BASIC CONCEPTS IN THE LAW OF CONTRACTS
Contracts are essential to business. They are a legal mechanism used in every industry and every part of the world to structure relationships among firms, and with customers, partners, and suppliers. Over several centuries, the law governing contracts has developed a large number of doctrines. Most are consistent with common sense, but unless you know what the rules are, you can easily make a mistake. This document introduces the fundamentals of contract law most relevant to businesspeople. Important legal terms are italicized.
What is a Contract? And what is Contract Law? Legally, a contract is a set of promises that the law will enforce. We make promises all the time. Only some of them – the ones that meet the contract formation requirements listed below – are legally enforceable. That means the legal system, in the form of courts, can step in to order some action or payment for violation of the contract. Contracts are therefore private deals with the possibility of public (governmental) enforcement. Of course, there are many reasons to fulfill promises other than legal obligations. Reneging on promises may be unethical, or may result in a loss of goodwill or reputation as costly or more so than anything a court can impose. The general principles of contract law are fairly universal around the world. However, specific rules vary from country to country. In common law countries such as the United States and Great Britain, most of the legal doctrines governing contracts have been developed by courts over the centuries. In civil law countries such as those in Continental Europe, most of the terms of contract law are specified through comprehensive legislative codes. Even in the U.S., some aspects of contract law are regulated by legislation. Certain classes of contracts involving employment, securities transactions, health care, and consumer financial transactions are subject to regulations that supersede the general principles of common law. Commercial contracts for the sale of goods (as opposed to services like consulting) are covered in virtually every state in the U.S. by the Uniform Commercial Code, which imposes specific statutory requirements. And certain contracts are made unenforceable by the Constitution: for example, a provision that a house may not be sold to a certain racial or ethnic group. Parties negotiating a contract each believe they will benefit from the agreement. For example, a corporation purchasing a license for enterprise software believes the benefit from the software will exceed the price it pays, and the software vendor believes the price will exceed sum of expected costs for providing access to its product. When parties enter into a contract, therefore, they generally do not expect it to be breached (violated), or to resort to the legal system. However, they recognize that sometimes a partner may make a promise with good intentions, and later fail to fulfill it, or that circumstances may chance in some way. When evaluating contracts, courts will generally not consider whether the deal was a good one for either side. The standard view is that no one forced the parties to enter into the contract; they should be held to the bargain they struck. Another way to think of a contract is as a legal hedge against uncertainty or risk. The contract gives each party confidence that if the other fails to perform, they can receive compensation through the courts. It also allows parties to specify how specific situations in the future may be addressed. For example, in the software license described above, what happens if the buyer decides to modify some of the software code and resell it? Rather than wait for the confusion if that happens, the parties can specify ahead of time how the situation will be handled, by adding provisions to the contract.
LGST 612 (Prof. Werbach)
Contemporary legal systems focus on two things in...