Elements of a contract – Fitzroy Legal Service (2024)

Entering into a contract must involve the elements of free will and proper understanding of what each of the parties is doing. In other words, the consent of each of the parties to a contract must be genuine. Only where the essential element of proper consent has been given is there a contract that is binding upon the parties.

Proper consent may be affected by any of the following matters:

• mistake;
• misrepresentation or misleading conduct;
• duress;
• undue influence or unconscionability; and
• unfair contract terms in standard form contracts.

Mistake

Only limited types of mistakes will cause a contract to be non-binding on the parties: they must be mistakes that go to the very basis of the agreement.

For example, a contract of sale for a car that both parties assume exists, but has actually been destroyed by fire, is non-binding on the parties.

By contrast, where the parties are only mistaken about the model of the car, the mistake does not go to the heart of the bargain and so such a contract would be binding.

Another example is when a person signs a written document mistakenly believing that it relates to something different from what it actually relates to. In this case, the person may not be bound by it. This means that if A signs a document that A reasonably believes to be a character reference to assist B obtain a loan from a finance company, and the document is actually a guarantee of the loan contract, then the guarantee would not be binding on A.

A third example is when C cannot read, due to blindness, illiteracy or other disability. Someone else tells C what is in the document and C signs it. The document C signed is not what C was told it was. The document C signed would not be binding on C.

By contrast, if a person who signs a document – believing it to be a contract – does not read the terms and conditions, that person is bound by the contract and is not entitled to plead mistake.

Other factors may also be relevant to a successful plea of mistake. For instance, whether or not the defence of mistake will be allowed often depends on whether an innocent thirdparty will be adversely affected by a decision that the contract is non-binding. Again, if the signer failed to take reasonable precautions, the defence will not succeed.

Misrepresentation or misleadingconduct

Misrepresentation or misleading conduct in a contract scenario can be dealt with under the common law and equitable principles. However, misrepresentation or misleading conduct is now often dealt with under the Australian Consumer Law (ACL). Whether a party relies on the common law and equitable principles and/or the ACL depends on the nature of the transaction (e.g. whether the transaction was made in trade or commerce), the type of misrepresentation, and the remedy a party isseeking.

This section focuses on the common law and equitable principles. For information about statutory protections against misleading or deceptive conduct, and the making of false representations in relation to the sale of goods and services, see Chapter7.2: Consumer protection laws.

If you think that misrepresentation or misleading conduct has occurred in the context of a contract, consider the statutory protections under the ACL. It can be easier to prove misleading or deceptive conduct and false representation under the ACL, and the ACL provides more flexible remedies compared to the common law and equitable principles.

What types of remedies are available formisrepresentation?

The remedies that are available for misrepresentation are rescission and/or damages and/or termination.

Rescission

Under the common law and equity rules, if a person is induced to enter into a contract as a result of another party’s misrepresentation or misleading conduct, then the misled party may choose to ‘rescind’ the contract. This means that the contract is void from the beginning and is unenforceable. Rescission of a contract also means that both parties are restored to the positions they were in before they entered into the contract (this may require the court to order some monetary adjustments).

For example, A induces B to enter into a contract of sale to purchase a business by presenting overinflated profit and loss statements that show the business to be much more profitable than it actuallyis. B can choose to rescind the contract on the basis that A misrepresented the business’ profit and loss statements and engaged in misleading conduct. Rescission would result in B having any money that they paid for the business returned as if the contract of sale never occurred.

If it is not substantially possible to restore the parties to their original positions, then rescission may not be available.

If the misled party chooses to rescind the contract, then they cannot sue the other party for breaching the contract (because, for example, the misrepresentation constitutes a term of the contract). This is because it is not possible to both cancel a contract from the beginning and sue for breaching it.

So using the above example, if B wanted to keep the business, despite the misrepresentation (and assuming the misrepresentation constituted a term of the contract), B could choose to keep the contract and instead sue A for breach of contract and claim any damages, including loss of profit, that they would have suffered as a result of the misrepresentation.

Under the ACL, the court has the discretion to order rescission.

Rescission is a defence to any action for damages or specific performance against the misled party.

Damages

A misled party may also have a right to damages (either in addition to, or instead of, rescission):

• in the tort of deceit, where there is fraudulentmisrepresentation;
• in the tort of negligence, where there is negligentmisrepresentation;
• under the ACL; and
• where the misrepresentation constitutes a term of the contract (whether as a condition, an ‘intermediate term causing a substantial loss of benefit’ or a warranty), and the other party breached that term with misrepresentation. For more information about conditions and warranties, see ‘The terms of a contract’, below.

It is important to note that in the first three scenarios above, the misled party may have the right to damages, even where the misrepresentation does not constitute a term of the contract.

Where this is the case, the amount of damages is not the amount necessary to put the misled party into the position they would have been in had the misrepresentation been true. Rather, damages is the amount necessary to put the misled party into the position they would have been in had the misrepresentation not occurred.

By contrast, where the misrepresentation consti­tutes a term of the contract, the amount of damages is based on the amount necessary to put the misled party into the position they would have been in had the contract been performed (i.e. as if the misrepresentation was true).

Termination

If the misrepresentation constitutes a condition of the contract (i.e. it is essential to the parties), or is an intermediate term of the contract (a breach of which would cause substantial loss of benefit), a misled party may choose to terminate the contract (which is different to rescinding the contract). The effect of terminating a contract is that the contract is valid up to the date of termination, but is then at an end and the parties are discharged from any remaining obligations they have under the contract. Under the ACL, the court has the discretion to order a contract be terminated.

A misled party can sue for ‘loss of bargain’ damages, which is the amount necessary to put the misled party in the position they would have been in had the contract been completed and the parties had fulfilled all their obligations.

If the misrepresentation constitutes a warranty (that is, it is a non-essential and subsidiary term of the contract), then the misled party is not entitled to terminate the contract, but they are entitled to damages for the loss suffered as a result of the breach of that warranty.

What type of misrepresentation was made?

Under the common law and equitable principles, there are three types of misrepresentation:

1. fraudulent misrepresentation;
2. negligent misrepresentation;
3. innocent misrepresentation.

Fraudulent misrepresentation

To prove fraud, it is necessary to show that the person making the statement knew it was false, had no belief in its truth, or knew it might be false and recklessly went ahead and made it anyway, not caring whether it was true or false. This is a subjective test; if the person who made the representation honestly believed that the representation was true, no matter how unreasonable, negligent or silly, then that person has not made a fraudulent misrepresentation. Accordingly, it is very difficult to prove fraud.

However, once fraud is proven, the misled party can rescind the contract if they were induced to enter into the contract due to such fraud or sue for damages for deceit. It may be possible to recover damages for the loss caused by the fraud even where the loss was unforeseeable. As set out above, the misled party may also be entitled to contractual remedies (e.g. damages/termination) if the fraudulent misrepresentation constituted a term of the contract.

Negligent misrepresentation

To prove negligent misrepresentation, it must be shown that:

• the person making the representation owed a duty of care to the other party to ensure that any information they gave was true and reliable; and
• the person breached that duty of care because the statement was misleading or false and made without due care; and
• the misled party suffered loss or damage by relying on that misrepresentation, which was reasonably foreseeable and not too remote.

A duty of care will be found where the person making the representation could reasonably be expected to foresee that the statement would be relied on. This can be due to some special skill or superior knowledge that they possess, as compared to the other party, and it is reasonable in the circ*mstances for the other party to rely on the statement.

If the negligent misrepresentation caused the misled party to enter into the contract, then the misled party can rescind the contract or sue for damages for negligence. Unlike fraud, the misled party can only recover damages that were reasonably foreseeable. The misled party may also be entitled to contractual remedies (e.g. damages/termination) if the negligent misrepresentation constituted a term of the contract.

Innocent misrepresentation

An innocent misrepresentation is where a misrepresentation is made with no intention to deceive and without any negligence.

If the misled party is nevertheless induced to enter the contract, either because it was a reasonable consequence of the misrepresentation (even though the representor did not intend or expect this) or because of its own idiosyncrasy, the misled party may be entitled to rescind the contract. However, it is arguable that if no reasonable person would have been induced to enter the contract or rely on the misrepresentation, then the misled party would not be entitled to rescind the contract.

Where there is innocent misrepresentation, the misled party is not entitled to damages for any tort.

The misled party is only entitled to the contractual remedies of damages/termination if the representation constituted a term of the contract, and the other party breached that term by their misrepresentation.

Duress

Proper consent may be affected by duress. Under the common law, duress is where there has been actual or threatened violence either to the other contracting party directly or to their immediate family, near relatives or close associates. The duress may be made by someone acting under the instructions of the party to the contract. The effect, though, will have been that a party has been forced into the contract by being deprived of their free will to act.

Duress now extends to contracts entered into as a result of threats to a party’s economic wellbeing, that is, a threat to a person’s business or trade. This form of duress is called economic duress.

To prove duress, it must be shown that:

• a party applied unlawful or unconscionable pressure (whether physical, economic or psycho­logical pressure) to force the other party to enter into the contract; and
• such pressure meant that the other party had no reasonable alternative but to enter into the contract, and
• such pressure was a cause of the other party entering into the contract.

The consequence of establishing duress is that the contract is voidable at the election (i.e. the choice) of the wronged party. Where the wronged party elects to have the contract declared void, both parties will be restored to their original positions as if the contract had not been entered into. This may require a court to order monetary adjustments or restitution. While it is arguable that duress is a tort that gives rise to a right to damages, this is not entirely clear.

However, duress is likely to be a contravention of various provisions of the ACL where it is done ‘in trade or commerce’. This includes unconscionable conduct under sections20, 21 and 22 of the ACL, which would give rise to a range of more flexible remedies, including rescission and damages. (Seealso ‘Unconscionable conduct’ in ‘Australian Consumer Law consumer protection‘).

Undue influence or unconscionability

Proper consent may be affected by undue influence. Undue influence is exercised by taking unfair and improper advantage of the weakness of another party, to the extent that it cannot be said that the other party voluntarily entered into a contract.

The main reason for the rule against the use of undue influence is to correct abuses of trust and confidence. It is applied where the parties are in a relationship where one party may be able to exercise considerable influence over the other party.

There are two categories of undue influence. The first is where no special relationship exists, but the stronger party has exerted dominance and influence over the weaker party. The weaker party has to prove that undue influence has been exerted.

The second category of undue influence is where the parties are in a special relationship of confidence; most cases of undue influence fall into this category. Such a relationship exists when one party’s position towards the other’s position involves a dependency or trust, in the form of authority or an expectation to give fair and independent advice to the weaker party.

Where a special relationship is found to exist, a presumption of undue influence will arise. It is then necessary for the stronger party to show that the contract was not the result of any undue influence. This could be shown by, for example, the weaker party obtaining independent advice before entering into the contract.

A special relationship of confidence and the presumption of undue influence can be established in two ways. First, the parties may be in a well-recognised special relationship; for example, solicitor and client, doctor and patient, parent and child, guardian and ward, and religious or spiritual adviser and devotee.

Second, the special relationship, although not falling within any well-recognised relationship, issuch that the complaining party is able to show that the other party was in a position of influence.

Forexample, it could be that the circ*mstnaces of a particular relationship between a bank and its customer gives rise to the bank occupying a special position of trust in connection with the conduct of the customer’s affairs. (It has to be stressed that in ordinary circ*mstances no presumption of undue influence arises out of a banker–customer relationship.) See, for example, Commercial Bank of Australia Ltd v Amadio [1983] HCA14 (for a summary of the Amadiocase, see ‘Unconscionable conduct’ in ‘Australian Consumer Law consumer protection‘).

The consequence of establishing undue influence is that the contract may be held voidable at the election (i.e. the choice) of the weaker party.

For details of complaints of undue influence in relation to some types of loan contracts and related complaints of unjust contract, unconscionable dealings, harsh and oppressive contracts, etc., see‘Unjust contracts’ in ‘Varying, re-opening and terminating credit contracts‘.

As with duress, undue influence is also likely to be a contravention of various provisions of the ACL where undue influence is exerted in ‘trade or commerce’. This includes unconscionable conduct under sections20, 21 and 22 of the ACL, which would give rise to a broader range of remedies, including rescission and damages (see ‘Unconscionable conduct’ in ‘Australian Consumer Law consumer protection‘).

Unfair contract terms in standardformcontracts

Unfair contract terms in standard form contracts are regulated by the ACL. Where a term of a standard form contract has been held to be unfair, the term is deemed to be void. However, the contract will continue to bind the parties if it can operate without the unfair term.

A term is unfair when:

• it causes a significant imbalance in the parties’ rights and obligations under the contract; and
• it is not reasonably necessary to protect the legitimate interests of the supplier; and
• it causes detriment to another party.
• In determining whether a contract term is unfair, a court must consider the transparency of the term and the operation of the contract as a whole. For example, highly advantageous terms might be balanced against other disadvantageous terms. Certain terms cannot be determined to be unfair (e.g. the price of a good, service or the main subject).
• Unfair contract terms are discussed in more depth in Chapter7.2: Consumer protection laws.