The Meaning of Covenants
A covenant is a legal clause in a statute, deed or other formal or legal document that represents a promise and requires either or both of the parties to a contract to act or refrain from acting in a certain way. Covenants have various uses in legal contexts. Covenants can be conditions to enforceable rights or obligations, and thus be affirmative or negative ("to repair" or "not to alter"). They can also be confirmatory, clarificatory or cautionary, requiring that something has been carried out in a specific manner or otherwise stating what would be the effect of complying or failing to comply with certain stipulations .
Covenants have binding strength, requiring a party to comply strictly with the terms or to otherwise rescind from the entirety of the contract. Major examples of where covenants are found in law include restrictive covenants as used in land ownership, or non-compete clauses often seen in employment contracts where they prohibit an individual from conducting business similar to that of his or her former employer. Within probate, there is a number of additional restrictive covenants that are examples of how a finding of capacity or testamentary intention could lead to a finding that a certain disposition was a sham (see the examples of "bona vacantia" and "in terrorem" clauses in the above linked article).
What is a Contract?
Contracts and covenants have a lot of overlap in the world of the law. They are at their core both promises made between parties. However, that is where the similarities end. While all covenants are contracts, not all contracts are covenants.
In their most basic form, contracts are a legally binding agreement between two or more parties. The agreement is based on either an exchange or a promise to exchange legal rights or contractual performance. For the agreement to be considered a contract, there are four essential elements that must be present.
Mutual Assent: For a contract to be valid, the parties must mutually agree to the terms within the contract. An offer made by one party must be effectively communicated to the second party or parties, and the second party or parties must then agree to those terms. Acceptance may be expressed orally, in writing, or by the performance of specific acts required by the agreement.
Consideration: Consideration is something of value that is exchanged between the parties involved in the contract. Consideration is often thought of as the price for the product or service being provided. However, consideration can also take the form of an exchange for another product or service, the mutual promise to perform specific acts, or the payment of a debt.
Capacity: When entering a contract, the parties involved must possess the legal ability to enter into the agreement. The parties must be of sound mind, of the legal age (which varies by state), and free from any undue influence or fraud.
Legality: The subject matter of the contract must be lawful. Contracts that are illegal or against public policy cannot be valid. Even if all four of the other elements are present, without legality, the contract is void.
Covenants vs Contracts: Key Distinctions
Covenants and contracts serve different purposes and come into play in virtually every facet of the law. However, these legal documents are not interchangeable by any means. A contract is an explicit agreement – in writing or verbally – between two parties. A covenant, on the other hand, is a solemn promise to do (or not do) something in the future. A covenant would be an element in a contract. If someone breaks a covenant, it might be a breach of contract though it can also be a breach of promise, and in many cases it would be neither.
Contracts are formed when:
Covenants are formed when:
In terms of "consideration," which is a legal term referring to something of value each party to the contract agrees to give the other to form an enforceable contract, the consideration for a contract is that each party either does or refrains from a specific action. Whereas, the consideration for a covenant is a future promise from the other party. Covenants are found in wills, mortgage contracts, and covenants not to compete usually found in employment agreements and asset purchase contracts. In real estate, restrictive covenants are agreements that restrict the ability to use the property.
Covenants and Contracts: Key Differences
Covenant agreements are legally enforceable, meaning that if there is a dispute in the future where one party feels that the other has not held up their end of the deal, there can be legal implications. If you are entering into a covenant agreement, you should know what these legal ramifications are. It is often critical to have a real estate attorney review any covenants related to your property before you purchase it.
While it can vary from state to state, typically one party that is bringing a lawsuit against another party for the breach of a covenant will ask for several specific types of damages, including but not limited to: signature damages, actual damages, consequential damages, punitive damages, costs, and attorney fees.
Signature damages: Often in real estate transactions, the seller will sue the buyer for breach of the covenant to purchase property and/or other agreements. As a result, the seller may be asking for signature damages, which is just a fancy way of saying they want what they would have gotten had the property never been released from escrow. Typically signature damages will go no further than the initial earnest money deposit, though additional costs could be included such as attorney fees. Other types of buyers may try to recover signature damages, such as in the case of a covenant that involves the sale of a business. It is in instances where the nature of the business is in question that the compensation awarded goes beyond the selling price.
Actual damages: These are the actual costs, or lost profits, that a party can demonstrate as negatively impacted by the breach of a covenant. This is easy to establish in many situations, such as a buyer not holding up their end of a real estate purchase and the seller losing substantial money as a result. It gets more difficult in business situations, however, and in order to be considered actual damages, there must be a real and specific loss because of a breach of covenant, not a theoretical or speculative one.
Consequential damages: These are the damages that follow from the actual damages like lost profits and are not damages suffered directly, but are a consequence of the breach that result in real damages to the suing party. For example, a company may suffer actual damages when party A breaches their duties under an agreement to provide data to company B, thus resulting in lower profits for company B. That, however, is the extent of the harm. Other than the lower profits, company B has not suffered – enter consequential damages. Damages can also be based on a business owner’s loss of goodwill from the public as a result of the breach. Damages could potentially include decreased sales not directly tied to the violations of a covenant. It is possible to sue for all three types of damages listed above, and generally, in many states, if any two are awarded, the signature damages will be the lowest and others may be awarded.
Punitive damages: This is a category of damages aimed at punishing the party in violation of a covenant, as well as deterring them from future breaches. Punitive damages are typically reserved for only intentional, grossly negligent, or otherwise outrageous behavior. Because of their punitive nature, however, not all states will allow punitive damages in addition to the other forms above, as they argue that one of these categories of damages is enough punishment.
In some states, you may be able to separately sue a party for their legal fees, or their costs resulting from filing the lawsuit. This should only be done after much thought, as even if an agreement allows you to sue first for fees, it may not be a good idea to do so. The safest option is to either pay your own fees or to try and reach a settlement out of court.
Practical Applications and Examples
Ensuring that a contract is enforceable is essential, should there be a breach. For a contract to be legally binding, it must contain five essential elements:
- Two or more parties
- A meeting of the minds (mutual agreement)
- Consideration (something of value exchanged between the parties)
- Competent parties (adults of sound mind)
5 . Legal purpose
In practice, interpretation of these contract elements is up to the court. Interpretation of terms of a contract may be affected by events leading up to, and surrounding, the formation of contract, including each party’s subjective perceptions. In such instances, a court may allow extrinsic evidence – such as subsequent actions of the parties and other evidence of intent – to be admitted.
Contracts: Enforceability
To illustrate the distinction between covenants and contracts, we can look at a variety of real-world examples. For instance, consider the employee non-compete agreement mentioned earlier. In many states, this would be a covenant rather than a contract because it only restricts future actions, and does not create any current obligations to perform work. An employee does not make a commitment to the employer on the day they sign the document, but it obligates them to do certain things in the future.
Similarly, an adhesion contract is a common example of a covenant as well. Most service contracts that are readily available (e.g., a SAT prep course) are adhesion contracts. You must complete the course to finish the contract, but no one is going to take away your car if you miss a class or give you a fine if you fall behind in homework.
Now, for a case study of the difference between covenants and contracts, take the majority of cases dealing with restrictive covenants. A physician might agree to never practice within 50 miles of a hospital, or an engineer agrees to never work for a competitor because they’ve just been privy to a ton of proprietary data. These agreements might be enforceable if they’re not too overly broad.
Another case study might involve that same physician following their employment with a hospital and trying to work for one of the hospital’s competitors. The hospital could file a case seeking enforcement of the non-compete agreement. If the agreement is not overly broad it may be enforceable and an injunction could be obtained.
However, if the hospital was actually sold to a different health system, the courts might find that the non-compete does not apply. That is because the hospital is not competing with itself, but with its new owner.
Conclusion: Covenant or Contract?
Whether you choose a covenant or a contract to govern your particular situation can largely depend on circumstances and the identified choice and advantages. Covenants are generally the preferred choice for agreements that involve real property and estates in land. The analytics behind this form of agreement make them the right choice for property-related agreements. Contracts, due to their flexibility, can be the right choice for everything from privacy policies to employment agreements .
Its important to remember that this guide is just that, a guide. Not all stipulations will fit perfectly into either category, but understanding the general differences is a starting point to help you decide. Professional legal review and input is necessary to ensure that the appropriate framework for these issues is identified. If you are considering a covenant vs contract for a business agreement contact our office to schedule a consultation.