Contract Formation Under US Law

CleanApp
CleanApp
Nov 22, 2019 · 13 min read

The rules of contract (“K”) formation in the US are relatively straightforward. Here’s a quick capsule summary.

1. What Law Governs?

There is no pan-American law of contract, as such.

In the US, contract law can be found in many different sources, including federal and state cases, federal and state statutes, and in many secondary sources. Special types of contracts may be governed by state-by-state enactments of the Uniform Commercial Code (UCC), such as state-enactments of UCC Article 2 (governing the sale of goods), 2A (governing the lease of goods), and so on.

So when we talk about US contract law, we’re talking about what’s known as the common law of contract. Many of these common law rules are restated in what’s known as the Restatement (Second) of Contracts, which is compiled and published by the American Law Institute (comprised of America’s leading jurists, practitioners, scholars, judges).

The Restatement (Second) of Contract (aka R2C) rules try to restate what’s known as the majority rule — the proposition of law followed in the majority of US jurisdictions. The R2C almost always gets the majority rule right; but not always.

With regard to contract formation rules, the majority rules are more or less settled. In this context, R2C rules are not controversial, and are often cited by courts as highly-influential authority. Of course, the moment a court cites the R2C, that rule becomes ‘law’ in that jurisdiction, which adds to that rule’s authoritativeness.

Lastly, while there are some differences between the UCC and R2C with respect to contract formation (see eg UCC 2–205 [Firm Offer]; 2–207 [Battle of the Forms]), the two bodies of law are meant to be largely complementary. Courts often cite to both sets of authorities interchangeably.

2. Can Parties Choose What Law Governs?

Contract parties may specify that body or bodies of law they want to govern their contract. This is known as a choice-of-law (COL) provision. Parties may also specify where a dispute must be brought, such as arbitration in location Y, or litigation in jurisdiction Z. These are knowns as choice-of-forum (COF) provisions.

Courts generally enforce COL/COF provisions.

But it’s never clear if a court will enforce these provisions. This is especially tricky when one of the parties is arguing there is a K and the other party is arguing there is no K.

It is not fair to automatically apply a COL/COF provision to the party that claims it never entered into that K. This would violate that party’s due process rights.

Among other things, applying a COL/COF provision against that party’s will is tantamount to imposing a contractual obligation on someone where there was no contract. It violates their freedom of contract rights, as well as the general prohibition on involuntary servitude, and so on.

3. Definition of Contract

Ok, so what is the majority rule for a contract?

  • a contract is a legally enforceable agreement between two or more parties. R2C § 1
  • to get a contract, a party must allege and prove two general elements of a contract — (1) mutual assent, and (2) consideration. R2C § 17(1)
  • mutual assent ordinarily takes the form of an offer by one party (A), followed by an acceptance by another party (say, B) R2C § 22(1)
  • generally, a contract may be made in any manner and in any language and/or form that the parties choose. R2C §§ 2, 4, 24, etc. (freedom of K doctrine)

This gives us the following shorthand ‘formulas’ for K formation:

  • K = MA + C
  • MA = typically (O + A)
  • K = MA (typically (O + A)) + C

4. Who Decides if K Exists? How?

In our scenario, one of the parties wants to enforce a K against another party that is denying the existence of this alleged K. Because of this configuration, A & B need an independent third party — C — to help them work out their dispute.

This third party (court, arbitrator, mediator, friend, etc.) is supposed to look at the facts and determine if the elements of a K are satisfied by reference to an objective standard of contract formation. This means C is asking whether a hypothetical reasonable person looking at the facts would determine whether the elements are satisfied.

In theory, C is not supposed to substitute C’s judgment for that of A and/or B.

  • Don’t: C is not supposed to say, “I am reasonable, so let me see if A & B had a contract.”
  • Do: C is supposed to imagine what a reasonable trier of fact would conclude — essentially adding one layer of abstraction and objectivity.

In practice, C (the reasonable trier of fact that is being asked by A & B to look at their dispute) is just a proxy for this hypothetical reasonable and fully-objective person.

At the end of the day, C is just human, so C will make mistakes.

But the standard we are asking C to apply is much more objective than just putting the parties on the stand and asking C to decide who is right in a “he said v. she said” A-B dispute.

5. Is there Mutual Assent?

To determine whether there is mutual assent (typically comprised of offer & acceptance) our third party C would look to the external manifestations of the parties.

This means looking at parties’ words (oral and/or written) and/or the parties’ conduct, and/or the broader context/circumstances in which the parties’ alleged K was supposedly formed.

  • Please note how we’re now saying “alleged K” and how the K was “supposedly formed.” As awkward as this sounds, we’re going to keep doing this to remind ourselves that we’re talking about types of cases where parties are disputing the very existence of a K.
  • Therefore, we cannot simply point to some contract document and say, “here, the parties signed this contract; therefore, they have a contract.”
  • The nature of a contract formation dispute is that one of the parties is disputing that they entered into a K (or that they did enter into a K, but that it is not enforceable for some reason).

In these types of K formation disputes, we cannot prove the existence of a K simply by alleging that the other side ‘signed’ a transaction.

We cannot simply look at the subjective intention of the parties at some earlier point in time to determine whether they intended to enter into a K or not. This is because parties can (and often do) change their minds.

Parties not only change their minds from time to time (t1 to t2). Parties also frequently lie about their previous intentions. This is why contract law has developed numerous objective standards for determining parties’ intent to enter into a K, or not.

The same is true for contract interpretation disputes (where parties may agree that there is a K, but may disagree about the meaning of a particular term). A big part of contract law is coming up with objective frameworks for determining party intent.

Contract law exists to help parties manage these types of disputes by giving them a conceptual structure, a shared vocabulary, and a broad range of institutional settings where they can adjudicate and/or arbitrate and/or mediate these disputes.

The doctrine of mutual assent is a good example of this.

It is an important element of a contract, but mutual assent isn’t just some item on a checklist that either exists or does not exist. The doctrine of mutual assent is itself comprised of multiple rules that parties can use to show that Yes, they intended to have a K, and/or¹ No, they did not objectively intend to have a K.

For example, mutual assent (MA) is ordinarily shown through offer (O) and acceptance (A). So let’s turn to these doctrines quickly, and then return to the question of intent.

6. What is an Offer?

Under the majority view, an offer (O) is a reasonably clear manifestation of intention to enter into a bargain, so that the only thing remaining for the offeree(s) to do is to accept. An offer may be made with words (oral and/or written) and/or through conduct. R2C §§ 4; 24.

Example 1: A says to B, “Hey B, we’ve been next door neighbors for 5 years, and now we’re thinking of moving. Do you want to buy our house for $330,000?”

A reasonable trier of fact (C) may conclude that A’s statement constitutes an offer because it is reasonable to infer from the circumstances that A & B know material aspects of this potential transaction, such as the status of the title on the home (whether there are outstanding financial encumbrances), the dimensions of the property, the timeline for concluding the potential sale and so forth.

It may be unreasonable to infer this if A & B just met one another on, say, Craigslist. But because A & B are neighbors, it may be reasonable to infer that A & B share understanding regarding the (a) title, (b) dimensions, (c ) timeline for concluding a potential sale.

On the other hand, either party could argue that A’s statement does NOT constitute an offer because it is not reasonably clear. There are simply too many terms that are left open between the parties for a reasonable third party (C) to determine the scope of a potential offer, mutual assent, and so on. Is the house being sold furnished? When does payment need to be made? How?

In typical residential home sale contexts, buyers take out mortgages to pay the purchase price. Here, there is no mention of financing whatsoever, so a reasonable trier of fact may conclude that A’s statement is not an offer, but merely an invitation to bid or a preliminary negotiation. In other words, if B says, “Yes, I accept!” a reasonable trier of fact may still conclude that the terms of this potential contract are not reasonably discernible; therefore, there is no mutual assent, and, potentially, no contract.

Please note, whether the statement above is an offer usually represents a question of fact for the trier of fact. We do not have all of the facts surrounding A’s statement, which is why the best we can do in our offer analysis above is make arguments for why C could find A’s statement is an offer, and why C could find that A’s statement is not an offer.

7. What is Acceptance?

In American contract law, acceptance (A) is manifestation of assent to the bargain. R2C § 50. Like an offer (O), acceptance can be made in words (oral and/or written) and/or conduct. R2C §§ 60, 69. Generally, acceptance must mirror the terms of the offer; but there are some instances where acceptance can include additional terms that are not in the offer (see UCC 2–207).

Example 2: A says to B, “Hey B, we’ve been next door neighbors for 5 years, and now we’re thinking of moving. Do you want to buy our house for $330,000?”

B doesn’t respond immediately, but an hour later sends a text message: “Yes, I accept your offer.”

If A’s statement is considered an offer, did B accept it when she sends a text message saying “Yes, I accept your offer.” — ? Just like with our offer analysis, above, arguments could be made for and against viewing B’s message as acceptance. Just like with offer, whether there is acceptance presents a classic question of fact that will need to be decided by a trier of fact.

But is there anything the parties can do to give themselves (and the potential C) more clarity? How would our analysis change if the parties used legal language instead? For example:

Example 3: A says to B, “B, we’ve been next door neighbors for 5 years, and now we’re moving. I’d like to make you a legal offer to buy my house for $330,000?”

B responds immediately: “Yes, I legally accept your offer.” They shake hands and A says, “I’m glad we could make this contract.” B responds, “I agree.”

8. Does Legal Intent Matter?

It seems that parties’ legal intent regarding their potential contract should matter to C.

Example 3 seems to be much more clear that A & B want there to be a legal contract. And if C’s job is to determine whether or not A & B have a contract, shouldn’t our analysis end there?

A & B are saying they have a contract. So, there’s a contract. Right?

Yes and no.

Yes, we do care about the parties’ intent, generally speaking. That’s why we have mutual assent (MA), offer (O), and acceptance (A) rules (among others) that help us determine parties’ objective intent from multiple points of view.

Where there is no dispute about K formation, there’s no need to get C involved, even if parties think they have a contract and act as though there’s a contract and a C could have found that there was actually no contract between A & B.

But, we also know that parties change their postures over time. At t2, parties may also lie about any legal intentions they might have had at t1.

Yet again, this is why we have a need for objective contract formation standards and relatively objective processes for helping parties manage their contractual expectations.

Precisely because it is so easy for parties to change their stories about legal intent, American contract law does not require parties to show that they intended to be legally bound. Here is the operative rule:

R2C § 21. Intention to Be Legally Bound

Neither real nor apparent intention that a promise be legally binding is essential to the formation of a contract [K], but a manifestation of intention that a promise shall not affect legal relations may prevent the formation of a contract.

[Translation: when parties say they’re creating a “legal K” that does NOT necessarily create a K; when parties say they do NOT want to create a K, that may block the formation of a K (& policy reasons militate against imposing a K). However, just because parties have said there’s no K, doesn’t mean there’s no K.]

R2C § 21 is an extremely useful rule for several reasons.

  1. First, R2C § 21 differs from English contract formation rules, which still appear to require intent to be legally bound (although that intent is presumed if there is evidence of mutual assent — or ‘agreement’ in English legalese). So there may be a higher likelihood that A’s & B’s words/conduct are found to create K(s) under US law than under English law.
  2. Second, R2C § 21 calls for an objective but also holistic approach to parties’ interactions, especially in light of R2C § 20 (effect of mistake) and R2C § 22(2) (conduct may show MA even where C cannot find O and/or A).
  3. Third, R2C § 21 debunks the idea of 100%-always-binding contract legalese, which is important for numerous policy reasons.

9. Can Parties Agree to Not Have Ks?

There are several reasons why parties cannot simply agree to opt out of any legal entanglements ahead of time. First, parties can and do frequently change their minds.

Second, the reality is that any agreement to not have a K (like, K1, above) be seen as a legal agreement, could itself be considered a … legal agreement … eg, contract (K2):

So, is it ever fully possible for A & B to opt out of legal entanglements like Ks with one another? Is it ever fully possible for A & B to block themselves from seeking recourse from any number of potential Cs down the road?

Legally speaking, the answer is no.

10. But That’s Not What I Thought…

If any of the points above contradict the way you thought contract law functioned, that’s great! This shows the importance of revisiting old assumptions about contracts.

This is relevant to anyone who forms contracts on a daily basis, which is to say — everyone. But the points here are especially relevant to people in cross-jurisdictional contracting spheres like blockchain.

If you are looking for other primers that explore these issues (and also deeper legal analysis), please subscribe to Crypto Law Review and feel free to search our archives.

The elements listed above are just the tip of the iceberg. The full set of rules and doctrines governing even ‘simple’ questions of contract formation is long. That list is always growing.

In our next installment, we’ll consider the fascinating doctrine of consideration. Here it is:

¹ Can A really argue that it has a K with B and simultaneously argue that it does NOT have a K with B? Yes. That’s partly due to US rules of civil procedure which permit what’s known as ‘alternative pleading’ (A can allege: a) yes, there was a contract between A & B; and b) no, there was no contract between A & B). If enough facts support both alternative arguments, A may be able to get all the way to trial on these alternative theories.

Crypto Law Review

A journal pushing the bounds of our legal imaginaries, on-chain, off-chain, and against the chain.

CleanApp

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CleanApp

Small NGO with a big patent urging BigTech & Crypto to enable trash/hazard reporting & open source data. "The Wi-Fi & Bluetooth of TrashTech" - cleanapp.io.

Crypto Law Review

A journal pushing the bounds of our legal imaginaries, on-chain, off-chain, and against the chain.

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