Contract Basics

A contract is a legally binding agreement enforceable in a court of law. However, not every agreement between two parties is a legally binding contract. The law imposes certain requirements on contracts. The fundamental requirements for forming a binding contract are:

• Offer
• Acceptance
• Consideration

Offer

An offer is a proposal to make a deal. An offer must be communicated to another person and remain open until it is accepted, rejected, retracted, or has expired. A counter-offer closes the original offer. Some terms of an offer, like price, quantity, and description, must be specific and definite because the offer has to identify the basic obligation of the contract. For example, saying to a friend "I offer to sell you my house" ordinarily would not be a sufficient offer to give rise to a contract because it doesn't include any of the necessary details such as price and other terms required in a house sale transaction.

Acceptance

Acceptance is an acknowledgment by the person to whom the offer was made that the offer is accepted. The acceptance must comply with the terms of the offer and must be communicated to the person who proposed the deal. For example, a person sells a sofa for $300 cash as is. The buyer, to accept the offer, has to accept that particular sofa, pay $300 cash, and take the sofa in its existing condition.

Consideration

Consideration is the bargained for exchange. It is the legal benefit received by one person and the legal detriment imposed on the other person. Usually consideration takes the form of money, property, or services. Using the sofa example, there is consideration on both sides of the contract. The seller gives up the sofa and gets the $300; the buyer gives up the $300 and gets the sofa. An agreement without consideration is not a contract.

Other Requirements

Beside the fundamental elements of a contract (offer, acceptance, and consideration), there are other requirements:

• Competence
• Consent
• Legality

Competence

Competence to make a contract means the legal capacity to make a contract. Generally, people are ruled competent to make contracts if they are over 18 years of age and of sound mind.

A minor (usually, a person under 18 years of age) who makes a contract can rescind or void it, with one general exception. A minor contracting for "necessities" is bound to pay for their reasonable value. A "necessity" can be food or shelter but, depending upon the law of the particular state, it may also include a car or other item. A minor who rescinds a contract gets back whatever the other party received from the minor.

People who are of unsound mind, that is, those who are incompetent because of mental illness or disability, can rescind their contracts, but the standard is high. Usually, a person who is incompetent must have made the contract without understanding that they were making a contract and without realizing the consequences of their action.

Consent

Consent means that each party to the contract must agree to the terms of the contract. This requirement of consent fits the general idea of contract as a private law-making activity. However, consent does not mean that you have to know what the contract says. For example, when signing a rental car agreement at the airport counter, you don't know what the terms are in this contract but you agree to them by signing the contract. The law presumes you have consented to a contract by signing it or manifesting some other type of assent, such as mouse clicking on I accept buttons in dialog boxes on your computer screen.

Legality

Legal subject matter is required for a contract to be enforceable. The law does not enforce contracts based on illegal activity. For example, a winner of a poker game usually cannot go into court and enforce an IOU in a state in which that type of gambling is illegal.

Contract Types

Contracts can be described and categorized in a variety of ways, and some contracts will fall under more than one category. For example, an insurance policy may be categorized as any of the following contracts:

• An insurance contract, because it involves insurance.
• A third-party beneficiary contract because it benefits a person who isn't a party to it (the beneficiary of the policy).
• A standard form contract because the provisions in it are always the same.
• A contract of adhesion if a court determines that as a practical matter, a person seeking insurance is unable to obtain insurance on terms other than those provided in the contract.

Contract Categories

Following are more details on the various contract categories:

A negotiated contract is a contract resulting from dickering over the terms of the agreement. The parties of a truly negotiated contract:

• Bargain for the terms
• Know and understand the provisions
• Consent to all provisions

Truly negotiated contracts are rare in modern commerce.

A contract of adhesion is a contract that is submitted to the other party on a take-it or leave-it basis. There is no bargaining of terms; either you accept the agreement or you do not accept it. Many consumer contracts are contracts of adhesion. Some contracts of adhesion contain onerous or unfair terms, which may not be enforceable. If a court determines that a contract is a contract of adhesion, then the court reviews the contract and may delete the unfair term or terms.

Third party beneficiary contracts are made specifically for the benefit of a person different from one of the two contracting parties. This other person is called a third party beneficiary of the contract. The simplest example is a life insurance contract. The two contracting parties are the insurance company and the insured person. The third party beneficiary is the person named in the insurance policy to receive the proceeds of the insurance policy on the death of the insured person. This third party beneficiary has rights in the contract and can sue on the insurance policy.

Unilateral and bilateral contracts are terms used to describe the way in which contracts arise. These terms are important because the unilateral or bilateral status of a contract may affect whether or not, and how, the contract is enforced. It is sometimes difficult to distinguish unilateral and bilateral contracts.

• A unilateral contract is one in which a person promises to do something on specified terms. Unilateral contracts often arise in an offer to sell an item to another person. If you tell another person "I'll sell you my car if you give me $3000," you are unilaterally offering the car if the other person gives you that amount of money. The contract can be accepted only by the payment of the money, not by a promise to pay the money. Ordinarily, you have not bound yourself to sell the car unless and until the person hands you $3000, and you can withdraw the offer to sell it at any time before the other person performs.
• A bilateral contract is an exchange of promises. If you tell another person "I'll sell you my car if you promise to pay me $3000," and the other person agrees by saying say "OK, I promise to give you the $3000 next Tuesday," and you agree by saying "OK," then you have entered into a bilateral contract. Ordinarily, under these circumstances, you've bound yourself to sell the car at that price.

General Principles of Contract Law

Contracts are everywhere. They are a part of modern life, and we enter into them, and perform them, every day. They are necessary to the acquisition of goods and services in the marketplace.

Legally, a contract is an agreement between two or more parties that creates duties and obligations.

• Some contracts are deliberately made, like a contract for the purchase of a house.
• Other contracts come into being because of conduct between parties that give rise to a contract, like contracts resulting from the purchase of goods and services. You make a contract with a store every time you purchase an item. You make a contract with the dry cleaner every time you drop off and pick up your dry cleaning from them.

Government Restrictions

The basic principle of contract law is the freedom of ordinary people to make contracts. This principle is also the bedrock principle of the US legal system and free enterprise. Through contracts, private parties make laws that govern their commercial relationships. The freedom of contract principle is:

• Flexible because parties may tailor contracts to their needs
• Innovative because parties may develop contracts to adapt to changes in the marketplace

However, the freedom of contract principle is not absolute And restricted by the government. Examples of government restrictions on freedom of contract include:

• It's illegal to make a contract to commit a crime, and no court would enforce such a contract.
• It's illegal in many states for a man and woman to make a surrogate mother contract.
• In some states, usury laws limit a bank's rate of interest on credit. Usury laws make it illegal for you to enter into a contract with a bank under which they lend you money and you pay interest in excess of the usury rate.

Most restrictions on freedom of contract are justified on the grounds of consumer protection or public policy. Thus, there is constant tension between the freedom to make private law and the state's activity in protecting the consumer.

Limitations on Contract Obligations

A contract gives contracting parties an opportunity to reduce the risk of transactions.

Clauses

For example, most contracts used by businesses in commercial transactions contain clauses that limit the obligations of the business. A common limitation is the exclusion of consequential damages. This contract clause limits the liability of a business in case its product or service fails to comply with the contract. In the absence of such a clause, the financial liability of the business is theoretically unlimited.

Obligations

Everyone who has an insurance contract has had the experience of reading the long list of exclusions, limitations, and exceptions. Similarly, everyone who has purchased a product has had the experience of reading the exclusion of warranties. Generally, these exclusions and limitations are enforceable in a court of law. However, there are many limitations on the ability of parties to limit their obligations under contracts.

For example, consumer protection laws frequently impose obligations on businesses in consumer transactions, even if the businesses have tried to avoid those obligations. The law of product liability imposes obligations on manufacturers to produce safe products, and prohibits manufacturers from limiting their obligations to consumers injured by unsafe products.

Assignment of Contracts

An assignment is a transfer of contract obligations to another party. It is a method of getting out of the contract by getting somebody else to perform the obligations. The other party to the contract usually must permit an assignment if it is reasonable, meaning that the assignment will not jeopardize the security of the other party or increase its risks. Normally, an assignment requires the explicit approval of the other party. Often the original party to the contract remains liable for the performance of the contract, if the person to whom the contract is assigned (the assignee) breaches the contract.

Assignments are important in several types of contracts. Using a long-term car lease as an example, assume you lease a car for 36 months and then six months later are transferred abroad and no longer need the car. What do you do? If you terminate the lease contract early, you may be subject to serious early termination penalties. Assigning the lease to someone else is an option if the lease contract permits it. In an assignment, your assignee assumes the remainder of your contract obligations. If everything works according to plan, you have terminated the contract for practical purposes.

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