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C H A P T E R 7
CONTRACTS
A contract is an agreement between two or more competent parties that courts will
enforce. Depending on the state, the legality of contracts is determined by statute,
Article 2 of the Uniform Commercial Code (UCC), the Restatement (Second) of
Contracts and or common law. This chapter discusses, analyzes, and examines all
elements of contracts and the laws that make them enforceable.
I. BASIC REQUIREMENTS OF A CONTRACT. A contract requires four elements:
agreement, consideration, capacity, and legal purpose.
II. AGREEMENT.
A. Offer. An offer is a manifestation of willingness to enter into a
bargain.
1. Intention. Offers made in jest or the heat of anger do not show
intention to be bound. Advertisements are generally not offers.
4. Termination of Offer—an offer can be terminated two ways:
(i) Termination by Operation of Law, or
B. Acceptance is a response by the offeree indicating willingness to enter
into the proposed agreement.
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1. Mode of Acceptance. The offeror is the “master of the offer”
with sole power to specify the means of acceptance.
III. CONSIDERATION. Contracts are exchanges of something of value
(consideration), e.g., money, an object, a promise, a service, forbearance or
assignment.
A. Adequacy of Consideration. Generally, courts will not scrutinize the
value of the consideration (the fairness) of a contract.
B. Bilateral and Unilateral Contracts.
2. Illusory Promises. An illusory promise is unenforceable.
3. Requirements and Output Contracts. In a requirements
4. Conditional Promises. Contracts may include conditional
promises, of which there are three types:
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(iii) Conditions subsequent operate to terminate an existing
contractual obligation if a specific condition occurs.
IV. CAPACITY. Capacity is the legal ability to understand the nature and effect
of an agreement. Minors and mentally incompetent persons lack legal
V. LEGALITY. Contracts must have a legal purpose. Contracts that are contrary
to a statute or public policy are illegal and generally considered void.
A. Licensing Statutes. If a party fails to have a required state license, the
other party to the contract does not have to fulfill its side of the bargain
(i.e. pay for services).
VI. PROMISSORY ESTOPPEL (or detrimental reliance) provides an exception to
the requirement of consideration if four requirements are met:
A. Promise. There must be a promise; a statement of future intent to act
or make a promise is not sufficient;
VII. PRECONTRACTUAL LIABILITY FOR FAILURE TO NEGOTIATE IN GOOD
FAITH. Under traditional contract law, the offeror is free to revoke the offer
without precontractual liability. Courts will typically impose an obligation of
good faith only if a letter of intent between the parties imposes such a duty.
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CASE 7.1 Copeland v. Baskin Robbins, 117 Cal. Rptr. 2d 875 (Cal. Ct.
App. 2002). Copeland agreed to purchase BR’s ice cream
facility, contingent upon BR’s executing a ‘co–packing’
agreement whereby BR would agree to purchase ice cream
VIII. UNCONSCIONABILITY. A contract is unconscionable if it is oppressive or
fundamentally unfair.
A. Procedural Element of an unconscionable contract lies in oppression
and surprise.
B. Substantive Element.
C. Liability Releases are conditions that purport to relieve one party from
liability for injuries suffered by the person using the facility. The
CASE 7.2 Kurashige v. Indian Dunes, Inc., 246 Cal. Rptr. 310
(Cal. Ct. App. 1988). Kurashige, used Indian Dunes
Park for motorcycle dirtbike riding. Prior to entering
the park he signed a general release. Kurashige was
IX. GENUINENESS OF ASSENT. A court will refuse to enforce a contract if one or
both of the parties did not genuinely assent to the terms of the contract, even if
otherwise there is evidence of a valid contract with consideration.
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A. Fraud. A contract is voidable if tainted with fraud.
1. Fraud in the factum is the misrepresentation or untruth about a
material fact of the contract.
B. Duress. A contract is also voidable if one party was forced to enter
into it through fear created by wrongful or illegal acts or threats (see
also undue influence).
C. Ambiguity. If the terms of a contract are subject to differing
D. Mistake of Fact. A mistake of fact might make a contract voidable. A
court’s willingness to void a contract based on mistake depends
heavily on particular circumstances. Court look at three factors to
determine mistake:
1. Substantiality of the Mistake. A court is likely to void the
E. Mistake of Judgment (or Value) occurs when parties make erroneous
assessments about some aspect of the bargain. Such a mistake is not a
XI. STATUTE OF FRAUDS. Certain types of contracts, while valid if merely oral,
must be put in writing to become legally enforceable.
BAGLEY, MANAGERS AND THE LEGAL ENVIRONMENT 7TH ED—INSTRUCTOR’S MANUAL
A. Transactions subject to the Statute of Frauds include:
1. A contract for the transfer of any interest in real property (such
as a deed, lease, or option to buy);
XI. THE PAROL EVIDENCE RULE. When there is a written contract that the
parties intended would encompass the entire agreement, parol (spoken)
XII. CHANGED CIRCUMSTANCES. Contracts can provide for a variety of future
events so that the parties involved can allocate the risks of different outcomes.
These include impossibility, impracticability, and frustration of purpose.
A. Impossibility. If the subject matter of a contract is destroyed, the
parties are discharged from their contractual obligations.
XIII. CONTRACT MODIFICATION. Traditionally, contract law does not allow a
contract to be modified for only one party. A novation, substitution of one of
the old parties, creates a new contract, can effect the desired change. As well
both parties may agree to terminate a contract.
XIV. DISCHARGE OF CONTRACT. Commonly, discharge occurs when both parties
have fully performed their obligations. What happens when either party has
not fully performed?
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A. Material Breach. If one party fails to perform that party commits a
material breach. Such breach discharges the other party from its
obligations and provides grounds to sue for damages.
B. Anticipatory Repudiation. If party A knows ahead of time (before
D. Novation. If party A prefers to retain the original contract, a third
party may be substituted for one of the original parties, B. The third
party will assume B’s rights and responsibilities. All parties must
agree to the substitution.
XV. DUTY OF GOOD FAITH AND FAIR DEALING. Every contract contains an
implied covenant of good faith and fair dealing in its performance. The
implied covenant imposes a duty on each party to refrain from any action that
will deprive the other party of the benefits of the agreement.
XVI. THIRD-PARTY BENEFICIARIES. At times, one who is not a party to a
contract may enforce a contract. A third-party beneficiary cannot sue to
enforce the contract unless the contracting parties intended to benefit the third
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XVII. REMEDIES. If one party breaches, the other party is entitled to monetary
damages or specific performance. Damages give the plaintiff the benefit of
A. Expectation Damages.
1. Compensatory Damages give the plaintiff the benefit of the
bargain, putting plaintiff in the cash position she would have
been had the contract been fulfilled.
2. Consequential Damages. Compensate plaintiff for losses that
occur as a result of the breach. Consequential damages must
B. Reliance Damages compensate the plaintiff for any expenditures made
in reliance of a contract that was subsequently breached. Reliance
damages return it to the position it was in before the contract was
formed.
C. Restitution and Quantum Meruit. Restitution is similar to reliance
D. Liquidated Damages. Specific amount of money agreed to by the
parties in the event of breach.
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XVIII. CONTRACTS RELATING TO MERGERS AND ACQUISITIONS.
A. Generally. A corporation can acquire control of another (the target)
by merger. Mergers cannot be completed until the shareholders
approve.
B. Agreements. Mergers and acquisitions are usually governed by
detailed acquisition agreements containing:
1. Representations and warranties about the entity being sold;
RESPONSIBLE MANAGER: TEACHING SUGGESTIONS
1. What language would you include in a letter of intent to require “good faith”
bargaining by the other party?
2. Why does the parole evidence rule allow one to show fraud or duress?
3. Though most English speaking nations use common law principles to interpret