Formation of a Contract - Understanding the Process

Contract formation is the crucial first step in breach of contract lawsuits. In order for there the court to determine that there has been a breach of contract, the court must first find that the contract is valid (and specifically, was validly formed). If the contract was not properly formed under the law, then a suit based on its provisions cannot succeed.

Before we move forward with addressing the mechanics of formation, however, let’s first address certain additional validity concerns related to contract formation.

Additional Validity Concerns

A contract will be found invalid if – at the time of formation – any of the contracting parties were incompetent, the contract was meant to promote some illegal, unenforceable purpose, or if any of the parties were induced into entering the contract by duress, undue influence, or misrepresentation.

Incompetency - Age

Though a minor can legally enter into a contract, they are also granted unilateral power to void their contracts, which means that they cannot be effectively held to the provisions of the agreement.  Basically, the contract is valid until the minor party decides that they want to void the contract.  Parties who are contracted with minors are not totally without recourse, however.  If the minor party turns the age of majority without having voided the contract, then they will lose the power to void the agreement.

Incompetency – Mental Incapacity

The test for capacity requires that the contracting party be capable of understanding the nature, meaning, and effect of the contract.  Under Probate Code section 811(a), a person who is deemed mentally incapacitated to contract is one for whom there is: a deficit in alertness, information processing, thought processes, or ability to modulate mood and effect, and there is evidence of a correlation between the aforementioned mental deficits and the decision or acts in question.  A deficit in mental function may be considered only if the deficit (by itself or in combination with others) significantly impairs the person’s ability to understand and appreciate the consequences of his or her actions.  Importantly, a diagnosis of mental illness is not itself enough to determine whether the contracting party is mentally incompetent to enter a contract.

Incompetency – Intoxication

If a party to a contract was intoxicated at the time of contract formation (alcohol or drugs), this may also invalidate the contract.  To determine whether the intoxication affected the party’s capacity to contract, the court will consider evidence as to whether the intoxicated party was able to understand the nature, meaning, and effect of the contract at the time of formation.

Illegal Purpose

Any contract between parties designed to promote an illegal purpose are considered de facto invalid under the laws of California.  For example, suppose that a husband contracted with a professional assassin to murder his wife.  After the husband pays the assassin tens of thousands of dollars, the assassin refuses to move forward with the murder attempt.  The husband cannot thereafter attempt to enforce the contract – it would be absurd, as the purpose of the contract is illegal, and in fact criminal.  Do keep in mind, however, that even illegal activity that is not criminal (such as buying-selling banned products) will render a contract invalid.

Duress, Undue Influence, and Misrepresentation

Duress, undue influence, and misrepresentation all generally fall under the same category – in effect, each involve inducing a party to the contract into entering the contract by some abuse of power, position, or knowledge.  For more details, please read our article on Breach of Contract, here.

The Process of Contract Formation

Contract formation is misleadingly simple on the surface.  The formation of a contract depends on an offer indicating a willingness by the offering party to bind themselves to the proposed terms, and an acceptance by the accepting party indicating a willingness to be bound to the same proposed terms.  Offer and acceptance can quickly become a quite winding, complicated process, however.

From now on, we will refer to the offering party as the offeror and the accepting party as the offeree.  Much of the mechanics of formation – and the ensuing confusion – is dependent on the actions of the accepting party, or the offeree.

Suppose that an offeror proposes an offer.  For there to be a valid contract formation, it would have to be demonstrated that the offeree a) intended to enter into the contract; b) the offeree accepted the proposed terms; and c) the offeree actually communicated the acceptance to the offeror.

Intention

An offeree cannot enter a contract by mistake.  Objective indications of the offeree’s intention to bind themselves to the terms of the contract must be present.  These indications may, to some degree, be determined by the offeror, as the offeror may require a specific set of behaviors or words in order for the offeree to demonstrate their intent to enter the contract.

Acceptance of the Terms

In California, among non-Merchant parties in non-Commercial transactions, the common law Mirror Image rule applies.  Under the mirror image rule, the acceptance must be a "mirror image" of the offer, in the sense that the terms of the agreement must match those that were proposed in the first place.  Generally, however, the courts do allow for minor differences between the offer and acceptance so long as the relevant terms are exactly the same.

As an example of the mirror image rule, imagine a situation in which an offeror proposes to build a table for the offeree.  The offeree tells the offeror that the table will cost $250.  If the offeree verbally agrees, or perhaps shakes the offeror’s hand, then it could be argued that the offeree indicated his acceptance of the proposed terms.  If the offeree instead counters the offer by stating that he will only accept if the table price goes down to $200, then the offeror cannot take that statement as an acceptance.  The offeror cannot go back to his workshop and build the table, and then, if the offeree does not pay the $250 first proposed, sue the offeree for damages.  For the negotiation to move forward, the offeror must respond in some manner to the offeree’s counter.  If the offeror agrees to the $200 counter, then the contract is formed and both parties can be held to the terms of the agreement.

An inquiry into the terms of the proposed agreement does not trigger an acceptance.  Alternatively, complaints about the terms of the agreement do not preclude the possibility of an acceptance.  If the circumstances indicate an assent to the terms, the court could find that the offeree accepted the terms of the agreement despite being dissatisfied with said terms.

Communicating Acceptance – Express and Implied

An offeree can accept an offer via express or implied acceptance.  Though express acceptance is quite a straightforward process in most contract cases (indicated through some well-accepted form, such as a verbal "I agree," a written assent, or a handshake), implied acceptance can be a bit more complicated.  Generally, implied acceptance is demonstrated through actions taken that indicate assent to the proposed terms.

Let’s consider an implied acceptance example.  Imagine that a paint supplier leaves several fresh cans of paint at a construction company’s offices, and tells the manager that if the company wants to use the paint that was given, it will cost $70 per paint can.  Suppose that the manager gives the paint cans to his construction team to use, which they do.  Even if the manager did not verbally manifest his assent to the paint supplier’s offer, the manager’s actions – where he gave the paint cans over to the construction team to use – clearly indicate an implied assent to the terms of the paint supplier’s offer.  If the manager were to refuse to pay the $70 per paint can fee, then the paint supplier could hold the manager (and perhaps the company as a whole) liable for damages.

And what about silent acceptance?  Though the laws regarding acceptance generally require that the offeree be pro-active in demonstrating their assent to the terms of a contract, in certain limited circumstances, a silent, passive acceptance may be enough to bind an offeree to the terms of a contract.  Usually, such cases involve repeat deliveries, where an active rejection is required.  For example, imagine that a milkman has been delivering milk to a family, daily, for over twenty years.  Suppose that the milkman delivers the milk in the morning, and milkman returns at the end of the day to collect his payment.  Everyday a new contract is essentially formed through the family’s silent assent to the familiar terms.  If the family were to stop paying without letting the milkman know that they no longer want milk delivered, then it is possible that the courts would find that the family is liable for the unpaid amounts.  Such a repeat circumstance may warrant an active rejection of the contract terms in order to prevent the formation of a new one.

When Does An Acceptance Become Effective?

Understanding the time at which an acceptance is deemed effective and a contract is formed is very useful in certain circumstances.  For example, some offeror’s may want to rescind their offer, but they cannot do so without consequences if the contract has been formed through the offeree’s acceptance.  Alternatively, some offeror’s may have set certain time limits for the offeree to express an acceptance.

Instantaneous Acceptance

Instantaneous acceptance occurs over the telephone, or in-person, or even online in live chat programs.  Once the offeree accepts, the time of formation is clear.  There is usually no ambiguity when it comes to instantaneous acceptance situations.

Non-instant Acceptance

Non-instant acceptance is usually "mailed" acceptance, but may also be any other form of non-instant communication (using a messenger, for example).  Generally, sending out properly addressed mail sets the time of acceptance and contract formation at the time that the mail was dispatched, not the time it was received.  This means that the mail can be lost, and the offeror can be left totally in the dark as to whether the offeree actually accepted the offer, and the contract would still binding on both parties.

The "never received mail" situation can be prevented by a contractual provision that requires that the offeror actually receive the mailed acceptance before a contract is deemed to be formed.

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For a free consultation with an experienced contract attorney, call the Law Offices of Brian O’ Grady at (650) 318-6131 to set up your appointment today.