Contract law theory explains that contracts are one of the most frequently encountered documents because they apply to both business settings and everyday life. Contract theory studies how people and organizations compose and create legal agreements. It examines financial and economic behavior principles and the way each party has different incentives that cause them to do, or not do, the agreed-upon actions. You run into contracts when buying cell phones, hiring landscapers and starting businesses. So, it's a good idea to know a bit about contract law.

What a Contract Is

A contract is an agreement to do, or not do, something. It's between participating parties, and it can be legally enforced. Three details are necessary for a contract to be legally binding:

  • An offer must be made.
  • The second party must accept the offer.
  • Something of value must be agreed to in exchange for the thing that is offered. This is referred to as consideration.

Both parties must have the intent to enter a legally binding agreement and understand that the agreement can be enforced by law. Both parties must be able to enter into a legally binding agreement. Neither party can be forced or coerced to enter into the agreement.

Why Contracts Exist

Contract theory states that contracts exist to pinpoint what involved parties expect to happen and distinguish what will happen. It is a way to show a transparent and precise understanding of what each party is expected to do. Under contract theory, implied trust between the parties involved in the contract is also examined and helps to ensure that all the terms are enforceable and that the parties will follow them.

Meaning of an Offer and Acceptance in Contract Law

Under contract law, an offer is something someone will do or an amount someone will pay. Accepting the offer means the second party agrees to the terms without asking the original party to make any changes. The second party's response becomes a counter-offer that the original party needs to accept if the second party makes changes to the original offer.

Oral Contracts and Written Contracts

Contracts can be completed orally, but they are easier to enforce when they are written. With an oral contract, you have to be able to prove it existed for it to be enforceable, and that isn't always an easy task. Written contracts can be formal documents arranged between lawyers or informal ones arranged through some email, text, or fax messages. Plus, certain kinds of contracts have to be in written form to be enforceable.

Statute of Frauds

Under the Statute of Frauds, the types of contracts that have to be written are:

  • Agreements that are made as part of the consideration or exchange for marriage
  • Agreements to sell land or transfer ownership of it.
  • Agreements that require more than one year to execute the terms.
  • Surety agreements that handle debt or responsibility for someone else.
  • Agreements for items valued over 500 dollars, because these sales fall under the Uniform Commercial Code.

Challenges with Verbal Agreements

A verbal agreement has several potential drawbacks. While it isn't always on purpose and can be purely a misunderstanding, there many ways one or more of the parties end up doing something other than the expected after entering into a verbal agreement. For an entrepreneur, the legal aspects of verbal agreements and misunderstandings between parties can create a lot of problems.

It's easy to get caught up in the stress and rush needed to get a business going, and that pressure can make you take some major risks. Something like absently saying yes to something you're asked to do and then not following through can land you in trouble. Putting the terms of a contract on paper so the terms are clearly defined protects all parties. This is because you can be legally held to the terms of an oral contract.

Provisions of Contracts

Provisions, or terms, are part of any contract. The provisions are the details of who will do what regarding the agreement. These terms include the facts about who, what, when, where, and how much is being exchanged. Also, one person can enter into a contract on someone else's behalf, but only with that person's permission. A person's capacity to enter into a contract is taken into consideration by the court when problems arise, and capacity includes both maturity and mental ability.

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