Why Contracts Should Create Obligations

What possible answers are there to the question of why contracts should create obligations between the parties that the law will enforce?  Which of the answers do you find most convincing and why?

Introduction

Contracts are known to be the backbone of the various laws in businesses as they determine the legality and the capacity of an agreement between two parties (Brown & Welsh, 2004). Classified as legal documents, contracts are one of the most common and accessible legal documents utilized by people all over the world.

By nature, contracts are flexible and can be agreed upon by two parties anytime without required legal knowledge or expertise (International Development Research Center, 2000). McKendrick, E (2005) defines contract as a legal document containing legal binding agreements enforceable by law. In layman’s terms, contracts are simply an exchange of promises between two parties which contains remedies for breaches in agreements. Since contracts’ main purpose is to formalize the agreements set between two different parties or more, it can therefore suit any type of agreement.

Normally, contracts cover a broad range of situations and objects of agreement from goods or commodities transfer, sale of properties, employment terms, marriage, insurance, leases, checks, security agreements, software licenses, franchise agreements, promissory notes, shareholder agreements, mortgages and many more (Larson, A. 2003).

A contract will not be considered a contract in the absence of any of the elements involved in it. According to Larson, A. (2003), several elements need to be present in order for a contract to be legal and enforceable by law which includes the following:

Mutual Consent- any law enforceable form of contract must be a product of a “meeting of the mind” or an agreement between two or more parties. In the absence of a mutual understanding between two parties, the contract will not be considered legal

Presence of an Offer and an Acceptance to the Offer- any legal contract is comprised of an offer to another party which is most likely to be accepted by that other party. The contract will only be considered a binding contract when the offer has been accepted by the other party.

Mutual Consideration- any legal contract contains an exchange of something with a higher value.

Delivery or Performance of an Agreement- in order for the contract to be completed, the actions or obligations of one party to another must be accomplished. When any of the parties failed to deliver the obligations as stated in the agreement, then the “breach of contract or agreement” takes place.

Agreement done in Good Faith- any enforceable or binding agreement is considered legal if only the agreements stated by both parties were done “in good faith”. Both parties should not have any ulterior motives of causing harm to the other party upon entering a contract.

Public Policies not Violated- any legal and enforceable contract does not violate an existing public policy. A specific contract on drugs for example cannot be considered legal and enforceable by law as it already violated an existing public policy.

Competent Parties- a contract will never exist in the absence of two or more mutually-agreeing parties. A contract must always consist of two parties who have the capacity to deliver the agreements stated in the contract

Friend, C. (2004) claims that people enter into contracts because of a variety of reasons. The Social Contract Theory, which states that the person’s political and moral obligations are dependent on an agreement or a contract, is nearly as old as the time of the great Greek Philosophers. This proves therefore that people have long been engaging in different types of contracts ever since given the many different types of situations.

Cochrane, M. (2007) also supports the notion that there are almost no specific reasons why people enter into contracts as the reasons are limitless. In fact, contracts are inevitably infused within the many areas of a person’s life. For instance, people enter into contracts when they decide to get married as well as when they decide to build a stadium within a community, lease a commercial space, adopt children, purchase real estate properties, work for a specific company and apply for a savings account in a rural bank.

In preparing for contracts, lawyers or any legal representative must be present to write, negotiate and prepare the contracts that will be used by both parties. It is important that a legal representative is present as he will be the one to ensure that the needs and intentions of both parties are met and are enforceable by the law. Also the presence of a legal representative makes the documents signed by the parties legal as he himself witnessed the mutual agreement between the parties (Trans Legal, 2010).

Oftentimes, the standard format of contracts is dictated by the legal body or the law firm consulted by the parties. In most cases, depending on the agreements of both parties, the standard format is revised and customized to suit the necessary agreements between the two parties. The documents pertaining or supporting the contract are therefore considered legal documents as the basic elements of a contract were met. Moreover, the preparation of the contracts varies depending on the complexity and the set terms agreed upon in the contract as well as the situation of both parties (Trans Legal, 2010).

Because of the legal nature of contracts, people enter into it in order to create a legal binding agreement between them and another party. As stated in the article entitled, The Need for Intention to Create Legal Relations in Contract Law, legal relations is established within a contract. Legal relations is one of the most sought after benefits of people out of making contracts as this puts them into a legal and rightful position to enter into an agreement. In a way this “legal relations” is what protects them from engaging in commercial dealings with much-reduced risks involved.

Also, it does not appear safe and worthwhile to make a handshake with a person you’ve agreed with when there is no legal binding document which serves as a legal reference between two persons. This legal reference is the contract itself which contains the conditions and terms of agreement between two persons agreeing into something. Other than the contract being a legal document which protects and legalizes the agreement between two competent parties, other benefits are also involved in signing up for a contract such as the clarification on the scope of work or the terms and conditions of the agreement and the clearly stated obligations and responsibilities of both parties (“The Need for Intention to Create Legal Relations in Contract Law”, 2008).

What is Contract Law?

According to Chen-Wishart, M. (2008), contracts, being an abstract concept itself, are prone to disputes between the actual parties who entered such an agreement due to its very nature. Contracts are not considered as “things” that go beyond the scope of the law since although it is mainly an abstract concept, it can still be greatly perceived by the physical senses.

Contract law is very important in the process of making agreements because of its capacity to define the rules in the “contracting game”. Also its application in the judicial process serves to be highly critical as it serves to fulfill the following:

guide the formation of the contract

identify and interpret legal terms in the contract and,

provides remedy for a breach

According to Thomson Reuters (2009) a breach of contract happens when one of the two mutually-agreeing parties failed to deliver the actions or obligations expected of the party to deliver to the other party. A breach of contract is the other party’s failure to fulfill or deliver an end of the agreement or bargain stated under a mutually-agreed contract. A breach of contract occurs when:

a.) one of the parties involved in the agreement failed to deliver on time

b.) one of the parties involved in the agreement failed to deliver according to the terms set on the agreement, and

c.) one of the parties involved in the agreement does not deliver or fulfill a specific obligation at all

Aside from its capacity to set guidelines for the process of making the agreement or the contract itself, contract law also defines which “agreements” and “promises” that occurred in a contract are legally binding or not. According to Chen-Wishart, M. (2008) contract law provides explanations on the real basis of contractual obligations.

In terms of classification, contract theories that served as the basis for contract law are classified as either descriptive or normative. The descriptive foundation of contract law is what provides explanation on the common practice of the law while the normative foundation is what provides for the main basis of developing the rules in contract law which stems from basic theories (Chen-Wishart, M. 2008).

By definition, contract theories paint the big picture out of which the contract agreement occurred. These contract theories generate various types of propositions offering a specific detailed rule. On the other hand, Bhana, Bonthuys & Nortje (2009) argues that while each contract theory offers or presents a specific type of rule, contract theories are not necessarily considered as rules by themselves.

Instead, contract theories only offer an answer to the question on why contracts should create obligations between the parties that the law will enforce. It also answers the question on why the law must be able to protect the contract agreements made by people among themselves. The role of contract theories therefore is to present legal enforcement mechanisms (Bhana, Bonthuys & Nortje, 2009).

According to Chen-Wishart, M. (2008) it is but an impossible task to identify or pinpoint a single contract theory which covers the contract law in its entirety as there are various types of contract theories which each explain a particular rule in the contract law.

The following contract theories that this paper will tackle will each give an overview and explanation on why contracts should create obligations between the parties that the law will enforce. These contract theories are the Reliance Theory, Promise Theory, and the Consent or Transfer Theory which this paper will delve into in detail in order to justify the point why contracts must create obligations between the parties involved in the agreement, that is, obligations which the law must strictly enforce.

Also, at the end of this paper, the author will choose which among the theories presented is most convincing in stating why contracts must create obligations between the parties that the law will enforce. This paper will give a detailed overview of what each theory states as well as rules each theory proposes.

What are Contractual Obligations and When are they Formed?

According to Cabot, G. & Harmon, S. (2002), contrary to many people’s belief, contractual obligations may exist and may be proven to be legal and lawful despite of it being “oral”. Many people assume that contracts have not been made if there were no signing of contracts in papers that took place.

Nevertheless, the most common form of contractual obligations is formed in writing. Certain big transactions such as real estate agreements, marriage contract and leasing contracts most commonly appear in writing. Thus when a piece of a written contract is already present, legally binding two or more parties in an agreement, contractual obligations also become present.

According to Bhana, Bonthuys & Nortje (2009), one of the major aims of establishing contracts are really for the creation of legal obligations between two competent and legal parties. Legal obligations or contractual obligations are defined as the legal relationship or legal tie that legally binds two people together with a corresponding performance, duty or action that is meant to be provided or given by each of the two parties to one another.

In a contractual obligation or relationship therefore, there exists a party which possesses the full rights of claiming a performance or delivered action from another party, and there also exists a party which exercises that performance or duty to be given to another party.

In simple words, the existence of a contract connotes an imposition of a duty or performance that must be given, provided or delivered to a specific party involved in the agreement. Sets of obligations are merely intended for a particular contract and are not expected to be delivered in another contract that both parties have also entered together with (Bhana, Bonthuys & Nortje, 2009).

Moreover in contractual obligations, debtors and creditors exist. Debtors refer to the party who has the obligation or performance to deliver to another party while creditors refer to the recipient of the performance or obligation delivered by the debtor. In cases wherein obligations are more than one, the contracts must specifically identify who among the parties play the role of the debtor and the creditor so that expectations will be aligned and obligations will be properly met (Bhana, Bonthuys & Nortje, 2009).

Nevertheless, it is very important to note that all obligations are created by contracts, although all contracts contain obligations. Commonly, these obligations are contained within the terms and conditions part of the contract. Since obligations are simply “performances” that need to be delivered by a specific party (debtor) to another party (creditor), these usually are something given, something done in favor of another party or something that a party (debtor) must refrain from doing. These types of performances or obligations are specifically identified within the contract (Bhana, Bonthuys & Nortje, 2009).

Why Should Contracts Create Obligations between the Parties that the Law will Enforce?

Based on the Scottish Law of Obligations (2009), contracts must create obligations between two parties which are enforceable by the law in order to regulate the duties and protect the rights of every individual entering into the agreement.

Contracts may exist either verbally or in writings but there is no complete assurance that the parties involved in the said contract or agreement will indeed fulfill the obligations or performances indicated in that piece of contract. Hence, it is completely necessary therefore to include very specific obligations that are enforceable by the law in order to push or even force both parties to deliver what they have committed to deliver with each other. Otherwise, if these obligations are not strictly enforced by law, the parties will be lenient and will not take seriously, the obligations set within the contract (Scottish Law of Obligations, 2009).

The law of obligations within contracts is also intended to protect the rights of every individual who entered into a contract or agreement. When a contract that has been made was proven to be legal, carrying all the essential elements that a “legal” contract must have, then the rights of the individuals within a contract are considered legal as well. Hence, when one of the parties involved in that agreement did not follow the terms and obligations indicated in the contract, then the other parties involved have the right to consult a legal entity or appeal to the court system for the remedies on the breach of contract or agreement.

This therefore proves that creating obligations between parties in a contract puts a specific party at an advantage as the latter can exercise that right to legally enforce another party to deliver his or her commitments as stated in the contract.

There are three specific theories which explain the necessity of creating obligations between two parties which are enforceable by the law and these contract theories are the following:

Promise Theory

According to Chen-Wishart, M. (2008) promise theory simply refers to the contractual obligation or liability of both parties involved in the contract agreement by virtue of their assumed voluntary obligations as stated in the contract which gives rise to “voluntary rights” of each of the agreeing parties.

Bergstra & Burgess (2008) defines promise theory as a model which depicts “voluntary cooperation” between two individuals, groups, agents, and autonomous actors who publish or put into writing their intentions with one another through the form of a promise. By definition, a promise is simply a declaration of people’s intent for the purpose of increasing the certainty of the recipient with regard to a specific claim or promise to be fulfilled in the past, present or future.

In explaining contractual liability, it is but necessary to delve into the morality of promise-keeping. By theory, promise theory is unilateral with its focus mainly on the promisor or the person making promises. What makes promise theory critically involved in the creation of obligations is simply its ability to form voluntary assumed obligations that the promisor needs to undertake towards another person, to whom he made such promises (Chen-Wishart, M. 2008).

As in most cases, this is where the breach of contract comes to life since most of the time, a promise made can easily be put aside by the promisor, thus breaking his or her voluntary assumed obligations for that person. This is where the law may be able to intervene in order to restore the voluntary rights of the person to whom the promise was made.

What is interesting in applying the promise theory is the fact that this theory recognizes that undertaking obligations towards a person is critical and must be taken seriously since legally, a promise is considering legally binding or legal when the person to whom the promise accepts it. Legally, promises made by the promisor to himself are considered irrelevant and not legally binding (Chen-Wishart, M. 2008).

Reliance Theory

According to Chen-Wishart, M. (2008), the reliance theory is somewhat connected to the essence of the promise theory. This is because reliance theory recognizes that contractual liability only arises during the following situations:

When a person (A) makes an implied or express promise to another person (B)

When the person (B) suffers loss by relying on the specific promise that the person (A) made

Any failure therefore on the accomplishment of that promise may be intervened by the law by setting contractual obligations particularly by the person who made such a promise. In reliance theory, the essence of creating contractual obligations is brought to life by protecting the rights and benefits of the person who relies on such a promise.

In the words of Chen-Wishart, M. (2008), reliance theory aims to ensure that those individuals who rely on such a promise do not suffer any extreme loss by relying too much on a reliance-inducing act. Based on the reliance theory, the contract law has the right and power to negate or fight against the harm normally caused by an induced reliance. Moreover, the reliance theory supports the three pillars which make up the law of obligations which are reward for any benefit, protection for any reliance-inducing act, and creation of liabilities and rights.

Furthermore, the reliance theory also presents quite a number of benefits when applied in contractual obligations such as the following:

a.) Moral justification- theories included in the reliance theory shows consistency when it comes to utilizing the “harm principle” wherein it is stated that the state has the right to interfere with a particular individual’s liberty in order to prevent other people’s harm which is equivalent to protecting the rights of an individual from a reliance-inducing act made by a particular person, which when that person failed to accomplish, may possibly cause harm on that certain individual.

b.) Provides the objective test of intentions- the reliance theory acts not on the basis of what the parties entering into the agreement intends to make but on what has been readily understood by the person on what the person is intending

c.) Tackles restraints on unfair conduct- reliance theory basically emphasizes one’s duty to care for others’ interests. It also emphasizes the liability that has been put upon a person who induced reliance from another person (Chen-Wishart, M. 2008).

Consent or Transfer Theory

According to Chen-Wishart, M. (2008), consent theory is primarily a social-philosophical theory which identifies people as free agents who normally enter in consensual types of relationships along with other so-called free agents.

Barnett, R. (1986) states that in any type of contract parties enter into, consent will always be at the central focus of the contracting agreement. This is because normally, parties enter into an agreement by consent.

The Scottish Law of Obligations (2009) also states that consent is an essential element in the formation of any type of contract. A contract would not exist if there was no mutual consent between two or more parties. Also, consent only takes place when there has been an acceptance of an offer by another party.

Moreover, other than consent the rules also dictate that in order for a contract to be considered valid, there must be at least two or more parties involved. Moreover, there are certain qualifications in order for a person or an entity to be considered a legal party. Factors such as age and the capacity or competency to deliver the obligations agreed upon in the contract are what determine the legality of a party wishing or intending to be part of a contract (Scottish Law of Obligations, 2009).

Furthermore, legal obligations are inevitable elements of a contract. A contract will never exist without the obligations, actions or performances to be fulfilled. Both parties enter into an agreement or a contract to do something in exchange of something. And oftentimes, these obligations or performances are being abused by both parties due to the lack of a strong reinforcement to fulfill such obligations. It is but human nature to violate laws, break promises and destroy oaths and many times, people loves to violate all the rules no matter how valuably it is intended for their protections (Scottish Law of Obligations, 2009).

As defined by Barnett, R. (1986) the consent theory involves the transfer of rights between and among right-holders. If the consent theory therefore involves rights-transfer, the law must therefore directly intervene and set limits on how people can possibly make use of those rights and how these rights may be transferred from one person to another.

Given this, there is no doubt that the consent theory is closely linked with contractual obligations as consent and the transfer of rights is a necessary pre-requisite for any contractual agreement. As stated in the article entitled, “the basic explanation on the binding characteristic of contractual commitments is mainly attributable to the very notion of entitlements or rights as well as how these rights are transferred and acquired (Barnett, R. 1986).

As continuously being re-emphasized, the very basic concept of consent could never be taken away from contractual agreement. This is because in the first place, no contractual agreement will be made without the existence of consent from among the parties involved. Also the very concept of contract itself is the transfer of entitlements from one person to another and even this very concept involves consent from the different parties involved (Barnett, R. 1986).

Which among the three contract theories which “create obligation among contracts between the parties that the law will enforce” is most convincing? Why?

In my view, the most convincing reason why contracts must create obligations between the parties involved which are enforceable by law lies at the very basic fact that human nature often fails to deliver what it intends to deliver. By nature, human beings often fail to deliver the promises they have made to another person even in a written contract.

In marriages for instance, one of the most basic contracts that people enter into, people deliberately fail to fulfill their marital obligations and duties as stated in the marriage contract. It is a sad fact and a reality that men and women who enter marriages easily forget about the vows, promises and legal obligations that bind husbands and wives in the marriage contract.

As the Promise Theory suggests, in most cases, breach of contract may easily be made by all parties involved in a contract agreement such as in marriage. Even promises made in front of hundreds of people such as in marriage, promises may easily be put aside and broken by the promisor, thus breaking his or her voluntary assumed obligations for that person. This is where the law may be able to intervene in order to restore the voluntary rights of the person to whom the promise was made.

For the author of this paper, the promise theory is the very essence of why creating contractual obligations which are enforceable by the law is a must. As stated in the promise theory, people are so used to destroying their promises and abandoning their legal obligations to another person even in a contract. Without the contract law in place, promise theory, people will simply continue making and breaking their promises within a contract which can possibly harm the person to whom they have made the promise. Hence, it is just fitting to acknowledge the theoretical principles presented by the promise theory in order to protect the voluntary rights and secure voluntary obligations from the promisor (Chen-Wishart, M. 2008).

Conclusion

Contracts are not just any form of agreement but a legal document intended to bind two or more competent parties entering into a mutual agreement with certain included obligations for both parties, enforceable by law. The flexibility of contracts caused its high rate of popularity among people covering a broad range of situations and objects of agreement from goods or commodities transfer to sale of properties, employment terms, marriage, and many more (Larson, A. 2003).

It is completely necessary for contracts to create and reinforce obligations among the parties involved which the law may enforce in order for the parties to avoid abusing and not taking seriously the agreements stated in the contract. It is only in this way that the human nature temptation of violating rules, laws and contracts may be lessened given that “punishments” and negative consequences are likely to occur if they violate the contract. Three basic theories support this principle which are the Promise Theory, Reliance Theory and Consent and Transfer Theory.

From among the various theories presented, the promise theory has proven to be the very essence of why creating contractual obligations which are enforceable by the law is a must. This is simply because people are so used to destroying their promises and abandoning their legal obligations to another person that without the contract law in place, people will simply continue creating and then breaking their promises within a contract which can possibly harm the person to whom they have made the promise. Given this dilemma, as presented by the promise theory, it is just fitting to acknowledge the theoretical principles presented in this specific contract theory in order to protect the voluntary rights of the person to whom the promise in a contract was made (Chen-Wishart, M. 2008).