CONTRACTS



Contracts 472
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A contract is a legally enforceable promise. Contracts are vital to society because they facilitate cooperation and trust. Rather than relying on fear of reprisal or the hope of reciprocity to get others to meet their obligations, people can enlist other people to pursue common purposes by submitting to contracts that are backed by impartial authority. Without contracts and their supporting institutions, promises would be much more vulnerable to ill will, misunderstanding, forgetfulness, and other human flaws. Indeed, contracts allow people that have never even met to reach agreements, such as lending/borrowing money to buy a house, which they would never consider making outside of a legal framework.

Discussed below are characteristics and types of contracts and the Uniform Commercial Code (UCC), which governs most commercial contracts in the United States.

BACKGROUND

Contracts have been used since ancient times to ensure the performance of different parties in all types of promises. Contract law had reached a relatively sophisticated state by the 15th century in England. Then, during the Industrial Revolution in the 19th century, the increasing complexity of contracts, combined with new ideas about free market economies, forced a new type of contract law. It was based on the "freedom of contract" concept, which basically held that individuals should be free to create their own agreements independent of outside intervention. The role of the courts was only to enforce the promises and not to determine the rightness or wrongfulness of the agreement.

Contract law during the 19th and early 20th century was characterized by strict interpretation. If two parties entered an agreement voluntarily, the courts were not concerned with complaints of perceived unfairness, such as illegal bargaining power. However, as business dealings became more geographically diverse and larger in volume, many types of contracts became standardized. Companies and individuals often used the same forms, or contracts, to handle numerous similar transactions. As a result, many contracts were not specifically tailored to the agreements that they represented, and the party to which the terms were dictated usually did not have a complete understanding of the promise. A corollary of that development was that contracts were often used to take advantage of less powerful, or less informed, parties.

Contracts continued to become more standardized and less representative of individual agreements during the middle and late 20th century. Consider how few people draft a truly singular contract (or even carefully read a standard contract) when they buy a car, assume a mortgage, take a job, or enter into other important agreements. Because of that trend, courts have gradually shucked the strict, technical interpretation of contracts in favor of a "fairness" approach based on criteria such as good faith, reasonableness, and justice. For instance, a plaintiff might successfully argue in court that he is not obligated to execute an agreement because the contract did not reflect his true intent.

The move toward more ambiguous criteria and greater intervention in the contract process by the courts has resulted in greater protection of weaker parties and a more realistic interpretation of agreements. The drawback, however, has been a dilution of the strength of contracts. Because the rules governing contracts have become more vague, agreements no longer supply the same predictability and social stability that they once afforded. Furthermore, individuals and companies are less able to craft agreements that will ensure the performance of both parties. Contract law and theory continues to evolve, though, in response to societal pressures and needs.

CONTRACT ELEMENTS

By its most basic definition, a contract is a legally enforceable promise. It differs from a simple verbal promise in that either party may ask the state to force the other party to honor its promise. To distinguish contracts from other types of promises and agreements, courts have established basic elements that are necessary for a contract to exist. A contract may be legally defined as a voluntary, legal, written agreement made by persons with the proper capacity. It should include: (1) an offer; (2) an acceptance; and (3) consideration, or an exchange of value. There are legal exceptions to most of these conditions, and all of them are subject to interpretation in the courts. Furthermore, some contracts do not meet these requirements, such as implied contracts and those created under promissory estoppel, both of which are discussed later.

MUST BE VOLUNTARY.

Contracts not entered into voluntarily are voidable. If a banker threatens to kill a client if he does not refinance his mortgage at a higher interest rate, the client would not be required to submit to the contract. Although that case is extreme, agreements made under any duress are generally not enforceable. For example, a company might tell a supplier that it was considering ending their business relationship if, within the next ten minutes, the supplier didn't sign a contract to provide materials at a certain cost. If the supplier signed the agreement, it might be able to convince the courts that it did so under duress or undue influence, and therefore was not bound by the contract's terms. In general, contracts created under duress, undue influences, fraud, and misrepresentation are voidable by the injured party.

MUST BE LEGAL.

Contracts are also void if they involve a promise that is illegal or violates public policy. For instance, a contract regarding the sale of illegal drugs is unenforceable. Likewise, contracts that are legal but are not in the public interest may be null. For example, a contract in which a company requires a customer to pay an extremely high rate of interest on borrowed funds could be deemed invalid by the courts. Or, suppose a company contracts with a customer to sell supplies to him that he uses to grow marijuana. If the company also tells him how to grow the illegal substance, the contract would become unenforceable because the agreement promoted the violation of a statute. As another illustration, a retail company that required an employee to sign an agreement that he would never work for another retailer probably would be unable to enforce the contract because it contained unreasonable restrictions or imposed undue hardship on the worker.

ORAL CONTRACTS.

Contracts do not have to be written to be enforceable in court. In fact, most oral contracts are legally enforceable. However, they are obviously much more difficult to prove. Furthermore, most states have adopted "statutes of frauds," which specify certain types of contracts that must be in writing. Examples of contracts that typically fall under the statues of frauds include agreements related to the sale of real estate, contracts for the sale of goods above $500, and contracts in which one person agrees to perform the obligation of another person. Yet even those contracts do not have to exist in conventional fashion. In fact, a simple memo or receipt may suffice. There are several exceptions to the statutes of frauds. For instance, when one party would suffer serious losses as a result of reliance on an oral agreement, the statute of frauds may be waived (see promissory estoppel below).

MENTAL STATE AND PROPER AUTHORITY.

Even if a contract is voluntary, legal, and written, it is void if the person that makes the agreement does not have the mental and legal capacity to do so; hence, a mentally retarded individual or a child could not be bound by a contract. But a person without the authority to make an agreement may also void a contract. For instance, suppose that an overly zealous salesman representing a ball bearing company signed an agreement with a buyer to supply one billion ball bearings to be delivered in 24 hours. The contract could be worthless if the salesman was acting outside of his authority to commit the company to that agreement. Or, suppose that a person signed a contract between her former employer and one of its customers. The agreement would likely be null because she did not have the capacity to act on the company's behalf.

OFFER.

In addition to being voluntary, legal, written, and made by persons with proper capacity, contracts usually must possess three basic components: an offer, an acceptance, and consideration. An offer is a promise to perform an act conditioned on a return promise of performance by another party. It is recognized by a specific proposal communicated to another party. Once a legal offer has been made, the offeror is bound to its terms if the other party accepts. Therefore, the offeror must clearly indicate whether the proposal is an offer or some other communique, such as an invitation to negotiate. The offeror may stipulate certain terms of acceptance, such as time limits, and even withdraw the offer before the other party accepts.

ACCEPTANCE.

Acceptance, the second basic requirement, is legally defined as "a manifestation of assent to the terms [of the offer] made by the offeree in the manner invited or required by the offer." As with offers and offerors, the courts look for an intent to contract on the part of the acceptor. The difference is that the offeror may stipulate terms of acceptance with which the other party must comply. If the offeree attempts to change the terms of the offer in any way, a rejection is implied and the response is considered a counteroffer, which the original offeror may reject or counter. As with most rules regarding contracts, exceptions exist. For example, the Uniform Commercial Code includes a "Battle of the Forms" provision whereby an offeree may imply acceptance under certain circumstances even if it changes or alters the offer.

CONSIDERATION.

Even if an offer is accepted, it must be consummated by consideration for a legally enforceable contract to exist. Consideration entails the parties' doing something that they were not previously bound to do outside of the agreement. In other words, promisees must pay the price (consideration) that they agreed to pay the promisor in order to gain the right to enforce the promisor's obligation.

The requirement of consideration serves an important purpose. It protects the promisor from being liable for granting, or relying on, gratuitous promises. For example, suppose that a person told her roommate that she would always pay the entire rent for their apartment. If she later changed her mind, she could not be held liable for the rent because she had neither asked for, nor received, anything in exchange for the promise. Had the other roommate promised to clean the apartment in exchange for the roommate's promise to pay the rent, an enforceable contract would exist (assuming other requirements were met).

CONTRACT TYPES

UNILATERAL VS. BILATERAL.

The two primary categories of contracts are "unilateral" and "bilateral." In a unilateral contract only one party promises something. For instance, if a car dealer tells a customer, "I will give you that car if you give me $15,000," he has made an offer for a unilateral contract—the contract will only be created if the customer accepts the offer by paying the $15,000. If the dealer says "I will promise to give you the car if you promise to pay me $15,000," a bilateral contract has been proposed because both parties must make a promise. The concept of unilateral contracts is important because it has been used by courts to hold a party liable for a promise even when consideration was not given by the other party. For instance, an employer may be liable for providing pension benefits that it promised to an employee, even if the worker gave no promise and did nothing in return.

EXPRESS VS. IMPLIED.

Contracts may also be classified as "express" or "implied." Express contracts are those in which both parties have explicitly stated the terms of their bargain, either orally or in writing, at the time that the contract was created. In contrast, implied contracts result from surrounding facts and circumstances that suggest an agreement. For instance, when a person takes a car to a repair shop he expects the shop to exercise reasonable care and good faith in fixing the car and charging for repairs. Likewise, the shop expects the customer to pay for its services. Although no formal agreement is created, an implied contract exists.

QUASI-CONTRACTS.

In addition to express and implied contracts are "quasi-contracts," which arise from unique circumstances. Quasi-contracts are obligations imposed by law to avoid injustice. For instance, suppose that a man hires a woman to paint his house. By accident, she paints the wrong house. The owner of the house knows that she is painting it by mistake but, happy to have a free paint job, says nothing. The painter would likely be able to collect something from the homeowner because he knowingly was "unjustly enriched" at her expense. Had she painted his house while he was on vacation, he would be under no obligation to her.

VALIDITY STATUS.

Contracts may also be categorized as valid, unenforceable, voidable, and void. Valid contracts are simply those that meet all legal requirements. Unenforceable contracts are those that meet the basic requirements but fail to fulfill some other law. For instance, if a state has special requirements for contracts related to lending money, failure to comply could make the contract unenforceable. Voidable contracts occur when one or both parties have a legal right to cancel their obligation(s). A contract entered into under duress, for example, would be voidable at the request of the injured party. Void contracts are those that fail to meet basic criteria, and are therefore not contracts at all. An illegal contract, for example, is void.

PROMISSORY ESTOPPEL.

A separate type of contract, and one that overtly exemplifies the trend away from strict interpretation and toward fairness, is created by promissory estoppel. Under the theory of promissory estoppel, a party can rely on a promise made by another party despite the nonexistence of a formal, or even implied, contract. Promissory estoppel can be evoked if allowing a promisor to claim freedom from liability because of a lack of consideration (or some other contractual element) would result in injustice. Suppose that a business owner promised an employee that he would eventually give him the business if he worked there until he (the owner) retired. Then, after 20 years of faithful service by the employee, the owner decides to give the business to his son-in-law. The owner could be "estopped" from claiming in court that a true contract did not exist, because the worker relied on the owner's promise.

UNIFORM COMMERCIAL CODE

The Uniform Commercial Code (UCC) was established by the American Law Institute and the National Conference of Commissioners on Uniform State Laws. Adopted by 49 states (Louisiana is the exception) and the District of Columbia, the UCC is a set of rules that governs commercial transactions. Although total uniformity of application has not been achieved, the UCC is considered a standard for fair dealing in everyday commercial transactions related to the sale of goods. Article Two (of nine) deals with contract law. It reflects the tendency toward fairness, rather than technical interpretation of contracts, and is more likely to reward legitimate expectations than are traditional contract laws.

Three basic assumptions on which Article Two is founded are (I) duty of good faith; (2) recognition of unconscionable contracts; (3) and merchant duties. The duty of good faith assumption implies that all parties in a contract are expected to observe "reasonable commercial standards of fair dealing" as defined by the UCC. The concept of unconscionable contract implies that a grossly unfair or one-sided contract can be corrected by the courts. Finally, the UCC recognizes that merchants are held to a higher standard in contracts than are nonmerchants because merchants are naturally more knowledgeable and better able to protect themselves.

The UCC only covers what it classifies as "goods," which includes most movable, tangible property. It does not cover contracts and transactions related to services, real estate, stocks and bonds, or other intangibles. The UCC is generally used by courts for cases in which "goods" are predominant in the contract. Where no specific UCC rules exist, the courts usually revert to common law.

SEE ALSO : Commercial Law ; International Law ; Licensing Agreements

[ Dave Mote ]

FURTHER READING:

Cohen, Cary. Effective Contract Administration: The Complete Handbook and Guide. New York: AMACOM, 1997.

Greico, Mark M. Purchasing Contract Law, UCC & Patents. West Palm Beach, FL: PT Publications, 1998.

King, Donald Bamett, and James J. Ritterskamp. Purchasing Manager's Desk Book of Purchasing Law. 3rd ed. Paramus, NJ: Prentice Hall, 1997.

Knapp, Charles L., and Nathan M. Crystal, eds. Rules of Contract Law. Boston: Little, Brown & Co., 1993.

Roberson, Cliff. The McGraw-Hill Complete Book of Purchasing Forms and Agreements. New York: McGraw-Hill, 1998.

Rohwer, Claude D., and Gordon D. Schaber. Contracts in a Nutshell. 4th ed. St. Paul, MN: West Publishing, 1997.

Salanie, Bernard. The Economics of Contracts: A Primer. Cambridge, MA: MIT Press, 1997.

Shippey, Karla C. A Short Course in International Contracts. San Rafael, CA: World Trade Press, 1998.



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