Contract law

1 What is a contract?

Definition:

A contract is an agreement, supported by consideration, made with intention to create legal relations.

The essential elements within this definition are:

• Agreement — an offer by one party that is accepted by the other (§2 and §3).

• Consideration — something of value given or promised by each side in return for what the other gives or promises (§4).

• Intention to create legal relations — not merely a social or domestic arrangement (§5).

• Capacity — the parties must be legally able to contract. In the UK this generally means being over 18 (unless the contract is for necessaries) and of sound mind, which includes not being incapacitated by alcohol or drugs.

For an ordinary (simple) contract, if any one of the first three is missing there is no contract at all — the exception to the need for consideration is a promise made by deed (§4.7). If capacity is missing the contract is usually voidable by the party who lacked it.

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1.1 Contracts that the law requires to be in a particular form

Most contracts need no particular form at all. A contract to buy a coffee, to hire a consultant or to sell a machine for £500,000 is just as good spoken as written — writing is evidence of the agreement, not a condition of it. But there are exceptions, and the syllabus asks you to recognise them.

Everything else in this chapter assumes a contract of no particular form.

2 Offers

2.1 What is an offer?

An offer is a definite statement of the terms on which the offeror is prepared to be bound if the offeree accepts them. Once accepted, the offeror is bound.

An offer may be:

• Express — stated in words, spoken or written. “I will sell you this car for $6,000.”

• Implied by conduct — bidding at an auction, or putting an item on the check-out belt and letting it be scanned and charged to your account.

and it may be:

• Made to a specific person or persons — and then only they can accept it.

• Made to the world at large — such as a public offer of a reward for finding a lost item. Anyone who meets the terms accepts it.

Case: Carlill v Carbolic Smoke Ball Co (1893)

The company advertised a flu remedy, the Carbolic Smoke Ball, and said that they would give compensation if any customer caught flu despite using it.

Miss Carlill bought the product, caught flu and claimed her compensation. The manufacturers claimed that there was no contract because the offer had been made to the world.

Held: there was an offer that Miss Carlill had accepted by using the ball. The compensation was payable.

2.2 Invitations to treat

An offer must be distinguished from an invitation to treat. This is where one party makes it known that they are ready to receive an offer. For example, products on supermarket shelves with prices attached do not constitute offers: these are invitations to you to offer to buy the articles by placing them in your basket and proceeding to the checkout. Similarly, sales adverts in catalogues, newspapers and on the Internet are not offers: they are invitations to treat.

Case: Partridge v Crittenden (1968)

Partridge advertised the sale of wild birds. He was charged with offering birds for sale contrary to a law protecting certain species.

Held: It was held that he was not offering birds for sale but had made an invitation to treat: buyers would offer to buy them. He was not guilty of the alleged offence.

2.3 Termination of offers

An offer does not last for ever. It comes to an end — and can then no longer be accepted — in six ways:

Case: Hyde v Wrench (1840)

Hyde offered to sell his farm for £1,000. Wrench made a counter offer for £950, which Hyde refused. Wrench then said that he would accept the £1,000 offer after all, but Hyde then refused to sell.

Held: Hyde was entitled to refuse to sell because his offer had been terminated by the counter-offer.

Case: Byrne v Van Tienhoven & Co (1880)

On 1 October Van Tienhoven & Co posted a letter to Byrne & Co offering to sell a product. Byrne and Co got the letter on 11 October and telegraphed acceptance immediately. However, on 8 October Van Tienhoven & Co had sent another letter withdrawing their offer, and so they refused to go through with the sale.

Held: It was held that the withdrawal of an offer is not effective until it had been successfully communicated to the offeree. Acceptance by the offeree before they receive notice of the revocation will be considered a valid acceptance.

Note that it can be difficult to revoke an offer if it had been made to the whole world. Such contracts are called unilateral contracts. The difficulty is in ensuring that everyone who saw the offer also sees the revocation and also that they have not begun to carry out what was required – which would imply acceptance of the offer. For example, someone offers a reward for finding a lost pet, but a week later decides to withdraw that offer. In the meantime, someone has begun looking for the pet and finds it (after the attempted withdrawal) then claims the reward. The offer of the reward cannot be revoked with respect to the person who finds the pet.

3 Acceptance

3.1 What is acceptance?

Acceptance must be unqualified and unconditional, otherwise it will constitute a counter-offer that will terminate the original offer.

Acceptance can be given in writing or orally or be construed by conduct, but silence cannot constitute acceptance. The offeree has to do something to indicate acceptance. So, if you are sent an unsolicited item through the post you cannot be forced to pay for it if you ignore it even if you are told that, unless the seller hears otherwise, you are deemed to have accepted it.

3.2 Communication of acceptance

The offeree must communicate acceptance to the offeror either personally or by an authorised third party. There can be complications as to when acceptance is actually received.

The general rule is that acceptance must be communicated to the offeror before there is a contract. When that happens depends on how the acceptance was sent:

Case: Household Fire Insurance Co v Grant (1879)

Grant applied for shares and the letter accepting his application was posted. However, the letter was lost in the post. Later Grant was required to pay for the shares.

Held: It was held that the contract to buy shares was formed when the acceptance letter had been posted.

Case: Felthouse v Bindley (1862)

A man offered to buy a horse, saying to the seller that if he heard nothing by the weekend he would consider the horse his. The horse was, however, sold instead at an auction and the auctioneer was accused of selling a horse that had been already sold to someone else.

Held: There was no contract as the contract had not been accepted. Silence is not acceptance.

3.3 Standard form contracts and the incorporation of terms

Most contracts you meet are not negotiated line by line. They are standard form contracts: one party — the insurer, the airline, the software vendor, the haulier — puts forward a printed set of terms and the other party takes them or leaves them. The rules of offer and acceptance still apply exactly as §2 and §3 set them out; the practical question becomes a different one:

A term becomes part of a standard form contract in one of three ways:

The battle of the forms

Standard form contracts produce a problem that follows straight from the counter-offer rule in §2.3. A buyer sends a purchase order “subject to our standard conditions of purchase”. The seller acknowledges it “subject to our standard conditions of sale”. The two sets of conditions are not the same, so the acknowledgement is not an acceptance at all — it is a counter-offer, which destroys the buyer’s original offer.

The exchange can go on for several rounds. The usual outcome is the last shot rule: the contract is made on the terms of whoever fired the last set of conditions before the other side did something that amounted to acceptance — typically delivering, or taking delivery of, the goods. Conduct is the acceptance; the terms are the last ones on the table.

The practical lesson for an accountant is that the printed terms your organisation relies on are only worth anything if they are the ones that got incorporated.

4 Consideration

4.1 What is consideration?

Offer and acceptance are not enough to form a contract: consideration is also needed. This means that both sides of the contract must give or do something for the other side (or promise to do so). The exchange of considerations could be:

• Money for goods

• Goods for goods

• Money for a service

• Money to escape an obligation etc

If the consideration is given at the time the contract is made (eg buying goods in a shop) it is known as executed consideration. If the consideration is the promise to do something in the future (eg agreeing to work for someone for a salary, starting in a month) it is known as executory consideration. For consideration to be valid it has to comply with a number of rules set out below.

The rules that follow, in §4.2 to §4.7, are the ones that decide whether what was given or promised counts:

4.2 Consideration must not be in the past

Past consideration is an act already performed before the later promise was made. So, if you tidy an elderly neighbour’s garden and she then promises to pay you $20, the promise cannot be enforced: the tidying was done before the promise, not in return for it. The tidying is in the past.

Case: Re McArdle (1951)

A man moved into his deceased father’s house temporarily and repairs costing £488 were carried out. The man and his brothers and sisters were to inherit the house equally, so the brothers and sisters signed a document promising to reimburse £488 when the house was sold. However, no payment was made.

Held: The repairs had been done before any agreement to share costs so there was no enforceable contract.

4.3 Consideration must move between the parties to the contract

An action to enforce a contract or to claim damages can only be enforced by someone who has given consideration.

Case: Tweddle v Atkinson (1861)

A couple were getting married. The two fathers each promised to pay the couple a sum of money. Both fathers died and the bride’s father had not paid the amount promised. The groom claimed against the estate of the bride’s father.

Held: The claim failed because the groom was not party to the agreement and had given no consideration: the agreement had been between the two fathers.

4.4 Consideration must be sufficient but need not be adequate

This means that the consideration given must have some value (sufficient) but does not need to match or be even close to the value being received (does not need to be adequate).

Case: Chappell and Co Ltd v Nestlé Co Ltd [1960] AC 87

Nestlé ran a promotion in which customers could send in three chocolate bar wrappers and a small amount of money and receive a gramophone record in exchange. For copyright reasons it had to be decided whether the wrappers formed part of the consideration — even though Nestlé threw them away.

Held: the wrappers were part of the consideration. They were of no intrinsic value to Nestlé, but insisting on them boosted sales, so they had value in the eyes of the law. Consideration must be sufficient; it need not be adequate.

4.5 Carrying out a contractual or statutory duty is not consideration

Case: Collins v Godefroy (1831)

Collins was required by law to appear in court as an expert witness in a case involving Godefroy who promised to pay Collins a sum of money for his time.

Godefroy then failed to pay.

Held: Collins had no claim. He had a legal duty to attend court so had done nothing else for the payment promised.

4.6 Consideration cannot be illegal

Illegal consideration is an act or a promise which is considered to be against the public interest or contrary to law.

Case: Foster v Driscoll (1929)

Foster agreed to smuggle whisky into the USA during prohibition. Payment was not made.

Held: the court would not enforce the contract because the consideration (ie arranging to smuggle) was illegal.

4.7 Speciality contracts

Sometimes consideration is not needed in the formation of a valid contract. These contracts are known as ‘speciality’ contracts or deeds, and a promise made by deed is enforceable even though no consideration was given. Deeds were historically sealed, and promises in them are still called ‘covenants’, but a seal is no longer required: a deed made by an individual must be signed in the presence of a witness who attests the signature, and delivered as a deed.

For example, a grandparent could promise to fund a grandchild at university. This would be unenforceable unless the promise is given in a deed, which is a formal document that must be signed, witnessed and delivered as a deed.

A deed is also the form the law requires for some contracts whatever the consideration — see §1.1.

5 Intention to enter into legal relations

For a contract to be valid there must have been an intention to enter into legal relations. Not every agreement leads to a contract which can be enforced through the courts. For example, you might have an agreement to meet a friend in a restaurant. It would be good manners to do so but your agreement would not create a legal duty to do so. This is much more in the nature of a social and domestic agreement and that is understood on both sides. Contract law is primarily to do with commerce and business.

Also, if the parties enter into an agreement marked as ‘subject to contract’ this will not be enforceable until a formal contract is executed.

Case: Simpkins v Pays (1955)

Three women lived in the same house and regularly entered a newspaper competition, which required the listing of eight items in order of merit. Each woman made a list, and the three entries were submitted on one form. There was no fixed arrangement about paying the entry fee and posting the form but the form was submitted in the defendant’s name. One of the lines won £750, which was paid to the defendant and the plaintiff sued to recover a third share of this.

Held: The judge held that there was evidence of an agreement to share the winnings, and that this was intended to be legally binding.

6 Terms, warranties and conditions

6.1 What is a term?

A term is any provision that is part of a contract. Terms specify the details about what each party has promised to do. Most terms are expressly agreed between the parties but there can also be implied terms.

Terms divide into:

• Conditions

• Warranties

6.2 Conditions compared to warranties

The distinction can be a fine one, as these two cases show — same year, both about opera singers:

Case: Poussard v Spiers (1876)

Mme Poussard was an opera singer who contracted to perform for three months. Because of illness she missed the opening night and the next three. Spiers replaced her with another singer and claimed that the contract with Poussard had ended.

Held: Madame Poussard was in breach of condition because she missed the opening night which was the most important performance because reviews of the production would be based on this night. Spiers were entitled to end the contract.

Case: Bettini v Gye (1876)

Bettini was an opera singer who contracted to perform for three months. Because of illness he missed a number of days of rehearsals and Gye replaced him.

Held: Missing several days of rehearsals was not vital to the contract so Bettini was in breach of a warranty only. Gye was not entitled to end the contract.

6.3 Implied terms

As mentioned above most terms will be expressly negotiated by the parties to the contract, but some terms are implied by custom, fact or law.

Implied by custom. Where a practice is so well established in a trade or locality that the parties must be taken to have contracted on the basis of it.

Case: Hutton v Warren (1836)

The claimant, a tenant farmer had planted seeds, but before the harvest the tenancy was terminated. The tenant billed the landlord for the costs of seeds and the value of the labour. The landlord refused to pay claiming that there were no terms in the contract that covered this payment.

Held: The tenant was entitled to payment because that was the customary procedure in tenancy terminations.

Implied by fact. Terms implied as fact rest on the assumed intention of the parties: the term is one the parties would obviously have included had they thought about it, and without which the contract makes no business sense.

Case: The Moorcock (1889)

A ship was moored at the defendant’s wharf. When the tide went out the ship became damaged by rocks. The claimant claimed damages from the defendant but the defendant argued that there was no term in the contract about the condition of the river bed.

Held: The court implied a term in fact, that the river bed would be safe for mooring: it made no sense to have the contract without such a term.

Implied by law. Parliament and the courts imply terms into whole classes of contract, whatever the parties said. Consumers get statutory protection against retailers; tenants get it against landlords; and, as chapter 9 §2.3 shows, a long list of terms is implied into every contract of employment — mutual trust and confidence, fidelity, reasonable care and skill, and a safe working environment among them.

7 Misrepresentation

7.1 What is a misrepresentation?

A misrepresentation is a false statement of fact or law which induces one party to enter into a contract.

Note the requirements. The statement must be:

• False.

• Relating to fact or law.

• Induces one party to enter a contract.

There are three types of misrepresentation:

• Innocent.

• Negligent.

• Fraudulent.

Contracts based on misrepresentations are voidable, if wished, by the innocent party – meaning that the parties are returned to their original positions.

7.2 Fact or law

There has to be a false statement about a fact or law; a statement about future intentions is not a misrepresentation unless there had been no intention of carrying out the action. A statement of opinion will not be a misrepresentation unless the utterer knew the facts and ‘opinion’ was an attempt at cover-up. Silence will not generally amount to a misrepresentation but smiles and gestures can do.

However, there are some contracts where there is a duty of ‘utmost good faith’ (“uberrimae fidei”), and some relationships — a fiduciary relationship such as that between partners, or between an agent and the principal — where all material facts have to be disclosed.

Insurance was the classic example, but for consumers the law has changed. Under the Consumer Insurance (Disclosure and Representations) Act 2012, a consumer no longer has a general duty to volunteer every material fact; the duty is to take reasonable care not to misrepresent — to answer the insurer’s questions truthfully and carefully. So a person taking out life insurance must answer the health questions on the proposal honestly and carefully, and it is for the insurer to ask. Business insurance is different: under the Insurance Act 2015 the business must make a fair presentation of the risk, which still includes disclosing material circumstances.

Half-truths can be misrepresentations. Also if a statement becomes false later the change in circumstances must be disclosed.

Case: Bissett v Wilkinson (1927)

A man buying land to use as a sheep farm asked the seller how many sheep the land would hold. The seller had not kept sheep on the land but estimated that 2,000 sheep could be supported. Based on this statement the land was purchased. However, the estimate turned out to be too high and an action was brought for misrepresentation.

Held: The statement was a statement of opinion and not a statement of fact and therefore not an actionable misrepresentation.

Case: Edgington v Fitzmaurice (1885)

A company issued shares stating in the prospectus that the capital raised was going to be used to expand the company. In fact, the company had cash flow problems and the money was going to be used to pay the company’s creditors.

Held: Although the prospectus contained a statement of future intent, because the company had no intention of using the money in this way it had made a misrepresentation.

7.3 Inducing one party to enter the contract

After establishing that a false statement of fact or law has been made, it is then necessary to show that the statement induced one party to enter the contract. There is no misrepresentation if the statement had been ignored, disregarded or was unknown to the party affected.

Case: Attwood v Small (1838)

A preliminary agreement was made for the purchase of an estate that generated income. The accounts supplied by the defendant were checked by the claimant’s own accountants, who were satisfied they were accurate, and so the claimant completed the purchase. In fact, the accounts had exaggerated the income generated by the estate and the claimant brought an action for misrepresentations.

Held: The claimant was unsuccessful. By getting his own experts to check the reports he had relied on his own judgement and the work of his own experts rather than on what was said by the defendant.

7.4 Innocent, negligent and fraudulent misrepresentations

All three kinds are actionable, but the state of mind of the person who made the statement differs, and so does what the innocent party can recover:

8 Companies and contracts

A company is a legal person in its own right (chapter 10 §5). It can own property, make contracts, sue and be sued in its own name. But it has no hands: everything it does, it does through people. Two questions follow — can the company make this contract at all, and did the person who signed have authority to make it for the company?

8.1 The company’s capacity

Historically a company could act only within the objects stated in its memorandum, and anything outside them was ultra vires and void. That is no longer the position. Under the Companies Act 2006, s.39, the validity of an act done by a company “shall not be called into question on the ground of lack of capacity by reason of anything in the company’s constitution”. In practice a modern company has unrestricted objects unless its articles say otherwise, and even where they do, the outsider is protected.

8.2 The directors’ authority to bind the company

It is the directors who cause the company to enter into contracts, and their authority can be limited — by the articles, by a shareholders’ resolution, or by the board’s own delegation rules. Major contracts should always be authorised by board resolution.

As between the company and the outside world, the Companies Act 2006, s.40 protects the third party: in favour of a person dealing with a company in good faith, the power of the directors to bind the company “is deemed to be free of any limitation under the company’s constitution”, and that person “is not bound to enquire as to any limitation on the powers of the directors”. So the contract stands.

As between the company and the director, it is a different story. A director who exceeds his or her powers can incur personal liability to the company, and may be relieved of it if the board subsequently ratifies the act. Where the conduct amounts to negligence, breach of duty or breach of trust, ratification is a matter for the shareholders, not the board.

8.3 How a company actually contracts, and one trap

9 Check your understanding

Five short questions on the chapter, with the answers under each. Work through them before you move on.

10 Test your knowledge

Two quick checks before you move on: work through the flashcards to fix this chapter’s key terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.