CPA REG: Business Law - Contract Formation and Enforcement

Contract Law for the CPA REG Exam

Business law, including contract law, is a significant component of the REG exam. Candidates must understand the essential elements of contract formation, the defenses to enforcement, performance and breach, and remedies. Contract law questions draw from both common law (which governs services, real estate, and employment contracts) and the Uniform Commercial Code (UCC Article 2, which governs the sale of goods).

Elements of a Valid Contract

A valid contract requires four elements: mutual assent (offer and acceptance), consideration, capacity, and legality. If any element is missing, the agreement may be void or voidable depending on the circumstances.

Offer

An offer is a manifestation of willingness to enter into a bargain. It must be communicated to the offeree, be definite and certain in its terms, and create a reasonable expectation that the offeror intends to be bound. Under common law, the terms must be sufficiently definite (parties, subject matter, time for performance, and price). Under UCC Article 2, only the quantity term is essential; other terms can be supplied by the code's gap-filler provisions.

An offer can be terminated by revocation (before acceptance), rejection, counteroffer, lapse of time, death or incapacity of either party, or destruction of the subject matter. Under the common law, an offer is freely revocable unless supported by consideration (an option contract) or a firm offer exists under the UCC. A UCC firm offer is a signed, written promise by a merchant to keep an offer open, which is irrevocable for the stated time or a reasonable time, up to three months, without separate consideration.

Acceptance

Under common law, acceptance must mirror the exact terms of the offer (the mirror image rule). Any change in terms constitutes a counteroffer rather than an acceptance. Under UCC Section 2-207, a definite expression of acceptance operates as acceptance even if it states additional or different terms. Between merchants, additional terms become part of the contract unless they materially alter the offer, the offer expressly limits acceptance to its terms, or the offeror objects within a reasonable time.

Acceptance may be by any reasonable medium unless the offer specifies the manner. Silence generally does not constitute acceptance. An acceptance is effective when dispatched under the mailbox rule (common law and UCC), while a rejection is effective upon receipt.

Consideration

Consideration requires a bargained-for exchange of legal value. Each party must incur a legal detriment or confer a legal benefit. Past consideration is not valid consideration. Preexisting duty generally does not constitute consideration unless the duty is modified in exchange for additional consideration. Under the UCC, a modification of a contract for the sale of goods requires no consideration if made in good faith.

Substitutes for consideration include promissory estoppel (where a promisor makes a promise the promisee reasonably relies on to their detriment), moral obligation coupled with a subsequent promise, and charitable subscriptions (enforceable without consideration in many jurisdictions).

Capacity and Legality

Parties must have legal capacity to contract. Minors (under 18) may void contracts at their option, making the contract voidable. Upon reaching the age of majority, a minor may ratify or disaffirm the contract. Contracts for necessities (food, clothing, shelter, medical care) are enforceable against minors to the extent of reasonable value. Mentally incapacitated persons and intoxicated persons may also void contracts under certain circumstances.

A contract with an illegal purpose or that violates public policy is void and unenforceable. Courts will not assist either party to an illegal contract, and money paid under an illegal contract generally cannot be recovered.

Statute of Frauds

Certain contracts must be in writing to be enforceable under the Statute of Frauds. Under common law, these include contracts for the sale of land, contracts that cannot be performed within one year, promises to pay the debt of another (suretyship), promises made in consideration of marriage, and executor's promises to pay estate debts from personal funds. Under UCC Section 2-201, contracts for the sale of goods priced at $500 or more must be in writing. The writing must identify the parties, indicate a contract has been made, state the essential terms, and be signed by the party against whom enforcement is sought.

Exceptions include partial performance, specially manufactured goods (UCC), admission in court, and the merchant's confirmation rule (UCC, where a written confirmation between merchants is enforceable against the recipient unless they object within 10 days).

Defenses to Enforcement

Even when all elements of a valid contract are present, defenses may prevent enforcement: fraud in the inducement (renders the contract voidable), duress (voidable), undue influence (voidable), mutual mistake of material fact (voidable), and unconscionability (court may refuse to enforce or modify the contract). Fraud in the execution (where a party is deceived as to the nature of the document) renders the contract void.

Exam Tips

• Distinguish between common law contracts (services, real estate) and UCC Article 2 (sale of goods)
• Know the mirror image rule (common law) versus UCC Section 2-207 (battle of the forms)
• UCC firm offers are irrevocable without consideration for up to three months
• UCC contract modifications need no consideration if made in good faith
• Memorize which contracts fall within the Statute of Frauds
• Understand the distinction between void and voidable contracts