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Forming a Contract

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Forming a contract

This section focuses on how contracts arise and the conditions that must be met for the legal system to recognize the relationship as a contract. The discussion also addresses situations when a contract is not formed.

General contract law concepts (N.D.C.C. title 9)

People enter into a contract by negotiating an agreement - the parties set the terms, but as discussed in the next section, their flexbility to set the terms of their contract is NOT unlimited.

Requirements of a contract (see N.D.C.C. §9-01-02)

Contracts are formed with the parties working to create a contract have achieved a "meeting of the minds"; that is, they agree to the same understanding at the same time, and part of that understanding is that each has assumed a legal obligation.  A more formal description of the requirements for creating a contract are the following four points.

1.  Persons who are capable of contracting

  • All persons are capable of contracting (that is, capable of accepting legal obligations) except minors and persons of unsound mind (N.D.C.C. 9-02-01).
  • A person is not allowed to enter into a contract if they do not have the capacity to understand that they are assuming a legal obligation.
    • Intoxication does not mean, however, lacking the capacity to understand. A contract entered into while a person is intoxicated is likely to be binding.

2.   The consent of these people.

  • The contracting parties must agree to accept the legal obligation and they must agreeing to the same understanding of the legal obligations that each is accepting.
  • The consent of the parties to a contract must be: 1. Free; 2. Mutual; and 3. Communicated by each to the other. N.D.C.C. 9-03-01.
  • A person cannot be obligated to a contract they did not agree to and a person cannot be forced to accept a contractual obligation (do not confuse "forced" with the idea of motivated, convinced, etc).  A contract is voluntary.
  • But see N.D.C.C. §8-07-02. "A common carrier, if able, shall accept and carry whatever is offered to him, at a reasonable time and place, of a kind that he undertakes or is accustomed to carry."

  • Consent is not mutual unless the parties all agree upon the same thing in the same sense.  N.D.C.C. 9-03-16.
    • Reaching mutual consent is sometimes referred to as a "meeting of the minds," that is, the thoughts and expectations of the parties are similar enough to conclude they are in agreement.  Occasionally, the question of whether there is a contract is posed as "was there a meeting of the minds?"
  • Consent can be communicated ... only by some act or omission of the party contracting by which he intends to communicate it ... N.D.C.C. 9-03-17.
    • The parties must communicate to one another their intent to enter into a contract with one another; that is, communicate their intent and willingness to assume a legal obligation to the other person.
    • Without communication, one party would not know that the other party is willing to accept a contractual legal obligation.

 

3.  A lawful purpose and possible obligations

  • The object of the contract (or the activity agreed to in the contract) must be legal and it must be possible. N.D.C.C. 9-04-02.
  • A contract is void if the object is unlawful, the activity is impossible, or the agreement is too vague to be understood.  See N.D.C.C. 9-04-03.
    • A contract can be for "any proper subject matter;" that is, the agreement must not violate law or public policy.  Buying and selling real or personal property, leasing real or personal property, buying and selling a service, or lending capital are proper subject matter for contracts.  Hiring a person to kill someone or to deliver illegal drugs are obvious examples of improper subject matter and such agreements will not be enforced by the court system (instead, the legal system, including the courts, will work to punish the criminal activity).
    • But is an agreement to avoid legal responsibility for an environmental problem (such as the liability associated with a hazardous waste site) contrary to public policy? E.g., 42 U.S.C. 9607(a) and (e)
    • Is an agreement that restrains competition contrary to public policy?
      • "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal."  15 U.S.C. 1
      • N.D.C.C. §9-08-06. In restraint of business void - Exceptions.
      • "This clause [in the employment contract between Solberg and the previous employer] inappropriately prohibits Solberg from [selling] a policy [to] a client who freely comes to her. This clause restrains third parties from contracting for insurance with the company or agent they choose. These limitations constitute a restraint of trade and therefore the agreement is "to that extent void."" Warner and Company v. Solberg, 2001 ND 156, 634 N.W.2d 65
    • Also see N.D.C.C. chapters 9-04 and 9-08.
      • e.g., N.D.C.C. §9-08-01 (Provisions that are unlawful) and §9-08-02 (Contracts against the policy of the law).
  • Possible or impossible -- is fulfilling the contract possible?  If yes, this requirement is met; if no, this requirement is not met and the contract is void. See N.D.C.C. §9-01-14.  This topic may be addressed again as an argument as to why I do not need to fulfill my contractual obligations.

4.  Consideration has been given (note -- this is not the typical definition for the word "consideration") -- something of value has been given by the accepting offeree to the offeror (N.D.C.C. 9-05-01); the parties have exchanged something of value.

  • Consideration could be a payment of cash, a transfer of property, or agreeing to be legally obligated to fulfill the terms of the agreement. 
  • Agreeing to a legal obligation is perhaps the most common form of consideration.  That is, when I accept the legal obligation to do something for you, I have given you something of value.  I have given you an intangible property right. Likewise, your acceptance of the contract (that is, the acceptance of a legal obligation) also has given me something of value; again, it is an intangible property right.

Thought question:  What is the conceptual relationship between "agreeing to be legally obligated" and intangible property? N.D.C.C. 9-11-01.

Consideration when forming a contract is not likely to be the same item of value that a person would be entitled to receive when the contractual obligation is fulfilled.

Example.  On Monday, we agree that I will sell my car to you on Friday for $2,000.  On Monday, we have given each other something of value; I have assumed the legal obligation to sell the car and you have assumed the legal obligation to buy the car. Each of us accepted a legal obligation that the other party can enforce. Accepting those legal obligations is the consideration needed to form the contract.  My delivery of the car to you on Friday and your delivery of $2,000 to me on Friday is not the consideration that formed the contract on Monday.

 

A contract is formed through a process of offer and acceptance

  • Offer -- statement by an offeror to an offeree suggesting terms of an agreement and asking the offeree to accept them. While an offer is outstanding, the offeror is legally obligated to be bound to the agreement if the offeree accepts the offer. After an offer is made, one of several things can happen:
    • 1.  the offer may terminate in one of several ways
      • Expires -- offer terminates after the period of time specified by the offeror or after a reasonable period of time if no period was specified; once an offer has expired, it no longer exists; restated, the law does not recognize an offeree's attempt to accept an expired offer.
        • There is no typical "reasonable time" in which an offer will expire.  If a time period is not specified by the offeree and a dispute arises, "reasonable time" will be determined by a jury based on the facts of the particular situation.
      • Revoked -- offeror informs offeree that offer has been withdrawn; offeror can withdraw an offer only if the offeree has not already accepted it; offer cannot be revoked if offeror has agreed to hold the offer available for a specified period of time and that period of time has not yet passed; N.D.C.C. 9-03-22 and -23.
      • Rejected -- offeree informs offeror that offer will not be accepted.
        • An offer, once expired, revoked, or rejected, no longer has any legal status; it is gone.
    • 2. Counteroffer - after an initial offer has expired, been revoked, or been rejected, the offeree can make an alternative offer to the offeror; the roles of the parties have been reversed; making a counteroffer implies a rejection of the initial offer.
    • 3. Accepted -- offeree informs offeror that offer will be accepted; at this point the parties have reached a "meeting of the minds;" once an offer is accepted and consideration has been provided, the parties have a contractual obligation to one another.

During negotiations:

  • When negotiating a contract, think ahead and clearly state what you envision for the agreement; it should describe who does what, when and under what circumstances.
  • The agreement should explain the relationship and its outcome if events occur as intended; the contract should also explain the relationship and outcome if events do not go as intended; that is, the contract should explain who bears the risks and consequences of unexpected events.
  • The law allows parties entering into contracts flexibility to negotiate an agreement to meet their needs; e.g., note the language in some statutes - "unless otherwise agreed to" which indicates that the provision of the statute does not apply if the parties addressed the issue in their contract. Restated, in many situations, contract law has little or no application if the parties had the foresight to resolve potential problems as part of their negotiated agreement.
  • A contract arises when the parties have reached an understanding that can be described as "a meeting of the minds."
  • How much must I tell the other side during negotiations?
    • We know we cannot lie to each other while negotiating a contract; that would be fraud (see N.D.C.C. chapter 9-03).
    • What if I recognize they are making a mistake; must I point it out?
    • What if we realize at a later time that we both made the same mistake (e.g., mistaken assumption) while entering into the agreement, is the contract still valid?
    • See Dahl v. Messmer, 2006 ND 166.
  • What am I suppose to do during negotiations?
    • Read the contract (if there is a written document)
     
    • Understand caveat emptor -- let the buyer beware
      • Caveat emptor is an old notion extending back to Roman law that imposes the responsibility on the buyer to figure out what the buyer is purchasing.  For example, a buyer should not agree to buy an item until he or she has explored or investigated the product.
    •  
    • Understand due diligence
      • Due diligence is a more recent concept; especially since the 1980s/1990s.  Due Diligence essentially states that the buyer needs to explore and investigate the situation as he or she makes a decision.  Examples of transactions where due diligence is expected include making an investment, buying land, buying a business, taking on a responsibility that may have environmental obligations, and extending a loan.

        See USLegal Due Diligence at http://definitions.uslegal.com/d/due-diligence/

      There also are some discussions about using due diligence as a legal defense, such as "yes, the food I manufactured turned out to be unsafe but I did everything I could during the production of that food to assure it would be safe; and since I did everything I could, I should not be liable for the unsafe food".  A similar argument was made by an employer whose employee was injured "on the job".  Both of these examples, however, were from outside the United States.  This defense may not work in either of these situations in the United States due to absolute liability (in the case of food) and workers compensation (in the case of workplace injury).

      A U.S. example of due diligence as a defense would be Business B arguing it has no obligation to Business C when Business A failed.  For example, B and A enter into a business arrangement; B then enters into an arrangement with C.  Business C entered into this arrangement with B knowing that A and B already had an agreement, and that the arrangement between B and C was based on the success of the relationship A and B.  Perhaps A was supplying an input to B, that B then modified and sold to C, for example.

      When A fails, a chain of events follows, that is, B cannot perform for C, and business C suffers a loss.  C then sues B on the basis that B did not adequately investigate A (which B and C were both relying on).  It is at this point that B would argue that it had adequately investigated A (i.e., B would claim it had performed "due diligence" as it entered into the agreement with A) and that C cannot bring a legal action against B for failing to adequately investigate business A.

      Of course, if C can establish that B had not performed due diligence in investigating A, C would have a better chance of recovering from business B.

      Only if 1) the A (e.g., a buyer) has no way to investigate the offer and A has to solely and reasonably rely on B (e.g., a seller), or 2) B blocks the A's due diligence effort with lies and misinformation would the law likely impose a legal obligation on B (if A does not discover a problem before the contract was entered into).

    • Bottom line -- persons entering into a contract must make an extensive effort to understand the current situation, the proposed obligations, and associated risks.

How do we know when a contract has been created?

  • Each party must be aware that all parties to the contract are accepting the legal rights and duties of entering into a contract.
  • Mutual agreement -- all parties to the contract must agree to be bound by their agreement; the parties are in agreement as to the legal rights and obligations for all parties arising from their agreement/contract.
  • Contracts can arise from actions as well as words; e.g., taking a food item to the checkout counter at a grocery store.

Situations that do not result in the creation of a contract - these arguments will generally be raised as a defense after a breach, not at the time the parties are trying to form the agreement even though the arguments are based on events that occurred during the formation process.

  • Mistake

There is no contract because my consent was obtained by mistake.

N.D.C.C. 9-03-03; N.D.C.C. 9-03-12 to -14; and N.D.C.C. 9-09-02(1).

 

N.D.C.C. 9-03-13. Mistake of fact defined. Mistake of fact is a mistake not caused by the neglect of a legal duty on the part of the person making the mistake and consisting in:

1. An unconscious ignorance or forgetfulness of a fact, past or present, material to the contract; or

2. Belief in the present existence of a thing material to the contract which does not exist, or in the past existence of such a thing which has not existed.

If you could have discovered that you were making a mistake, but you did not put forth the effort that would have revealed the mistake, you have to live with the consequences of making the mistake.  Thus, as you enter into a contract, you must make every effort to check your information to make sure it is correct; if you do make the effort and there is a mistake, you may be able to escape the contract.  If you do not make the effort and there is a mistake, you are stuck with the agreement.

"Rink's mistake of fact was caused by his failure to read the contract and thereby ascertain the type of agreement offered before signing it. We conclude that Rink is therefore, "deprived of any recovery on the basis of a mistake of fact, for the reason that [his] mistake of fact was caused by [his] neglect of a legal duty."" Rink v. NPN, Inc., 419 N.W.2d 194 (N.D. 1988)

N.D.C.C. 9-03-14. Mistake of law defined. Mistake of law constitutes a mistake within the meaning of this title only when it arises from:

1. A misapprehension of the law by all parties, all supposing that they knew and understood it and all making substantially the same mistake as to the law; or

2. A misapprehension of the law by one party of which the others are aware at the time of contracting, but which they do not rectify.

See Diocese of Bismarck Trust v. Ramada Inc., 553 N.W.2d 760 (N.D. 1996); this case involves a written contract containing a mistake and therefore did not accurately document the parties' agreement.

  • Fraud/duress

There is no contract because my consent was obtained by fraud.

e.g., an intentional misstatement of fact that induced you to accept the offer

e.g., statement about a future action when there is no intent to complete that act

N.D.C.C. 9-03-03; N.D.C.C. 9-03-07 to -10; specifically -08 and -09; also N.D.C.C. 9-09-02(1).

Towne v. Dinius, 1997 ND 125, 565 N.W.2d 762

There is no contract because I accepted the offer because I felt I had no choice (duress):

More specifically, however, one challenging the validity of a contract on the ground of economic duress must establish three elements: "(1) that one side involuntarily accepted the terms of another; (2) that circumstances permitted no other alternative; and (3) that said circumstances were the result of coercive acts of the opposite party."   Taken from Mellon v. Norwest Bank of Mandan, 493 N.W.2d 700 (ND 1992).

 

Must the agreement/contract be written?

  • Oral contracts are valid. e.g., N.D.C.C. §9-06-02.
  • The law requires, however, that certain contracts must be in writing for a court to enforce the agreement, see statute of frauds. e.g., N.D.C.C. §9-06-04.
  • For practical purposes, parties may want to document their agreement (create a written contract).

Statute of Frauds

  • Certain agreements must be written and signed for a court to enforce them (e.g., N.D.C.C. §9-06-04); including transfer of land, agreements that cannot be completed within one year from time of the contract, and sale of personal property for more than $500 (N.D.C.C. 41-02-08).

A contract for the sale of goods for the price of five hundred dollars or more is not enforceable ... unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought ..."  (N.D.C.C. 41-02-08(1)).

  • A written agreement subject to the statute of frauds will be enforced only against the person who signs the writing.
  • Agreements subject to the statute of frauds need not be in writing; but they are unenforceable in court if they are not written.  Many contracts that are subject to the statute of frauds are entered into and fulfilled by the parties without a writing; that is fine but be aware that if such an unwritten agreement leads to a dispute, the courts will be unable to enforce the agreement.
  • Statute of frauds is usually raised as a defense by a breaching party to argue that the breaching party has no obligation to fulfill (the agreement is unenforceable) because it was oral but should have been written.

Exceptions to Statute of Frauds:

In some situations, courts will enforce an unwritten agreement that should have been in writing; those exceptions are introduced in this section.

  • Partial Performance

    "One of the exceptions to the statute of frauds' requirement of a signed writing is found in N.D.C.C. 47-10-01 ...  Cases accepting the doctrine of part performance have recognized three major categories of acts by the purchaser that may make an oral contract enforceable: paying the contract price, taking possession of the property, and making improvements." Johnson Farms v. McEnroe

    "An oral contract, however, may be taken out of the statute of frauds by part performance ... consistent ... with the existence of an oral contract ..."  Kuntz v. Kuntz, 1999 ND 114, 595 N.W.2d 292

 

  • Estoppel

    The breaching party (the person who is not performing their agreed upon obligation) cannot raise lack of writing as a defense when the non-breaching party relied on the promise of the breaching party, this reliance is detrimental to the non-breaching party, and it was reasonable for the non-breaching party to rely on the promise of the other party.

    Example: "The basic elements of equitable estoppel were set forth by this court ... The basic elements of equitable estoppel that must be met as to the person being estopped are: (1) conduct which amounts to a false representation or concealment of material facts, or, at least, which is calculated to convey the impression that the facts are otherwise than those which the party subsequently attempts to assert; (2) the intention, or at least the expectation, that such conduct will be acted upon by, or will influence, the other party or persons; and (3) knowledge, actual or constructive, of the real facts.

    "The elements that must be found as to the person claiming the estoppel are: (1) lack of knowledge and the means of knowledge of the truth as to the facts in question; (2) reliance, in good faith, upon the conduct or statements of the party to be estopped; and (3) action or inaction based thereon, of such a character as to change the position or status of the party claiming the estoppel, to his injury, detriment, or prejudice.'"

    Gruebele v. Mott Grain Co., 262 N.W.2d 747 (N.D. 1978)

 

  • Uniform Commercial Code (UCC) Merchant Exception

"Between merchants, if within a reasonable time [after an oral agreement is reached], a [written confirmation of the oral contract, signed by the sender] is received [by the other party] and [that] party ... has reason to know [the] contents [of the document, the writing] satisfies the requirements of [the statute of frauds] against [the receiving] party unless [the receiving party sends written notice to the first party within ten days objecting to the content of the written confirmation]. (N.D.C.C. 41-02-08(2)).

If you are a merchant doing business with another merchant, send a written confirmation after a phone conversation (for example) to bind the other party to the agreement the two of you reached during the conversation.

Is an e-mail sufficient confirmation?  Certainly a letter is adequate; that is what was being contemplated when this was written in the 1960s.  Would a fax (which became common in the 1980s) be adequate?  How about an e-mail in the 21st century?

Is a farmer a merchant?

"Merchant" means a person who deals in goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction or to whom such knowledge or skill may be attributed by his employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill. (N.D.C.C. 41-02-04(3))

Can a person be a merchant with respect to one type of goods and not a merchant with respect to another type of goods?

If farmers are merchants, can one farmer use a written memo to confirm an oral contract for the sale of personal property and thereby legally bind another farmer to their agreement?

Implied Contract (Unjust Enrichment)

Are there times when the law will imply a contractual relationnship or contractual obligations without the parties reaching an agreement or even intending to enter into an agreement?  The answer is yes.

[13] "Unjust enrichment is an equitable doctrine, applied in the absence of an express or implied contract, to prevent a person from being unjustly enriched at the expense of another." ...There are five elements necessary to proving unjust enrichment: "1. An enrichment; 2. An impoverishment; 3. A connection between the enrichment and the impoverishment; 4. Absence of a justification for the enrichment and impoverishment; and 5. An absence of a remedy provided by law."... A determination of unjust enrichment "holds that a certain state of facts is contrary to equity.

[14] The doctrine of unjust enrichment "is invoked 'when a person has and retains money or benefits which in justice and equity belong to another.'" ... "A person who has been unjustly enriched at the expense of another is required to make restitution to the other." Restatement of Restitution 1. For a complainant to recover, it is sufficient if another "has, without justification, obtained a benefit at the direct expense of the [complainant], who then has no legal means of retrieving it." ... "The essential element in recovering under a theory of unjust enrichment is the receipt of a benefit by the defendant from the plaintiff which would be inequitable to retain without paying for its value.

"Even where a person has received a benefit from another, he is liable to pay therefor only if the circumstances of its receipt or retention are such that, as between the two persons, it is unjust for him to retain it."

Apache Corporation v. MDU Resources Group, 1999 ND 247, 603 N.W.2d 891

In summary, persons entering into a contract have to reach an agreement.

  • "A contract requires parties capable of contracting, consent of the parties, a lawful object, and sufficient consideration. N.D.C.C. 9-01-02. Parties' consent must be free, mutual, and communicated to each other. N.D.C.C. 9-03-01."  Kuntz v. Kuntz, 1999 ND 114, 595 N.W.2d 292

  • A contract arises when there is a meeting of the minds

  • A contract is voluntary - you cannot be forced into accepting contractual obligations.

  • A more formal description of the negotiating process is offer, rejection, revocation, counteroffer and acceptance.

  • There has to be consideration; that is, the parties gave each other something of value. In the past, consideration had to be tangible. Today, exchanging legally enforceable obligations is often considered adequate consideration (watch out for the different meanings for the word "consideration").

  • Contracts can arise from oral agreements, but the statute of frauds requires that certain contracts must be documented in writing to be enforceable.

 

Last updated December 22, 2010

   
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