CHAPTER 3

Basics of Contracts

Contracts are an essential part of virtually every business for both employees and employers. Clearly, the entire field of contract law cannot be covered here, but, by becoming aware of some of the ramifications of contract law, you will see where you need to be cautious. In this chapter we will cover contract fundamentals. In later chapters we present specific kinds of employment contracts.

CONTRACT BASICS

A contract is a legally binding promise or set of promises. The law requires that the parties to a contract perform the promises they have made to each other. In the event of nonperformance—usually called a breach—the law provides remedies to the injured party. For the purposes of this discussion, it will be assumed that the contract is between two people, though it frequently involves business organizations, as well. It should be noted that when business organizations are involved, there are additional considerations, such as whether the person acting on behalf of the business has appropriate authority, how that authority must be evidenced and, regardless of authority, whether that individual’s act will be deemed within the appropriate scope of the business. These issues complicate the analysis. You should discuss these issues with your attorney.

The three basic elements of every contract are the offer, the acceptance, and the consideration. To illustrate these elements, suppose a human resources manager meets with a prospective employee and explains what employment opportunities are available in the company (the offer). The prospective employee says that the job presented is perfect and acceptable (the acceptance). They agree on a salary (the consideration). That is the basic framework, but a great many variations can be played on that theme.

TYPES OF CONTRACTS

Contracts may be express or implied. They may be oral or written. There are generally at least two types of contracts that must be in writing if they are to be legally enforceable:

1. any contract that, by its terms, cannot be completed in less than one year, and

2. any contract that involves the sale of goods for over $500.

EXPRESS CONTRACTS

An express contract is one in which all the details are spelled out. It can be either oral or written. If you are going to the trouble of expressing contractual terms, you should put your understanding in writing. For example, a company might make a contract with a retail store for six dozen gallons of apple cider to be delivered by the company on October 1, at a price of $1.75 per gallon, to be paid within thirty days of receipt. This scenario is fairly straightforward. If either party fails to live up to any material part of the contract, a breach has occurred. The other party may withhold performance of the party’s obligation until receiving assurance that the breaching party will perform. In the event no such assurance is forthcoming, the aggrieved party may have a cause of action and sue for breach of contract.

If the apple cider is delivered on October 15 and the store had advertised the availability of the special apple cider during the week of October 1, time was an important consideration and the store would not be required to accept the late shipment. If time is not a material consideration, then, even with the slight delay, this probably would be considered substantial performance and the store would have to accept the delivery.

IMPLIED CONTRACTS

Implied contracts are usually not reduced to writing and need not be very complicated. An example might be if you call a supplier to order five boxes of computer paper without making any express statement that you will pay for the paper. The promise to pay is implied in the order and is enforceable when the paper is delivered.

With implied contracts, however, things can often become a lot stickier. Suppose a manufacturer of notepads asks you to send over a supply of a new kind of glue you have just begun marketing to try it out. You deliver a generous amount. The notepad manufacturer likes the glue, uses it up, and is overheard commenting that it is the best glue yet for the manufacture of notepads. Is there an implied contract to purchase in this arrangement? That depends on whether you are normally in the business of giving away large, free samples of new products.

UNDERSTANDING CONTRACT PRINCIPLES

In order to understand the principles of offer, acceptance, and consideration, you should examine them in the context of several potential situations for hypothetical business owner, Pat Smith. Smith is an automobile dealer who has an impressive collection of vintage cars in mint condition. Let us look at the following situations and see whether an enforceable contract comes into existence.

• At a cocktail party, Jones expresses an interest in Smith’s cars. It looks like the market value of your cars keeps going up, Jones tells Smith. I’m going to buy one while I can still afford it.

Is this a contract? If so, what are the terms of the offer—the particular car, the specific price? No, this is not really an offer that Smith can accept. It is nothing more than an opinion or a vague expression of intent.

• Brown offers to pay $14,000 for one of Smith’s cars that she saw in an auto show several weeks ago. At the show, it was listed at $14,500, but Smith agrees to accept the lower price.

Is this an enforceable contract? Yes! Brown has offered, in unambiguous terms, to pay a specific amount for a specific car and Smith has accepted the offer. A binding contract exists.

• One day, Jones shows up at Smith’s car lot and sees a particular car for which he offers $14,500. Smith accepts and promises to transfer title the next week, at which time Jones will pay for it. An hour later Brown shows up. She likes the same car and offers Smith $16,000 for it.

Can Smith accept the later offer? No—a contract exists with Jones. An offer was made and accepted. The fact that the object has not yet been delivered or paid for does not make the contract any less binding.

• Green discusses certain renovations he would like Smith to perform on a particular car Smith has just acquired. He offers to pay $16,000 for the car if the final product is satisfactory to him. Green approves preliminary sketches and Smith completes the work. But when Green arrives to pick up his car, he refuses to accept it because it does not satisfy him.

Is there a contract in this case? Green is making the offer in this case, but the offer is conditional upon his satisfaction with the completed work. Smith can only accept the offer by producing something that meets Green’s subjective standards—a risky proposition. There is no enforceable contract for payment until such time as Green indicates that the completed work is satisfactory.

If Green comes to Smith’s car lot and says that the car is satisfactory but then, when Smith delivers it, says he has changed his mind, it is too late. The contract became binding at the moment he indicated the work to be satisfactory. If he then refuses to accept it, he would be breaching his contract.

PROVING AN AGREEMENT

Contracts are enforceable only if they can be proven. All the hypothetical examples mentioned could have been oral contracts, but a great amount of detail is often lost in the course of remembering a conversation. The best practice, of course, is to get it in writing. The function of a written contract is not only that of proof, but to make very clear the understanding of the parties regarding the agreement and the terms of the contract.

Some business owners prefer to do business strictly on the basis of a handshake, particularly with their immediate suppliers and retailers. The assumption seems to be that the best business relations are those based upon mutual trust alone. Although there may be some validity to this, business owners really should put all agreements in writing. Far too many trusting people have suffered adverse consequences because of their reliance upon the sanctity of oral contracts.

Under even the best of business relationships, it is still possible that one or both parties might forget the terms of an oral agreement. It is also possible that both parties might have quite different perceptions about the precise terms of the agreement reached. When the agreement is put into writing, however, there is much less doubt as to the terms of the arrangement. Thus, a written contract generally functions as a safeguard against subsequent misunderstandings or forgetful minds.

Perhaps the principal problem with oral contracts lies in the fact that they cannot always be proven or enforced. Proof of oral contracts typically centers around the conflicting testimony of the parties involved. If one of the parties is not able to establish by a preponderance of evidence (more likely than not) that their version of the contract is the correct one, then the oral contract may be considered nonexistent—as though it had never been made. The same result might occur if the parties cannot remember the precise terms of the agreement.

WHEN WRITTEN CONTRACTS ARE NECESSARY

Even if an oral contract is established, it may not always be enforceable. As already noted, there are some agreements that must be in writing in order to be legally enforceable.

An early law that was designed to prevent fraud and perjury, known as the Statute of Frauds, provides that any contract that, by its terms, cannot be fully performed within one year must be in writing. This rule is narrowly interpreted, so if there is any possibility, no matter how remote, that the contract could be fully performed within one year, the contract need not be reduced to writing.

For example, if a company agreed to provide another company with a fixed quantity of merchandise each year for a period of five years, the contract would have to be in writing. By the very terms of the agreement, there is no way the contract could be performed within one year. If, on the other hand, the contract called for the company to deliver a fixed quantity of merchandise to another company within a period of five years, the contract would not have to be in writing under the Statute of Frauds.

It is possible, though perhaps not probable, that the company could provide all of the merchandise within the first year. The fact that the company does not actually complete performance of the contract within one year is immaterial. So long as complete performance within one year is within the realm of possibility, the contract need not be in writing to be enforceable.

The Statute of Frauds further provides that any contract for the sale of goods valued at $500 or more is not enforceable unless it has been put into writing and signed by the party against whom enforcement is being sought. The fact that a contract for a price in excess of $500 is not in writing does not void the agreement or render it illegal. The parties are free to perform the oral arrangement, but if one party refuses to perform, the other will be unable to legally enforce the agreement.

The law defines goods as all things that are movable at the time the contract is made, except for the money used as payment. The real question becomes whether a particular contract involves the sale of goods for a price of $500 or more. Although the answer would generally seem to be fairly clear, ambiguities may arise.

Agreements involving land, buildings, and certain real estate leases must also be in writing to be legally enforceable. The law with respect to real estate varies from state to state and, if you are involved in a real estate transaction, you should work with an experienced attorney.

In addition, some states have identified specific contracts that are enforceable only if in writing regardless of the other rules which would otherwise apply. For example, Oregon state law prescribes that a contract for landscape work, regardless of its duration or price, must be in writing.

ESSENTIALS TO PUT IN WRITING

A contract should be written in simple language that both parties can understand and should spell out the terms of the agreement.

A contract should include the following:

• the date of the agreement;

• identification of the parties (i.e., the buyer and seller in the case of sale of goods or services);

• a description of the goods or services involved;

• the price or other consideration; and

• the signatures of the parties involved.

To supplement these basics, an agreement should spell out whatever other terms might be applicable, such as pricing arrangements, payment schedules, insurance coverage, and benefits. Many transactions are important enough that additional clauses covering certain contingencies should be added as well.

Finally, it should be noted that a written document that leaves out essential terms of the contract presents many of the same problems of proof and ambiguity as an oral contract.

IN PLAIN ENGLISH

The terms of the contract should be well conceived, clearly drafted, conspicuous (i.e., not in tiny print that no one can read), and in plain English, so everyone can understand them.

NO-COST WRITTEN AGREEMENTS

At this point, owners of small businesses might object, asserting that they do not have the time, energy, or patience to draft contracts. After all, they are in business to make a product or sell a service, not to formulate written contracts steeped in legal jargon.

Fortunately, the businessperson will not always be required to do this, because the supplier or retailer may be willing to draft a satisfactory contract. In the employment context, union shops will generally have established contracts. In nonunion shops, employers may have form contracts of their own. However, be wary of signing any form contracts—they will almost invariably be one-sided, with all terms in favor of whoever paid to have them drafted. You should carefully read, and be sure that you understand, every contract before you sign it. If you do not completely understand any part of a contract, then you should consult with an attorney in order to be sure that you are willing to be bound by that contract.

As a second alternative, the businessperson could employ an attorney to draft contracts. However, this might be cost-effective only for substantial transactions. With respect to smaller transactions, the legal fees may be much larger than the benefits derived from having a written contract.

The Uniform Commercial Code (UCC) provides businesses with a third and, perhaps the best, alternative. While the UCC applies only to the sale of goods, in situations where it applies, businesses need not draft contracts or rely on anyone else (a supplier, retailer, or attorney) to do so.

CONFIRMING MEMORANDUM

The UCC provides that, where both parties are merchants and one party sends to the other a written confirmation of an oral contract within a reasonable time after that contract was made and the recipient does not object to the confirming memorandum within ten days of its receipt, the contract will be deemed enforceable.

A merchant is defined as any person who normally deals in goods of the kind sold or who, because of occupation, represents themselves as having knowledge or skill peculiar to the practices or goods involved in the transaction. Most businesspeople will be considered merchants.

It should be emphasized that the sole effect of the confirming memorandum is that neither party can use the Statute of Frauds as a defense, assuming that the recipient fails to object within ten days after receipt. The party sending the confirming memorandum must still prove that an oral contract was made prior to or at the same time as the written confirmation. (However, once such proof is offered, neither party can raise the Statute of Frauds to avoid enforcement of the agreement.)

The advantage of the confirming memorandum over a written contract lies in the fact that the confirming memorandum can be used without the active participation of the other contracting party. It would suffice, for example, to simply state “this memorandum is to confirm our oral agreement.”

Because you would then still have to prove the terms of that agreement, it would be useful to provide a bit more detail in the confirming memorandum, such as the subject of the contract, the date it was made, and the price or other consideration to be paid. Thus, you might draft something like the following:

This memorandum is to confirm our oral agreement made on July 3, 2020, pursuant to which supplier agreed to deliver to purchaser on or before September 19, 2020, 5,000 sheets of letterhead for the purchase price of $600.

The advantages of providing some detail in the confirming memorandum are twofold. First, in the event of a dispute, you could introduce the memorandum as proof of the terms of the oral agreement. Second, the recipient of the memorandum will be precluded from offering any proof regarding the terms of the oral contract that contradicts the terms contained in the memorandum. The recipient or, for that matter, the party sending the memorandum, can introduce proof only regarding the terms of the oral contract that are consistent with the terms, if any, found in the memorandum.

Thus, the purchaser in the example would be precluded from claiming that the contract called for delivery of 10,000 sheets of letterhead because the quantity was stated in the written memo and not objected to. On the other hand, the purchaser would be permitted to testify that the oral contract required the supplier to engrave the letterhead in a specific way, because this testimony would not be inconsistent with the terms stated in the memorandum.

IN PLAIN ENGLISH

If drafting a complete written contract proves too burdensome or too costly, the businessperson should submit a memorandum in confirmation of the oral contract. This at least surpasses the initial barrier raised by the Statute of Frauds. Moreover, by recounting the terms in the memorandum, the businessperson is in a much better position to prove the oral contract at a later date.

Even though the UCC does not provide a method whereby an employee can use a confirming memorandum for the purpose of confirming an oral employment contract, an employee can nevertheless use the confirming memorandum to prevent the other party who does not object in a timely manner from disputing the items stated in the memorandum. In fact, a confirming memorandum could very well state that if the recipient does not object or clarify the items set forth in this memorandum within a prescribed period of time then the individual providing the memorandum will treat the silence as acceptance.

ADDITIONAL TERMS

One party to a contract can prevent the other from adding or inventing terms that are not spelled out in the confirming memorandum by ending the memorandum with a clause requiring all other provisions to be contained in a written and signed document. Such a clause might read as follows.

This is the entire agreement between the parties and no modification, alteration, or additional terms shall be enforceable unless in writing and signed by both parties.

If you use such a clause, be sure there are no additional agreed-to terms that have not been included in the written document. A court will generally be confined to the four corners of the document when trying to determine what was agreed to between the parties. This means that nothing more than what is on the paper containing the agreement will be allowed as evidence.

An exception to this rule is that a court may allow oral evidence for the purpose of interpreting ambiguities or explaining the meaning of certain technical terms. The court may also permit the other parties to introduce evidence of past practices in connection with the contract in question, in connection with other agreements between the parties, or even in connection with contracts between other parties.

Businesspeople should not rely on oral contracts alone, because they offer little protection in the event of a dispute. The best protection is afforded by a written contract. It is a truism that oral contracts are not worth the paper they are written on.

CONTRACTING ONLINE

In 2000, the Electronic Signatures in Global and National Commerce Act (E-SIGN) became effective. This act was intended, among other things, to encourage online commerce and provide the parties who take advantage of it with the ability to contract in cyberspace.

Where a contract is required to be in writing, parties can decide to contract electronically by affirmatively agreeing to do so. When a company dealing with a consumer is required to provide a contract or notice in writing, that company must both seek the customer’s consent to receipt of an electronic document and verify that the document can be accessed and retained by the consumer. For example, the company must notify the customer of the hardware and software requirements for accessing the document.

Once a consumer consents to electronic receipt of documents, the consumer must notify the company of any change in email address. If the customer desires to withdraw their consent to electronic receipt, the location where documents can be sent must be disclosed to the company, as well.

Online contracting is available only when there is a method for preserving the electronic contracts and other relevant data electronically. This will eliminate the need for warehousing hard copies of the documents for online contracting. No special technology must be used for online contracting and the parties are free to establish their own vehicle for accomplishing the act’s requirements. Electronically signed documents can be encrypted if the parties agree. In fact, this is likely to be the standard procedure, at least at the initial stages of the development of the online process of contracting.

CONCLUSION

We have now provided you with some of the fundamentals of contract law, which are important for you to understand. In the next chapter we will discuss specific employment contracts and the issues that may arise in the employment context. Later chapters will add additional useful information for both employers and employees.