What is a Legal Contract?

Human-like drawing of a contract
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A contract is a legally enforceable agreement between two or more parties. It may be oral or written. A contract is essentially a set of promises. Typically, each party promises to do something for the other in exchange for a benefit.

Required Characteristics

To constitute a legal contract, an agreement must have all of the following 5 characteristics:

  • Legal purpose A contract must have a legal purpose to be enforceable. For example, Steve hires Paul to kill Susan. Steve drafts an agreement outlining Paul's responsibilities, namely to acquire a gun and shoot Susan in the head. The agreement also specifies the amount Steve will pay Paul once Susan is dead. A contract of murder for hire is illegal. If Paul fails to fulfill his obligations under the agreement, Steve will have no recourse against Paul. The agreement Steve has drafted is unenforceable.
  • Mutual Agreement All parties to the contract must have reached a "meeting of the minds." That is, one party must have extended an offer to which the other parties have agreed. For example, Jim signs a contract with Tom's Tree Trimming. The contract outlines the scope of the work Tom will perform on Jim's property. Jim and Tom have a mutual agreement regarding the work that will be done.
  • Consideration Each party to the contract must agree to give up something of value in exchange for a benefit. For example, you hire an independent contractor to repave your driveway. You and the paving contractor sign an agreement in which you promise to pay a sum of money in exchange for the paving work. Both you and the contractor have agreed to give up something of value. You have agreed to pay money, and the contractor has agreed to perform the paving work.
  • Competent Parties The parties to a contract must be competent. That is, they must be of sound mind, of legal age, and unencumbered by drugs or alcohol. If you enter into a contract with a minor or an insane person, the contract will not be enforced.
  • Genuine Assent All parties must engage in the agreement freely. A contract may not be enforced if mistakes have been made by one or more parties. Likewise, a contract may be voided if one party has committed fraud or exerted undue influence over another. For example, you sign a contract in which you agree to sell your house to your next-door neighbor for $1. When you signed the contract, your neighbor was pointing a gun at your head. Clearly, you made the agreement under duress, so the contract is not valid.

    Some types of contracts must be in writing. An example is a contract in which you agree to sell your property to someone else. Real estate sales contracts must be written in order to be enforceable.

    Bilateral or Unilateral

    Most contracts are bilateral. This means that each party has made a promise to the other. When Jim signed the contract with Tom's Tree Trimming, he promised to pay the contractor a specified sum of money once the job was completed. Tom, in turn, made a promise to Jim to complete the work described in the agreement.

    In a unilateral contract, one party makes a promise in exchange for an act by the other party. Insurance policies are unilateral contracts. When you buy liability insurance or any other type of policy, you pay a premium (an act)  in exchange for the insurer's promise to pay future claims.

    Breach of Contract

    If one party fails to fulfill his or her duties under the agreement, that party has breached the contract. For example, suppose that you've hired a masonry contractor to construct a brick patio outside your restaurant. You pay the contractor half of the agreed-upon price upfront. The contractor completes about a quarter of the work and then stops. He keeps promising he'll return and complete the job but never does.

    By failing to fulfill his promise, the contractor has breached the contract.

    If one party breaches a contract, the other party may suffer a financial loss. In the previous example, you paid for 50% of the work but only received half that much. You have several options for obtaining compensation.

    1. Sue for Damages You may sue the contractor for damages. For example, you might sue for the cost of hiring another contractor to finish the job plus the costs you have incurred due to the delay.
    2. Specific Performance You can compel the contractor to complete the work required by the contract.
    3. Other Remedies If the contractor tricked or forced you into signing the contract, you might convince a court to terminate the agreement or amend its terms.

    Failure to fulfill the terms of an insurance policy may constitute breach of contract.

    An insurance policy imposes obligations on both you and your insurer. An insurer has an obligation to pay covered claims. If the insurer reneges on this duty, you may sue the insurer for breach of contract. Likewise, you have an obligation to cooperate with your insurer when it investigates a claim. If you file a claim and then refuse to cooperate with the insurer's investigation, your refusal to cooperate may constitute breach of the insurance contract. Your insurer may rely on your breach of the policy as a basis for denying the claim.