114/4221 VOCABULARY FORMATION OF CONTRACTS

Question 1

Acceptance

Answer 1

Acceptance is the agreement of the offeree to the proposal (the offer) of the offeror. It may be either oral or written and must conform to all the terms of the offer (“mirror image” rule) (UCC 2-207). Acceptance provides an exception for nonmaterial terms in contracts between merchants. Any reply to an offer that adds qualifications or conditions or changes the terms of the offer is not an acceptance but is a rejection and a counteroffer. Silence rarely constitutes acceptance.

Acceptance is effective on dispatch by a reasonable means of communication—usually the same method used by the offeror—i.e., it is effective as soon as it is put out of the offeree’s possession.

Example: The “mailbox” rule states that the acceptance is effective as soon as it is dropped in the mailbox (the postal service acts as an agent).

Question 2

Agreement

Answer 2

An agreement is an element of a contract. It is an offer by the offeror followed by an acceptance by the offeree. An agreement must be reasonably definite as to what each party is to do and must manifest genuine intent by both parties to agree and be legally bound. An agreement is a mutual understanding, an objective “meeting of the minds.”

Question 3

Accord

Answer 3

An accord is an agreement between the parties to a contract to permit some different performance to replace the original promised performance. Accord alone does not discharge (end) the contractual obligation; accord and satisfaction (carrying out the accord) discharges the obligation. An accord usually refers to the settlement of a disputed contract.

Question 4

Agency

Answer 4

Agency is a consensual fiduciary relationship in which one party (the agent) agrees to act for and under the control of another (the principal). This relationship may be one of employment (master-servant) or of authority (principal-nonservant/agent, e.g., bank manager); independent contractors (e.g., CPAs and lawyers) do not act in an agent capacity (due to lack of control by the principal over the contractor).

“Control” relates to control of the physical conduct of the agent and includes the RIGHT or ability to control, as well as actual control or supervision.

Types of agency:

• Express agency: created by written contract or oral appointment, e.g., power of attorney;
• Implied agency: created by acts or deduced from circumstances showing the intention to create the relationship;
• Agency by ratification: approval after the fact of an unauthorized act done by the agent;
• Agency by estoppel: created by operation of law; prevents denial of the existence of agency by the principal when a third party relies on circumstances which reasonably lead to the conclusion that an agency exists;
• Apparent agency: based on manifestations by the principal to third parties (reliance is not necessary).

Question 5

Capacity

Answer 5

Capacity is the legal ability to contract resulting from the ability to comprehend the nature and effect of a transaction. A contract between two competent parties is valid, because both parties are competent, and a contract in which one or both parties is not competent is voidable or void. For example, married women have full legal competence (i.e., modern statutory repudiation of common law disabilities which claimed that a woman could not contract without her husband’s signature). Parties are considered to be competent unless demonstrated otherwise. Incompetent parties (e.g., parties lacking legal capacity) include the following:

• Infants (e.g., legal minors less than 18 years old): A contract with an infant is voidable by the minor only (the other party may not avoid the contract).
• Persons legally insane (with or without adjudication): A contract with persons legally insane is void from inception if adjudication preceded the contract, if adjudication followed, or if the person is shown to be insane without adjudication.
• Drunkards: A contract is enforceable unless the party was so intoxicated at the time of contracting that any reasonable person would agree that he or she lacked capacity. In such case, the contract is voidable by the sober drunkard.
• Corporations: Corporations can contract only through agents. The power to contract is limited by charter with respect to the subject matter of contracts (e.g., the contract must reasonably accomplish some object for which the corporation was created). Private corporations are liable for ultra vires contracts.
• Illegal aliens: A contract with an illegal alien is voidable.
• Convicts: Legal capacity is limited for felons.

Question 6

Common Law

Answer 6

Common law is the body of rules developed from custom, usage, and previous court decisions rather than from written legislation. It has been subsequently used as a basis for later court decisions (judge-made law or case law as opposed to legislated law).

Common law liability for accountants relies on the common law theory of negligence—the accountant is obligated to exercise the ordinary reasonable care, skill, and competence of other members of the profession (i.e., the generally accepted standards of the profession).

Question 7

Consideration

Answer 7

Consideration is a required element of a contract. It is some act of forbearance or detriment incurred, or benefit or promise thereof, given to and received by the other party in exchange for an act or promise by the second party. Consideration is an element of the contract that supports the promise given, causing the promise to be enforceable. It is the inducement to enter into a contract.

The benefit or detriment need not have a monetary value to be sufficient legal consideration (e.g., the waiving of a legal right would be considered a detriment incurred).

Consideration must be mutual for a valid contract—both parties must give consideration. The relative value of the two considerations, however, need not be equal to be legally sufficient.

Consideration is not any of the following:

• Past consideration (consideration given in the past in exchange for a previous promise)
• A preexisting duty (that which the promisor is already legally bound to do by contract or statutory duty)
• Illusory promise (a promise in form but not in substance)
• A moral obligation (something a person feels morally obligated to do but is not legally obligated to do)

Promissory estoppel is an example of enforcement of a contract when consideration on the part of the promisee is lacking.

Question 8

Contract

Answer 8

A contract is an agreement between two or more persons that establishes an enforceable legal relationship between the parties. The essential elements of a contract are:

• an agreement (offer and acceptance),
• consideration,
• valid subject matter, and
• legal capacity.
  A void contract never had any legal status. A voidable contract is valid only until one party exercises a right to void the contract. An unenforceable contract is valid when made but is made unenforceable by some later event, such as the statute of limitations, discharge of the contract in bankruptcy, or involuntary destruction of the subject matter.

Question 9

Counteroffer

Answer 9

A counteroffer is a reply to an offer that adds qualifications, conditions, or new terms. In contract law, it is a rejection of the offer by the offeree combined with a new offer to the original offeror.

The Uniform Commercial Code (UCC) modified this definition considerably but specifically stated that an acceptance which includes terms additional to or different from those in the original offer** does** constitute an acceptance and the contract is formed and the new terms are considered as proposals for inclusion in the contract. Between merchants, the terms become part of the contract unless:

• the offer expressly limits acceptance to the terms of the offer,
• the new terms materially alter the offer, or
• notification of objection is timely given.

UCC 2-207

Question 10

Duress

Answer 10

Duress is a wrongful act that compels contractual agreement through fear. It is the actual or threatened causing of an action or inaction, e.g., threat of bodily harm, property damage, or criminal prosecution, which forces the other party to enter into the contract against his free will and judgment. A contract made under duress is voidable at the option of the victim due to invalid consent. It is based on fact and circumstance, and is subjective (what the injured party thinks). Factors to be considered include the age, sex, experience, intelligence, and relation of the parties.

Question 11

Fraud

Answer 11

Fraud is the intentional misrepresentation or failure to disclose a material fact or facts that results in injury or loss to someone relying on it.

Elements necessary to prove fraud include the following:

• A material (significant) misrepresentation or omission of fact
• Knowledge of the falsity (scienter)
• Intent that the misrepresentation be relied on
• Actual reliance by another party
• Resultant damage suffered as a result of reliance
• Research shows that there are usually three conditions present when fraud occurs:

1. A situational pressure (a nonshareable financial need)
2. A perceived opportunity to commit and conceal the dishonest act (viewed as a way to secretly resolve the nonshareable pressure)
3. Some aspect of the individual’s personal integrity that allows him to rationalize his dishonest behavior
   1.

Question 12

Fraud in the Inducement

Answer 12

Fraud in the inducement is false representation or failure to disclose of a material fact knowingly made or omitted, justifiably relied upon in the making of the contract, and resulting in injury. It is antecedent fraud that occurs during the negotiation, precedes the making of the contract, and induced the other party to enter into the contract, and may be in the form of an act, an omission, a concealment, or a nondisclosure. A contract signed under fraud in the inducement is voidable at the option of the defrauded party. It is less serious than fraud in the execution and applies to common law and commercial paper only. (It does not apply to securities fraud.)

Question 13

Irrevocable

Answer 13

Irrevocable means not subject to being invalidated due to withdrawal or cancellation. It is said of trusts, offers and acceptances to contracts (prior to agreement), and offers (and acceptances of offers) to sell (under UCC) in certain circumstances and/or under certain contractual specifications.

Trusts are considered to be irrevocable (i.e., the settlor or grantor does not have the right to terminate the trust during the specified time of the trust) unless such right was reserved and specified by the settlor when the trust was established.

Irrevocable offers are the exception to the general rule that offers are revocable by notification to the offeree by the offeror any time prior to acceptance (effective when received by the offeree).

Example: Irrevocable offers include the following:

• Paid for option (made irrevocable by contract between the parties)
  Unilateral contract when there is substantial performance by the offeree.
  Stated time of a written offer signed by a merchant (even if there is no return consideration) (UCC 2-205)

Question 14

Joint and Several

Answer 14

“Joint and several” is a legal phrase used in definitions of liability, meaning that an obligation (to pay or to perform) may be enforced against all liable parties jointly or against any one of them separately.

Question 15

Joint Liability

Answer 15

Joint liability is the legal theory that holds that two or more persons promise to perform one obligation or that two or more persons may be held liable for the action of one (“together we promise”).

Said of partners: All partners may be sued for the actions of one partner or of the partnership. All partners are jointly (and severally) liable for the debts and other obligations of the partnership (e.g., breach of contract).

A release on one joint obligor releases all. If one dies, the others are still liable.

(Contrast with several liability—obligor may be jointly liable or both jointly and severally liable.)

Question 16

Limited Liability

Answer 16

“Limited liability” is said of an individual who cannot be held legally responsible for the debts or other liabilities of another party. This is usually said of corporate shareholders. Corporate shareholders are liable only to the extent of their investment in the corporation; they are not liable either for the debts of the corporation or the acts of the officers, directors, or employees of the corporation. Limited partners also have limited liability.

Question 17

Offer

Answer 17

An offer is a proposal made by the offeror, stated in reasonably specific terms, which manifests intent to be bound. It is distinguished from invitations to bid or preliminary negotiations. An offer may be either oral or written.

An offer must be reasonably definite and certain as to what is agreed upon. The essential terms are parties, price, subject matter (quantity and type), and time for performance. The standard used to judge an offer is an objective one—would a reasonable person believe that an offer was made? (Uniform Commercial Code “gap fillers” (UCC 2-204) will provide terms for elements which are absent, except quantity. The contract will not fail for indefiniteness.)

Ads, price lists, quotes, bids, and inquiries such as “What will you give me…?” or “Would you take $___?” are not an offer but an invitation to trade or a proposal to negotiate.

An offer may terminate due to revocation by the offeror before acceptance, rejection by the offeree, lapse of time, or by operation of law.

Question 18

Partner

Answer 18

A partner is an individual, estate, trust, corporation, or other entity that owns a capital or profits interest in a partnership. A partner’s taxable income for a tax year includes his distributive share of certain partnership items for the partnership’s tax year ending with or within the partner’s tax year. A partner must report his distributive share of partnership items on his tax return whether or not it is actually distributed. These items are furnished to the partner on Schedule K-1 (IRS Form 1065). See the instructions for Form 1065 for more information. A partner is not considered an employee.

To determine the allowable amount of any deduction or exclusion that is limited, a partner must combine any separate deductions or exclusions on his or her income tax return with the distributive share of partnership deductions or exclusions before applying the limit.

In general, a partner cannot deduct partnership expenses paid out of his or her personal funds unless required to do so by the partnership agreement. These expenses are usually considered incurred in and deductible by the partnership. If a partner is required by the partnership agreement to pay, out of his or her personal funds, an employee who performs part of the partner’s duties, the partner can deduct that payment as a business expense.

Partners must treat partnership items on their individual tax returns as they are treated on the partnership return. If a partner treats an item differently on his or her individual return, the IRS can automatically assess and collect any tax and penalties that result from adjusting the item to make it consistent with the partnership return. However, this does not apply if a partner who is not part of an existing large partnership files IRS Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, with his or her return identifying the different treatment.

Question 19

Parol Evidence

Answer 19

Parol evidence is a legal rule of contract interpretation that states that extrinsic (oral or written) evidence (i.e., outside the contract) is not admissible to add to, alter, or vary the terms of a written contract. All preliminary negotiation should have been merged into the writing.

Despite the parol evidence rule, oral evidence may be admitted as proof:

• of fraud, misrepresentation, duress, undue influence, lack of consideration, or illegality of the subject matter (constitutes proof, which destroys the contract).
• of an oral condition precedent to the written contract: proof that the parties agreed orally to a condition that had to be fulfilled before the contract became effective.
• to explain an ambiguity or omission: evidence cannot contradict the terms of the contract but can explain them.
• of a subsequent modification (oral or written) made to the contract. (Oral modification is acceptable if it is supported by consideration and does not violate the statute of frauds.)

Question 20

Partnership

Answer 20

A partnership is an association of two or more persons to carry on as co-owners of a business for profit. Partnerships are governed in the various states of the United States by the Uniform Partnership Act (UPA). A partnership may be general, limited, or joint venture.

Characteristics of a partnership include the following:

• Voluntary association of persons as individuals (the partnership has no separate legal identity under common law, but under the UPA it is now an entity for most purposes)
• Simple agreement without governmental sanction
• A fiduciary relationship (mutual agency—each partner is an agent for the others and for the partnership)
• Co-ownership
• Mutual agency of partners
• Joint and several liability
  A partnership does not pay income tax. It is a pass-through entity, so profits and losses of the partnership pass through to its partners. A partnership does file an informational tax return using IRS Form 1065, U.S. Return of Partnership Income.

Question 21

Promise

Answer 21

A promise is an engagement (undertaking) to pay (as related to commercial paper) that is more than acknowledgment of an obligation (e.g., an IOU is merely an acknowledgment, hence not negotiable). A promise must be unconditional. (Contrast to order.) (UCC 3-102)

Question 22

Promissory Estoppel

Answer 22

Promissory estoppel is an equitable legal doctrine applied to contracts designed to prevent injury to a party resulting from reliance on a promise made. It holds the promisor liable on a promise, even if no consideration was given by the other party. Recovery is based on one party’s reliance on the promises of another even though no contract actually exists. It prevents (“estops”) the promisor from denying the existence of the contract, from denying the promise he has expressly or implicitly made and which was relied on to the detriment of the promisee. Consideration from the promisee is not required (acts in lieu of consideration). The contract is enforceable against the promisor.

Conditions required for a finding of promissory estoppel:

The promisor knew or should have known that the promise alone was likely to induce a specific action on the part of the promisee.
The promisee, after the promise is made, does take the expected action.
The action taken by the promisee was definite and substantial in nature (i.e., detrimental to the promisee).

A promise to donate money to a charity on which the charity relied in incurring large expenditures: This scenario is a classic example of promissory estoppel. If a charity reasonably and detrimentally relies on a promise to donate money, the promise may be enforceable despite the lack of consideration. This principle helps prevent the promisor from arguing there was no consideration to avoid fulfilling their promise after the promisee has already taken action in reliance on that promise.

Question 23

Public Policy

Answer 23

Public policy pertains to or furthers the general public good. An act that is “against public policy” is injurious to the general public good, such as restraining trade or competition, bribery, corruption of a public official, or unduly influencing legislative or executive action.

Question 24

Ratify

Answer 24

To ratify is to affirm or sanction a contract (1) by accepting the benefit of the act retroactively, with full knowledge of the facts and the right to avoid the contract (express ratification) or (2) by failure to repudiate or disaffirm the contract (by silence or by retention of goods received; implied ratification). Ratify is the opposite of repudiate.

Question 25

Redress

Answer 25

Redress is the righting of a wrong, the compensation for a wrong paid to the injured party. In civil actions, it takes the form of damages (reimbursement for the loss), injunction (court order to perform or refrain from performing a particular act), or specific performance (court order to perform the specific act detailed in the contract). In criminal actions, redress is in the form of fine, imprisonment, death, or impeachment.

Question 26

Remedy

Answer 26

A remedy is an attempt to put the injured party in the same position as if the contract had been performed (rather than breached). Possible remedies include compensatory damages, nominal damages, liquidated damages, restitution, injunction, and specific performance.

Remedies to the buyer and seller under the Uniform Commercial Code (UCC) are many and varied depending on the circumstances of the breach.

Question 27

Revoke

Answer 27

In contract law, to revoke is to withdraw an offer by the offeror before it is accepted by the offeree.

Question 28

Risk of Loss

Answer 28

Risk of loss is an attribute of ownership that makes the party liable for damage to or destruction of the goods. It passes from seller to buyer at the point mutually agreed on (usually either shipping point or destination), and it can be with only the buyer or the seller or can be split between the parties. Insurance coverage has no effect on risk of loss. The Uniform Commercial Code (UCC) provides default provisions for risk of loss under different circumstances.

Question 29

Statute of Frauds

Answer 29

The statute of frauds is found in Article 2 of the Uniform Commercial Code (UCC). It specifies that certain contracts must be in writing and signed by the party to be charged in order to be enforceable. The writing need not be formal; a signed memo or several writings (e.g., letters) may be sufficient.

The writing must contain the subject matter, the names of the parties, the consideration, the terms of the contract (must state at the very least the quantity of goods sold), and the signature of the party to be charged.

The statute applies only to the following:

• The sale of goods having a value in excess of $500
• A contract that will not be performed within one year of the signing
• The sale of real property or of securities
• The promise to answer for the debt of another

Question 30

Termination

Answer 30

Termination is the end point of the winding-up period that results in the settling of the financial affairs of a partnership. No new business is conducted during the period. Termination is strictly regulated by the Uniform Partnership Act.

Question 31

Unilateral Contract

Answer 31

A unilateral contract is a promise by one party only, the consideration for that promise being an act by the other party, the act constituting both the acceptance and the performance, e.g., “I promise to give you $15 if you mow my lawn.” The acceptance of this unilateral agreement is the performance of the act.

Question 32

Uniform Commercial Code (UCC)

Answer 32

The Uniform Commercial Code (UCC) is a set of uniform rules dealing with eight subjects of commercial law, modifying common law of contracts. The UCC applies almost exclusively to the sale of goods and is designed to liberalize the way merchants do business while protecting the consumer.

Areas covered include the following:

Article 1—General Provisions
Article 2—Sales
Article 2A—Leases
Article 3—Negotiable Instruments
Article 4—Bank Deposits
Article 4A—Funds Transfers
Article 5—Letters of Credit
Article 6—Bulk Transfers and Bulk Sales
Article 7—Warehouse Receipts, Bills of Lading, and Other Documents of Title
Article 8—Investment Securities
Article 9—Secured Transactions

Authorities
UCC 2-201

Question 33

Void

Answer 33

A void contract is one that never had any legal status.

Question 34

Voidable

Answer 34

A voidable contract is valid only until one party exercises a right to avoid the contract. Voidable contracts can be made valid by (1) ratification or (2) silence by the party with the right to avoid the contract. The party affirms or sanctions the contract by accepting the benefit of the act retroactively, with full knowledge of the facts and the right to avoid the contract (express ratification) or by failure to repudiate or disaffirm the contract (by silence or by retention of goods received; implied ratification).