Forming a Contract

Forming a Contract

In this lesson, you’re expected to learn about:
– the main elements of a contract
– the Doctrine of Promissory Estoppel and Genuine Assent
– a Contract of Adhesion
In order to form a valid contract, each of the following main elements of a contract must be satisfied:
1) Capacity of the Parties

According to the law, only a person who is legally able has the power to make a binding contract.

This requirement intends to protect people from being taken advantage of who may not fully understand what they are doing due to age, mental disability or intoxication.

2) Mutual Agreement

The mutual assent of the parties to a contract is also known as the “meeting of the minds” and it is manifested by both an “offer”and an “acceptance”:

i) Offer: the offer is a demonstration of the willingness of a party to enter into a bargain and is the first step in the traditional process of forming a valid contract. It is transmitted directly to the offeree by the offeror’s acts or words, whether spoken or written, through any medium.

NOTE: The use of the word “offer” is recommended but not mandatory to demonstrate the offeror’s intent to make a contract. When the word is not used, the court will analyze circumstances, actions or other words to determine the offeror’s real intent to enter into a valid contract.
An offer must be:
 Sufficiently definite
• Communicated to the offeree
• Clearly indicating the offeror’s intent to make a contract

The expiration of an offer may be at the time specified by the offeror, or at an earlier time because of rejection, counter-offer, death, or incompetency of either party. Additionally, it may be revoked by the offeror at any time before its acceptance.

ii) Acceptance: as an answer to the offer, the offeree’s acceptance will bind the deal (meeting of the minds).

The acceptance must be:
• Clear and unqualified: if it modifies the offer, it is considered as a conditional acceptance that is treated as a counteroffer. A counteroffer corresponds to a rejection of the original offer and the making of a new one.
• Accepted in a manner required by the offer.

NOTE: As a rule, silence is not considered an acceptance, except in specific cases, i.e. when the parties mutually agree that silence means acceptance or when in previous dealings, the parties have considered silence to be an acceptance.
3) Legality of the Agreement

Contracts that are in violation of common or statutory law, or that are against public policy are generally held illegal and thus void and unenforceable by either party at common law. As a consequence, property or money transferred cannot be recovered. These include contracts:

• to commit a crime, a tort or a fraud;
• that are sexually immoral;
• that prejudice public safety; and
• to defraud revenue.

4) Consideration

Consideration is based on the idea of “something for something” in exchange – some action, forbearance, or promise.

According to the bargain theory, the promise is given in a contract as part of a “bargain”. A party makes his/her promise to give up something of value in exchange for the other party’s giving of value.

Therefore, the following situations do not satisfy the “bargain” element because there is a lack of consideration and, as a consequence, the agreement is legally unenforceable:

• Promises to make gifts – it is mere gratuity from one party.

• Sham and nominal consideration – when consideration is so insignificant as to bear no relationship to the value of what is being exchanged.

• Illusory Promises – an agreement in which one party gives as consideration a promise that does not actually obligate him to anything under the contract. The mutual promises in a contract must be real.

• “Past consideration” – one party was already legally obligated to perform, e.g., promises to pay a pre-existing debt or promises to pay for services already received.

NOTE: Consideration is only required in common law systems (e.g. the U.S. and U.K.). The civil law tradition (e.g. Spain, Germany, and Japan) does not require an exchange of consideration as a condition to form a valid contract.
[Optional] Bargain Theory of Consideration Law
Read this article to learn more about Bargain Theory:
The Doctrine of Promissory Estoppel

In many jurisdictions of the U.S., it is possible to recover on a promise made without consideration when the reliance on the promise was reasonable, and the promisee relied on his/her detriment.

The doctrine of promissory estoppel comes from equity law and is an alternative to consideration as a basis for enforcing a promise.

For example, the promise to make a charitable contribution to a church is ordinarily unenforceable (promise to make a gift). However, if the promise is followed by expenditures or actions taken by the church in reliance upon the promise, it may create a binding contract.

[Optional] Promissory Estoppel
Watch this 3-minute video lecture about the concept of promissory estoppel:
Obtaining Assent by Improper Means
Genuineness of Assent

As explained, the meeting of minds means a true mutual assent of the parties and is an essential element of a valid contract. A party who demonstrates that they did not genuinely assent to the terms of a contract, even if words and actions seem to prove otherwise, may rescind the contract.

There are some reasons why mutual assent may be lacking:

1) Mistake

When one or both parties have different understandings about subject matter, value, or other aspect of the contract. It can be:

• Unilateral: only one party is mistaken about material fact regarding subject matter of the contract. Generally, the mistaken party will not be permitted to rescind the contract. Courts are unlikely to grant relief unless the mistake is known or should have known by the other party.

NOTE:  A person should not be allowed to benefit from his/her own ignorance or carelessness. It is a person’s duty to read what is being signed, observe apparent defects, or examine that which is displayed before claiming the invalidity of the agreement.
• Mutual: both parties have a common but erroneous belief about a material fact that is important to the subject matter of the contract. Contract may be rescinded on the ground that no contract has been formed because there has been no “meeting of the minds” between the parties.
NOTE: In the earlier common law, the principle of “caveat emptor” (“let the buyer beware”) required buyers to inspect fully and carefully. Failure to do so was at their peril. Modern law, influenced by equity concepts of fairness and new consumer-friendly rules, enforces “caveat venditor” (“let the seller beware”). Mere failure of the seller to speak, in cases where he should have spoken, may permit the negligent, unobservant buyer to withdraw from the contract.
2) Fraud

It is a misrepresentation of material fact with the intent to deceive, on which the innocent party justifiably relied, resulting in injury to the other party.

Elements required:

• Misrepresentation of material fact: as a rule, contracts can only be rescinded for fraud when the alleged misrepresentation is to a material fact, than to an opinion (“mere puffing” – it is customary for the seller to “huff and puff” and to exaggerate the value of his/her goods).

• Knowledge of falsity and intention to deceive (called scienter*): the party misrepresenting the material fact must do so knowingly with the intent to defraud the other party.

• Justifiable reliance of the defrauded party: a defrauded party is reasonably influenced by the misrepresentation. If the seller lies, knowingly and intentionally, and the buyer recognizes the lie, but buys anyway, there is no fraud.

• Causing injury to the other party: the defrauded party must have suffered injury as a result.

scienter: the fact of an act having been done knowingly, especially as grounds for civil damages.
When there is a fraud, the defrauded party can rescind the contract after proving it. Alternatively, the party may also affirm the contract and bring an action in court to recover damages for the deceit.
NOTE: Fraud is a grave offense under the law. Not only is fraud a tort but also a crime.
3) Misrepresentation

Also know as innocent misrepresentation, it is a false statement innocently made by one party to a contract with no intent to deceive.  Unlike fraud, it is not a tort and the only available remedy is the rescission of the contract (no damages).

4) Duress

When one party coerces the other (either physically or mentally) to enter into a contract. Although the contract is valid in form, due to lack of voluntary assent, it is voidable by the innocent party.

5) Undue Influence

When one party takes advantage of another by reason of a superior position in a close or confidential relationship – e.g. parent/child, doctor/patient, religious advisor/member.

The concern here is about the use of excessive pressure by the dominant person and, on the other hand, the susceptibility of the subservient person. Although the contract is valid in form, it is voidable by the innocent party.

Adhesion Contract

A contract of adhesion is a standardized agreement drafted exclusively by one party (usually a business with stronger bargaining power) and signed by the weaker party (usually a consumer in need of goods or services), who must adhere to the contract and therefore has little or no ability to negotiate the terms of the contract. Thus it is placed on a “take it or leave it” basis.

While these types of contracts are not illegal per se, courts carefully scrutinize adhesion contracts and sometimes void certain provisions because of the possibility of unequal bargaining power, unfairness, and unconscionability*.

Unconscionabilitya doctrine in contract law that describes terms that are so extremely unjust, or overwhelmingly one-sided in favor of the party who has the superior bargaining power, that they are contrary to good conscience.
To avoid enforcement of a contract based on adhesion, the adhering party must show that:

· the parties had substantially unequal bargaining positions; and
· enforcement against the adhering party would be manifestly unfair or oppressive.

Mini Case Study
Example of Offer Revocation before its Acceptance

Dickenson v. Dodds
In the Court of Appeal
Citation: 2 Ch. D. 463 (1876)

Brief Facts: On Wednesday, June 10, 1874, the defendant made a written offer to sell property to the plaintiff. The offer was worded such that it would remain open until 9:00 am, Friday, June 12, 1874. After this offer was made, on Thursday, June 11, 1874, the plaintiff learned that the defendant had changed his mind and determined to sell the property to another person. The plaintiff then manifested his acceptance, in the proper manner, before 9:00 am on June 12, 1874.

Issue: Can an offer be revoked (even though he promised not to do so) without explicit notification?

HoldingYes, the plaintiff clearly knew that the property has been sold to someone else. There was no mutual assent and no consideration to keep the offer open. Because the defendant’s actions were inconsistent with his offer and because the plaintiff was aware that the defendant had changed his mind, his power of acceptance was terminated.

Rule of Law: This case deals with the difference between “agreements to sell” and “offers to sell”. When an agreement to sell is made and intended to be left open until a certain time, it is generally irrevocable until that time lapses. An offer to sell, on the other hand, is merely that and is revocable at the offeror’s acceptance.

[Optional] Elements of a Contract
Watch this 9-minute video lecture about the elements of a contract by the Director of Paralegal Studies at Lee College, Texas:
Jim Rohn