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A contract is any legally-enforceable promise or set of promises made by one party to another and, as such, reflects the policies represented by freedom of contract. In the civil law, contracts are considered to be part of the general law of obligations. This article describes the law relating to contracts in common law jurisdictions.
Distinguished from torts
Contract claims (where the parties have defined their own legal relationship) are usually distinguished from tort claims (where the relationship between the parties is defined by law or custom). As discussed more fully below, a contract may be express (either written or oral) or may be implied from circumstances. In certain cases (for example where there is a relevant "Statute of Frauds") a contract must either be written or at least evidenced in writing. Except in those special cases, there is no reason why a purely oral contract should not be valid.
Scope of common law contract law
Basic common law contract law addresses four sets of issues:
- When and how is a contract formed?
- When may a party escape obligations of a contract (such as a contract formed under duress or because of a misrepresentation)?
- What is the meaning and effect to be given to the terms of a contract?
- What is the remedy to be given for breach of a contract?
Contract formation: Generally, formation of a contract requires a bargain in which there is a manifestation of mutual assent to the exchange and a consideration (see also consideration under English law).
Escape from contract: A party may in some cases escape obligations established by a contract for one of the following reasons:
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- Mutual or unilateral mistake as to a basic assumption upon which the contract was made
- Misrepresentation of facts inducing one of the parties to enter the contract
- Duress inducing one of the parties to enter the contract
- Lack of capacity to contract (such as infancy, influence of drugs, alcohol or mental illness)
- Unconscionability
- Violation of a public policy
- Absence of a writing evidencing formation of the contract if the Statute of Frauds requires such a writing
- Performance of the contract becomes impossible or extremely difficult or costly by virtue of events occurring after the contract is formed
- The principal purpose of the contract is substantially frustrated by virtue of events occurring after the contract is formed
In some situations, a collateral contract may exist.
Meaning and effect of contract terms: Many contract disputes involve a disagreement between the parties about what terms in the contract require each party to do or refrain from doing. Hence, many rules of contract law pertain to interpretation of terms of a contract that are vague or ambiguous. The parol evidence rule limits what things can be taken into account when trying to interpret a contract.
Privity: In general, only parties to a contract may sue for the breach of a contract.
Validity of contracts
For a contract to be valid, it must meet the following criteria:
- Mutual agreement - (see main article offer and acceptance): There must be an express or implied agreement. The essential requirement is that there be evidence that the parties had each from an objective perspective engaged in conduct manifesting their assent, and a contract will be formed when the parties have met such a requirement. For a contract based on offer and acceptance to be enforced, the terms must be capable of determination in a way that it is clear that the parties assent was given to the same terms. The terms, like the manifestation of assent itself, are determined objectively.
- Consideration: There must be consideration (see also consideration under English law) given by all the parties, meaning that every party is conferring a benefit on the other party or himself sustaining a recognizable detriment, such as a reduction of the party's alternative courses of action where the party would otherwise be free to act with respect to the subject matter without any limitation.
- Competent, Adult (Sui Juris) Parties: Both parties must have the capacity to understand the terms of the contract they are entering into, and the consequences of the promises they make. For example, animals, minor children, and mentally disabled individuals do not have the capacity to form a contract, and any contracts with them will be considered void or voidable. Although corporations are technically legal fictions, they are considered persons under the law, and thus fit to engage in contracts.
- For adults, most jurisdictions have statutes declaring that the capacity of parties to a contract is presumed, so that one resisting enforcement of a contract on grounds that a party lacked the capacity to be bound bears the burden of persuasion on the issue of capacity.
- Proper Subject Matter: The contract must have a lawful purpose. A contract to commit murder in exchange for money will not be enforced by the courts. It is void ab initio, meaning "from the beginning."
- Mutual Right to Remedy: Both parties must have an equal right to remedy upon breach of the terms by the other party
- Mutual Obligation to Perform: Both Parties must have some obligation to fulfill to the other. This can be distinct from consideration, which may be an initial inducement into the contract.
Written contracts
Contrary to common wisdom, an informal exchange of promises can still be binding and legally as valid as a written contract. A spoken contract is often called an "oral contract", not a "verbal contract." A verbal contract is simply a contract that uses words. All oral contracts and written contracts are verbal contracts. Contracts that are created without the use of words are called "non-verbal, non-oral contracts" or "a contract implied by the acts of the parties."
Courts in the United States have generally ruled that if the parties have a meeting of the minds, and act as though there was a formal, written and signed contract, then a contract exists. However, most jurisdictions require a signed writing for certain kinds of contracts (like real estate transactions).
In the United States, a law setting out such requirements is typically called the Statute of Frauds; the name originates from an English statute that was for "the prevention of frauds." The point of the Statute of Frauds is to prevent false allegations of the existence of contracts that were never made, by requiring formal (i.e. written) evidence of the contract. Contracts that do not meet the requirements of Statute of Frauds legislation are unenforceable, but not void. However, a party unjustly enriched by an unenforceable contract may be subject to restitution for unjust enrichment.
In Australia, for contracts subject to legislation equivalent to the Statute of Frauds, there is no requirement for the entire contract to be in writing, although there must be a note or memorandum evidencing the contract, which may come into existence after the contract has been formed. The note or memorandum must be signed in some way, and a series of documents may be used in place of a single note or memorandum. It must contain all material terms of the contract, the subject matter and the parties to the contract.
In England and Wales, the Statute of Frauds is still in force, but only for guarantees, which must be evidenced in writing, although the agreement may be made orally. Certain other kinds of contract (such as for the sale of land) must be in writing or they are void.
Furthermore, the existence of a written contract does not necessarily ensure its enforceability or validity. A contract can be deemed unenforceable if it requires a party to undertake an illegal act, if it was signed under duress or while intoxicated, if the disparity in knowledge between the parties is extreme and the weaker party was given onerous terms, etc. For example, in Massachusetts a contract is not enforceable if it is executed on a Sunday.
If the terms of a contract subject to Statute of Frauds legislation are to be varied, the variations must be noted in writing as well. However, the contract may be discharged orally.
If a contract is in a written form, then generally, you are bound by its terms regardless of whether you have read it or not (L'Estrange v. F Graucob Ltd [1934] 2 KB 394). However, this is tempered by the exception that if the terms of the contract are misrepresented, then the plaintiff is unable to rely on the terms of the contract; in addition, the document must be contractual in nature (Curtis v. Chemical Cleaning and Dyeing Co [1951] 1 KB 805).
Furthermore, if a party wishes to use a document as the basis of a contract, reasonable notice of its terms must be given to the other party prior to their entry into the contract (see Balmain New Ferry Company Ltd v. Robertson (1906) 4 CLR 379). This includes such things as tickets issued at parking stations.
Void, voidable and unenforceable contracts
In general, there are three classifications of contracts that are not binding:
- Void: If a contract is held to be void, the contract has never come into existence. For example, a contract is void if it is based on an illegal purpose or contrary to public policy; the classic example is a contract with a hit man. Such a contract will not be recognized by a court, and cannot be enforced by either party.
- Voidable: A contract is voidable if one of the parties has the option to terminate the contract. Contracts with minors are examples of voidable contracts.
- Unenforceable: If a contract is unenforceable, neither party may enforce the other's obligations. For example, in the United States, a contract is unenforceable if it violates the Statute of frauds. An example of the above is an oral contract for the sale of a motorcycle for US$5,000 (because in the USA any contract for the sale of goods over US$500 must be in writing to be enforceable).
Uncertainty and incompleteness
If the terms of the contract are uncertain or incomplete, the parties cannot have reached an agreement in the eyes of the law. An agreement to agree does not constitute a contract, and an inability to agree on key issues, which may include such things as price, may cause the entire contract to fail.
However, a court will attempt to give effect to commercial contracts where possible, by construing a reasonable construction of the contract (see Hillas v. Arcos Ltd (1932) 147 LT 503).
Courts may also look to external standards, which are either mentioned explicitly in the contract (Whitlock v. Brew (1968) 118 CLR 445) or implied by common practice in a certain field (Three Rivers Trading Co., Ltd. v. Gwinear & District Farmers, Ltd. (1967), 111 Sol. J. 831). In addition, the court may also imply a term; if price is excluded, the court may imply a reasonable price, with the exception of land, and second-hand goods, which are unique.
Severence of unenforceable clauses
If there are uncertain or incomplete clauses in the contract, and all options in resolving its true meaning have failed, it may be possible to sever and void just those affected clauses. The test of whether a clause is severable is an objective test - whether a reasonable person would see the contract standing even without the clauses.
Spy contracts
In the U.S., one unusual type of unenforceable contract is a personal employment contract to work as a spy or secret agent. This is because the very secrecy of the contract is a condition of the contract (in order to maintain plausible deniability). If the spy subsequently sues the government on the contract over issues like salary or benefits, then the spy has breached the contract by revealing its existence. It is thus unenforceable on that ground, as well as the public policy of maintaining national security (since a disgruntled agent might try to reveal all the government's secrets during his lawsuit).
Bilateral v. unilateral contracts
Contracts may be bilateral or unilateral. The more common of the two, a bilateral contract, is an agreement in which each of the parties to the contract makes a promise or promises to the other party. For example, in a contract for the sale of a home, the buyer promises to pay the seller £200,000 in exchange for the seller's promise to deliver title to the property.
In a unilateral contract, only one party to the contract makes a promise. A typical example is the reward contract: A promises to pay a reward to B if B finds A's dog. B is not obliged to find A's dog, but A is obliged to pay the reward to B if B finds the dog. In this example, the finding of the dog is a condition precedent to A's obligation to pay.
An offer of a unilateral contract may often be made to many people (or 'to the world') by means of an advertisement. In that situation, acceptance will only occur on satisfaction of the condition (such as the finding of the offeror's dog). If the condition is something that only one party can perform, both the offeror and offeree are protected — the offeror is protected because he will only ever be contractually obliged to one of the many offerees; and the offeree is protected, because if she does perform the condition, the offeror will be contractually obliged to pay her.
In unilateral contracts, the requirement that acceptance be communicated to the offeror is waived. The offeree accepts by performing the condition, and the offeree's performance is also treated as the price, or consideration, for the offeror's promise.
The most common type of unilateral contract is the insurance contract. The insurance company promises to pay the insured a stated amount of money on the happening of an event if the insured pays premiums; note that the insured does not make any promise to pay the premiums.
Courts generally favor bilateral contracts. The general rule in the United States is: "In case of doubt, an offer is interpreted as inviting the offeree to accept either by promising to perform what the offer requests or by rendering the performance, as the offeree chooses." Restatement (Second) of Contracts § 32 (1981) (emphasis added). Here the law attempts to provide some protection from the risk of revocation in a unilateral contract to the offeree. Note that if the offer specifically requests performance rather than a promise, a unilateral contract will exist. See option contracts for more information on protection given to the offeree in a unilateral contract.
Express and implied contracts
A contract can be either an express contract or an implied contract. An express contract is one in which the terms are expressed verbally, either orally or in writing. An implied contract is one in which some of the terms are not expressed in words.
Implied in fact or implied in law
An implied contract can either be implied in fact or implied in law. A contract which is implied in fact is one in which the circumstances imply that parties have reached an agreement even though they have not done so expressly. For example, by going to a doctor for a physical, a patient agrees that he will pay a fair price for the service. If he refuses to pay after being examined, he has breached a contract implied in fact.
Quasi-contract
A contract which is implied in law is also called a quasi-contract, because it is not in fact a contract; rather, it is a means for the courts to remedy situations in which one party would be unjustly enriched were he or she not required to compensate the other. For example, an unconscious patient treated by a doctor at the scene of an accident has not agreed (either expressly or by implication) to pay the doctor for emergency services, but the patient would be unjustly enriched by the doctor's services were the patient not required to compensate the doctor.
Incorporation of terms
Course of dealing
If two parties have regularly conduct business on certain terms, it may be reasonable to presume that in future dealings where there is no contract, the parties wish to incorporate the terms of the previous contracts. However, if a party wishes to incorporate terms by course of dealing, the original document must have been contractual in nature, and delivery receipts may not fit this description. In Australia, there is a further requirement that the document was procured after formation.
Express and implied terms
Different types of statements
Whether a statement is a term of a contract is important because only if a promise is a term of the contract can a party sue for the breach of the contract. Statements can be split into the following types:
- Puff (sales talk): If no reasonable person hearing this statement would take it seriously, it is a puff, and no action in contract is available if the statement proves to be wrong.
- Representation: A representation is a statement of fact made to induce another person to enter into a contract and which does induce them to enter into a contract, but it is one that the maker of the statement does not guarantee its truth. If the statement proves to be incorrect, it cannot be enforced, as it is not a term of the contract, but it may prove to be a misrepresentation, whereupon other remedies are available.
- Term: A term is similar to a representation, but the truth of the statement is guaranteed by the person who made the statement. The test is an objective test.
Factors that a court may take into account in determining the nature of a statement include:
- Timing: If the contract was concluded soon after the statement was made, this is a strong indication that the statement induced the person to enter into the contract.
- Content of statement: It is necessary to consider what was said in the given context, which has nothing to do with the importance of a statement.
- Knowledge and expertise: In Oscar Chess Ltd v. Williams [1957] 1 WLR 370, a person selling a car to a second-hand car dealer stated that it was a 1948 Morris, when in fact it was a 1939 model car. It was held that the statement did not become a term because a reasonable person in the position of the car dealer would not have thought that an inexperienced person would have guaranteed the truth of the statement.
Terms implied in fact
The Privy Council proposed a five stage test in BP Refinery Western Port v. Shire of Hastings:
- Reasonableness and equitableness: The implied term must be reasonable and equitable.
- Business efficacy: The implied term must be necessary for the business efficacy of the contract. For instance, if the term simply causes the contract to operate better, that does not fit this criterion.
- Obviousness: The term is so obvious that it goes without saying. Furthermore, there must be one and only one thing that would be implied by the parties. For example, in Codelfa Construction Pty Ltd v. State Rail Authority of New South Wales (1982) 149 CLR 337, a term regarding the inability of construction company to work three shifts a day could not be implied because it was unclear what form it would have taken.
- Clear expression: The term must be capable of clear expression. No specific technical knowledge should be required.
- Consistency: The implied term may not contradict an express term.
In Australia, the High Court has ruled that the test in BP Refinery applies only to formal contracts, while the test in Byrne and Frew v. Australian Airlines Ltd (1995) 185 CLR 410 shall apply to informal contracts:
- Necessity: The term must be necessary to ensure reasonable or effective operation of a contract of the nature before the court.
- Consistency: The implied term may not contradict an express term (same as for formal contracts).
- Clear expression: The term must be capable of clear expression (same as for formal contracts).
- Obvious: McHugh and Gummow JJ have stated that it must also be obvious.
Terms implied in law
These are terms that have been implied into standardised relationships. The other difference between this and terms implied in fact is that the test is one of necessity (Liverpool City Council v. Irwin [1976] 2 WLR 562); a necessary term is one where the contract is rendered worthless or nugatory if it is without it.
Terms implied by custom or trade
You are generally bound by the custom of the industry that you are in. To imply a term due to custom or trade, you must prove the existence of the custom, which must be notorious, certain, legal and reasonable (Con-stan Industries of Australia Pty Ltd v. Norwich Winterthur Insurance (Australia) Ltd (1986) 160 CLR 226). See also Frigaliment Importing Co., Ltd., v. B.N.S. International Sales Corp., 190 F. Supp. 116 (S.D.N.Y. 1960) (plaintiff failed to prove what he meant by "chicken") and U.C.C. § 1-205.
Agreements to negotiate
It is common for lengthy negotiations to be written into a heads of agreement document that includes a clause to the effect that the rest of the agreement is to be negotiated. Although these cases may appear to fall into the category of agreement to agree, courts nowadays (at least in Australia) will imply an obligation to negotiate in good faith provided that certain conditions are satisfied (Coal Cliff Collieries Pty Ltd v. Sijehama Pty Ltd (1991) 24 NSWLR 1):
- Negotiations were well-advanced and the large proportion of terms have been worked out; and
- There exists some mechanism to resolve disputes if the negotiations broke down.
The test of whether one has acted in good faith is a subjective one; the cases suggest honesty, and possibly also reasonably.
"Subject to" contracts
If a contract specifies "subject to contract", it may fall into one of three categories (Masters v. Cameron (1954) 91 CLR 353):
- The parties are immediately bound to the bargain, but they intend to restate the deal in a formalised contract that will not have a different effect; or
- The parties have completely agreed to the terms, but have made the execution of some terms in the contract conditional on the creation of a formalised contract; or
- It is merely an agreement to agree, and the deal will not be concluded until the formalised contract has been drawn up.
If a contract specifies "subject to finance", it imposes obligations on the purchaser (Meehan v. Jones (1982) 149 CLR 571):
- The purchaser must seek finance; and
- When offers of finance arrive, the purchaser must make a decision as to whether the offers of finance are suitable.
Once again, there is an element of good faith involved.
Statutory law applicable to contracts
The rules by which many contracts are governed are provided in specialized statutes that deal with particular subjects. Most countries, for example, have statutes which deal directly with sale of goods, lease transactions and trade practices. For example, most American states have adopted Article 2 of the Uniform Commercial Code, which regulates contracts for the sale of goods.
There are also many acts around the world which deal with specific types of transactions and businesses. For example, the states of California and New York in the U.S. have statutes that govern the provision of services to customers by health studios, and the UK has the Sale of Goods Act 1979 which governs the contracts between sellers and buyers.
Remedies
Damages
Typically, the remedy for breach of contract is an award of money damages. Courts usually adopt one of three ways of calculating the value of damages.
The most common is to assess the sum which would restore the injured party to the economic position that he or she expected from performance of the promise or promises (known as an "expectation measure" or "benefit-of-the-bargain" measure of damages).
When it is either not possible or desirable to award damages measured in that way, a court may award money damages designed to restore the injured party to the economic position that he or she had occupied at the time the contract was entered (known as the "reliance measure"), or designed to prevent the breaching party from being unjustly enriched ("restitution").
Specific Perfomance
There may be circumstances in which it would be unjust to permit the defaulting party simply to buy out the injured party with damages. For example where an art collector purchases a rare painting and the vendor refuses to deliver, the collector's damages would be equal to the sum paid.
The court may make an order of what is called "specific performance", requiring that the contract be performed.In some circumstances a court will order a party to perform his or her promise (an order of "specific performance") or issue an order, known as an "injunction," that a party refrain from doing something that would breach the contract.
Both an order for specific performance or an injunction are discretionary remedies, originating for the most part in equity. Neither is available as of right and in most jurisdictions and most circumstances a court will not normally order specific performance.
Procedure
In the United States, in order to obtain damages for breach of contract or to obtain specific performance, the injured party may file a civil (non-criminal) lawsuit, usually in a state court, or petition a private arbitrator to decide the contract issues presented.
Many contracts provide that all contract disputes must be arbitrated by the parties to the contract, rather than litigated in courts. By law, some contracts, including most securities brokerage contracts, must be arbitrated; other contracts are referred by courts as a matter of local law or policy. Arbitrated judgements are generally enforced and appealed in the same manner as ordinary court judgements; a majority of states have adopted the Uniform Arbitration Act to facilitate the enforcement of arbitrated judgements.
In England and Wales, a contract may be enforced by use of a claim, or in urgent cases by applying for an interim injunction to prevent a breach.
Theoretical considerations
Contract theory is the body of legal theory that addresses normative and conceptual questions in contract law. One of the most important questions asked in contract theory is why contracts are enforced. One prominent answer to this question focuses on the economic benefits of enforcing bargains. Another approach, associated with Charles Fried, maintains that the purpose of contract law is to enforce promises. This theory is developed in Fried's book, Contract as Promise. Other approaches to contract theory are found in the writings of legal realists and critical legal studies theorists.
See also
External links
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