1.1 What is a contract?
We can say that a contract is an agreement between two or more parties which gives rise to rights and obligations which will be enforced according to the system of law applying to the contract.1
A simple example is where A and B agree that A shall build a house for B for a fixed price according to plans prepared by B’s architect. Under this contract, A will have both an obligation to build the house according to the plans and a right to payment of the price when the work is done. B will correspondingly have both the obligation to pay A and the right to have the house built according to the plans.
Depending on which system of law applies to their contract, if A does not fulfill his obligation to build the house according to the plans then B might be able to obtain compensation for this ‘breach’ or breaking of the contract. The system of law applying to the contract might say, for example, that B is entitled to obtain a sum of money sufficient to put him in the position in which he would have been had the contract been properly performed, that is, had A in fact built the house in accordance with the plans; this sum of money could be the cost to B of rectifying A’s deficient work.
The way in which B would actually go about obtaining the compensation to which he would be entitled according to the system of law applying to the contract depends upon a number of circumstances, and could be quite complicated. In a simple case where A and B both reside in the same country and have their assets there, B will typically go to the local court to obtain an order against A for the relevant compensation. If A does not pay, then B may be able to ‘execute’ his order by obtaining other orders against A to force him to pay; for example, an order for the sale of A’s assets. In a more complicated case, where A and B live in different countries, or A’s assets are in a different country, the procedures for executing his order for compensation against A could be more complicated for B.2
Let us look more closely now at what is meant by an agreement between two or more parties giving rise to a contract between them.
When we say that a contract is an agreement, that does not mean that the parties need to have reached agreement on all the details that concern their project. Many systems of law will give effect to contracts in which only certain matters, regarded as essential to the contract, are agreed.3
Nor does ‘agreement’ necessarily mean actual agreement or a meeting of minds, in a psychological or subjective sense. Many systems of law will find that the parties have made a contract containing certain terms, even though one or other party might not actually have assented to those terms. As long as the parties have acted towards each other in such a way as to lead a reasonable third person observing them to conclude that they had agreed certain terms, then they will be held to have done so and be bound accordingly.4
Many systems of law also distinguish between the agreement or contract itself and the sometimes lengthy negotiations leading up to the agreement. Once the contract is formed, the terms of the contract are what bind the parties and create the obligations and rights which may be enforced. The discussions or negotiations taking place beforehand will not be taken to form part of the contract. In some legal systems they may not even be used in order to interpret the terms of the contract, although some systems may permit the factual background to the parties’ transaction to be used to interpret the words of the contract where they are ambiguous or uncertain.
This distinction between the agreement itself and the negotiations leading up to it highlights the importance for each party to the contract to identify clearly what are the terms agreed between them which will bind each of them, and to make sure that various other matters, which might have been discussed but had been abandoned or modified in the course of the negotiations, are clearly distinguished from the terms of the contract itself.
1.3 Do contracts need to be in writing?
It is sometimes thought that you cannot have a contract if there is nothing in writing; that there has to be a document, signed by both parties, with perhaps other formalities as well.
But this is not always the case. Whether a contract needs to be in writing depends on the system of law that applies to the parties’ transaction. Sometimes, a legal system will require a written document; for example, in contracts concerning the sale of land many legal systems require a written contract. In other cases, the contract could be contained entirely in oral or word-of-mouth exchanges, without the need for any writing. These contracts could be just as binding as written ones.
It is true that in a construction project of any size you will normally have a written contract; this will not only be written, but will typically be a very detailed contract setting out the parties’ rights and liabilities. However, the possibility of oral or non-written contracts should still be borne in mind. In some systems of law, such contracts might even be found to exist alongside written contracts in certain cases. Parties who wish to avoid uncertainty and ensure that there are only written terms of their contract will need to obtain legal assistance in drafting their agreements. It is also important to note that in some legal systems you might have a contract which arises from a mixture of oral agreements and agreements recorded in informal exchanges between the parties, such as faxes, letters, e-mails or minutes of meetings.
1.4 Other elements of a contract
We have seen that a contract involves an agreement between two or more parties, but what more is needed before the parties are bound by a contract? This question arises because, in many systems of law, it is not enough for the parties to reach agreement in order for a contract to exist between them; other conditions need to be met.
In English law, for example, which applies to many projects with no particular connection with England, the contract is seen fundamentally as a kind of bargain, where one party confers, or promises to confer, some benefit on the other party in return for some benefit or promise of benefit to himself. This conferring, or promising to confer, a benefit in return for another benefit or promise is called consideration; it is what you get in return for your promise to the other party and, except in certain limited cases, it is necessary before a binding contract comes into existence in English law. Thus, in our earlier example of the simple contract where A agrees to build a house for B according to B’s plans for a fixed price, B’s promise of payment of the price is consideration for A’s promise to build the house according to the plans, and makes the agreement a binding contract.
If the system of law applying to the contract requires consideration, this will seldom be in issue where you have a construction contract; in such cases, it is normally obvious what the consideration is.
Other requirements for a contract could include certain formalities; in contracts involving certain subject matters the system of law applying to the transaction might require the contract to be set out in a formal document, with the seal or stamp of the parties to the contract. Specialist legal advice will be needed in order to ensure that the parties’ agreement complies with any formalities necessary before it becomes a binding contract.
1.5 Capacity and authority
Let us imagine that you have been negotiating with representatives of a party to a project for the design and construction of a chemical plant in the Gulf; you are the French design-build contractor, and the other party is a Korean joint-venture owner. You and the owner’s representatives have recorded in detail the terms of the intended contract between you in a formal document. After much discussion, the details of every aspect of your agreement have been reduced to writing, and everything appears ready now for the signing, or ‘execution’, of the contract. The other side’s senior representative and you then both duly sign the contract in each other’s presence.
Now you think that you have a binding contract. However, you might not have a binding contract if the person who signed the contract for the other party was not authorised to do so.
One very important, but sometimes overlooked, feature of contracts in general concerns the authority of the person signing or executing the contract on behalf of the named party. Does that person truly have power or authority to bind the named party by signing the contract, apparently on its behalf?
This question arises most commonly in connection with companies or corporations rather than with individual people. Most legal systems contain rules for the formation, constitution and regulation of companies or corporations; they are treated as legal persons, just like real people, having legal rights and obligations themselves and being able in particular to enter into contracts in their own names. So ‘A Ltd.’, or ‘A Corporation’, or ‘A Incorporated’ might be names of a distinct legal person, the company or corporation named.
Construction projects of any size will almost invariably involve contracts between companies rather than real people. But because companies are only abstract legal persons, they cannot act except by real people with authority, or power, to act for them; these authorised people are the agents of the company. So in dealings with third parties, including entering into contracts with them, companies will act by or through their agents.
A company’s agents will include a whole range of people, with different levels of authority. Some people may have authority, given by the company, to enter into contracts on the company’s behalf but only up to a certain financial limit; others may be able to enter into contracts of any size, but only in certain geographical areas, or where the contract concerns a particular subject matter. Whether, and if so what, contracts a person is authorised to enter into on behalf of a company will depend on the constitution and internal organisation of the company and, more generally, upon the system of law that applies to that company.
If a person is authorised to enter into contracts of a certain size or type, then he may be said to have actual authority to bind the company by executing contracts of that size or type. However, many legal systems also have a concept of apparent or ostensible authority, whereby a company could still be bound by the acts of a person who does not have actual authority. If a company, by its words or conduct, represents or holds out to the other party that a particular individual has authority to contract with it then it may be open to the other party to argue that the company is bound by the individual who signs the contract, even if that individual lacked actual authority to do so.5