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How A Contingent Contract Works

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What Is a Contingent Contract?

Contracts generally exist in two types: contingent and absolute. A contingent contract requires the promisor to perform an outlined obligation only when certain conditions are met. It differs from an absolute contract in that absolute contracts require the promisor to perform on the terms agreed upon within the contract without any conditions. The Indian Contract Act of 1872 provides a more detailed contingent agreement definition: “If two or more parties enter into a contract to do or not do something, if an event which is collateral to the contract does or does not happen, then it is a contingent contract.”

Although this act doesn't apply to those in the U.S., the definition clearly states the terms of a contingent contract and what types of agreements would apply.

Essential Components of a Contingent Contract

In order to qualify as a contingent contract, an agreement must meet certain criteria and contain several key components. The first is a dependence on a certain event happening or not happening and the condition that if this future event does or doesn't happen, the agreement is valid and both parties must act upon their outlined duties. The events can be subsequent or precedent, as the order or timing doesn't matter.

For example, if a person entered into a contract with another person that the first would pay the second $500 if they arrived at a particular location at a certain time, this would qualify as dependence on a certain event happening. If the second person arrived in the location within the timeframe established, the first person would be contractually obligated to pay them the $500. A common example of a contingent contract is a contingency clause in an employment contract , which might stipulate that the terms are valid only if the individual can pass a background check or drug test before accepting the position.

Another essential component of a contingent contract is the event serving as collateral for the contractual agreement. Whether a situation arises may qualify as the collateral event, such as in the example above. If the second person in that example didn't arrive at the location within the timeframe, they would not have met the collateral requirements of the contingency agreement and thus would not receive the $500.

Another example is a contract that involves betting on the outcome of a sports match. If the contract specifies that when one team wins, those who bet on that team's success would receive a payout, the winning of the event is the collateral in the agreement. The event also cannot be a wish or will of the person entering into the contract, nor can it be certain to occur. It shouldn't be dependent on the promisor's desires, nor should it be at their discretion.

Types of Contingent Contracts

Some of the most common types of contracts used by insurance companies are contingent contracts, including those related to guarantees, indemnity, and providing insurance. For example, in a contract entered into by a policyholder and a life insurance company, the payout is made only if the insured individual dies under specific conditions. Until the death occurs, the contract payout amount is not eligible, and it will be paid only if the individual dies under the outlined circumstances. This type of contract qualifies as a contingent agreement.

Other types of insurance policies utilize contingent contracts. Homeowners insurance policies agree to pay out under certain conditions that cause damage to the property, but unless a situation occurs that causes the applicable damage, the funds would not be issued.

Another type of contingent contract is an agreement based on the non-occurrence of a particular event. For example, if Company A contracts to sell goods in transit to Company B if the boat carrying those goods does not return, the goods are sold only if the boat doesn't return. If the boat does return, the contract would become void because the non-occurrence of an event did not happen, or the event did occur.

The contingent contract definition allows for the specification of a timeframe, although this is not a requirement for the agreement to be considered valid. In the previous example of the boat carrying goods, Company A may agree to sell the goods to Company B only if the boat doesn't return within 10 days. As long as the occurrence or non-occurrence of the event happens or doesn't happen within the timeframe outlined, the terms of the contract must be enforced.

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Advantages of Contingent Contracts

Contingent contracts have several benefits for those who choose to enter into them. One benefit is the elimination of the need to come to an agreement right away, or allowing both parties to bet on what they predict will happen. Contingent contracts allow commitments to become self-enforcing by eliminating the need to renegotiate or make adjustments when situations occur. Additionally, this type of contract can limit the need for future litigation, as the terms for what will happen in response to a particular event are clearly outlined in the agreement.

Here is an article that further explains the benefits of contingent contracts.

Enforcement of a Contingent Contract

In order to enforce a contingent contract, the event outlined in the agreement must either occur or not occur, depending on the terms. If the event does not take place and the contract was based on that particular event occurring, the contract cannot be enforced.

If any action renders the event outlined impossible, the contract would be considered void. For example, if a person entered into a contract that they would receive $1,000 for teaching another person how to cook, that contract would become void if either party died, as the event (cooking lessons) would no longer be able to take place in the future.

Additionally, a contract that is contingent on an impossible event cannot be enforced. An example of an impossible event is bringing a person back from the dead. In order to qualify as an enforceable contingent contract, the event must be reasonably able to occur or not occur.

Contingent Contracts in Real Estate

Real estate is an industry that often includes contingent contracts since buyers may issue contingent offers based on a particular event. A buyer may make an offer to a seller for a home that is contingent on the buyer selling their current home. Another contingency in a real estate contract is the condition of the property, and determining that condition usually requires the completion of a professional home inspection and/or appraisal. The three main clauses in a real estate purchase contract fall under three main categories:

  • Mortgage/lender approval
  • Home inspection
  • Appraisal

The contingencies exist in a real estate contract to protect the potential buyer from entering into an agreement that doesn't fairly represent the property being purchased.

Negotiating a Contingent Contract

If you are considering entering into a contingency contract or are entering the negotiation phase of the contract, it's helpful to understand the main factors that go into this type of agreement. The first factor is the level of risk you're willing to take on by entering into the agreement. The odds of the event happening or not happening on which the agreement is contingent on is usually the key factor in evaluating the risk. You should also consider the potential reward of entering into a contingent contract.

As you better understand the meaning of a contingent contract, you can gain insights into the benefits available to you by entering into this type of agreement.

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