Contracts

FORMATION OF A CONTRACT
A contract consists of one individual making an offer,
another accepting the offer, and the existence of consideration
between the contracting parties.
OFFER
An offer is the expression of a willingness to enter into a
bargain. An offer must be directed to a particular offeree
and be sufficiently clear so as to justify another individual
in the belief that acceptance of the offer would constitute
an agreement. Although an offer need not set forth all
terms of the potential bargain (even the price may be left
to be later determined), a valid offer must identify the
fundamental elements of the proposed agreement. An
offer may be revoked at any time before it is accepted or
before it is reasonably relied upon by another individual.
ACCEPTANCE
Acceptance of an offer is the communication by the
offeree of mutual assent, that is, the agreement to be
bound by the terms of an offer. An offer may be accepted
only by a person to whom the offer was directed and only
before the offer terminates or is revoked. A valid acceptance
must be communicated to the offeror by the same or
similar means under which the offer was communicated,
and must be unequivocal to make the agreement binding.
At common law, it is generally held that any deviation
from the terms of the offer is not an acceptance, but rather
a rejection and a counteroffer. If the offer identifies a specific
mode of acceptance, such as form, date, time, or
place, that mode must be followed for an acceptance to be
valid. Generally, an acceptance is not effective until it
comes into the possession of the offeror, although some
states employ the mailbox rule, which makes acceptance
sent by U.S. mail effective upon its deposit in the mail. If
an offer specifically invites acceptance by performance of
a specified act, performance of that act by the offeree constitutes
acceptance without notification of the offeror.
Except in very limited circumstances, such as where the
parties have a pattern of previous dealings or where it
would be inequitable to find otherwise, silence does not
constitute acceptance.
CONSIDERATION
An offer and acceptance alone do not create a valid and
binding contract. A third element, consideration, must
exist. Consideration is a bargained-for exchange, that is,
the existence of mutuality of obligation. Both parties must
derive some benefit—or, alternatively, both parties must
experience some detriment or forbearance—for a contract
to exist. Without consideration, an offer and acceptance
represent merely a naked, unenforceable promise.
While the existence of consideration is critical to the
enforceability of a contract, the quantity or quality of consideration
is immaterial. Generally, courts are not concerned
with the value or adequacy of consideration and
will not interfere with a bargain entered into between the
parties because of insufficient consideration. Certain acts
or forbearance cannot constitute consideration. A preexisting
duty to perform or refrain from performing may
not be consideration for a contract. Therefore, fulfilling
an existing contractual obligation or refraining from an
unlawful act cannot constitute consideration. An exception
to this rule is that the agreement to pay a preexisting
debt may be consideration. A promise to make a gift is not
consideration, nor is a moral obligation. A promise not to
sue, so long as the right to sue actually exists, may be consideration.
DEFENSES
In its most basic form, a contract exists where there is an
offer, an acceptance of the offer, and consideration to support
the contract. Despite the existence of these three elements,
enforcement of a contract may be denied if a
sufficient defense to the formation of a contracts is present.
In order for an individual to enter into a contract,
that person must have the legal capacity to do so. At common
law, minors, individuals who are mentally ill, persons
under the influence of alcohol or drugs, and those under
a legal guardianship lack legal capacity to contract. The
rule as to minors is that a contract of a minor is voidable,
not void. That is, a minor has the option to make a contract
valid or not. However, if a minor enjoys the benefit
of a contract, the minor is obligated either to repay the
other party or to fulfill the minor’s obligations under the
contract. In addition to capacity, an individual must have
the legal competency to enter a contract. Competency is
generally defined as the mental ability of a party to contract.
In other words, a legally competent person is one
who possesses the ability to recognize and understand the
contractual obligations that will result. Courts will assume
that capacity and competency exist until it is proved otherwise.
If the parties to a contract make a mutual mistake
with regard to that contract, such as a mutual misunderstanding,
there is no mutual assent and therefore no contract.
Clerical errors, known as scrivener’s errors, will
generally be corrected by a court. That is, rather than finding
the contract invalid, the court will merely correct the
error.
A contract that is based on a fraudulent misrepresentation
of a material term is unenforceable. A fraudulent
misrepresentation is material if the maker intended for the
misrepresentation to induce the other party to enter the

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 155
Contracts
contract and if the misrepresentation would likely induce
a reasonable person to so enter the contract.
Duress may make a contract unenforceable. Physical
duress, or forcing a person to accept an offer, invalidates
the contract, while the threat of physical harm makes the
contract voidable at the election of the victim. Courts are
divided on whether economic duress is sufficient to deny
the enforceability of a contract.
A contract that is entered into under undue influence
is also voidable at the election of the victim. Undue influence
exists where one improperly takes advantage of one’s
relationship with another to coerce the other person to
enter a contract. Examples are the influence that an adult
child may have over an elderly parent who is dependent
on the child for care, or the reliance of an unsophisticated
individual on a sophisticated adviser, where the adviser is
aware of the reliance.
As a general rule, an illegal bargain is void as a matter
of law and may not be enforced. Therefore, a contract to
commit murder, to rob a bank, or to steal a car is void as
a matter of law.
A contract may be void because enforcement of the
contract would be unconscionable. It is important to
understand that mere disproportionality of the benefits of
a contract, no matter how great, does not make the contract
void as unconscionable. Unconscionability may be
found only where there is grossly disproportionate bargaining
power to the extent that one of the parties had virtually
no choice in accepting the terms of the contract.
Contracts are rarely found to be unconscionable unless a
significant public policy issue is involved.
CONTRACT INTERPRETATION
An offer, acceptance, and consideration must be present
to form a contract. The defenses to contract formation, as
discussed above, may be used to show that no contract
exists. However, even if it is shown that a contract does
exist, questions may arise as to the content and meaning
of that contract.
RULES OF CONSTRUCTION
In interpreting contracts, courts generally follow certain
fundamental rules of construction. Under the four corners
rule, courts will restrict their analyses to the written terms
of the agreement itself, wherever possible. Ambiguities
will be construed against the drafter. Courts will generally
seek to harmonize the terms of a contract in a manner that
makes those terms consistent. Courts will generally find
that specifics in a contract will control over generalities.
Words and phrases used in a contract are given their plain
meaning absent evidence to the contrary.
PAROL EVIDENCE RULE
The parol evidence rule provides that if the parties to a
contract intended for their contract to be a complete integration,
that is, if the parties intended that the written
agreement be the full extent of the understanding between
them, then evidence other than the contract itself may not
be admitted to contradict the written terms. Therefore, in
interpreting a contract, the court should generally not
look beyond the contract itself for interpretation. The
parol evidence rule permits evidence intended to prove or
disprove the legitimacy of contract formation, such as evidence
showing a party’s capacity or showing fraud or
mutual mistake, but prohibits evidence intended to vary,
contradict, or change the terms of the written agreement.
Of course, if a contract refers to another document, that
other document may be admitted to explain the terms of
the contract at issue.
STATUTE OF FRAUDS
A common mistake is the belief that oral contracts are not
enforceable. In fact, most oral contracts, if they fulfill all
of the requirements of a contract, are indeed enforceable.
However, the statute of frauds requires that in certain specific
circumstances, contracts must be in writing. While
the requirements vary from state to state, generally the
statute of frauds requires the following contracts to be in
writing: contracts by executors, administrators, or other
personal representatives; contracts in consideration of
marriage; contracts for the sale of real estate; contracts for
the sale of goods exceeding $500; and contracts that will
not be performed within one year of the making of the
contract. The statute of frauds generally does not require
any particular written form, and generally a contract will
suffice so long as it identifies the parties, describes the subject
matter, states the essential and material terms, states
that consideration exists, and is signed by the party against
whom enforcement is sought.
REMEDIES AND DAMAGES
Throughout this article, reference has been made to the
court’s enforcement of a contract. This, of course, begs the
question of what course of action may be taken to enforce
a contract, to repay the victim of a breach of contract, or
to punish those who breach.
Generally, the victim of a breached contract is entitled
to be made whole, or put in the same position as that
party would have been in had the contract been fulfilled.
Commonly, this is done by forcing the breaching party to
pay the aggrieved party compensatory damages. Compensatory
damages are intended to compensate the nonbreaching
party for the actual damages suffered.
Normally, compensatory damages are measured by the

156 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION
Cooperative
party’s expectancy, or what the parties should have reasonably
foreseen as flowing from the breach. Expectancy
damages are often described as conferring the benefit of
the bargain upon the nonbreaching party. Where
expectancy damages are difficult to determine or otherwise
impractical, a party may receive reliance damages,
which are intended to compensate for the losses incurred
in relying on the breaching party’s fulfillment of the contract.
A third alternative for compensation is restitution,
where the breaching party must compensate the victim for
the benefit conferred upon the breaching party.
Liquidated damages are a method used by contracting
parties to estimate the damages that will result in the
event of a breach. Liquidated damages may not serve as a
penalty against the breaching party, but so long as they are
a reasonable estimate of the damages that would be suffered
by the nonbreaching party, they will be enforced. A
clause in an apartment rental contract that requires a
breaching party to pay two months rent is a common
form of liquidated damages.
Punitive damages are those intended to punish the
breaching party. Punitive damages are available only in
very rare cases; they generally are not awarded in contract
disputes.
Finally, equitable relief is available to nonbreaching
parties where none of the above remedies would be sufficient.
Under the concept of equity, a court may take corrective
action other than by awarding money. In rare
circumstances where none of the above described compensatory
damages would be sufficient, a court may order
specific performance. That is, the court will order the parties
to fulfill their obligations under the contract. This
method is not favored because of the practical difficulty of
enforcement, but in some cases, such as the purchase of
real estate, art, and the like, it is the only remedy that is
sufficient. Also available is an injunction, which is a court
order preventing a party from taking further action, such
as a continued breach of a contract.