Introduction

Contract law provides the legal framework for establishing agreements between two or more parties. Understanding contract law is crucial for investors to protect their rights and interests when entering into deals and partnerships.

A contract represents a voluntary, deliberate promise between competent parties who exchange something of value in order to create a legal obligation to do or refrain from doing some specified action in the future. Contracts form the foundation of business relationships and commercial transactions.

For investors, knowledge of contract law principles empowers them in several key ways:

• Evaluating proposed deals and identifying potential risks or unfavorable terms
• Negotiating agreements that align with their interests and priorities
• Understanding available remedies in case of a breach of contract
• Avoiding pitfalls related to invalid, void, or unenforceable contracts
• Resolving disputes through litigation or alternative dispute resolution if necessary
• Modifying terms when circumstances change while preserving a valid legal contract

A basic grasp of contract law provides investors confidence when entering into binding business partnerships. It enables them to create agreements that factor in key issues like jurisdiction, liability, and exit strategies. Overall, contract law literacy represents a core skill for investors seeking to manage risk and optimize returns.

Elements of a Valid Contract

For a contract to be valid and enforceable, it must contain several key elements:

• Offer: One party (the offeror) makes an offer to another party (the offeree). This offer creates the power of acceptance and must be made with serious intent.
• Acceptance: The offeree accepts the exact terms of the offer made by the offeror. This acceptance must be unconditional and unambiguous.
• Consideration: Both parties must exchange something of legal value for the contract to be binding. This can be money, physical objects, services, promises, etc. Consideration demonstrates that the parties intend to be bound by the contract.
• Capacity: The parties must have the legal capacity to enter into a binding agreement. Those who lack capacity include minors, mentally incompetent individuals, and in some cases, intoxicated persons.
• Legal purpose: The contract must have a lawful object or purpose. Contracts for illegal activities are void and unenforceable.

The elements of offer, acceptance, consideration, capacity, and legal purpose must all be present for a contract to be legally binding. If any of these key ingredients are missing, the contract can be declared void or voidable. Understanding these essential components creates the foundation for crafting a valid and enforceable contract.

Types of Contracts

There are several ways to categorize the different types of contracts:

a. Express vs Implied

• Express Contracts – An express contract is one in which the terms are spelled out in words, either verbally or in writing. An offer is made by one party and acceptance is communicated by the other party.
• Implied Contracts – An implied contract does not involve direct, expressed communication between the parties. Instead, an implied contract is inferred from the conduct of the parties or the circumstances. Actions and situational context demonstrate there is an agreement.

b. Unilateral vs Bilateral

• Unilateral Contracts – In a unilateral contract, only one party makes a promise or undertakes a performance without first securing a reciprocal agreement from the other party.
• Bilateral Contracts – A bilateral contract consists of mutual promises made between two parties. Each party is both a promisor, making an offer and binding promise, and a promisee, to whom the offer is made and the promise is given.

c. Executed vs Executory

• Executed Contracts – An executed contract is one in which both parties have fulfilled their contractual obligations. The contract has been fully carried out or performed.
• Executory Contracts – In an executory contract, one or both parties still have obligations left to perform under the contract. An executory contract is partly or wholly unperformed.

Breach of Contract

A breach of contract occurs when one party in a binding agreement fails to deliver according to the terms of the agreement. This could occur in a number of ways:

• Failing to perform – This means not taking an action defined in the contract. For example, if the contract states that one party will provide a product or service by a certain date but then does not deliver it, they have breached the contract.
• Defective performance – This means inadequately delivering what was promised per the contract. For instance, if a product or service is provided but is faulty, does not meet specifications, or is otherwise unsatisfactory, the delivering party has breached.
• Preventing or hindering performance – If one party obstructs the other party from being able to uphold their end of the contract, they are breaching the agreement.
• Repudiation – This is when one party communicates, through words or actions, that they do not intend to perform their contractual duties as outlined in the agreement.

There are several remedies available when a contract is breached:

• Damages – The non-breaching party may be awarded monetary compensation intended to put them in the position they would have been in had the contract been performed. Expectation, reliance, and restitution damages are common damage categories.
• Specific performance – The breaching party is ordered by the court to fulfill their contractual obligations. This is an equitable remedy typically used when monetary damages are inadequate.
• Rescission – The contract is retroactively cancelled as if it never existed. This typically occurs if there is a major breach or misrepresentation during contract formation.
• Reformation – The contract is rewritten or altered to accurately reflect the original intent of the parties. This is used to correct errors in the original agreement.
• Injunctions – The breaching party is legally prohibited by the court from continuing their non-performance. This stops further damage from occurring.

The type of remedy will depend on the situation and whether the breach was partial or total. Understanding breach of contract and associated remedies is important for any party entering into a business agreement.

Void, Voidable, and Unenforceable Contracts

There are subtle legal differences between contracts being void, voidable, and unenforceable. Understanding these distinctions is important for investors to know their rights and options when dealing with faulty contracts.

a. Void Contracts

A void contract is a contract that has no legal validity from the outset. This occurs when there was no genuine “meeting of the minds” between the parties, making mutual assent lacking. Examples of void contracts include ones involving minors, incapacitated persons, or prohibited activities.

Void contracts cannot be enforced and have no legal effect. However, if one party performed under a void contract, they may be entitled to restitution for the reasonable value of goods/services provided.

b. Voidable Contracts

A voidable contract is a valid contract that can be legally voided or cancelled later by one party if they choose to do so. This may occur if there was misrepresentation, mistake, undue influence, or duress involved in contract formation.

If a contract is voidable, one party has the option to rescind (cancel) the contract and release both parties from their obligations. However, the contract is valid and remains enforceable until actively cancelled by the aggrieved party.

c. Unenforceable Contracts

An unenforceable contract is a valid contract that cannot be enforced primarily due to a technicality or procedural error. This includes unsigned written contracts or oral contracts that violate the statute of frauds.

Unenforceable contracts remain legally valid obligations, but the judicial system will not enforce them. Parties can still choose to fulfill them, but have no recourse if the other party breaches.

The key differences are that void contracts are invalid from the start, voidable contracts can be retroactively cancelled, while unenforceable ones remain valid but unenforceable in court. Understanding these nuances helps investors know their options.

Contract Interpretation

Courts utilize several rules when interpreting ambiguous or unclear terms in a contract. These rules help determine the intent of the parties when entering into the agreement.

• Plain Meaning Rule – Courts will first look to the plain, ordinary meaning of the language used in the contract. Clear and unambiguous terms are interpreted according to their plain meaning without the use of extrinsic evidence.
• Context Rule – The context and circumstances surrounding the contract are considered to help interpret ambiguous terms. This includes industry customs, the nature of the agreement, prior negotiations, subsequent conduct, etc.
• Contra Proferentem – Ambiguities are construed against the drafter of the contract. This rule incentivizes the drafter to make the terms clear.
• Reasonable Interpretation – Courts will apply a reasonable interpretation of unclear terms, based on what a reasonable person would understand the language to mean. An unreasonable interpretation will not be enforced.
• Good Faith and Fair Dealing – There is an implied covenant of good faith and fair dealing in every contract. Courts will not enforce an interpretation made in bad faith to deprive the other party of their reasonable expectations.
• Parol Evidence Rule – Extrinsic evidence cannot be used to contradict or supplement clear written terms. But it can help clarify ambiguous terms.
• Course of Performance – The parties’ conduct in carrying out the contract can demonstrate their interpretation of ambiguous terms.
• Course of Dealing – The parties’ conduct in previous dealings can also clarify unclear terms.

Third Party Rights

Generally, only the parties that sign a contract can enforce its terms. However, there are some exceptions that allow third parties to enforce a contract, even if they were not originally part of the agreement.

The most common situations where a third party can enforce a contract are:

• Intended beneficiary: If the contract indicates that a third party is intended to benefit from the agreement, they may be able to enforce the terms. For example, if you and I sign a contract stipulating that I will pay your child’s college tuition, your child could potentially enforce that contract as the intended beneficiary.
• Assignment of rights: Contractual rights can be assigned or transferred to a third party. Once assigned, the third party steps into the shoes of the original party and can enforce the terms. For example, Company A signs a contract to buy widgets from Company B. Company A could then assign its contractual rights to purchase widgets to Company C. Company C could then enforce the widget purchase agreement even though they were not originally a party.
• Third party beneficiary laws: Some jurisdictions have laws that expressly allow certain third party beneficiaries to enforce a contract. These laws vary but may cover situations like life insurance contracts or contracts made to satisfy a court order.

Outside of these exceptions, third parties generally cannot enforce a contract if they were not an original party to the agreement. Only the people who actually signed the contract can bring legal action based on its terms. However, third parties may indirectly benefit from a contract even if they cannot directly enforce it.

Special Contract Types

Certain types of contracts have additional or different legal requirements compared to general contracts. Here are some key examples:

i. Employment Contracts

Employment contracts establish the rights and responsibilities between an employer and employee. Key clauses often cover the job description, compensation, benefits, confidentiality, non-compete agreements, and termination conditions.

Employment contracts may be oral or written. Written contracts provide more legal protection for both parties. All employees should review an employment contract carefully before signing to fully understand their rights and obligations.

ii. Contracts for Sale of Goods

The sale of goods is governed by the Uniform Commercial Code (UCC) in the United States. Key provisions cover delivery deadlines, transfer of ownership, inspection rights, acceptance/rejection of goods, warranties, and remedies if the goods are defective.

Under the UCC, both parties must act in good faith and according to reasonable commercial standards. Documentation requirements are more flexible for standard commercial transactions.

iii. Service Contracts

Service contracts outline the services one party will provide to another. Common examples include contracts with contractors, accountants, lawyers, architects, and consultants. Key terms often cover pricing, performance timeline, quality and scope of services, intellectual property rights, and liability limitations.

Unlike goods, services are intangible. The UCC does not apply to service contracts. Common law, industry standards, and negotiations between the parties govern service agreements.

International Considerations

When it comes to contracts that cross borders or involve parties from different countries, there are some additional factors to consider:

• Choice of Law – Which country’s laws will govern the contract? This needs to be specified in the contract. Even with a choice of law clause, there could still be issues when trying to enforce the contract across borders.
• Jurisdiction – Similarly, the contract should specify which court would have jurisdiction in case of a dispute. The chosen court needs to have authority over the parties involved.
• Language – Using a contract template or language geared to a certain jurisdiction may not translate perfectly in another country. Key legal terms and concepts may get lost in translation.
• International Conventions – There are some international treaties like the United Nations Convention on Contracts for the International Sale of Goods (CISG) that can impact contracts between parties from signatory countries. Knowing how such conventions apply is important.
• Local Laws – Some local laws and regulations like foreign exchange controls, privacy protections etc. may affect contracts even when foreign law is chosen to govern it. It’s important to be aware of restrictions that could override the contract.
• Enforcement – Enforcing a contract across borders can be difficult, especially if assets are located overseas. Understanding the process for enforcement before issues arise is prudent.
• Arbitration Clauses – To avoid getting tied up in a foreign court system, contracts often specify international arbitration in a neutral venue. This still requires parties to abide by the arbitration ruling.
• Due Diligence – When contracting with overseas partners, researching their reputation and business standing is important to avoid issues down the road.

Cross-border contracts require careful consideration of the above issues to ensure smooth enforcement and operations. Consulting international business attorneys is recommended when drafting such contracts.

Conclusion

Contract law is complex but important for investors to understand. Here are the key takeaways:

• A valid contract requires an offer, acceptance, consideration, competency and legal capacity, and lawful object and purpose. Breaches of contract can lead to lawsuits and damages.
• Contracts can be express or implied based on conduct. Standard form contracts are common but should be reviewed carefully.
• Contracts can be made void, voidable, or unenforceable for reasons like illegality, mistake, misrepresentation, duress, undue influence, unconscionability etc.
• When interpreting contracts, courts look at the objective meanings of words, and construe ambiguous terms against the drafter. Parol evidence rule limits what outside evidence can be considered.
• Third party rights are limited but intended and incidental beneficiaries can sometimes enforce contracts.
• Special contracts like employment agreements and NDAs have unique elements investors should understand before signing.
• International contracts require consideration of governing law, jurisdiction, arbitration clauses and other factors.

Understanding how contracts work is vital for investors and startups to protect their rights and avoid disputes. With knowledge of contract basics and experience working with lawyers, investors can negotiate fair deals and achieve business objectives.