Formation of Contracts in California

Introduction

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 principles and laws governing contracts. In this article, we’ll discuss the elements required to form an enforceable contract, express versus implied contracts, and written versus oral contracts, as well as the covenant of good faith and fair dealing.

What is a Contract?

In its most general broad terms a contract is an agreement among two or more individuals or entities to do something, or to refrain from doing something, that they don’t have a legal duty to do or not to do. Civ. Code §1549. For a valid enforceable contract to exist, 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 Gehres Law Group business litigation attorneys like to use on this point is one where there is an agreement among competitors to fix prices at a certain amount, which is a violation of both California and Federal antitrust laws and is, therefore, illegal and void.

It is essential to the existence of a contract that: 1) Parties are capable of contracting (age, mental capacity, agency issues apply to this requirement); 2) The parties consent to all of the terms must be clear; 3) The subject of the agreement must be lawful (as discussed above); and, 4) There is something of value given that is not illegal and for which there is not already an existing duty to provide.

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 a promise 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.

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 made a mutual agreement (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 $500 to anyone who finds my lost dog,” and B finds and returns A’s lost dog, B has accepted the offer by doing the thing requested, namely, finding (and returning) A’s lost dog, and a unilateral contract has been formed. Acceptance of the offer is by the act of finding and returning the dog not by a statement of agreement.

If courts have doubts as to which type of contract was formed, the presumption is that it was a bilateral contract. The reason that matters is mostly in when the contract becomes enforceable. With a bilateral contract it is enforceable immediately. However, with a unilateral contract, it isn’t enforceable until the condition precedent to payment, for example finding the dog and offering him to person A, has been performed.

The 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.

Any benefit conferred, or agreed to be conferred, upon the promisor, by any other person, to which the promisor is not lawfully entitled, or any prejudice suffered, or agreed to be suffered, by such person, other than such as he is at the time of consent lawfully bound to suffer, as an inducement to the promisor, is a good consideration for a promise. 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 finding and returning of the dog, are all things of value.

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 $22 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 $2200 ($22 a bushel x 100 bushels). Even though the farmer and the grocery chain have not expressly agreed that the grocery chain will pay $22 per bushel for one hundred 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 $22 per bushel for all 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 benefited from the loans and would be unjustly enriched if he were not required to repay the loans. This case underscores the importance of having a local San Diego law firm like the Gehres Law Group review your business arrangements with you and recommend and draft express contracts that will protect your interests and help you avoid implied terms and conditions and contracts that might not be in your business’s best interest.

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, as with the issue of implied contracts, 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 or void and a contract that is simply not enforceable. As a business litigation lawyer will tell you, a contract that is not valid, or is void, if it is missing an essential element, which can be legality. In other words, no contract is legally formed. On the other hand, a contract that is unenforceable appears to contain all of the essential elements of a contract but because of vague language, the statute of limitations, the term limit of the contract, or a superseding law that overrides it, a defense that the contract is unenforceable is available to the parties.

A contract may not be void, but could be voidable. With the latter it means that one of the parties can, because of the operation of fact or law, choose to unilaterally cancel the contract. For example, a minor who enters into a contract, can, because they are not old enough to enter into a contract, choose to cancel the contract. The differences between a void contract and a voidable contract can be significant in other ways as well. 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

Finally, although not technically an element of a contract per se, in California 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 their 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 and states that they will take payment any time by or before that time and date. Buyer then 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 and Seller refuses to sell Buyer the car stating that payment wasn’t made within the specified time. 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 principles 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.

By | 2019-05-24T14:36:58-08:00 March 20th, 2019|Business Contracts, Business Law, Business Litigation, Civil Litigation, Commercial Law, Contract law, Contracts|Comments Off on Formation of Contracts in California