Collateral Contract: Definition & Examples

Instructor: Kenneth Poortvliet
A contract is an agreement between two people, but some agreements can actually be multiple, separate contracts. In this lesson we will learn what a collateral contract is.

What is a Binding Contract?

Sammy Saw wants to buy some logs from a Canadian logging company, but it only works for him if the logs are under a certain price. He doesn't want to commit to the shipments if the price skyrockets. One way is to enter into a contract to enter into another contract. But can you do that?

A contract is an agreement between two parties each promising to get something and give something from the other party. This is called consideration, and without it, there is no binding contract.

For example, if Johnny Clean agrees to wash Ms. Robinson's car for 100 dollars, and then he washes her car, she is obligated to pay the $100. Why? Because they agreed to each give up something and get something. Johnny gave up his time, labor and supplies to wash her car to get $100. Ms. Robinson promised to give $100 to get a clean car.

Breached Contracts

This is a valid, binding contract that can be enforced by the courts. If either failed to to their part, then the contract is breached (one party not living up to their obligation) and the court will award the breached party damages from the breaching party. The breaching party has no defense by just saying that they didn't mean to fail on their end. Intent to breach is not required to give damages. Sometimes both parties breach, and the court can still award damages to both based on how they were damaged by the other.

So why is consideration important? Because it determines whether a contract exists. For example, let's say Ms. Robinson told Johnny he could wash the car, and if she felt like it, then she'd pay him $100. There is no consideration here as Ms. Robinson did not agree to pay the money upon the cleaning of the car as it was contingent on ''if she felt like it'', which was not a promise to give something.

Conditional Contract

Sometimes parties will want to agree to something but only if something else happens first. For example, Felix wants to buy Oscar's home but only if Oscar removes the family cemetery at the back of the property because Felix is very superstitious. One way is to enter a conditional contract which places a condition upon the consideration of the contract.

There is a problem with this solution. It is in the court's remedy for a breach. For example, let's say Oscar removes the cemetery, and the sale goes through. But upon further inspection, there were some bodies not moved.

If Felix goes to court, the remedy under a conditional contract that was already executed (completed by both parties) would be to award Felix an amount equal to the cost of removal of the bodies. This is not acceptable to Felix. It's not the money, it's that he didn't want to be the owner of dead bodies, so removing them doesn't fix his problem.

Collateral Contract

So how can Felix enter into an agreement that would make the sale void if the bodies were still there? They can enter into a collateral contract, which is a contract with its own consideration to promise to enter into a second contract. Thus if it turned out there was no valid consideration for the collateral contract, then the court can consider the second contract void.

So remember that each contract had to have consideration? In Felix and Oscar's case, they draft (but not sign) contract #2 for the sale of the house with the consideration being money for Oscar and the deed to the house for Felix. Both get and give, thus there is consideration. However, they hold off signing this contract and they enter into contract #1, a collateral contract.

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