1. © 2007 by West Legal Studies in Business / A Division of Thomson Learning CHAPTER 8 Contract Formation

2. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 2Introduction Common law of contracts. –Restatement of the Law of Contracts. Contracts for the Sale of Goods. –UCC Article 2 governs sales contracts. –Relationship between common law and Article 2.

3. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 3 Function and Definition Contracts are designed to provide stability and predictability, as well as certainty, for both, buyers and sellers in the marketplace. Necessary to ensure compliance with a promise or to entitle the innocent party to some form of relief. What is a Contract? –Contract is an agreement (based on a promise) that can be enforced in court.

4. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 4 Requirements of a Valid Contract Agreement. Consideration. Contractual Capacity. Legality. DEFENSES: –Genuineness of assent –Form.

5. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 5 Types of Contracts Bilateral - Offeree must only promise to perform (“promise for a promise”). Unilateral - Offeree can accept the offer only by completing the contract performance (“promise for an act”). –Case 8.1 Ardito v. City of Providence (2003). –Offers for Unilateral Contracts are generally revocable unless substantial work.

6. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 6 Formal vs. Informal Contracts. Express (oral or written) vs. Implied-in- Fact (conduct creates and defines the terms of the contract): –Plaintiff furnished some service/property. –Plaintiff expected to be paid and defendant knew. –Defendant had a chance to reject and did not. Types of Contracts

7. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 7 Contract Performance Executed v. Executory. –Executed - A contract hat has been fully performed on both sides. –Executory - A contract that has not been fully performed on either side.

8. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 8 Contract Enforceability Valid. –Elements: Agreement, consideration, contractual capacity, and legality. Voidable (unenforceable). –Valid contract can be avoided or rescinded. Void: No contract.

9. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 9Agreement Agreement = Offer and Acceptance. Once an agreement is reached, if the other elements of a contract are present, a valid contract is formed.

10. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 10 Requirements of the Offer Offeror’s serious intention.  Definiteness of terms.  Communication. 

11. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 11 Offeror’s Serious Intention Offers made in anger, jest, or undue excitement are usually not offers. –Case 8.2 Lucy v. Zehmer (1954). Expressions of opinion are not offers. Statements of intention or preliminary negotiations are are not offers. Advertisements, Catalogues, Price Lists, and Auctions are treated as Invitations to negotiate and not as offers.

12. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 12 Definiteness of Terms Terms (Expressed or Implied). –Identification of the parties. –Object or subject matter of the contract. –Consideration to be paid. –Time of payment, Delivery, or Performance.

13. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 13Offer-Communication Offeree’s knowledge of the offer: –Directly by the Offeror. –Use of Agents.

14. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 14 Termination of the Offer An offer may be terminated prior to acceptance by either: –Action of the Parties; or by  –Operation of Law.

15. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 15 Revocation of the Offer by the Offeror: –Offer can be withdrawn anytime before Offeree accepts the offer. –Effective when the Offeree or Offeree’s agent receive it. Exceptions: –Irrevocable Offers. –Option Contract: Promise to hold an offer open for a specified period of time in return of consideration. Termination by Action of the Parties

16. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 16 –Exceptions (Cont’d): Detrimental Reliance or Promissory Estoppel where Offeree relies on offer to his or her detriment, thus Offeror is barred from revoking the offer. Rejection of the offer by the Offeree: –Rejection by the Offeree (expressed or implied) terminates the offer. –Effective only when it is received by the Offeror or Offeror’s agent. Termination by Action of the Parties

17. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 17 Rejection of Offer by Offeree (Cont’d). –A counteroffer by the Offeree is a rejection of the original offer and making of a new offer. Mirror Image Rule. –Offeree’s acceptance to match the Offeror’s offer exactly. Termination by Action of the Parties

18. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 18 Termination by Operation of Law Lapse of Time. –Offer terminates by law when the period of time specified in the offer has passed. –If no time period for acceptance is specified, the offer terminates at the end of a reasonable period of time. Destruction of the Subject Matter.

19. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 19 Death or Incompetence of the Offeror or Offeree. Supervening Illegality of the Proposed Contract. Termination by Operation of Law

20. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 20 Acceptance: –Voluntary act (expressed or implied), –by the Offeree that shows unequivocal assent (agreement) to the terms of an offer. Additional terms may constitute rejection. Communication: Generally, silence is not acceptance.Acceptance

21. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 21 Mode and Timeliness of Acceptance Mail Box Rule - Acceptance is effective on dispatch, providing that authorized means of communication is used. –Offeror specifies (expressly or impliedly) how acceptance should be made. –Effective is properly dispatched (mailed, shipped). Exceptions: 

22. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 22 Exceptions: –If acceptance is not properly dispatched by the Offeree. –If Offeror specifies that acceptance will not be effective until it is received. –If acceptance is sent after rejection, whichever is received first is given effect. Mode and Timeliness of Acceptance

23. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 23 Unauthorized Means of Acceptance. –Not effective until it is received by the Offeror. If timely sent and dispatched it is considered to have been effective on its dispatch. Technology creates unique issues for application of the mailbox rule. Mode and Timeliness of Acceptance

24. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 24Consideration Consideration is legal value given in return for a promise or performance. –Must have something of legal value or sufficiency. –Must be a bargained-for exchange.

25. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 25 Consideration for a promise must be either: –Legally detrimental to the promisee, or –legally beneficial to the promisor. Adequacy of Consideration. –Case 8.3 Seaview Orthopaedics v. National Healthcare Resources, Inc. (2004). Legal Sufficiency of Consideration

26. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 26 Preexisting Duty: Generally, a promise to to what one already has a legal duty to do is not consideration. Exceptions: Unforeseen Difficulties. Recession and New Contract. Agreements that Lack Consideration

27. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 27 Past Consideration is no consideration because the bargained-for exchange element is missing. Illusory Promise: promissor has not definitely promised to do anything (no promise at all). Agreements That Lack Consideration

28. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 28 Promissory Estoppel Promissory Estoppel / Detrimental Reliance: –Must be clear and definite promise. –Promisee must justifiably and substantially rely. –Justice will be served.

29. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 29Capacity Contractual Capacity. –The legal ability to enter into a contractual relationship. Full competence. No competence. Limited competence.

30. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 30Minors In most states, a person is no longer a minor for contractual purposes at the age 18. A minor can enter into any contract that an adult can. A contract entered into by a minor is voidable at the option of that minor.

31. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 31 A contract can be disaffirmed at any time during minority or for a reasonable period after the minor comes of age. If minor disaffirms he must return the goods. Exception: contracts for necessaries. Minor’s Right to Disaffirm

32. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 32Intoxication Key is whether there was contractual capacity at the time the contract was formed. Contract can be either voidable or valid. –Courts look at objective indications to determine if contract is voidable. If voidable. –Person has the option to disaffirm. –Person may ratify the contract expressly or impliedly.

33. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 33 Mental Incompetence Contract Void: If a person has been adjudged mentally incompetent by a court of law and a guardian has been appointed. Contract Voidable: If the person does not know he or she is entering into the contract or lacks the mental capacity to comprehend its nature, purpose, and consequences. Contract Valid: If person is able to understand the nature and effect of entering into a contract yet lack capacity to engage in other activities.

34. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 34Legality A contract to do something prohibited by federal or state statutory law is illegal and therefore void (never existed). –Contract that calls for for a tortious act. –Contract that calls for an act contrary to public policy (such as a covenant not to compete).

35. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 35 Genuineness of Assent Contract may be unenforceable if the parties have not genuinely assented to its terms by: –Mistake. –Misrepresentation. –Undue Influence. –Duress.

36. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 36 Mutual Mistakes If both parties have made a mistake about a material fact, the contract can be rescinded by either party. Case 8.4 Roberts v. Century Contractors, Inc. (2004).

37. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 37 Unilateral Mistakes of Fact One party mistaken as to some material fact. Does not afford the mistaken party any right to relief from the contract unless: –But if other party to the contract knew or should have known that a mistake of fact was made, or –If there was a gross clerical error.

38. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 38 Fraudulent Misrepresentation Contract is Voidable by Innocent Party. Elements: –Misrepresentation of Material Fact. –Intent to Deceive. –Reliance on Misrepresentation. –Injury to the Innocent Party.

39. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 39 Undue Influence Contract is Voidable. –Confidential or Fiduciary Relationship. –Relationship of dependence. –Influence or Persuasion. –Weak party talked into doing something not beneficial to him or herself.

40. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 40Duress Forcing a party to enter into a contract under fear or threat (voidable contract) Threatened act must be wrongful or illegal. Improper Threat. –Threat to exercise legal rights (criminal or civil suit). –Economic or physical.

41. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 41 Adhesion Contracts Overwhelming bargaining power of offeror who has exclusive power to create contract. Signer must agree to receive commodity or service. Standard form contracts (arbitration). –Case 8.5 Thibodeau v. Comcast Corp. (2006).

42. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 42 The Statute of Frauds To be enforceable, the following types of contracts must be in writing and signed: –Contracts involving interest in land. –Contracts involving “One year rule.” –Collateral or Secondary Contracts. –Promise made in consideration of marriage. –Contracts for the sale of goods priced at $500 or more.

43. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 43 Statute of Frauds Exceptions: –Partial Performance. –Admissions. –Promissory Estoppel. –Special Exceptions under the UCC.

44. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 44 Third Party Rights There are two important exceptions to the rule of privity of contract: –A party to a contract may transfer the rights arising from the contract to another or to free himself or herself from the duties by having another person perform them. The first of these actions is referred to as an assignment of rights and the second, delegation of duties. –Where a contract involves a third party beneficiary contract.

45. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 45Assignments Generally, all rights can be assigned, except in the following circumstances: –When assignment is expressly prohibited by statute (for example, worker’s compensation benefits). –When a contract is personal in nature (unless all that remains is a money payment). –Where the assignment will materially increase or alter the risk or duties of the obligor. –If a contract stipulates the right cannot be assigned, then ordinarily it cannot be assigned.

46. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 46Delegations A delegation is the transfer of duties under a contract to a third party (the delegatee), who then assumes the obligation of performing the contractual duties previously held by the one making the delegation (the delegator). A valid delegation of duties does not relieve the delegator of obligations under the contract. –If the delegatee fails to perform, the delegator is still liable to the obligee.

47. THE LEGAL ENVIRONMENT TODAY Miller Cross 5 th Ed. © 2007 by West Legal Studies in Business / A Division of Thomson Learning 47 Third Party Beneficiaries A third party beneficiary contract is one made for the purpose of benefiting a third party. Third party beneficiaries can be categorized into: –Intended beneficiaries, or –Incidental beneficiaries.