6.1 Contract Formation

6.1 Contract Formation

REG Blueprint Area II, Group B, Topic 1 asks two application questions: did a contract form, and what kind of contract is it. Formation is not a vibe. It is offer, acceptance, and consideration, plus capacity and legality, under either the common law of contracts or UCC Article 2. Mix the two bodies of law and the item is lost.

Which law applies

A mixed contract for goods and services is usually classified by the predominant-purpose test. An off-the-shelf equipment sale with incidental installation is Article 2. A six-month tax-provision engagement is common law. REG will tilt the facts; do not invent a 51-percent formula the item does not give you.

Offer

An offer is a manifestation of willingness to enter a bargain, so made as to justify another person in understanding that assent will conclude it. REG tests three elements.

1. Intent (objective theory). Would a reasonable offeree think the speaker meant to be bound? Jokes, angry outbursts, and most advertisements are not offers. An advertisement is an invitation to deal unless it is clear, definite, and leaves nothing open to negotiation (the classic first-come, first-served, one-item, stated-price pattern). Price quotes and catalogs are invitations.
2. Definite terms. Common law wants the essential terms knowable. Article 2 will fill price (§2-305), delivery, and payment so long as the parties intended a contract and there is a reasonably certain basis for a remedy. Quantity is the term Article 2 will not invent, except in output and requirements contracts, which must be tendered in good faith.
3. Communication. The offeree must know of the offer. Returning a lost dog without knowledge of a posted reward is not an acceptance of that reward offer.

How an offer dies

Until acceptance, a revocable offer can be terminated five ways:

• Revocation. The offeror takes it back. Effective when received by the offeree, not when mailed. Public offers are revoked by comparable publicity. An ordinary offer is revocable even if the offeror promised to hold it open, unless an option or a UCC firm offer locks it.
• Rejection. Effective on receipt. A later change of heart is a new offer, not an acceptance of the dead one.
• Counteroffer. Under common law, a purported acceptance that changes terms is both a rejection and a new offer. "I accept, but only if you throw in the fixtures" is a counteroffer.
• Lapse. The time stated in the offer, or a reasonable time if none is stated. Face-to-face offers generally lapse at the end of the conversation unless the offeror signals otherwise.
• Death or incapacity of offeror or offeree terminates a revocable offer by operation of law, even without notice. It does not terminate an option contract supported by consideration; the option is a separate contract.

Acceptance and the mailbox rule

Acceptance is the offeree's manifestation of assent to the offer's terms. Common law uses the mirror-image rule: the acceptance must match the offer. A variance is a counteroffer.

The mailbox rule (deposited-acceptance rule) makes a properly dispatched acceptance effective on dispatch, even if it is delayed or lost, unless the offer requires receipt. Limits REG tests:

• The acceptance must be sent by a medium the offer invited, or a reasonable medium.
• Revocation of an offer is effective only on receipt. If an acceptance is mailed before a revocation arrives, a contract exists.
• Acceptance of an option contract is generally effective only on receipt (the mailbox rule does not protect the option holder).
• If the offeree sends a rejection and then an acceptance, whichever arrives first controls. If the offeree sends an acceptance and then a rejection, the mailbox rule still forms the contract on dispatch of the acceptance, unless the rejection arrives first and the offeror reasonably relies on it.

Unilateral contracts (a promise in exchange for performance) are accepted by completing the requested act. The Restatement rule REG expects is that beginning performance makes the offer irrevocable for a reasonable time to complete — the offeror may not revoke after the offeree has started the job.

Consideration

Consideration is a bargained-for legal detriment or benefit. Each side must do something it was not already legally obligated to do, or forbear a legal right, in exchange for the other's promise.

• Past consideration fails. A promise to pay for work already completed as a gift is not bargained-for. "Because you finished the audit last month, I will pay a $5,000 bonus" is not an enforceable contract.
• Preexisting duty. Performing a duty one already owes the other party is not new consideration. A builder under contract to finish a warehouse for $400,000 who refuses to complete unless paid $40,000 more has no enforceable modification at common law unless there is a genuine dispute, additional work, or an unforeseen-difficulty exception the jurisdiction recognizes. UCC §2-209 is the goods-side contrast: a good-faith modification of a contract for sale needs no consideration.
• Illusory promises ("I will buy if I feel like it") and naked gifts are not consideration. A real option needs real consideration or a UCC firm offer; do not treat a recital of "$1" as a substitute for §2-205's signed writing when the subject is goods and the offeror is a merchant.

Capacity and legality

Capacity. Minors (under 18), persons adjudicated incompetent, and severely intoxicated persons form voidable contracts. The protected party may disaffirm. A minor who buys necessaries (food, shelter, clothing, emergency medical care) is liable in restitution for their reasonable value, not automatically the contract price. After majority, a former minor who ratifies — by words or by keeping the benefits — is bound.

Legality. An agreement with an illegal object is void. Contracts to commit a crime and wagering contracts where gambling is illegal fall here. A covenant not to compete is not automatically illegal; it is enforceable if it is reasonable in time, geography, and scope and protects a legitimate interest (trade secrets, customer goodwill). Unconscionable terms may be refused enforcement. A contract that is legal when made can become unenforceable if a later statute makes performance illegal — that is a discharge issue in /study-guides/cpa-reg/contracts/performance-discharge.

Types REG will name

• Bilateral (promise for a promise) versus unilateral (promise for performance). Most commercial deals are bilateral.
• Express (stated in words, oral or written) versus implied-in-fact (formed by conduct: sitting in the barber's chair). Implied-in-law / quasi-contract is not a true contract; it is a restitution device, covered with remedies.
• Executed (fully performed on both sides) versus executory (something remains to be done).
• Valid (all elements, enforceable), void (no legal effect — illegal object), voidable (one party may avoid — infancy, fraud, duress, mutual mistake), unenforceable (a defense blocks the remedy — statute of frauds, statute of limitations).

UCC §2-205 firm offer

A merchant who makes an offer to buy or sell goods in a signed writing that by its terms gives assurance it will be held open cannot revoke for lack of consideration during the time stated, or for a reasonable time if none is stated, but in no event more than three months. If the assurance is on a form supplied by the offeree, the offeror must separately sign that clause.

Three months is a ceiling on irrevocability without consideration, not a maximum offer life. A firm offer that recites six months is irrevocable for three months and then becomes an ordinary revocable offer unless consideration supports the extra time.

UCC §2-207 battle of forms

Between merchants, a definite, seasonable expression of acceptance operates as an acceptance even if it states additional or different terms, unless acceptance is expressly made conditional on assent to those terms. Additional terms are proposals. Between merchants they become part of the contract unless (a) the offer expressly limits acceptance to its terms, (b) they materially alter the contract (a surprise warranty disclaimer or an arbitration clause is the usual example), or (c) notification of objection is already given or is given in a reasonable time. If the writings do not form a contract but the parties perform, §2-207(3) uses the terms on which the writings agree plus UCC gap-fillers. Do not apply the common-law mirror-image rule to a goods battle of forms.

Statute of frauds

MYLEGS is the common-law memory key for contracts that need a writing signed by the party to be charged:

• Marriage — promises in consideration of marriage, including prenuptial agreements.
• Year — contracts that cannot be fully performed within one year of formation. A contract for life is not within the one-year clause, because death can occur within a year.
• Land — any interest in real property, including leases beyond the short-term exception a jurisdiction recognizes.
• Executor — a personal promise by an executor or administrator to pay a decedent's debt from the fiduciary's own funds.
• Goods — UCC §2-201: a contract for the sale of goods for the price of $500 or more. The official UCC text still uses $500. AICPA tests uniform acts one year after majority adoption; a proposed higher threshold that has not become the majority uniform text is not the REG number. Do not invent $5,000 or any other figure.
• Suretyship — a promise to answer for the debt of another (the main-purpose / leading-object exception can take a self-serving promise out of the statute). Suretyship as a relationship is developed in /study-guides/cpa-reg/debtor-creditor/suretyship-guarantors.

The writing need not be a formal contract. It must reasonably identify the subject, indicate a contract was made, and state the quantity (UCC) or essential terms (common law), and it must be signed by the party against whom enforcement is sought.

Exceptions REG actually uses. Part performance of an oral land contract — typically a combination of possession, payment, and improvements — can take the deal out of the statute to the extent of the performance. Under §2-201(3), an oral contract for goods of $500 or more is still enforceable (a) for specially manufactured goods not suitable for sale to others in the ordinary course, once the seller has made a substantial beginning or commitments for their procurement, (b) to the quantity admitted in a pleading or testimony, and (c) for goods paid for and accepted or received and accepted. Between merchants, a confirmatory memorandum sent within a reasonable time binds the recipient unless objected to in writing within 10 days.

Worked scenario: merchant's firm offer versus option contract

Facts. On March 1, Harbor Supply, a merchant dealer in industrial fittings, sends a signed letter to Lakeside Manufacturing: "We offer 1,000 brass valves at $18 each. This offer will remain open until July 15." No payment or other consideration is given. On March 20, before Lakeside replies, Harbor faxes: "Offer withdrawn; price is now $24." On March 21 Lakeside sends an acceptance of the $18 offer. Independently, Lakeside also holds a March 1 option from a different merchant, Riverton, reciting $200 paid for the exclusive right to buy 500 steel couplings at $30 until April 30. Riverton tries to revoke on March 10.

Analysis.

1. Harbor's letter is a UCC §2-205 firm offer. Harbor is a merchant, the writing is signed, and it gives assurance it will be held open. No consideration is required. The stated period (March 1 to July 15) exceeds three months, so irrevocability lasts three months from March 1 — through about June 1 — not through July 15. Harbor's March 20 revocation is ineffective. Lakeside's March 21 acceptance forms a contract at $18.
2. If the same letter had been an unsigned email, or a non-merchant's note, §2-205 would not apply and the March 20 revocation, received before acceptance, would kill the offer.
3. Riverton's deal is an option contract. The $200 is bargained-for consideration. The option is irrevocable for the full stated period (through April 30), even if that period is longer than three months, and even if Riverton dies. Death would have killed an ordinary revocable offer; it does not kill a paid option.

The exam fork is mechanical: goods + merchant + signed writing + assurance it will remain open → firm offer, max three months, no consideration. Anything else that is to be held open needs consideration (an option) or it is revocable.

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