Contracts
Introduction
A contract is a legally enforceable agreement between two or more parties. Contract law is one of the most heavily tested areas on the REG exam. This chapter covers the essential elements of contract formation, defenses, performance, and remedies.
Elements of a Valid Contract
Every enforceable contract requires five elements:
| Element | Description |
|---|---|
| Offer | A definite proposal made with the intent to be bound upon acceptance |
| Acceptance | An unconditional agreement to the terms of the offer |
| Consideration | A bargained-for exchange of value between the parties |
| Capacity | Both parties must have legal capacity (minors, intoxicated persons, and mentally incompetent persons may lack capacity) |
| Legality | The purpose of the contract must be lawful |
Offer
An offer must be (1) communicated to the offeree, (2) definite and certain in its terms, and (3) made with intent to contract (objective standard). Advertisements are generally invitations to deal, not offers.
Example: Gies Co. sends a letter to MAS Inc. stating, "We will sell you 1,000 widgets at $10 each, delivery within 30 days." This is a valid offer — it identifies the parties, subject matter, quantity, and price.
Acceptance and Key Rules
- Mirror Image Rule: An acceptance must match the offer exactly. Any change in terms is a counteroffer, which rejects the original offer.
- Mailbox Rule: An acceptance is effective when dispatched (placed in the mail), not when received — provided the offeree uses an authorized medium of communication.
:::tip Exam Tip
The mailbox rule applies only to acceptances. Rejections, revocations, and counteroffers are effective only upon receipt.
:::
Consideration
Consideration requires a legal detriment to the promisee or a legal benefit to the promisor. Past consideration is not valid consideration. A pre-existing duty does not constitute consideration unless there is a modification under the UCC (no consideration needed for good-faith modifications of contracts for the sale of goods).
Types of Contracts
| Type | Description |
|---|---|
| Bilateral | Both parties exchange promises (most common) |
| Unilateral | One party makes a promise in exchange for the other party's performance |
| Express | Terms are stated in words (oral or written) |
| Implied-in-fact | Terms are inferred from conduct and circumstances |
| Implied-in-law (Quasi-contract) | Not a true contract; imposed by a court to prevent unjust enrichment |
Statute of Frauds
Certain contracts must be in writing and signed by the party to be charged to be enforceable. Use the mnemonic MY LEGS:
| Letter | Category | Description |
|---|---|---|
| M | Marriage | Contracts made in consideration of marriage (e.g., prenuptial agreements) |
| Y | Year | Contracts that cannot be performed within one year from the date of making |
| L | Land | Contracts for the sale or transfer of an interest in real property |
| E | Executor | An executor's promise to pay estate debts from personal funds |
| G | Goods | Sale of goods priced at $500 or more (UCC §2-201) |
| S | Surety | A promise to answer for another's debt |
The one-year rule applies only if the contract is impossible to perform within one year. If there is any possibility of completion within one year, the Statute of Frauds does not apply.
Example: BIF Partners hires an employee "for life." This contract does not fall within the Statute of Frauds because the employee could theoretically die within one year, making performance within one year possible.
Parol Evidence Rule
When parties reduce their agreement to a final written contract (an integrated agreement), the parol evidence rule prevents the introduction of prior or contemporaneous oral or written agreements that contradict the written terms.
Exceptions (parol evidence is admissible to show):
- Fraud, duress, or mistake in the formation of the contract
- Ambiguity in the contract terms
- A condition precedent to the contract taking effect
- A subsequent modification of the contract
- Partial integration — the writing was not intended to be the complete agreement
Third-Party Rights
Third-Party Beneficiaries
| Type | Description | Can Sue? |
|---|---|---|
| Intended beneficiary | Person the contracting parties intended to benefit | Yes, once rights vest |
| Incidental beneficiary | Person who benefits indirectly | No |
Example: Kingfisher Industries contracts with a builder to construct a warehouse, with a clause requiring the builder to pay MSA Records (a subcontractor) directly for materials. MSA Records is an intended third-party beneficiary and can enforce the contract if the builder fails to pay.
Assignment and Delegation
- Assignment: Transfer of contractual rights to a third party. Most rights are assignable unless the contract prohibits assignment, the assignment materially changes the obligor's duties, or the rights are personal in nature.
- Delegation: Transfer of contractual duties to a third party. The delegating party remains liable unless there is a novation (all parties agree to substitute a new party).
Discharge of Contracts
A contract may be discharged by:
| Method | Description |
|---|---|
| Performance | Full performance discharges both parties; substantial performance discharges the performing party but allows a claim for minor defects |
| Agreement | Mutual rescission, accord and satisfaction, novation, or modification |
| Breach | Material breach excuses the non-breaching party and gives rise to damages |
| Impossibility | Performance becomes objectively impossible (e.g., destruction of subject matter, death in a personal services contract, supervening illegality) |
| Impracticability | Performance is possible but would impose extreme and unreasonable difficulty or expense |
| Frustration of purpose | The principal purpose of the contract is substantially frustrated by an unforeseen event |
Example: Illini Entertainment contracts with a venue to host a concert. A new government order prohibits large gatherings. The contract may be discharged by frustration of purpose — the event that gave the contract its value (the concert) can no longer occur.
Remedies for Breach
| Remedy | Description |
|---|---|
| Compensatory damages | Place the non-breaching party in the position they would have been in had the contract been performed |
| Consequential damages | Losses that flow as a foreseeable consequence of the breach (must be reasonably foreseeable at the time of contracting) |
| Liquidated damages | A pre-agreed amount of damages stated in the contract; enforceable if reasonable and actual damages are difficult to estimate |
| Specific performance | Court order requiring the breaching party to perform; available when the subject matter is unique (e.g., real property, rare goods) |
| Rescission and restitution | Cancel the contract and restore both parties to their pre-contract positions |
:::tip Exam Tip
Punitive damages are generally not available in breach of contract actions. They may be awarded only in cases involving fraud or other tortious conduct.
::: The non-breaching party has a duty to mitigate damages — they must take reasonable steps to minimize losses resulting from the breach.
Summary
| Topic | Key Rule |
|---|---|
| Valid contract | Offer + acceptance + consideration + capacity + legality |
| Mirror image rule | Acceptance must match the offer exactly |
| Mailbox rule | Acceptance effective when dispatched |
| Statute of Frauds | MY LEGS — must be in writing |
| Parol evidence | Cannot contradict a final written contract (with exceptions) |
| Intended beneficiary | Can enforce the contract once rights vest |
| Assignment | Transfers rights; generally assignable |
| Delegation | Transfers duties; delegator remains liable without novation |
| Specific performance | Available for unique subject matter |