US Contract Law

While topics in contract law may be universal, this book will focus primarily on the American (USA) law of contracts.

This book discusses the legally binding obligations that parties can voluntarily enter into and how the courts deal with enforcing those obligations.

Note: This is an extremely early version and is likely to contain mistakes. This page is not a substitute for legal representation. Also, this is a general overview of contract law as it is practiced and enforced in the United States. The details may be different depending on which State(s) is(are) involved. Nevertheless, the writers encourage every person to acquaint themselves with the principles of a legal system that governs nearly all sales and transactions. The world is, after all, a "global marketplace."

Legal Theories of Contracts

What is a Contract?

     A working definition of Contract comes from the American Law Institute's 
     Restatement 2nd:

     § 1. Contract Defined:

     A contract is a promise or a set of promises for the breach of which the law gives a remedy, 
     or the performance of which the law in some way recognizes as a duty.

Another definition comes from the Uniform Commercial Code (UCC), which specifically covers contracts for "Goods" (instead of services):

     § 1-201(11) [Revised § 1-201(11)]: 

     “Contract” means the total legal obligation which results from the parties’ 
     agreement as affected by this Act and any other applicable rules of law. 

Both of these definitions make clear that not all promises or agreements are contracts. The promises or agreements that are contracts are the ones the legal system will enforce. That definition certainly appears circular: which ones will our legal system enforce?

That enforcement mechanism kicks in when a contract has been formed and it has been breached. The legal system is then asked to supply a remedy. These concepts of formation, breach, and remedy will play a large part in our discussion. While not always taken in that order, those are also the major topics around which your Contracts course is organized. And they form the basis for a claim for breach of contract, as we will now see.

Was There a Breach of Contract?

These three elements of a claim for breach of contract reflect the major topics of Contract Law:

     The first element is called Formation.

     The second element is called Performance and Breach.

     The third element is called Remedies.

The only other major topic in Contracts is Third Parties. Contracts is so much fun that one person is a party! It takes two to make a contract, however, so the first two parties are the parties to the contract. The "Third Party" is a party who is not a party to the contract.

It is clear that the parties to a contract have certain rights and obligations towards each other as defined in the contract. Sometimes third parties can have rights and obligations by virtue of the contract as well. The parties to the contract may have intended for the contract to benefit a third party, in which case the third party would be a beneficiary of the contract (third party beneficiary). The parties to the contract might also seek to assign their rights under the contract or to delegate their duties under the contract to a third party (assignment and delegation).

To have a claim of breach of contract succeed, the plaintiff must prove that all the elements of a claim are satisfied. To defeat the plaintiff's claim, the defendant needs to knock out only one element. You will find it helpful when analyzing Contracts cases to figure out which element the defendant is contesting.

Sources of Contract Law

Contracts always involve the future. Problems frequently arise because events did not turn out as one or both of the parties had anticipated and they look to contract law to provide the solution for that particular situation. Where do we go to find the rules to resolve contract disputes?

There is a hierarchy of sources. [Insert chart here.]

The principal state statute you will deal with in Contracts is the Uniform Commercial Code (UCC or Code). The Code has a number of parts, called Articles, that apply to different transactions. You will be concerned with Article 1, which contains General Provisions that apply to the whole Code, and Article 2, Sales.

The UCC is an odd duck. One of its principal goals, expressed in § 1-102(2)(c) [Revised § 1-103(a)(3)], is “to make uniform the law among the various jurisdictions.” You would think the easiest way to make the law uniform would be to enact a federal law. But that is not the way of the Code. The Code is promulgated by two groups, the National Conference of Commissioners on Uniform State Law (NCCUSL), and the American Law Institute (ALI). After both of these groups have approved proposed statutes that are drafted by a committee of experts, NCCUSL then takes the proposal to each state, asking the state to enact it. If every state enacts the same law, then the law is uniform. NCCUSL and the ALI have had tremendous success with the UCC, getting most of it enacted in every American jurisdiction.

However, the UCC is not entirely uniform. Legislatures are of course free to change the proposed version in the course of enacting the law, and most legislatures have taken advantage of that freedom. The CALI lessons will cite to the Uniform version of the Code, but you should be aware that your state may have a nonuniform provision.

Application of UCC Article 2

The subject matter of UCC Article 2 is, as expressed in § 2-102, “transactions in goods,” and generally, the sale of goods. So whenever your facts indicate that the contract involves the sale of goods, you should go to UCC Article 2 for the rule. But what are “goods”? Section 2-105(1) provides this definition:

     (1) "Goods" means all things (including specially manufactured goods) which are movable
         at the time of identification to the contract for sale other than the money in
         which the price is to be paid, investment securities (Article 8) and things in
         action. "Goods" also includes the unborn young of animals and growing crops and
         other identified things attached to realty as described in the section on goods to
         be severed from realty (Section 2-107).

So goods are movable. All well and good. But if a transaction is a hybrid, involving both goods and non-goods, do we apply Article 2? One approach to this problem, from the case of Bonebrake v. Cox, 499 F.2d 951 (8th Cir. 1974), asks us to determine whether the sale of goods was the "predominant purpose" of the transaction. If it was, then Article 2 is applied to the entire transaction.

The Common Law

What if we have a sale of goods (please double check this info as it is not as 'good' as it would appear), but we find no rule in Article 2 that addresses our issue? For example, Farmer claims that because he was drunk when he made the agreement with Cereal Company, the agreement is not binding. UCC Article 2 has no rule on whether agreements a person makes when drunk are enforceable. Where do we go to find the applicable rule? UCC § 1-103 (Revised § 1-103(b)) tells us:

§ 1-103. Supplementary General Principles of Law Applicable. Unless displaced by the particular provisions of this Act, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other validating or invalidating cause shall supplement its provisions.

Where do we find these “principles of law and equity”? In a few states, notably Louisiana, which has a French Civil Code tradition, and California, which adopted the Field Code developed by law reformer David Dudley Field in the 19th century, general principles of law, including contract law, are found in statutes. These statutes, however, are often broadly stated and will not answer your question. For example, if you were researching in California whether agreements a person makes when drunk are enforceable, you would find this applicable statute in the Civil Code:

§ 39. Conveyance or contract; rescission; rebuttable presumption.

(a) A conveyance or other contract of a person of unsound mind, but not entirely without understanding, made before the incapacity of the person has been judicially determined, is subject to rescission ....

In most jurisdictions, general principles of contract law are a matter of common law; that is, the tradition of judge-made law handed down in judicial opinions. In a state where contract law is found in a code, like California, there is still a strong common law tradition because the courts must interpret the code to determine whether it is applicable to a particular situation.

In theory, if you wanted to know what the common law rule is, such as whether an agreement made by a person when drunk is enforceable, you would have to read all the cases on point and attempt to distill the rule from them.

In practice, someone has already done that work for you. Enter the Restatement. The Restatements are another project of the American Law Institute. As suggested by the title, a Restatement represents a distillation of the principles of law into “black letter” rules that can be easily, perhaps too easily, stated. We are blessed with an excellent Restatement in our area, the Restatement (Second) of Contracts.

CALI Contracts lessons will occasionally refer to a section from the Restatement (Second) of Contracts (and since it is the only Restatement we will refer to, we may often just call it "the Restatement"). But don’t assume that just because the Restatement states a rule that it is “the law.” Each Restatement is written by a committee of lawyers, judges, and law professors. It reflects the opinion of the authors as to what the general principle is or should be. It is not mandatory authority because it is not enacted by a legislature, and it may not reflect the rule in a particular jurisdiction.

Federal Courts, State Courts, and the Applicable State Law

Sometimes the contracts cases you study have been decided by a federal court. In those cases, it is helpful to ask how the court got jurisdiction. Frequently (but not always) the cases are in federal court because of diversity jurisdiction; that is, the federal court takes jurisdiction when the plaintiff and the defendant are citizens of different states.

Default Rules and Freedom of Contract

Have you studied Erie R.R. v. Tompkins, 305 U.S. 673 (1938), in Civil Procedure yet? For our purposes, the gist of it is that the Supreme Court declared that there is in general no federal common law of contracts. Whether a case is heard in federal court or in state court, the court will apply the law of the relevant state.

Which state’s law will the court apply? That question is answered by the choice of law rules. You may eventually study that subject in a course called Conflicts of Law. According to the Restatement (Second) of Conflict of Laws (yes, there is a Restatement for that, too), the general rule for choice of law in a contracts case is found in § 188:

     § 188. Law Governing In Absence Of Effective Choice By The Parties

     (1) The rights and duties of the parties with respect to an issue in contract are determined by the local law of the state which, with respect to that issue, has the most significant relationship to the transaction and the parties under the principles stated in § 6.

     (2) In the absence of an effective choice of law by the parties (see § 187), the contacts to be taken into account in applying the principles of § 6 to determine the law applicable to an issue include:
           (a) the place of contracting, 
           (b) the place of negotiation of the contract, 
           (c) the place of performance, 
           (d) the location of the subject matter of the contract, and 
           (e) the domicil, residence, nationality, place of incorporation and place of business of the parties. These contacts are to be evaluated according to their relative importance with respect to the particular issue.

     (3) If the place of negotiating the contract and the place of performance are in the same state, the local law of this state will usually be applied, except as otherwise provided in §§ 189-199 and 203.

According to Restatement (Second) of Conflict of Laws § 188, the general rule is that the local law of the state that "has the most significant relationship to the transaction" will govern. There is an even narrower rule for contracts involving the sale of chattels (goods). Restatement (Second) of Conflict of Laws § 191 provides:

     § 191. Contracts To Sell Interests In Chattel

     The validity of a contract for the sale of an interest in a chattel and the rights created thereby are determined, in the absence of an effective choice of law by the parties, by the local law of the state where under the terms of the contract the seller is to deliver the chattel unless, with respect to the particular issue, some other state has a more significant relationship under the principles stated in § 6 to the transaction and the parties, in which event the local law of the other state will be applied. 

We’re not going to go into those rules in detail, but we will use this opportunity to emphasize the important principle called Freedom of Contract. Contract law is generally not regulatory. It is facilitatory -- it facilitates the making of agreements between the parties. When we speak of the rules of contract law, we don’t mean rules in the sense of inflexible commandments. We are generally speaking of “default rules” -- the rules that apply in the absence of the parties’ agreement. In fact, this point is nicely captured by the caption to Restatement (Second) of Conflict of Laws § 188: Law Governing In Absence Of Effective Choice By The Parties.

Unless it is a formation rule or a matter of policy is involved, the parties are generally free to use freedom of contract to change the default rule. This principle is stated in UCC § 1-102(3) [Rev. § 1-302(a)], which provides that "The effect of provisions of this Act may be varied by agreement, except as otherwise provided in this Act. "

Valid Contract Formation

Basic Vocabulary

Agreement

An agreement consists of an offer and an acceptance, this sometimes referred to as mutual assent.

Offer

According to the Restatement of Contract Law, "an offer is a manifestation of an intent to be contractually bound upon acceptance by another party." In other words, when a potential party to a contract makes others aware that he wants to enter into a contract, an "offer" has been made.

An offeror must spell out enough terms such that the offeree can merely say "I accept." For example, "I'll buy your house" isn't enough to constitute a valid offer. At a minimum, a price and boundaries for what land will be sold must be included within the offer. However, there are jurisdictions in which an advertisement stating that a car will be sold for a certain price is considered legally binding on the advertisers.

Offers can be made with an expiration date on them. If an offer is made with no explicit expiration date, the courts will create one based on local business customs, how the parties have handled in the past, and the nature of the contract.

Separate agreement can be made to extend the length of time of previous offers. The agreements, usually called "option contracts", bind the original offeror to keep his offer valid and exclusively available to the original offeree for some period of time, usually in exchange for some amount of money.

It is important to distinguish between an offer and merely an invitation to treat. An invitation to treat is generally an offer to the world, such as goods on display in a shop, or an advertisement in a newspaper. Where an invitation to treat occurs, it is the one wishing to purchase a product that makes the legal 'offer' to the owner who then 'accepts'.

Acceptance

Accepting the terms of the offer.

Consideration

This element is broken down into two parts: First, the consideration given in return for the promise or performance must be of legally sufficient value. It may be money, an action the party has no legal duty to do, or not taking an action the party has a legal right to take. Second, the consideration must consist of bargained-for exchange. This element distinguishes contracts from gifts. This is a continuance of the concept of mutual assent, a meeting of the minds between offeror and offeree. Note that "legally sufficient value" does not save either party from an unwise contract. Under the doctrine of freedom of contract, people are free to bargain and contract as they wish. Just because one party may think their offer or acceptance is unequal to the value of consideration they got in return does not void the contract.

Consideration is something of sufficient, but not necessarily adequate, value that is exchanged between the parties. As long as the consideration has sufficient value to the offeror then this is deemed to be sufficient consideration.

Past consideration generally is not acceptable. This is that the consideration must take place in light of the offer and acceptance. As with English law there is always the exception. In cases such as a window cleaner, past consideration is necessary (a window cleaner will clean the windows first then ask for payment later in respect of the performance that has already occurred).

The Bargaining Process

This section deals with the essential elements of the bargaining process. There are basically two requirements: (1) Assent and (2) Definiteness.

Assent

Mutual assent to be bound is an essential element of contract formation. Parties may achieve mutual assent through a bargaining process which involves an offer and an acceptance. So, identifying the offer and acceptance can be the method by which mutual assent is established.

There are three essential elements to an offer. Res. 2d Contracts sec. 24. All must exist before there can be a legally valid offer.

Once you decide that an offer has been made, next determine if the offer is revocable. An offer can become irrevocable by formation of an option contract, Res. 2d Contracts sec. 25, by beginning to perform under an offer that looks to acceptance by performance only, Res. 2d Contracts sec. 45, by detrimental reliance, Res. 2d Contracts sec. 87(2), by statute, including a firm offer under U.C.C. 2-205, and by a writing signed by the offeror which recites a purported consideration and proposes a fair exchange. Res. 2d Contracts sec. 87 (a).

If the offer can be terminated before acceptance, you must next consider whether an offeree's power of acceptance has been terminated by revocation, rejection (including a counteroffer), lapse, or death or incapacity of the offeror or offeree. Res. 2d Contracts sec. 36. If the offeree's power of acceptance has been terminated, no acceptance is possible. If it hasn't then consider if there has been an acceptance. A valid acceptance requires that there be a manifestation of present intent to accept, and that the acceptance be made in the manner invited or required by the offer. Res. 2d Contracts sec. 50. An offer can require that the offeree can accept only by making a promise. If it does, then no other means of acceptance is possible. Similarly, if the offer requires a performance only, then no other means is possible. Res. 2d Contracts sec. 30.

Objective vs. Subjective Assent

The cases are legion that require a "meeting of the minds" for the formation of a valid contract. If taken literally, it would require that all of the parties to a valid contract must simultaneously intend to bind themselves to the contract. Does modern contract law require a "meeting of the minds?" If so, what exactly does it mean?

The Offer An offer is defined as a manifestation of willingness to enter into a bargain so made as to justify another person in understanding that her assent to that bargain is invited and will conclude it. Res. 2d Contracts sec. 24. A legally sufficient offer requires a manifestation of present intent. Because of the nature of this objective test of intent, modern cases require that one look not only at the words used by the purported offeror, but also at all of the surrounding circumstances to determine whether a reasonable person in the position of the purported offeree would understand that the offeror intended to be bound. Murray p. 69. Farnsworth p. 135. Offers can be oral, written, or implied by conduct.

Legal Capacity

Both parties to a contract must have contractual capacity. This means they must be seen as competent persons in the eyes of the law. Common qualifiers are: Being of the age of majority (18 in the United States), possessing the freedom of choice (free of outside influence such as duress, undue influence, and intoxication), and being of sound mind at the time of the contracts formation (on this topic an entire book can be written).

Legality

The contract's purpose must be legal, for example murder is illegal. Therefore you cannot form a contract which to be completed requires someone to murder another person as the purpose of the contract is to conduct an act which is not legal. This means that contract law will not apply.

This is the strict sense of the legality dependant upon state, so an act legal in one state may result in a void contract if contracted elsewhere.

Relieving Party from Promise

Duress

Restraint or danger, actually inflicted or impending, which is sufficient in severity or apprehension to deprive a person of free choice, destroy his volition, or obtain consent only in form.

Under the law, a person is not guilty of a crime if he participated only because he believed, and had good reason to believe, that he would be seriously harmed if he did not participate and had no other way of escaping serious harm. The burden is on the government to prove the defendant's guilt beyond a reasonable doubt. To find someone guilty, therefore, there must be proof beyond a reasonable doubt that when he participated in the offense, he did not have a reasonable belief that such participation was the only way he could save himself from serious harm.

An actual or a threatened violence or restraint of a man's person, contrary to law, to compel him to enter into a contract, or to discharge one.

Some divide duress into two sorts:

First. Duress of imprisonment, where a man actually loses his liberty. If a man be illegally deprived of his liberty until he sign and seal a bond, or the like, he may allege this duress, and avoid the bond. But, if a man be legally imprisoned, and either to procure his discharge, or on any other fair account, seal a bond or a deed, this is not by duress of imprisonment, and he is not at liberty to avoid it.

Second. Duress per minas, which is either for fear of loss of life, or else for fear of mayhem, or loss of limb,; and this must be upon a sufficient reason. In this case, a man way avoid his own act. Lord Coke enumerates four instances in which a man may avoid his own act by reason of menaces: 1. For fear of loss of life; 2. Of member; 3. Of mayhem; 4. Of imprisonment.

It is not every degree of violence or any hind of threats, that will invalidate a contract; they must be such as would naturally operate on a person of ordinary firmness, and inspire a just fear of great injury to person, reputation or fortune. The age, sex, state of health; temper and disposition of the party, and other circumstances calculated to give greater or less effect to the violence or threats, must be taken into consideration.

A contract by violence or threats, is void, although the party in whose favor the contract is made, and not exercise the violence or make the threats, and although he were ignorant of them.

Violence or threats are cause of nullity, not only where they are exercised on the contracting party, but when the wife, the husband, the descendants or ascendants of the party are the object of them.

If the violence used be only a legal constraint, or the threats only of doing that which the party using them had a right to do, they shall not invalidate the contract A just and legal imprisonment, or threats of any measure authorized by law, and the circumstances of the case, are of this description.

But the mere forms of law to cover coercive proceedings for an unjust and illegal cause, if used or threatened in order to procure the assent to a contract, will invalidate it; an arrest without cause of action, or a demand of bail in an unreasonable sum, or threat of such proceeding, by this rule invalidate a contract made under their pressure.

All the above articles relate to cases where there may be some other motive besides the violence or threats for making the contract. When, however, there is no other cause for making the contract, any threats, even of slight injury, will invalidate it.

Statute of Frauds

The Statute of Frauds is a collective term describing the various statutory provisions which render unenforceable certain types of contracts unless they are evidenced by a writing.

Contract Interpretation

Parol Evidence Rule

The nutshell version of this rule: when drafting a contract -- write what you mean, and mean what you write. If a judge looking at the contract can figure out what the parties' intentions were, then there is no need to have the parties give any testimony whatsoever on what they meant when they drafted the contract. If a judge cannot reasonably understand the parties' intentions on a point of contention, then oral testimony, also called parol evidence, is allowed. See the examples below.

It can happen that once the parties to a contract are somewhat along in their contractual relationship that a dispute will arise regarding what the contract requires one or both parties to actually do. For instance, say Jane hires Bob to paint her house for $5,000.00 with the job to start in August, and the written contract states exactly that with no other wording regarding any sort of time requirement for getting the work done. Jane then tells Bob that she wants the job finished by the end of August because she has family visiting from out of state on September 1st. Bob tells Jane that he completely understands her situation. Summertime is a very busy time for Bob, so he starts the job on August 31st to meet the deadline, but he then leaves the job to paint other houses and, as a result, he does not finish until mid-October. Jane is infuriated and embarrassed that her visitors had to deal with looking at the partially painted house and she firmly believes that Bob knew he would not be able to get the work done in August as she asked. So, she refuses to pay half of the agreed amount ($2,500.00). Bob files a lawsuit.

Bob tells the judge that he completely abided by the contract and did exactly as he was required to do. Jane says that Bob knew that she wanted him to start and finish in August, despite the fact that the contract said Bob only needed to start in August. The judge believes that both Jane and Bob are telling the complete truth, but finds that Bob is entitled to the remaining $2,500.00 due on the contract. Here's why Jane loses: the contract did not state that Bob must finish in August; It merely stated he must begin in August. When a judge can look at the plain language of a contract and from that can understand what the duties are for each party, the Parol Evidence Rule prevents the judge from taking into account oral evidence as to what a party or the parties actually meant. In other words, the written word trumps the spoken. In this case, the judge, even if he or she feels it is unfair to Jane, does not need testimony to understand that the contract only required Bob to start in August -- not complete the job in August.

But what if the contract stated that Bob must start on August 15th, and that he must do the work quickly and in a workmanlike manner until completion. Before signing the contract, Jane tells Bob of the reason for the "quickly" requirement -- that is she has visitors coming on September 1st. Bob tells Jane that he completely understands. Bob does start on August 15th but does not finish until September 15th, and tells Jane that he did indeed proceed quickly as she requested. Jane withholds the $2,500.00 and, predictably, Bob files a lawsuit.

The judge, this time, would be very willing to hear the oral testimony of both parties because, while it is clear the parties contemplated some requirement for a finish date, it is unclear from the plain language of the contract what that date actually was. Looking at the contract, it is absolutely impossible to find a solid finish date, and the parties' expectations as to what that meant under the contract can only be derived from oral testimony. Jane's statement regarding her timetable and Bob's statement that he completely understood might be enough to convince a judge that the contract required Bob to be finished by August 31st.

To sum up in outline fashion: 1. If the contract is specific as to the point in dispute: no oral testimony is allowed. 2. If the contract is ambiguous as to the point in dispute: oral testimony is allowed.

Justifications for Nonperformance

Impossibility

when an act cannot be performed due to nature, physical impediments, or unforeseen events. It can be a legitimate basis to rescind (mutually cancel) a contract

Frustration of Purpose

Frustration of purpose is a term used in the law of contracts to describe a defense to an action for non-performance based on the occurrence of an unforeseen event which makes performance impossible or commercially impracticable. A common situation is that the subject matter of the contract - a house or a car for example - is unintentionally destroyed.

Remedies

Expectation Damages

Give the benefit of the bargain i.e. expected gain. 'For the party who has suffered a loss to be put in the position as if the contract's obligations had been performed.'

Reliance Damages

Restore to before contract. Repay any loss

Restitution Damages

Action off the contract. Party receives damages for the benefit they conferred on the other party, so as not to allow unjust enrichment. For the party who has suffered a loss to be put back in the position had the contract not been agreed at all - recovery of losses, as opposed to expectation damages, see above.

Punitive Damages

Punish breach. Usually only used for tortious breach; therefore, this is not a usual type of damages in Contracts Law. Policy: Breaching a contract can be efficient. The law does not wish to force all promises to be adhered to. It simply wishes to put the non-breaching party in the position he would have been in if the contract had been performed.

Specific Performance

Perform as promised. Complete the bargain Used only when damages can’t or won’t be sufficient. Specific performance is the very last resort that the English Legal System shall generally resort to. This is making a person carry out obligations agreed to under the terms of the contract. This is not a good option for either parties. The person is unlikely to perform tasks to a satisfactory standard for the Claimant and it is essentially like slavery for the Defendant whom is being made to carry out obligations.

Sources

Overview and Sources of Contract Law by Scott J. Burnham, Professor of Law, The University of Montana School of Law

Contract Formation I by Matthew C. McKinnon, Professor of Law, Michigan State University School of Law