CHAPTER

Nature and Classes

of Contracts
LEARNING OBJECTIVES
1 State the five requirements for a valid contract.
2 Describe the types of contracts and how they differ from agreements.
3 Explain the difference between a contract and a quasi contract.

PREVIEW CASE

Brooklyn Union Gas Co. (BUG) discovered that gas was being consumed at 369 Euclid
Avenue although there was no record of an account or meter at that address. The
last account at that address had been closed fourteen years earlier. John Diggs was in
possession of the premises at 369 Euclid. BUG sued him for the gas consumed at that
location on the basis of a quasi contract for his unjust enrichment. Had BUG suffered any detriment?
Had Diggs received any benefit for which he had not paid? Do you think it was ethical for Diggs to
use the gas when there was no account for his address?

A
Contract contra can be defined as a legally enforceable agreement between two or
contract
Legally enforceable more ccompetent people. At first glance, this seems like a very simple defini-
agreement tion. N
Notice that this definition does not even require a written document.
Chapters 5 th through 13 are devoted exclusively to explaining and clarifying this
definition.
Making contracts
co is such an everyday occurrence that we often overlook their
iimportance, except when the contracts are of a substantial nature. When one buys a
cup of coffee during a coffee break, a contract has been made. When the purchaser
agrees to pay 50¢ for the coffee, the seller agrees not only to supply one cup of
coffee but also agrees by implication of law that it is safe to drink. If the coffee
48 Part 2 Contracts
 Chapter 5 Nature and Classes of Contracts 49

contains a harmful substance that makes the purchaser ill, a breach of contract
has occurred that may call for the payment of damages. A breach of contract Breach of Contract
is the failure of one of the parties to perform the obligations assumed under the Failure to perform
contract. contractual obligations
Business transactions result from agreements. Every time a person makes a
purchase, buys a theater ticket, or boards a bus, an agreement is made. Each
party to the agreement obtains certain rights and assumes certain duties and
obligations. When such an agreement meets all the legal requirements of a con-
tract, the law recognizes it as binding on all parties. If one of the parties to the
contract fails or refuses to perform, the law allows the other party an appropriate
action for obtaining damages or enforcing performance by the party breaking the
contract.
Contracts are extremely important in business because they form the very
foundation upon which all modern business rests. Business consists almost
entirely of the making and performing of contracts. A contract that is a sale of
goods is governed by the Uniform Commercial Code (see Chapter 16).

Requirements for a Contract

A valid contract is an agreement that courts will enforce against all parties. Such LO 1
a contract must fulfill the following definite requirements: Requirements for valid
contract
1. It must be based on a mutual agreement by the parties to do or not to do a
specific thing. Valid Contract
2. It must be made by parties who are competent to enter into a contract that Contract enforceable
by law
will be enforceable against both parties.
3. The promise or obligation of each party must be supported by consideration
(such as the payment of money, the delivery of goods, or the promise to do
or refrain from doing some lawful future act) given by each party to the
contract.
4. It must be for a lawful purpose; that is, the purpose of the contract must not
be illegal, such as the unauthorized buying and selling of narcotics.
5. In some cases, the contract must meet certain formal requirements, such as
being in writing or under seal.
You may test the validity of any contract using these five requirements.

Contracts Contrasted with Agreements

A contract must be an agreement, but an agreement need not be a contract. An LO 2
agreement results whenever two or more people’s minds meet on any subject, no Types of contracts
matter how trivial. Only when the parties intend to be legally obligated by the and differences from
terms of the agreement will a contract come into existence. Chapter 6 explains agreements
how such agreements are formed. Ordinarily, the subject matter of the con-
tract must involve a business transaction as distinguished from a purely social
transaction.
If Mary and John promise to meet at a certain place at 6 p.m. and have din-
ner together, this is an agreement, not a contract, as neither intends to be legally
bound to carry out the terms of the agreement.
If Alice says to David, “I will pay you $25 to be my escort for the Spring
Ball,” and David replies, “I accept your offer,” the agreement results in a contract.
50 Part 2 Contracts

David is legally obligated to provide escort service, and Alice is legally bound to
pay him $25.

Classification of Contracts
Contracts are classified by many names or terms. Unless you understand these
terms, you cannot understand the law of contracts. For example, the law may
state that executory contracts made on Sunday are void. You cannot understand
this law unless you understand the words executory and void. Every contract may
be placed in one of the following classifications:
1. Valid contracts, void agreements, and voidable contracts
2. Express and implied contracts
3. Formal and simple contracts
4. Executory and executed contracts
5. Unilateral and bilateral contracts

Valid Contracts, Void Agreements,

and Voidable Contracts
Agreements classified according to their enforceability include valid contracts
(defined earlier), void agreements, and voidable contracts.
Void An agreement with no legal effect is void. An agreement not enforceable in
Of no legal effect a court of law does not come within the definition of a contract. A void agree-
ment (sometimes referred to as a void contract) must be distinguished from an
Unenforceable unenforceable contract. If the law requires a certain contract to be in a particu-
Contract
Agreement that is not lar form, such as a deed to be in writing, and it is not in that form, it is merely
currently binding unenforceable, not void. It can be made enforceable by changing the form to
meet the requirements of the law. An agreement between two parties to perform
an illegal act is void. Nothing the parties can do will make this agreement an
enforceable contract.
Voidable Contract A voidable contract would be an enforceable agreement but, because of cir-
Enforceable agreement cumstances or the capacity of a party, one or both of the parties may set it aside.
that may be set aside by The distinguishing factor of a voidable contract is the existence of a choice by
one party
one party to abide by or to reject the contract. A contract made by an adult with
a person not of lawful age (legally known as a minor or infant) is often voidable
by the minor. Such a contract is enforceable against the adult but not against the
minor. If both parties to an agreement are minors, either one may avoid the agree-
ment. Until the party having the choice to avoid the contract exercises the right to
set the contract aside, the contract remains in full force and effect. An agreement
that does not meet all five of the requirements for a valid contract might be void
or it might be a voidable contract.

Express and Implied Contracts

Contracts classified according to the manner of their formation fall into two
Express Contract groups: express and implied contracts. In an express contract, the parties
Contract with the express their intentions by words, whether in writing or orally, at the time they
terms of the agreement make the agreement. Both their intention to contract and the terms of the agree-
specified in words
ment are expressly stated or written. Customary business terms, however, do not
need to be stated in an express contract in order to be binding.
 Chapter 5 Nature and Classes of Contracts 51

COURT C AS E

Facts: Sean Smith and others were indicted for Smith asked the court to enforce the immunity
the capital murder of Hilton Merriman. Smith and agreement saying that he had complied with it.
District Attorney Randall Sherrod entered into an Sherrod testified that when he dismissed the first
oral immunity agreement by which Smith agreed indictment against Smith he had considered the
to give a videotaped statement and testify against immunity agreement a “done deal.”
a codefendant. Smith gave the statement and al-
though not called to testify was available to do so. Outcome: Although the immunity agreement
When the other defendants’ cases were disposed was oral, Smith had complied with it. An oral agree-
of, the indictment as to Smith was dismissed. Two ment is enforceable, so Smith was acquitted.
years later, James Farren was elected district attor-
ney. Farren got a second indictment against Smith. —Smith v. State, 96 S.W.3d 377 (Tex.)

An implied contract (also called a contract implied in fact) is one in which Implied Contract
the duties and the obligations that the parties assume are not expressed but are (Implied in Fact
implied by their acts or conduct. The adage “actions speak louder than words” Contract)
Contract with major
very appropriately describes this class of contracts. The facts of a situation imply terms implied by the
that a contract exists. The parties indicate that they have a mutual agreement parties’ conduct
so clearly by their conduct and what they intend to do that there is no need to
express the agreement in words to make it binding.

COURT C AS E

Facts: William Shoemake of Texas insured his Live Oak and asked Live Oak to send that notice to
home with Hochheim Prairie Farm Mutual Insur- Shoemake. Live Oak did not. A few months later,
ance Co. through Live Oak Insurance Agency. After fire destroyed the home. When Hochheim denied
he died, his son, Billy Dan of Louisiana, told Live the claim because the policy had lapsed, Billy Dan
Oak’s customer representative of the death and to sued Live Oak for failing to perform an implied
switch the insurance to his name. For two years, contract. The jury found for Billy Dan, and Live Oak
Hochheim sent renewal notices to Texas. When appealed.
they were returned undelivered, Live Oak sent
them to Billy Dan, who paid them. Live Oak in- Outcome: The appellate court found that al-
cluded a note with the second renewal notice ask- though there was no express contract with Live
ing if he still wanted the policy and where to send Oak, its actions were adequate to find that it
it. Billy Dan’s wife called Live Oak and said to send had agreed to provide an insurance policy on the
the policy to Louisiana. Hochheim asked Live Oak house.
to forward the next renewal notice to Shoemake
and requested his address. The renewal was not —Live Oak Insurance Agency v. Shoemake,
paid, so Hochheim sent a notice of policy lapse to 115 S.W.3d 215 (Tex.App.)
52 Part 2 Contracts

Formal and Simple Contracts

Formal Contract A formal contract must be in a special form or be created in a certain way.
Contract with special Formal contracts include contracts under seal, recognizances, and negotiable
form or manner of instruments.
creation
When very few people could write, contracts were signed by means of an
impression in wax attached to the paper. As time passed, a small wafer pasted
on the contract replaced the use of wax. The wafer seal was in addition to the
written signature. This practice is still used occasionally, but the more common
practice is to sign formal contracts using the word “Seal” or the letters “L.S.”
after the signatures:
Jane Doe (Seal); Jane Doe [L.S.]
Today, it is immaterial whether these substitutes for a seal are printed on the
document, typewritten before signing, or the people signing write them after their
respective names. However, in some states, the document itself also must recite
that it is under seal. In jurisdictions where the use of the seal has not been abol-
ished, the seal implies consideration.
In some states, the presence of a seal on a contract allows a party a longer
time in which to bring suit if the contract is broken. Other states make no dis-
tinction between contracts under seal and other written contracts. The Uniform
Commercial Code abolishes the distinction with respect to contracts for the sale
of goods.

CO URT C AS E

Facts: Charles Stuckey signed an agreement to alleged the contract was under seal so a suit could
purchase an interest in a condominium. The agree- be brought up to twenty years after its execution.
ment recited that it was executed under seal. The
word “seal” appeared after Stuckey’s signature Outcome: Because there was no indication that
and the signatures of the sellers, but not after the the escrow agent’s signature was under seal, the
signature of the escrow agent, Phillip Johns. Eleven agreement was not a sealed contract as to him. The
years after the sale of the property, Stuckey sued six-year requirement applied, and the case was dis-
the escrow agent. The agent asked the court to missed.
dismiss the suit because a suit on a written con-
tract had to be brought within six years. Stuckey —McCalla v. Stuckey, 504 S.E.2d 269 (Ga.)

Recognizance Recognizances, a second type of formal contract, are obligations entered

Obligation entered into into before a court whereby people acknowledge that they will do a specified
before a court to do an act that is required by law. By these obligations people agree to be indebted for
act required by law
a specific amount if they do not perform as they agreed, such as the obligation a
Negotiable criminal defendant undertakes to appear in court on a particular day.
Instrument Negotiable instruments, discussed in later chapters, are a third type of for-
Document of payment, mal contract. They include checks, notes, drafts, and certificates of deposit.
such as a check All contracts other than formal contracts are informal and are called simple
contracts. A few of these, such as an agreement to sell land or to be responsible
Simple Contract for the debt of another, must be in writing in order to be enforceable; otherwise,
Contract that is not formal
they need not be prepared in any particular form. Generally speaking, informal
 Chapter 5 Nature and Classes of Contracts 53

or simple contracts may be in writing, may be oral, or may be implied from the
conduct of the parties.
A written contract is one in which the terms are set forth in writing rather Written Contract
than expressed orally. An oral contract is one in which the terms are stated in Contract with terms in
spoken, not written, words. Such a contract is usually enforceable; however, when writing
a contract is oral, disputes may arise between the parties as to the terms of the
Oral Contract
agreement. No such disputes need arise about the terms of a written contract if Contract with terms
the wording is clear, explicit, and complete. For this reason, most businesspeople spoken
avoid making oral contracts involving matters of great importance. Some types of
contracts are required to be in writing and are discussed in Chapter 11.

Executory and Executed Contracts

Contracts are classified by the stage of performance as executory contracts and
executed contracts. An executory contract is one in which the terms have not Executory Contract
been fully carried out by all parties. If a person agrees to work for another for Contract not fully
one year in return for a salary of $3,500 a month, the contract is executory from carried out
the time it is made until the twelve months expire. Even if the employer should
prepay the salary, it would still be an executory contract because the other party
has not yet worked the entire year, that is, executed that part of the contract.

COURT C AS E

Facts: Six months after they married, Josephine the waiver of inheritance right was executory so he
Archibald and Toney Edwards separated. While was not bound by it.
separated, they signed an agreement by which
they gave up the right to inherit from each oth- Outcome: The court held that because the
er’s estates. They reconciled shortly thereafter and waiver bound Toney to do something in the future,
lived together until Josephine died. Josephine left it was executory and not executed. Toney could
a will written before her marriage that left noth- choose a share of Josephine’s estate.
ing to Toney. State law provided that a surviving
spouse could choose to get a share of a deceased —In re Estate of Archibald,
spouse’s estate. Toney opted for that share saying 644 S.E. 2d 264 (N.C. App.)

An executed contract is one that has been fully performed by all parties to Executed Contract
the contract. The Collegiate Shop sells and delivers a dress to Benson for $105, Fully performed contract
and Benson pays the purchase price at the time of the sale. This is an executed
contract because nothing remains to be done on either side; that is, each party
has completed performance of each part of the contract.

Unilateral and Bilateral Contracts

When an act is done in consideration for a promise, the contract is a unilateral Unilateral Contract
contract. If Smith offers to pay $100 to anyone who returns her missing dog and Contract calling for an
Fink returns the dog, this would be a unilateral contract. It is unilateral (one-sided) act in consideration for
a promise
in that only one promise is made. A promise is given in exchange for an act. Smith
made the only promise, which was to pay anyone for the act of returning the dog.
Fink was not obligated to find and return the dog, so only one duty existed.
54 Part 2 Contracts

Bilateral Contract A bilateral contract consists of a mutual exchange of promises to perform

Contract consisting of some future acts. One promise is the consideration for the other promise. If
mutual exchange of Brown promises to sell a truck to Adams for $5,000, and Adams agrees to pay
promises
$5,000, then the parties have exchanged a promise for a promise—a bilateral
contract. Most contracts are bilateral because the law states a bilateral contract
can be formed when performance is started. This is true unless it is clear from
the first promise or the situation that performance must be completed. The test is
whether there is only one right and duty or two.

Quasi Contract
LO 3 One may have rights and obligations imposed by law when no real contract
Difference between exists. This imposition of rights and obligations is called a quasi contract or
contract and quasi implied in law contract. It is not a true contract because the parties have not
contract made an agreement. Rights and obligations will be imposed only when a failure
to do so would result in one person unfairly keeping money or otherwise benefit-
Quasi Contract ing at the expense of another. This is known as unjust enrichment. For example,
(Implied in Law
Contract) suppose a tenant is obligated to pay rent of $300 a month but by mistake hands
Imposition of rights the landlord $400. The law requires the landlord to return the overpayment of
and obligations by law $100. The law creates an agreement for repayment even though no actual agree-
without a contract ment exists between the parties. For the landlord to keep the money would mean
an unjust enrichment at the expense of the tenant. Courts will also invoke the
Unjust Enrichment principles of unjust enrichment when there is a contract, but there is no remedy
One benefiting unfairly
at another’s expense provided under the contract. An unjust enrichment offends our ethical principles,
so the law imposes a contractual obligation to right the situation.

PREVIEW CASE REVISITED

Facts: Brooklyn Union Gas Co. (BUG) discovered that gas was being consumed at
369 Euclid Avenue although there was no record of an account or meter at that ad-
dress. The last account at that address had been closed fourteen years earlier. John
Diggs was in possession of the premises at 369 Euclid. BUG sued him for the gas consumed at that
location on the basis of quasi contract for his unjust enrichment.
Outcome: The fact that Diggs knew he was receiving gas and BUG was not paid for it estab-
lished his quasi-contractual liability.

—Brooklyn Union Gas Co. v. Diggs, 2003 WL 42106 (N.Y. City Civ.Ct)

QUESTIONS

ETHICAL 1. What provision does the law allow if a party to a contract fails or refuses to
perform it?
POINT
2. How does a contract differ from an agreement?
Notice that quasi
contracts arise because 3. When is a contract actually an unenforceable agreement? Can it be made
of strictly ethical enforceable?
considerations. It is
unfair for one person
4. What two items must be expressed in order to have an express contract?
to benefit at the 5. How must a sealed contract be executed?
expense of another.
6. What is a recognizance?
 Chapter 5 Nature and Classes of Contracts 55

7. Why are most business contracts written rather than oral?

8. Explain the difference between an executor and an executed contract.
9. Are all contracts the result of mutual promises by both parties?
10. When will the law impose a contract when no real contract exists?

CASE PROBLEMS
When the concluding question in a case problem can be answered simply yes or
no, state the legal principle or rule of law that supports your answer.
1. Uhrhahn Construction prepared proposals for work on construction projects for LO 2
Lamar and Joan Hopkins. The Hopkinses signed the proposals for each project
under sections titled “Acceptance of Proposal.” The proposals stated that any
changes to the written estimates and specifications had to be in writing. During
the construction, the Hopkinses made several oral requests for additional work
not included in the proposals. They paid for some of them after receiving invoices
labeled change orders for such work. When they did not pay for the rest, Uhrhahn
sued, alleging there was an implied contract to make oral changes. Was there such
an implied contract?
2. Rental Management, Inc., demonstrated its computer software to Rent-A-PC, a LO 3
computer rental business. Rent-A-PC discovered that the software needed to be
modified for its business. Rent-A-PC agreed to Rental’s charges and paid a deposit
of $42,110. Rent-A-PC discovered that the software did not include the modifi-
cations it had requested. It informed Rental it was going to stop implementation
of the software and requested the deposit back. When Rental did not return
the $42,110, Rent-A-PC sued, alleging unjust enrichment. Rental claimed that
because it had incurred costs in obtaining the software for Rent-A-PC, it was not
unjustly enriched. Was it?
3. By letters, the Twin Buttes School District had hired Cheryle Good Bird to be the LO 2
elementary school head cook for two different school years. Each letter specifi-
cally set the term of employment as one school year. Before the first contract had
expired, Good Bird had received a letter telling her she had been chosen to be the
head cook specifically for the next school year. During the second contract period,
the principal by letter told Good Bird the head cook position for the next school
year was going to be advertised, but she could apply for it. Good Bird reapplied,
but was not hired. Good Bird sued the school district, claiming it had breached an
implied contract. Did Good Bird have an implied contract to continue to be the
head cook?
4. Nina Parkhurst owned a ranch and asked her son, Doug Boykin, to move to it and LO 1
manage it for her. Boykin and his wife moved to the ranch and managed it for
several years. They talked with Parkhurst many times, urging her to transfer 49
percent of the ranch to them. Parkhurst said she had thought and talked about
possibly transferring the ranch but had made no decision. The Boykins claimed
they were on the ranch under an oral contract with Parkhurst and the oral contract
also entitled them to a 49 percent interest in the ranch. She sued them and asked
the court to declare that there was no contract. Was there a contract?
5. David and Kimberly Birt met with Richard Gibbs, a loan officer with Wells Fargo LO 2
Home Mortgage, Inc. After reviewing the Birts’ financial documents, Gibbs said
they were eligible for a home construction loan. He told them to get a builder and
56 Part 2 Contracts

design plans. The Birts had plans drawn and gave them to their proposed builder.
Gibbs knew from a second credit report that the Birts would not be able to borrow
as much as expected, but told them to sign a contract with the builder, which they
did. They got a letter welcoming them to Wells Fargo Mortgage Resources and
containing lending disclosures, but they knew the figures in the disclosures were
just an example. Several weeks later, when they still had not received a loan com-
mitment letter, the Birts contacted Gibbs’s supervisor. He told them the loan was
denied. They sued Wells Fargo. Was there an implied in fact contract with Wells
Fargo?
LO 3 6. Alan Kortmeyer and Carolyn Allen owned a lot in Glenhaven, a mobile home
park. They lived there for thirteen years and got water, sewer, garbage, and snow
removal services. For six years, they paid $60 a month for these services, but then
concluded that they were only required to pay a proportionate share of the costs
of the services. Glenhaven continued to supply the services and bill them $60 a
month; they received the services but paid nothing for them. Glenhaven finally
sued. Must Kortmeyer and Allen pay for the services and, if so, on what basis?
LO 1, 2 7. After an argument with his wife, Russell Pelo bought a shotgun and made threats
of self-harm. In accordance with state law, he was detained in a hospital psychiat-
ric unit for examination after a judge found him seriously mentally impaired. After
Pelo was released, he refused to pay the hospital bill or allow his health insurer to
pay it. When sued for the hospital bill, Pelo said he should not have to pay because
he did not want to be hospitalized. Must he pay for services he did not want?