or refuse to do a small residual portion. This latter situation is called
"substantial performance" and it has the effect of binding
the other party to performance, at least in an equivalent portion.
The measure of
damages can be set out in the contract itself ("liquidated damages")
or can be based on a multitude of legal principals. In all cases each
party has a responsibility to mitigate their losses. That means that
even if your contractual partner is not keeping their end of the bargain,
you should use reasonable effort to keep your losses at a minimum.
Specific performance
is exceptional and ordered only when an award of damages would be "inadequate."
With land contracts, however, the courts have far greater direct authority
and specific performance is the preferred remedy for breach of land
contracts. An injunction is another coercive legal remedy which can
be used in some breach of contract cases where a direct order is required
to stop a party from continuing an ongoing breach. An injunction will
only be granted where monetary damages would not protect the injured
party.
Compensatory damages
are out-of-pocket expenses caused by the breach. Damages are an attempt
by the court to compensate the innocent party to the contract, the party
that suffers the breach. The purpose is compensation not punishment
so only real, actual damages can be ordered by the court.
Generally, there
are two main methods of calculating damages:
The difference
between what was contracted for and what was received. This is known
as the diminution of value test. Whatever it costs to put the plaintiff
in the position he would have been in had the defendant fully performed
his contractual obligations. This is known as the cost of performance
method. The defendant is ordered to pay the cost of fixing the defect,
of completing the contract.
At Legal & Compliance,
Enforceability Equals Profitability
At Legal &
Compliance we understand that a well written and enforceable contract
means financial success for our clients and their businesses. A proper
contract typically requires less time and money to enforce in the event
of an unanticipated dispute. Because of our strong business perspective,
Legal & Compliance, LLC is well versed in the practical applications
of contracts.
Each and every
document is the culmination of years of commercial experience coupled
with the knowledge that no two business scenarios are ever quite the
same. In response to this, each contract we draft incorporates the unique
elements most suitable to helping our clients protect their hard-earned
business and personal interests. We take nothing for granted and strive
to anticipate the unanticipated.
This trademark
philosophy allows us to confidently represent our clients in all aspects
of contract law. By combining creative foresight with sound contract
basics, we believe our work product exceeds contemporary industry standards
and stands as a testament to our dedication and attention to detail
when serving our clients and their businesses.
Whether you are
a well established company with a deep six-figure budget or a start-up
entity simply seeking to get started on the right foot, it only makes
good business sense to attempt to avoid problems before they occur.
