Chapter Three:
Law of Contract
By: Zerihun Yitayew(LLB, LLM
0925272623
Chapter Objectives
• At the end of the chapter, students are able to
Comprehend the sources of obligations;
Appreciate the essence and meaning of
contract;
Understand the formative requirements of
contract;
Know the effects of contract;
Examine remedies of non-performance; and
Synthesize grounds of extinguishing
obligations.
3.1. Law of Obligations
There are two sources of obligations.
1. Law and
2. Contract.
3.1.1 Law as a source of obligations
Laws impose obligation whether the person obliged
like or not.
Consent/ agreement is not necessary.
The following are illustrations of these obligations:
The obligation to pay income tax.
The obligation to compensate the victim of one's
wrong.
The liability of an employer for the action of his
employee.
3.1.2. Contract as a Source of Obligations
Unlike obligations from the law, the obligations
here exist if the parties consent to it.
But if they once enter in to the contract, they are
no more free. Some of these obligations are:
The obligation of the buyer to give the price to
the seller---under k+ of sale.
The obligation of the employee to work for
the employer---under k+ of employment.
The obligation of the borrower to repay the
money he took from the lender---k of loan.
3.2. Definition of contract
Article 1675 of the CC defines contract as follows.
"A contract is an agreement whereby two or more
persons as between themselves create, vary or
extinguish obligations of a proprietary nature.’’
The definition can be dissected into the following elements.
A) Contracts are agreements.
There must be an agreement to be legally binding.
All contracts are agreements, the vice versa is not true.
B) Two or more persons for the existence of contract
Contracts are bi-party juridical acts that exist between two
persons to the minimum.
So, one-person cannot conclude a contract with himself.
C) “…as between themselves…”
This is the principle of relative effect of contracts(privity of
contract) that third parties are not concerned by the
contracts made by other persons.
D) The object of contracts is the establishment(create),
vary(amend) or extinguish (performance) of an obligation….
E) “…proprietary nature of the obligation”
The obligations must be aimed at property/ economic gain.
If the obligations are formed principally for reasons other
than that of money or property, the contract may not be
covered in contract in general.
Take marriage. Since marriage mainly is aimed at social
benefits, it is not normally considered as a contract in
general.
It is a social status.
3.3. Formation of a Contract
The law provides mandatory formative requirements
that parties must comply with.
Art. 1678 of Civil Code a valid contract shall exist
when
1. The parties are capable of contracting and give
their consent sustainable at law;
2. The object of contract is sufficiently defined, and
is possible and lawful;
3. The contract is made in the form prescribed by
law, if any.
Thus, the four mandatory conditions are evident in
the provision above: capacity, consent, object and
formality.
3.3.1. Capacity
The law makes incapable persons disable to enter into
contract.
Minors and judicially interdicted persons – protection
Legally interdicted persons and foreigners) –
prohibition.
They are incapable of binding themselves to somebody by
contract.
3.3.2. Consent
Consent is a defect-free mutual agreement by the
contracting parties.
Consent carries a double aspect:
First, the parties must agree on the scope of their
undertaking on each and every important detail and,
Second, there must be a willingness on the part of the
contractants to make their undertaking legally binding.
The agreement will be legally binding only if it is
accompanied by a genuine intention to be
bound.
Ordinarily, mutual assent is evidenced by a
contractual offer and acceptance.
[Link]. Offer
It is a firm and precise proposal made by the
offeror (the party who takes the initiative to
conclude a contract) to the offeree to enter into
a contractual engagement regarding a particular
subject matter.
Three elements are necessary for an offer to be
effective at law:
A. Serious intention (firm proposal):
Advertisements, catalogues, price lists and circulars
are not offers to contract but invitations to
negotiate.
B. Certainty or definiteness: -
An offer must have reasonably definite terms to
enable the court to give remedy in the case of
breach.
C. Communication: -
The manner of communication may be in writing or
oral or signs or conduct in so far as there is no
doubt as to the making of the offer.
1. Termination of Offer
An offer can be terminated by the action of the
parties or through the operation of the law.
i) Termination by the Action of the Parties
A. Revocation: - refers to the offeror's act of
withdrawing an offer.
B. Rejection: - when the offeree has rejected the
offer.
C. Counter-offer: - A rejection of the original offer
and the simultaneous making of a new offer by
the offereeis called a counter-offer (any material
change in, or addition to, the terms of the
original offer).
ii) Termination by Operation of Law
A. Lapse of time: - An offer terminates
automatically by law.
If no time for acceptance is specified in the offer,
the offer terminates at the end of a reasonable
period of time.
What constitutes a reasonable period depends
on the subject matter of the contract, business
and market conditions, and other relevant
circumstances.
A. Death or Incompetence of Either party; - An
offer is personal to both parties and cannot pass
to the descendant's heirs, guardian, or estate.
[Link]. Acceptance
Contracts are formed when the offeree accepts an
offer.
Acceptance is a voluntary act by the offeree that
shows assent to the terms of an offer.
It refers to the pure and simple agreement given by
the offeree to the offeror.
Acceptance must be communicated.
Question# what if the offeree keeps silent?
Silence refers the total absence of any form of
expression, be it verbal, written or behavioral.
The rule is that silence does not constitute
acceptance (Art 1682 CC.) kept silent is a basic ideal
of contractual liberty.
[Link]. Vices of Consent (mistake, fraud
and duress (Article 1696 CC)
Contract law requires a free consent.
Vices of consent are defects that vitiate the
validity of consent.
The sanction of a vice of consent is relative
nullity (invalidation).
Invalidation is the avoidance of a contract due to
defect in consent& incapacity.
The principal effect of invalidation is restitution
or reinstatement i.e. returning the parties back to
their original position.
1. Mistake
Is an erroneous belief about a certain state of affairs.
E.g., failure to read a contract before signing.
All mistakes do not invalidate a contract.
A contract to be invalidated due to mistake the following two
important requirements must be fulfilled.
1. Mistake must be both decisive and
2. Mistake must be fundamental.
For instance, buying an artificial diamond believing that it is the
real one.
In addition to its decisive nature, mistake must be fundamental.
E.g., Rewarding 100,000 to Haile Woldesellassie believing that he
was promising the reward to the famous athlete Haile G/selassie.
So, if the mistake fulfills the two criteria we set above, the
mistaken party may invalidate the contract.
2. Fraud
It is misrepresentation of material facts to induce a person
into a contract.
It is not all fraud that invalidates a contract. Normally for
fraud to exist, in addition to the false statement, there must
be a deceitful action (practice) such as forgery of
documents.
However, the contract may be invalidated by the existence
of a mere false statement where there is a confidential
relationship among the contracting parties.
Confidential relationship refers to relations that should
depend upon confidence, trust and loyalty among the
people concerned. For instance, relations between close
relatives, agent and principal, and the insurer and the
insured are considered to be confidential relations.
Sources of fraud
Fraud may come from one of the contracting parties
or by a third party.
In the first case, the contract will be automatically
invalidated at the request of the party deceived since
the deceiver must not benefit from his wrong which
resulted in a contract.
In the second case, although it is a rare case, it may
happen that a third party (who is not a party to the
given contract) may deceive one of the parties into a
contract (e.g., brokers).
In principle, the contract remains valid. However, if
the other party was aware of the deceit and entered
into the contract regardless of it, the contract may be
invalidated at the request of the party deceived.
3. Duress
It is the act of compelling another person to enter into an
agreement by threat of force or an act of violence.
Duress may invalidate the contract.
For example, someone may come to a person with a gun and
say "unless you agree to give me your stereo, I will shoot
you". Being afraid of death, one may agree to give him the
radio.
The victim party has the right to avoid the agreement
because the contract is entered due to duress.
The threatened or actual violence may be to the life, liberty,
or property of the party, the spouse (wife or husband),
ascendants (e.g. parents), or descendants (e.g. children).
Like fraud, duress may come from two sources: the
contracting party or a third party. But unlike fraud, the
contract will be invalidated irrespective of the sources.
3.3.3. Object of Contract
The term "object" must not be confused with a
thing, movable or immovable, concerned by the
contract.
The "object of the contract" refers to the obligations
undertaken by the parties in a given category of
contract.
Per article 1678 of the CC the object of the contract
is sufficiently defined, is possible and lawful.
The object (obligation) consists of three broad forms:
1. Obligation to do,
2. Obligation to give, and
3. Obligation not to do.
1. Obligation to do:- are themselves divided into
two subcategories. One is obligation of result in
which a definite end is to be achieved under the
contract, and The other is obligation of means
in which a party undertakes to do his/her best to
achieve the result without guaranteeing the
achievement of an outcome.
2. Obligation to give:- a party undertakes to
transfer a right (such as full ownership) on a
thing to another party.
3. Obligations not to do:- are negative obligations
that require a party to refrain from acting some
way.
The general requirements of object of contracts
are three:
1. The object of the contract must be sufficiently
defined: avoiding vagueness, ambiguity or
incompleteness in the contract.
2. The object of the contract must be possible:
For instance, the obligation to bring up a dead
man in return for payment of a million birr is
invalid and cannot be taken to courts of law
because curing a dead man is humanly
impossible.
3. The object of the contract must be lawful and
moral.
There are certain kinds of contracts which cannot be
enforced in court unless there are written
agreements.
Some of such kinds of contracts are:
1. Contracts in relation to immovable property;
2. Contracts with public administration;
3. Contracts of guarantee;
4. Contracts of insurance; and
5. Contracts to vary written contracts;
In addition to be in written, it has to be supported by
the parties' signature; and
must be signed by at least two witnesses
attesting that the agreement among the
contracting parties is the genuine desire and
consent of the parties.
3.3.4. Form of Contracts
Form is an instrument upon which the terms and
conditions of agreement can be reduced.
Article 1719 of the Civil Code provides that no special
form is required of parties when they conclude a
contract and consensualism is upheld in principle.
Formality requirement may be created by
By the law imposes a certain formality
requirement or
By parties can impose upon themselves the
compliance with a certain form.
In both cases, sanction for the non-observance of
such requirement is the absolute nullity of the
contract (null and void.)
3.4. Effects of contract
3.4.1. Performing Contractual Obligations
Performance is the purpose for the contract is formed and
is the natural consequence of a contractual engagement.
1. Performance by Whom? the debtor, by agent of the
debtor, by court or by the law.
Personal performance by the debtor may be an essential
element of the contract.
2. To whom shall performance be made?
Performance can validly be made to the creditor or to a
third person authorized by the creditor, a court of law or
the law.
3. What to perform:
• It is the rule of law that performance must exactly be the
same with the contract.
4. Where to perform a contract? (Art. 1755 of CC)
Performance in the agreed place in the
contract.
No agreed place, performance shall take place
at the place where the debtor had his normal
residence at the moment of concluding the
contract.
5. When to perform a contract (Art. 1756 of CC)
Similarly, the time of performance can be agreed
upon by the parties.
Where there is no such time-limit is stipulated in
the contract, performance would be made
forthwith (immediately).
6. Currency
As a rule, money debts are discharged in local currency.
Legal Interest rate (Art 1751 & 2479 Civ. Code)
The legal rate of interest that is to be paid on a debt is 9% unless the
patties expressly stipulate a different rate. But parties cannot fix the
interest rate higher than 12% (Art. 2479 of Civil Code).
Fixing above that constitute a crime of usury.
Order of payment (Art. 1752---Costs, interest due, principal
debt)
When the amount available for payment is inadequate (partial
payment) to pay-off all the debts, the following is order of payment.
1st – costs, 2nd – Interest due, and 3rd – principal debt.
Expenses
• Any cost of performance has to be covered by the debtor himself
unless the contracting parties can agree otherwise who bears the
expenses of performance.
3.4.2. Non-performance of Contracts
Is total failure, defectiveness and delayance in
performance.
It refers to the breach or the non-compliance
with the promise made in the contract.
The procedural device for failing party is the
giving of a default notice.
Default Notice:- is the reminding of the debtor
by the creditor to put the former in default.
Purpose of notice is to remind the debtor of his
obligations and to give him the last chance to
perform before the case goes to a court of law.
Available Legal Remedies of Non-Performance
of contract (Art. 1771 of the CC)
1. Specific performance
2. Cancellation (by court or Unilaterally) and
3. Damages caused to by non-performance.
The first two remedies, i.e. specific performance
and cancellation, cannot be claimed together for
the invocation of one would naturally exclude the
other.
But damages can be claimed in the absence of
either of the other two, or in addition to either of
them.
1. Specific (Forced) Performance
Is order of the court to force the debtor to perform
the obligation.
Specific performance as a legal remedy is not always
awarded to the creditor whenever he demands it.
Thus, forced performance is the outcome of two
cumulative conditions:
i. Special interest of the creditor and
ii. Execution without intruding the personal liberty
of the debtor.
Personal liberty is a constitutional right that is
internationally recognized and protected.
2. Cancellation
Cancellation as a remedy for non-performance is
in principle declared by the court. It can be made
by either the court or one of the party.
I. Judicial Cancellation:- is made by the court.
II. Unilateral cancellation:- is a cancellation where
the creditor has the right to consider himself as
released without a requirement to go to court
for getting the same decision.
[Link]. Damages
Damages is a money payable to the victim party due
to non-performance.
It may be due whether or not the other remedies are
claimed (Specific performance & Cancellation).
I. Nature of Contractual Damages
Contractual damages are characterized by the
absence of a fault requirement.
This is different from the nature of tortuous damages
which are fault-based as a rule.
However, the defendant is entitled to assert the
defense of force majeure if the non-performance is
the result of force majeure, the party will be released
from the payment of compensation for the resulting
damage.
Force majeure is a circumstance that is
unforeseen and makes performance absolutely
impossible (Art. 1792 CC).
The law makes an illustrative list of cases of force
majeure. It includes the
enactment of a law that prohibits the
implementation of the contract;
a natural catastrophe such as earthquakes,
thunder and floods;
on outbreak of international or civil war; or
the debtor's death or unexpected serious
accident or illness.
On the other hand, cases that can never
constitute defense of force majeure include
strike or lockout occurring in the debtor's
factory,
an increase or decrease in the price of raw
materials necessary for the performance of
the contract, or
the passing of new law which makes the
debtor's obligation more onerous.
II. Extent of Damages
The amount of damages that is payable is equal
to the normal damages that is expected to result
from the non-performance.
3.4. Extinction of Obligations
Obviously contractual obligations do not stay forever.
They come to an end by several grounds as in the
following.
1. Performance
It is a full discharge (fulfillment) of contractual
obligations.
2. Invalidation
This is the way of extinction of obligation due to
defective contracts.
3. Cancellation
Cancellation is due to non-performance but
invalidation results from defect in contract.
4. Termination
The parties to a contract may terminate their
obligations by agreement or by unilateral action
allowed under the contract.
The differences b/n termination and cancellation are
Termination – prospective effect which does not
affect things done in the past.
It simply extinguishes the future obligations
of the parties.
Cancellation & invalidation – restitution (getting
the parties back to their original position by
asking them to return what they have taken from
one another) is the order that takes place.
5. Novation
This is extinction of obligations by substitution
(existing obligations for new ones).
6. Set-off
Where two persons owe debts to one another, set-
off shall occur and the obligations of both persons
shall be extinguished (Presence of debtor-creditor
relationship.
Set off usually applies to monetary obligations.
7. Merger
Merger happens when the positions of debtor-ship
and creditor-ship fall upon one and same person.
8. Remission
Is releasing the debtor from his obligations by the
creditor. It must be accepted by the debtor.
9. Period of Limitation
Is a duration (period) within which a legal action must be
brought before legal organs.
The maximum period of limitation in contractual claims is
ten (10) years for all kinds of issues such as remedies for
non-performance or invalidation for defective contracts.
But shorter periods of limitation are provided by different
laws.
1. In the Labor claims, the period of limitation is
3 months for claim of reinstatement and
6 months for claim of wages (or any kind of
remuneration or payment that is due to a worker).
2. Under insurance contract, the period of limitation is
two (2) years.