– CONTRACTS
7
CONTRACTS
The law of contracts defines those duties that individuals or organizations voluntarily assume, generally through promises. Contractual duties may arise in either of two general situations: under the doctrine of traditional contract or under the doctrine of detrimental reliance, also known as promissory estoppel.1
Contract law is generally said to be based on the policy of individualism. A person is bound if, and only if, that person consents to the duty. The idea that one should be bound only through consent grew out of a naturalist conception of legal obligation. As will be seen, however, in the course of constructing the specific rules of contract law, the courts have embraced a more positivist conception of law and have given preference to policies other than individualism, including majoritarianism, paternalism, efficiency, and those policies associated with formalism.
I. TRADITIONAL CONTRACT
One situation that gives rise to contractual duties exists where two or more persons form a traditional contract. The rule defining traditional contract provides that a contract is formed where two elements are present: an offer is accepted, and the contract is supported by consideration.
A. Offer and Acceptance
The first element is an offer by one party that is accepted by the other party. The offer or the acceptance may occur by the express words of the parties or by their conduct. An example of an acceptance by conduct occurs where the first party sends a letter to the second party offering to purchase one lot of widgets for three hundred dollars and the second party ships the widgets.
1. THE OBJECTIVE TEST
One of the rules defining the element of an offer and acceptance states the test to be used to interpret the meaning of the parties’ words or conduct. This rule, usually called the objective test, provides that words or conduct shall be interpreted in the way that a hypothetical “reasonable person” would interpret them.
For example, a man who is negotiating to buy a car from his neighbor, upon hearing the neighbor’s proposed terms, may exclaim, “Sounds good!”—which could be interpreted either as an expression of acceptance or merely as comment that the offer appears favorable. A jury applying an objective test would decide whether a reasonable person would interpret “Sounds good!” as an acceptance of the offer or as the expression of an opinion about the offer.
One of the policy considerations supporting the objective test is that it leads to predictability and uniformity in the law. It does so by allowing both parties to assume that words and conduct have a reasonable meaning. It also does so by encouraging parties to deal with each other in the normally expected manner, because parties who choose an unusual way of expressing themselves do so at their own peril. Another policy consideration underlying the objective test is that it promotes efficiency in adjudication because it allows the jury to avoid determining what the parties really meant. It may also diminish the frequency of frivolous litigation because it discourages parties from filing suit in the hope that they can persuade a jury that they attributed their own special meaning to the terms of the contract. Finally, because the objective test permits the court to supply its own definition of a term under the banner of the reasonable person, the objective test is also supported by the policy of majoritarianism.
In using an objective test, a jury may give the speaker’s words a meaning that the person never intended them to have. In this sense, an objective test imposes on parties those obligations that they will be deemed to have assumed based on a reasonable interpretation of their words or conduct, whether they actually intended to assume them or not. By finding an offer or acceptance where it does not truly exist, the objective test, like formalism generally, is subject to the charge that it produces artificial results, that it treats as a contract something that is not a contract at all. The objective test thus is inconsistent with the policy of individualism, under which courts are expected to enforce the will of the parties.
The use of the objective test illustrates the phenomenon in which a general rule is defined by a more specific rule that is based on a policy inconsistent with the policy underlying the general rule. The general rule is based on a policy of individualism, whereas the more specific rule is based on majoritarianism, efficiency, and policies associated with formalism. Despite the theoretical inconsistency, however, the objective test for interpreting expressions of individual will is well established in contract law.
2. THE SUBJECTIVE TEST
The alternative to an objective test is a subjective test, which interprets a party’s words or conduct to mean what that party actually intended them to mean, no matter how idiosyncratic.
A subjective test in theory ensures that no party is required to assume a contractual obligation that that party did not actually intend to assume. The test thus is based on a policy of individualism rather than majoritarianism. It leads, however, to uncertainty and to some degree of inefficiency. The hearer cannot assume that the words mean what might be reasonably thought; thus, the hearer must attempt to probe the speaker’s true intent.
Another objection to the subjective test is that the true intent of a party can never be known with confidence. The speaker may not have consciously considered the disputed issue at the time, and even if the speaker did, time and the pressure of a dispute may have changed that recollection. The greater uncertainty inherent in a subjective test might encourage frivolous litigation because a party would always have the hope of persuading a jury that the words spoken had a special meaning.
If the naturalist and individualist conception of contract were to prevail, the court would embrace a subjective test. In fact, however, subjective tests are rare in contract law. Predictability and efficiency are of such great importance in contract law that the courts almost uniformly use an objective test to interpret the meaning of a contract.
B. Consideration
The second element of a contract is that both parties must have given consideration. A more specific rule defines the element of consideration as a benefit conferred or a detriment incurred by a party in exchange for a benefit from or a detriment to the other party. An even more specific rule defines the phrase “in exchange” to mean that consideration must be bargained for as part of the contract.
The requirement of consideration renders some agreements unenforceable under traditional contract doctrine. For example, if an aunt offers to give her nephew $1,000 and the nephew accepts, no enforceable contract has been formed even though there has been an offer and acceptance. No contract exists because the nephew did not confer a benefit or incur a detriment in exchange for the promise.
At one time, the requirement of consideration seems to have had an evidentiary function: it was more plausible that the parties had actually entered into a contract if both were seen to be exchanging something of value. Thus, contracts under seal did not require consideration because the signed and sealed document provided sufficient evidence of an agreement.
In more recent times, the requirement of consideration appears to rest on a policy of limiting contractual liability. Courts apparently did not wish to enforce what, in effect, were promises of gifts—promises for which the promisor received nothing in return. The doctrine seems to have achieved its modern form in the late nineteenth century and reflects the individualist policy of the courts of that era, which sought to limit government intervention in the private sphere.2
The doctrine is internally inconsistent, however, because although justified by a policy of individualism, it does not enforce individual will.3 An individual may wish to be bound to give a gift yet cannot effect that result under contract law. The court, in the name of limiting government involvement in private affairs in order to maximize private choice, refuses to enforce what is in fact the private choice of the parties. In its consequences, then, the doctrine is consistent with a majoritarian policy.
Although the consideration doctrine seems majoritarian in its consequence, the existence of the doctrine does not fully resolve the conflict between the community and the individual. The conflict reemerges as the issue of how to define a benefit or detriment.
An individualist policy would support a rule that the court will not inquire into the value of a purported benefit or detriment but will accept the parties’ characterization of it, even if the supposed benefit or detriment appeared to be completely worthless. To adopt an individualist definition of consideration would subvert the majoritarian policy underlying the doctrine. By divorcing the doctrine from its underlying majoritarian policy, such a definition would convert the doctrine to a merely formal requirement.
A majoritarian policy would support a rule that the court will inquire into whether the purported benefit or detriment is in fact that. To adopt a majoritarian definition of the doctrine would only further deepen the community’s involvement in scrutinizing a contract that was supposed to represent the will of the parties. That is, the law not only would require that there be consideration on both sides of the contract (even though the parties wished to make a contract unsupported by consideration on both sides) but would also reserve for the community the prerogative to decide what constitutes sufficient consideration.
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