Principles of Business

Form 4 (Contracts)

Concepts of contracts

Business and the Law

There are laws that aim to protect and control businesses, and they are continually increasing and
evolving. Their main purposes are:

 To ensure there is free competition between businesses.

 To maintain a good level of safety and secure ethical working conditions.
 To protect consumers (bearing in mind that businesses are also consumers).

There are laws of product protection, to prevent others from stealing the intellectual creations
of people (copyright) and to prevent imitation of original invention of products (patents).

Patent and copyright laws are provided by government to reward and protect creative efforts. At
the beginning of any book, you will see that the copyright holder of this book is indicated by the
sign ©.

Another form of protection available to business is a trademark. Trademarks are words, letters
or symbols that are associated with a particular company or product. Company names, team
emblems and label designs are typical examples of the use of trademarks. Examples of
trademarks are Google, Shell, McDonalds etc.

The law of contract is particularly important to business, and many thousands of contracts are
made each day in the business world.

WHAT IS A CONTRACT?

A contract is a specific type of agreement between two or more parties that is legally binding
and enforceable in a court of law.

A contract involves an obligation on the part of the contractors. This obligation may be expressed
verbally or in writing, but there must be an apparent intention to create legal relations and not
just a mutual exchange of promises (which will be an agreement).

A contract may be written or unwritten, depending on its type. A written contract takes a
particular form. In other words, the wording, phraseology and terms used follow an accepted
format that is recognized as legally significant.

Written contracts may be formalised by a seal or by a witness’ signature. An advantage of a

signed contract is that the parties concerned cannot dispute the contents.
An agreement is any understanding between two or more parties.

Characteristics of Contracts

All legal contracts must have the following five characteristics:

 Legality: A contract must have a legal purpose. If a contract involves any illegal act
(eg. contracting someone to murder or commit burglary) it is illegal and
void.

 Consideration: Each party to the agreement must agree to give up something (a

consideration in exchange for a benefit, eg. You promise to pay a
decorator to paint your house, and the decorator has promised to
provide the labour in return for the payment.

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 Agreement: All parties to a contract must be of mutual agreement (sometimes referred
to as a ‘meeting of minds’ – one party has extended an offer to which the
other parties have agreed (offer and acceptance).

 Capacity: The parties must be competent, that is, they must both be of sound mind,
legal age and not influenced by drugs or alcohol.

 Good faith: All parties must engage in the agreement freely and honestly, with a
genuine
intention of the contract being carried out.

There are two types of contracts:

1. Simple Contracts
2. Speciality Contracts

1. Simple Contracts

A simple contract, as its name implies, is a ‘simple’ agreement between two parties. It
needs no special form; it may be by word of mouth (orally) or in writing (some simple
contracts must be in writing) or it may be implied by conduct (indicated by actions).

Simple contracts are the most frequent form of contracts undertaken. Eg. travelling,
dining in a restaurant, buying stationery etc.

2. Speciality Contracts

Speciality contracts (contracts by deed) are also referred to as ‘deeds’ or ‘contracts

under seal’. They tend to be a more formal type of contract, often written on a special
form, and they have three requirements:

 Signing – the contract is signed by all parties involved.

 Sealing – the contract is attached with some form of raised seal. *

 Delivery – the contract is placed (or touched) by the person to whom it is delivered.
All parties must have a copy.

A speciality contract does not have legal significance unless all three of the above procedures
have been carried out. Sometimes such contracts will have an attestation by one or more
witnesses, but this is not always necessary. Examples of speciality contacts are: mortgage
agreements, insurance contracts, land or property sales, hire purchase agreements and some sales
of goods contracts.

A contract of record refers to an order imposed by a court requiring a party to abide by a ruling
set down by the court. The ruling requires someone to do, or not do, something. Eg. a business
person may be told they must cease trading, or that they must pay compensation to some
aggrieved party.

OFFER AND ACCEPTANCE

There are three parties to a contract, and these are:

1. The Offeror – the person who makes the offer (eg. a seller).
2. The Offeree – the person to whom the offer is made (eg. a buyer).
3. The Acceptor – the offeree, having accepted the offer.

Example 1: Negotiating a contract

Hannah Offeror: I will sell you my pencil sharpener for $ 3.00 (offer).

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Luke (Offeree): It’s not worth that much to me but I’d give you $2.00 for it.

Hannah Offeree/Acceptor: Ok. I will let you have it for $2.00 (acceptance).
CONTRACT PROCESS

The formation of a simple contract involves one party (the offeror) making an offer to the other
party (the offeree) which must be accepted by the latter party for a contract to exist. Example:
one firm (the seller) may offer to produce a product for another company at some future date and
on specified terms (in three weeks and at a delivered price). In return, the other company (the
buyer) would agree to pay a specified sum of money (a consideration) for the goods to be
supplied.

Having made the contract, both parties would then be legally bound to honour the agreement. In
the event of either party failing to comply with the terms of the contract, the other party could
seek damages for breach of contract through the courts.

To be a party to a contract there must be intent to enter into the contract. If you are very young,
drunk or drugged, or similarly limited, a court may hold that you did not intend to make it, and
the agreement would be invalid.

If someone was forced into an agreement (eg. by threat), the agreement would be invalid. It is
also important to realise that a supplier has no obligation to accept an offer from a purchaser.

OFFER

An offer is a bid or proposal by one person to another (a proposal of contract). A contact has not
been made until an offer has been unconditionally accepted. The offer lapses on the death of
either the offeror or the offeree before the acceptance. It also lapses if it is not accepted within
the time prescribed within the contract.

An offer can be expressed (orally or written) or implied from the conduct of the person making
the offer.

An express offer would be if you placed an advertisement offering a reward for your lost wallet.

An implied offer would occur if you purchased a meal in a restaurant and paid the server the
correct amount for the meal.

ACCEPTANCE

An acceptance can be made in several ways. It can be made by a written statement. If the
written statement is sent by post it is effective from the time of posting.

The acceptance can be made by a verbal statement (eg. the sales assistant says, ‘I agree to sell
you the trainers’). Acceptance can also be by conduct (eg. sales assistant takes your money and
puts it in the till).

If the offeror wishes to revoke (cancel) the offer, this must be done before acceptance.

Counter-offer is when a new term has been accepted, and therefore a binding contact has been
formed (eg. an item is $100.00, and the shop assistant says that the price is $120.00).

The acceptance of the offer must not be uncertain either. If the shop assistant says that your offer
will probably be accepted, then the acceptance is not complete, because the outcome is not
certain.

COUNTER-OFFER

Sometimes there is rejection of the original offer and a proposed counter-offer is made. In effect
the roles of offeror and offeree become reversed. Once the counter-offer is accepted, a binding
contract has been formed.

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INVITATION TO TREAT

An invitation to treat is an invitation to make an offer. It is a statement which is intended to

persuade someone else to make an offer. The price label put on an item by a shop is an invitation
to treat and not an offer. If the shop assistant tells you that the price is wrong and that the real
price is higher, there is nothing you can do about it. In this case your offer has been rejected.

A person making an invitation to treat does not intend to be bound by it as soon as it is accepted
by the person(s) to whom it is offered. It is an invitation to enter into negotiation with a view to
creating an offer.

CONSIDERATION

Consideration is the name given to the price or benefit (or reward) that the parties to a contract
receive. A contract must involve some kind of payment or other consideration to be valid. It is
usual for both the offeror and the acceptor to benefit, and the consideration is the item of value
(eg. goods, services, money) that each gain.

CAPACITY

The term ‘capacity’ is used to identify who is eligible to enter a contract. Anyone who enters a
contract must be able to take responsibility for their actions associated with the contract. They
must have contractual capacity to be eligible to enter a contract. To ensure that persons are not
exploited or taken advantage of by virtue of their circumstances at any point in time, the law
makes certain provisions. Thus, the following persons are not normally considered to have full
capacity:

 Persons under the influence of alcohol or drugs are in a state that suggests temporary
loss of full consciousness and, therefore, are unable to undertake any binding legal
decisions.

 Persons of unsound mind, that is people who are diagnosed as being mentally ill, are
not normally accorded full capacity to enter a contract. The argument is that such a
person would be unable to make an informed decision and thus take responsibility for the
outcomes of the contract. However, if it can be proven that such a person is, without
doubt, capable of entering into contracts, then they would be granted full capacity.

 Aliens, that is people who live in a country other than their own and who are not
naturalised citizens of the country, would not be granted full capacity if their country
were at war or in conflict with the country in which they are living.

 Minors (people below the age of 18) have some restrictions on the type of contract that is
binding on them. If a minor enters a contract where they are not eligible to do so, the
agreement is said to be void. Eg. A minor can enter a contract for the purchases of
necessities, for food and clothing, but not for luxury items such as buying a car. A minor
cannot enter into agreements that will result in them owing money.

There are two exceptions to capacity law regarding minors:

1. A minor could be permitted to enter into a contract if it can be proven that what is
required by the minor is a necessity (eg. food, clothing and lodging).

2. Minors may also be permitted to enter into contracts of educational value, eg. a
contract for a student educational loan.

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LEGALITY

All contracts must conform to the law. The basic elements required for the agreement to be a
legally enforceable contract are mutual assent (expressed by a valid offer and acceptance),
adequate consideration and legality. A contract involves any illegal acts, or it is deemed to
promote civil wrongs, crime or immorality, it becomes illegal and void.

POSSIBILITY

Within the context of consideration, the parties to a contract must be able to meet the
requirements of the contract. However, from time to time ‘impossibility’ arises, and thus
interferes with the possibility of meeting the obligations of the contract. Example a contract has
been drawn up between two parties to use a venue for an event: the first party is to provide a
show arena, and the second party is to perform. However, if the facility is destroyed by a freak
storm just before the event it cannot reasonably take place, unless that party has another suitable
venue.

GOOD FAITH

Good faith, and fair dealing, is a necessary part of a contract. It refers to the genuineness of the
consent of the parties involved to carry out the contract. The parties of a contract must deal with
each other honestly, fairly and in good faith, to not prohibit the right of the other party to receive
the benefits of the contract. All parties must participate in the contract without any undue
pressure or persuasion.

DISCHARE OR TERMINATION

Discharge of a contract refers to the termination (release) of contractual obligations. There are
seven ways that a contract is terminated or discharged:

Way of Terminating a Contract Explanation

By Performance This is the most usual way that a contract is terminated. The
contract is fulfilled and completed. Eg. a purchaser agrees to
buy something, pays for it and leaves the shop.
By Breach of Contract If one party does not carry out his or her part of the
agreement. Eg. a seller aggrees to deliver the goods within
10 days but fails to do so.
By Mutual Agreement When both parties agree to cancel the agreement before it is
performed. Eg. The purchaser takes an item back to the shop
and is given a refund.
By Impossibility When circumstances beyond the control of the parties make
it impossible to complete the contract in the manner that was
intended. Eg. irreparable damage occurs to an object that
forms the main part of the contract, like when a contractor
agrees to pain a building that is destroyed before he can do
so.
By Lapse of Time An offer does not last for an indefinite time. Even where
there is not time span stipulated, an offer will terminate after
a reasonable lapse of time.

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 By Merger Discharge of contract by merger occurs where a new contract
of a higher order replaces the previous one.
By Death If one of the parties to a contract dies, contractual relations
come to an end.

MISTAKES AND MISREPRESENTATION

Mistakes occur in the contract procedure, making the agreement void (invalid). Sometime the
details of the agreement are misrepresented by giving a false or misleading account, usually with
an intent to deceive.

1. Common Mistake

A common mistake occurs when the parties to a contract agree on the subject of the
contract but both parties are equally mistaken about some aspect of the contract. Eg. The
object of the contract does not exist. Both make the same mistake.

2. Mutual Mistake

A mutual mistake is an erroneous assumption, which both parties assume to be true at the
time of the agreement. There is a ‘meeting of minds’ but both parties are mistaken about
the same material fact (influencing information significant to the matter at hand) within
their contract hence the contract is void.

3. Unilateral Mistake

In unilateral mistake only one of the parties is mistaken in the contract agreement
whereas the other party is not mistaken. Since one party is mistaken in their
understanding there is an unfair advantage in the bargaining power. Fraud is an example
of unilateral mistake in practice.