Basics of U.S. Contract Law

David J. MackDorsey & Whitney LLP51 West 52nd StreetNew York, New York 10019P:212.415.9200 F:646.390.6575http://www.dorsey.com/mack.david@dorsey.com

©2011 Dorsey & Whitney LLP. This presentation and the textual content hereof are intended for general information purposes only and should not be construed as legal advice or legal opinions on any specific facts or circumstances. An attorney-client relationship is not created or continued by reading this material. Dorsey & Whitney LLP will be pleased to provide further information regarding the matters discussed therein.

October 2011

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Table of Contents

Contracts Around the World What is a Contract? Do I Need a Written Contract? Common Business Contracts Elements of a Contract Contract Enforceability Negotiating a Contract Drafting and Reviewing a Contract Performing the Contract Breach of Contract Remedies for Breach

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Contracts Around the World

The laws governing contracts vary throughout the world and can affect the legality, enforceability, performance requirements and even the available remedies for breach.

While there are often differences among the laws of the various countries, provinces or states, U.S. contract law concepts described in this presentation should be generally applicable to most situations around the world.

However, before you enter into any contract, make sure to consult with a qualified attorney in your local jurisdictions.

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What is a Contract?

A contract is an agreement between two or more parties that creates an obligation on all parties to perform (or not perform) a particular action or set of related actions.

Contract law determines what makes a particular contract enforceable, and provides remedies when a contract is breached.

If you are not careful, a contract may not be enforceable when you want it to be, and may be enforceable when you don’t want it to be.

Working with a qualified attorney on all significant issues is the only certain way to make sure your contract works how you intend.

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Do I Need a Written Contract?

Whether a contract exists depends on whether parties have reached a mutual agreement – which can be oral.

Generally a written contract is entered into to protect the parties against misunderstandings and to clarify the obligations and particular agreement between parties.

Contracts can cover a wide range of circumstances, both in business settings and personal relationships. Business contracts are varied and can cover all aspects of a business, including those with customers, employees, investors and business partners.

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Do I Need a Written Contract?

(1) the amount of money involved,

(2) the value of the products or services involved,

(3) the duration of the contract,

(4) the risk of not entering into the contract, and

(5) other factors specific to each case.

Check with an attorney periodically about your business dealings to determine whether a contract is important, and if so, what it should look like.

The importance of having a detailed written contract depends on:

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Common Business Contracts

Sales/Service Contracts: spells out terms of sale of goods or services, payment terms, warranties, rights and obligations of parties;

Confidentiality/Non-Compete Contracts: protects confidential information of a business including client lists, inventions, trade secrets, and other important information. Non-compete provisions must be reasonable as to time, place and scope; and

Partnership Agreements: spells out the obligations between partners and their responsibilities with regard to the ownership and management of a business.

There are dozens of different types of contracts. Selecting the type that best fits your intended agreement is a critical ‘art’. Below are a few common types of contracts for commercial businesses:

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Other Types of Business Contracts

Below is a list of other types of contracts that are commonly used in commercial businesses:

Arbitration Agreement

Asset Purchase Agreement

Assignment Agreement

Bonus Agreement 

Collaboration Agreement

Consulting Agreement

Credit Agreement

Deferred Compensation Plan

Development Agreement

Distribution Agreement

Employee Stock Plan

Employment Agreement

Equipment Lease

Franchise Agreement

Guaranty Agreement

Indemnification Agreement 

Joint Venture Agreement

Lease 

License Agreement

Loan Agreement

Manufacturing Contract

Merger Agreement

Non-Disclosure Agreement

Operating Agreement

Promissory Note

Repurchase Agreements

Sales Contract

Services Agreement

Shareholder Agreement

Stock Option Agreement

Stock Purchase Agreement

Supply Agreement

Trademark License Agreement

Underwriting Agreement

Voting Agreements

Waiver Agreement

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Elements of a Contract

Element Description Example

An Offer

One party must promise to do or refrain from doing some specified thing in the future,

conditioned on an act, forbearance, or return promise

given in exchange

“I will build a house for you, if you pay me $1,000”

Acceptance

The agreement by one who receives an offer, by express act or implied conduct, to the

terms of the offer

“I accept your offer to build my house” or “Here is $1,000”

Consideration

Something (such as an act, a forbearance or a return

promise) that was bargained for and received by each party

to a contract

The built house and the $1,000

A legally enforceable contract requires the following:

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Elements of a Contract: The Offer

An offer is a communication that gives therecipient the power to create a contractthrough his or her acceptance.

Offers must contain sufficient terms, such as price,quantity, quality, time and place of delivery, in order to determine the specific obligations to be created.

Once an offer is made, it may be accepted at any time until it expires by its terms or is expressly revoked.

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Elements of a Contract: Acceptance

Acceptance is an offer recipient’s agreement to perform according to the terms of the offer, and the act of acceptance of a valid offer creates a binding contract.

Acceptance can be express (e.g., stating “I accept the deal”) or implied (e.g., paying for the goods or services offered for sale).

Some offers contain limitations on how and when the offer may be accepted, and the acceptance must conform to those limitations (e.g., an offer may include a time limit for responses and may require written acceptance).

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Elements of a Contract: Contractual Intent

A binding contract requires a “meeting of the minds” of the parties, in that both intend to be bound to the same contractual terms.

Offers clearly made in jest or frustration likely lack the requisite intent to be valid offers. Similarly, general statements, such as advertisements, are not definite enough to be offers.

Acceptance of the offer must be clear and unambiguous. An offer cannot be partly accepted, or accepted with a caveat. A partial acceptance is actually a rejection and is considered a counter-offer on the new terms.

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Elements of a Contract: Consideration

Consideration is an essential element for the formation of a contract. It may consist of a promise to perform a desired act or a promise to refrain from doing an act that one is legally entitled to do.

Consideration must have a value that can be objectively determined. For example, a promise of love or affection is not enforceable because of the subjective nature of the promise.

“Consideration” means something of value given by both parties to a contract that induces them to enter into the agreement to exchange mutual performances. For example, a promise to make a gift is not enforceable because it is one-sided.

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Elements of a Contract: Governing Laws

Contract law is governed by two main sources: Common law, created by courts through the

interpretation of prior facts and circumstances. This is the primary source of contract law in many countries, as courts generally interpret and define the other sources as well; and

Specific statutes in each jurisdiction, generally at the state level. For example, the Uniform Commercial Code (“UCC”) of each state in the United States governs contracts pertaining to the sale of goods in that state.

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Contract Enforceability – Written or Oral Contracts

Contracts may generally be written or oral, and both types may be equally binding. However, there are restrictions and dangers associated with oral contracts: The Statute of Frauds is a common law principle that

prevents enforcement of oral contracts relating to (1) the sale of land, (2) the sale of goods with a value in excess of a small number of dollars (e.g., $500), or (3) contracts that are unable to be fully performed within one year.

The terms of oral contracts may be impossible to prove, presenting difficulty in enforcement.

Written contracts can reduce or eliminate confusion and are best to protect the interests of a business or individual. Oral contracts should be avoided!

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Contract Enforceability – Bars to Enforcement

A contract will not be enforced if it is “unconscionable”, meaning that no rational person would make that contract, and no fair or honest person would accept, the contract terms. These include contracts that are grossly unfair or against public policy.

Contracting parties must have the capacity to contract, meaning they may not be: (1) minors; (2) under duress; (3) intoxicated; (4) mentally handicapped; or (4) pressured by outside forces in ways that deprive them of their free will.

A contract will not be enforced if the subject matter of the contract is illegal or contrary to public policy, such as contracts dealing with crimes.

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Negotiating a Contract

Begin contract negotiations with the following steps:

Understand what it is you want to accomplish with the contract and what the other party wants to accomplish;

Identify your position and the other party’s position (strengths vs. weaknesses);

Be prepared and provide room for negotiation; and

Bring solutions to the table – try to work towards resolution of disagreements rather than just butting heads!

Until a final definitive agreement is reached, all draft agreements, term sheets or letters of intent should clearly state the following:

“This document is not intended to create or constitute any legally binding obligation between the parties hereto, and no party shall have any liability or obligation to another with respect to this document until a fully integrated definitive agreement is prepared, authorized, executed, and delivered by all parties.”

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Negotiating a Contract: Other Considerations

In some circumstances, a party will insist on using its contract form and will not be willing to negotiate terms. This is called an “adhesion contract” and the other party will not be able to obtain the desired product or service unless it acquiesces to the form contract. Adhesion contracts may not be enforceable to the extent they contain unreasonable terms.

When dealing with government entities or political subdivisions such as cities and towns, be aware of legal requirements applicable to those entities, including public bidding requirements, fair wage laws, open door laws and others.

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Drafting a Contract

When given the opportunity, it is generally best to be the party that drafts the contract.

Advantages of “controlling the draft”:

• Provides extra control over the negotiations;

• Allows you to define the issues;

• Prevents hidden or surprise issues;

• Enables the deal to be structured onyour terms; and

• Helps you influence the timing of thedrafting process.

Once the basic outline of terms is negotiated, contract drafting may begin:

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Drafting a Contract: Basics

Consult with an Attorney!

Ambiguities in contract provisions are generally construed against the draftsman.

It is acceptable to begin drafting from a sample contract, but do not be controlled by or become overly reliant on its provisions – one size does not fit all!

Take the time to draft a contract that protects your interests and is clear and complete. For routine or recurring types of transactions, create a thorough but flexible form that allows easy selection of common options for terms.

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Drafting a Contract: Major Elements

Parties

Effective Date

Statement of Service

Pricing

Indemnities

Representations and Warranties

Performance Standards

Remedies

Risk Allocation

Miscellaneous Provisions

Governing Law and Dispute Resolutions

Signatures

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Reviewing a Draft Contract

A draft contract or comments on a draft contract received from the other party should be carefully reviewed.

Review should include:

• Careful reading of all contract terms;

• Obtaining clarification on terms that appear ambiguous, confusing or vague;

• Adding terms that are necessary to the transaction;

• Confirmation that your important comments have been reflected in the draft; and

• Final confirmation that your objectives are met by the contract before signing.

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Performing the Contract

Once a valid contract is signed by all parties, its terms are binding on the parties, and they must fully perform their respective obligations that the contract requires.

Whatever is written in the contract becomes the complete agreement.

• Make sure all terms are in the final contract, and be sure not to verbally agree to modify the terms. Verbal agreements to modify a written contract have all the problems of oral contracts and may or may not be enforceable.

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Breach of Contract

A breach of contract occurs where a party to a contract fails to perform, precisely and exactly, that party’s obligations under the contract. This can happen in two ways:

• Party states: “I will not perform the contract”; or

• Actually not performing.

The non-breaching party may then take legal action against the breaching party for damages and other remedies.

Don’t knowingly breach a contract unless you have consulted with an attorney about the risks of such a breach!

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Breach of Contract: What Now?

If you believe you or another party is in breach of a contract, consult with an attorney right away!

Contract breaches may be addressed in a variety of ways:

• The parties may agree upon a waiver or amendment to eliminate the breach;

• The non-breaching party may take the breaching party to court (or arbitration) in order to obtain damages and other remedies; or

• The parties may agree to mediate a solution to the breach.

Consult with an attorney before taking any action, or you may lose some of your rights, and you may subject yourself to penalties as well.

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Remedies for Breach

Upon proving that a party has breached a contract, a court may impose a variety of remedies to remedy the breach.

Types of possible remedies:• Monetary damage awards to compensate the non-breaching

party;• Equitable remedies that will enable the contract to continue

or prevent further breach;• Reformation of the contract to reflect the actual intent of the

parties; or• An order to compel the breaching party to perform its

actions under the contract. Remedies are not exclusive, and generally multiple types

of remedies may be awarded to the non-breaching party.

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Remedies for Breach: Monetary Damages

The most common remedy for a breach of contract is a monetary award, which can come in many forms: • Compensatory – this award will compensate the non-breaching

party for actual losses incurred from the breach;

• Consequential – this award will cover damages that were suffered as a result of the breach, but not directly caused by it;

• Expectation – this award will provide value equal to what should have been received had the breach not occurred; or

• Nominal – this award is a small amount that recognizes a breach occurred but that it did not result in actual loss.

Damage awards for breach of contract may not be punitive (more than actual damages) unless the breaching party acted with recklessness, malice or deceit.

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Remedies for Breach: Equitable Remedies

Courts may also award equitable remedies, which are designed to prevent or address a wrong when monetary damages are not appropriate or sufficient:

• Injunction – a court can order a party to either continue performing or stop performing an action. A party seeking an injunction must show that there is no other sufficient remedy and that irreparable injury will result without the injunction; or

• Specific Performance – a court may order a party to perform, as nearly as practicable, its performance as promised under the breached contract. This is not likely to be awarded unless monetary damages are inadequate, damages are impossible to determine or the subject of the contract is unique, such as in the sale of land. This remedy will never be granted against an individual when it would require him or her to personally perform services.

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Useful Sites

Additional Information on Contracts• Lawyers.com

http://contracts.lawyers.com

Sample Business Contracts• OneCLE Sample Business Contracts

http://contracts.onecle.com

• FindLaw Sample Business Contractshttp://contracts.corporate.findlaw.com

General Business Assistance• Small Business Guidance

http://www.allbusiness.com/

• Business Serviceshttp://www.legalzoom.com/

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