Home Entrepreneurs & SMEs Foundations of Commerce: Understanding the Essentials of Contract Law

Foundations of Commerce: Understanding the Essentials of Contract Law

December 13, 2023

Since contract law is the foundation on which all commercial transactions are built, it’s vital that every businessperson should have an understanding of how it works. Here, we delve into the nuances of contract law, exploring some foundational ideas and concepts that all business owners should know.

What is a contractual agreement?

A contractual agreement¹ is a fundamental component in the legal and commercial fields, serving as the framework through which parties voluntarily exchange promises and create binding obligations. A contract is established when there is a voluntary exchange of promises that leads to the formulation of obligations. If these obligations are defaulted on or not met, legal remedies and enforcement can be sought through the courts to address the breaches.

If negotiations are unproductive, the aggrieved party may seek legal remedies, primarily compensatory and consequential damages.

When individuals agree to the terms of a contract, they are essentially creating and defining their own rules and obligations, distinguishing contracts from other branches of law like torts, where obligations and rules are imposed externally. This self-formulated set of rules and commitments embedded in contracts allows for the anticipation and predictability of future relationships among the contracting parties. Each party involved is cognisant of the fact that they are legally bound to adhere to the agreed-upon terms, and any failure to do so will be subject to judicial scrutiny and enforcement.

The principle of freedom of contract

The principle of “freedom of contract” underpins contractual agreements, emphasising that parties generally face no restrictions on what they can agree upon initially. This means that individuals can formulate virtually any type of contractual agreement, provided that the agreement conforms to the requisites of common law. It is noteworthy that, while the genesis of contract law is primarily situated within common law, there exist specific areas, such as employment² and partnerships, where legislative enactments may modify, restrict, or supersede common-law principles, thereby delineating the boundaries of contractual freedom.

Distinguishing between agreements and legally binding contracts

Contracts

While the terms “agreement” and “contract” are often used interchangeably, it is important to note that not every agreement qualifies as a legally binding contract. For an agreement to attain the status of a valid contract, it must fulfil several foundational elements:

Consensus: To form a contract, the involved parties must reach a mutual agreement to bind themselves to a specific transaction. This agreement implies that parties have negotiated from equal bargaining positions. Typically, reaching consensus involves the process of making an offer and accepting it, but consensus can also be implied.
Consideration: A valid contract requires a commitment from each party either to perform a certain act or to refrain from doing something. This consideration is essentially the price each party is willing to pay to enter the contract, reflecting their mutual obligations and responsibilities within the contractual relationship.
Capacity: Parties entering a contract must possess the legal capacity to understand and commit to the agreement. Certain individuals and entities, such as infants, those who are mentally incapacitated or intoxicated, and, in Canada, non-Canadian citizens, corporations, and indigenous persons defined as “Indians” under the Indian Act, face limitations on their contracting capacity, meaning that their ability to enter into legally binding contracts is restricted.
Legality: For a contract to be valid, both the object and consideration involved must be legal and not violate public policy. Any agreement involving illegal activities or going against societal norms and regulations cannot form a valid contract.
Intention: The intention to create legal relations is pivotal in contract formation. Both parties must have a serious intention to make the agreement and must genuinely intend to create legal obligations and be bound by them.
In the absence of any of these elements, an agreement cannot be deemed a valid contract, regardless of the mutual consensus between parties on the terms of the agreement. Understanding these fundamental components is essential, as it helps differentiate between casual, non-binding agreements and legally enforceable contracts, thus preventing potential legal disputes and ensuring the integrity of contractual relationships.

Breach of contract and remedies

A contract is deemed breached when one entity does not meet the stipulated obligations detailed within the contractual agreement, leading to a violation of the rights of the other entity involved. The resolution of such breaches employs various remedies aimed at correcting the violation and mitigating any consequential damage or loss. Contract breaches manifest in several forms, including:

Material breach: This breach represents a grave contravention of a contractual clause, affecting the very core of the contract, which empowers the aggrieved party to pursue damages and, potentially, the annulment of the contract.
Anticipatory breach: An anticipatory breach transpires when one party’s contravention is so egregious that it is perceived as “repudiating” the contract. For it to be classified as such, the breach must constitute a “significant failure of performance” or rob the aggrieved party of “essentially the entire benefit” agreed upon.
Partial breach: This ensues when an entity falls short in fulfilling a segment of their contractual duties. Despite the breach being partial, the aggrieved party is usually eligible to claim damages correspondent to the breach’s extent.
When a breach of contract occurs, the initial step is usually to attempt remediation of damages through negotiations between the involved parties, aiming for a mutually agreeable resolution and to preserve the underlying business³ relationship. If negotiations are unproductive, the aggrieved party may seek legal remedies, primarily compensatory and consequential damages, to cover direct and indirect losses stemming from the breach. In contract law, a “remedy” is a court-ordered compensation or resolution designed to place the non-breaching party back to the position they would have been in had the contract been fulfilled as agreed, ensuring fairness and justice while considering the nature and impact of the breach.

Final thoughts

Contracts

In conclusion, the intricate fabric of contract law is pivotal in shaping commercial relationships and transactions, acting as the backbone to the legal and commercial fields. Understanding contract law is essential, whether you’re experienced in business or just starting out, as it guides you through the complex world of business deals and provides a structured framework allowing parties to voluntarily define and create binding obligations.

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About the Author

Roberts & Obradovic Law Firm, a law firm focused on providing prompt expert legal advice and representation on various corporate, privacy, employment, and litigation matters for businesses and individuals. To contact a business lawyer, visit their website.