Contract formation

Contract formation requires mutual assent to the same terms by the parties, generally manifested by an offer and acceptance. Current law favors an objective standard for determining a party's intent to be contractually bound. Thus, in general, communications are given the meaning that the recipient of the communication should have reasonably understood. Nevertheless subjective intent is relevant in determining whether the parties intended to be bound. Without such subjective intent, there is no contract. A validly formed contract must provide a basis for determining the existence of a breach and for giving an appropriate remedy.

What is an Offer?

An offer is a manifestation of an intent to be contractually bound upon acceptance by another party. An offer creates in the offeree the power to form a contract by an appropriate acceptance.

The following types of communications, which do not manifest an intent to be contractually bound, do not constitute offers:

1) opinions about future results, including professional opinions;

2) statements of intention (including letters of intent which merely memorialize negotiations);

3) invitations to submit a bid;

4) price estimates – however, where the estimate is deemed to be a factual misrepresentation because it was made by an expert, estoppel may be invoked if the offeree relied to his detriment on the estimate;

5) advertisements, catalogs and mass mailings – courts have ruled that it is unreasonable for one to believe that the merchant intends to be bound with all whom receive or read such literature unless the power of acceptance is clearly limited to the first person(s) that fulfills the act for which the incentive is offered;

6) auctions with reserve – an auction is "with reserve" unless announced to the contrary. In an auction with reserve, the auctioneer solicits offers in the form of bids. However, if the auction is announced to be "without reserve," the auctioneer's request for bids or his statement that an item will go to the highest bidder will be deemed an offer.

An offer is not valid until received by the offeree or his agent. If the offer has a stated time within which the acceptance must be made, any attempted acceptance after the expiration of that time will fail and will merely constitute a counter-offer by the offeree. If no specific time is stated within which the offeree must accept, it is assumed that the offeror intended to keep the offer open for a reasonable period of time, to be determined based on the nature of the proposed contract, trade usage, prior dealings and other circumstances of which the offeree knows or should know. Generally, the time for accepting an offer begins to run from the time it is received by the offeree. If there was a delay in delivery of the offer of which the offeree is aware, the usual inference is that the time runs from the date on which the offeree would have received the offer under ordinary circumstances. Generally, courts hold that in telephonic or face-to-face communications in which an offer is made, the offer lapses when the conversation terminates in the absence of a clear indication that the offer remains open beyond the conversation.

With limited exceptions, an offer is generally revocable at any time prior to acceptance. An offer may be revoked by any words that communicate to the offeree that the offeror no longer intends to be bound. An offer is also revoked by action that is inconsistent with the intent to be bound once the offeree learns of such inconsistent action.

An offeree's power to accept an offer is terminated by:

· the death or insanity of the offeror, even without notice to the offeree of such occurrence;

· death or insanity of the offeree, unless an offer is irrevocable, such as in the case of an option contract;

· death or destruction of a person or thing essential to performance;

· the offeree's rejection of the offer, which cannot be reinstated by the offeree's subsequent attempted acceptance;

· the offeree's counter-offer, which impliedly manifests a rejection of the offer;

· revocation of the offer;

· expiration of the offer.

What is an Acceptance?

Traditionally, the nature of the contract dictated whether the offer could be accepted by a return promise or by actual performance of the promised act.

In a unilateral contract, the offer empowers the offeree to only accept by complete performance of the promise. The offeree's failure to perform does not constitute a breach since no contract is formed until the offeree renders full performance.

In a bilateral contract, the offers empower the offeree to only accept by return promise. Bilateral contracts are formed upon the giving of the promise to perform an obligation in the future, and failure to fulfill such promise results in breach.

Under the modern approach, an offer invites acceptance by any means reasonable under the circumstances, unless otherwise indicated by language or circumstances. This approach reflects the fact that many offers do not specify whether acceptance is to be by full performance or promise.

Silence may not constitute an acceptance except where:

· based on prior dealings between the parties, it is reasonable that the offeree should notify the offeror if he does not intend to accept; or

· "where the offeror has stated or given the offeree reason to understand that assent may be manifested by silence or inaction, and the offeree in remaining silent and inactive intends to accept the offer";

The offeror is entitled to notice of the acceptance. Thus, even if the offeree effectively accepts an offer and a contract is formed, failure by the offeree to notify the offeror of the acceptance within a reasonable time may preclude the offerer from enforcing the contract.

An acceptance becomes effective according to the following rules:

1) the offeror may specify when the acceptance will be effective;

2) absent such specification, an acceptance is effective when sent, if sent by reasonable means, e.g., by an authorized medium and with proper postage and correct address;

3) if an acceptance is sent by means that are not appropriate or reasonable under the circumstances or if it is improperly dispatched, the acceptance will be effective upon receipt. However, if the acceptance is seasonably but improperly dispatched, it will still be deemed effective when sent if it is received within the time in which a properly dispatched acceptance would have been received;

4) in the case of option contracts, an acceptance is not operative until received by the offeror;

5) in transactions governed by the CISG, the acceptance becomes effective when it reaches the offeror.

In transactions governed by the CISG, a trivial variation of terms in an acceptance from those set forth in the offer does not prevent the formation of a contract unless the offeror objects (CISG art. 19).

A contract is formed with agreed terms and any standard terms that are not knocked out due to inconsistency. However, if one party objects to the knocking out of any of its standard terms, no contract is formed (UNIDROIT art. 2.11).

A rejection of an offer by the offeree is effective when received by the offeror. If an offeree dispatches more than one response to an offer, regardless of whether the rejection is sent before or after the acceptance, if the rejection is received later than when the acceptance was dispatched, a contract is formed since an acceptance is effective upon dispatch but a rejection is effective upon receipt.

Consideration

Consideration is a bargained-for performance or return promise which is given by the promisee in exchange for the promisor's promise. Consideration need not be furnished by or to the parties themselves as long as it is part of the bargained exchange.

Adequacy of consideration relates to whether the bargain involves an exchange of equal value. Generally, however, courts do not concern themselves with whether consideration is adequate, honoring the concept of freedom of contract. On the other hand, courts do require consideration to be "sufficient", which relates to whether there is a legal detriment incurred as part of a bargained exchange of promises or performances.

Statute of Frauds

Certain agreements must satisfy the statute of frauds, which requires the agreement to:

1) be memorialized in a writing or record;

2) be signed by or on behalf of the party against whom enforcement is sought;

3) indicate that a contract has been made between the parties;

4) state with reasonable certainty the essential terms of the unperformed promises, in the case of non-goods contracts;

5) specify the term of quantity, in the case of contracts for the sale of goods.

Approaches to Contract Intepretation

1) "Plain meaning" rule – if a writing or term appears to be unambiguous on its face, it must be interpreted solely on the basis of such writing. The majority of jurisdictions apply this rule, despite growing criticism.

2) Williston's rules ("reasonable person" approach) – if a writing is an integration, the meaning given to it as a whole or any individual terms therein is that of a reasonably intelligent person in the circumstances that surrounded the making of the contract. If the writing is not an integration and is unambiguous, the terms are to be interpreted by an objective test – the interpretations that a reasonable person would give them. If the writing is not an integration and is ambiguous, subjective intent of the parties is relevant.

3) "Reasonable expectations of the parties" approach – this approach, espoused by Corbin and incorporated by the Restatement and UCC, allows all relevant extrinsic evidence to assist in interpretation, including the subjective intent of the parties.

Void and voidable contracts

Certain defenses – generally those that affect assent – can render a contract voidable by the aggrieved party. Other defenses – typically those that pertain to law and public policy – may render a contract void. The distinction is not clear-cut; for example, while defenses such as incapacity, duress or mistake generally render a contract merely voidable, if the circumstances prevented a meeting of the minds, the contract will be deemed void. Likewise, contracts with an illegal purpose will generally be deemed void unless the parties are not in pari delicto.

The legal effects of a contract being deemed voidable as opposed to void are:

1) where a contract is merely voidable, the innocent party may enforce the contract, but the contract cannot be enforced against him. If a contract is void, neither party can enforce the contract;

2) rights in a voidable contract are transferable; rights cannot be transferred in a void contract;

3) if a party improperly transfers property to a bona fide purchaser for value, the injured party may recover the property if the contract governing the transaction is void but not if it was voidable;

4) voidable contracts may be ratified by the party with the power to avoid the contract once the reason for such avoidance – such as minor age, mental impairment, duress, undue influence or mistake – no longer exists. Void contracts cannot be ratified.

Defenses affecting assent

1. Incapacity to contract

a) Minors

Contracts entered into by a minor (an "infant") – one below the age at which state law deems persons to possess capacity to contract, currently 18 years old in most states – are generally voidable by the minor-party, even if he misrepresented his age. A minor can furthermore avoid contractual obligations for a reasonable time after attaining the age of majority. However, if he fails to disaffirm within a reasonable time, the contract will become binding against him.

b) Mental Impairment

Mental incapacity can result from mental illness or defect – e.g., senility, insanity, retardation – or drug or alcohol intoxication. A party that suffers a mental illness or defect at the time the contract is made may avoid the contract where the mental impairment prevented him from:

· understanding the nature and consequences of the transaction; or

· acting in a reasonable manner in relation to the transaction, and the other party had reason to know of his condition.

However, if the contract is made on fair terms and the other party was without knowledge of the mental illness or defect, the incapacitated party may be precluded from avoiding the contract where:

· the contract has been fully or partially performed; or

· the circumstances have changed such that avoidance would be unjust.

A party that was intoxicated when the contract was made may avoid the contract only if the other party had reason to know that, by reason of intoxication, the party was unable to understand the nature and consequences of the transaction or was unable to act in a reasonable manner in relation to the transaction.

2. Duress

If assent to a contract was obtained by coercion constituting duress, the contract may be avoided by the person subjected to the duress. An improper threat of harm that induces the other party to assent to contract terms constitutes duress. "Improper threat" is established where:

· the threatened act would harm the recipient and would not significantly benefit the party making the threat;

· the effectiveness of the threat in inducing the manifestation of assent is significantly increased by prior unfair dealing by the party making the threat; or

· what is threatened is otherwise a use of power for illegitimate ends.

The threat must be of sufficient gravity to make the contract voidable, determined based on an examination of the victim's experience, sophistication, age, and other relevant personal characteristics. The highest standard is applied in cases constituting "economic duress", such as refusals to do business with the victim.

3. Undue influence

A defense based on undue influence may arise where:

· one party takes advantage of the other party's position of weakness, e.g., based on age, illness, mental state, intoxication, etc., thus preventing the latter from exercising free will in the transaction; or

· one party breaches a fiduciary relationship with the other party.

Business contracts between an attorney and his client are presumptively invalid but can be overcome if the attorney demonstrates that:

1) the transaction was fair and equitable;

2) the attorney informed the client of the nature and consequences of the transaction;

3) the attorney fully disclosed his own interest in the matter; and

4) the attorney encouraged the client to obtain independent advice or rendered the client the type of advice that a disinterested attorney would have given a client.

4. Mistake

A mistake is an erroneous belief related to the facts as they exist at the time the contract is made.

a) Mutual mistake

The adversely affected party may void a contract based on mutual mistake made at the time of the contract formation where:

1) the mistake concerned a basic assumption on which the contract made;

2) the mistake materially affects the agreement; and

3) the adversely affected party does not bear the risk of the mistake.

b) Unilateral mistake

Common law provides that a party may avoid a contract based on a unilateral mistake where the mistake was palpable, i.e., the other party knew or had reason to know of the mistake, such as where the contract contains an egregiously erroneous recording of a price. If the unilateral mistake is not palpable, the aggrieved party may avoid the contract where:

1) enforcement of the contract against the mistaken party would be unconscionable; and

2) avoidance would not result in substantial hardship to the non-mistaken party.

5. Misrepresentation

a) Generally

An aggrieved party may avoid a contract based on misrepresentation where:

1) the assertion was either material or fraudulent; and

2) the person seeking to avoid the contract reasonably relied to his detriment on such assertion.

A misrepresentation is material if:

· it would be likely to induce a reasonable person to agree to the bargain, or

· the party who made the misrepresentation knew or should have known that it was likely to induce the other party to manifest assent to the bargain, whether or not a reasonable person would have been induced.

A misrepresentation is fraudulent if it was made with:

1) the intention of inducing the other party to rely on it, and

2) knowledge of its falsity or lack of adequate foundation for the representation. (scienter)

b) Misrepresentations of Law and Opinion

Misrepresentations of fact may render a contract voidable. Misrepresentations regarding the law or that constitute an opinion do not render the contract voidable, except where:

· there is a relationship of trust and confident between the parties (particularly important in cases regarding a misrepresentation of the law where the maker of the statement is a lawyer)

· the maker of the statement is in fact or claims to be an expert on such matter

· the maker of the statement has superior access to facts underlying the false opinion

· the statement is made by a third person posing as a disinterested person

· the statement is such that no reasonable person in the position of the maker of the statement could legitimately hold such opinion

Non-performance and defective performance

Any non-performance of a contractual duty which has become due constitutes a breach. An anticipatory repudiation of obligations also serves to breach a contract.

In contracts for the sale of goods, in addition to repudiation, a seller breaches the contract by offering a tender or delivery of non-conforming goods, and the buyer breaches by wrongfully rejecting goods, wrongfully revoking acceptance of goods, or failing to make a payment when due.

Discharge

A party's contractual duties may be discharged by the following types of occurrences:

complete performance; rescission of the contract; substitute contract; accord and satisfaction; novation; an account stated; avoidance of duties in a voidable contract; illegality; bankruptcy; rejection of proper tender; occurrence of a condition subsequent; breach by the other party; impracticability and frustration of purpose; failure of consideration.

I. Read the text and answer the questions.

1. How can contract be defined?

2. What is the difference between void and voidable contracts?

3. What is mistake? What types of mistakes may be found?

4. What is duress?

5. In what case may party's contractual duties be discharged?

6. What are approaches to interpretation of contracts?

7. What are the types of contracts?

8. What is an offer?

9. What is an acceptance?

10. How can an offer be expressed?

II. Define if the following sentences are true or false. Use the required information from the text above and correct the false statements.

1. Misrepresentations of fact may render a contract voidable.

2. If a minor fails to disaffirm within a reasonable time, the contract will not become binding against him.

3. Contract formation requires mutual assent to the same terms by the parties, generally manifested by an offer and acceptance.

4. A party that was intoxicated when the contract was made always avoids the contract.

5. All contracts are enforceable ab initio.

6. The distinction between void and voidable contracts is clear-cut.

7. Consideration is a bargained-for performance or return promise which is given by the promisee in exchange for the promisor's promise.

8. Any non-performance of a contractual duty which has become due constitutes a breach.

9. Mistake may be unilateral and multilateral.

10. The threat must be of sufficient gravity to make the contract voidable.

Date: 2015-01-29; view: 1446