4 Introduction to Contract Law
Learning objectives
On completion of this Chapter, you should be able to:
- describe what is a contract and its sources
- recognise the sources of contract law, and distinguish between a contract and an agreement
- define a contract and identify the essential elements of a contract
- explain the difference between a formal contract and a simple contract.
Key terms
Here are some terms you will encounter in the text, which will help you further understand this chapter:
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- Acceptance: an unqualified assent given in response to an offer, which creates an agreement.
- Agreement: one of the requirements for the creation of a contract, normally consisting of an ‘offer’ and an ‘acceptance’, which may arise expressly or be inferred from conduct, between two or more people.
- Contract: an agreement containing promises made between two or more parties, with the intention of creating certain rights and obligations, which is enforceable in a court of law.
- Escrow: an assurance in the form of a deed, money or bond held by a third party on behalf of two transacting parties that the transaction can be completed.
- Formal contract or deed: a contract that has been signed, sealed and delivered, and does not require consideration.
- Simple contract: a contract that is made orally or in writing (or both) involving an agreement between parties with the intention of creating legally enforceable obligations and which requires consideration to be valid.
Introduction
This chapter introduces you to what the sources of contract law are, what a contract is, its creation and classification and concludes with a brief note on e-commerce. Chapters 4 – 12 introduce you to what is perhaps the most important area of law you will encounter in business or your daily life. Contracts play a crucial role in business and society. Without them, life as we know it could not exist. Contracts underpin all transactions involving businesses, as well most transactions that you enter into as a consumer. An understanding of contract law will help you understand not only how and when a contract has been created, but also what are the rights and obligations of you and the other party to the contract.
However, there are three things you need to be aware of before we begin:
- First, the contracting parties owe each other a duty of good faith, not just when entering into a contract but then when both parties are carrying out their contractual duties. PNG courts have legislative powers to review contracts that are unfair under (see s 1(a)) of the Fairness of Transactions Act 1993 . But it should also be noted that although the duty of good faith exists in PNG contract law, it is still developing, so always be on guard when entering into a contract that you understand exactly what you are getting to (see s 4(1) of the Fairness of Transactions Act 1993). It will be one of the smartest things you will ever do).
- Secondly, if you have to prepare a contract, always try and write it in ‘plain English’, that is, keep it simple. If I have to write a contract, I always get someone to check it to try and ensure that it makes sense and that there are no errors. The reason is that what you write and what you see are sometimes different.
- Final point, like Chapter 3 on negligence, this and subsequent chapters are all written with you standing in the shoes of the plaintiff. Why you ask? Because in real life, in the examples given in these chapters, you could be the injured party.
Why is it important to have an understanding of contract law?
Contract law plays an important role in business and society generally, and an understanding of contract law can be a very useful tool to have a basic knowledge of. Contracts, along with negligence, are a fundamental part of everyone’s daily life. They form the basis of the daily business and consumer transactions that you enter into. Without enforceable contracts, society as we know it could not exist. Voluntary agreements are all very well but remember that agreements can never become binding without a legal contract.
A contract brings a degree of certainty for both businesses and consumers that the parties will fulfil the obligations that they have agreed to because of its legal enforceability in a court of law. As you will see, voluntary agreements are not legally enforceable.
What are the sources of contract law?
PNG contract law is primarily derived from three sources:
- common law (case law)
- equity (case law)
- statute law.
Much of contract law, and the right of freedom to contract, that applies in PNG is based in common law principles that were developed in the English, Australian and New Zealand common law courts – that is, case law decisions. You will often find both English and Australian cases still being cited as authority for a contractual principle even today and you will find little statute law.
Equitable principles are, like common law, derived from case law, and have also played an important role in contract law. For example, in the case of formation of a contract, two areas where the courts have applied equitable or statutory principles are in the areas of:
- promissory/equitable estoppel, which allows a promise to be enforced even if there is no consideration (as you see when we look at consideration, this is normally an essential element in every simple contract)
- unconscionable contracts, where one party has taken unfair advantage of the other (note the purpose of the Fairness of Transactions Act 1993).
Online reference
If you have a chance, have a look at the Fairness of Transactions Act 1993. Its purpose is mainly to ensure overall fairness in any transaction.
What is the difference between a contract and an agreement?
To a layperson, the terms ‘contract’ and ‘agreement’ are often used to mean one and the same thing. In fact, one of the traditional definitions of a contract is that it is a legally enforceable agreement. But while contracts involve an element of agreement, do not assume that every agreement is going to turn into a legally binding contract.
Business tip
Be aware, an agreement is not necessarily a contract.
As just noted, while every contract involves an element of agreement, do not assume that every agreement will result in a legal contract, because:
- the parties may not intend to create legal relations (for example, many public competitions state that a contract is not intended, and going out with a friend on a social occasion is certainly not intended to create a contract); and/or
- one or more of the principles governing contractual relations may not have been satisfied (for example, the purpose of the agreement may be illegal or there is a lack of consideration).
Sometimes a contract exists irrespective of the wishes of the parties. An example is your compulsory third-party insurance through Motor Vehicles Insurance Ltd (MVIL) as part of the registration of your vehicle. This can hardly be seen as an ‘agreement’ because neither you nor MVIL has any choice about either the contents of the contract, or even about whether you wish to make a contract for compulsory third-party insurance coverage.
What is a contract?
To have any legal significance, the agreement must contain a promise, be supported by consideration and have been intended by the parties to be legally enforceable in a court of law. It is the performance of this promise and its legal consequences which are fundamental to modern society and which form the basis of the study of contract law.
The person who makes the promise is called the promisor, and the person to whom the promise is made is the promisee. Think about it. You make promises every day: to meet someone, to go to the movies, to lend money, to obey certain rules and so on. However, remember that not all of these ‘promises’ are intended to create legal relationships, for example, agreeing to meet someone or going to the movies. If you don’t turn up, do you expect to be sued?
How is an ‘apparent’ simple contract created?
The term ‘simple contract’ refers to the manner of its formation, not the nature of its terms or that it is ‘simple’ to create. The creation of a simple contract (note that at this stage there is no question of whether the contract is valid or enforceable), requires the presence of three elements (or three steps if you like):
- Step 1: was there an agreement between the parties? There must be an offer by one party, and an acceptance or some evidence of a final agreement by the other (see chapter 5 on agreement).
If you think there is an agreement, go to:
- Step 2: was there an intention to contract? The parties must intend that their promises create legally enforceable obligations (see chapter 6).
If you think there is an agreement and intention to contract, go to:
- Step 3: was there valuable consideration? There must be something of value or benefit passing from one party to another in return for a promise to do something, unless the promise is made under seal or in the form of a deed (see chapter 6).
Once you have established that each of these elements is present, an apparent simple contract can be said to exist. But at this point you do not know whether it is valid, and therefore enforceable. So don’t stop checking yet.
Is the contract enforceable?
If you are satisfied that there is an agreement and that you and the other party intend to create a contract supported by consideration (if you are entering into a deed, consideration is not required), then you have successfully created a simple contract, but is it valid and enforceable?
There are now three more steps you need to take before you can start to feel confident that what you have created is a valid and enforceable contract, not an unenforceable one:
- Step 4: do the parties have legal capacity? Did both of the parties understand what they were doing? What if one or both of the parties had limited capacity, for example, were underage (that is, under 18), or under the influence of alcohol or drugs (see chapter 7 on ‘Capacity’)?
- Step 5: is there genuine consent? What did the parties’ consent to or, was there a mistake, a misrepresentation, duress undue influence or unconscionable conduct which could mean the contract may fail (see Chapter 8 on ‘Consent’)?
- Step 6: was there legality of purpose and in the proper form? The purpose of the contract must be legal, not illegal.
- Step 7: was there any particular form the contract needed to be in (that is, could the contract be oral, or did a statute require it to be in writing)? Are there any statutory requirements that must be satisfied? (see Chapter 9 on ‘Legality’ and ‘Form’).
As you will discover, how these questions are answered will help determine whether or not the contract is enforceable in court should a dispute arise between you and the other party.
How are contracts classified?
Contracts may be classified in a variety of ways, including formation, enforcement, performance and discharge. Knowledge of how contracts are classified will help you understand what type of contract you are dealing with, what is required of you and the other party, and the enforceability of the contract.
What are bilateral and unilateral contracts?
Contracts are either bilateral or unilateral, depending on what the offeree (the person to whom the offer is made) must do to accept the offeror’s (the person making the offer) conditions of agreement. Most contracts are simple and bilateral.
Note the difference between a bilateral and a unilateral contract. The parties have different obligations under a unilateral contract compared with a bilateral contract. This is why you need to understand whether the language of the offer is creating a unilateral or a bilateral contract.
- Bilateral contract: A bilateral contract involves a promise for a promise. It is the most encountered form of contract because it is created every time someone buys goods or services. Both parties have obligations. As a buyer, you have an obligation to pay for the goods or services, and the seller has an obligation to provide them.
- Unilateral contract: A unilateral contract is where only one party assumes an obligation. There is no contract until the offeree performs the requested act, as they have the option of choosing whether or not to perform. It is a ‘promise for an act’.
An example of a unilateral contract involves reward cases where you lose something and offer a reward to anyone who finds it. There is no obligation on anyone to go and look for the item. But if someone is aware of the reward and they find the lost item and return it to you, then there is an obligation on your part to pay the reward if the finder makes a claim for it. If the offeree abandons their effort halfway through, they would not be in breach of contract. Nor would they be entitled to payment for their efforts because they have not complied with the conditions for payment of the reward (that is, they have not found the lost item).
Problems can arise if you, as the offeror of a unilateral contract, attempt to revoke an offer after the offeree has begun performance. While there are no problems if you withdraw the offer before the offeree begins performance, there may be difficulties where the offeree has begun or substantially completed performance. As you will see in Section 4 of this chapter, part-performance of the act called for may be regarded as sufficient consideration for you as the offeror not to be able to revoke your promise.
What does classification according to enforceability mean?
As you read on, you will discover that there are references by the courts to the contract being ‘valid’, ‘voidable’, ‘void’, ‘unenforceable’ or ‘illegal’. It is important to understand the meaning and effect of each of these words on a contract because they are words used by the courts to describe the enforceability of the contract between the parties.
- Valid: a valid contract is one that the law will allow either party to enforce. The parties intend to enter into a legal relationship and have agreed on the terms, thus creating legal rights and obligations, which the parties can enforce against each other in court.
- Voidable: the contract remains valid and binding unless and until it is rescinded or terminated (ended) by the innocent party. The difference between recission and termination is important when looking at remedies, as we shall see in the chapter ‘Rights and liabilities of the parties, discharge and remedies’, as they create different outcomes in relation to damages. Whether a contract is void or voidable can be particularly important where an innocent third party is involved. If the contract is voidable (that is, it is valid and binding unless and until repudiated by the injured party), the seller of an item may not be able to recover the item from a third or subsequent party in possession of it if the item was obtained fraudulently.
- Void: a person who enters into a void agreement cannot enforce it or be forced to comply with it because there are no legal rights or obligations to enforce or comply with from the beginning of the transaction. Nor could they pass on good title to a third party because they would have no title to give. For example, if you have your computer stolen by another person and they sell it to a third party, the contract between the thief and the third party is void or of no legal effect. The thief has no title to give to the third party. If third party subsequently sells the computer to a fourth person then that person gets the same title to the computer that the third party had – that is, no title. You could then force the fourth party to give back the computer or its value. Why? Because the fourth party has no title and they would have to seek compensation from the third party, and they would have to try to find the thief (good luck there) to get back the value of the computer.
- Unenforceable: while the contract appears to be valid, no legal action can be brought on it. This can happen because some procedural requirement is lacking – for example, a statute requires the contract to be evidenced in writing – for example, contracts for the sale of land. Correction of the defect will generally render the contract enforceable. This raises the issue of form (see below).
- Illegal: when the purpose of the contract contravenes a statute or the common law, it will be illegal and generally treated as being void – for example, something of a criminal nature, such as robbing a bank with a friend.
What is classification according to performance?
- Executed contracts: an executed contract is performed and completed at the time of making. For example, if I wash your car for K25 and you pay me as soon as I finish, the agreement has been fulfilled and the contract expires.
- Executory contracts: an executory contract arises when one of the parties promises to do, or refrain from doing, something in the future. For example, I agree to wash your car next week for K25. Here, both promises are yet to be performed.
What is classification according to formation?
- Express contracts: these are contracts where all the terms are agreed on by the parties and they may be:
- wholly in writing (if the contract is important to you, have it put in writing as evidence of what you have agreed to)
- evidenced in writing
- oral
- partly written and partly oral.
- Implied contracts: the contract is implied from the circumstances surrounding the acts or conduct of the parties. For example, if you catch a taxi, it is implied that you will pay the fare and the driver will get you (safely) to your destination.
- Quasi-contracts: The contract is the result of an ‘agreement’ imposed by law, such as third-party car insurance and is imposed irrespective of whether there is agreement between the parties.
Is the contract a formal or simple contract?
Contracts may be classified into formal and simple contracts. Here the question is about the way in which the contract is made (its ‘form’) and not about its content (its terms). Of the two, the simple contract is the one most often encountered in commercial and day-to-day transactions, but it is still important to understand the difference between formal and simple contracts because of the consequences that may follow if the wrong choice is made – that is, the enforceability of the contract.
- Formal contracts: these are contracts that must comply with certain execution formalities usually imposed by statute, that is, be in writing and signed. They get their validity from their form alone.
Note that the Electronic Transactions Act 2021 has impacted on the statutory requirements requiring certain contracts to be in writing and signed as set out in the Frauds and Limitations Act 1988 and the Copyright and Neighbouring Rights Act 2000 by providing that the Electronic Transactions Act 2021 will apply, with some exceptions, to any kind of transaction whether it be commercial, non-commercial, domestic or international.
- Deeds (contracts under seal): these are promises that must be in writing on paper, parchment or vellum, and signed by the party or parties to the contract and delivered. There is no need for consideration. They are often used in a company arrangement (a binding arrangement between a company and its creditors as to how the company’s affairs will be handled). A deed that is delivered subject to conditions and does not come into operation until the fulfilment of these conditions is called an escrow.
- Simple contracts: this is a contract that is neither a formal contract or a deed, so to be enforceable, it must have valuable consideration present for it to be valid.
Subject to statutory requirements, simple contracts can be created expressly, impliedly or by quasi-contract. By way of an example, a receipt from the supermarket for groceries or a service station for fuel which contains on its face the date and time of purchase, the items and the price, as well as the total price paid by the purchaser is evidence of acceptance of the items and would be more than enough to establish a contract.
Business tip
If the contract is important, put it in writing
As noted above, if the contract is important, put it in writing and have both parties sign it at the bottom of the last page, as well as signing or initialling the bottom of each page. This is because written evidence provides greater certainty as to what the parties agreed to than is the case with verbal contracts, where much of the evidence will be based on the recollections of the parties. Verbal contracts can lead to expensive litigation as the parties argue over what they really agreed to.
If the parties have taken the time to reduce the agreement to writing, the courts will assume that it is a complete record of the contract. Hence the need to be careful when drawing up a contract because the courts are generally reluctant to admit evidence of acts or words of the parties before the execution of the document if this has the effect of adding to, varying or contradicting the written agreement. This is known as the parol evidence rule (see the chapter 6 ‘Construction of the contract’).
When are contracts void unless in writing?
Certain simple contracts, to be valid and enforceable, are required by statute to be wholly in writing. If they are not, they are void. Note that the Electronic Transactions Act 2021 now satisfies the statutory requirement of ‘in writing’ if the document is in electronic format.
What contracts must be evidenced in writing?
There is a second class of contracts that statutes require to be evidenced in writing. The absence of writing does not affect their validity, but it makes them unenforceable in a court of law.
The Sale of goods of K20 or more
Section 6 of the Goods Act 1951 requires contracts for the sale of goods costing K20 or more to have one of the following three requirements, or they will be unenforceable:
- the buyer has accepted part of the goods sold and actually received the same; or
- the buyer has given something in earnest to bind the contract or has given something in part-payment to bind the contract; or
- some note or memorandum in writing of the contract is made and signed by the party to be charged or by their authorised agent—for example, an auctioneer is the agent of the seller and, after the sale, also an agent of the buyer.
What is a note or memorandum?
A note or memorandum can take any documentary form—a letter, docket, invoice or even an entry in an auctioneer’s book—and it does not even have to be contained in one document, but it must show all of the following (s 6(1)):
- the names of the parties
- the subject matter
- the consideration; and
- the signature of the party to be proceeded against or the party’s authorised agent.
What is e–Commerce?
E-commerce is about individuals and businesses buying and selling goods and services online, that is, over the internet. You can participate in e-commerce anywhere you can find an internet connection. In PNG the formation of the e-contract is regulated under the Electronic Transactions Act 2021 and, it provides that the law must treat electronic and paper-based contracts, in terms of formation, equally.
It should be noted that the legal framework required to govern e-commerce in PNG for products and services is a work-in-progress with the National Government yet to develop a comprehensive e-commerce policy notwithstanding that e-commerce now makes up a significant proportion of the PNG market.
Reflection questions
It is the end of the chapter so a good time for a break. Here are some revision questions for you to think about as well as a problem question while having a break. Write down your thoughts as they form part of your notes.
A. What elements are necessary for the creation of a valid simple contract?
B. Explain the difference between a formal and a simple contract.
C. Explain what sort of problems may arise in contract law for users of e-commerce?
D. Explain whether an unaddressed proposal in an electronic communication to create a contract is an invitation to make an offer or is it an offer that others can accept?
PROBLEM: You have decided to buy some land to build a house on. You made an offer on some land owned by Kone. An initial text from the defendant’s agent advised you that the vendors would accept K410,000 on a 30-day settlement. It identified the land and the essential terms of the bargain. You confirmed acceptance of the terms and asked Kone to advise on the procedures for the contract and payment of the deposit.
The agreement was not made subject to the signing of a contract and it was anticipated that you would pay a deposit forthwith and sign a contract in accordance with the terms of the agreement. On the same day, Kone’s agent sent you a text which contained several attachments, which you downloaded, signed and scanned and returned to the Kone’s agent.
Kone subsequently refused to sign the contract. One of his arguments was that as the contract was for the sale and purchase of land, PNG law provided that no action could be brought on any contract for the sale unless an agreement or some memorandum or note of it was in writing and signed by Kone or his authorised agent.
QUESTION: Is there a contract?
WHAT IS YOUR DECISION?
HINT: Do you think that an exchange of texts was sufficient to constitute a note or memorandum? Remember that the memorandum or note does not need to be contained in one document; it can be made up of several documents that can be connected.
Key points
To help you have a better understanding of Chapter 4, here is a list of Key Points on some introductory matters with respect to contracts.
- What is the difference between a contract and an agreement? A contract is a written or oral agreement containing promises made between two or more parties that create rights and obligations enforceable in a court of law. An agreement, while similar to a contract, is not legally binding and enforceable because it lacks one or more of the essential prerequisites that must be present for a legally enforceable contract.
- What is the definition of a contract? A contract is an agreement containing promises made between two or more parties that create rights and obligations that are enforceable in a court of law.
- What are the elements of a simple contract? Intention to create legal relations, agreement and consideration must be present to create a simple contract. There is no question of validity.
- What is required for a simple contract to be valid? Legal capacity, genuine consent, legality of objects, and compliance with form will determine whether the simple contract is not valid or enforceable.
- What is the difference between formal and simple contracts? A formal contract is signed, sealed and delivered, and derives its validity from its form alone (it does not need consideration). A simple contract requires the presence of all 6 elements (including consideration) and compliance with any statutory requirements (form), and may be oral, written, or partly oral and partly written.