The Basics of a Contract

BINDER ON CONTRACTS

Oral or Written?

While many contracts are enforceable when made orally (but see the statute of frauds), oral contracts present tremendous proof problems if they need to be enforced in court. As you write contracts, always keep that in mind: If this contract is ambiguous, will a court rule against me in a declaratory action; if this deal was just done on a handshake, do I have the witnesses to back up what our oral agreement is. To me, the role of a transactional attorney and paralegal is to write the best deal for the client that will also not wind up in litigation down the road - a difficult task!!!!! That's why if we wind up in court, we must make sure our client is protected (thus, clauses such as attorney's fee clauses, for example, are inserted).

IMPORTANT - a lot of the contract law we discuss here is from the common law - as the case law evolved over the years.

HOWEVER, always remember that if contract law is "codified" - put into a statute - the OCGA - that will override the classic general common law principles of contract law.

EXAMPLE - Believe it or not, you could form a general partnership in GA on a handshake. However, GA has codified a whole set of statutes on partnership. So, down the road if there's a lawsuit over an oral partnership agreement, we'd go straight to the OCGA to see how the statute treats the problems (and THEN to the case law to see how GA cases interpret the statutes).

Elements of a Valid Contract

1. OFFER AND 2. ACCEPTANCE

TERMS:

offeror - person who made the offer

offeree - person who received the offer (and can propose a counteroffer - a new proposal which becomes the offer - note that in general contract law, a counteroffer rescinds the original offer)

express contract - can be written or oral -- it's when the terms are actually stated, as opposed to an implied contract, where a contract is form based on the conduct of a party -- for example -- the painter story from the Intro class.

quantum meruit, quasi contract, unjust enrichment - these are all terms based in Equity - this is when someone knows they'll lose on the Breach of Contract claim, but feel they should win on the basis of fairness.

license -- giving someone permission to use something for a limited time or purpose

3. CONSIDERATION - a bargained for exchange (giving something up, getting something of roughly equal value in return)

TERMS:

past consideration - is NOT valid consideration -- for example -- saving a person from drowning and then someone promising you money AFTER you performed the deed in the past

promissory estoppel - another equitable term -- this is when you cannot establish consideration -- cannot establish a bargained for exchange between the parties (promissory estoppel is used as a substitute for consideration, when a person relies on a promise made by another to the former's harm)

4. CAPACITY TO ENTER INTO A CONTRACT -

TERMS:

undue influence (different from economic duress) - undue influence is when a fiduciary (a person in a position of trust, such as an attorney, priest granddaughter, influences you to enter into a contract or change the terms of a will -- courts will invalidate such a contract/will, because of the lack of capacity of the person entering into it.

minor contracts - many such contracts are VOIDABLE (not VOID) at the option of the minor. However, if the minor turns 18 and hasn't gotten out of the contract, then s/he has "ratified" the contract.

MINORS CANNOT GET OUT OF: 1- Certain contracts entered into as a business venture; 2- student loans; 3- contracts for "necessaries" - food, shelter, etc

5. INTENT

TERMS:

mistake, misrepresentation, intoxication, adjudicated insane by a court -- any of these circumstances could lead to a contract being voided by a court, because the parties did not have the requisite intent to enter into the contract.

6. LEGALITY

TERMS:

illegal contract - such as a gambling contract, cannot be enforced by a court and will be considered void

void contract - having no legal effect

voidable contract - one party has the option to void the contract such as certain minor contracts

adhesion contract ("unconscionable contract") - a one sided contract -- when a consumer argues that s/he didn't have a opportunity to "bargain" the terms of the contract, and thus shouldn't be held to an outrageous term of a contract.

statute of frauds -- certain oral contracts will be void and unenforceable , unless in writing -- such as:

1. contracts for the sale of real property

2. sales of goods for over $500

3. contracts which cannot be performed within a year (for example, a commercial lease for 5 years)

Parol evidence -- the court will not allow any testimony to change the CLEAR AND UNAMBIGUOUS TERMS of a contract. However, if the court finds the contract term to be unclear, such testimony can come in, along with any prior drafts of the contract.

Elements of Breach of Contract

If a party breaches a contract, here are the elements a plaintiff must establish to prevail on a breach of contract claim:

1. The existence of a valid contract (that's 1-6 listed above)

2. Defendant breached (broke) the contract

3. Plaintiff performed all "conditions precedent" (a fancy way of saying obligations) to the contract prior to filing this lawsuit

4. Plaintiff notified the defendant about the breach (preferably in writing - defer to the contract as to how to notified breaching party)

5. Damages

Story Time

Something that will not happen to you from this day forward.

A person went into a car dealer one evening and signed a contract (Security Agreement) to purchase a truck - in the process, she traded in her car. When the person expressed her hesitancy to sign the contract, the dealer closed the deal by saying to her "Drive the truck around for a week; if you still have doubts, come back and we'll cancel the deal." The buyer had no witnesses to this statement.

You know where this story is heading - the buyer goes back to the dealer the next morning, regretting the amount of money that the truck will cost. Of course, the dealer said that she couldn't get out of the contract and that her trade-in was already sold.

The dealer gets to stand behind the MODIFICATION/MERGER CLAUSE in the contract (look it up in your own car contract). This clause would exclude the statement made by the dealer to the buyer. However, the statement was still a misrepresentation of fact - leading to several tort actions (fraud, intentional and negligent misrepresentation). But where's our witness? (how can we prove this in court?)

A consumer in this scenario should immediately turn to that state's consumer statutes - in some states, consumers have 3 business days to get out of most consumer contracts. However, the state of Georgia is not so friendly. The buyer turned to an attorney and to our city's consumer advocate only to be told that there is no such statutory provision in our friendly state (though there is such a statute dealing with health club contracts and possibly other consumer contracts).

Caveat emptor.

You're going to hear me talk about "leverage" a lot in my classes. Where is the buyer's leverage in this case to get something done? In the contract? NO. With consumer statutes? NO. With a witness to the dealer's statement? NO. With her trade-in still on the lot? NO. So what do you do?

When trapped, I believe in creating leverage. Leverage is obviously created when armed with an attorney. However, not everyone has that luxury. The next step is to get a consumer advocate working for you - combined with bad publicity. What better way than to involve the threat of bad publicity? If the dealer can be caught in any lie, I guarantee they'd avoid the publicity and work it out. If he cannot be caught in the lie, I'm afraid our buyer will have little or no recourse.

Leverage is the determining factor for drafting a good contract that the other side will sign. If the other side "needs the deal" more than we do, we'll have leverage in the negotiations. If there is ever a contract dispute, hopefully the language we negotiate will back us up. Leverage comes in many forms - and it usually comes down to money.

A cynical point on contracts - Contracts are made to be broken. Just because parties signed on the dotted line doesn't mean all is well. If a business person has signed a bad deal and is losing money, s/he might try to get out of the deal. If the other side does not agree, the business person will consider breaching the contract to force a more reasonable deal. If that person has a "war chest" (more money) that the person wishing to enforce the deal, then that translates into leverage and possibly a reasonable deal.

Yikes!!! What does this have to do with offer, acceptance, etc??? Exactly the point - while we need to learn the building blocks of contracts, a business person needs to see the realities of deal making.

Final Note: the buyer in the above situation better be correct in her assertion to the media, because this kind of action can open her up to a slander lawsuit. Oh, but that's in the TORTS lecture, please don't confuse us here!

Important Clauses

COVENANT NOT TO COMPETE - This clause is a "restrictive covenant" - it prevents a party from doing something - usually leaving a business for a competing business. These CLAUSES MUST BE REASONABLE as they relate to

1 - geographic region

2 - time frame

3 - scope

They are STRICTLY CONSTRUED by the court - meaning that they are interpreted very narrowly by a judge - the judge will enforce the literal meaning of the clause only and will not "read into it" and will not rewrite them (called "blue penciling") - in addition, if this type of clause is at all unreasonable, the court will not allow a "savings clause" to save it.

What is reasonable for the time frame, region and scope? Whatever is "reasonable for that particular industry" - you need to go to relevant caselaw to figure that one out. What could be reasonable for a contract for a dentist (region - if s/he leaves the practice, s/he will not compete within a 20 mile radius -- versus a salesperson of a certain product would might be precluded from selling in GA and FL).

It's hard to give you an answer on this - the attorney needs to understand the industry he is writing the contract for as well as what the cases say on the topic.

ATTORNEY'S FEES - a clause stating that the prevailing party to an action is entitled to recover costs and reasonable attorney's fees from the other side (in other words, a client who had to pay his/her lawyer to defend him/her in court should be able to recover that amount above damages from the other side).

CHOICE OF LAW and VENUE - this can be done in one or two clauses. If our client is in Clayton County, GA and the other side is in New York, where do you think we want to litigate in the event of a lawsuit.

SEVERABILITY (SAVINGS) CLAUSE - hugely important - General contract law states that if any clause of a contract is found by a court to be illegal (against the law) or unenforceable (for example, a contract of adhesion), then the ENTIRE CONTRACT IS THROWN OUT. Pretty harsh, eh? The savings clause does just that - it's a statement that "saves" the rest of the contract that the judge found reasonable.

MODIFICATION (also called INTEGRATION, MERGER) - a clause which says a couple of things - that this contract is the entire agreement between the parties, all oral agreements merge into this contract, and the only way the parties can modify the contract is if it's in writing and signed by both parties.

ASSIGNMENT CLAUSE - look at your car contract - do you have the right to assign the payment obligations to another party without the permission of the bank or finance company? Yeah, right. Also important:

Assignment with recourse - be careful about ever agreeing to this - this means, for example, if you want to assign payments to someone else, the bank will have YOU remain liable for the amount if the person you assign the car payments to ever defaults. It has the same effect as if you co-signed a contract for someone - you remain secondarily liable for the debt. BE CAREFUL OUT THERE!!!!

Assignment without recourse - this is more typical and it means just as it sounds.

LIQUIDATED DAMAGES CLAUSE - very important to know - it's a clause put in a contract which pre-determine how much the damages will be because they will be hard to figure out. The amount must be reasonable and not deemed to be a penalty by the court - otherwise, the clause will be held unenforceable (OCGA 11-2-718)

ACCELERATION CLAUSE - should be in all contracts where there is still money to pay - it says that upon default, the entire balance is due. For example, if a contract calls for $200 a month and a balance of $20,000 - the whole amount is now due and owing on default!! Be careful!!!

TIME IS OF THE ESSENCE CLAUSE - if deadlines are important for a contract - you may want to insert this - often done in construction contracts when the project needs to be done by x date.

BEST EFFORTS CLAUSE - found often in services contract - that the person will use his/her best efforts to perform duties.

Other terms to know

RELEASE - gives up all of your rights to sue - can be General or Limited

USURY - unlawful interest amount charged for a debt. See OCGA 7-4-2

ANTICIPATORY REPUDIATION - can you sue someone even when the other side is not in breach of the contract yet? (but based on good information you believe they will be in breach) Maybe - example - a furniture dealer is supposed to deliver to you a unique piece of furniture that takes 1 year to custom build. No other pieces exist. It is promised to you on Dec 1. On Nov 1, you discover that that piece of furniture is going to someone else for a higher price. Do you need to wait until after Dec 1 when the other side has "breached" the contract or can we sue right away? Assuming the fact that there's no other way for the dealer to get a replacement by Dec. 1, under anticipatory repudiation, you could sue right away

ARBITRATION - sometimes put in a contract to avoid going to court

CONFESSION OF JUDGMENT - upon default, you agree that the other side will have a court judgment against you. Yikes!! OCGA 9-12-18

The Uniform Commercial Code (UCC)

The UCC is a set of statutes adopted by 49 states (excluding Louisiana). It is embodied in GA's OCGA and it governs business transactions among merchants and consumers. Before deferring to general contract law (case/common law), it is important to always check the UCC to see if one of these statutes applies. We will deal with 2 articles of the UCC, dealing with the sale of goods (Article 2) and secured transactions (Article 9). Beyond the scope of this lecture is a discussion of Commercial Paper (banking, checks, etc.) found in UCC Articles 3 & 4.

UCC - Article 2 - Sale of Goods

"Goods" under the UCC are defined as any moveable object. The computer that you are about to throw across the room - that's a good (though possibly not a good thing to do). The desk that you are working on - that's a good. The house or apartment you're working in - that is affixed to land and is not covered by Article 2 - so land, and things affixed to land would not be goods, thus not subject to Article 2 rules. What about that tree outside your home - that's affixed to land. Right, but once it's cut down, it then becomes a good.

A contract for services also does not come under this Article. If a painter paints your house for $2,000, you're paying for the service, not for goods. But you may say "out of the $2,000, $300 was for paint - isn't that a good?" Yes, but when we analyze the whole contract, if it is predominantly a service contract, the courts will hold that it does not come within Article 2's purview.

Why the fuss? Because Article 2 has different rules from general contract law. For example, when consumers buy goods that simply don't work - even if the product does not come with an EXPRESS WARRANTY, the UCC provides for an IMPLIED WARRANTY OF MERCHANTABILITY - sort of a guarantee that the product works.

Here's an example of something that would come under the UCC - a buyer's right and duty to COVER (OCGA 11-2-712)

This example deals with a merchant buying goods from another merchant, assuming the goods are FUNGIBLE (interchangeable).

A ton of bricks needed to build a home is interchangeable (in other words, if a seller doesn't get the bricks to a buyer, that buyer could find the bricks elsewhere). On the other hand, specially ordered handmade tiles from Italy would probably not be fungible. So, what happens in the following scenario:

Seller agrees to send to buyer 10 tons on bricks by March 1 at $1,000/ton ($10,000). The buyer gets a call from the seller on Feb 15 saying that he can't produce that number of bricks for the buyer on time. What should be going through your mind is that buyer may have a claim for ANTICIPATORY REPUDIATION, but forget that for now. The buyer has a bigger headache - he needs to start building for a client, and he committed to clause in that contract (TIME OF THE ESSENCE) calling for a rapidly approaching deadline.

Now our buyer needs to scramble --- the FAIR MARKET VALUE of bricks has gone up since signing the contract with seller. There are two reliable companies selling bricks for $1,500 a ton and a third reliable company selling bricks for $2,000 a ton. The UCC gives our buyer the right to get similar bricks at fair market value and then sue the original seller who breached the contract for cover -- if the buyer had already paid the original seller $10,000, he can then buy the bricks from one of the reliable companies for $1,500/ton ($15,000), then sue the original seller for the $10,000 + $5,000 extra for what had to be paid to the new company (in addition to any cause for the damage caused by breaching the contract). This is the process of COVER - letting our buyer recover from a breach of contract by substituting goods at fair market value, then holding the original seller responsible for any more the former had to spend.

What if the buyer went with the $2,000/ton company (for $20,000)? Assume for a second that all three companies promised delivery at the same time and the quality of the bricks is the same. What happens if the buyer covers by paying $20,000? The original seller may have an argument - that the buyer FAILED TO MITIGATE DAMAGES - that is, if the buyer could've gotten the substitute goods for $15,000, why should the original seller be stuck with a bill for an extra $5,000? Don't forget that just because a party didn't breach the contract, it doesn't mean that s/he doesn't haven't a duty to lessen the damages that the other side eventually might have to pay.

One other things about Article 2 - this is where we find the Statute of Frauds rule that the sale of goods for over $500 must be in writing - there is an exception - when a merchant is selling something to another merchant and these parties have done business together before - the contract may not need to be in writing.

UCC - Article 9 - Secured Transactions

What is a secured transaction? It's when you finance a purchase and that purchase is backed up by collateral. For example, that car you are financing is backed by the car as collateral - if you default, the car may be repossessed and then you may be sued for the balance deficiency. A promissory note you sign for a bank is a security interest if it is backed up by collateral such as the $10,000 coin collection gathering dust in your security box.

Same thing for the purchase of your home - if you default on the mortgage, the bank may foreclose on the home.

Thus, a secured transaction applies to personal (goods) and real (land) property.

What about goods which then become attached to real property??!!! Such as a home fireplace (the fake, gas kind, that is secured to the wall) . This might be called a FIXTURE. It will lose its identity as a "good" if its removal would cause substantial damage to the real property. Better file a "fixture filing" (see below) to protect your interest in keeping it classified as "goods."

Many things we need to know:

First, once the contract is signed the secured transaction must be PERFECTED (this protects the creditor's priority to the collateral).

The process of perfection FOR THE PURCHASE OF GOODS occurs when a FINANCE STATEMENT (also known as a UCC-1 FORM) is filled out and filed immediately with the appropriate office (see the handout I gave for a copy of a UCC-1 form).

It tells the court if there is a dispute among creditors in the future as to who has PRIORITY to the collateral (who has the better claim). This often comes up when creditors are battling to recover from a debtor, when the debtor has limited resources, or if the debtor is in bankruptcy court (for Fixtures, it's a different form - if the owner of the fixture does not file a UCC form for the fixture, that fixture likely becomes a part of the real property and thus is owned by the owner of the real property - in other words - the fixture loses its identity).

In Georgia, UCC-1's are filed with the clerk of the superior court in the county where the collateral is located and last for 5 years (can be renewed).

"FORECLOSING" on a security interest (getting back the collateral) can be accomplished in GA without resorting the courts (non-judicial proceeding). There is a procedure in GA to effect foreclosure outside the courts, as long as the secured party doesn't "breach the peace" (OCGA 11-9-503) -- an example of breaching the peace is breaking into someone's locked garage to repossess a vehicle.

Note: The information on this web site is for classroom purposes only and is not offered as legal advice. Consult an attorney in your state for legal questions on this information.