5.1 Contract Law Essentials
Key Takeaways
- A valid contract requires four essentials: competent parties, mutual assent (offer and acceptance), consideration, and a legal purpose; real estate sales contracts must also be in writing under the Statute of Frauds.
- Contracts are classified as void (no legal effect), voidable (one party may cancel), valid (fully enforceable), or unenforceable (valid but not provable in court).
- The Statute of Frauds requires contracts for the sale of real estate, and leases longer than one year, to be in writing and signed to be enforceable.
- Remedies for breach include specific performance (a court order to complete the sale), liquidated damages (a pre-agreed sum, often the earnest money), and rescission (canceling the contract and restoring the parties).
- Assignment transfers contract rights to a new party while the original party stays liable; novation substitutes a new party and releases the original from liability.
The Four Essential Elements of a Valid Contract
A contract is a legally enforceable agreement between two or more parties to do, or refrain from doing, some legal act. The exam tests whether you can identify when a contract is valid and when it fails. Four elements must be present for any contract to be valid:
- Competent parties — each party must have the legal capacity to contract. This means being of legal age (a majority, generally 18) and of sound mind. Contracts signed by minors are generally voidable by the minor, and a contract signed by a person legally declared incompetent is void.
- Mutual assent — also called offer and acceptance or a "meeting of the minds." One party makes a definite offer and the other gives an unqualified acceptance. A counteroffer rejects the original offer and creates a brand-new offer, so the original offeror is no longer bound.
- Consideration — something of legal value exchanged by each party. Usually money, but it can be a promise, a service, or forbearance. "Love and affection" alone is not valid consideration in a real estate sale.
- Legal purpose — the object of the contract must be lawful. An agreement to do something illegal (such as commit fraud) is void from the start.
For real estate sales contracts, a fifth practical requirement applies: the contract must be in writing and signed under the Statute of Frauds, discussed below.
Classifying Contracts
The exam expects you to label contracts along several dimensions. Memorize these pairings:
| Classification | Definition | Real estate example |
|---|---|---|
| Bilateral | A promise exchanged for a promise; both parties are obligated | A purchase agreement — buyer promises to pay, seller promises to convey |
| Unilateral | A promise made by only one party, accepted by performance | An option to buy; an open listing where only the producing broker is paid |
| Express | Terms are stated, orally or in writing | A signed listing agreement |
| Implied | Created by the parties' conduct, not words | A buyer accepting agent services without a written agreement |
| Executory | Not yet fully performed; obligations remain | A signed sales contract before closing |
| Executed | Fully performed by all parties | A deed delivered and recorded at closing |
Do not confuse an executed contract (fully performed) with the act of executing (signing) a document — the exam uses both meanings.
Valid, Void, Voidable, and Unenforceable
These four terms describe a contract's legal status:
- Valid — meets all essential elements and is fully binding and enforceable.
- Void — has no legal effect at all; it was never a contract (for example, an agreement for an illegal purpose, or one signed by an adjudicated incompetent).
- Voidable — appears valid but one party has the right to cancel (rescind) it. Contracts involving minors, fraud, duress, or misrepresentation are voidable by the injured party.
- Unenforceable — valid between the parties but a court will not enforce it, usually because it fails the Statute of Frauds (oral land contract) or the statute of limitations has run.
Statute of Frauds, Contingencies, and Earnest Money
The Statute of Frauds requires certain contracts to be in writing and signed to be enforceable. In real estate this includes any contract for the sale of real property and any lease longer than one year. An oral agreement to sell land is unenforceable even if both parties admit it exists.
A contingency is a condition that must be satisfied before the contract becomes binding or before closing can occur. Common contingencies include financing (buyer must obtain a loan), inspection, appraisal, and sale of the buyer's current home. If a contingency is not met, the protected party may cancel without breaching.
Earnest money is a good-faith deposit the buyer provides to show serious intent. It is not consideration that makes the contract valid (the mutual promises already do that), but it secures the seller's commitment and is typically held in the broker's trust/escrow account. If the buyer defaults, the earnest money is often forfeited as liquidated damages.
Breach and Remedies
A breach occurs when a party fails to perform. The non-breaching party may pursue:
- Specific performance — a court order forcing the breaching party to complete the sale. Because each parcel of land is considered unique, buyers can often compel a seller to convey.
- Liquidated damages — a sum the parties agreed in advance to accept as full settlement, frequently the buyer's earnest money.
- Compensatory (money) damages — actual losses caused by the breach.
- Rescission — canceling the contract and restoring both parties to their pre-contract positions, returning any deposits.
Assignment vs. Novation
Assignment transfers a party's rights under a contract to a third party (the assignee), but the original party generally remains secondarily liable if the assignee fails to perform. Novation substitutes a new party or a new contract for the old one and releases the original party from liability entirely, with all parties' consent. The key distinction the exam tests: novation extinguishes the original obligation; assignment does not.
A seller signs a contract to sell land but later refuses to close. The buyer wants the court to force the seller to convey the specific property. Which remedy is the buyer seeking?
An oral agreement to sell a house cannot be enforced in court because of the Statute of Frauds. How is this contract best classified?
Which arrangement releases the original party from all liability by substituting a new party with everyone's consent?
A buyer's offer is met by the seller changing the price and returning it signed. What is the legal effect of the seller's response?