What Makes a Contract Invalid?
When parties draw up a contract and sign it, they intend the agreement to be legally binding for both parties and enforceable in court. Knowing what makes a contract invalid will help you ensure your contracts will be enforceable in a court of law.
Although you have the freedom to enter into a contract with another party, your agreement must meet some conditions for it to be valid. And there are risks involved if your contracts are invalid. For instance, if you use another person’s content under an invalid content licensing agreement, you may become liable for intellectual property infringement.
Contract management is the process of managing contracts from creation to execution. Invalid contracts may be a challenge at the execution stage, and if a contract is invalid, all your hard work will be futile. Worse still, it can expose you to lawsuits and liabilities. (Find out what makes a contract enforceable.)
Here are some reasons a contract might be invalid:
1. Illegal subject matter
The subject matter is the goods or services that one party provides and the other party pays for. If the subject matter is illegal, the contract will not be valid.
All terms of your contract must not contravene any federal or state law. If the formation or performance of the contract will require a party to break the law, the contract is invalid.
Examples of contracts with illegal subject matter:
- Agreement for the sale or distribution of prohibited substances, such as drugs
- Contracts to engage in an illegal activity
- Contracts for hiring underage workers
- Contracts to prevent competition or create illegal monopolies.
2. Contracts formed under duress
Duress is when pressure is exerted upon a person to make that person enter into a contract they otherwise wouldn’t enter. It could be by use of force, such as when a person is held at gunpoint, or the threat of force. Duress can also be economical, like threatening to burn down a person’s house if they don’t sign a contract.
For an action to amount to duress, it must be unlawful. So, a threat to file a civil suit against a person does not amount to duress because filling a suit is a legal action.
Contracts made under duress are invalid and unenforceable. Parties must voluntarily consent to be bound by the agreement without coercion or intimidation. If any party was compelled to enter into the contract against their will, it will invalidate the contract.
To determine whether there is duress, you’ll look at the effect of the action on the person’s state of mind. In other words, if the action made the person feel that there is no reasonable choice other than to enter into the contract.
3. Substantive unconscionability
Unconscionability in contracts can be substantive or procedural. Substantive unconscionability in contracts is when the terms of a contract are harsh, unfair, excessively oppressive, and unduly one-sided. Substantive unconscionability will make a contract invalid, and it can be tricky to determine.
The supreme court defined it as a contract that:
No man in his senses and not under delusion would make on the one hand, and as no honest and fair man would accept on the other.
In a later case, the courts defined it to be when a contract is:
so grossly unreasonable or unconscionable in the light of the mores and business practices of the time and place as to be enforceable according to its literal terms.
Unconscionability can arise when the terms of a contract so unreasonably favor the stronger party to the point of being oppressive that the court feels the need to intervene. The modern test is when a contract is so unfair that it “shocks the conscience.”
Several features in a contract may suggest unconscionability:
- When the provision violates a statutory right or public policy
- Where one party takes all the benefits, and the other party gets none
- The contract imposes a condition that is impossible to meet
- The language is abusive or imposes a needlessly burdensome condition
The claim of unconscionability is common in non-compete clauses in employment agreements and arbitration agreements.
4. Procedural unconscionability
Unlike substantive unconscionability that deals with the terms of the contract, procedural unconscionability focuses on the circumstances in which the contract was made. It can arise when contract negotiation is unfair to a party because of unequal bargaining power, lack of meaningful choice, or a wide knowledge gap on the subject matter.
A contract can also be procedurally unconscionable because of a lack of opportunity to negotiate the terms. For example, an arbitration agreement is given to an employee months after the employee has resumed work.
Another major indicator of procedural unconscionability is unfair surprise. Unfair surprise is when the real meaning of the terms of the contract is intentionally hidden, thereby preventing a party from making a reasoned choice. It could be by writing the terms in complex and technical language or much smaller font than the rest of the contract or adding the terms after the other party has signed the agreement.
5. Lack of capacity to enter a contract
For a contract to be valid, all the parties must have the legal capacity to contract. Certain persons by law cannot enter a contract.
- Minors: Persons under 18 years can not enter a contract except for contracts of necessity, for example, food and lodging (in some states). When a minor enters a contract, they can honor the contract or void it. However, in some states, the minor must exercise the right to void the contract before turning 18. Otherwise, they can no longer void it. It’s important to note that a contract with a minor is enforceable against the other party as long as they have the capacity. Only the minor may void the contract.
- Mental capacity: Persons with a mental deficiency cannot enter a contract except for contracts for necessities. They or their guardian can void the contract. States use different tests to determine whether a person has the mental capacity to enter into contracts. The cognitive test would consider a person mentally capable if they understood the meaning of the contractual words and the implication. The affective test would invalidate the contract if the other party knew about the mental deficiency.
- Intoxication: Persons under the influence of drugs or alcohol are generally considered to have the capacity to enter a contract. The reasoning is that people who voluntarily get themselves intoxicated should not be allowed to escape their contractual obligation.
However, suppose the intoxication made the person unable to understand the nature and consequence of their action, and the other party took advantage of that. In that case, the intoxicated person may void the agreement. But they must void the contract within a reasonable time after learning they entered into the contract.
6. Contract of adhesion
Contract of adhesion, also known as standard form contract, or boilerplate agreement, is an agreement where one party drafts the terms of the contract with no input from the other party. The other party also has little or no ability to negotiate the terms.
Contract of adhesion presents a “take it or leave it” situation, and it is common with leases, insurance, mortgage, automobile purchases, and other forms of high-volume consumer contracts.
Generally, contracts of adhesion are enforceable. But, they are a typical example of an agreement with unequal bargaining power. The courts usually subject them to rigorous scrutiny to determine if they are unfair and unconscionable.
The courts use the test of “reasonable expectation” to determine enforceability. They can invalidate part of a contract of adhesion if the terms of the contract exceed what the weaker party can reasonably expect.
7. Statute of Fraud requirement
Oral contracts are as valid and enforceable as written contracts. However, under the Statute of Fraud, certain types of contracts must be in writing before they are valid.
Contracts that must be in writing to be valid under the Statute of Fraud:
- Contract for the sale or transfer of an interest in land
- Contracts where the obligation cannot be fulfilled within one year
- A promise to pay an estate’s debts from the executor’s personal fund
- Contract or promise made in consideration of marriage
- Any contract for the sale of goods where the value is above $500
- Contracts of suretyship—where a party promises to pay another person’s debt
For a contract to comply with the Statute of Fraud, the writing must contain key elements of the contracts—names of the contracting parties, terms and conditions, and subject matter—and the contracting parties must also sign it.
Better contracting with CLM software
Contracts are a regular part of doing business, but they don’t need to be strenuous and complicated.
Ensuring your contracts are valid is only a tiny part of contracting. Ironclad’s CLM is designed to help you create valid and enforceable contracts with ease. Learn how we can help you solve all your contract challenges.