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Understanding Contracts

Fanger & Associates LLC, An Ohio Law Firm

Contracts pervade our daily lives. When we marry, we enter into a contract. When we buy a home and have gas, electricity, and water furnished to the house, we sign separate contracts. When we buy food or clothing, or go to the doctor or dentist, we act under contracts. When we write a check we act under a contract with our bank to honor the check, and the check itself may fulfill our obligation under another contract. We earn our livelihood under contract. The daily business of not only our households, but of the world, is conducted under a series of contracts.

The law of contracts is governed by the common law with some significant areas governed by statute (particularly various business transactions). See Part VII, "Business Transactions." Because so many of our relationships with others are affected by the law of contracts, it is important to know what a contract is, the obligations created by contract, and how contracts may be enforced.

A contract is a legally binding agreement between two or more competent persons to do, or not to do, a particular thing. It is more than just a promise or an exchange of promises. The promises must be given in return for something.

The three basic elements to a contract are: (1) an offer; (2) an acceptance of the offer; and (3) sufficient consideration to support the offer and acceptance. In addition, there must be a reasonable certainty as to what the parties are to do, or not to do, when they are to do it, and what the consideration is. Finally, the parties must be competent to contract, that is, they must be of sufficient age, in reasonable possession of their wits, and not under legal disability.

The first requirement for a valid contract is that the parties have a meeting of the minds. A meeting of the minds is evidenced by an offer, and an acceptance of the offer. The second requirement is that the promise of each party is given in return for some benefit sufficient to justify the promise. This benefit is the consideration for the contract.

An offer can be made by words or acts. That is, it can be made specifically (in writing or orally), or it can be implied from the conduct of the person making the offer. A standard real estate contract contains an express, written offer to buy a particular piece of property. A householder who tells the boy next door she will pay him $5 to mow the lawn makes an express, oral offer. A person who goes to her doctor for treatment of a cold generally does not make a specific offer to pay in return for treatment, but her conduct implies an offer to pay for the doctor's services. An offer can be made by advertisement, though the usual advertisement is nothing more than an invitation to patronize the advertiser's establishment. The time for accepting an offer may be expressly limited, and the offer expires if not accepted within that time. If no time limit is specified, the offer must be accepted within a reasonable time. The offer may be revoked or withdrawn before acceptance.

Like an offer, an acceptance can be express or implied, written or oral. If a repairman responds to a call to come and fix a washing machine, his acceptance of the implied offer to pay for his services is implied from his responding to the call. When an offer specifies the manner in which it must be accepted, an attempt to accept it any other way may not be enough. In general, acceptance requires some affirmative act. An offeror usually cannot specify that the offeree's silence will constitute acceptance. Under Ohio law, a person receiving unrequested merchandise may keep it without payment. The law is directed at the practice of delivering unrequested merchandise with a statement that unless the merchandise is returned within a specified time, the person receiving the merchandise has accepted the offer to buy the merchandise and must pay for it. The law makes it clear that there is no obligation to pay for unsolicited merchandise.

The person to whom an offer is directed may reject the offer. The person may also make a proposal of her own, that is, make a counteroffer. A counteroffer wipes out all previous offers. Sometimes, an offer may be accepted, but with conditions attached. An acceptance with conditions is actually a counteroffer.

There are two ways of classifying consideration. Either the person making the promise (the promisor) gains some right or benefit in return for her promise, or else the person to whom the promise is made (the promisee) gives up some right or benefit in return for the promise. For example, if a buyer offers $2,500 for a car, and the seller accepts, the consideration for the buyer's promise to pay is the car, and the consideration for the seller's promise to sell is the money. In each case, the person making the promise acquires a benefit in return for her promise. Quite often, a sale is not closed immediately, but the property is held by a deposit. In this case, in return for the buyer's promise to forfeit the deposit if he does not complete the sale, the seller gives up the right to sell the property to someone else in the interim.

Consideration can be money, property, rights, services, or the promise to do (or not to do) certain things. For example, there have been occasions when the consideration for the transfer of valuable property among kin was the "love and affection" they bore each other. The promises the parties make to one another may be sufficiently binding that the promises themselves constitute adequate consideration. In such a case, the promises are said to have mutuality of obligation.

A contract cannot be enforced if its terms are so vague that no one can determine what to enforce. There is an offer and acceptance of sorts when, for example, Bill tells Lily that he will do something for Lily sometime in the future, and Lily agrees. However, there is no certainty as to what is to be done, no certainty as to when it is to be done, and no certainty as to the consideration for doing it. The contract (if there is one) could be unenforceable because of any one of these uncertainties.

In order for a contract to be binding, the parties to it must be competent to make it. A person cannot make a promise he cannot fulfill because of some legal or other disability. An insane person is unable to make a binding agreement. A minor under age 18 does not have full power to contract. Such persons are incompetent to enter into a binding contract. Disability (incompetence) cannot be used to gain an unfair advantage. If a person under disability fulfills her part of a supposed contract, the other party cannot repudiate the agreement. Similarly, a minor may not be able to repudiate a contract where there would be unfair loss to the other party. See Part X at "Family Rights and Obligations," and at "Minors and Their Rights."

Contracts may be formed from only one promise, or they may contain mutual promises. Under some circumstances, a contract may be enforced by a court action even before the time for its performance has arrived. The terms of a valid contract may be specific, or they may be implied from the conduct of the parties. Also, with some important exceptions, it makes no difference whether a contract is written or oral.

Agreements (contracts) may be classified into two general types: "unilateral" and "bilateral."

In a unilateral contract, there is only one promise, and it is contained in the offer. The offer is accepted by performance of the thing called for in the offer. For example, suppose a farmer offers a bulldozer operator $50 to remove some stumps. The bulldozer operator does not accept, saying he does not know when, or even if, he will have time, and anyway he is not sure $50 is enough. The farmer nevertheless leaves the offer open. At this point, there is no contract, and therefore nothing for either party to enforce. If the bulldozer operator subsequently removes the stumps, he tacitly accepts the $50 offer, the removal of the stumps is sufficient consideration for the farmer's promise to pay, and the contract comes into existence. If the farmer does not pay the $50, the bulldozer operator has a cause of action for breach of contract.

In a bilateral contract, the parties make mutual promises which are sufficient consideration for each other. Offer, acceptance, and consideration are present at the outset, even though the promises have yet to be performed. For example, suppose a manufacturer orders a piece of equipment from a machine tool company. In an exchange of letters, the parties agree to the specifications for the equipment, its price, and the date and manner of delivery and installation. The contract is in existence at this point, even though the equipment has not been delivered and no money has changed hands. There has been an offer and acceptance, and the promise of each party is sufficient consideration for the promise of the other party. Each party may now have a cause of action for an attempted disavowal of the agreement by the other party, or even for an expected (anticipatory) breach of the contract. That is, if it seems clear that a party is not going to perform its part of the bargain, even though the time for performance has not arrived, the other party may seek a remedy in court.

The terms of an enforceable contract are usually specific enough that it is an express contract. Sometimes, neither party really specifies what the terms are, but their actions are such that the conditions of the contract can be inferred. In such a situation, there may be an implied contract. More often, the contract and some of its terms will be express, but other terms must be implied. For example, a continuing contract for certain kinds of supplies may be somewhat vague as to the price for each delivery. Assume that a printer regularly buys a specific kind and quantity of paper, but the price of the paper fluctuates with supply. Because the contract is express in most respects and regularly performed, there is no doubt that it exists. In a dispute, however, a court may have to decide whether an implied condition was to continue to deliver the supplies at the original price, or to make each delivery at the current price without notice.

With some important exceptions, it does not matter whether a contract is written or oral. If the basic elements are present, an oral agreement is just as valid as a written agreement and enforceable in the same ways. The popular confusion on this point probably stems from the fact that the terms of an oral contract may be somewhat harder to prove than those of a written contract.

There are some instances where a contract must be in writing. First, a contract should be written where the parties have come to an understanding in negotiations that the final agreement will be in writing. (In this situation the contract should be reduced to writing even if it is a type of contract which would be valid and enforceable even if it was an oral contract.)

Second, the law requires that certain types of contracts be in writing. These are: (1) contracts to answer for someone else's debt, default, or wrongful act or omission; (2) contracts by the executor or administrator of an estate to use his (the executor's or administrator's) own estate to pay for damages attributable to the estate in which he is a fiduciary; (3) prenuptial agreements or contracts between engaged couples settling various questions of property and rights in consideration of marriage; (4) contracts for the sale of land or any interest in land; and (5) contracts which will not be fully performed (by at least one party) within one year. For example, a cosigner's agreement to guarantee repayment of a loan made to another is a promise to answer for the debt of another, and must be in writing. Similarly, many insurance policies are agreements to answer for the wrongful act or omission of another, and must be written. Also, a contract to buy a home is an agreement for the sale of land, and must be in writing. The requirement that these contracts be written comes from the old English Statute of Frauds. The basic concepts of this English statute have been incorporated in the Ohio statutes, and the statutes of other states. Further, the concepts of the English statute have been incorporated into the common law of still other states.

There are some other types of contracts which must be in writing even though not listed in the Statute of Frauds. One of the most important of these is a commercial contract for the purchase and sale of goods involving $500 or more. Thus, for example, a contract to buy equipment costing $500 must be in writing, or at least be evidenced by some kind of written memorandum.

The requirement that a contract be written does not mean that the contract must be formal. The contract can be plain or fancy. It might be many pages long, and printed or typewritten. It may have a fancy seal. It might be a sales slip which is no more than a memorandum of the contract of sale. It might be a few sketchy notes on the back of an old envelope.

As a general rule, a party to a contract is bound to do everything required under the agreement. If a party substantially fulfills the requirements of a contract, that party can enforce the contract against the other party. However, the party who substantially performed will probably be able to recover the value of such substantial performance and not the full contract price or value.

Partial performance which is not substantial performance may have the following effects. The party who provided only partial performance: (1) will not be able to recover for the value of the partial performance, and (2) will be liable to the other party for breach of contract.

In general, a party to a contract must do exactly as she promised. If she fails, she is not in a position to complain if the other party does not perform her part of the bargain. For example, suppose a contractor builds a garage measuring 20 feet square instead of 24 feet square as specified in the contract. The property owner is justified in refusing to pay for the job until it is done right.

Sometimes a contract specifies that a party is to perform his part of the agreement to the satisfaction of the other party, or to the satisfaction of a third party (such as an architect or engineer). In such cases, satisfaction is usually required, provided the other party or third person does not unreasonably withhold approval.

Historically, strict and exact compliance with a contract was required. Even a minor deviation from the terms of one party's promise would completely excuse total nonperformance by the other party, or would be grounds for the other party suing for breach of contract. Now, such strict compliance is unnecessary, and substantial performance is sufficient. If a party does not perform her part of a contract exactly, but does perform it substantially, the other party would not be justified in refusing to complete her part of the bargain. In such a case, the party who gives substantial performance can sue the other party for breach of contract. She cannot, however, demand the full contract value for her substantial performance, because it was not complete or perfect performance. She is entitled to recover only the value of what she actually did.

For example, suppose a customer orders a car with certain accessories. If the car is delivered with one or more of the accessories missing, the dealer is not entitled to the full contract price for the car. Arguably, delivery of the car may be substantial performance of the contract. If the buyer refused to pay, such refusal could be grounds for a breach of contract suit by the dealer. The dealer's recovery would be limited to the contract price of the car less the value of the missing accessories. The buyer might also be able to sue the dealer for specific performance or damages.

Anything less than substantial performance is called partial performance. For purposes of determining whether a party has lived up to her contract, partial performance is no performance at all. If a party's performance is not in substantial compliance with her side of an agreement, she cannot sue if the other party repudiates the contract. Moreover, the other party has a cause of action against her for breach of contract. If the injured party does sue, the defendant can set off the value of her partial performance against the damages resulting from her breach of contract.

For example, suppose a homeowner contracts with a tree surgeon to remove several dead trees from her property for an agreed price of $200. The tree surgeon fells the trees, leaves the fallen trees where they landed, and stops work. The tree surgeon has performed some work, but his work is only partial performance; he cannot collect the full agreed price for merely felling the trees. Nevertheless, if the homeowner sues him for breach of contract, then the value of cutting the trees down must be deducted from the damages due the homeowner by reason of the tree surgeon's breaking his promise.

Obviously, if one party to a contract breaks his promise, the law will not require the other party to go through with the bargain. In some cases, if the injured party wishes to sue, she must first demonstrate that she was ready, willing, and able to do her part.

When a contract consists of mutual promises which are the consideration for each other (that is, a bilateral contract), one party cannot hold the other liable for breach of contract unless she herself makes a good faith offer to perform her part of the agreement. The offer to perform is called a "tender." A good faith tender is an action, or a series of actions, which shows that the person making the tender is willing and able to perform. If we assume that payment is an explicit condition of delivery, a prospective buyer cannot hold the seller liable for failure to deliver unless the buyer tenders the purchase price, that is, actually offers to pay, and is ready, willing, and able to pay.

There are a number of situations in which a party to a contract is excused from performing her part of the agreement. This section outlines some of those situations.

When a contract consists of mutual promises, each promise is the consideration for the other. Therefore, if one party fails to live up to her promise, the consideration for the other party's promise has failed and justifies the other party's refusal to execute his promises. Sometimes it is clear that a party will not be able to perform when the time for performance arrives. In this situation, the party who could perform may be excused from performing her side of the agreement. The following example illustrates this situation. A store owner enters into a contract with a supplier for merchandise which is to be delivered immediately but paid for at the end of the month. The store owner becomes insolvent. The supplier does not have to deliver the merchandise because it is obvious that the store owner will not be able to pay at the end of the month. In this situation, there is a prospective failure of consideration, which justifies the supplier in refusing to perform the agreement to deliver the goods.

When the time of performance is the essence of a contract, then delay by one party can excuse performance by the other, and can even give the other party grounds for a suit for damages. For example, contracts for large buildings often require precision scheduling, and the prime contractor will specify that various subcontracts must be completed by certain dates. Delay in performing a subcontract may justify the prime contractor's repudiation of the contract, and give the prime contractor the right to recover any losses caused by the delay.

A party to a contract may voluntarily relinquish, or waive, some or all of the provisions of a contract, and waiver can be an excuse for nonperformance by the other party. A waiver is an amendment of the contract. An amendment may be formal or informal. It may be in writing or implied through the actions (and inactions) of the parties. If the original contract was required to be written (See Part VI, at "Written and Oral Contracts"), the amendment must be written. In general, a written amendment is the safest and most effective way to change a contract.

If one party to a contract prevents the other party from complying with the contract, nonperformance is excused. Moreover, the person prevented from complying with the contract may sue. For example, the owner of a building cannot contract to have the building renovated, then deny the renovator sufficient access to the building to perform the work.

The general rule is that the fact that a contract becomes impossible to perform does not excuse the failure to perform it. The law takes the view that the parties to the contract established the conditions of the contract and that it is their problem if they do not plan ahead. In summary, the general rule is that where a contract does not provide for contingencies, it should be interpreted to achieve its goals. If a contract cannot be performed in one way, it must be performed in the next best way, or in the best available way. There are some important exceptions to this rule. Performance which has been made illegal will be excused. Thus, a lease might specify that the owner make certain alterations in the premises, but if the alterations would violate a building code passed after the lease was signed, the alterations need not be made. Also, a party cannot be forced to perform where, for example: the person who is to perform becomes ill or dies; war intervenes and makes performance impossible; or the object of the contract is lost or destroyed (a valuable painting which is to be restored is stolen; a building which is to be painted is destroyed by fire).

The usual remedy for breach of contract is an action for damages. In some cases, the injured party can compel specific performance of the contract, have the contract modified or canceled, or obtain a court order to prevent further loss.

Generally, the proper remedy for breach of contract is money damages for the loss caused by the breach. The defendant's liability is not necessarily the contract price or value. It may be the value of the actual loss suffered by the injured party. For example, assume a buyer reneges on her contract to buy a house for $45,000, and the seller is forced to sell to another buyer for $40,000. The first buyer is guilty of breach of contract. Her basic liability is not the $45,000 contract price, but the $5,000 difference between the original contract price and the price for which the house eventually sold. There may be additional damages, such as the expenses incurred in finding another buyer, and the losses resulting from the delay or inconvenience.

Where the object of a contract is unobtainable by other means, or is unique, a court may compel a party to comply with the contract rather than pay damages. For example, land is considered unique, and a rare museum piece or antique may be unique. The person who contracted to sell the land, museum piece, or antique may be required by the court to transfer the land or thing to the purchaser pursuant to the contract. Note that there is nothing unique about the money the seller would receive as the purchase price, so that if the buyer defaults, the seller's only remedy is money damages.

Sometimes, particularly in complicated or long-term contracts, a party may not be able to render performance in exactly the way required by the original promise or promises, but can perform in other ways. In such cases, where it would be fair to keep the contract in existence but on modified terms, a court may order the contract to be amended or reformed.

The technical term for cancellation of a contract is "rescission." Generally, it is a remedy, or action, which the injured party can take without going to court. The supplier who was to deliver merchandise to the store which became insolvent (mentioned in the "Actual or Prospective Failure of Consideration" section above) would probably call the store owner and say the contract is canceled. The supplier probably should write a letter to the store owner to formalize and record the cancellation. However in some cases, a party might remain bound to a contract despite a breach by the other party, and her best remedy may be to go to court to have the contract rescinded.

Sometimes there is a real threat that a breach will be continued or repeated. In this situation, money damages is an inadequate remedy because the injured party would have to go to court repeatedly. In such a case, the injured party could request the court to order the guilty party not to violate the contract in the future, under pain of punishment for contempt of court.

It should be noted that specific performance, reformation, rescission, and injunction are all extraordinary remedies. In Ohio, the common pleas court has jurisdiction over these extraordinary remedies. Accordingly, although the amount of money in controversy may be within the monetary jurisdiction of a municipal court, or county court, a party who wishes to enforce any of these extraordinary remedies, either in addition to or instead of money damages, must bring the action in common pleas court, unless it involves a matter within the jurisdiction of an housing or environmental municipal court. (Other trial courts have limited jurisdiction in this area.)

Articles appearing on this website are intended to provide broad, general information about the law. Before applying this information to a specific legal problem, readers are urged to seek advice from an attorney.

Reprinted and distributed by Fanger & Associates LLC with permission from the Ohio State Bar Foundation as a service to our clients and friends.

Excerpted from The Law And You, A Handbook of General and Everyday Law Affecting Ohio Citizens. Prepared for the Ohio State Bar Association by the Ohio State Bar Foundation. Copyright © 1997-1999 Ohio State Bar Association.
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