The principles of contract law

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What defines a contract?

What are the key elements of a contract?

What are the different types of contracts?

The differences between a contract and an agreement

What constitutes a breach of contract?

Final words

There are few legal considerations more ingrained in the day-to-day activities of individuals around the U.S. and beyond than contract law. Contracts are an integral part of everything from buying a home to signing up for the newest social media platform to just about everything in between.

Understanding how contracts work, why they are so important to governments, businesses, and individuals living and working in almost every segment of society, and how to create sharper, more effective documents is vital to legal professionals of every background. Here, some of the critical components of contract law, as well as some of the common ways they are applied effectively, will be broken down and explored to assist attorneys and other legal professionals tasked with creating and litigating these important documents.

To start, it is important to consider exactly what constitutes a contract, what happens when there is a dispute between parties, and how contracts are generally utilized across the industry.

What defines a contract?

A contract is a formal, legally binding agreement: an agreement between parties, creating mutual obligations that are enforceable by law. Legal professionals must ensure that the contracts they draft are not only well-constructed but also form an enforceable contract—a formal, legally binding agreement. Understanding the nuances of a written contract is crucial in this process.

Among the basic elements of such an agreement are mutual assent, which must be expressed by a “valid offer and acceptance” and adequate consideration, in addition to legality and party capacity.

Most contracts in the U.S. are governed by common and statutory law in the states they are applied, notes the information resource. Naturally, some elements of contract law vary from state to state, but overall, most of the country handles large swaths of contract law in a fairly consistent manner. Additionally, private law dealing with agreements between non-governmental parties can sometimes override some of the rules laid out in statute and adjudicated into common law, it adds.

Contracts play a pivotal role in various aspects of life, from buying a home in the realm of real estate to engaging in transactions across different sectors. Whether it involves the sale of goods or the fulfillment of contractual obligations, the intricacies of contract law touch upon a wide range of activities.

Among some common examples of areas where contracts are generally deployed are:

• Lease and mortgage agreements
• Sign-up agreements and online purchases
• Employment contracts
• Insurance agreements
• Promissory notes

As one might imagine, these agreements dictate the actions and behaviors of almost everyone in both the public and private sectors. As a society, the concept of mutually beneficial agreements and arrangements, codified by the court system and written law, is the bedrock of many relationships, both personal and financial. As such, it is critical these documents are drafted clearly and with crisply discernable purpose.

In order to most effectively draft and execute these agreements, it is advisable to look at some of the common components of existing contracts. One way to accomplish this is to use a contract lifecycle management tool or a contract drafting solution that offers legal pros an efficient avenue to explore the nuances of some of these elements.

Here, we will take a cursory look at those elements that provide the foundation for most all contract law.

What are the key elements of a contract?

While contracts themselves cover an enormous array of legal areas, they do share a remarkable amount in common across industry and type. To that end, several key elements constitute contract formation; contract law is shaped by considerations of public policy, and parties involved, such as the offeror, must be aware of these legal principles. Those elements are offer, consideration, acceptance, and mutuality.

Offer

The offer, explains the educational center, involves one party promising to do something, or conversely, promising to refrain from doing a particular action.

Consideration

Consideration, it adds, is when something of value is offered in exchange for the above-stated action or inaction.

“This can take the form of a significant expenditure of money or effort, a promise to perform some service, an agreement not to do something or reliance on the promise. Consideration is the value that induces the parties to enter into the contract,” reads information from the university.

As such, the mere presence of that consideration is what separates a contract from that of a “gift.” In the legal sense of the word, a gift is a transfer of property that is made voluntarily and gratuitously with no promise of anything of value to be provided in return, adds the judicial center. Additionally, failing to deliver on a promised gift is not considered an enforceable “breach of contract.” Such a breach, along with remedies and enforcement related to those breaches, will be explored further later.

Acceptance

Acceptance, with respect to a contract deals, with the unambiguous nature by which an agreement is solidified. This may be done verbally, or through performance or deed, notes the university.

Mutuality

The fourth element of a valid contract is mutuality. Simply stated, this element requires both parties to understand the terms and substance of an agreement.

Additionally, many legal experts also point to the elements of “capacity” and  “legality” as necessary to create a legally binding contract agreement. If an individual attempts to enter into a contract without the ability to reasonably understand what they are doing—individuals under the influence of alcohol, for example, may be deemed unable to enter into a contract—a judge may find a valid contract agreement was unable to be properly executed. In turn, that contract agreement may be voided due to the absence of the capacity element.

Similarly, contracts must also fall within the scope of existing law in order to be considered valid. Contracts created in friction with the law may be considered to lack “legality” and may also be invalidated should they be challenged in a court of law.

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What are the different types of contracts?

Just as there are several different areas where contracts are generally used, and there are many common elements of a valid contract, there are also several different types of contracts.

The type of contract used depends on a number of factors. Those factors range from the composition of the parties involved to the nature of their relationship and the ultimate goal of the agreement. Oftentimes, the type of contract used is dictated by the preferences of the parties involved, however, in some instances, one type of contract simply doesn’t fit a particular circumstance. The Uniform Commercial Code (UCC) provides a framework for certain contracts, particularly those involving the sale of goods, within the broader area of law.

Some commonly used types of contracts are:

• Adhesion
• Unilateral
• Bilateral
• Executed
• Aleatory
• Fixed-Price
• Cost-Reimbursement

Adhesion contracts, for example, are negotiated between parties of uneven bargaining strength. An adhesion contract is drafted by one party, which is responsible for setting the terms of the agreement, and another party of considerably lesser strength who must then decide whether or not those terms are acceptable.

On the other hand, a unilateral contract involves one entity making a promise to another should a given set of circumstances take place. This contrasts with its counterpart, the bilateral contract agreement, which involves both parties making a promise in order to fulfill the terms of a given agreement.

Furthermore, according to information from the U.S. Department of State, a fixed-price contract, for example, involves an agreement between a buyer and seller who each agree in advance on what constitutes full payment for services and supplies provided in a contract. In contrast, a cost-reimbursement contract is used when the amount of work cannot be “definitely described” or it is difficult to estimate the costs with any “reasonable degree of certainty.”

The differences between a contract and an agreement

While a contract is undoubtedly a type of agreement, not all agreements constitute a legally binding contract. In order to form a contract, the above-stated elements must all be present in the document and its surrounding acknowledgments. Parties can agree to all sorts of things, but in order for that agreement to be enforceable by law, a very specific set of elements must be included. The legal concept of specific performance may come into play when addressing breaches of contract, and adherence to the statute of frauds is essential for certain types of agreements.

There are a number of different types of agreements commonly observed in day-to-day business activity. While not all agreements are contracts, some, though, do rise to that level. Thomson Reuters coverage of the Master Service Agreement (MSA) provides some helpful insights into one common agreement between vendors and clients. Understanding the dynamics of bargaining power is crucial for contracting parties to negotiate and establish fair and equitable agreements.

(MSAs) are broad, foundational contract arrangements outlining the scope of the relationship between two entities doing business with one another. Additionally, a companion component of an MSA is the Statement of Work (SoW), which lays out highly specific expectations and timelines with respect to a given project.

The SoW is a powerful tool for businesses, municipalities, and individuals looking to facilitate a working relationship with one another. Oftentimes, an SoW is deployed when two independent parties desire to work together toward the mutual completion of a work project or goal. The document, which can vary in size and complexity, provides important details with respect to the actual tasks needed to reach that mutual goal.

Further still, an “indemnity agreement” is another important legal pact between parties that often plays an important role in personal and business dealings. An indemnity agreement is “an arrangement whereby one party agrees to pay the other party for any damages regardless of who is at fault.” This is similar to a “hold harmless agreement,” which ensures one party will not be held for tort liability “arising out of the indemnitor’s negligent act or omission.”

What constitutes a breach of contract?

A counteroffer during negotiations may lead to modifications in the terms, and these interactions are integral to the framework of civil law. While form contracts offer standardized terms, parties are obligated to act in good faith during negotiations and throughout the life of the contract. Sometimes, obligations arise from an implied contract, emphasizing the dynamic nature of the law of contracts.

Unfortunately, sometimes parties dispute the terms of a written or verbal contract, or even whether or not a valid contract existed in the first place. Parties frequently accuse one another of misrepresentation with respect to their intentions, inadequate performance, or even outright lying. Oftentimes, these disagreements require some form of arbitration or adjudication.

Breach of contract is one common form of disagreement over a contract agreement. A breach of contract is “a failure, without legal excuse, to perform any promise that forms all or part of the contract. This includes failure to perform in a manner that meets the standards of the industry or the requirements of any express warranty or implied warranty, including the implied warranty of merchantability.”

When deciding a breach of contract case, a judge must consider several important questions, notes the educational center. First, a judge must determine if a contract did, in fact, exist. Once that determination is made, a judge will then consider what the requirements of that contract were, if it was at any point modified, and then if a breach occurred.

Then, a judge must decide if that breach was “material” to the terms of the contract and what potential legal defenses might apply to the breaching party. Finally, a judge would have to determine what damages took place as a result of the breach.

A breach of contract can be material or minor. The parties’ obligations and remedies depend on which type of breach occurred. A breach is material if, as a result of the breaching party’s failure to perform some aspect of the contract, the other party receives something substantially different from what the contract specified.

Final words

The understanding of contracts is embedded in the fabric of the broader legal system, influencing interactions at personal and professional levels. Legal contracts are important to understand as they are the foundation of a company or party’s relationship with another company, its clients, or even its employees. Knowing what contracts are, how they are crafted, and what their roles are in the legal ecosystem will help law firms and businesses know how to effectively manage them.

To that end, those in need of such agreements can jumpstart their drafting process with Practical Law’s up-to-date documents and clauses filled with drafting annotations, notes, and negotiation tips, provided in the recommended legal language of expert attorney-editors.

Practical Law is a phenomenal resource for drafting all your contracts, agreements, and clauses, and it has helped lawyers and attorneys from remarkably diverse backgrounds do just that. Standard templates provide starting points to set up these documents, and those templates are coupled with insights from experts who have years of experience in their practice areas.

Check out how your law firm can benefit from Practical Law to draft all your contracts, agreements, and clauses.

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