EXPLAINER: CONTRACTS 101
This post was co-authored by Ryan Reiffert, San Antonio corporate & transactional attorney and
Evan Janssen, a student at St. Mary’s School of Law
BackgroundContracts are no strangers at the Law Offices of Ryan Reiffert, PLLC. I assist with and review personal transactions, business agreements, government procurement documents, investment contracts, and much more for individuals, business entities, and more on a daily basis. Some are 2 pages, some are 20 pages, some are 200 pages. But all share the same basic DNA: offer, acceptance, consideration. I bring you this first installment in the explainer series so that you can educate yourself on contract law and – hopefully – better recognize when it’s appropriate to bring in a professional. Contract law is one of the most ancient branches of law, having its roots in Greek and Roman law (in fact Plato’s last and longest dialog is titled The Laws ) and deals in part with the law of contract), and indeed there is evidence of contracts being made and fulfilled in ancient Mesopotamia, some 4 millenia ago. Our modern legal system is somewhat less remotely derived (although still plenty old), descending to us from English Common Law. When it comes to entering into a contract, it is actually not that difficult. In fact, it might sometimes be done almost-accidentally. As mentioned above, under Texas law, you can form a contract or a legally enforceable agreement when you have three simple elements (1) one party makes an offer, (2) the receiving party accepts this offer and (3) there is an exchange of “consideration”.
Offer and AcceptanceAn offer must be made to begin the process. An offer exists when one party clearly expresses intent to enter into a contractual relationship that is bound by a specific set of terms. The offer gives the offeree the power to make a decision on whether or not there will be a contract. The offer needs to contain key information such as what, how, where, and the price. “Harder” language such as “You must”, “In order to accept”, or flat-out “This is an offer” make proposals look more like an offer. “Softer” language such as “If this makes you satisfied” or “Please call” looks much more like an invitation to negotiate and should not be seen as offers. The acceptance of that offer must be an agreement or a “meeting of the minds”. It cannot be an acceptance of a different offer. While this issue can generate a whole lot of thorny law-school problems under the UCC (especially when sophisticated parties send dueling purchase orders but nonetheless agree on essential terms like price, quantity, delivery time) that have been amusingly dubbed “the battle of the forms” the basic idea is that you must say “yes” to the offer in order to have an acceptance. If you propose different terms, you have made a counter-offer, which must then be accepted by the first party For instance, I make an offer to my coworker by offering to sell her my home stereo system for $250. If my coworker says nothing, and ignores my offer – this is not a contract, as my offer has not been accepted. If my coworker says “no; I don’t want a home stereo” – this is not a contract, as my offer has been explicitly rejected. If my coworker says “that piece of junk isn’t worth $250; I’ll give you $100” – this is also not a contract (it is a counter-offer). In order for a contract to be formed, my coworker must respond affirmatively to my offer to sell her my home stereo for $250. This could be by delivering a letter that says “yes I will”; it could be by saying “I accept”; it could be by signing an agreement that sets forth the terms; it could be by nodding her head; or it could be by a handshake (one of the most famous handshake deals of all time gave rise to the Pennzoil v. Texaco case). Another lesson of that case is that contracts don’t necessarily need to be in writing to be enforceable. Keep that in mind for a discussion of the statute of frauds below. An acceptance must also be in compliance with any procedural instruction given in the offer. If the offer says “To constitute valid acceptance, you must call”, sending an email or a fax would not been seen as a valid acceptance. It is crucial that you follow any procedural instruction given with the offer in order to avoid potential avoidance or revocation. If there is no specific form of acceptance laid out, you may generally communicate your acceptance at your discretion. Finally, acceptance must occur when the offer is in effect. An offer is in effect as long as the stated time on the offer (ex: This offer remains open for 24 hours”) has not passed. If there is no time stated on the offer, the offer will remain open for a “reasonable” amount of time. What constitutes reasonable typically is decided by the trier of fact—either a judge or a jury. Offers may be revoked by the offeror at any time before acceptance. The offeror must communicate this revocation to the offeree. Under the “Mailbox Rule”, if acceptance has been sent before revocation, the contract will be enforced as accepted. For example, I send the offer to sell my home stereo station to my coworker on a Monday. The offer holds that a valid acceptance can be any form of communication (Phone, e-mail, mail, etc.). On Tuesday morning, she decides that she wants to accept my offer by mail. She heads to the post office and sends a letter of acceptance in. That Tuesday afternoon, after not having heard back from my coworker, I decide to revoke the offer. I give her a call and tell her the offer is no longer open. On Wednesday, my coworkers letter of acceptance is received in the mail. Despite the fact that I had called her to revoke the offer not knowing she accepted, she had already accepted the offer thus creating a binding contract. An offer is considered accepted at the time that acceptance is communicated, no matter the form of communication. To avoid these potential problems, it is ideal to communicate your acceptance in the quickest way allowed in the offer. But wait. There is one more element required to turn a “mere agreement” into a binding contract recognized by the law – the element of consideration.
ConsiderationThe legal concept of consideration is a vital element in the law of contracts that benefits both parties and is essential for the party entering into a contract. As a matter of theory, it separates a contract (legally enforceable) from a “mere promise” (legally unenforceable). There has been much ink spilled over why mere promises are not legally enforceable; and in some very rare circumstances (e.g., promises to give money to charity), they have been enforced. When looking at a gift promise the court will look to whether the offeree reasonable believed that the intent of the offeror was to induce the action. If the answer is yes, there is consideration and the promise will be enforced. We won’t get into the academic side of this debate too much here; the simplest explanation that I have heard is that a unilateral promise will not be enforced because the other party has not done anything or made any changes to its behavior that would warrant enforcement by the legal system which, having finite resources, ought to devote its time to those arrangements where the aggrieved party did make promises or take actions to consummate the bargain. On a basic level, consideration calls for bargain and exchange. A promise must induce the detriment, and the detriment must induce the promise. Consideration may include money, land, physical goods, a promise to do something that one is not required to do, or a promise to refrain from doing something (or any combination of these things) that one is permitted to do. It is fundamentally the “benefit” received under the contract. LEGAL NERD NOTE – “Peppercorn Consideration”: the term “peppercorn consideration” refers to consideration of a very low value exchanged by the parties as an explicit attempt to generate a contract. Sometimes this is one dollar, or five dollars, or (hence the name) a single peppercorn. As stated by the court in Chappell & Co Ltd v Nestle Co Ltd ( AC 87) “a peppercorn does not cease to be good consideration if it is established that the promisee does not like pepper and will throw away the corn”.
Statute of FraudsThe Statute of Frauds is a very old thing, and originally refers to an act of the English Parliament passed during the reign of Charles II, in 1677. Most of the States have adopted very similar rules. In Texas, it is codified under the Business and Commerce Code, Chapter 26. The Statute of Frauds requires that, in order to be enforced as a legal contract, certain types of promises or agreements must be memorialized in writing, signed by the party to be charged, and with sufficient content to evidence the contract. The types of promises and agreements subject to the Statute of Frauds in Texas are:
- Certain Guarantees: a promise by an executor or administrator to answer out of his own estate for any debt or damage due from his testator or intestate, or a promise by one person to answer for the debt, default, or miscarriage of another person;
- Marriage Consideration: an agreement made on consideration of marriage or on consideration of nonmarital conjugal cohabitation;
- Long-Term Executory Contracts: an agreement which is not to be performed within one year from the date of making the agreement;
- Certain Real Estate Matters: a contract for the sale of real estate, or a lease of real estate for a term longer than one year;
- Certain Oil & Gas Matters: a promise or agreement to pay a commission for the sale or purchase of: (A) an oil or gas mining lease; (B) an oil or gas royalty; (C) minerals; or (D) a mineral interest; and
- Certain Medical Matters: an agreement, promise, contract, or warranty of cure relating to medical care or results thereof made by a physician or health care provider as defined
Ambiguity or Vagueness in ContractsDisagreement on the interpretation of a clause can happen at some point if the formed contract contains vague or has clauses that are reasonably subject to more than one interpretation (ambiguous). To avoid ambiguities in contracts, businesses or individuals should, first and foremost, READ THE CONTRACT CAREFULLY. It is best to hire a corporate lawyer that can assist in the forming of contracts, especially for business or large transactions. Aside from contract review and contract drafting, a high-quality corporate lawyer also assist with breach of contract matters
Parol Evidence RuleSimply put, the parol evidence rule holds that a contract ought to be interpreted by looking at the “four corners of the document” only and not using external (or “parol”) evidence. It prevents the inclusion, use or consideration of external statements or words to help in the interpretation of the contract – such as, for example, an email, text message, or phone call between the parties not made part of the actual agreement itself. LANGUAGE NERD NOTE: for those of you wondering what on earth prisoners being released early has to do with contract law… that’s a different word – that’s PAROLE and it means exactly that: early release of a prisoner. PAROL, on the other hand, simply means an oral (as opposed to written) expression Interestingly, the words are very closely related; both of these words come to English from the ecclesiastical Latin parabola (meaning “speech”) to Anglo-Norman French parole (meaning “word” or “formal promise”). So “Parol evidence” means oral evidence, while a prisoner who is “Paroled” is released early based on his word (oral promise) that he will behave himself once released. Like most rules, there are exceptions to the parol evidence rule – namely, contracts with ambiguous clauses. If the contract itself can be shown to be ambiguous, vague, or unclear, then parol evidence may be admitted to help the finder of fact interpret and show its meaning. “OK, but wait a second, Ryan” you might ask. “You JUST said that parol evidence is derived from the word for ORAL evidence, but when you first explained this, your example was about emails and text messages above – those are obviously written. So which is it??” And that’s a good point. Parol evidence means external evidence, not strictly oral-only evidence. But, think back to the time hundreds of years ago when the parol evidence rule was developed. Emails and text messages and various informal written communications… weren’t really a thing. The contract was a solemn, written document, and virtually any evidence outside of that document would have been unwritten.
Avoiding Contract Ambiguity with Clear Drafting and Merger (or Integration) ClausesMost clients don’t want their offhand comments in a negotiation, or previous iterations of a contract, to be used to evaluate the contract. So, it’s important to draft a clear document. Avoid terms that are vague or may have dual meanings. When enumerating timelines, requirements, or metrics, be as specific and detailed as possible. Always define key terms. There are, in addition, other contract drafting tips that a competent corporate lawyer can help you with to avoid being hit with parol evidence. For example, a merger (or integration) clause may say something to the effect of:
“This Agreement, including the Exhibits, Annexes, Attachments, and/or Schedules attached hereto and which are incorporated herein by reference, [together with [list Ancillary Agreements, if any]] constitutes the full, exclusive, and sole agreement of the parties hereto and correctly states all rights, duties, and obligations of each party as of this document’s date, with respect to the subject matter of this Agreement. In the event that any term, condition, provision, requirement or specification set forth in this body of the Agreement conflicts with or is inconsistent with any term, condition, provision, requirement or specification in any exhibit and/or attachment to this Agreement, the provisions of this body of the agreement shall prevail. Any prior agreement, promises, negotiations, or representations between the parties not expressly stated in this document are not binding. All subsequent modifications shall be in writing and signed by the parties or else will be null and void ab initio.”If you have ever signed a contract for anything, you have probably seen a clause that looks something like the foregoing. This clause is explicitly instructing a court to disregard and ignore any parol evidence. Drafting a clause like this to cover the correct matters and exclude the correct matters takes skill and experience offered by a high-caliber corporate attorney.
Breach of ContractOne party’s failure to fulfill any of its contractual obligations is known as a “breach” of the contract. The breach can range from anything from a late payment to a failure to deliver or perform. A breach of contract is typically classified into one of two types or “buckets” – a minor breach or a material breach. A minor breach occurs when part of the contract (an item, payment, etc.) is not completed by a specified due date. A material breach occurs when the purpose of the contract has been completely wiped out. For example, if I enter a contract with a vendor for 15 laptops and they deliver me 15 televisions, the heart of the contract has been materially altered. Therefore, the delivery of the televisions is a material breach. Breaches then fall into one of two categories: an “actual breach” or an “anticipatory breach”. An actual breach is when one party refuses to perform the terms of the contract while an anticipatory breach is when one party repudiates a promise before the time for performance arises or elapses. Remedies from a breach typically come in the form of damages.
Contract Damages: Expectation Damages vs. Reliance DamagesThere are a few ways to measure damages in a breach of contract case, and we will very (very very) briefly summarize them here. Expectation damages are essentially the “benefit of the bargain”. They can be seen as the market value of the promised performance (less the consideration promised but not given, if any). So, if I enter into a contract that I expect will result in revenues of $100, but I will be required to spend $60, my expectation damages are $40 – the profit I would have received had my counterparty fully performed the contract as required. The paradigm case for expectation damages is the “Hairy Hand” case (Hawkins v. McGee). Reliance damages, on the other hand, require that one of the parties act in reasonable reliance on the contract, to that party’s detriment. These damages are calculated by asking what it would take to restore the injured party to the economic position they were in before the party acted in reasonable reliance on the promise. These damages may be awarded after a breach of contract or by way of promissory estoppel.
Specific PerformanceIn other circumstances, damages may be an insufficient remedy, and a party may request an injunctive or equitable remedy. Think of a priceless or sentimental object or anything else that, for whatever reason, can’t really be fairly valued or given a dollar equivalent. In such circumstances, a party might ask for specific performance. Specific performance awards the aggrieved party the particular performance, or item, that was unjustly taken away or withheld from them. Specific performance is most commonly seen in contracts relating to real property but is generally used by the courts as a last resort. Notably, parties can include a clause in the contract that provides for specific performance as a remedy in the event of breach. Such a clause might read something like this:
“In the event of any actual or threatened default in, or breach of, any of the terms, conditions and provisions of this Agreement, the Party who is or is to be thereby aggrieved shall have the right to specific performance and injunctive or other equitable relief of its rights under this Agreement, in addition to any and all other rights and remedies at law or in equity, and all such rights and remedies shall be cumulative. The Parties agree that the remedies at law for any breach or threatened breach, including monetary damages, may be inadequate compensation for any loss and that any defense in any action for specific performance that a remedy at law would be adequate is waived. Any requirements for the securing or posting of any bond with such remedy are waived by the Parties to this Agreement.”As with the sample Merger/Integration clause above, there’s a good chance you’ve seen one of these before if you’ve been in business for a while. Also as with the sample Merger/Integration clause above, a good business attorney is extremely important to be able to correctly draft the Specific Performance clause to correctly match the terms of the contract and the terms of the underlying business deal.