Lesson 3: Introduction to Contracts

Transcription

1 Lesson 3: Introduction to Contracts Lesson Topics This lesson focuses on the following topics: Introduction Elements of a Valid Contract Express or Implied Contracts Unilateral or Bilateral Contracts Valid, Void, Voidable & Unenforceable Contracts Executed or Executory Contracts Lesson Learning Objectives By the end of this lesson, you should be able to: Name the five essential elements of a contract. Identify the three stages of a contract. Define consideration for a contract. Know the difference between contracts that are valid, void, voidable and unenforceable. Introduction In this lesson, we will discuss contracts and the basic components that create a legally enforceable agreement. Real estate professionals exert a lot of time and effort towards obtaining listings, showing properties and establishing a relationship with the principal. All of these activities require that the licensee have some type of agreement with the party that he or she is working with. Usually, once a real estate licensee has landed a client or listing, he or she will have to deal with contracts such as listing agreements, buyer representation agreements and purchase contracts. Therefore, real estate professionals Page 1 of 35

2 should take the time and energy to understand the documents that govern their industry, not only to better assist their clients, but also to avoid legal issues. A contract is a legally binding and enforceable agreement; it consists of three stages: offer, acceptance, and performance. Essentially, for a contract to exist, one party must make an offer, which is that party s promise to carry out certain obligations in exchange for another party s promise to fulfill the terms of the offer. If the other party agrees to the terms of offer, he or she must show acceptance of the agreement; acceptance is signing the contract. The written acceptance of the contract must be communicated to the other party, or his agent. This communication can be oral or in writing. The Statute of Frauds requires all real estate contracts to be in writing and signed in order to be enforceable. Finally, once an offer and an agreement have been made, there must be performance of the contract. This means that both parties must carry out their duties and obligations as outlined by the agreement. In the real estate industry, contracts take place every day. A contract can be a salesperson s guarantee to show a property five times a week, it can be a seller s promise to pay an 8% commission rate or it can be a tenant s agreement to lease an apartment for a year. These are all examples of when a contract should be drawn up. Contracts are necessary because they establish the terms of the agreement in clear and comprehensible language. The contract allows the parties to understand their role in the agreement and know what is expected of them. If either party disputes the agreement, the parties should be able to use the contract to resolve any discrepancies. When there is a well-defined and comprehensive contract, the parties can avoid going to court to resolve any conflicting issues. Essentially, the purposes of a contract are to define the obligations of each party, to bind each party to their obligations and to identify the repercussions of not fulfilling the contract. Page 2 of 35

3 Both parties are liable for the terms established in the contract; therefore, it is extremely important that both parties understand and agree to all of the stipulations in the agreement. This includes understanding the different types of contracts that exist as well as what components comprise a valid contract. Elements of a Valid Contract There are several instances when a real estate licensee will need to have a contract. Contracts allow the licensee to identify his or her obligations to the principal, and they also allow the principal to recognize his or her responsibilities to the licensee or the third party. The licensee should remember that just because he or she has a written and signed contract, it does not necessarily mean that he or she has an enforceable and legally valid contract. A legally enforceable agreement must create legal rights for all parties involved in the contract and contain the five essential elements of a legally valid contract. The five essential elements of a legally valid contract are: 1. Legally competent parties 2. Mutual assent 3. Lawful objective 4. Consideration 5. Adherence to the statute of frauds Legally Competent Parties For a contract to be valid and legally enforceable, the parties involved in the contract must be legally competent. Legal competency implies two things. First, the individual has reached the age of majority (usually 18 years of age) or had her disabilities of minority removed by a court, and second, the individual has not been declared mentally incompetent by a judge. Majority laws protect minors from entering into agreements that they may not have the experience or knowledge to understand. This means that if anyone under the age of 18 Page 3 of 35

4 enters into a contract, the contract is considered voidable. All contracts entered into with a minor as one of the parties may be either ratified or voided when the minor reaches the age of majority. A void contract means that the contract has no legal effect; it, in essence, cannot be enforced or carried out because the terms of the contract do not create legal rights or the terms call for illegal acts. A voidable contract has all of the essential elements of a legally enforceable contract, but one or more of the parties has the authority to rescind the contract. Usually, in a voidable contract, one party is either mentally incompetent or a minor, or the contract involves fraud or duress. Individuals who have been declared mentally incompetent by a judge and individuals who appear incapable of comprehending contracts (but have not been declared incompetent by a judge) cannot enter into a contract. The purpose of mental competency laws is to protect individuals of unsound mind from agreeing to terms he or she does not fully understand; therefore, all contracts entered into by an individual of unsound mind are void. In order to contract with a person of unsound mind, individuals will need to contract through the person who has the power of attorney. Example One: Party A, who is a minor, signs a sale contract, agreeing to purchase Party B s car. He signs the contract under the impression that the car is in superb condition. In the contract, Party B expressly states that the car is in perfect condition; this means that the car does not need any major engine repairs. Party B defined major engine repairs as any repair that arises from an engine malfunction and results in costs of over $150. Essentially, Party B is guaranteeing Party A that the car will run well and Party A will not have to spend a substantial amount of money to maintain the car. However, Party B knows that the car has a bad alternator; if the alternator malfunctions, the car will not be able to start up. (The alternator works together with the battery to supply power while the vehicle is running; therefore, if the alternator does not work, the car has no power to run.) One week after completing the sale transaction, Party A takes possession of the car. Soon thereafter, Party A starts having trouble starting the car. He calls a tow truck to Page 4 of 35

5 transport his car to the auto shop. At the auto shop, they tell Party A that the car needs a new alternator, which will cost him about $250. Party A contacts Party B and tells Party B that he wants to rescind the contract because Party B had lied to him about the condition of the car. Party B tells Party A that it is too late to withdraw from the contract since Party A has already completed and signed all the required paperwork. Party B further explains that once a party enters into a contract, each party is legally bound to the terms of the agreement. Who do you think is correct in this situation? Think carefully about the situation which each party is in and consider all factors that may affect the outcome of this situation. Ask yourself the following questions: Is the contract legally enforceable? That is, does it contain the five elements of a valid contract? Does the contract involve misrepresentation, fraud or duress? Was either party a minor? First and foremost, one important aspect of this situation is that Party A is a minor, and second, Party B fraudulently misrepresented the car. As was previously mentioned, any contract made by a minor can either be void or voidable. In this case, the contract is voidable because the contract created legal rights for all parties AND contained all the necessary elements of a valid contract, but the contract involved a minor AND misrepresentation. In this case, Party A will be able to rescind the contract because the contract was based on fraudulent terms. Party A ended up having to pay $300 (the cost of repairs and tow) to fix the car; the contract specifically defined a major engine repair as any repair that costs over $150. Their contract specifically stated that the car would not need any major Page 5 of 35

6 engine repairs. Party B misrepresented the condition of the car because he told Party A that the car was in excellent condition and needed no major repairs when he knew that the car s alternator was bad. If Party B had disclosed the information to Party A prior to the signing of the contract, then Party B would not be liable for fraud. Example Two: Party A decides that he wants to have his fence painted; therefore, Party A employs Party B, a minor, to do the work for him. The contract stipulates that Party B must have the work completed within one week. In return for Party B s services, Party A would supply Party B with paint, paint brushes and a ladder. Party B agrees to paint Party A s fence so he signs the contract. After talking to his parents, Party B realizes that the terms of the contract are unfair he realizes he would be working for nothing. The next day, Party B approaches Party A and says that he will not perform his part of the contract unless Party A compensates him. Party A tells Party B that he is bound to the original terms of the agreement since he signed the contract, and if Party B does not fulfill his part of the contract, Party A will take him to court to force performance. Party B says that he does not care since Party A does not have a valid claim against him. What do you think will happen in this situation? Again, think carefully about the situation which each party is in and consider all the factors that may affect the outcome of this situation. Ask yourself the following questions: Does the contract contain the five essential elements of a valid contract? Does the contract involve misrepresentation, fraud or duress? Was either party a minor? Page 6 of 35

7 A legally enforceable contract must contain five essential elements: legally competent parties, mutual assent, lawful objective, adherence to the statute of frauds and consideration. Did the contract in the previous example contain all of the essential elements? Think carefully about what each element is comprised of. The contract in Example 2 did not possess three of the five essential elements. First of all, Party B was a minor, and second, there was no consideration. There cannot be a contract without consideration; the theory behind consideration is that a person cannot do something for nothing. When there is a contract, both parties must suffer a detriment or loss. In this case, Party B would lose the value of his time and gain nothing, whereas Party A would lose nothing and gain a painted fence. Because the contract did not create legal rights for Party B, the contract is void. When a contract is void, neither party can seek the legal enforcement of it. It is, in effect, not a contract. Power of Attorney There are some situations in which a person is incapable of making decisions for himself or herself. When this happens, the person should consider granting another individual the power of attorney. When an individual (the principal) has given another person the power to act on his or her behalf, he or she has given that other person the power of attorney; this person is known as the attorney-in-fact. The power of attorney may give the attorney-in-fact the power to: Buy or sell real estate Manage the principal s properties Conduct the principal s banking transactions Invest the principal s money Make legal claims and conduct litigation Give gifts on the principal s behalf Page 7 of 35

8 There are three types of powers of attorney: 1. Nondurable Power of Attorney: This type of power of attorney takes effect immediately. Often, a nondurable power of attorney is used for specific transactions, such as closing a real estate transaction or making legal claims. Usually, the power of attorney remains in effect until the principal revokes it, or until the death or mental incompetence of the principal. Nondurable powers of attorney have two basic forms. The first form of nondurable power of attorney is referred to as a general power of attorney, which grants the agent broad decision making powers and allows the agent to conduct any business for the principal. The second form is called a limited power of attorney and is usually granted for a specific business purpose. These are frequently used when the principal knows in advance he or she will be unable to attend the events necessary to sign the documents or for the convenience of the principal. (A good example is the purchaser of a new car in many cases will authorize the dealership to license and register the car at the Department of Motor Vehicles). 2. Durable Power of Attorney: This type of power of attorney enables the attorney-in-fact to act for the principal once he or she is not mentally or physically competent to make decisions. A durable power of attorney remains in effect until the principal revokes it or the principal passes away. 3. Springing Power of Attorney: The principal creates a springing power of attorney when he or she anticipates an event that will render him or her incapable of making decisions on his or her own. Usually, a springing power of attorney will become effective when the principal becomes mentally or physically incapable of making decisions. For example: Before Principal A passes away, she wants to purchase a house for her daughter. Please identify which type of power of attorney best suits each situation. 1. Principal A wants to give her son the power of attorney if she ever becomes paralyzed or physically incapable of making a decision. What type of power of attorney should she give her son? a. Springing power of attorney Page 8 of 35

9 b. Nondurable power of attorney c. Durable power of attorney 2. Principal A wants to give her daughter the power of attorney for a specific real estate transaction and wants to be able to revoke it once the transaction is complete. What type of power of attorney should she give her daughter? a. Springing power of attorney b. Nondurable power of attorney c. Durable power of attorney Exercise Answers 1. a. Springing power of attorney 2. b. Nondurable power of attorney Mutual Assent In order for a contract to be legally enforceable, there must be mutual assent (that is, agreement) among the parties in the contract; if either party disagrees to any terms or provisions within the contract, there is no contract. Typically, prior to the creation of a contract, there must be a meeting of the minds this means that all parties to be bound by the contract must meet and come to mutually acceptable terms. Once all the parties come to terms that they agree to, they must show acceptance of those terms. All parties in a contract can express mutual assent through their actions and words; therefore, mutual assent can be expressed or implied. For a contract to exist there must be some form of mutual assent, either through a written agreement or actions. A written agreement must show acceptance on behalf of all parties bound by the contract; this means that the terminology used in the document must expressly state that the parties agree to all of the conditions in the contract. A phrase such as I accept and agree to all of the conditions and provisions stated in this contract should be included in the document, along with the signatures of all the parties bound by the contract. Page 9 of 35

10 Fast Fact: Often, mutual assent is also referred to as a meeting of the minds. When there is a meeting of the minds, all parties who will be bound by the contract meet to discuss the terms of the agreement until they arrive at mutually acceptable terms. Example: Seller A has a property listed for sale. After seeing the listing in the paper, Buyer B contacts Seller A to set up a time to view the property. Buyer B visits Seller A s property and decides that she wants to purchase it, so she makes an offer of $180,000 on the house. The original listing price on the house was $225,000, but since Seller A has not been receiving any offers on the house, he decides to accept Buyer B s offer of $180,000. In order to show his acceptance of the offer, Seller A must sign the purchase contract. By signing the purchase contract, Seller A is showing that he is willing to sell his property to Buyer B for $180,000 and by presenting Seller A with the contract, Buyer B is illustrating that she is willing and able to pay $180,000 for the property. In a mutual agreement: There must be an offer and acceptance. There can be an offer and a counteroffer. The contract must not contain any form of fraud, misrepresentation or duress. There cannot be mistakes in the terms and conditions of the contract. Offer, Acceptance, and Performance There are three stages of a contract: the offer, acceptance, and performance. There is an offer when the conditions in the contract are presented, and there is acceptance when both parties agree to those terms. Once all parties bound by the contract have agreed to the terms of the offer, all parties must carry out (perform) the obligations outlined in the contract. Offer Once the buyer has found a property that he or she wishes to purchase, he or she will make an offer on the property. An offer is not just a statement of the price that the buyer is willing to pay; the offer also includes the details of the sale, such as how the buyer Page 10 of 35

11 wishes to finance the purchase, who will pay the closing costs, what inspections will be performed, what personal property will be included in the sale and the terms of cancellation. Basically, the offer is the sale contract itself. The offer is continuously modified until it meets the satisfaction of all the parties bound by the contract. After all of the parties (to be bound by the contract) have agreed on an offer, they must show their acceptance of the offer by signing the contract. Counteroffer If the offeree does not like the terms of the contract, he or she can make a counteroffer this means that he or she will modify the terms that he or she does not agree to and present it to the offeror; however, once the offeree changes the contract, he or she is placing a new offer on the table. The original offeror now has the right to either accept the new offer or make a counteroffer in return. An offer is considered rejected if the offeree blatantly rejects it or if the offeree makes changes to the offer. Example: Buyer B presents Seller A with an offer of $175,000 for her 4-2 Victorian-style house. Seller A tells Buyer B that she is not willing to part from her property for less than $225,000. In this case, Buyer B s offer of $175,000 is the original offer, and Seller A s offer of $225,000 is the counteroffer. Buyer B can counter Seller A s offer of $225,000 by offering $190,000. The process of counter-offering can continue until both parties come to a mutually acceptable agreement. Buyer B and Seller A might decide that $200,000 is an acceptable compromise. Exercise: Please read the following scenario. Afterwards, you will be asked to identify the original offer, counteroffer and final offer. After several months of looking at homes, Buyer B has finally found the house of her dreams. It is a four-bedroom, three-bathroom, ranch-style house situated on 2 acres of land. The listing price on the property is $375,000. Although Buyer B loves the property, she is not willing to pay $375,000. After talking to her real estate agent, Buyer B decides Page 11 of 35

12 to make an offer of $325,000. Seller A rejects the offer of $325,000 but states that he is willing to compromise. He says the lowest he is willing to sell his property for is $350,000. Buyer B discusses the offer with her real estate agent, and they both conclude that $350,000 is a reasonable price for the property. Buyer B contacts Seller A and says that they have a deal. 1. What was the original offer on the house? a. $375,000 b. $350,000 c. $325,000 d. $300, What were the counteroffers? a. $375,000 b. $350,000 c. $325,000 d. Both B and C 3. What was the final offer? a. $375,000 b. $350,000 c. $325,000 d. $300,000 Exercise Answers 1. a. $375,000. Feedback: The original offer would be the price that the property is listed at. This is the seller s offer to the buyer. 2. d. Both B and C. Feedback: A counteroffer occurs when either party rejects the original offer and makes a new and modified offer. Page 12 of 35

13 3. b. $350,000. Feedback: The final offer is the agreement that both parties concede to. In this case, the final offer was also a counteroffer. Once the buyer and seller or agent and client have come to mutually acceptable terms, they will have to show acceptance of those terms. Acceptance shows that the parties agree to the contract and are willing and able to perform the contract. There are three types of offers and acceptance: 1. Express Offer and Acceptance: A candid and unqualified outward manifestation of agreement. When there is express offer or acceptance, there is no mistake as to whether the parties have agreed to the offer. The parties explicitly state that they agree to the terms of the offer. An example of express acceptance would be, Yes, I agree to your offer. On real estate agreements each party will sign the purchase contract and initial any changes. 2. Implied Acceptance: The parties bound by the contract act in a manner that implies acceptance of the offer. An example of an implied offer and acceptance would be if the parties began acting out the obligations of the contract, like if one party transferred the title of the property to another party. 3. Conditional Acceptance: Acceptance based upon a specific condition or event happening. A conditional acceptance can also be viewed as a counteroffer. For example, Buyer B says, I will buy the home if the title search shows a free and clear title. This means that he will buy the home only if his condition is met. Note: Both the buyer and the seller have the right to retract their offer at any time up until the time the offer is completely agreed upon and the acceptance of the offer has been communicated to the other party or their agent. The person extending the contract is the offeror and the person accepting or rejecting the contract is the offeree. The offer remains open until it is accepted, rejected, retracted prior to acceptance, countered or expired. Once the offer has been accepted, all parties bound by the agreement are expected to perform the terms of the contract. Page 13 of 35

14 If the offeror wants to assign or transfer his/her rights under the contract to another person, the contract can be assigned before closing. However, if the offer or has not heard of the offer s acceptance, he or she can revoke his or her offer at any time; this is known as retraction. For example, if Buyer A makes on offer on a house and has not heard of an acceptance, she can revoke her offer. Performance Once the terms, obligations and provisions of the contract of the contract have been established, it is the responsibility of all the parties to carry out their part of the contract. This is known as performance. Performance typically requires each party to carry out a specific action in order to achieve a specific end result. Example: Seller A has an ad in the newspaper listing his property at $250,000. Buyer B contacts Seller A and offers him $225,000 for the property. At this point, Seller A tells Buyer B that he will consider the offer and will let him know; however, Buyer B explains to Seller A that he has two weeks to make a decision. In this example: Buyer B s bid of $225,000 represents the offer. Seller A s decision will either be an acceptance, rejection or counteroffer. Seller A has three options: 1. He can accept the offer. 2. He can reject the offer and offer a counteroffer. 3. He can simply reject the offer. Buyer B has two options: 1. She can wait for the offer to be accepted or rejected. 2. She can retract the offer (before hearing of its acceptance/rejection). Page 14 of 35

15 Note: The Texas Promulgated Contract Forms do not have an expiration date. If a licensee adds an expiration date it is the unauthorized practice of law. All offers and counter offers remain active until accepted, rejected or withdrawn. Please identify whether the following action or statement is an example of an express, implied or conditional acceptance. 1. Seller A says, I will accept your offer if the termite and asbestos inspections show no findings. Is this an express, implied or conditional acceptance? 2. Seller B says, I have decided that your offer of $100,000 is appropriate so I will accept and sign your offer. Is this an express, implied or conditional acceptance? 3. Seller C transfers the title to Buyer X, and Buyer X places a down payment on Seller C s property. Is this an express, implied or conditional acceptance? Exercise Answers 1. Conditional 2. Express 3. Implied Fraud Fraud occurs when an individual purposefully deceives another individual in order to induce him or her to part with something valuable. Fraud usually results from a failure to disclose information, a false promise or a lie. The difference between fraud and misrepresentation is the knowledge of the person committing the fraud or misrepresentation. When there is fraud, the level of malice is intentional and damaging; this means that an individual knowingly plans to deceive another individual in hopes of benefiting from that injury. Example: Buyer B explains to Seller A that he is looking for a safe and secure neighborhood to raise his family. He asks Seller A if there have been any recent crimes in the area, and Seller A says there have not been, even though she knows that there Page 15 of 35

16 have been car thefts within the last three months. Seller A is purposefully withholding information because she suspects that Buyer B will not purchase the home if he knows about the robberies; therefore, Seller A is involved in fraud. Read the scenario and identify which of the following incidents are examples of fraud. A. Seller A tells Buyer B that there is a bus stop nearby, when he knows for a fact that there is not. B. Seller A tells Buyer B that the market is unstable and unpredictable. C. Seller A tells Buyer B that property values have been rising, even though they have not been. D. Seller A tells Buyer B that the house is a great investment. E. Seller A tells Buyer B that the property is located in a beautiful area. F. Seller A tells Buyer B that the property has been renovated within the last two years, even though she knows that the property hasn t been touched in five years. Exercise Answers The examples of fraud were: a) Seller A tells Buyer B that there is a bus stop nearby, when he knows for a fact that there is not. c) Seller A tells Buyer B that property values have been rising, even though they have not been. f) Seller A tells Buyer B that the property has been renovated within the last two years, even though she knows that the property hasn t been touched in five years. Innocent Misrepresentation Innocent misrepresentation occurs when wrong information is provided, but it is not done intentionally or for the purposes of deceiving another individual. Innocent misrepresentation occurs when an individual unknowingly deceives another individual; however, this innocent deception causes another individual to suffer a loss or injury. Page 16 of 35

17 Example: Buyer B visits Seller A s home and notices that there is a hiking trail behind the property. Buyer B loves the prospect of living near a trail so she makes an offer on the house, and Seller A accepts it. However, two weeks before Buyer B moves in, the city closes the trail to the public. In this case, Seller A had no way of knowing that the city would close the trail; therefore, she innocently misrepresented the property. Seller A provided Buyer B with inaccurate information, but she did not do so intentionally or for the purposes of deceiving Buyer B. Mistake In contracts, a mistake occurs when there is an unintentional ambiguity or oversight that wholly affects the agreement. A mistake is an honest misinterpretation of the facts and information provided. Example 1: Seller A advertises that she has a beachfront property for sale. Buyer B contacts Seller A, who gives the buyer faulty directions to the property. Seller A explains to Buyer B that she will not be available to show the property, but Buyer B can look over the exterior of the property if she wants. After viewing the property, Buyer B tells Seller A that she is definitely interested in the property. However, after further discussions with Buyer B, Seller A realizes that Buyer B misinterpreted the directions and looked at the wrong property. Therefore, Buyer B has made a mistake. Since the seller gave admittedly bad directions and the buyer looked at the wrong property, we have a bilateral mistake. If the mistake is unilateral, then the contract cannot be rescinded. Example 2: John has a ring he wishes to sell and Jennifer wishes to buy the ring. John shows Jennifer the ring and she thinks that the ring has a genuine sapphire stone. It does not. John never tells Jennifer the ring is a sapphire, he just tells her he purchased the ring to give to his ex-girlfriend, and now that they have broken up, he has no use for Page 17 of 35

18 the ring. Jennifer pays John $200 for the ring and then takes it to a Jeweler who tells her the ring is not a genuine sapphire. This contract cannot be rescinded since the mistake was a unilateral mistake. Duress In order to have a mutual agreement, the offer and acceptance must be freely given. This means that the offeror cannot use duress (or force) to get the offeree to agree to the contract. Any contracts made under duress are void. For example, if a tenant blackmails his or her landlord into reducing his or her rent, then the contract is made under duress and is inadmissible. Please complete the paragraph using the following terms. Duress Innocent misrepresentation Fraud Mistake Negligence Fraudulent misrepresentation Offer Counteroffer 1. Buyer B visits a property he found listed in the paper; the address on the ad is 123 ABC Lane. Buyer B likes the property he sees; therefore, he contacts Seller A for more information. When Buyer B mentions the property s address, Seller A realizes that there was a typo in the ad; the address should have been 321 ABC Lane. Buyer B had looked at the wrong property. This was obviously a(n). 2. Seller A provides Buyer B with the correct address, and this time, Buyer B visits the right property. Buyer B arrives at the property expecting to see the property in pristine condition, but instead, he discovers that several of the windows of the Page 18 of 35

19 property have been broken and the doors had been removed. He is upset with Seller A for telling him that the house was in perfect condition. Buyer B calls Seller A and wrongly accuses Seller A of. 3. Seller A explains that he did not know that the windows were broken. Later, Seller A discovers that some neighborhood kids had vandalized the property, and she admits to Buyer B that she is guilty of. 4. Seller A tells Buyer B that she is willing to sell the property for $150,000; $20,000 less than the listing price. Buyer B admits that he was overzealous with his accusations and believes that the windows and doors can be easily repaired; however, he is only willing to pay $140,000 because he feels that the house needs a lot of repairs. Seller A rejects Buyer B s. Exercise Answers 1. mistake 2. fraud 3. innocent misrepresentation 4. counteroffer Lawful Objective Lawful objective means that the contract cannot call for any illegal activities. When a contract contains lawful objective, it takes all necessary laws and statutes into consideration. When a contract is drawn up, the offeror must consider the law and any regulations governing the transaction because any contract that involves illegal conduct is considered void and is unenforceable in a court of law. A legally valid contract adheres to all federal and state laws. For example, seller wishes to sell property that has been declared hazardous by the EPA due to a leaking underground storage tank. The property cannot be sold until the seller mitigates the hazardous condition. Buyer buys property and learns of the condition. This contract was void from the beginning. Page 19 of 35

20 Consideration (not earnest money) In order for a contract to be legally enforceable, there must be consideration from each party. Consideration is something valuable that each party exchanges in order to demonstrate that he or she agrees to the contract s terms; it can be a promise, money, property, forbearance or services. In most real estate transactions, consideration is met in the form of a promise for a promise; however, most people consider money to be the most popular form of consideration. If there is no consideration, then the contract is not legally binding. The legal philosophy is that a person cannot do something of value without receiving something in turn. This basically means that each individual (or party) must suffer a detriment in order to gain a benefit. In a real estate contract the exchange of promises acts as consideration. The buyer promises to pay $xxxxxx for the property and the seller promises to give a deed. Earnest money is not consideration. The promises are the consideration. Example: Person A provides Person B with housing; however, Person B must offer Person A something in return, such as money or a promise to help out with housekeeping or property maintenance. Without a promise from Person B the contract would be void. It does not contain all of the essential elements of a contract. Adherence to the Statute of Frauds Each state has a law known as the Statute of Frauds; this law requires that specific contracts be in writing and signed by all of the parties who are bound by contract. The purpose of the Statute of Frauds is to ensure that all of the parties have the terms of their agreement readily in hand; by having a copy of their agreement, any disputes that arise can be easily resolved. Page 20 of 35

21 A Statute of Frauds calls for the following contracts to be in writing: Contracts involving the sale or transfer of real estate Contracts concerning debts or specific duties Contracts that cannot be completed within one year Contracts for the sale of goods (with a value of over $500) under the Uniform Commercial Code Contracts with the consideration being the agreement to marry (prenuptial agreements) The Statute of Frauds is designed to prevent injury from fraudulent conduct and to thwart attempts to seek legal enforcement of a nonexistent contract. A written contract reduces the chances of litigation and provides the parties with a reference to the terms and conditions of their agreement. Usually, the parties in a valid and comprehensive contract can refer to the contract to resolve any misunderstandings that may arise, thus eliminating the need for litigation. Going to court to resolve a contract dispute can be costly; therefore, in order to save money on court costs, all parties in a contract should strive to clearly state and understand the terms of their agreement. For example, a tenant visits an apartment complex and talks to the landlord about renting an apartment for a year. The tenant visits a couple of apartments before settling on a studio apartment. Prior to renting the apartment, the tenant negotiates the rent of the apartment with the landlord. Finally, both parties verbally agree that $400 is a fair rent for a studio apartment. The landlord fills out the lease, and both parties sign it. However, soon thereafter, the tenant realizes that the rent on the lease is listed at $425. The tenant approaches the landlord and says that the landlord filled out the lease incorrectly and demands that the landlord change the lease. The landlord tells the tenant that since he signed the contract, the terms will remain as they are. The landlord tells the tenant that if he wants to move in, he must pay the first month s rent ($425) and pay the deposit ($150). Not wanting to lose the apartment, the tenant pays the first month s rent and deposit. Page 21 of 35

22 In this case, the tenant acted irresponsibly by not carefully reading the terms of the contract prior to signing it, and the landlord acted deceptively by altering the terms of their verbal agreement. However, unless the tenant can provide evidence that the landlord promised to rent him the apartment for $400, he does not have a case against the landlord. Leases for more than one year must be in writing; this means that if the tenant signed the agreement, he is bound to the terms stipulated in the agreement. If the tenant takes the case to court, the landlord can provide evidence of the tenant s agreement to pay $425 by producing the signed contract. Not only does the landlord have written evidence of that agreement, the landlord can also show that the tenant began performance of the contract by paying the first month s rent. Therefore, it is vital that all parties to a contract read over the terms of the agreement carefully; if they do not understand the terms of the agreement, they should have an attorney look over the contract and explain it to them. Contracts are legally binding and enforceable; failure to understand them can lead to damages and losses. A contract does not necessarily have to consist of formal documents; it can be made up of signed letters and memorandums. As long as the documents contain the essentials of a valid contract, the terms of the Statute of Frauds are satisfied. For example, a landlord and tenant are communicating through letters about lowering the tenant s current monthly rental rate. The tenant had written the landlord, disclosing some financial problems he had been having, and asked the landlord if he would lower the rent by $15 a month. In a letter, the landlord writes that he agrees to the tenant s suggestion of lowering the rent by $15 a month; the letter is closed with the landlord s signature. The tenant is currently paying $340 so his new rent would be $325. Although the landlord and tenant both agree to the new rental rate of $325, neither can draw up a new agreement addressing the change in the lease. Three months later, the landlord sends the tenant a bill for $75, stating that the tenant has not been paying his full rent. The tenant refuses to pay the landlord because the Page 22 of 35

23 landlord had agreed to lower his rent in the letter. The landlord says that because they never drew up a new contract, the tenant is bound to the terms of the old agreement. The landlord tells the tenant that if he does not pay, then he will take the tenant to court to force payment. What do you think will happen? Consider the following points: The landlord and tenant did not create a new formal contract. The tenant never signed anything agreeing to the landlord s promise to lower the rent. The only existing contract is the old one, stipulating $340 as the rent. Although the tenant and landlord do not have an actual formal contract stipulating the change in rent, the tenant does have proof of the landlord s agreement to lower the rent by $15. The letters are evidence of the landlord s agreement to the tenant s offer. The landlord promised to lower the rent, and he illustrated this by signing his letter to the tenant. In situations like this, if the tenant has signed proof of communication between himself and the landlord regarding lowering his monthly rent, then the tenant has a solid defense in court. In this case, the tenant will prevail because the court will most likely find that the landlord should uphold his promise. The Statute of Frauds does not make a contract void; instead, the statute makes a contract voidable. In the event that one party does not wish to follow through with the agreement, the party can withdraw from the contract. The contract remains valid until one party opts to void it. Oral contracts are established when the offeror states the offer and the offeree accepts the offer. In an oral contract, there are no formal or written documents spelling out the terms and conditions of their agreement. Instead, each party relies on the word of the other. Oftentimes, oral contracts are called verbal contracts in everyday speech. The term verbal simply means in words. This would make all contracts verbal contracts, regardless of whether they are written or spoken. For legal purposes it is best to use the Page 23 of 35

24 term oral contract (meaning a spoken agreement) when we want to identify a contract that is not recorded in writing. Express or Implied Contracts Implied Contracts Implied contracts are inferred from the actions of various parties, but are not necessarily written or spoken. Even though these contracts are established by the parties conduct rather than a written document or an explicit discussion, they can have all of the legally binding power of more explicit contracts. For implied contracts to be legally enforceable there must be an exchange of promises. One party offers money, services, property rights, etc., in exchange for something else of value. Implied contracts have an offer and acceptance which are simply understood and not explicitly spoken or written. Examples of Implied Contracts When individuals visit their doctor for an examination, they generally expect to pay for the exam at the end of the visit. It is the general social conventions surrounding medical practices combined with an individual s acceptance of the doctor s services which create an implied contract between doctor and patient. The patient owes the doctor compensation for services rendered. When an individual dines at a restaurant, orders food and eats it, he or she creates an implied contract with the restaurant. The individual is expected to compensate the restaurant for the meal. When an individual takes a taxi cab to one s destination, this creates an implied contract with the cab driver. The passenger must compensate the cab driver for the transportation provided. Social conventions play a large role in creating implied contracts. To avoid errors, oversights and misunderstandings from an individual not familiar with a specific service, many individuals take steps to spell out the terms of implied contracts. Taxi cab drivers Page 24 of 35

25 post rates on the windows of their taxi cab. Restaurants post prices on their menus. This makes it clear services are for sale, not a gift. Real estate licensees should not let any aspect of their services be defined by an implied contract. Implied contracts do not help avoid errors, oversights and misunderstandings of an agreement with individuals outside the real estate industry. Implied contracts are likely to be a source of confusion. For example, a licensee can show prospective buyers many properties and be representing the seller. Express Contracts Express contracts are oral and written contracts in which the parties explicitly state, or express, their intentions and their expectations regarding the contract. They stand in contrast to implied contracts where the existence of a contract (and the nature of its terms) is inferred from the parties conduct. If one party deviates from the agreed-upon terms of an express contract, the injured party can seek damages and legal recourse. Express contracts essentially serve as a reference in the event of errors, oversights and misunderstandings. An express contract best serves as a reference when it is written. Example of Express Contracts A lease agreement is an express contract in which both the lessee (tenant) and the lessor (landlord) sign the agreement. If the lessee fails to uphold the terms in the lease, then the lessee is subject to the conditions set forth in the lease agreement concerning such violation. Most written leases explicitly state the penalties (such as late fees or eviction), for violations (such as non-payment of rent), which provide prospective tenants and landlords an opportunity to see and consider all terms before accepting a lease. Page 25 of 35

26 Unilateral or Bilateral Contracts Bilateral Contracts This is an agreement in which both parties give consideration and promise to perform the actions specified in a contract. This kind of contract creates reciprocal obligations, in which each party is mutually obliged to the other. Examples of Bilateral Contracts In a bilateral contract, Party A must promise to do something for Party B and Party B must promise to do something for Party A. This contract obligates both parties to fulfill certain terms. To satisfy or complete a bilateral contract, all parties involved must carry out their promises. In a real estate transaction, the buyer (Party A) promises to pay the seller (Party B) the agreed-upon price and the seller (Party B) promises to transfer the property title to the buyer (Party A). There are thus specific things both of them must do before the contract can be considered complete. If the buyer pays the seller, but the seller does not transfer the title, then the contract is not complete and the buyer can seek legal recourse against the seller for failing to honor the obligations imposed by the contract. Unilateral Contracts This is a contract made between two or more parties in which only one of those parties makes a promise or otherwise accepts an obligation. In short, this contract is an offer (promise) which can only be accepted by actually performing the terms of the offer. Examples of Unilateral Contracts In a unilateral contract, Party A makes a commitment and Party B accepts this commitment. This contract is completed or fulfilled when Party A has carried out the commitment. There is nothing Party B must do to execute such a contract. Page 26 of 35

27 Party A does not have to agree to the contract openly or explicitly. Instead, Party A agrees to the contract by carrying out the action specified in the contract. A broker promises to pay a $1,000 bonus to any salesperson who brings in 10 new listings, not knowing who will bring or will not bring 10 new listings. This does not obligate a salesperson to anything. The broker unilaterally agrees to give $1,000 to any salesperson who satisfies the set performance standards. No salesperson in the office has to agree to anything but may collect on the promise if he or she chooses. Valid, Void, Voidable & Unenforceable Contracts Oral contracts occur when an individual (the offeror) states his or her offer, and another individual (the offeree) says whether he or she accepts the offer. In an oral contract, there are no formal or written documents that identify the terms and conditions of their agreement; instead, each party relies on the word of the other. Oral contracts are sometimes called verbal contracts. However, the term verbal implies that there is a usage of words, and because both written and verbal contracts involve some exchange of words, it is inaccurate to use the term verbal contract. Valid Contracts Recall that the five essential elements of a valid contract are: Mutual assent (100% agreement) Legally competent parties (18, sane and sober) Consideration (An exchange of something of value) Lawful objective (The purpose of the contract must be legal) Adherence to a statute of frauds if required (Written and signed offer and acceptance) Once a contract has been created, it falls into one of four categories: Valid Void Page 27 of 35

28 Voidable Unenforceable Valid contracts are legal agreements meeting all the essential, basic requirements of the law. They accurately reflect the contracting parties intentions making them legally binding and legally enforceable for all parties involved. Contracts do not always have to be written and signed, unless it is required by the Statute of Frauds. A strictly oral or implied contract can be just as legally binding as a written contract. Void Contracts A void contract has no legal effect; this means that the stipulations and conditions in the contract cannot be legally enforced. A void contract is an attempt to create a legally binding agreement; however, it does not impose any legal rights or satisfy the requirements of a legally valid contract. Typically, void contracts are unenforceable because they call for an illegal act, fraud, misrepresentation, duress or undue influence. Examples: A contract entered into only because one party threatened the business of another. A contract that requires an individual to steal someone else s property in exchange for a promise. A contract that requires an individual to embezzle money. Voidable Contracts Voidable contracts are those entered into with one party not competent to make a contract. So, if a contract is entered into with a minor, the contract otherwise has mutual assent, consideration, meets all the requirements of the statute of frauds and is for a legal purpose the contract is deemed voidable. The incompetent person may ratify the Page 28 of 35