An Overview of Contract Law



The Extraordinary Importance of Contract Law:

Contract law lies at the heart of our system of laws and serves as the foundation of our entire society. This is not an exaggeration. It is a simple observation - one that too often goes unobserved.

Our society depends upon free exchange in the marketplace at every level. Contract law makes this possible. Exchanges in the marketplace always depend upon voluntary agreements between individuals or other "legal persons". Such voluntary agreements could never work without contract law.

Contract law serves to make these agreements "enforceable", which usually means that it allows one party to a contract to obtain money damages from the other party upon showing that the latter stands in breach.

Without contract law, these voluntary agreements would instantly become impractical and unworkable. Since such agreements lie at the very heart of our society and economy, and since they depend upon contract law, it is no exaggeration to say, as I have just done, that "contract law lies at the heart of our system of laws and serves as the foundation of our entire society." Those were the very words that I used to begin this essay.

Stated more precisely, it is our system of contract law that underpins and makes possible the many private, voluntary agreements by which exchanges of goods and services are accomplished in our society at every level. No exchange is exempt from the contract law, which indeed can be rightly called the cornerstone of marketplace civilization.

In this article, I will briefly explain the different types of contracts that can be made, paying special attention to the common problems that arise in their formulation. I will also discuss how contracts are enforced or avoided, and how a wronged party to a contract can obtain recompense and other relief from the wrongdoing party. I will explain the principle of good faith, which in California is known as the "covenant of good faith and fair dealing", and which has been too often overlooked by commentators and practitioners alike.

I do not aim to provide a comprehensive explanation of all the theoretical and practical difficulties. This is an overview, not an exhaustive treatise. Sometimes the overview will better help the reader understand the essential points, or the "forest" if you will, while the treatise is better for explaining the many intricacies and complexities that can be rightly called the "trees" of contract law.

Definition of a Contract:

A contract is nothing other than a voluntary, private agreement to exchange valuable things. It most often is an exchange of valuable promises. For example, a home-buyer might promise to pay $250,000 to the seller, who in exchange promises to deliver unencumbered title to the buyer.

Good Faith and Fair Dealing:

Most exchanges are straightforward matters that are self-executing and done without any problem at all. When I buy a cup of coffee at my local cafe (which I have just done so that I may enjoy it while I compose the present essay on my laptop), the cafe and I have made a self-executing exchange, which we have done without a hitch.

Ditto, if I buy a book at the local bookstore or have my car washed at the local car-wash. Ditto again, if I purchase airplane tickets from a travel agent, or have my house painted, or have my teeth cleaned at the dentist's office.

Fortunately, most exchanges are performed on the spot to everyone's satisfaction. Were this otherwise, our society and general commerce would soon become choked by controversy and disputes. Thus it may be said that our system depends above all on the good faith and honesty of our people. Indeed, the principle of "good faith" is central to contract law.

Every contract made or performed in California is said to include an implied-in-law covenant of good faith and fair dealing, by which each party to the contract agrees to act in good faith and deal fairly with the other. This has been construed to mean that one party to a contract should not try in bad faith to cheat the other party of the benefit of the bargain made by the contract.

Inevitable Complications and Controversies:

While most exchanges are performed without incident, not all of them are, as we all know. This is true even in the simplest of matters (e.g., the sale of a cup of coffee) and is even more likely in a complicated transaction (e.g., the financing, delivery, and insurance of commercial aircraft for an overseas company over a thirty-year term).

Let us take a simple example first. I will list only a few of the problems that might arise from a simple contract for a one-time sale of a single box of tomatoes. If you offer to give me $10 for a carton of tomatoes that I have sitting on a table behind me, and if I agree to accept it as payment in full for the tomatoes, we have made an oral contract that we can perform on the spot: You hand me the $10 bill, and I give you the carton. Nothing more simple or straightforward, right? But what if you discover that my tomatoes were too ripe when you bought them, and that they all go rotten within two hours of the purchase? What if I take your $10 bill, but then refuse to give the box of tomatoes, telling you to "beat it, scram, or else you'll get hurt!" What happens if your $10 bill turns out to be counterfeit, or if you take the tomatoes but refuse to pay, or pay with a check that you later cancel or that is returned unpaid by the bank? What if the carton breaks while you are carrying it, and all the tomatoes fall to the ground and are ruined? What if you needed these tomatoes for the dinner you meant to make for your boss, who, in disappointment, decides not to give you the promotion he had earlier discussed with you? My point is only that problems can and often do arise in even the simplest, easiest exchanges.

In more complicated transactions, the possible difficulties are varied and sometimes difficult for the parties even to envision at the outset, much less address in an intelligent, orderly manner. Let's consider one such example. Suppose a large American company makes a contract with a large foreign company by which it becomes obliged to design, deliver, and insure an entire generation of commercial aircraft over a thirty-year period. The possible complications might take me literally years to ponder, list, analyze, and explain. It could take a decade or longer for feuding teams of lawyers in several countries to sort out the possible complications that might arise.

To avoid such controversy, which results in burdensome attorney's fees and an equally burdensome devotion of attention and effort that could be better employed in more constructive endeavors, it is necessary to have a proper contract in place at the outset: If the exchange is to be done on the spot and simultaneously, a written contract need not be used, but the parties should either reasonably trust one another's good faith or have an exact understanding of the exchange before they undertake it. If the exchange cannot be performed in full on the spot, there should be a written contract to state the parties' obligations and the essential terms of the exchange. A good written contract will also address at least the most likely complications that might arise, assigning responsibility for any such complication to a specific party in a specified manner.

A good written contract is one that clearly describes the exchange to be done and also addresses the possible complications that might arise during the performance of the exchange.

Different Kinds of Contracts:

I earlier provided a simple definition of a contract. Here is a more technical definition: A contract is a private compact, voluntarily made, by which the parties agree to exchange valuable things with one another. A contract comes into existence when (1) one party makes an offer that the other party accepts, and (2) the parties thereby agree to exchange valuable benefits on specified terms and conditions, with reasonably specific agreement on the price, place, time, the goods or services to be delivered, and the other essential terms of the exchange.

Let us consider three different examples, so that this point can be illustrated clearly.

First Example: An Oral Contract. Suppose that I offer to pay you $1000 to proof-read this article and offer constructive criticism on how it might be made more useful or enjoyable to my probable audience. I further specify that I want you to state your criticisms in writing to me no later than "next week Thursday", whereupon I will pay you in full. If you agree to these terms, perhaps by saying "I accept your offer", we have made an oral contract by which I have promised to pay you $1000 next week Thursday, on condition that you give me your editorial comments in writing on that date.

But no contract would have been made if you had instead stated the following: "I agree to everything, except the price, which is too low for such important work on your extraordinary article! I propose to do the work for $10,000." In this event, you would have made a counter-offer, which is really a rejection of the offer and the proposing of a new offer in its place. I could then accept your counteroffer, thereby making a oral contract, or I could make some new counteroffer, which would be a rejection of your last offer, but with a new offer to you, or I could decide that there is no point in continuing to negotiate with you, in which case I would reject your offer and discontinue or terminate the effort to negotiate a contract. But to return to my example of a binding contract: Suppose that we finally agree upon the exact terms of my paying you to proofread this article. We have in this instance made a binding oral contract.

Second Example: An Implied Contract/Unilateral Performance. Now let's consider a second example. If I pay $1.50 in exchange for a cup of coffee given to me by the serving-person at my local cafe, a contract has been made and performed on the spot: The parties to the contract are the cafe and me. We have impliedly agreed that I will pay the $1.50, and that in exchange the serving person will make and give me a fresh cup of coffee that I may consume at leisure on the premises. I have given a valuable benefit (ready money) in direct exchange for another valuable benefit (a fresh cup of coffee that I can enjoy at leisure in a cafe).

In this case, the cafe and I have not merely made a contract, but have performed it on the spot. Since we did not actually haggle over the terms of the exchange, we have performed a unilateral contract: The cafe has in effect said to all comers, "If you approach our counter and order food or beverage at the prices stated on our menu, we will furnish you the food or beverage that you order, on condition that you pay for it on the spot. You may then consume your food or beverage at leisure on our premises."

In response to this open offer to all comers, I have taken the unilateral action of approaching the serving-person to order the coffee. My unilateral action of ordering a cup of coffee sets into motion the immediate performance of the exchange. The actual terms of the contract are implied by the cafe's posting of its prices, my own conduct, and the ensuing, simultaneous exchange.

Third Example: A Written Contract. For our third example, let's consider consider a more complicated contract that by its very nature requires a comprehensive written agreement. Suppose that a huge multinational corporation seeks to sell fighter aircraft to the United States Air Force, which is predisposed to meet its military needs by purchasing this aircraft. The two parties contemplate that the seller will help to design the aircraft, manufacture it, deliver it on a specified schedule, and provide insurance for it. Suppose that the Air Force agrees in principle to pay at least $417 billion dollars for this aircraft over a ten-year period. The negotiations themselves will last for months, if not years. Offers, counter-offers, and term sheets will abound. Both parties will employ elite attorneys to compose a master contract and ancillary documents that will supposedly explain the transactions and address each possible problem that might arise during their performance. The ensuing documents, which will likely fill a large room, will collectively constitute the series of written contracts and related documents by which the entire arrangement is to be performed.

In each example given above, the parties have agreed to exchange valuable benefits on specified terms and conditions (in the first example, I have also tried to show how contracts are sometimes proposed, but rejected by parties who exchange counteroffers but never reach a definitive binding offer-and-acceptance).

A lay-reader might think at first glance that my third example (the Air Force contract) is somehow a more formal, more binding contract than the first two examples (the proof-reading contract and the cafe contract). But this would be a mistaken conclusion: In all three examples the parties have made a binding, enforceable contract, by which each has agreed to give something of value in exchange for getting something of value. The only difference lies in the complexity of the exchange, not in its character.

The essential principle of every contract, no matter how large or small, is the giving of something in exchange for the getting of something. Typically, one "gives" a promise to do something, and in exchange "gets" a promise from someone else to do something.

Contracts can be stated in writing, in which event they are called written contracts. Or they can be made by oral agreement, whereupon they are called oral contracts. Or they can arise by implication, in which case they are said to be implied contracts. These then are the three different kinds of contract - written, oral, and implied.

Usually the parties to a written contract understand that they have entered into a binding agreement, but they do not always grasp this point when making an oral or implied contract. But the law never ignores this circumstance, nor is a party's ignorance of this "legal fact" an excuse that can be plead as a defense in court. If I offer to pay you $25 tomorrow for a carton of tomatoes, and if you accept my promise and bring me the carton at the appointed place and time, I commit a breach of oral contract if I refuse to pay the $25 for them. It matters nothing that we made no written agreement. We made an oral one, and you can seek damages for its breach in court if you so desire.