6. Contract Law
All contracts start when an individual or business proposes a deal. It might involve buying or selling goods, performing services, or making an exchange. An offer is a conditional promise to do or refrain from doing something now or in the future. In other words, it is willingness to enter into a contract. Offers can be formal or informal. In some industries, such as retail and restaurants, offers are often posted on menus, signs, and advertisements. For example, a sign listing menu items hanging above a cash register is the restaurant’s offer to sell customers those items at those prices.
Once made, offers can be terminated in several ways. An offer that has been properly communicated continues to exist until it:
- Is rejected;
- Is replaced by a counteroffer;
- Lapses or expires;
- Is revoked; or
- Is terminated by operation of law.
Unless it states a specific time, an offer remains open for a reasonable time. A lapsed offer is an offer that is no longer valid because a reasonable time to accept it has expired. An expired coupon is an example of a lapsed offer.
To constitute an agreement, once an offer has been made, there must be an acceptance of the offer. Legally, acceptance is an implied or express act that shows willingness to be bound by the terms of an offer. Express acceptance occurs when a party states that they accept the offer. Acceptance may be implied based on the parties’ conduct.
For example, a retailer offers to sell a product to consumers for the price listed on the shelf. A consumer may accept that offer by handing the cashier the item and money to pay for it. The consumer does not need to say anything to complete the transaction. But the consumer must do something to accept. Silence, without more (such as handing over payment), is not acceptance. This is because silence may be evidence that the consumer either does not know about the offer or has rejected it. To be effective, both parties must understand and agree to be bound by the contract.
Distinguishing between knowing what constitutes acceptance and what is actually negotiation ahead of accepting an offer is important and sometimes misunderstood. If an acceptance changes, adds, or modifies the terms of an offer, it is a counter-offer and no contract is formed. The original party may decide to accept, reject, or propose another offer as a result. Although this sounds straightforward, with today’s fast-paced communications, parties may respond to part of an offer, negotiate various parts of the contract simultaneously, or agree to terms in installments. As a result, there may be confusion about what the full terms of a contract are.
Offer and acceptance form mutual assent, which is also called “meeting of the minds.” This is the parties’ intention to enter into a binding contract on the terms they agreed upon. If parties do not agree on the essential terms, then there can be no meeting of the minds to enter into a contract. This is the basis for many of the defenses to contract formation.
Consideration is the exchange of something of value (money, a promise to do something or not to do something) that shows the parties intend to be bound by the contract. The “something” that is promised or delivered must be a legal detriment. A legal detriment is giving up a legal or property right.
Consideration may be concurrent or a promise to perform in the future. However, it cannot be “past consideration” based on something that has occurred before the formation of the current contract. In other words, an act or promise made before the current contract is not adequate consideration because it was not given in exchange for the current promise.
When bargained-for consideration is not present, a court may validate a promise based on promissory estoppel. Promissory estoppel is the principle that a promise made without consideration may nonetheless be enforced to prevent injustice if the promisor should have reasonably expected the promisee to rely on the promise, and the promisee relied on the promise to his or her detriment. Promissory estoppel is an equitable doctrine used as a substitute for consideration that allows the imposition of contractual liability to prevent unfairness.
To establish promissory estoppel, a party must show:
- A definite promise;
- The party making the promise should have expected that the other party would rely on the promise;
- A reasonable person would have relied on the promise;
- The party relied on the promise, and it resulted in a substantial detriment; and
- Basic justice and fairness require that the promise be enforced.
Consideration and Promissory Estoppel:
Contract law employs the principles of consideration and promissory estoppel. In most cases, consideration need not be pecuniary (monetary). Most contracts are enforceable only if each party receives consideration from the agreement. Consideration can be money, property, a promise, or some right. For instance, when a music company sells studio equipment, the promised equipment is the consideration for the buyer. The seller’s consideration is the money the buyer promises to pay for the equipment.
However, the promissory estoppel doctrine is an exception to the requirement of consideration for contracts. Promissory estoppel is an equitable doctrine that was developed to deal with the unfairness that can arise where a party promises to not to enforce an existing contractual right and then attempts to go back on that promise. For instance, if two people are in a contract, and one person promises that they won’t enforce a contractual right they have, but later sues for breach, the promisee can use promissory estoppel as a defense. Equitable doctrines, such as promissory estoppel, have discretionary remedies. This means that the court can decide if the remedy will be given, even if it is proven there is a breach.
It is important to note that promissory estoppel requires that the parties have a legal relationship.
There are five requirements of promissory estoppel:
- The promise must have been intended to alter legal relations. In other words, it was not simply a friendly indulgence. This can sometimes be inferred from conduct or words.
- The promise must be voluntary.
- The promisor must have the knowledge or relevant facts for the promise to be enforceable.
- The promise must have been intended to be relied upon.
- There must be a detriment/loss from acting on the promise not to enforce a contractual right.
Capacity and Legality:
For a contract to be legally binding, the parties entering into it must have the capacity to do so. As a legal matter, there are certain classes of people who are presumed to lack the capacity to form a contract. These include legal minors, those experiencing mental health issues, and those who are intoxicated. If people meeting these criteria enter into a contract, the agreement is considered voidable. If a contract is voidable, then the person who lacked capacity has the choice to either end the contract or continue with it as agreed upon. This design is meant to protect the party lacking capacity.
Examples of the application of these rules include the following:
Minors Have No Capacity to Contract:
In Canada, minors under the age of 18 (19 in some provinces) lack the capacity to make a contract and may therefore either honour an agreement or void the contract.
Consider this example:
Mary, 16, an athlete, signs a long-term endorsement deal with a well-known brand and is compensated for several years. At age 20, she decides she wants to take a better endorsement deal, so she tries to void the agreement on the grounds that it was made when she was a minor and that she lacked capacity at that time. Mary will not likely succeed in having her agreement voided, as she has passed the period of incapacity.
If a person lacks the mental capacity to enter into a contract, then either he or she, or his or her legal guardian, may void it, except in cases where the contract involved necessities. In most provinces, mental capacity is measured against the “cognitive standard” of whether the party understood the meaning and effect of the contract.
Consider this example:
Mr. Williams contracted to sell a patent. Later, however, he claimed that he lacked capacity to enter into the contract because at the time he signed the contract, he was at a party where he got himself drunk. He claimed that his intoxication prevented the contract from being valid.
Courts generally do not find a lack of capacity to contract for people who are voluntarily intoxicated.
The rationale for this decision is that individuals should not be allowed to avoid their contractual obligations by virtue of their self-induced states. However, courts also seek to avoid the undesirable result of allowing the sober party to take advantage of the other person’s condition. Therefore, if a party is so inebriated that he or she is unable to understand the nature and consequences of the agreement, then the contract may be voided by the inebriated party.
Contracts must be created for the exchange of legal goods and services to be enforced. An agreement is void if it violates the law or is formed for the purpose of violating the law. Contracts may also be found voidable if they are found violative of public policy, although this is more rare. Typically, this conclusion is only invoked in clear cases where the potential harm to the public is substantially incontestable, eluding the idiosyncrasies of particular judges.
Some examples of contracts that would be considered illegal are contracts for the sale or distribution of illegal drugs, contracts for illegal activities such as loansharking, and employment contracts for the hiring of undocumented workers.
Breach of Contract and Remedies:
Once a contract is legally formed, both parties are generally expected to perform according to the terms of the contract. A breach of contract claim arises when either (or both) parties claim that there was a failure, without legal excuse, to perform on any, or all, parts and promises of the contract.
Several inquiries are triggered when a breach of contract claim is initiated. The first step is to determine whether a contract existed in the first place. If it did, the following questions may be asked: What did the terms of the contract require of the parties? Were the contractual terms modified at any point? Did the breach occur? Was the claimed breach material to the contract? Does any legal excuse or defense to enforcement of the contract exist? What damage was caused by the breach?
Typically, the remedies that will be available if a breach of contract is found can include monetary damages, restitution, rescission, reformation, and specific performance.
Rescission or reformation may be available to parties who enter into contracts by mistake, fraud, undue influence, or duress. Rescission terminates the duties of both parties under the contract, while reformation allows courts to equitably change the contract’s substance.
Specific performance compels one party to perform the promises stated in the contract as nearly as practicable. Specific performance is only mandated when monetary damages do not adequately compensate for the breach. Personal service, however, may not be used to compel specific performance, since doing so would constitute forced labor.
Inevitably, when valid contracts are created, the potential for breach exists. An understanding of what happens when a contract’s terms are breached is fundamental to an understanding of contract law.
Bilateral and Unilateral Contracts:
In a bilateral contract, both parties make a promise of performance. These contracts are also called mutual or reciprocal contracts. Bilateral contracts are the most common form of contracts. They include ordering food in a restaurant, buying gas for vehicles, purchasing goods and services, and related examples.
A unilateral contract, on the other hand, is a contract where one party makes a promise that the other party can accept only by doing something. For example, a business offers a reward for information leading to the arrest of a thief. A person cannot collect the reward money by promising to give information–he or she must perform under the contract by providing the information.
Express and Implied Contracts:
An express contract is a contract in words (orally or in writing) in which the terms are spelled out directly. The parties to an express contract, whether written or oral, clearly intend to make a legally enforceable agreement. For example, an agreement to buy a car for $10,000 and to take title next Monday is an express contract.
An implied contract is a contract that is inferred from the parties’ actions. Although no discussion of terms took place, an implied contract exists if it is clear from the conduct of the parties that they have an agreement. A delicatessen patron who asks for a “turkey sandwich to go” has made a contract and is obligated to pay when the sandwich is made. By ordering the food, the patron is implicitly agreeing to the price, whether posted or not.
A contract that is fully enforceable and reflects the parties’ intent is valid. Conversely, an unenforceable contract is a contract where the parties intend to form a valid bargain, but the court declares that it cannot be enforced for legal reasons. For example, Ramesh owes Jai money, but Jai has waited too long to collect it and the statute of limitations has run out (in Ontario, the Limitations Act (2002) fixes this period at 2 years). The contract for repayment is unenforceable and Jai is out of luck unless Ramesh makes a new promise to pay or actually pays part of the debt.
An agreement that is lacking one of the legal elements of a contract is void because it never was a contract. In other words, it is not legally enforceable because it is not a contract at all. An agreement that is illegal is also void. For example, a promise to commit a crime in return for payment is void because neither side can enforce the agreement in court.
By contrast, a voidable contract is a contract that can be annulled. It is a contract that is unenforceable by one party but enforceable by the other. For example, a minor may “avoid” a contract with an adult; meaning the adult may not enforce the contract against the minor if the minor refuses to carry out the bargain. The adult must comply if the minor wishes the contract to be performed. A contract may be voidable by both parties if they are both minors. Usually, the parties to a voidable contract are entitled to be restored to their original position.
A voidable contract remains a valid contract until it is voided. Thus, a contract with a minor remains in force unless the minor decides he does not wish to be bound by it. When minors become adults, they have two choices:
- Ratify the contract–that is, agree to be bound by it; or
- Disaffirm the contract–that is, disavow or avoid it.
Ratification may be explicit or implicit. For example, by continuing to make payments or retaining goods for an unreasonable period of time, a party may ratify the contract. If a party has not disaffirmed the contract while still a minor, she may do so within a reasonable time after becoming an adult.
Degree of Completion:
An executory contract is a contract that has yet to be completed. Most executory contracts are enforceable. If some, but not all, of the terms of the contract have been performed, the contract is called partially executed. A contract that has been completed or carried out fully by both parties is called an executed contract.
Performance and Breach of Contract:
Performance simply means undertaking the legal duties imposed by the terms of the contract.
But how do we know whether the contract terms have been performed? Sometimes it’s easy to determine. For instance, if someone offers to sell his scooter for four hundred dollars, a purchaser agrees, and they exchange the scooter for the money, then the contract has been fully performed. A contract was formed, the parties performed their obligations under it (known as complete performance), and they are subsequently discharged from further duties arising under the contract. Complete performance results in an executed contract.
When a party fails to perform under the terms of the contract without a legally justifiable reason, the party is in breach of contract. Not all breach of contract situations give rise to litigation. Some breaches are minor and may be overlooked by parties, especially if there is a long-term business relationship between them. Others may be major and give rise to significant issues between the parties.
Performance to the standard of personal satisfaction can be enforced if the contract expressly requires it. This means that contract performance is evaluated subjectively, either by one party to the contract or by a third-party beneficiary specified in the contract. If the subject of the contract is something for which approval is dependent on someone’s subjective opinion, like personal taste, then assessment can be made on a subjective standard providing this standard is clearly specified in the contract. These contracts often occur in the entertainment industry, as well as the building of custom homes.
Undue influence occurs when one party overpowers the free will of another by use of superior power or influence. In other words, it is unfair persuasion. Undue influence is not a normal level of persuasion. Rather, it occurs when a party agrees to a contract that they would not have otherwise consented to without the unreasonable pressure of the other party. For example, an elderly person who is isolated from others due to poor health and living conditions may be lonely and eager for company. If a caretaker exerted influence over the elder to the extent that he or she could no longer exercise free will, then undue influence occurs. Contracts and transactions in which elders transfer most or all of their wealth to others are frequently reviewed for undue influence.
Duress occurs when there is a threat to a person, family or property. Economic pressure may constitute duress if it is wrongful and oppressive. Cases involving duress often occur in emergency situations. For example, when someone is required to sign legal paperwork in an emergency room before receiving medical treatment for themselves or their children. If a person enters into a contract under duress, he or she can get out of the contract after the emergency situation has passed. Duress essentially overcomes a person’s free will to voluntarily choose to enter into the contract.
Unconscionability occurs when the contract contains markedly unfair terms against the party with less bargaining power or sophistication than the party who created the terms and induced the other party to sign it. Common cases involving unconscionability claims occur when one party is an experienced business dealer, while the other party is an average consumer. If the business dealer uses a very small font and inserts terms into the contract in a way that intentionally misleads the consumer into signing on unfair terms, then the contract may be deemed unconscionable.
In the context of contracts, a mistake is the situation in which the parties did not mean the same thing or when one or both parties formed untrue conclusions about the subject matter of the contract. In other words, a mistake is an erroneous belief.
Mutual mistake refers to something that is a mistake by both parties that relates to an essential term of the contract. For example, a contract to buy property that is not actually owned by the seller would be a mutual mistake, if the seller believed in good faith that he owned the property. When mutual mistakes occur, either party may rescind the contract.
Unilateral mistake occurs when only one party is laboring under a mistake. Mistake does not mean bad bargaining. Courts will not step in to save parties from bad bargaining absent evidence of undue influence or unconscionability. In general, parties cannot rescind the contract when unilateral mistakes occur except when the mistake makes the contract unconscionable, the error is apparent to the other party, or when significant mathematical errors occur.
Misrepresentation and Fraud:
Misrepresentation and fraud are also defenses to contract. Misrepresentation is when a party makes a false statement that induces the other party to enter into the contract. Fraud is a closely related concept, and it simply means that one party has used deception to acquire money or property. Fraud may also be a basis for criminal charges, depending on the circumstances leading to the contract.
Commercial impracticability is a defense that can be used when fulfilling a contract has become extraordinarily difficult or unfair for one party. For example, a sales contract relating to the sale of goods destroyed by a natural disaster would fall under this defense. It becomes impossible for the seller to deliver goods that no longer exist and it would therefore be unfair to enforce damages against the seller for breach of contract. This is also called frustration of purpose or impossibility in some jurisdictions.
Sometimes a party to a contract files for bankruptcy protection. The bankruptcy court will determine which debts the bankrupt party must pay, and which are dischargeable. Contract obligations are suspended temporarily through the bankruptcy court’s automatic stay. In other words, the debt does not have to be paid during the course of the bankruptcy. At the conclusion of the bankruptcy, if the contract obligation is determined to be a dischargeable debt, then the debt will not have to be paid.