5.1 General Perspectives on Contracts

Introduction to Contract Law

Contract is probably the most familiar legal concept in our society because it is so central to our political, economic, and social life. So commonplace is the concept of contract—and our freedom to make contracts with each other—that it is difficult to imagine a time when contracts were rare, when people’s everyday associations with one another were not freely determined.

Historical Perspective

Yet in historical terms, it was not so long ago that contracts were rare, entered into by very few: that affairs should be ordered based on mutual assent was mostly unknown. In primitive societies and in feudal Europe, relationships among people were largely fixed; traditions spelled out duties that each person owed to family, tribe, or manor. People were born into an ascribed position—a status (not unlike the caste system still existing in India)—and social mobility was limited. Sir Henry Maine, a nineteenth-century British historian, wrote that “the movement of the progressive societies has…been a movement from status to contract.”  This movement was not accidental—it developed with the emerging industrial order. From the fifteenth to the nineteenth century, England evolved into a booming mercantile economy, with flourishing trade, growing cities, an expanding monetary system, the commercialization of agriculture, and mushrooming manufacturing. This evolution necessitated the creation of contract law.

Contract law did not develop according to a conscious plan, however, but it was a response to changing conditions. Not until the nineteenth century, in both the United States and England, did a full-fledged judge-made law of contracts arise together with, and help create, modern capitalism. Today, the contract determines the nature of most economic transactions.

In An Economic Analysis of Law, Judge Richard A. Posner (a former University of Chicago law professor) suggests that contract law performs three significant economic functions. First, it helps maintain incentives for individuals to exchange goods and services efficiently. Second, it reduces the costs of economic transactions because its very existence means that the parties need not go to the trouble of negotiating a variety of rules and terms already spelled out. Third, the law of contracts alerts the parties to troubles that have arisen in the past, thus making it easier to plan the transactions more intelligently and avoid potential pitfalls.

The Definition of Contract

The Restatement (Second) of Contracts (Section 1) says, “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.” Similarly, the Uniform Commercial Code (UCC) says, “‘Contract’ means the total legal obligation which results from the parties’ agreement as affected by this Act and any other applicable rules of law.”  As operational definitions, these two are circular; in effect, a contract is defined as an agreement that the law will hold the parties to.

Most simply, a contract is a legally enforceable promise between two or more parties. Not every promise or agreement creates a binding contract, so a contract requires more than just an agreement. The law of contracts takes into account the way in which contracts are made, by whom they are made, and for what purposes they are made. 

Overview of the Study of Contracts

Although contract law has many nuances, it consists of several principal inquiries, each of which will be taken up in subsequent Chapters.

Did the parties create a valid contract? One party to a contract must make a clear and unequivocal offer to the other party which in turn must accept the offer without any conditions or changes. Each party must exchange something of value (consideration) with the other party. Both parties must have the legal capacity to enter into a contract. And finally, the contract must be for a lawful purpose.

Did the parties intend to enter a valid contract? Both parties must have a genuine intent to create a legally binding agreement. If it turns out that one or both parties did not have the requisite intent, the attempt at contract may not be valid.

Do we know what the contract means and can it be carried out? Many contracts can be oral, but sometimes contracts need to be in writing (or evidenced by some writing), or they can’t be enforced. If the terms of a contract are unclear, a court has to interpret the contract, or it can’t be enforced.

Do persons other than the contracting parties have rights or duties under the contract? Sometimes third parties may have rights in the contracts of others, and so we must determine if any other parties have rights in the contract that is under review.

How do we know when the contract has come to an end? A contract can be terminated with performance, without performance, and sometimes a contract may be breached. A contract that is not fully performed may have remedies available, and we will study how those remedies will be assigned and calculated.

Together, the answers to the questions outlined above determine the rights and obligations of contracting parties.

5.2 Sources of Contract Law

The most important sources of contract law are state case law and state statutes (though there are also many federal statutes governing how contracts are made by and with the federal government).

Case Law

Law made by judges is called case law. Because contract law was made up in the common-law courtroom by individual judges as they applied rules to resolve disputes before them, it grew over time to formidable proportions. Because of this, much of U.S. contract law is rooted in common law principles. Common law is law that has developed over time through judicial decisions in individual contract disputes and claims. Courts in the United States have issued rulings in contract-related cases for centuries, creating a body of precedent that serves as the foundation of contract law. Thus, by the early twentieth century, tens of thousands of contract disputes had been submitted to the courts for resolution, and the published opinions written by judges, if collected in one place, would have filled dozens of bookshelves. Clearly this mass of material was too unwieldy for efficient use. A similar problem also had developed in the other leading branches of the common law.

The Restatement (Second) of Contracts

Disturbed by the plethora of cases, the difficulty in finding a specific case, and the resulting uncertainty of the law, a group of prominent American judges, lawyers, and law teachers founded the American Law Institute (ALI) in 1923 to attempt to clarify, simplify, and improve the law. One of the ALI’s first projects, and ultimately one of its most successful, was the drafting of the Restatement of the Law of Contracts, completed in 1932. A revision—the Restatement (Second) of Contracts—was undertaken in 1964 and completed in 1979. Hereafter, references to “the Restatement” pertain to the Restatement (Second) of Contracts.

The Restatements (they also exist in the other fields of law besides contracts, including torts and property) are detailed analyses of the decided cases in each field. Encompassing a wide range of disciplines, the Restatements summarize the common law principles as they have evolved across the majority of U.S. jurisdictions. In addition to presenting common law doctrines, the Restatements offer commentary, hypothetical scenarios illustrating the application of these principles, and summaries of relevant cases.

The Restatement won prompt respect in the courts and has been cited in innumerable cases. The Restatements are not authoritative, in the sense that they are not actual judicial precedents; but they are nevertheless weighty interpretive texts, and judges frequently look to them for guidance. They are as close to “black letter” rules of law as exist anywhere in the American common-law legal system.

Today, common law or case law (the terms are mostly synonymous) governs contracts for the sale of real estate and services. “Services” refers to acts or deeds (like plumbing, drafting documents, driving a car) as opposed to the sale of property.

Statutory Law: The Uniform Commercial Code

Common-law contract principles govern contracts for real estate and services. Because of the historical development of the English legal system, contracts for the sale of goods came to be governed by a different body of legal rules. In its modern American manifestation, that body of rules is an important statute: the Uniform Commercial Code (UCC), especially Article 2, which deals with the sale of goods.

History of the Uniform Commercial Code

In addition to the overabundance of cases that was discussed above, in commercial transactions there was an another barrier to legal efficiency in contracting. The development of the common law through judicial interpretation meant that the law varied, sometimes greatly, from state to state. This was a serious impediment to business as the American economy became nationwide during the twentieth century. Although there had been some uniform laws concerned with commercial deals—including the Uniform Sales Act, first published in 1906—few were widely adopted and none nationally.

Enter the Uniform Commercial Code (UCC). The UCC is a model law developed by the ALI and the National Conference of Commissioners on Uniform State Laws; it has been adopted in one form or another by the legislatures in all fifty states, the District of Columbia, and the American territories. It is a “national” law not enacted by Congress—it is not federal law but uniform state law.

Initial drafting of the UCC began in 1942 and was ten years in the making, involving the efforts of hundreds of practicing lawyers, law teachers, and judges. A final draft, promulgated by the ALI, was endorsed by the American Bar Association and published in 1951. Various revisions followed in different states, threatening the uniformity of the UCC. The ALI responded by creating a permanent editorial board to oversee future revisions. In one or another of its various revisions, the UCC has been adopted in whole or in part in all American jurisdictions. The UCC is now a basic law of relevance to every business and business lawyer in the United States, even though it is not entirely uniform because different states have adopted it at various stages of its evolution—an evolution that continues still.

Organization of the UCC

The UCC consists of nine major substantive articles, each dealing with separate though related subjects. The articles are as follows:

• Article 1: General Provisions
• Article 2/2A: Sales and Leases of Goods
• Article 3: Commercial Paper
• Article 4/4A: Bank Deposits and Collections and Funds Transfers
• Article 5: Letters of Credit
• Article 6: Bulk Transfers
• Article 7: Warehouse Receipts, Bills of Lading, and Other Documents of Title
• Article 8: Investment Securities
• Article 9: Secured Transactions

Article 2 deals with the sale of goods, which the UCC defines as “all things…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.”  As these sales/leases are accomplished by contracting, agreements covered by Articles 2/2A which relate to the present or future sale of goods also make up the law of contracts.

Figure 5.1 Sources of Law

International Sales Law

The Convention on Contracts for the International Sale of Goods

A Convention on Contracts for the International Sale of Goods (CISG) was approved in 1980 at a diplomatic conference in Vienna. (A convention is a preliminary agreement that serves as the basis for a formal treaty.) The CISG has been adopted by more than forty countries, including the United States.

The CISG is significant for three reasons. First, it is a uniform law governing the sale of goods—in effect, an international Uniform Commercial Code. The major goal of the drafters was to produce a uniform law acceptable to countries with different legal, social, and economic systems. Second, although provisions in the CISG are generally consistent with the UCC, there are significant differences. For instance, under the CISG, consideration is not required to form a contract, and there is no Statute of Frauds (a requirement that certain contracts be evidenced by a writing). Third, the CISG represents the first attempt by the U.S. Senate to reform the private law of business through its treaty powers, for the CISG preempts the UCC. The CISG is not mandatory; parties to an international contract for the sale of goods may choose to have their agreement governed by different law, perhaps the UCC, or, say, Japanese contract law. The CISG does not apply to contracts for the sale of (1) ships or aircraft, (2) electricity, or (3) goods bought for personal, family, or household use, nor does it apply (4) where the party furnishing the goods does so only incidentally to the labor or services part of the contract.

5.3 Objective Theory of Contracts

The objective theory of contracts is a fundamental principle in contract law that focuses on the objective intent of the parties involved in a contract rather than their subjective beliefs or intentions. Using the objective theory of contracts, a contract is formed based on the outward, objective manifestations of the parties’ intentions, as perceived by a reasonable person. In other words, it’s not necessary for the parties to share the same internal, subjective understanding of the contract terms; what matters is how their words and actions would be reasonably understood by an outside observer. This standard takes into account the parties’ communications, actions, and conduct leading up to and including the time of the contract’s formation. Courts will therefore look at the objective evidence of the parties’ intent, rather than their individual, subjective beliefs or unexpressed intentions. This means that even if one party secretly harbored a different intention, the contract is based on what they objectively conveyed to the other party. The objective theory of contracts promotes clarity and predictability in contract law and provides a foundation for enforcing agreements based on the parties’ objective expressions of intent.

5.4 Classifications of Contracts

Contracts are classified in different ways. Ascribing a classification to a contract helps to learn about that contract, and potential rights and obligations under that contract. This section will describe the primary ways that contracts are classified.

Express, Implied or Quasi Contracts

A contract is either express, implied-in-fact (implied) or imposed by the court as an implied in law contract (quasi).

Express Contract

An express contract is a contract in which the terms and conditions are explicitly stated, either orally or in writing, with the intent of both parties to enter a contract. It’s a clear and definite agreement between the parties. For example, a homeowner hires a plumber to fix a leaky hose fixture outside their house. The homeowner and the plumber have a written agreement that outlines the specific terms of the plumbing service, such as the scope of work, the cost, and the timeline for completion. Even if neither party signs the document, this would still be an express contract, as the agreement is clearly expressed in words.

Implied Contract (Implied in Fact)

An implied contract is a contract in which the agreement is not explicitly stated in words but is inferred from the conduct and actions of the parties involved. An implied contract between the homeowner and the plumber could arise if the homeowner calls the plumber and the plumber performs the work, fixing the leaky hose fixture outside the house without discussing specific terms of the agreement. Clearly, both parties intended for the plumber to be paid for any work completed, but the detailed understanding between the two parties was not directly discussed, resulting in an implied contract.

Quasi Contract

Unlike both express and implied contracts, which embody an actual agreement of the parties, a quasi contract does not arise from the agreement of the parties. In fact, there is a lack of agreement in quasi contract situations. This is why a quasi contract is an obligation said to be “imposed by law” in order to avoid unjust enrichment of one person at the expense of another. In other words, it is an obligation imposed by a judge to prevent injustice, and not a contract at all. Suppose, for example, that a local plumbing company mistakenly sends a plumber to your house, thinking it belongs to the neighbor on the next block who had called for a repair to the leaky hose outside their house. On arrival to your home, the plumber actually does find a leaking hose and fixes it while you are home. You never communicated with the plumbing company even though you saw the repair taking place. Although it is true there is no contract, the law implies a contract for the value of the material: of course you will have to pay for the service you received.

Bilateral or Unilateral Contracts

Bilateral Contracts

The typical contract is one in which both parties make mutual promises. Each is both promisor and promisee; that is, each pledges to do something, and each is the recipient of such a pledge. This type of contract is called a bilateral contract. The example above where the homeowner and the plumber enter a contract with express terms to fix the leaky fixture outside the house also illustrates a bilateral contract. The homeowner has offered payment, and the plumber has promised the repair.

Unilateral Contract

A unilateral contract is a contract where one party makes a promise and the other party can accept that promise only by performing a specific act. Unilateral contracts are as valid as bilateral contracts. Suppose that the homeowner puts a sign on their lawn that says “I will pay $100 to the first person to fix the leaky fixture outside my home.” A plumber sees the sign, says nothing, but goes to the pipe, gets to work, and repairs the leak. This is a unilateral contract. In a unilateral contract, the acceptance of the promise is indicated through performance, rather than by making a reciprocal promise.

Figure 5.2 Bilateral and Unilateral Contracts

Valid, Void, Voidable and Unenforceable

Valid

A valid contract is a legally binding and enforceable agreement that meets all the essential elements required by contract law. If a contract contains all of the required elements and complies with all relevant laws and regulations, it is valid and enforceable. Parties to a valid contract have legal obligations to fulfill their promises.

Void

Not every agreement between two people is a binding contract. An agreement that is lacking one of the legal elements of a contract is a void contract—that is, not a contract at all. An agreement that is illegal—for example, a promise to commit a crime in return for a money payment—is void. Neither party to a void “contract” may enforce it.

Voidable

By contrast, a voidable contract is one that may become unenforceable by one party but can be enforced by the other. For example, a minor (any person under eighteen, in most states) may “avoid” a contract with an adult; the adult may not enforce the contract against the minor if the minor refuses to carry out the bargain. But the adult has no choice if the minor wishes the contract to be performed.

A voidable contract remains a valid contract until it is voided. Thus a contract with a minor remains in force unless the minor decides he or she does not wish to be bound by it. When the minor reaches majority, he or she may “ratify” the contract—that is, agree to be bound by it—in which case the contract will no longer be voidable and will thereafter be fully enforceable.

Unenforceable

An unenforceable contract is one that some rule of law bars a court from enforcing. For example, Tom owes Pete money, but Pete has waited too long to collect it and the statute of limitations has run out. The contract for repayment is unenforceable because he’s simply waited too long, and Pete is out of luck.

The doctrine of promissory estoppel

A promise or what seems to be a promise is usually enforceable only if it is otherwise embedded in the elements necessary to make that promise a contract. Sometimes, though, people say things that seem like promises, and on which another person relies. In some circumstances courts have recognized that insisting on the existence of the traditional elements of contract to determine whether a promise is enforceable could work an injustice where there has been reliance. Thus developed the equitable doctrine of promissory estoppel, which has become an important adjunct to contract law. The Restatement (Section 90) puts it this way: “A promise which the promisor should reasonably expect to induce action or forbearance on the party of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise. The remedy granted for breach may be limited as justice requires.” To be “estopped” means to be prohibited from denying now the validity of a promise you made before. Contract protects agreements; promissory estoppel protects reliance, and that’s a significant difference. Practically speaking, promissory estoppel may serve to provide a remedy in situations where under traditional contract law, a party may have none.

Executory v. Executed

Executory and executed are terms used to describe the current status of a contract based on whether or not the parties have fulfilled their respective obligations at the moment of the classification. This helps us understand where the contract stands in terms of performance.

Executory

An executory contract is a contract in which one or more parties have not yet fulfilled their obligations or duties. In other words, the contractual promises made by one or more parties remain uncompleted or “in progress.” The completion of these promises is expected to occur in the future, and the contract is still active. Until all parties have performed their respective obligations, the contract remains executory. For example, if the homeowner has made an agreement with the plumber to come to their home to repair the leaky fixture, but the repair is not complete yet, the contract is executory.

Executed

An executed contract is a contract in which all parties involved have fully performed and completed their obligations. All promises made in the contract have been fulfilled, and there are no remaining duties or outstanding actions required. Once a contract is executed, it is considered closed, and the parties no longer have any legal obligations under that specific contract. The plumbing contract would be executed when the pipe leak is repaired, and the homeowner has paid the plumber for the service.

Formal and Informal Contracts

Formal contracts are contracts that require a specific form or format to be legally valid and enforceable. These formalities typically involve the manner in which the contract is created, executed, and documented. The four types of formal contracts recognized by the Restatement are (1) contracts under seal, (2) recognizances, (3) letters of credit, and (4) negotiable instruments.

The primary difference between a formal contract and an informal contract lies in the level of formality and the specific requirements for their creation and enforceability. Therefore, an informal contract is a contract that is not a formal contract. Note that this is not a difference between written and unwritten contracts. An informal contract can also be a written contract. The contract would be written and informal if there are no requirements that the contract be written in a specific format.

Additional Terminology: Suffixes Expressing Relationships

Although not really part of the classification of contracts, it is worth highlighting that in legal terminology, common English language suffixes (end syllables of words) are used to express relationships between parties. For example:

Offeror. One who makes an offer.

Offeree. One to whom an offer is made.

Promisor. One who makes a promise.

Promisee. One to whom a promise is made.

Obligor. One who makes and has an obligation.

Obligee. One to whom an obligation is made.

Transferor. One who makes a transfer.

Transferee. One to whom a transfer is made.

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References

Sir Henry Maine, Ancient Law (1869), 180–82.

Richard A. Posner, Economic Analysis of Law (New York: Aspen, 1973).

Uniform Commercial Code, Section 1-201(11).

Uniform Commercial Code, Section 2-105.