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Business Theory and Practice

© Oxford University Press, 2007. All rights reserved.

Business TheoryDominant theories underlying contract law:

(1) Market and bargaining theory • predominant in 19th century/early 20th century• promotes freedom of contract (partner freedom and

term freedom) and• sanctity of contract (parties should be held to their

bargains)• these principles of freedom and sanctity of contract

reinforced the purpose of contract law to provide certainty.

Business Theory cont…(2) Consumer Protection After WW2 consumer protectionism became more

commonWhy ? The decline of laissez faire , increasing monopolies ,

corporatisation and standard form contracts.• Characteristics of this theory : flexibility, equity,

avoidance of unjust enrichment and justice• examples include the doctrines of equitable estoppel

and unconscionability• Policy rationale : Intervention to promote consumer

interests and principles of fairness and reasonableness in contract.

• more discretionary remedies and less predictable in outcome.

Business Practice Basic issue : How relevant is contract law to daily commercial practice?

• The nature of empirical studies

There are a number of different approaches to the theories of contract law e.g. economic analysis, feminist approach , relational approach.

We focus on the theories of Professors Stewart Macauley, Hugh Beale and Tony Dugdale.

Studies show : how contract law operates in society and how it is viewed by participants in the legal system.

• Predominant view:

– The Relational approach - Professor Macaulay

Macauley study :

• study of inter-firm contacting in Wisconsin, published in 1963: 48 companies and 6 law firms

• contract involves two elements: 1) Rational planning of the transaction2) Sanctions ensure performance or compensate for no performance of contract.

Business Practice cont ...Macaulay - re planning:

• Provides the framework within which parties conduct their business relationships.

• business people may plan for primary obligations (such as actual performance) and time and manner of payment, but rarely for what will happen if things go wrong

• long-term business relationships involve friendship, reputation, interdependence, morality and altruistic desires

• relational contracts are dynamic and change over time.

Business Practice cont ...Macaulay - re sanctions:

The law creates the background for the way parties settle their contractual disputes.

e.g a “strong case” means a parties negotiating position and their outcome are strengthened.

Also the threat of lititgation ( going to Court)

• extra-legal sanctions and pressures (‘relational’ sanctions) – in particular the need to maintain the firm’s reputation- more important than threat of legal action in inducing performance

• litigation a last resort; implied breakdown of the business relationship.

Business Practice cont ...Beale and Dugdale’s parallel study (Bristol, 1975) of 19

firms of engineering manufacturers:

• Confirmed the basic situation outlined by Macaulay but also mentioned the role of trade customs and unwritten norms , trust and personal contact.

• Theory agrees with Macaulay’s basic picture but also updated it in a number of respects. Their research highlighted role of trade customs, trust and personal contact.

Business Practice cont ...Beale and Dugdale found:

(i) relatively minimal amount of contractual planning: planning expensive and risk of loss may be small

(ii) contract remedies are also rarely used, due to expense, delays and uncertainty of legal proceedings

(iii) apart from primary obligations, parties relied on trade custom or a ‘gentleman’s agreement’ with other party to deal with adjustment or enforcement of obligations.

Business Practice cont ...Deakin et al study (1993-1994) of mining equipment

and kitchen furniture manufacturers in Britain, Germany and Italy (62 firms interviewed)

• highlights the impact on contractual relations of the overall contractual environment

• found significant variations between countries as well as between sectors.

Business Practice cont ...Deakin et al:• contractual practices in Britain kitchen furniture

sector confirm the earlier empirical studies: attitude of give-and-take, reliance on business reputation and personal dealings

• position in mining equipment different: more emphasis on formal relations. Confirms Beale and Dugdale, since such contracts have high level of complexity and thus more risk involved.

• The outcome of the study suggests that a formal legal contract is compatible with trust between the parties and does not harm fostering a good relationship between the parties

Business Practice cont ...If contract law stands at the margins of important long

term continuing business relationships, as the empirical studies suggest:

• why study contract law?

– Underpins economy and financial system and impacts distribution of wealth of society (relevant to business)

– Establishes the framework or background that parties conduct their business

• what is the role of contract law?

See Notes below

Definition of a Legal Contract

A legal contract is an agreement between two or more parties in which legal rights and obligations are created, and are enforced by a court.Or put another way :An agreement between two or more parties that is enforceable in a court of law.

Elements of a Valid Legal Contract• For a contract to be legally enforceable the contract

must contain the following elements:

(1) AN OFFER(2) ACCEPTANCE OF THE OFFER(3) CONSIDERATION(4) INTENTION TO CREATE LEGAL RELATIONS(5) CERTAINTY OF TERMS(6) CAPACITY TO CONTRACT

• All of these elements must be present before there is a valid and legally enforceable contract.

The Elements of a Valid Contract cont…

THE CONTRACT

OFFER CONSIDERATION

ACCEPTANCE INTENTIONCERTAINTY

CAPACITY

Elements of a Contract: 1) Offer What is an offer?

– Does not have to be in writing– Promissory: Promise to do something or to refrain from

doing a certain act– Intention: To be legally binding– Communication: To the Promisee– Certainty: Terms must be clear & certain – Finality: Must be a degree of finality with the terms

Elements of a Contract: 1) Offer cont…

Objective Test: For the Court to determine whether a statement made by one party is an offer or not the Court uses an “objective test” to see whether a statement is an offer or not.

• Reasonable person test : The court asks the question- Whether a reasonable person standing in the position of the recipient would believe the statement was a promise in the form of an offer?

• Standard applied by courts• Contract Law v Criminal Law• Contract law applies an objective test to determine

liability• Criminal law applies subjective test to determine guilt

Elements of a Contract: 1) Offer cont…

Offers v. Invitations to Treat• Shop Displays – generally an invitation to treat.• Advertisements- generally invitation to treat• Catalogues• Sales Puffery• Vending Machines• Delicatessens

Elements of a Contract: 1) Offer cont…

An offer must be made to another person• Offeror: party that makes the offer• Offeree: party that receives the offer

Offer made to the whole world

Carlill v Carbolic Smoke Ball Company ( page 49)See notes below

Elements of a Contract: 1) Offer cont…

An Offer must be communicatedThe general rule is that the party who recieves the offer

(the offeree) must communicate the acceptance back to the offeror)

• Offeror to Offeree • Mode of Communication• Verbal/ Writing/Post• Contemplation of the PartiesSee notes below

Elements of a Contract: 1) Offer cont…

Termination of an offerAn offer can be terminated through the following ways:

(1) Revocation (2) Lapse (3) Rejection By Offeree (4) Implied rejection : counter offer

Eg - A offers to sell his car to B for $1000. B says to A, “I will give you $750". B statement amounts to a counter offer which terminates the original offer by A

Do you have a valid offer?

Offer

Do you have validoffer?

Yes

No

PreliminaryInquiries

Supply ofInformation

Invitation To Treat

Elements of a Contract: 2) Acceptance• An acceptance is a final and unqualified assent to all

the terms of the offer.• General rule : The party who receives the offer (the

offeree) must communicate the acceptance back to the offeror)Rules of acceptance :(1) Offer still in force(2) Offer to made by the offeree(3) Unqualified an absolute (4) Acceptance can be in writing, oral or by conduct(5) Silence does not constitute an acceptance(5) Communication

Elements of a Contract: 2) Acceptance cont…

• Communication of acceptance

• Completed acceptance

• Reasonable time

Elements of a Contract: 2) Acceptance cont…

• Postal acceptance ruleThe postal acceptance rule : A special rule has been made by

the Courts that where post Is the preferred method of acceptance then acceptance occurs at the time the letter is posted and not when the letter is delivered. ( acceptance is deemed to have occurred at the time the letter is posted.)

Limitations to the rule • letters and telegrams• instantaneous methods of communication• addressed and stamped• actual communication contemplated

Do you have a Valid Acceptance?

Acceptance

Must Match theTerms of the Offer

Communication

Exceptions

Postal AcceptanceUnilateralContracts

Elements of a Contract: 3) Consideration

• Applies to all contracts other than contracts made under seal/ deed. Contracts made under deed form do not require consideration.

– Every contract whether written or oral requires some form of consideration before the contract can be legally enforceable.

Example : money Other examples :

o A promise to do somethingo A promise not to do somethingo An act or performance of an obligation

o Definition Consideration is an essential element in every simple contract. The doctrine of consideration requires that:

(1) there must be an exchange between the parties, involving either a promise for promise, or promise for performance; and

(2) the promise or performance given in exchange must have value.

Elements of a Contract: 3) Consideration cont…• Rules of Consideration• Consideration does not have to be adequate

– The law is not concerned about whether the consideration is adequate or equally beneficial just that something of value is exchanged between the parties

• Consideration must be sufficient

• Consideration must not be illegal i.e. cant be an unlawful act• Consideration must move from the promisee

For consideration to be valid and enforce a promise, it must move from the party who receives the promise.

• Past consideration is not good considerationOnly new consideration is valid so an existing contractual obligation is past consideration

Rules of ConsiderationConsideration

Involves a mutualexchange

Must not be pastCannot be illegalMust not be

ilusory

Elements of a Contract: 3) Consideration cont…

Renegotiating Debts

• Performing existing contractual obligations does not amount to good consideration to enforce a promise : Foakes v Beer

Example (1) : A owes B $100. A decides to pay B $90 in full satisfaction of the debt. B then sues A for the balance ($10). B will succeed because there is no consideration for his promise to accept $90 for full payment : Foakes v Beer

Example (2) : A owes B $100. A decides to pay B $90 earlier for full payment. B will not succeed for the further $10 because A has done something extra, he has paid earlier : Pinnels case.

Elements of a Contract: 3) Consideration cont…

• Promissory EstoppelThe strict application of the doctrine of consideration is modified with the doctrine of promissory estoppel. The doctrine of estoppel operates to enforce certain promises which have not been supported by valuable consideration.

Elements of the doctrine of estoppel:– There must be a promise by the promisor to the promisee– The promisee must have relied on the promise– The promisee will suffer detriment if the promisor is allowed to go back

on his promise– It would be unconscionable (unfair) to allow the promisor to break his

promise

Elements of Promissory Estoppel

PromissoryEstoppel

Promise/Representation/

AssumptionReliance Material Detriment Unconscionability

Promissory Estoppel cont…

Walton Stores v Maher

• Walton’s case was seen as important in the development of the doctrine, because it extended the operation of the doctrine to create a new right of action.

• Promissory estoppel only operates when all the above elements have been satisfied. Promissory estoppel has its origins in the High Trees Case. The doctrine has been extended in the High Courts decision in Walton Stores.

• The principle of promissory estoppel only applies when it would be inequitable/unconscionable (unfair) to allow the promisor to go back on his promise.

Promissory Estoppel cont…

Example: • A enters into a lease agreement with B. The lease

provides that A pays B $500 weekly rent. A then falls into financial difficulty and asks B if he could reduce the rent for 12 months to $300. B agrees. A relies on B’s promise to accept $300 rent, and pays him that amount. 12 months later B sues A for the difference in rent ($200 week).

• Advise A.

Elements of a Contract: 4) Intention to Create Legal Relations• Commercial agreements

For a contract to be legally enforceable there must be an intention by the parties to be legally bound. In Commercial and Business Agreements there is a presumption that the parties intend to create legal relations: Edwards v Skyways.

Exclusions:1) ExpressThis presumption can be rebutted but the onus is on the party seeking to exclude legal relations. An express exclusion of intention by the parties will be given effect by the courts.

2) Social & Domestic Agreements.There is a presumption that social and domestic agreements are not intended to create legal relations. However this can be rebutted by evidence to the contrary.

Elements of a Contract: 4) Intention to Create Legal Relations cont…

• Husband & Wife AgreementsThe courts consider domestic arrangements between husband and wife to be social agreements and not legally enforceable: Balfour v Balfour.

Exceptions: If the agreement between husband and wife involves essentially a commercial matter then the agreement will be enforceable : Milliner v Milliner.

Do you have an intention to create legal relations?

Do the parties havean intention to create

legal relations?Yes

Check to see whetherthe intention has been

expressly excluded

If intention has notbeen excluded check

for other elements

No

Check if thecommercial

presumption applies

Check if the social/domestic

presumption applies

If the commercialpresumption applies

check for otherelements

Elements of a Contract: 5) Certainty of Terms• As a general rule the courts will not enforce vague or

incomplete agreements. • However the courts will strive to fund a valid contract. If

terms are uncertain, the courts may clear the uncertainty by the ff means:- Trade customs & Usage- Previous dealings between the parties to determine the

essential terms of the agreement.

Elements of a Contract: 6) Capacity to Contract

• The capacity of certain persons to enter into legal contracts may be affected.

• Especially minors, drunkards and bankrupts.

6) Capacity to Contract – Minors

Minors• Minors are any persons below the age of 18. • Contracts with minors fall within three categories:

- Valid- Voidable; and- Void

• Valid Contracts - 2 types: Contracts for Necessaries and Contracts for Beneficial Service.

6) Capacity to Contract – Minors cont…Contract for Necessaries• Necessaries are defined as goods suitable to the condition in life of such a

minor and to his actual requirements at the time of such sale and delivery.

Two important questions arise:(1) Can the goods/services be classed as necessaries for a person in the circumstances of the minor in question?(2) Were the goods/services in fact necessary to the minor at the time?

• If the answer is yes to both these questions then there will be a valid contract and the minor will have to pay.

• Examples of goods/services which are necessaries include: food, housing, education, medical and legal expenses.

6) Capacity to Contract – Minors cont…

Contracts for beneficial services• The key question here is to ask:

Does the contract of service provide a benefit to the minor?: Hamilton v Lethbridge.

• If the answer is yes, then the contract for beneficial services will be a contract for necessaries and the minor will have sufficient capacity to form a valid contract.

6) Capacity to Contract – Minors cont…

Voidable Contracts• These are contracts which can be avoided by the minor

before he/she turns 18 or within a reasonable time after he/she turns 18.

• They apply to contracts which are of a permanent nature/continuing obligation. Eg: shares, leases and partnerships.

• With voidable contracts the minor can free himself from future obligations, but will have to pay for benefits already received.

6) Capacity to Contract – Minors cont…

Void Contracts• Contracts other than for necessaries or beneficial contract of

service are void against the minor. • Contracts involving loan repayments are also void against the

minor.