Will Your Contract Be Enforced Under the Law?

In the world of commerce, from real estate transactions to the sale of goods, understanding the ins and outs of contracts can be key to avoiding a breach of contract and potential legal action. Particularly for small business owners, understanding the legality of contracts is essential.

If you have a business agreement, one of the first things to determine is whether the promise or agreement will be an enforceable contract under the law. While contracts usually involve promises to do something (or refrain from doing something), not all promises are contracts. This principle holds whether you're dealing with a commercial lease, an employment agreement, or a sale of goods under the commercial code.

How does the law determine which promises are enforceable contracts and which are not?

Is the Agreement a Contract?

In a dispute, the court must initially determine whether an enforceable agreement exists. While most people assume that all contracts must be written agreements, a verbal contract can be valid under certain conditions.

Elements of a Contract

For an agreement to be a valid contract, one party must make an offer, and the other party must accept it. There may be a counteroffer. There has to be a "meeting of the minds." There must be "consideration." Consideration means that something of value is given in return for a promise. In addition, the terms of a contract must be sufficiently defined for a court to enforce them. These terms often include the deliverables one or both parties promise to provide.

Enforcement and Contract Defenses

If a court determines that a legally binding contract exists, it must decide whether it should be enforced. There are several reasons why a court might not enforce a contract. These are defenses to the contract. They protect people from unfairness in the bargaining process or the contract itself.

If there is a valid defense to a contract, it may be voidable. This means the injured party may be able to cancel or revoke the agreement. Sometimes, the unfairness is so extreme that the contract is void. In other words, a court will declare that no legal document was ever formed. In business, this can happen with an overly restrictive noncompete or nondisclosure agreement. What are some of the reasons a court might refuse to enforce a contract?

Capacity to Contract

To be bound by a contract, a person must have the legal ability to form a contract in the first place. This is "capacity to contract." A person who is unable, due to age or mental impairment, to understand what they are doing when they sign a contract lacks the capacity to contract. For example, a person under legal guardianship due to a mental defect lacks the capacity to contract. Any contract signed by that person is void.

A minor generally cannot form an enforceable contract. As a result, the minor or their guardian may cancel the contract. After reaching the age of majority (18 in most states), a person still has a reasonable period to cancel a contract made as a minor. If the contract is not canceled within a reasonable time, it is binding and enforceable.

Courts are usually not sympathetic to people who claim they were intoxicated when they signed a contract. Generally, a court will void the contract if the other party knew about the intoxication and took advantage or if the person was involuntarily drugged.

Undue Influence, Duress, Misrepresentation

Coercion, threats, false statements, or improper persuasion by one party to a contract can void the contract. The defenses of duress, misrepresentation, and undue influence address these situations:

• Duress: A party must show that agreement to the contract happened because of a serious threat of unlawful or wrongful action. The party must also prove they had no reasonable alternative but to agree to the contract.

• Undue influence: Undue influence occurs when someone uses their close relationship unfairly to convince another person to do something. One person trusts the other person to act in their best interest. But this trust is misplaced.

• Misrepresentation: A misrepresentation may be a number of things. It can be:
  • A false statement of fact
  • The deliberate withholding of information that a party has a duty to disclose
  • An action that conceals a fact (for example, painting over water damage when selling a house)

Unconscionability

Unconscionability concerns the fairness of contract formation and the terms of the contract. When the contract terms are oppressive, or the bargaining process or terms shock the court's conscience, the court may strike down the contract as unconscionable.

A court will consider several factors in determining whether a contract is unconscionable. Suppose there is a gross inequality of bargaining power. The weaker party to the contract has no meaningful choice regarding the terms, and the resulting contract is unreasonably favorable to the stronger party. In that case, there may be a valid claim of unconscionability.

A court will also look at whether one party is uneducated or illiterate, whether that party had the opportunity to ask questions or consult an attorney, and whether the price of the goods or services under the contract is excessive.

Public Policy and Illegality

Rather than protecting the parties to a contract as other contract defenses do, the defenses of illegality and violation of public policy protect the public welfare and the integrity of the courts by refusing to enforce certain types of contracts. The courts will not enforce contracts to engage in illegal or immoral conduct.

Mistake

To cancel a contract for mistake, both parties must have made a mistake about a basic assumption on which the contract was based. The mistake must have a material effect on the agreed exchange. It must also relate to facts existing when the contract is made. In addition, the party seeking to avoid the contract must not have contractually assumed the risk of mistake.

Parties sometimes attempt to claim mistake as a defense to a contract when they have failed to read it and later become aware of terms they dislike. Failure to read the contract is not a defense. A person who signs a contract is presumed to know what it says and is bound to the terms they would have known about had they read it.

Force Majeure

Many business contracts include a "force majeure" clause. This provision cancels the contract if certain situations beyond the parties' control occur and the circumstances make performing the contractual duties impractical or impossible.

The circumstances that trigger a force majeure clause are negotiated by the parties. They typically include:

• Natural disasters (like floods, hurricanes, tornadoes, and earthquakes)
• Acts or threats of terrorism
• War, civil disorder
• Disease outbreaks or pandemics
• Labor strikes or disruptions
• Fires

Typically, courts interpret force majeure clauses narrowly, so only events included in the clause would trigger it.

Some contracts include a force majeure clause with boilerplate language that cancels the contract if circumstances have made enforcing the contract "impossible." This is a higher threshold because a contract often becomes impractical while still possible. That's why many business law attorneys recommend spelling out exactly what circumstances should trigger the force majeure clause.

Contracts lacking a force majeure clause can still cancel the agreed-upon duties by relying on the common law contract doctrines of "impracticability" and "frustration of purpose." However, these doctrines are applied more narrowly.

Concerned That Your Contract May Not Be Enforceable? Talk to An Attorney

While a contract may appear valid on its face, there are times that it's not enforceable under contract law. This can create legal issues. If you have concerns that your contract may not be enforceable under the law or need help drafting a contract for your business, it's a good idea to consult a skilled business lawyer. The proper legal guidance can protect your business and ensure the validity of your contracts.