Have you ever watched the TV shows Judge Judy or The People's Court? In shows like this, the plaintiff dramatically exclaims, “But they promised to pay me back!” while the defendant insists, “There was no real agreement!”
The judge leans in, ready to drop a legal truth: “Was it a legally binding contract?”
Whether it’s a handshake deal or a multi-page business agreement, contract law helps determine what’s enforceable—and what’s not. For businesses and individuals alike, understanding the basic principles of contract law is essential for avoiding disputes and building trustworthy, binding agreements.
Learn the role contract law plays in everyday business and how to protect yourself and your organization by drafting smart, enforceable contracts.
What is contract law?
Contract law is the legal framework that governs agreements between two or more parties. It determines what makes a contract valid, how contracts should be interpreted and what legal remedies are available if someone breaks the agreement.
Not every promise or handshake counts as a legal contract. To be enforceable, a contract must meet specific criteria, like mutual agreement, a lawful purpose and an exchange of value. Understanding contract law helps prevent misunderstandings and ensures your agreements hold up if challenged.
How are contracts formed?
For a contract to be considered a legally-binding agreement, it must include (but is not limited to) the following elements.1
Mutual Assent
Both contracting parties must agree to the contract terms and intend to enter a contractual agreement.
Offer and Acceptance
One party presents and makes an offer, and the other accepts it under the terms presented.
Consideration
A legal concept where adequate consideration must be exchanged between both parties involved, reflecting that both parties will receive something of value.
Lawful Purpose
The contract or agreement must not violate public policy or statutory law.
Legal Capacity
All parties involved must be able to enter into the binding contract legally.
*If one of these elements is missing, the contract may be deemed invalid in court.
Who can legally enter a contract?
Even with the right terms in place, a contract may not be valid. It depends on the party. Below are groups that may lack the capacity for the contract to be enforceable.1
- Minors: Individuals under 18 cannot enter into legal contracts or agreements except for necessities such as housing, food, or medical care.
- Mentally-Incapacitated Individuals: A person who is legally incompetent or mentally impaired may not be able to form a valid contract.
- Intoxicated Individual: Contracts or agreements signed under severe intoxication may be challenged in court.
- Entities Without Authority: A contract signed by someone without proper authorization in a company may not be enforceable.
Contract drafting and management
So you may wonder, where do you start in building a successful agreement?
A well-drafted contract is the foundation of a successful contractual relationship and ensures a binding agreement between parties. Ensuring that all parties involved understand their rights, responsibilities and expectations is imperative.
Proper and complete contract drafting and management help prevent contract disputes, minimize legal risks, and ensure that agreements remain legally binding and enforceable.
Common mistakes to avoid in contract drafting
Even well-intentioned contracts can result in legal disputes if they’re not properly drafted. Common mistakes include vague wording and incomplete information, which can lead to confusion or a breach of contract. Here are some of the most common factors that can affect the enforceability of a contract or lead to legal complications.
- Vague terms: Failing to define key terms can lead to misinterpretation.
- Ignoring dispute resolution clauses: Every contract should include how disagreements will be handled via mediation, arbitration, or litigation.
- Overlooking the importance of written agreements: Under the statute of frauds, certain contracts (like those for real estate or long-term services) must be in writing to be enforceable.
Key elements of effective contract drafting
Contracts play an essential role in business transactions. Most contracts include the core elements, but it’s important to confirm all are present. Using standard templates can streamline the process and help ensure nothing is missed. A well-drafted contract should include:
- Clear identification of the parties: The contract should specify the full legal names of the contracting individuals or entities.
- Detailed description of scope: Clearly define the scope of work or obligations, as well as the responsibilities and expectations of each party.
- Payment terms: Specify the amount, method, and timing of payments, as well as any penalties for late or missed payments.
- Duration and termination clauses: Clearly outline the contract's duration and the conditions under which it can be terminated.
- Dispute resolution: Determination of how disputes will be handled, whether through arbitration, mediation, or litigation.
- Governing law: Specify the legal framework or jurisdiction of the agreement.
- Signature of the parties: Both parties must sign for the document to be considered a binding agreement. The signatures signify mutual consent.
Why is proper contract drafting and management important?
Imagine a freelance web developer who agrees to create a website for a small business. The contract reads, "Freelancer will build a professional website for Client for $2,500." However, it lacks details about the number of pages, completion deadline, revision limits and payment schedule.
The freelancer delivers the site, but the client has a list of demands for revisions beyond expectations, beginning a dispute with the freelancer.
Since the contract was vague, both parties interpreted their contractual obligations differently, leading to frustration and legal threats.
If the contract had been well-drafted and detailed—with clear terms regarding the development of the site scope, revision limits and payment agreement, both parties would've had a mutual understanding, preventing the dispute.
Illegal contracts are invalid
A legal contract must not violate any public policy or statutory law to be valid and enforceable. Contracts involving illegal activities, such as fraudulent business practices or drug trafficking, are automatically deemed unenforceable.
Imagine a 17-year-old purchased an expensive tablet through a financing contract, agreeing to make monthly payments. After a few months, the minor decides they no longer want the tablet and stops making payments. The seller demands payment, but the minor successfully voids the contract.
How? The minor successfully voided the contract by arguing they lacked legal capacity when they signed. This scenario highlights why businesses must verify the capacity requirements of individuals entering into contracts.
If the individual was 18, the contract would have been legally binding, and they would have been obligated to follow through with the terms of the agreement.
By understanding contract drafting and management, individuals and businesses can create legal agreements that protect their interests and ensure compliance with contract law.
Types of contracts in contract law
Contract law acknowledges various types of valid contracts and their components, such as Fixed-Price, Master Service Agreements, or Indemnity.2 Each type of agreement carries a distinct legal implication. Contracts can vary in form, such as written or verbal contracts, unilateral contracts, bilateral contracts, or implied contracts, and each type dictates the specific rights and responsibilities of the parties involved.
Contract law recognizes several types of contracts, each with different legal implications:
- Verbal contracts: Spoken agreements that can be legally enforced - In some situations, verbal agreements can be valid, but specific contracts must be in writing to be enforceable under the fraud statute.
- Written contracts: Agreements that are documented and signed, providing clear evidence and proof of terms and obligations.
- Express contracts: Whether written or verbal, clearly stated terms define the parties' obligations.
- Bilateral contracts: Agreements where both parties exchange mutual promises to perform certain obligations on both sides.
- Implied contracts: Formed through the parties' actions rather than direct spoken or written terms.
- Executory contracts: Contracts in which the obligations are not entirely performed by one or both parties involved.
- Unilateral contracts: One party makes a promise only fulfilled when the other party completes a specific action.
Contract interpretation and disputes
Courts follow specific principles when interpreting contracts.
- Plain meaning rule: Ensures contracts abide by the written obligations and governs contract interpretation.
- Parol evidence rule: Limits the use of external evidence to alter a written contract unless a mistake, fraud, or ambiguity is involved.
- Common law principles: Used to resolve these disputes and determine the legal consequences of the disagreement.
Here are some examples...
An example of the plain meaning rule
A company contracts with a supplier to deliver "150 units of standard-grade steel." The buyer later claims they expected to receive a higher quality of steel, but the contract clearly states "standard-grade."
The buyer decides to sue the supplier, but the courts rule in favor of the supplier, enforcing the contract as written and applying the plain meaning rule.
The plain meaning rule states that courts interpret a contract's terms based on their clear and ordinary meaning. Courts will not consider external factors when analyzing the agreement if the contract language is unambiguous.
An example of the parol evidence rule
A business owner, John, signs a written contract with a supplier for one of his products. The contract says that John will receive 500 product units each month for one year at a fixed price. Months later, the supplier claims that they had a verbal agreement allowing them to increase prices after six months. John disputes this, pointing to the contract stating that the price is fixed for the contract term.
The judge applies the parol evidence rule in court, preventing the supplier from introducing the alleged verbal agreement as evidence since the written contract is unambiguous. As a result, the court enforces the contract as written, ruling in John's favor.
The parol evidence rule prevents parties from introducing prior verbal or written statements that contradict a written contract. This rule ensures that the contract clearly states all agreed-upon terms and that outside discussions do not override the document.
Under common law, courts use established legal precedents to clarify disputes and determine whether the contract can be enforced. The judge considers previous rulings on similar cases and applies the same legal reasoning to ensure consistency.
An example of the common law rule
A consultant agrees to work for a company for 6 months. The company fires the consultant after 2 months without cause. The consultant sues the company for breach of contract, and the court (following common law principles) rules in favor of the consultant based on past cases that recognize the right to damages when a party fails to uphold a legal agreement.
By understanding the legal principles, contracting parties can better interpret and navigate contract disputes in business.
What does ‘breach of contract’ mean?
You may have heard the term breach of contract, but what does it mean?
Let's say a woman named Margaret owns a catering business and signs a written agreement with a wedding planner, agreeing to provide catering services for a large wedding.
According to the contract, Margaret's company will supply a full-course meal for 200 guests. However, on the wedding day, Margaret fails to deliver the food, citing a conflict in scheduling.
The couple is left scrambling at the last minute for a replacement and suffers a financial loss. In this case, the couple can sue Margaret for breach of contract.
The couple can seek damages for emotional distress and the additional costs incurred. If the courts find Margaret in breach, she may be required to compensate the couple for their losses or fulfill her contractual obligations in another way.
However, it could be unenforceable if Margaret can prove that the contract lacked mutual obligations or was based on a fraudulent misrepresentation.
In this scenario, a breach of contract occurs because an agreement was made, and one party failed to fulfill the contract's obligations. The breaching party may face legal consequences, including damages or specific performance.
Certain agreements can sometimes be deemed unenforceable due to a lack of mutual obligations or fraudulent misrepresentation.
Legal recourse for Breach of Contract
As mentioned above, if the court finds Margaret in breach, she may be required to compensate the couple. When a breach occurs, the non-breaching party may seek various remedies.
- Damages: Monetary compensation to cover the direct losses and, in some cases, consequential losses that were foreseeable at the time of the contract formation.
- Specific Performance: A court order that requires the breaching party to fulfill their contractual duties. The court typically uses the order of specific performance when monetary damages are insufficient, such as in real estate transactions.
- Rescission: Cancellation of the contract, releasing both parties from their obligations.
- Reformation: Modification of the contract to reflect the party's true intentions. People often use this action to correct errors or ambiguities.
Understanding these remedies helps protect your rights and manage disputes proactively.
Understanding the role of the UCC in contract law
In commercial transactions, there is what is known as the Uniform Commercial Code (UCC). The UCC standardizes contract law principles across states.
It governs contracts involving...
- Sales of goods
- Leases
- Secured transactions
The UCC ensures predictability and consistency in commercial transactions. By standardizing contract law across the United States, the UCC helps businesses understand their obligations and rights, whether engaged in leasing arrangements, the sale of goods, or secured transactions.
The principles of the UCC create a streamlined process for businesses to operate confidently and with clarity in their contracts, domestically and internationally.
Mastering contract law for stronger business relationships
Contracts are the backbone of professional relationships, shaping everything from one-time deals to long-term partnerships. A strong understanding of contract law—from drafting to dispute resolution—empowers businesses and individuals to protect their interests, avoid costly mistakes and build trust.
Contract law bridges the disciplines of law and business. And it’s one of the areas a corporate paralegal might support lawyers with.
Check out What Does a Corporate Paralegal Do? A Beginner's Guide for a look at this interesting industry intersection.
Rasmussen University’s Paralegal Associate’s degree and Paralegal Certificate programs are not designed to prepare graduates for any professional certifications or state-issued licenses. Rasmussen University does not offer a Juris Doctor (J.D.) which is the professional doctorate degree in law.
1The Essential Elements of a Contract, March,1, 2024, Thompson and Reuters. https://legal.thomsonreuters.com/blog/the-essential-elements-of-a-contract/
2The different types of contracts, March 1, 2024, Thompson and Reuters. https://legal.thomsonreuters.com/blog/the-different-types-of-contracts/
