What Is a Legal Contract?

How a Legal Contract Works

A contract is essentially a set of promises that can be enforced by law. Typically, a party promises to do something for another in exchange for a benefit. A contract can be written or verbal and involves one party making an offer and another accepting. If the contract's promise isn't kept, the harmed party can seek a legal remedy.

To be a legal contract, an agreement must have all of the following five characteristics:

• Legal purpose: A contract must have a lawful purpose to be enforceable. For example, if one business partner contracted someone to kill another business partner, but the person took the money without fulfilling the contract, there's nothing that can be done. A contract of murder for hire is illegal and the contract is unenforceable.
• Mutual agreement: All parties to the contract must have reached an agreement. That is, one party must have extended an offer to which the other parties have agreed. For example, Jim signs a contract with Tom's Tree Trimming. The contract outlines the scope of the work Tom will perform on Jim's property. Jim and Tom have a mutual agreement regarding the work that will be done.
• Consideration: Each party to the contract must agree to give up something of value in exchange for a benefit. For example, you hire an independent contractor to repave your driveway. You and the paving contractor sign an agreement in which you promise to pay a sum of money in exchange for the paving work. Both you and the contractor have agreed to give up something of value. You have agreed to pay money, and the contractor has agreed to perform the paving work.
• Competent parties: The parties to a contract must be competent. That is, they must be of sound mind, of legal age, and unencumbered by drugs or alcohol. If you enter into a contract with a person who isn't competent, the contract can't be enforced.
• Genuine assent: All parties must engage in the agreement freely. A contract may not be enforced if one or more parties have made mistakes in the language. Likewise, a contract may be voided if one party has committed fraud or exerted undue influence over another. For example, you sign a contract in which you agree to sell your house to your next-door neighbor for $1. When you signed the contract, your neighbor was threatening you. Clearly, you made the agreement under duress, so the contract isn't valid.

Breach of Contract

If one party fails to fulfill their duties under the agreement, that party has breached the contract. For example, suppose that you've hired a masonry contractor to construct a brick patio outside your restaurant. You pay the contractor half of the agreed-upon price upfront. The contractor completes about a quarter of the work and then stops. They keep promising they'll return and complete the job but never do. By failing to fulfill their promise, the contractor has breached the contract.

If one party breaches a contract, the other party may suffer a financial loss. In the above example, you paid for 50% of the work but only received half that much. You have several options for obtaining compensation:

1. Sue for damages: You may file a lawsuit against the contractor for damages. For example, you might sue for the cost of hiring another contractor to finish the job plus the costs you have incurred due to the delay.
2. Specific performance: You can compel the contractor to complete the work required by the contract.
3. Other remedies: If the contractor tricked or forced you into signing the contract, you might convince a court to terminate the agreement or amend its terms.

Failure to fulfill the terms of an insurance policy may constitute a breach of contract. An insurance policy imposes obligations on both you and your insurer. An insurer has an obligation to pay covered claims. If the insurer reneges on this duty, you may sue the insurer for breach of contract.

Likewise, you have an obligation to cooperate with your insurer when it investigates a claim. If you file a claim and then refuse to cooperate with the insurer's investigation, your refusal to cooperate may constitute a breach of the insurance contract. Your insurer may rely on your breach of the policy as a basis for denying the claim.

Types of Legal Contracts

Most contracts are bilateral. This means that each party has made a promise to the other. When Jim signed the contract with Tom's Tree Trimming, he promised to pay the contractor a specified sum of money once the job was completed. Tom, in turn, made a promise to Jim to complete the work described in the agreement.

In a unilateral contract, one party makes a promise in exchange for an act by the other party. Insurance policies are unilateral contracts. When you buy liability insurance or any other type of policy, you pay a premium (an act) in exchange for the insurer's promise to pay future claims.

Frequently Asked Questions (FAQs)