business law

all about business
Click on any of the terms below to get a full explanation of that topic.
•  What is a Contract?
•  Sources of Contract Law
•  A Common Law Case Study
•  Requirements for a Valid Contract
•  The Agreement
•  The Offer
•  Revocation
•  Rejection
•  Counteroffer
•  Consideration
•  Legal Detriment
•  The Peppercorn Theory
•  Agreements Without Consideration
You may know what business is. You may even be familiar with law. Today, we're going to put them together—business law. We'll deal with one super-huge business law concept here—contracts.

Now, you've probably heard a lot about contracts. Maybe you've even signed one. Maybe your favorite basketball player just signed one. But what is a contract? Simply put, a contract is a legally enforceable promise or set of promises.

So, it follows that contract law determines what promises are enforced, whether promises have been performed, and remedies for breaches of contract (meaning somebody has broken a contract in some way). These remedies are basically compensation for, or fixes to, the breached part of the contract.

We'll get to the bottom of this contract stuff by looking at two areas: the sources of contract law and the requirements for a valid contract. We'll start with the sources of contract law.

The Sources of Contract Law

There are basically two sources of contract law: The Uniform Commercial Code (the UCC) and common law. Let's see how and when each apply to contract law.

In the chaotic days before the Uniform Commercial Code, each state in our fair union had its own commercial laws. It was anarchy! Well, it wasn't that bad, but things were inconsistent. The UCC was created to establish a uniform set of rules to govern commercial transactions. This, my friends, brought harmony and stability to our great nation. Or at least a little consistency. The UCC attempts to unify the national marketplace.

The UCC covers a broad range of commercial transactions. For our purposes, when we discuss the UCC, we're talking about Article Two, which concerns the laws covering the sale of goods.

What are goods? A good is a tangible item that a person can buy or sell. A loaf of bread is a good. Now, when you purchase that loaf of bread, you automatically become a party to a UCC contract. Not everything that can be bought or sold is a good. Something like a haircut, for instance, is not a good. It is a service.

Contracts that don't cover the sale of goods are covered by either other portions of the UCC or by common law. Common law, also known as case law, consists of law formed through court decisions. Things like services or land sales are covered by common law. Hmm, land is a tangible item that can be bought or sold, right? Why isn't it considered a good? Well, because it's not often that during a land purchase the land is actually physically moved someplace else.

A Common Law Case Study

Let's look at a case that illustrates common law and its application to contracts. We call it "Jack's Drywall Problem." It's about a service that wasn't performed correctly. Because it's a service, it falls within the boundaries of common law. In common law, there already exist lots of past cases that have dealt with services that were not performed that way the purchaser wanted them. In the case of "Jack's Drywall Problem," past decisions made by judges can be applied to this case.

Mel's a drywaller. Jack is a guy. A guy who had a wall that needed to be dried. Well, he had an area of his house that needed to be drywalled. Anyway, Jack contracted Mel to drywall his living room. So, Mel did some drywalling. The problem? Mel drywalled Jack's bedroom. And he didn't even do a good job. Mel did a bad job, and he did the wrong job.

In other words, Mel broke the contract in which he was to drywall the living room. Based on past court cases in common law, Jack can refuse payment to Mel, even though he did do some drywalling. In addition, Jack is entitled to receive the monetary equivalent of the amount of damage done to his bedroom.

Okay, that's a little background on the sources of contract law. Now, let's get down to the contract itself, and see what the requirements are for a valid contract.

The Requirements for a Valid Contract

What is a valid contract? Well, basically, a contract is valid when it meets all the requirements for the formation of a contract. The four main requirements for a valid contract are legal capacity, legality, agreement, and consideration.

Legal capacity: this means that the person signing the contract must be at least eighteen years old and mentally competent. Legality: this means that the contract must be for a legal purpose. Okay, those two requirements are fairly straightforward. The other two requirements, agreement and consideration, are a bit more complicated, so we'll go into a bit more detail for each.

The Agreement

An agreement is a mutual acceptance of the contract's contents by both sides. There are three parts to an agreement that we'll cover. They are the offer, the acceptance, and the objective theory of contracts.

The Offer

The offer is a proposal made by one person to another. The offer creates a legal relationship between these two people once the offeree accepts. Who's the "offeree"? Well, when it comes to contract law there are two parties—the offeror and the offeree. The offeror is the party who makes the offer. The offeree is the person who either accepts or does not accept the offer. So, for there to be an agreement, there must be three things: an offeror, an offeree, and of course, an offer!

Now, how exactly do you make an offer? The process of making an offer requires that the terms are clear. The offeree (the party who either accepts or does not accept the offer) needs to know exactly what is being proposed.

Making an offer is kind of like playing a game of tennis. The ball starts in the offeror's side of the court. Once the offer is made it gets sent into the offeree's side of the court. So, think of the offer as the ball. Once this offer is made to the offeree, something called power of acceptance comes into play.

Power of acceptance means that the offer is now being controlled by the offeree. The offeree may either take the ball or hit it back to the offeror. At this point, the offeree is able to examine the offer, and consider whether or not she wants to accept it. This leads us to acceptance, the second requirement of an agreement.

Acceptance occurs when the offeree communicates her assent (that is, her acceptance) of the offer. In other words, it's when the offeree says to the offeror, "Okay, your offer sounds cool with me, my friend. Let's do it."

But acceptance can be a little bit more involved than that. There are three important points to acceptance, which are the form the acceptance takes, when acceptance usually occurs, and when offers are terminated.

First, the form the acceptance takes. How will the offeree let the offeror know that she has accepted the offer? A letter? A phone call? An email?

Well, almost any form of communication works—Morse code, skywriting, semaphore (that thing sailors do on passing ships), whatever. Unless the offeror said the acceptance had to be in a specific form, any reasonable form of communication works. Even the esoteric bio-symbology of the Bee People. Whatever that is.

Second, when the acceptance usually occurs. An acceptance is effective as soon as the message leaves the possession of the offeree. There's a rule that explains this called "the mailbox rule." Basically, the mailbox rule says that, unless the offer requires a different form of acceptance, as soon as a letter of acceptance is put in the mail, the offeree's acceptance is effective. As soon as you stick it in the mail, it a "go."

If we compare this to a tennis game, acceptance is effective the moment the gal who receives the ball hits it back to the guy who hit it to her in the first place. And, the ball—the offer—can get there almost any way—special delivery, snail mail, pony express, etc.

Third, when offers are terminated. Offers do have time limits; they don't just hang around and wait for you to decide whether or not you want to accept. So, you can't assume that when someone offers to make a deal with you, that the deal will always be available.

There are at least seven reasons why an offer may terminate. Those reasons are revocation, rejection, counteroffer, lapse of time, an intervening illegality, destruction of subject matter, and death or insanity of either party. Let's look at each one individually.

Revocation is when the person that's made an offer decides he wants to take it back. He can revoke the offer as long as there has not yet been an acceptance.

Rejection is when an offeree says, "No" to the offer. The offer then dies.

A counteroffer is when the offeree responds to the offer with an offer of her own. This has two effects: first, rejection of original offer (which terminates it) and second, the creation of a offer. In a way, the offeree and offeror have switched roles as a result of a counteroffer.

Here's an example. Say your mom asks you to eat all your brussels sprouts so you can have dessert. But, you're a stubborn child with a severe mental block against brussels sprouts, and you know your business law in and out. You promise to eat two brussels sprouts if you can have dessert. Bang, the counteroffer is rolling. Mom is so impressed with your negotiating skills that she calls MENSA and ships you off the next day to become a brilliant chess player. And you'll never have to eat brussels sprouts again.

So, Mom made you an offer: you can have dessert if you eat your veggies. But you made a counteroffer instead, which had two results. One, you terminated that first offer by rejecting it. Second, you created a another offer—the counteroffer. The counteroffer was that you would eat some of your veggies if Mom let you have dessert. Mom accepted. She was smart. And you ate a little bit, a little bit of your veggies.

Offers can also terminate due to lapse of time. If the offer states that it terminates at a specific date, and should an acceptance not be made by that time, then that offer is terminated. This type of termination is kind of like those expiration dates on coupons for 25 cents off of your next purchase of Honey-Coated, Chocolate-Frosted, Sugar Rockets.

Even if an offer states no time for termination, it automatically terminates at the end of a reasonable time. Of course, reasonable is an extremely slippery concept.

The fifth way an offer may be terminated is through intervening illegality. This is when the subject matter of the offer becomes illegal after the offer is made but before it's accepted. We'll explain.

OK, say you own this rare spotted-back Alaskan turtle for a pet. You love the little guy, but you're moving to Tibet. So you've decided to sell your turtle. You find a guy with a pet store and you offer it to him. The store owner is interested but he wants a day or two to think about it. While he's thinking it over you read in the paper that day that the rare spotted back Alaskan turtle was just put on the endangered species list by the government. And, being a concerned citizen and a card-carrying member of several dozen endangered species activist groups, you know that it's illegal to sell endangered species. This is an intervening illegality. The proposed contract is killed, because it no longer has legality. The turtle's endangered status is the intervening factor which makes the proposed contract between you and the pet store owner illegal.

The destruction of subject matter means that the thing that was going to be bought and sold has been DESTROYED! Say a nice couple, the Smiths, is selling its house to an equally nice couple, the Joneses. Well, the Smiths have made an offer—they'll sell the house to the Joneses for $100,000. The offer's right there on the table, so to speak. The Joneses think it over and are just about to accept the offer. Unfortunately, this nice little house has a gas leak. KA-BOOM! The house blows up! Well, without a house, there's really no deal. The offer is terminated because of the destruction of subject matter (in this case, the house).

The last manner in which an offer may terminate is the subsequent death or insanity of either party. Both parties to the proposed contract must be mentally competent. And alive.

O.K. we've just covered the first two parts of the agreement—the offer and the acceptance. Let's discuss the third part, the objective theory of contracts.

The objective theory of contracts is a kind of measurement. It's a theory because it's not a hard and fast fact. Anyway, by applying this theory, we can determine whether or not both sides have agreed to a contract. It also tells us what exactly they agreed to. This theory is used most often in court. Like, if you were a judge, you'd probably use the objective theory a lot.

Now, the "objective" part of the theory means that the court (that is, the judge or jury) doesn't take into consideration what each party was actually thinking. The court considers what a hypothetical reasonable person would think in similar circumstances. Say you try to get out of a contract by claiming you were "just kidding" when you made an offer. The court doesn't care! If the offeree was reasonable in believing you were serious, then your offer was valid.

We've been discussing one of the requirements for a valid contract—agreements. But there's another requirement necessary for a valid requirement—consideration.


Consideration is something of legal value which is given in exchange for something else. In order for a contract to be enforceable, there's got to be something that each party gives up in the deal. This something can be money, property, or a service.

Remember Mel, our drywaller? He might not be a good drywaller, but he's not going to work for free! Nope. If he is contracted to do work, he wants a promise that he'll get paid. There's got to be consideration on both sides of the contract. Remember, no consideration, no contract.

A couple of points: there are two ways to recognize consideration, and there are some agreements that lack consideration (don't wig out on that right now, just stick it in the back of your brainpan for the time being). Let's just worry about the two ways to recognize consideration for right now.

You see, if consideration is part of what is needed to make a valid contract, then we've got to figure out whether or not it's there. The two important ways to determine the existence of consideration are legal and the Peppercorn Theory of Consideration.

Legal detriment means to give consideration. Someone must either give up an existing right or accept a duty—you don't get something for nothing, you get something for something. Each party that is bound to a contract must be giving up something for what they are going to receive from the other party. The concept which underlies legal detriment basically says that there is no binding contract without consideration.

For example, Mel's promise to drywall Jack's living room is the acceptance of a duty, which is a form of consideration. Well, now that there is consideration, there must necessarily be legal detriment. That's because legal detriment is the giving of consideration by one party to another.

The other party, Jack, in this case, is now obligated to also give some type of consideration, as outlined in the contract. In non-legal terms, this means Jack's got to promise to pay Mel for the drywalling. So, Jack's promise to Mel is Jack's legal detriment. Something to remember for later: the consideration has to be something that a person is not already obligated to do or give.

The second important rule of consideration is the Peppercorn Theory. And, you guessed it, it's actually named after that little round black thing that gets ground into pepper.

The Peppercorn Theory states that something as insignificant as a little peppercorn can be sufficient consideration when given in exchange for a promise. No matter how little the consideration is, whether it's a peppercorn or a penny, it is still sufficient consideration. See, people are free to make silly choices when they go into deals.

So, if you're silly enough to agree that a peppercorn is ample payment for your services, then that's okay with the law.

Now, let's take a look at sneaky agreements that don't involve consideration (bring that idea from the back of your brainpan to the front).

There are three main types of agreement which lack consideration: promised gifts, pre-existing duties, and past consideration.

A promised gift is an unenforceable agreement with no consideration. If you promise to give someone something, but get no promise in return, then the promise you made is not enforceable.

Pre-existing duty goes like this. First, remember that when you promise to do something in exchange for something else, you are giving consideration in exchange for consideration. Say you promise to do something that you already have a duty to do. In this case, your promise is not consideration. It is a pre-existing duty. You're not incurring any legal detriment because you're doing or giving something you already have to do or give!

The final type of act or promise that lacks consideration, past consideration, is an act which already has been performed. It's not possible to bargain for something that has already happened.

Here's our million-dollar example. Imagine that you mow lawns. You like mowing lawns! It's your life! Without being asked, you mow your neighbor's lawn. When your neighbor realizes what you've done, he promises to pay you five dollars on Tuesday. So, on Tuesday you go to your neighbor and ask him for the five bucks he promised you. He slams the door in your face. And well he should.

Why? Well, it's the classic lawn boy mistake: you gave no consideration for his promised five dollars. But what about the job you've already done on his lawn, you ask? Well, the key word here is already. It was already done before he made his promise, so it couldn't have been done in exchange for the promise. So, there's no consideration, and, no consideration, no valid contract. In other words, for an agreement to be binding must be made before the exchange takes place.

Well, my contract says that I can stop here. We've gone over contracts, the UCC, what constitutes an offer, and an acceptance, and we've made some friends along the way (well, okay, maybe that's pushing it…).

Now that you've read All About Business Law, test your knowledge with our Sample Test.

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