San Diego business law attorneys and litigation lawyers alike regularly deal with the law of contracts. Whether you are negotiating a contract or have hired a trial lawyer to pursue a breach of contract lawsuit, it is helpful to know some of the basic principals and laws governing contracts. In this Part 1 of Everything You Wanted to Know About Contracts, we explore the elements required to form an enforceable contract, express and implied contracts, written and oral contracts, as well as the implied duty of good faith and fair dealing. For more information about this implied duty, click here.
What is a Contract?
A contract is an agreement among two or more individuals or entities to do something, or to refrain from doing something. Civ. Code §1549. For a contract to be valid, what the parties have agreed to do or refrain from doing must be legal; otherwise, the contract is void, or to put it another way, there simply is no contract. R.M. Sherman Co. v. W.R. Thomason, Inc. (1987) 191 Cal. App. 3d 559, 563. An example our business litigation attorneys like to use on this point is one of an agreement among competitors to keep prices high, which is a violation of the antitrust laws and which is, therefore, illegal and void.
How is a Contract Formed?
There are four requirements for the formation of a contract: (1) a lawful object, (2) an offer, (3) an acceptance of the offer, and (4) “consideration.” Civ. Code sec. 1550.
An offer is an offer to do something or to refrain from doing something. For instance, “I will pay $5000 for your car,” is an offer to do something, namely, purchase a car. “I will quit smoking for one year, if you pay me $1000,” is an offer to refrain from doing something, namely, to refrain from smoking. Both are valid offers.
Contracts may be “bilateral” or “unilateral.” A bilateral contract is one in which contract is formed by mutual promises made by each party to the other. A unilateral contract is one in which one party makes a promise in exchange for an expected act by the other, rather than a promise by the other.
If a buyer says to a prospective seller, “I will pay $5,000 for your car,” and the prospective seller replies, “Okay, I will sell you my car for $5000,” the seller has accepted the offer by agreeing to sell his car to the buyer, and a bilateral contract has been formed; each party has agreed to do something for the other.
If person A says to person B, “I will pay you $5000 if you paint my house,” and B paints A’s house, B has accepted the offer by doing the thing requested, namely, painting the house, and a unilateral contract has been formed.
The third and last requirement for formation of a contract is “consideration.” Lack of consideration is a defense often asserted by our San Diego business litigation attorneys in contractual disputes. Consideration can basically be viewed as a quid pro quo — you do something for me, and I will do something for you. See Civ. Code §1605. In the above examples, for instance, the person making the offer and the person accepting the offer are each doing something for the other. A party to a contract provides “consideration” by providing the other party with something of value. In the above examples, the car, the payment for the car, and the painting of the house, are all things of value. So also is refraining from smoking, since that is something of value to the “offeror” who is willing to pay the “offeree” to quit smoking.
Express and Implied Contracts
Contracts may be either express or implied. Civ. Code §1619. An express contract is one in which the parties’ agreement is expressed in words. Civ. Code §1620. An implied contract is one in which the agreement of the parties is shown by their conduct, rather than by their words. Civ. Code §1621.
Implied contracts may be either implied-in-fact or implied-in-law. An implied-in-fact contract is one in which the parties’ conduct has created a reasonable expectation of certain performance by both parties. Consider this example from our San Diego business litigation attorneys: Farmer and grocery chain enter into several express contracts over a period of time for the sale of bushels of apples by the farmer to the grocery chain for $20 a bushel. Thereafter, the grocery chain orders 100 bushels of apples from the farmer, and the farmer ships 100 bushels of apples to the grocery chain, with an invoice for $2000 ($20 a bushel x 1000 bushels). Even though the farmer and the grocery chain have not expressly agreed that the grocery chain will pay $20 per bushel for the thousand bushels shipped to it by the farmer, based on the parties’ former dealings, an implied agreement was created that the grocery chain would pay the farmer $20 per bushel for apples shipped by the farmer to the grocery chain at the grocery chain’s request.
An implied-in-law contract is sometimes referred to as a “quasi-contract.” It is not a real contract, but is one implied by law to prevent unjust enrichment of one party, at the expense of the other party. When one party has conferred a benefit on the other, which the other has knowingly accepted in circumstances in which it would be inequitable for the other party to retain the benefit, without paying for its value, the law implies the existence of a contract.
As an example, in Halperin v. Raville (1986) 176 Cal. App. 3d 765, Plaintiff was friends with father who owned a business, and made various loans to father to help father keep his business going. Son assisted Plaintiff in liquidating Plaintiff’s assets so that Plaintiff could loan money to father. Son worked for the business and also loaned money to father to pay the business’s debts. Son referred to the business as a “father and son” business or “our” business. Plaintiff sued the son as well as the father for failure to repay the loans he had made to father. Although it was clear that Plaintiff had not loaned money to son, and there was no contract between father and son, the court found son liable, ruling that son had benefitted from the loans and would be unjustly enriched if he were not required to repay the loans.
Written versus Oral Contracts
The general rule is that contracts may be written or oral, and an oral contract is just as enforceable as a written contract. Of course, it is better practice to reduce oral contracts to writing, so that there can be no dispute at a later time as to what the terms of the contract are.
However, certain oral contracts are not enforceable, either because of the significance of the type of contract, or because the contract is of a type conducive to fraudulent claims. For a list of these contracts, click here.
It is important to note the distinction between a contract that is not valid and a contract that is not enforceable. As a business litigation lawyer will tell you, a contract that is not valid is void. In other words, no contract is formed. On the other hand, a contract that is not enforceable is valid, so long as it is not illegal; however, if a party to such a contract does not wish to fulfill his obligations under the contract, he may refuse to do so, asserting that it is unenforceable.
The difference between a void contract and a voidable contract can be significant. For instance, the law prohibits third parties from interfering with contracts. Herron v. State Farm Mut. Ins. Co. (1961) 56 Cal. 2d 202, 205. If a contract is void, it is invalid and does not exist. Therefore, a third party cannot interfere with it. However, if the contract is merely voidable, it is a valid contract, and a third party may not interfere with it – i.e., cause a party to the contract to refuse to comply with it. Buckaloo v. Johnson (1975) 14 Cal. 3d 815, 824.
The Implied Covenant of Good Faith and Fair Dealing
There is an implied covenant in all contracts, whether written or oral, that neither party will do anything that would deprive the other party of the benefit of his bargain. Pasadena Live, LLC v. City of Pasadena (2004) 114 Cal. App. 4th 1089, 1092-1094. This is known as the implied covenant of good faith and fair dealing.
Consider this example: Seller and Buyer agree that the Seller will sell his car to Buyer for $5000. Buyer needs time to obtain the money to purchase the car. Seller and Buyer agree that Buyer will bring a check for $5000 to Seller’s office no later than noon on a specified future date. Buyer arrives at Seller’s office at 10 AM on the specified date, but the office is closed. Consequently, Buyer is unable to pay Seller for the car by noon on that date. In this instance, Seller has breached the covenant of good faith and fair dealing. Implied in the parties’ agreement is the Seller’s promise that the office will be open during the morning on the specified day and the Seller will be in his office on that day, so that the Buyer can make payment for the car within the time agreed upon. The Seller’s breach of the implied covenant renders Seller liable to Buyer for breach of the contract.
While these are some basic principals of contract law, your business litigation lawyer or business law attorney can explain how some of the finer points of contract law may affect your particular situation at any stage of forming or enforcing a contract. Coming next week – some common remedies available for breach of contract.