© 2010 Rockwell Publishing Lesson 6: Contract Law Principles of California Real Estate.

Lesson 6: Contract Law

Principles of California Real Estate

Introduction

Contract: An agreement between two or more competent persons to do, or not do, certain things in exchange for consideration.

Legal Classifications of Contracts

Contracts may be classified according to certain basic characteristics.

Every contract is:express or impliedunilateral or bilateralexecutory or executed

Legal Classifications of Contracts Express vs. implied

Express contract: One that has been put into words, oral or written.

Implied contract: Created by the actions of the parties, not express agreement.

Most contracts are express, not implied.

Legal Classifications of Contracts Unilateral vs. bilateral

Unilateral contract: Only one party is legally obligated to perform as promised.

Bilateral contract: Both parties promise to do something and are legally obligated to perform as promised.

Most contracts are bilateral.

Legal Classifications of ContractsExecutory vs. executed

Executory: Contract has not yet been performed, or is in the process of being performed.

Executed: Contract has been fully performed.Note that “executed” may also refer to a

contract that has just been signed.

• Contract• Express or implied• Unilateral or bilateral• Executory or executed

SummaryLegal Classifications of Contracts

Elements of a Valid Contract

A valid contract requires: parties with legal capacity mutual consent lawful objective consideration

Contract is not legally binding unless all parties have legal capacity to enter into it.

Two requirements for legal capacity: age mental competence

Elements of a Valid Contract Contractual capacity

Generally, person must be at least 18 (age of majority) to enter into contract.

Someone under 18 is minor.Minors do not have capacity to appoint

agent or enter into contract.

Parent or legal guardian may enter into binding contract on minor’s behalf.

Contractual CapacityAge

Void: Contract has no legal effect. Neither party can enforce it.

Real estate contract in which one party is a minor is void.

Other contracts (not related to real estate) signed by minor are voidable by minor.

Other party can’t enforce contract.Minor can choose to enforce contract,

through parent or guardian.

Exception: Emancipated minor may enter into any type of contract, including real estate. (Copies of emancipation documents should be part of closing.)

Minor may be emancipated by:marriage (even if divorced)military servicecourt order

Mentally competent: Of sound mind.If one party has been declared mentally

incompetent, contract is void.Guardian can enter into contracts on

behalf of incompetent person.

If someone enters into contract while temporarily incompetent, contract may be voidable.

Contractual Capacity Mental competence

Aliens may enter into contracts to transfer property, although they may be subject to certain reporting requirements.

Incarcerated persons may also contract to buy or sell property, subject to public safety limitations.

Contractual Capacity Aliens and convicts

• Capacity• Age of majority• Mental competence • Aliens and convicts

Summary Contractual Capacity

Contract is legally binding only if both parties have consented to its terms.

Once contract is signed, consent is presumed.

No one should sign contract without understanding its contents.

Elements of a Valid Contract Mutual consent

Mutual consent is sometimes called mutual assent, mutuality, or meeting of the minds.

Mutual consent is achieved through offer and acceptance:

Offeror makes offer to offeree. If offeree accepts offer, contract is

formed.

Mutual Consent Offer and acceptance

Offer terminates if before acceptance:offeror revokes offertoo much time passesofferor dies or becomes incompetentofferee rejects offerofferee makes counteroffer

If offer terminates before accepted, no contract formed.

Offer and Acceptance Termination of offer

Offeror can revoke offer any time before acceptance.

Offeror must notify offeree of revocation.Even if offer was supposed to remain

open until particular date, offeror can revoke it before that date.

Termination of OfferRevocation

Offer with deadline for acceptance expires automatically when that date or time arrives.

Offer without deadline expires after reasonable amount of time.

Termination of Offer Lapse of time

If offeror dies before offer is accepted, offer is terminated and no contract is formed.

If a court determines offeror is mentally incompetent, offer is terminated.

Termination of OfferDeath or insanity

Rejection terminates offer.After rejecting offer, offeree can’t change

mind and accept it.Contract formed only if offeror still wants

to proceed.

Termination of OfferRejection by offeree

Counteroffer: When offeree agrees to some terms in original offer, but changes one or more terms.

Although sometimes called qualified acceptance, counteroffer is rejection of original offer and tender of new offer.

Roles of parties are reversed.

Termination of Offer Counteroffer

Offer and AcceptanceCommunication of acceptance

To create binding contract, offeree must communicate acceptance to offeror before offer terminates.

Acceptance effective as soon as it is mailed, rather than when it is received.

Negative Forces Affecting Consent

Acceptance must be freely given.Contract voidable by victimized party if

he can show consent resulted from:fraudundue influence duress

Negative Forces Affecting ConsentFraud

Fraud: Misrepresenting material fact to someone who relies on misinformation.

Material fact: Information that is likely to affect a decision.

Fraud is either actual or constructive.

Actual fraud: Person making misrepresentation knows or should know that it’s false:

intentional deceit, orstatements made without knowing

whether they’re true.

Constructive fraud: Person in position of trust or with superior knowledge unintentionally misleads someone.

It isn’t necessary to actually make misleading statements to commit fraud.

Simply concealing material fact may be fraud.

Negative Forces Affecting ConsentUndue influence

Undue influence: Taking advantage of one’s influence over another, or their weakness of mind or distress, to pressure them into contract.

Persuasion strong enough to overpower will, so consent isn’t truly voluntary.

May involve abuse of special relationship based on trust: broker-seller, attorney-client

Negative Forces Affecting ConsentDuress

Duress: Compelling someone to do something against their will, using force, constraint, or threats.

Elements of a Valid ContractLawful objective

Contract’s purpose (and consideration exchanged) must be lawful or contract is void.

Elements of a Valid ContractConsideration

Consideration: Something of value exchanged by contracting parties.

Money, property, services, or promise to do something (or not do it).

In typical real estate sale:seller’s promise to convey titlebuyer’s promise to pay agreed price

Elements of a Valid ContractStatute of frauds

Statute of frauds: State law that requires certain types of contracts to be in writing, and signed.

Statute of FraudsContracts must be in writing

California’s statute of frauds applies to any contract:not performed within one yearfor sale or exchange of real estate

(purchase agreement)for lease of property, if term is greater

than one year

Statute of FraudsContracts must be in writing

Statute of Frauds (cont’d): authorizing agent to buy or sell real

estate (power of attorney) authorizing agent to find buyer or seller

for real estate (listing agreement, buyer representation agreement)

assumption of mortgage or deed of trust

A contract subject to statute of frauds is unenforceable if it isn’t in writing and signed.

However, oral real estate contract may still be enforced in unusual circumstances, such as when purchase price has been paid.

Statute of FraudsNoncompliance

Any form of writing will suffice, including notes, letters or memos, so long as they:

identify contract subject matter and show agreement between parties, and

are signed by party to be bound.

Statute of Frauds

Contract may be printed, handwritten, or both.

If conflict between printed and handwritten parts, handwritten part takes precedence.

If party disputes whether contract was in writing, statute of frauds may not be used as defense.

Statute of Frauds

• Mutual consent• Termination of offer• Counteroffer• Fraud, undue influence, duress• Lawful objective• Consideration• Statute of frauds

SummaryMutual Consent/Other Contract Elements

Legal Status of Contracts

Four terms are used to describe legal status of a contract:

voidvoidableunenforceablevalid

Legal Status of ContractsVoid

Void contract: No legal effect whatsoever.

Parties are in same position they’d be in if they had not attempted to contract.

Contract can be disregarded.Occurs most often when one of the

essential contract elements is lacking.

Legal Status of ContractsVoidable

Voidable contract: Contract appears to be valid, but has some defect giving one or both parties power to withdraw.

Examples:non-real estate contract entered into by

minor (voidable by minor or guardian)contract entered into as result of fraud,

undue influence, or duress

Voidable contract is binding unless party asks court to rescind contract.

Withdrawing party must take legal action within reasonable time.

Otherwise, court may rule that contract has been ratified.

Legal Status of ContractsVoidable

Legal Status of ContractsUnenforceable

Unenforceable contract: One that can’t be enforced in court because:

its contents can’t be proved (oral contract or written contract that is vaguely worded)

other party has voidable contract statute of limitations has expired

Statute of limitations: Sets time limit for filing a lawsuit; party who misses deadline loses right to sue.

California statute of limitations: breach of written contract: 4 yearsbreach of oral contract: 2 years

Court may also bar claim under doctrine of laches.

Legal principle that allows court to decide unreasonable delay in asserting claim prevents legal action.

Different from statute of limitations, which sets specific deadline for filing claim.

Legal Status of ContractsValid

Valid contract:has all essential elementsis free from negative influencescontents can be proved in courtstatute of limitations hasn’t expired

If one party fails to perform as promised, other can sue to have contract enforced.

Summary Legal Status of Contracts

• Void• Voidable • Unenforceable• Valid

Discharging a Contract

Once there is a valid, enforceable contract it may be discharged by:

full performance, oragreement between parties

Discharging a ContractFull performance

Most contracts are discharged by full performance:

each party performs as promised, andcontractual relationship ends

Discharging a ContractAgreement between parties

The parties to contract may also agree to discharge contract in following ways:

rescissioncancellationassignmentnovation

Discharging a ContractRescission

Rescission: Parties sign written agreement to end contract and undo steps already taken.

If either party paid money or gave property, it’s returned.

Parties return themselves to positions they were in before contract was formed.

Discharging a ContractCancellation

Cancellation: Parties agree to terminate contract without undoing steps taken.

Money paid before cancellation is not returned (mainly, good faith deposit).

Discharging a ContractAssignment

Assignment: One party (assignor) withdraws and assigns his interest to new party (assignee).

Original contract not really discharged.Assignee has primary liability, but

assignor has secondary liability.If assignee defaults, other party can still

sue assignor.

Generally contract can be assigned without permission, unless:

contract has clause forbidding assignment, or

personal service contract (usually not assignable without permission).Example: listing agreement.

Discharging a ContractAssignment

Discharging a ContractNovation

Novation: Substitution of new party or new obligation between same parties.

Always requires consent of other (original) party.

Discharging a ContractAssignment vs. novation

When contract is assigned, there is continuing liability for the assignor.

With novation, there is no continuing liability for withdrawing party.

Summary Discharging a Contract

• Discharge• Full performance• Rescission• Cancellation• Assignment• Novation

Breach of Contract

Breach of contract: When one party fails, without legal excuse, to perform any of the promises contained in agreement.

If one party breaches contract, other party may have right to sue.

A breach may be material or minor.

Four legal remedies for breach of contract:

rescission compensatory damages liquidated damages specific performance

Remedies for Breach of Contract

Remedies for Breach of ContractRescission

As explained earlier, rescission is termination of contract that returns parties to their original positions.

Rescission may be:by agreement between parties, orcourt-ordered remedy for breach of

contract.

Remedies for Breach of ContractLiquidated damages

Liquidated damages: Remedy parties agree to in advance, with provision in contract.

If one party breaches, other party is entitled to agreed sum of money (liquidated damages).

Liquidated damages are only remedy; can’t sue for more.

Remedies for Breach of ContractLiquidated damages

In real estate transactions, buyer’s good faith deposit often treated as liquidated damages for seller, if buyer breaches contract. (Note special CA rules regulating these deposits.)

Remedies for Breach of ContractCompensatory Damages

Compensatory damages: Amount of money court orders breaching party to pay other party, to compensate them for losses incurred as a result of breach.

Most common remedy for breach of contract.

Remedies for Breach of ContractSpecific performance

Specific performance: Court orders breaching party to perform contract as agreed.

Remedies for Breach of ContractSpecific performance

Specific performance not always granted.Court may decide damages are adequate

compensation.

Generally, specific performance awarded only if subject of contract is unique.

Court may be willing to grant specific performance to real estate buyer.

Breach of ContractTender

Tender: Unconditional offer by one of the parties to perform as agreed.

Before party can sue for breach of contract, non-breaching party must show he is ready to carry out his side of bargain (deliver deed or fund purchase).

Summary Remedies for Breach of Contract

• Rescission• Compensatory Damages• Liquidated damages• Specific performance• Tender

© 2010 Rockwell Publishing Lesson 6: Contract Law Principles of California Real Estate.

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