CONTRACT BASICS. This Fact Sheet has been made possible by the funding received by the Creative People s Centre from the New Zealand Law Foundation.

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1 CONTRACT BASICS What is a contract? How is a contract formed? What is Offer and Acceptance? Why is Intention to create legal relations important? How does uncertainty arise in the context of a contract? What is consideration? What happens if there is no consideration? Should the contract contain all the terms agreed on? Do I have to have read a contract to be bound by it? How important is it to define correctly who the actual parties to the contract are? Are there any situations where I need a written contract? Are there any other benefits to having a written contract? When should I insist on a written contract? Are there any situations in which a contract will not be found to be binding? How is a contract breached? What happens when a contract is breached? What kind of damages can be claimed for a breach of contract? Is there any limit to the damages I can potentially recover? What is the Disputes Tribunal? Are there any limits to what disputes the Disputes Tribunal can hear? What is Specific Performance? What is an Injunction? This Fact Sheet has been made possible by the funding received by the Creative People s Centre from the New Zealand Law Foundation. This Fact Sheet is not legal advice. This information is intended to provide a general outline of the relevant legal issues and further professional advice should be sought before any action is taken in relation to the information contained in this Fact Sheet. This checklist remains at all times the property of the Creative People s Centre. You may make use of this Fact Sheet only for your own personal information. Under no circumstances may this Fact Sheet or the information in it be copied or distributed to any third party by you without the prior written agreement of the Creative People s Centre.

2 What is a contract? A contract is basically a legally binding promise or set of promises between two or more people. The law provides for remedies in the event that a party to a contract does not comply with its terms. This is often referred to as being in breach of a contract. A contract can be either in written form, or it can be made verbally. A contract will normally only apply in a commercial context and agreements relating to personal and domestic arrangements can generally not be binding contracts. How is a contract formed? There are four key elements that must be satisfied before a binding contract, either written or verbal, is formed: Agreement (comprising offer and acceptance); Intention to create legal relations; Certainty; and Consideration. What is Offer and Acceptance? An agreement is reached by one party (the offeror ) making an offer to the other party (the offeree ) and the offeree accepting that offer. For example, I will pay you $100 for your painting. The offer must be clear, definite and explicit, and leave nothing open for negotiation. Offer and acceptance are important in the formation of a contract so that each party is aware that it is under a legal obligation and knows what the terms of the contract are. Acceptance must be communicated to the offeror. In most cases silence is not treated as acceptance. The general rule is that a contract is formed once acceptance by the offeree has been notified to the offeror. A counter offer by the offeree, for example, another price offered for the painting, is a rejection of the original offer. A new offer is then on the table for acceptance by the other party. It is possible for an offeror to withdraw an offer by notifying the offeree at any time before the offer is accepted by the offeree. Why is Intention to create legal relations important? It is important to establish that both parties intended entering into an immediate and binding agreement. In most commercial transactions, it is presumed that there is an intention to create legal relations.

3 How does uncertainty arise in the context of a contract? Leaving an important term out of a contract or having the key terms of the contract insufficiently defined creates uncertainty. Uncertainty also arises where there was never any intention to enter into a contract, or there was an intention, but one of the parties did not intend for the arrangement between them to be binding just yet. As long as all essential matters have been agreed upon in a contract, minor disputes or uncertainties within a contract can be determined by the courts if the parties are not able to come to an agreement themselves and one of the parties decides to refer the matter to court. What is consideration? All contracts must be supported by consideration. Consideration could be described as what one party gives or agrees to give in return for that which is being offered by the other party. Usually consideration will take the form of a monetary payment. For instance in the case of the purchase of a painting for $100 the $100 would be the consideration. As well as money, consideration can also take other forms such as services rendered. In other words instead of paying you $100 for your painting someone could agree to mow your lawns. Consideration can also be provided at a later time such as would be the case if someone took possession of the painting mentioned above now but agreed to pay you the $100 next week. What happens if there is no consideration? If there is no consideration being given in return for that which is being promised by one party then there is no legally binding agreement formed. However in some circumstances where one party has encouraged the other to rely on what is being promised then it is possible that the promise can still be found to be binding on the party making it. Should the contract contain all the terms agreed on? The terms of the contract can either be implied from the actions of the parties, or are expressly written into the contract. To avoid any misunderstandings further down the track, it is preferable for the terms to be set out in writing, rather than just entering into a deal on a handshake. The Court will sometimes imply terms into a written contract, if it is obvious that they should have been included, or the parties have a trading history together and certain terms have become customary between them.

4 Do I have to have read a contract to be bound by it? Signing a contract means you are agreeing to the terms of the contract whether or not you have taken the time to read the contract. The fact you didn t read the contract or have it explained to you before singing it can t necessarily be relied upon to get you out of any of the obligations under the contract. How important is it to define correctly who the actual parties to the contract are? It is very important to correctly define who the actual parties to a contract are. For example it s no good having a contract with Joe Bloggs personally, when you want the obligations to be enforceable against Joe Bloggs trading company Joe Bloggs Limited. In this situation as Joe Bloggs Limited is a separate legal entity to Joe Bloggs personally (for more information on legal entitles and business structures please refer to our Fact Sheet Business Structures ) you may end up having no legal comeback against Joe Bloggs Limited in the event that the contract is breached. Are there any situations where I need a written contract? Although a contract can either be in writing or can be made verbally, there are some instances such as with assignments of copyright or with exclusive licenses of copyright where the law provides that to be fully binding on the parties the contract must be in writing. Are there any other benefits to having a written contract? One of the significant benefits of having a written contract is that it makes the parties to the contract actually have to talk about what their obligations and liabilities are going to be under the contract and put this down on paper. What this can do at the outset of negotiations before a legally binding contract has even been formed is resolve any honest misconceptions on either party s part about the subject matter of the contract and each party s obligations under the proposed contract. This can save both parties significant bother down the track. Also with a written contract in the event that something does go wrong later, the parties at least have a record of what was agreed and this can be useful to help clarify between the parties what their obligations and rights in fact were. As a clear record of the agreement initially reached between the parties, a written contract can also be useful if further legal action relating to a claimed breach of the contract is taken.

5 When should I insist on a written contract? Outside of the situations such as assignment of copyright where a written contract is essential, this question depends entirely on a number of commercial factors specifically relating to the situation in question. However, as a rough rule of thumb: the more important the performance of an obligation by another party is to you; the more severe the ramifications are for you if the obligation is not performed; or you have any liability, potential or actual to a third party if the obligations under the contract are not performed, then for the sake of certainty you should insist on getting something in writing. Are there any situations in which a contract will not be found to be binding? Even if a contract has satisfied the four basic requirements previously mentioned above, there can still be instances where a contract can later be held to not be binding. Such situations can include where: one party to the contract may be a minor (less than 18 years old); one of the parties may have deliberately misrepresented certain facts to induce the other party to enter into the contract; one of the parties may have exerted undue pressure on the other to make them enter into the contract; the subject matter or intended outcome of the contract is illegal; or one of the parties made an honest mistake when agreeing to enter into the contract. How is a contract breached? Generally speaking a contract is breached when a party to a contract does not do what they agreed to do in the contract or, conversely, does something that was not agreed to in the contract. Whether there has in fact been a breach of the contract will really depend on the facts in question and the wording of the contract in that particular situation. Sometimes in a contract it is provided that where unforeseeable events (e.g. a storm or an act of terrorism,) result in one party failing to meet their obligations under the contract, that such breach of the contract will not be automatically treated as a breach of the contract in the normal way.

6 What happens when a contract is breached? In the event of the breach of a contract, and subject to anything else to the contrary in the wording of the contract, the innocent party generally has two choices: 1. They may treat the contract as still in force and continue on with performing their obligations and enforcing their rights under the contract and in which case they can still pursue the other party to the contract for some form of remedy for the breach that has occurred; or 2. They may cancel the contract entirely and seek to take action against the other party in respect of the breach. When it comes to taking action against the other party for breach of contract there are various options which can be pursued through the Court, however in any situation it is important to take any such action as soon as possible. What kind of damages can be claimed for a breach of contract? The most common remedy for breach of a contract is damages, a monetary payment awarded by the Court. The objective is to restore the innocent party, so far as money can do it, to the position they would have been in if the contract had been performed. The amount of money judged to be due is usually assessed at the time the contract was breached. In measuring the damages, the Court will consider the value to the injured party of the loss of the promised performance. If the kind of loss sustained was foreseeable, the party in breach should be liable for the full extent of the loss. The sum of damages to be awarded can be agreed between the parties at the time of negotiation of the contract. In such situation a specified amount of damages are agreed as a genuine pre-estimate of loss which would probably arise from a breach or a particular type of breach. This avoids the difficulty of proving the actual amount of damages through the courts and also enables the parties to know in advance what their liabilities will be. In some cases, it may also be possible to obtain damages for mental distress and injury to goodwill or reputation. Is there any limit to the damages I can potentially recover? When it comes to damages it is important to know that there is an obligation on the party bringing the claim to take all reasonable steps to mitigate (or lessen) the loss that they are claiming in respect of. Damages cannot be recovered for any loss which the aggrieved party could have avoided.

7 What is the Disputes Tribunal? The Disputes Tribunal provides a means of settling a claim or dispute in a way that is considerably faster and cheaper than going to court. Hearings are private and informal, there are no Judges or lawyers involved, each party represents themselves, and the disputes are heard by an impartial referee. The referee will encourage both parties to discuss the dispute and may suggest ways in which it might be settled. If an agreement is not reached, the referee will make a decision. Referees are required to give either oral or written reasons for their decision. Any such agreements and decisions reached are legally binding on the parties and can be enforced in the same way as a court order of the District Court. Are there any limits to what disputes the Disputes Tribunal can hear? The monetary limit for a claim in the Disputes Tribunal is $7,500 or, if everyone involved agrees, $12,000. If a dispute involves more than these amounts, and a party wants the Disputes Tribunal to deal with the dispute, they must reduce the amount they are claiming. The Tribunal cannot be used for disputes relating to: rates, taxes, social welfare benefits or ACC payments; parenting or care of children; matrimonial property; wills; ownership of land; the value of goodwill (with a business that is bought or sold); and trade secrets or other intellectual property such as copyright. For more information on the Dispute Tribunal please refer to the Ministry of Justice website at What is Specific Performance? Specific Performance is an order that is made by the Court for the party in breach to perform their outstanding obligations under the contract. Generally specific performance will not be ordered where damages are an adequate remedy. In particular, the Court will take into consideration whether the act will require the constant supervision of the Court to ensure obedience, and whether hardship will be caused to the party in breach in carrying out their specific performance obligations.

8 What is an Injunction? An injunction is another remedy available to the Court which they can enforce in response to a breach of contract. There are two types of injunction that can be ordered by the Court: Injunctions can either provide for someone to perform a certain act such as may be required to undo the original breach of the contract or injunctions can be used to enforce stopping someone from doing something that would be a breach of the contract. An injunction is usually only granted if it will produce a fair result in the circumstances. In considering whether an injunction is an appropriate remedy in any situation the advantage to the party who is seeking the injunction will be balanced against effects that the granting of the injunction will have on the other party.