Discharge of Contracts Flashcards
When we talk about the discharge (termination) of contracts, there are a couple of assumptions you can make:
We’re talking about an executory contract. That makes sense, right? You can’t terminate a contract that hasn’t been created or that has already been executed. It has to be “live”… that is to say, in that range of time between creation and execution.
The contract is valid — or at least it’s thought to be valid until some discovery or event says otherwise.
Two Primary Classifications
If you read up on this topic long enough, you will quickly find a sizable number of smart and experienced people with very different approaches to organizing the discharge of contracts.
As for me, I’m going to approach it as though they all fit under one of these two classifications:
Operation of law
Acts of the parties
We’ll begin with a look at the operation of law…
Discharge of Contracts
When contracts are discharged by operation of law, it means that they are discharged as a result of the application of law without regard to the desires of the parties — as opposed to acts of the parties, which DO reflect the intent of at least one of the parties to the contract.
Is It Operation of Law or Force of Law?
The operation of law is sometimes referred to as the force of law, particularly when the discharge of a contract goes against the desire of one or more of the parties.
While many view the terms as interchangeable, the term force of law is often used to underscore the legally compelling nature of the cause for the discharge of contracts, whereas the operation of law can be for a discharge that is purely administrative in nature.
Discharge of Contracts
Here’s a list of some of the more common reasons for the discharge of contracts that would be considered an operation of law:
Full performance
Expiration
Statute of limitations
Lack of legal element
Destruction of property
Death or incapacity
Bankruptcy
Alteration of the contract
Would it surprise you if I said we will now look at each of these in a little more detail? I didn’t think so.
Operation of Law
Let’s look at the first three discharges due to the operation of law on our list.
Full Performance
Let’s start with the most positive way to discharge a contract.
Full performance typically means both parties did what they were supposed to do and received what they had hoped to receive. And, once all obligations are performed, a contract is considered executed and discharged.
Wish it was always that simple, Anthony.
Expiration
Many contracts have a set expiration date. Once that date passes, the parties are released from future obligations, and the contract discharges as an operation of law. It has expired: It no longer functions or has force.
The expiration of a contract, however, should not be confused with a promise within a contract that has an internal performance deadline.
Let’s say the original contract is about to expire. If the parties choose to continue to operate under the same terms and conditions, they should create a separate and new contract for that purpose.
Statute of Limitations
In the event a party to a contract defaults in their performance, the wronged party must bring a lawsuit against the defaulting party within the time frame as set forth by the statute of limitations. The right to recovery for damages is lost once that date passes.
The merit of a damage claim has no bearing whatsoever in the discharge of contracts due to the statute of limitations.
Arizona Real Estate Contracts
The statute of limitations for breach of contract for Arizona real estate contracts (all of which are to be in writing) is six years.
The statute of limitations for specific performance to convey real property is four years.
Operation of Law: Full Performance, Expiration, & Statute of Limitations
Next up for causes of the discharge of contracts: Lack of legal element and destruction of property.
Lack of Legal Element
When I speak of a lack of legal element, I mean that something regarding the contract lacks legal standing or purpose or is unlawful in some way.
Once the legal defect is discovered, the contract may be discharged as an operation of law for lack of legal element.
Those Elements Are Essential
You may recall back to the first chapter of this level, we listed the essential elements of a valid contract:
Offer and acceptance
Consideration
Legally competent parties
Reality of consent
Lawful objective
If any of these are missing from the inception of the contract, that would be considered a lack of legal element.
For example, if it could be proven, after the fact, that one of the parties to the contract had entered into the agreement as a minor or under duress, the contract could be discharged as an operation of law for lack of legal element.
Other contracts start out perfectly valid, but something happens along the way to make them legally lacking in some regard. When that happens, they, too, can be discharged as an operation of law for lack of legal element.
For instance, if one party contracted another to build a structure on agricultural property, and it was later found to be the habitat of a federally protected species, the objective of the contract would then be considered as having an illegal purpose and be discharged.
You Mean I’ve Got a Choice? 🤷♂️
If you’re wondering why, in some instances, I’ve used language to indicate that a contract could be discharged rather than must be discharged, that’s because it depends on the circumstance.
With contracts deemed to have an illegal purpose — like engaging in construction where expressly prohibited by environmental law — the parties can NOT choose to continue with the contract.
But if the legal element that is lacking has to do with one of the parties entering into the agreement — as with a minor entering into a contract or an adult agreeing to a contract under duress — that type of lack of legal element simply makes the contract voidable by that party, which means they can choose whether or not to have the contract discharged as an operation of law.
Destruction of Property
In an earlier chapter, I touched on the concept of possibility to complete while teaching you about the essential elements of a valid contract. I mentioned that, on occasion, an otherwise valid contract can be rendered void somewhere along the way due to an act of God or an operation of law that arose after the agreement was initially reached.
The destruction of property (think earthquake, fire, flood, etc.) is one such example where a once-valid contract becomes void and is discharged due to an operation of law.
EXAMPLE
Anna enters into a contract to purchase a home just outside of Kansas City. But, prior to closing, a tornado barrels through that area and blows the house to bits, leaving nothing but the foundation in the storm’s wake.
The destruction of the subject property voids and discharges the purchase contract. Anna is no longer bound by the agreement she signed just weeks before.
Arizona Risk of Loss Before Close of Escrow
A common provision in Arizona purchase contracts places the burden on the seller for property loss that occurs between the signing of that contract and closing.
If the cost of damage repair exceeds 10% of the purchase price, the buyer would have the right to cancel the purchase contract.
Operation of Law: Lack of Legal Element & Destruction of Property
Death or Incapacity ⚰️
Harkening back, again, to the essential elements of a valid contract, you’ll recall that legally competent parties are required to enter into a contract. But what happens if a party becomes incapacitated or dies during the contract?
In most cases, death or incapacity does NOT relieve the party of contractual obligations. An exception to this rule is made for personal services contracts.
Why? Because personal service contracts are based on the specific abilities, talents, etc., that the person offering the service brings to the agreement. A personal service contract involves the performance of action rather than of a supply of goods.
While I might be fine entering into a contract where you perform a function for me, I might not agree to your Uncle George taking over and carrying out the same task. (Nor could I legally compel him to do so in your place.)
Personal Service Contracts in Real Estate
In real estate, agency agreements (listing agreements and buyer representation agreements) are personal service contracts. These can be discharged as an operation of law due to the death or incapacity of the parties.
Remember, however, that an agency agreement contract is between a broker and a client, not the salesperson and a client. If something happens to you as a sponsored salesperson while representing your broker’s clients, the broker could simply reassign those clients to other sponsored agents. This would occur after a respectful moment of silence for your “misfortune,” of course.
A trail of money leading up to a small keychain of a house.
Bankruptcy 💰
Bankruptcy by either party will often result in the discharge of a contract as an operation of law, including agency agreements and real estate purchase contracts.
Arizona Real Estate Contracts
When a seller or their listing broker files for Chapter 7 bankruptcy, the listing agreement is discharged.
The listing agreement involving a seller going through Chapter 13 bankruptcy might remain valid, depending on trustee ratification (approval from the official overseeing the bankruptcy proceedings).
Note: Any type of bankruptcy of a salesperson (agent as opposed to their broker) will have no effect on a valid agency agreement.
Alteration of Contract 📄
Alteration of contract has occurred whenever a party to the contract attempts to modify the terms or conditions of the original contract in a material way. This is true whether the alterations were done with or without the other party’s consent or knowledge.
The consequence of the alteration is the discharge of the old contract since the new terms/conditions no longer represent the original intent of the parties.
It is perfectly legal to alter a contract after it’s been signed, but the material change must be made by mutual consent of the parties. If one party attempts to alter a contract without the consent of the other, the alteration would likely be considered unenforceable.
Some contracts contain language stipulating how alterations are to be carried out. If so, those directions must be followed. And once a contract has been altered, a new contract has been created, and the obligations to the old contract have been discharged.
Operation of Law: Death or Incapacity, Bankruptcy, & Alteration of Contract
We’re now going to turn our attention to the discharge of contracts due to acts of the parties. Not everyone uses the term acts of the parties. Read on and see what you think…
Acts vs. Agreement
Some in the real estate biz refer to acts of the parties as agreement of the parties. Those who prefer acts over agreement would say that, while most parties enter a contract in an agreeable fashion, they’re not always so agreeable in the discharge of contracts.
Sometimes, only one party wants to see the contract discharged and the other party complies, even if they’re not particularly happy about it.
Regardless of the parties’ disposition, contracts that are said to be discharged as a result of acts of the parties are primarily classified as such to differentiate them from contracts that are simply discharged as an operation of law — which often takes place without regard for the parties’ actions or desires.
Some Effort Required
When contracts discharge due to acts of the parties, it means that at least one party initiated the efforts or actions that led to the discharge.
Here’s a list of some of the common reasons for the discharge of contracts due to acts of the parties:
Merger
Mutual agreement/rescission
Cooling-off period
Novation
Assignment
Accord and satisfaction
Revocation
Renunciation/Abandonment
And, as was the case with our operation-of-law list, I’ll now take you, one by one, through the reasons for discharge due to acts of the parties…
Acts of the Parties
Merger
Discharge of contract by merger is based on the idea that the original contract can be merged into a new agreement, and the original agreement disappears (is discharged) in the process.
For example, a purchase agreement merges into a deed after closing. If a duty was tied to the original purchase agreement but not reflected in the new deed, then the duty is not enforceable.
Mutual Agreement/Rescission
A contract can be discharged by mutual agreement of the parties, but it needs to be formalized.
Why? Because the release from the original agreement is considered to be a new contract itself. Therefore, it includes the need for consideration and all other essential elements of a valid contract.
Fortunately, the mutual release of the duties that existed in the original contract qualifies as consideration in the new contract.
Mutual agreement is also known as mutual rescission. This differs from the cancellation of a contract in that it returns the parties to their pre-contract position. Because of this, any monies that exchanged hands must be returned.
Cooling-Off Period
The term cooling-off period refers to a window of time within which a party has the right to rescind specific types of contracts for any reason and without liability.
According to the Federal Trade Commission (FTC), federal law provides for a cooling-off period of three days for a sale made:
At your home, workplace, or dormitory
At a seller’s temporary location, like a hotel or motel room, convention center, fairground, or restaurant
When you invite a salesperson to make a presentation in your home
The FTC also provides a substantial list of exceptions to and exemptions from this rule, including sales involving real estate!
Cooling Off in Arizona
In addition to the FTC laws, state statutes provide Arizonans experiencing buyer’s remorse additional protections/opportunities to cancel certain types of contracts — as long as they do this within a designated window of time.
Subdivision Land Purchaser
A purchaser of subdivision land has cooling-off/rescission rights within:
Seven days after entering into a purchase contract
Six months if the purchaser has not personally inspected the property
Three years if promised access has not been made available
Unsubdivided Land Purchaser
Cooling-off/rescission rights on the purchase of unsubdivided land are available within three years.
Timeshares
Per Arizona Revised Statute § 32-2197.03(A), a timeshare purchase contract can be canceled within seven calendar days.
Acts of the Parties: Merger, Mutual Agreement, & Cooling-Off Period
Time for the next three on our “discharge due to acts of the parties” list!
Novation
Novation is a mutual agreement of the parties to replace an existing contract with a new one. The existing contract is canceled or discharged, and the new one is entered into.
Novation is often used to substitute one party for another in a new contract. This is true even if the new contract contains all the same terms and conditions of the original agreement.
The important thing to remember with novation is that the substituting of parties happens jointly with the creation of a completely new contract.
Assignment
With the assignment of existing contracts, the original party to the contract transfers their rights and obligations to a new party. The original contract, however, remains intact. The assignor usually remains liable if the assignee fails to perform.
Assignment should occur only after proper notice to the other original party to the contract has occurred.
Assigning Liability Along with Those Rights
In some instances, the original party will have an assignment clause put into the agreement that releases them from any future obligations to the contract if assigned. If the original party fails to set up the contract this way, they could be held legally liable if the new party does not perform.
Some Contracts not Assignable
Sometimes contract assignment is allowed, but other times contracts will explicitly prohibit it. And certain types of contracts, like personal services agreements, can’t be easily assigned, if at all.
Technically Not Discharge
Assignment isn’t technically a form of contract discharge, but it is a way for a party to remove themselves from active participation in a contract.
The subleasing of an apartment is a common example of assignment in action.
Assignment ≠ Nominee
It’s worth mentioning here that an assignee and a nominee are two different things.
A nominee is a third party who has been designated by a party to act on their behalf in a transaction. Often, the intent is to conceal the identity of the true party to the transaction. The party represented by a nominee remains liable to the terms of the contract.
Accord and Satisfaction
Accord and satisfaction is an agreement in which the parties agree to discharge the original contract in favor of a new one. The “new” contract is basically the old contract with accepted performance being substantially less than what was initially promised.
Complete or substantial performance generally provides the performing party the right to see the contract discharged through the operation of law. That’s because the party is being treated as though their obligation of full performance had been met.
Partial performance, however, is the level of performance where material obligations or duties have not been met in a substantial way. And that’s where accord and satisfaction can be used to arrive at a mutually agreed-upon manner to discharge the contract.
Accord and Satisfaction in Real Estate
A common real estate example of accord and satisfaction would be where a seller accepts receipt of the earnest money in lieu of the sale of the property. (This is usually outlined in a forfeiture clause.) Another example would be a broker who accepts reimbursement of expenses in exchange for releasing a client from an agency agreement.
Recap
Here’s a chart that gives you a quick comparison of Novation, Assignment, & Accord and Satisfaction. You don’t have to thank me… I’m happy to do it for you.
A chart comparing and contrasting different types of contracts to novation, assignment, and accord, and satisfaction.
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Acts of the Parties: Novation, Assignment, & Accord and Satisfaction
You like tomato and I like tomahto… revocation and renunciation, I wouldn’t blame you for coming away thinking they’re just two words that mean the same thing. Although you wouldn’t be completely off-base, there are some subtle differences to be aware of.
Revocation
Revocation is the annulment or cancellation of a contract.
While either party has the power to revoke a contract, it does NOT necessarily mean the party has the right to do so. If the revoking party is unable to show cause, they could incur liability for their decision to revoke and may still be obligated to their duties according to that agreement.
Renunciation Renunciation (aka abandonment) is a similar unilateral action with similar consequences as that of revocation.
If that’s the case, why even bring this term into the conversation? Good question, Anthony?
The primary difference between the two terms only comes into play with agency agreements. It has to do with which party is taking action to terminate the relationship.
In an agency relationship contract:
A principal revokes the agent’s authority to act on their behalf.
An agent renounces their authority (and willingness) to act on the principal’s behalf.
In contracts involving two principals (no agents), both parties revoke, not renounce.
Again, in either case, having the power to take this unilateral action does not necessarily give the party the right or relieve them from the duties of the contract. Justifiable cause would have to be shown to avoid the potential of liability or obligation.
Acts of the Parties: Revocation & Renunciation
Moving on from the adventures of Thelma and Louise, let’s shift gears a bit (pun intended) and talk about clauses, conditions, and contingencies.
These contractual tools can allow for cancellation or termination of an agreement and are often used to bring about a discharge due to the acts of the parties. They are sometimes referred to as “subject to” clauses, underscoring their conditional nature.
The cancellation or termination can occur with or without penalty, depending on the specifics.
The forfeiture clause mentioned in our discussion on accord and satisfaction is an example where a termination penalty is incurred. An appraisal clause, on the other hand, is an example of a clause that would allow a buyer to exit from the purchase contract without penalty.
Elements of a Contract Contingency Clause
A properly constructed contingency contract clause will contain the following information:
How satisfied
Performance deadlines
Liable parties for associated costs
Clauses, Conditions, & Contingencies
A party to an agreement who, without cause, fails to perform according to the terms and conditions of a contract is said to be in breach of contract. In other words, their behavior is considered to be an illegal exercise of discharge due to acts of the parties.
Breach of contract terminates the defaulting party’s rights while maintaining their obligations.
When this occurs, the wronged party has a number of remedies available to them.
Contract Remedies
To avoid the expense of a lawsuit, parties to a contract will often agree to efforts in mediation or arbitration.
Here’s a snappy little diagram that compares these two contractual remedy options!
A Venn diagram showing similarities and differences between mediation and arbitration.
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Legal Remedies
If efforts to resolve the breach is not resolved via mediation or arbitration, legal remedies will often be sought.
Here’s a quick look at the four primary legal remedies for breach of contract.
An infographic recapping the four primary legal remedies, specific performance, rescission, forfeiture, and suit for damages.
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Let’s go into each one in more detail, shall we?
- Specific Performance
It’s a fact of life that sometimes people regret their choices and change their minds. Pull up your social media pics from a few years back, and you’ll see what I mean.
But once a party has entered a legally binding contract, it’s not that easy to get out. In fact, it is possible that the courts could rule for specific performance, which serves to compel the defaulting party to fulfill the contract as originally agreed.
If you weren’t enthusiastic about pursuing the matter through a lawsuit, you could accept partial performance from the defaulting party through the application of accord and satisfaction.
- Rescission
Rescission has just the opposite effect of specific performance. Rather than force completion of the contract, it attempts to put the parties back in a position as though the contract never existed. It is an annulment of the contract.
Rescission usually takes place in the early stages of an agreement and often requires the return of any monies that have already changed hands.
- Forfeiture
Some contracts contain a forfeiture clause identifying liquidated damages that will serve as compensation to the injured party. Forfeiture provides a way to terminate the contract relationship but with compensatory recognition that one party was injured as a result of the breach of contract.
Forfeiture in Real Estate
In real estate purchase contracts, forfeiture is typically confined to the earnest money that was put down by the buyer when they originally entered into the contract.
- Suit for Damages
The party injured by the breach of contract can initiate a suit for damages. The suit must adhere to the statute of limitations. The courts are typically concerned with restoring the wronged party to the place that they were financially prior to the contract.
The type of damages sought will be influenced by the particulars of the breach and what the contract has to say, if anything, about the award of damages in the event of a breach of contract.
Liquidated Damages
As mentioned in the discussion about forfeiture, sometimes a contract stipulates what damages are to be paid in the event of a breach of contract. These are known as liquidated damages.
Typically, liquidated damages will comprise the forfeiture of earnest money or other funds held for breach. The parties will rely on the forfeiture clause in the contract to recover liquidated damages in lieu of a lawsuit in situations where actual damages are hard to prove or quantify.
Compensatory Damages
Compensatory damages, aka actual damages, refer to the award given to a wronged party as compensation for actual injury or loss. It is further broken down into two categories: special damages and general damages. The former covers such things as economic loss and damage to property. The latter addresses such things as pain, suffering, and emotional distress.
General damages are much more difficult to define and measure than are special damages. Therefore, the courts will look at the specifics of the case and use legal precedent in their rulings if considering general damages.
Punitive Damages
Punitive damages are rarely sought or awarded in breach of contract suits, except in cases of fraudulent misrepresentation. Also referred to as exemplary damages, punitive damages are awarded in unusual cases where the defendant’s behavior is viewed as intentional and particularly harmful.
The purpose of punitive damages is both to punish the offender and to deter others from this behavior in the future.
Breach of Contract
Wow, Anthony. You’ve finished the last chapter of the level. Good on you, friend!
Before you go, let’s review some of the important terms, concepts, and principles you’ve learned along the way.
Key Terms
Here are the key terms you learned in this chapter:
assignment
the transference of rights and obligations in a contract from one party to another
liquidated damages
damages established by the contract to be paid as compensation in the event of default
specific performance
a legal remedy that requires the party in breach of contract to perform in accordance with the terms of the contract (as opposed to paying damages)
Key Concepts & Principles
Here are the concepts and principles you’ll want to master from this chapter:
Discharge of Contracts
The discharge of contracts refers to the termination of a contract. Most contracts are discharged as a result of either the operation of law or the acts of the parties.
Operation of Law
When contracts are said to be discharged by operation of law, it means that they are discharged as a result of the application of the law without regard to the desires of the parties. This would include such things as:
Full performance
Expiration
Statute of limitations
Lack of legal element
Destruction of property
Death or incapacity
Bankruptcy
Alteration of the contract
Acts of the Parties
Contracts that are said to be discharged as a result of acts of the parties are primarily classified as such to differentiate them from contracts that are simply discharged as an operation of law. They require a specific effort from one or both parties. Examples include:
Merger
Mutual agreement/rescission
Cooling-off period
Novation
Assignment
Accord and satisfaction
Revocation
Renunciation/Abandonment
A chart showing how contracts can be discharged under the different categories of Operation of Law or Acts of the Parties.
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Breach of Contract
A party to an agreement who, without cause, fails to perform according to the terms and conditions of a contract is said to be in breach of contract.
The wronged party has a number of contractual or legal remedies to consider when faced with a breach of contract.
Here’s what you’ll want to remember about the contractual remedies of arbitration and mediation:
A venn diagram showing two intersecting circles with the similarities and differences between mediation and arbitration.
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And here’s a summary of the four primary legal remedies:
An infographic recapping the four primary legal remedies, specific performance, rescission, forfeiture, and suit for damages.
Chapter Summary
