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Contracts

Contracts play a vital role in virtually all business undertakings in that they establish the rights and obligations of the contracting parties. Almost all business activities are governed by contract including commercial leases, equipment leases, partnership agreements, shareholders agreements, insurance contracts, employment contracts, franchise or distributorship contracts, loan agreements and sales contracts, to name a few.

This section is intended to provide a basic insight into some of the main components of contracts, rules which may govern the scope of contract and to illustrate the general format of certain contracts.

Key Questions

i.       WHAT IS A CONTRACT?

ii.      WHAT ARE THE ESSENTIAL ELEMENTS OF A CONTRACT?

iii.     CAN A WRITTEN CONTRACT BE MODIFIED BY A VERBAL AGREEMENT BETWEEN THE PARTIES?

 iv.    WHAT IS A "FOUR CORNER" CLAUSE?

 v.     HOW CAN A CONTRACT LIMIT OR EXCLUDE LIABILITY? WHAT RULES GOVERN EXCLUSION AND LIMITATION CLAUSES?

 vi.    WHEN DO CONTRACTS NEED TO BE WITNESSED? WHEN DO CONTRACTS NEED TO BE SEALED?

 vii.   WHAT IS MEANT BY "ASSIGNMENT OF CONTRACTS"?

viii.   WHAT SHOULD A CONTRACT WITH A CUSTOMER CONTAIN?

 ix.    HOW ARE CONTRACTS ENFORCED?

 x.     WHAT ARE SOME DEFENCES TO ENFORCEMENT OF CONTRACTS?

 xi.    WHAT IS A BREACH OF CONTRACT?

 xii.   WHAT ARE THE REMEDIES FOR BREACH OF CONTRACT?     

i.          WHAT IS A CONTRACT?

While many specific types of contracts exist for a wide variety of purposes, a contract can generally be seen as an agreement between two or more persons which creates an obligation to do or not to do a particular thing.

ii.         WHAT ARE THE ESSENTIAL ELEMENTS OF A CONTRACT?

The essential elements required for the formation of a contract are offer, acceptance and consideration.

a)         Offer

In assessing whether a contract has been formed, all the circumstances must be examined to see if one party, the offeror, has made a firm "offer" and if the other party the offeree has "accepted" that offer. Would a reasonable person view the act of the offeror as a true offer? In determining whether an offer has been made, factors such as the history of the transaction, language used and subsequent conduct of the offeror should be considered.

An offer must be communicated. Communication may be made either to a particular person or to the public at large. An example of an offer to the public at large is advertisements for rewards or for services to be rendered.

The offer must consist of a definite promise to be bound provided that certain specified terms are accepted. The offeror must not merely be feeling his way towards an agreement nor merely initiating negotiations from which an agreement might or might not result.

b)         Acceptance

Acceptance of the offer must be unequivocal. If there is still discussion about the terms of the contract then the offer has not been accepted. If the offeree introduces a new term which the offeror has not had the chance of examining, he is in fact merely making a counter-offer and the effect of this is to destroy the original offer.

Just as there must be communication of the offer to the offeree, there must also be communication of the acceptance to the offeror in order to form a contract. This is essential to establish a "meeting of the minds" which is a fundamental requirement for a contract.

Acceptance may be inferred by words or by conduct. In certain circumstances, silence and conduct can be construed as acceptance. Because of this, it can sometimes be very difficult to determine if there has been acceptance and to fix the precise moment at which acceptance occurred.

When considering whether acceptance has occurred, it is necessary to first determine whether the offer was still open for acceptance. An offer may be terminated by counteroffer, rejection, revocation, through lapse of time, if it is subject to a condition which fails, or by the death of one of the parties.

The offer must also state how communication of acceptance is to occur. If there is a significant deviation from the mode of communication stated in the contract, including time, place and method, then the court will likely find there is not acceptance. However, if the offeree has substantially complied but was unable to communicate in the specified manner, (ie) by fax, then the court will look at the intention of the offeror in specifying the particular mode to determine whether acceptance has been validly communicated. For example, the offeree may have hand delivered the acceptance to the offeror=s office.

Certain rules known as the "postal acceptance rules" apply to acceptance by mail, courier or telegraph. These rules do not apply to revocation or to instantaneous modes of communication such as fax, telex or telephone. If the offeror indicates, expressly or impliedly, that the post is to be used for acceptance, then he assumes the risk if the post is miscarried. Acceptance is said to be effective when a letter is posted unless:

  1. the terms of the offer require actual notice;
  2. the postal acceptance rule leads to inconvenience or absurdity; or
  3. the offeree did not intend to be bound until communication reached the offeror.

Contracts are formed in the place where the acceptance is received.

c)         Consideration

Courts enforce bargains not mere gratuitous promises. To be enforceable a promise must be supported by consideration. In simple terms, consideration is the price one party pays for the other party's act or promise. Consideration has been defined more technically as "some right, interest, profit or benefit accruing to one party, or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other"; in other words consideration results in a benefit to one party or a detriment to the other. A common form of consideration is cash offered in exchange for merchandise.

d)         Other Requirements

It must be emphasized that there must be a "meeting of the minds" for a contract to be created. A contract is not binding if it lacks certainty, if it is too vague or therefore if it is incomplete.

Where the obligation of the parties to the contract depends on a future uncertain event or act by a third party, there is no binding contract until this condition is met.

The law also considers certain individuals to lack the capacity to enter into valid, enforceable contracts. For example, a person whose mental capacity is such that he is incapable of understanding the nature of his acts is also incapable of entering into a valid contract. Minors are also restricted in their ability to enter into enforceable contracts. The basic rule is that if the contract is not for the necessities of life (ie) food, clothing or shelter, a minor can cancel any contract he enters into. If the minor wants to confirm the contract, however, he can do so thus forcing the other party to comply with the terms of the contract.

iii.        CAN A WRITTEN CONTRACT BE MODIFIED BY A VERBAL AGREEMENT BETWEEN THE PARTIES?

Although it may be clear that a valid contract has been made, often it will still be necessary to determine the extent of the obligations that it creates. The contents of the contract are not necessarily confined to those that appear in the resulting written documents.

Terms which are found within the actual written contract are known as express terms. They differ from representations which are assertions or statements made before or at the time of the contract which may or may not become part of the contract. These are governed by what is known as the Parol Evidence Rule.

The Parol Evidence Rule applies when the contract has been reduced to writing and a dispute has arisen as to whether or not the written contract is representative of the entire contract. This rule seeks to preserve the integrity of written agreements by refusing to permit contracting parties to attempt to alter their contract through the use of oral declarations. Under this rule, when parties put their agreement in writing, all previous oral agreements merge in the writing and generally a contract as written cannot be modified or changed new oral evidence (referred to as parol evidence).

While parol evidence to a contract is not admissible where if contradicts or is inconsistent with the written contract, the rule does not forbid the use of parol evidence which is not inconsistent with the matters stated in writing. In other words, when oral assurances add to, subtract from or vary the agreement, as opposed to contradict, such oral evidence will generally be admissible.

While the general rule is, therefore, that the parties are bound by their documents, in practice its operation is subject to a number of exceptions. First, evidence may be admitted to prove a custom or trade usage and thus to "add" terms which do not appear on the face of the document and which alone give it the meaning which the parties wished it to possess.

Second, evidence is permitted to show that the contract does not yet operate or has ceased to operate. Such evidence is offered to show that, while on its face the document purports to record a valid and immediately enforceable contract, it had been previously agreed to suspend its operation until the occurrence of some event which has not yet taken place.

Finally, the exclusion of oral evidence is considered inappropriate where the document is designed to contain only part of the terms; where the parties have made the contract partly in writing and partly by word of mouth. This occurs often enough to prevent the ban on oral evidence from being a strict rule of law. It will be presumed that a document which looks like a contract is to be treated as the whole contract. However, this is a rebuttable presumption. In each case it must be determined whether the parties have reduced their agreement to the precise terms of an all-embracing written contract. If they have, oral evidence will not be admitted to vary or contradict it. If they have not, the writing is considered part of the contract and must be judged with the oral terms. The question is one of intention. The recent tendency is to infer that the parties did not intend the writing to be exclusive but rather wished it to be read in conjunction with their oral statements.

Two other points worth mentioning are that the parol evidence rule only prevents evidence with regard to terms, not validity; and that an exclusion clause in a written contract can be overridden by an express oral warranty provided at the time of sale.

iv.        WHAT IS A "FOUR CORNER" CLAUSE?

The term "four corners" refers to the face of a written instrument. Under the four corners rule the intention of the parties is to be gathered from the instrument as a whole and not from isolated parts. Therefore, a four corner clause simply establishes that what is found on the face of the document represents the agreement in its entirety that has been reached between the contracting parties.

v.         HOW CAN A CONTRACT LIMIT OR EXCLUDE LIABILITY? WHAT RULES GOVERN EXCLUSION AND LIMITATION CLAUSES?

The common law has long been familiar with the attempt of one party to a contract to insert terms excluding or limiting their own liabilities. These clauses have resulted in an abundance of litigation from which it is possible to draw a number of conclusions:

a)         The document relied on as containing notice of the excluding or limiting term must be an integral part of the contract. It must have been intended as a contractual document and not as a mere receipt of payment.

b)         If the document is to be regarded as an integral part of the contract, it should be signed by the party against whom the excluding or limiting term is targeted. If it is unsigned, it must be determined whether reasonable notice of the term was given before the contract was made. Note that such notice may be inferred from previous consistent dealings between the parties.

c)         If the document is signed it will normally be impossible, or at least difficult, to deny its contractual character. In the absence of fraud or misrepresentation, a person is bound by a document which he has signed whether or not he has read the contents. If a clause limiting liability is onerous, unusual or imposes an unnecessarily harsh obligation on the signing party, the courts have more recently held that there is a duty to bring the clause to the attention of the party especially if it is an individual consumer.

d)         If there is any doubt as to the meaning and scope of the excluding or limiting term, the ambiguity will be resolved against the party who inserted it and who is now relying on it. Since this party seeks to protect himself against liability, he must establish that the words clearly and aptly describe the contingency that has in fact arisen.

vi.        WHEN DO CONTRACTS NEED TO BE SEALED?

Common law requires a seal only in the case of a gratuitous promise, ie. a promise made by one party who has not received consideration for it. In such a case, if the court is to enforce the contract it must be under seal.

While there is no general requirement that a contract be made under seal or witnessed, all relevant legislation should be canvassed in order to determine whether such undertakings are necessary. For example, at one time corporate documents could only be executed under seal.

vii.       WHEN CAN A CONTRACT BE ASSIGNED?

An assignment of a contract occurs when one party transfers his interest and rights under the contract to another person. Although most contracts can be assigned, the following questions should be considered to determine if a particular contract can be assigned:

a)         Is the contract of a personal nature of the type that limits its performance to the named individuals in the contract?

b)         Does the contract expressly permit or deny an assignment?

c)         Does the assignment violate law or public policy?

d)         Does the assignment impose additional duties, rights, or obligations on the other parties to the contract which are different from those contracted for?

Each of these factors must be considered in the particular context in which the assignment arises. For example, an assignment of a personal services contract is usually prohibited when the nature of the services to be performed is unique or specialized. The theory is that the nature of the contract changes when the services contracted from an individual are transferred to another. This would apply to painters, artists, authors, doctors, teachers, etc. If the personal service to be performed is routine, then assignment is usually permitted.

viii.      WHAT SHOULD A CONTRACT WITH A CUSTOMER CONTAIN?

A contract is simply the agreement between the supplier and the customer. It does not have to be in writing, but a written contract is strongly recommended. The contract lists the rights and obligations of both parties. The contract is legally binding so it is important to be careful about the wording. Note that any agreement not contained in the document may or may not be binding.

The actual contents of a contract are largely a matter of common sense. For example, in a contract for kitchen repair work the contract should contain references to the following matters:

a)         a description of the work to be performed including any special instructions and time frame for completion;

b)         any penalty for late completion;

c)         responsibility for supplying materials;

d)         limitation of liability, if any;

e)         the contract price;

f)          deadline for payment and penalty for late payment;

g)         consequences for both parties if either breaches the contract.

Many companies have standard form contracts. If you are creating a standard form contract it is recommended that you seek the assistance of a lawyer. If you are signing a contract which has been drafted by the other party you should review its terms carefully as they will likely be strongly in favour of the party who drafted it.

ix.        ENFORCING YOUR CONTRACT

The most common breach of contract by a customer is a refusal to pay. The right to be paid and methods by which these rights can be enforced are strictly limited by time. In general, legal action must be initiated within 6 years for a breach of contract action.

Contracts for up to $2,000 to $4,000 (depending on the particular provincial legislation) may be dealt with in provincial Small Claims Court without the need for a lawyer. Contracts in excess of this amount must be enforced in the Court of Queen's Bench, where a lawyer is recommended.

x.         DEFENCES TO ENFORCEMENT OF CONTRACTS

An unwilling contract participant may have a range of defences available. A common defence to prevent enforcement of a contract is that a valid and enforceable contract was never entered into.

Another defence is that there was a mutual mistake of a fundamental term of the agreement which prevented the formation of a contract because there was no meeting of the minds. For example say A offers to buy Y's truck for $500. Y has two trucks and thinks A is buying truck 1 whereas A thinks he is buying truck 2. There is a mutual mistake as to which truck A is buying. In this case there would be no agreement on a fundamental term and no contract.

If the mistake is made only by one party, it will not usually prevent formation of the contract. However, if one party knows about the other party's mistake he cannot take advantage of it. When the mistake is only about the value of an article, the courts will usually enforce the contract because the value of the article is a common risk taken in most contracts.

Generally, courts will set aside a contract if the defence is that fraud or misrepresentation affected a material term of the agreement. Contracts that are illegal or violate public policy are also unenforceable, such as contracts relating to crimes or that charge an illegal interest rate.

xi.        BREACH OF CONTRACT

The effect of a breach of contract will depend on the nature or the breach. A minor breach will not relieve the offended party from performing his duties under the contract but will entitle him to sue for any resulting damages. If the breach is material, the offended party can treat the contract as ended, refuse to perform any of his contractual duties and sue for damages.

Whether the breach is material depends on a number of factors including:

  • the extent of the benefits the offended party loses as a result of the breach;
  • the extent to which the offended party can be compensated for the loss by the payment of damages;
  • prior failures of the breaching party to perform contractual duties;
  • the hardship caused to the offended party by the breach;
  • whether the breach was negligent or wilful versus the result of a frustrating event;
  • the likelihood that the breaching party will perform the remainder of his duties under the contract.

xii.       REMEDIES FOR BREACH OF CONTRACT

The payment of damages is the most frequent remedy for breach of contract. These are divided into various categories. Compensatory damages are for reasonably foreseeable losses suffered as the result of the breach. In addition, punitive damages are sometimes awarded by the court as punishment to the breaching party, although this is rare in breach of contract cases. Nominal damages might be given in those cases where a breach of contract occurs but no actual damages are proven.

In some cases, the courts will order that the breaching party specifically perform his duties under the contract. Most of the time specific performance is available only when money damages are insufficient, for example a contract for the sale of land.