When one files an action in court seeking relief against another party, (the “complaint”) the legal action is normally based on allegations of wrong doing caused by a party or parties (the “defendants”) who have caused the injured party (“the plaintiff”) damage. The colloquial term for filing such an action is “filing suit” or “commencing legal action.”
The overwhelming majority of such legal actions allege a wrongful act based on negligence or intentional wrongdoing (an action known as “tort” and discussed in a separate article) or/and are based on breach of a written or oral agreement between the parties (“breach of contract.”)
A contract is a binding obligation between two or more persons predicted on a mutual understanding (“agreement”) of the parties. If one of the parties fails to conform to the obligations of the contract, that is called a breach of contract. Such agreements may be oral or written and can even be “implied” by the court in certain circumstances discussed later in this article.
This article will discuss the normal requirements to both create and enforce a binding contract in California.
This web site has more detailed articles discussing particular types of contract situations which the reader may wish to visit after reviewing this basic article. See Commercial contracts;Promissory Notes;Contracts to Make Wills;Real Estate Ownership and Transactions and Tenancy in Common in San Francisco and Bay Area Communities.
ELEMENTS OF A CONTRACT
While each state in the United States has slightly different criteria as to how to create an enforceable agreement, all are essentially identical in their basic requirements. Contractual requirements are essentially commonsense as seen below.
FIRST, the parties must have intended to create a binding obligation between themselves. Unless unusual events occur, one can not enter into a contract “by mistake.” While ambiguity of terms or errors as to facts that lead one to create a contract are discussed below, the parties must have determined between themselves to enter into a binding agreement.
The above necessarily requires that the contracting parties be of legal age to contract (18 or 21 depending on the State), of sound mind, and with the requisite state of mind to intend to form an agreement which the Courts will have the power to enforce. Moral obligations, in which a party does not intend to be legally bound but feels morally obligated to perform, do not meet that requisite legal intent.
While mistakes as to facts can lead a party to foolishly or mistakenly enter into an agreement, assuming that the party intentionally intended to enter into a binding agreement, the courts will normally still enforce the agreement since the other party relied on the commitment.
For example, if a defendant made an error in reading the map and entered into a contract to dig a trench not realizing that the ground was not sand but solid rock, thus it will cost twice as much to dig, the court will ignore the fact that the defendant entered into the contract based on an error in judgment and will compel the defendant to perform. Error of fact is not a defense unless both parties were in error in which case some courts have held that the parties failed to agree since both were in error as to the true facts. Error caused by the intentional misrepresentation of the plaintiff can also void a contract since the court will not encourage such fraudulent acts.
SECOND, the parties must contract to perform a legal act. No court will enforce a contract to engage in illegal or immoral activities. Thus, for example, a contract to import illegal goods or to evade taxes will be unenforceable in a court of law in the United States.
THIRD, each party must either give up something or transfer some benefit to the other party before a binding agreement is created. This is called “consideration“ and simply means that the contract involves mutual obligations of the parties in which each side achieves some benefit from the other. A typical example is that one party buys a house by paying money to the other. One party gives up money to buy the house. The other party gives up the house to get the money. It is an enforceable contract.
A related concept to consideration is mutuality. That concept is that if one party seeks to enforce a contract, that party, itself, must be bound to the contract. Mutuality is actually no more than another way of insisting that each side must surrender something of value to create a binding contract. (An exception to mutuality is third party beneficiary contracts discussed below.)
It is important to note that the consideration need not be identical or of equal value. The courts allow great freedom of contract and will not try to impose the court’s idea of value on the parties. Nevertheless, unless there is some exchange, and the exchange is more than nominal, the Courts will look with disfavor upon the contract.
All these concepts seek to impose fairness...the idea that one must pay something or give up something to bind another. Failure of consideration can eliminate a contract. Thus if I sell you a house which, unbeknownst to you, you already own (you were unaware that you had inherited it) then I can not enforce the contract to have you pay me even if you signed that contract in mistake since I have really given nothing up.
Some courts have held that if one reasonably relies on promised performance of another, and the other had grounds for knowing of that reliance, that the contract is enforceable even if the consideration is one way. Thus, if I promise to give you an automobile as a gift and based on that you move to a distant location, the courts may enforce that obligation because you relied on my promise even though you had not obligated yourself to pay me anything or give me anything in return, i.e. it was a gift. This doctrine is called promissory estoppel.
FOURTH, the basic essential terms of the contract must be agreed between the parties. Those terms usually include: who are the bound parties; who gives up precisely what and when. If the parties failed to agree on these key terms, or on only one or two of them, the court will usually void the attempted agreement on the grounds of uncertainty or a failure of the parties to have “a meeting of the minds.” Except under unusual circumstances, an American court will NOT substitute its judgment for those of the parties and “write in” critical clauses. The parties are free to contract or not to contract and this freedom to contract is not lightly abridged or taken over by the court.
OTHER REQUIREMENTS: Various types of contract, by statute or by case law, may have additional requirements to be enforceable. Thus many home improvement contracts require warnings to the home owners in specified language, give a grace period in which the owner may withdraw acceptance of the contract, etc. Contracts involving property or which involve large amounts of money or long times to perform often have to be in writing and signed by the bound party (the doctrine of the statue of frauds) while other contracts, to affect the rights of third parties, may have to be notarized (trusts) or notarized and recorded (title deeds.)
Oral contracts are usually enforceable, so long as they do not violate the statue of frauds described above, but the time to file suit to claim damages for an alleged breach in California is two years from the actual breach of the contract or from when it should have been reasonably discovered that the contract was breached. Most written contracts in California have a four year period to sue from date of breach or reasonable discovery of breach. While each state may have different statue of limitations, (the time in which a party must bring suit) most give a longer statue of limitations to written contracts than to oral contracts.
Realistically, it is always preferable to have a written contract not only to have the four year statute of limitations described above, but to avoid confusion between the parties and to make the case in court easier to prove. An old saying is that “an oral contract is worth the paper it is written on.” While an exaggeration, the basic tenant is true: try to reduce to writing any important contract you enter into.
One can transfer rights under most contracts to another person (assign the contract) just as one can assign an existing judgment to another person. Further, under the doctrine of third party beneficiary, a person in whose favor a contract was created may be able to enforce a contract even though not actually a party to the contract. A typical example is that if I contractually obligate myself to a father to provide education to his son and breach my obligation, the son may be able to sue me directly for breach of contract as a third party beneficiary to the contract even though the son was not obligated to pay me anything. In such event, the son’s rights are contingent on the father having met the contractual obligations described above, such as consideration, terms fully agreed to, legality of the contract, etc.
DAMAGES FOR BREACH OF CONTRACT
Assuming one proves a breach of contract, what remedy will the court grant? The normal measure of damages is “the benefit of the bargain.” This means the court will seek to place the injured party in the same position that party would have been if the breach had not occurred.
For example, if you promise to sell me an 1999 automobile for $20,000.00 and then breach your contract, the court will award me damages equal to the benefit of the bargain. If I can purchase an equivalent car for 25,000.00, the benefit of the bargain would be five thousand dollars and that would be my damages. Assuming I can replace the car for 18,000.00, then I have no damages at all and the fact that I can prove breach will accomplish no monetary recovery for me. Measurement of damages is thus a critical element of any case and before one files suit one must carefully analyze the extent of damages that may be proven.
Too often an angry plaintiff, sure that they will prevail in court on a clear breach, fails to carefully review precisely what damages will accrue even if proven. While the court will award court costs of filing suit and costs of experts and deposition reporters (See Article on Litigation), unless there is a clause in the contract awarding attorneys fees, the plaintiff usually does not receive attorneys fees as part of the judgment. It is not unusual for a party to spend tens of thousands of dollars in fees, win the case, receive a token judgment, and be monetarily damaged more by the case being brought than by the original breach.
Nor can a plaintiff sit back and allow massive damages to build up. There is an ongoing duty to mitigate damages which is defined as doing those tasks reasonably necessary to minimize the harm caused by the defendant’s breach. For example, if a roofing contractor breaches his contract to repair my roof and thus there is leakage which is destroying my hardwood floor, I am obligated to seek a replacement contractor to quickly repair the roof and to seek to protect the floor as reasonably necessary. If I fail to do so, the Court may limit my damages to what would have occurred had I acted to reasonably mitigate the damages.
The basic rule of law in the United States is that courts will award monetary damages for breach of contract. In certain unique situations the courts will actually order a party to do more than pay money. The usual situation involves breach of contract relating to real property or where the court is convinced that payment of money will not remedy the harm caused by the defendant. The courts have held that each piece of real property is unique and that an injured party may seek “specific performance” of the contract rather than payment of damages. Thus, if you breach a contract to sell me a house, I can elect to go for monetary damages or to have the court order you to conform to your obligations under the contract and transfer the house to me for the price we contracted to.
Punitive damages, in which a party asks for the court to “punish” a party for wrongdoing by ordering exemplary damages, seldom lie in contract. It is important to recall that breach of contract is NOT a crime nor even particularly discreditable in the commercial world. One always has the right to breach a contract...if one is willing to pay the damages. Punitive damages lie in intentional breach of a legal duty, usually not founded on contract, such as the duty undertaken by fiduciaries or the duty not to commit fraud on others; but those are not actions predicated on breach of contract. It should also be noted that punitive damages are seldom found outside the United States and seldom enforced in non United States jurisdictions even if the judgment is achieved in the United States
CONTRACT VERSUS TORT
A “tort” is a wrong committed by a defendant not based on a contractual obligation but which gives one a right to sue predicated on the defendant breaching a duty of due care or intentionally harming one in violation of a duty or the law. Typical examples are personal injury actions in which a person’s negligence causes physical or property damages (whether in driving a car, carrying heavy equipment, building a bridge or whatever) thus the damaged persons who are hit by the car, crushed by the equipment, or who fall off the poorly built bridge can sue for damages based on the tort of negligence and receive damages. Intentional torts, such as assault and battery or fraud, allow a party to sue for damages if they are the victim of such wrongs caused not by the carelessness of the other party, but by that party’s planned wrongful actions. See our article on this web site on Torts for more details.
An action on a contract is not an action based on tort since suit on a contract is not a question of negligence or intentional wrongdoing, but breach of an obligation undertaken in an agreement.
Nevertheless, It is common to have various torts pled in the Complaint along with the action for breach of contract, the typical torts being fraud (intentionally misleading the party) negligent misrepresentation (negligently misleading the party) and the like. These topics are further discussed in the Article on Torts. American courts normally see thousands of actions for breach of contract in any session and unless good evidence of torts is demonstrated, courts are unlikely to take the tort actions seriously. The courts are aware that too often American lawyers “puff up” their pleadings and settlement claims by adding in tort actions to frighten defendants. See our article on Fraud and Deceit on this web site.
As with punitive damages, it is important to differentiate between breaching a contract, which, if not creditable, is certainly not evil or criminal, and being the victim of fraud or intentional wrongdoing. You are free to contract. You are also free to decide to breach the agreement-you simply have to pay the other side’s damages provided you have no creditable defense. On the other hand, if misrepresentation has occurred, there are significant remedies available to the harmed party including but not limited to punitive damages and those may lie whether or not a contract was entered into.
USUAL DEFENSES TO BREACH OF CONTRACT
Many of the defenses usually raised by defendants to the complaint for breach of contract have already been discussed above in describing the elements necessary to make a binding agreement. Thus, defenses such as statute of frauds (contract must be in writing and was not); failure of consideration, failure of mutuality, mutual mistake of the parties, failure of the parties to agree to key terms (“ambiguity”) are the common defenses normally raised.
And for those contracts subject to special rules, such as home improvement contracts, it is common to plead (if one is the homeowner) that the contract did not meet the strict legal requirements, such as warning notices to homeowners, the three day cooling off period, etc. Especially with contracts involving consumer goods or the sale of residential real property, the Legislature has passed numerous laws requiring special provisions and protections and one finds those issues raised whenever such contracts are in dispute.
But by far the most common defense is that of performance excused because the other party had breached first. If the other party breaches a contract, aside from the duty to mitigation described above, one is excused from further performance and may simply file suit for damages and/or abandon the contract entirely.
As in all United States trials, the plaintiff has the burden of proof to prove breach of contract by a preponderance of the evidence. Once that burden is attained, then the defendant has the burden of proof to demonstrate that the defenses indicated above apply.
ANTICIPATORY BREACH OF CONTRACT
Quite often a party’s performance is not due until after time or other events have passed. A typical example is that of purchasing products. The seller may commit itself to sell products months or even years away for payment now. It is not unusual for a party to learn that a possible defendant has taken steps which indicate that the defendant will inevitably breach the contract in the future, even though performance is not yet due. Can the plaintiff sue now even though the actual breach will not occur until some time in the future?
Quite often, one can commence action before a breach occurs IF the defendant has communicated clearly that the defendant intends to breach or if the defendant has made it impossible for the defendant to perform in the future. A typical example would be commodities futures. If a buyer in the United States learns that a scarce crop which the buyer had contracted to buy from a particular Seller had just been committed by that Seller to a different Buyer, then a suit may be brought immediately on the doctrine of Anticipatory Breach of contract. It is important to note that IF there is some way the Seller could still perform and if the Seller has not communicated an intention to abandon the contract, that the Buyer would not be able to sue until the breach actually occurred.
CONCLUSION: CONTRACT TERMS IN THE UNITED STATES
Commercial transactions normally utilize standard terms and conditions, more fully discussed in the Retainer Articles in this website on commercial transactions. Likewise, most industries have particular terms and conditions that are typical for their types of transactions. See the Articles on Mechanics Liens (for construction); Real Estate, for property; Wills and Trusts (for trusts); and, in general, each particular type of law has its particular types of contracts. Nevertheless, the basic laws of contract described above normally apply in those fields as well.
The reason contracts are present in all the other areas of law is that they form the basis for the bulk of the duties the courts are likely to impose upon Parties. Contract law and tort law form the basis of the overwhelming majority of litigation in the United States and it is in the freedom to contract that the courts and government grants to parties the right to form their own relationships...and enforce them by rule of law. Where most countries pass laws to create the relationships between citizens, in the United States the citizens are normally free to create their own business and property relationships and do so by binding obligations in contracts, both written and oral.
With that freedom comes the obligation to understand the ramifications of the contract and to undertake the responsibility for abiding by the contract and for planning on the results of one’s own decisions. You are free to contract. You are free to breach an agreement: but the result of that breach is that you may pay the full damages you have caused to the other party.
A contract is an opportunity to create a mutually beneficial relationship and the courts will actively assist in making sure that a contract is adhered to...provided the parties do an adequate job of creating the contract such that the courts will consider it legal and binding. In some ways, the freedom to contract is the very essence of the freedom to use our legal system, for it allows anyone to create a document that the legal power of the government will enforce. Such power and such responsibility is used so often in the United States that it is often taken for granted. But to recognize how unique this is, all need one do is contract in any one of two dozen other nations which ignore contracts or are subject to corrupt courts and one quickly understands both the benefits...and the risks...inherent in executing a contract in this country.
When one considers writing one's own contract, one should carefully examine the possible downside of poor drafting. See our article on The Usual Suspects in Contractual Disputes as to critical areas of concern.
A client, just prior to executing a multi million dollar contract, looked at the writer and smiled and commented, “It’s odd, isn’t it? All I do is scribble my name on this line, here, and suddenly an eight million dollar project is underway and I am responsible for all these payments. All because I put my name on this line. Remarkable.”
Then he chuckled and signed and began a construction career that made him wealthy and famous in his community. If he had failed on that construction job, he would have been bankrupt.
That is the power of contracts.