Key Takeaways

  • The objective theory of contracts evaluates agreements based on outward expressions rather than internal intent.
  • Courts use a "reasonable person" standard to determine if a contract exists, focusing on what was communicated rather than what was thought.
  • The theory helps enforce predictability and fairness in contract law by minimizing subjectivity.
  • Exceptions exist where subjective intent might matter, particularly in cases involving ambiguity or fraud.
  • Modern applications of the objective theory appear in commercial contract interpretation, especially in disputes over unclear or poorly drafted terms.

The objective theory of contracts holds that an agreement between parties is legally binding if, in the opinion of a reasonable person who is not a party to the contract, an offer has been made and accepted.

This legal concept has become the standard for determining the intent of parties in an agreement since the late 19th century. The objective theory of contracts supersedes the previous standard, known as the subjective theory of contracts or “meeting of the minds,” that was commonly applied throughout the early 1800s. Thus, the main determinant in the validity of a contract is the acts, or external performances of the parties, not the internal state of mind, or intent of the parties, that exists when coming to an agreement.

Subjective Theory vs. Objective Theory of Contracts

There is some debate as to what constitutes a legally binding contract. Many legal scholars believe that the Common Law governing contracts has always, to some degree, required an objective test by an unbiased third party to determine the validity of an agreement. Some scholars argue that the objective theory is only a recent development and that precedent dictates that the long-held subjective theory should still be applied in the courts.

However, even these scholars, known as “subjectivists,” recognize that by the late nineteenth century the other side, the “objectivists,” had gained the upper hand, and the objective theory is the widely accepted theory.

Briefly, the major differences can be summarized by the following examples:

  • Party A owns a guitar signed by Elvis Presley appraised as being worth several hundred thousand dollars. A neighbor, Party B, expresses interest in the guitar and in jest tells Party A that they’d pay a million dollars for the opportunity to own such a treasured keepsake. Party A agrees and challenges in court that an agreement was reached with the neighbor, even though he knows that the neighbor does not have access to that kind of money. The subjective theory holds that there was not a “meeting of the minds,” and that neither party had an expectation of the transfer of the guitar occurring.
  • In a similar scenario, the neighbor expresses interest in the guitar, and this time, Party A states a price for selling the guitar based on the appraisal rate and actually lets the neighbor get the instrument appraised by a third-party. The neighbor then sells valuable assets to raise the funds to purchase the guitar, but at the last minute the owner decides not to sell. Applying the objective theory, the court could determine that through the act of setting a price, letting an independent appraisal occur and the neighbor acting to raise the funds, a valid contract between the parties does exist.

What spurred the transition from the long-held concept of subjective theory to the popularity of the objective theory of contracts now being used in U.S. courts of law? Scholars agree that many prominent judges issued decisions in contract disputes applying the objective theory of contracts beginning sometime in the late-nineteenth century. These included U.S. Supreme Court judges and leading authorities on contract law, such as Christopher Columbus Langdell and Samuel Williston, who argued that it was difficult for one person to subjectively determine the thoughts of another and to, in effect, read a person’s mind.

Objective Theory in Modern Contract Interpretation

In contemporary legal practice, the objective theory of contracts is crucial for interpreting ambiguous or complex agreements. Courts often analyze contracts not just by their text, but by what a reasonable person would interpret from the words and actions of the parties involved. This is especially important in commercial contexts, where standard form contracts or industry norms may affect interpretation.

The theory promotes fairness and predictability by reducing reliance on personal testimonies about subjective intent, which can be difficult to verify. Instead, the focus remains on what was objectively communicated between parties. For instance, in disputes over ambiguous clauses, courts may reference industry standards, past dealings between the parties, and customary practices to clarify what the contract likely meant to an objective observer.

Not Always Black and White

Although both sides, the “subjectivists” and the “objectivists” appear to hold vastly different views on the way intent should be determined by a court of law, in many cases, both theories can justifiably be applied.

If two parties enter into an agreement through a clear and obvious “meeting of the minds” and also make external acts that show their intent to consummate an agreement, the contract could be deemed binding. However, both theories could also be used if one party was to argue there was no actual intent to form an agreement. It would come down to whether or not a “reasonable person” would consider that both parties were proceeding in good faith toward the agreement or whether or not the deal was too good to be true and to one party’s obvious advantage.

When Subjective Intent Still Matters

Although the objective theory dominates contract interpretation, courts sometimes consider subjective intent when:

  • There is ambiguity in the agreement: If the language used can reasonably support multiple interpretations, courts may look at each party’s intended meaning to resolve the ambiguity.
  • Misrepresentation or fraud is alleged: In cases where one party claims they were misled, the court may evaluate the internal belief or knowledge of the accused party.
  • Preliminary negotiations are unclear: If parties disagree on whether their interactions resulted in a binding agreement, subjective evidence (e.g., emails or oral statements) might be admissible to determine the parties' understanding.

Such instances demonstrate that while the objective theory governs most contract disputes, there remains limited room for examining subjective intent in exceptional cases.

Key Elements Courts Consider Under Objective Theory

Courts evaluating contract disputes through the lens of the objective theory typically examine several key factors:

  • Language of the agreement: The actual words used in the contract hold primary weight, especially if they are unambiguous.
  • Conduct of the parties: Actions before, during, and after the agreement can affirm or challenge whether a mutual understanding existed.
  • Reasonable expectations: The standard of a reasonable person is used to infer whether the parties appeared to intend to be legally bound.
  • Industry standards: In business settings, common trade practices or prior dealings are considered to interpret vague or technical terms.

By relying on these objective elements, courts aim to enforce contracts based on how they would be understood in a legal and commercial context, rather than speculating on private intentions.

Frequently Asked Questions

  1. What is the objective theory of contracts?
    It is a legal doctrine that determines contract formation based on outward expressions of intent rather than a party’s internal thoughts or beliefs.
  2. How does the objective theory differ from the subjective theory?
    The objective theory focuses on how a reasonable third party would interpret the agreement, while the subjective theory considers the actual intent of the parties involved.
  3. Why do courts prefer the objective theory?
    It ensures consistency and reduces the risk of manipulation by relying on observable facts rather than unverifiable personal beliefs.
  4. Can subjective intent ever be considered by the court?
    Yes, in cases involving ambiguity, fraud, or misrepresentation, courts may look at subjective evidence to clarify meaning or intent.
  5. Does the objective theory apply to all types of contracts?
    It applies broadly, especially in commercial and business contracts, but exceptions exist where specific context or intent may influence interpretation.

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