Elements of a Contract

For a contract to be enforceable, these key characteristics must be present.

Offer
Acceptance
Consideration
Legality
Capacity
Consent
Writing (only certain types of contracts must be in writing.)

Is it certain that the defendant promised to do something?

If she did promise, is it fair to make her honor her word?

If she did not promise, are there unusual reasons to hold her liable anyway?

Types of Contracts

In a bilateral contract, both parties make a promise.. When the bargain is a promise for a promise, it is a bilateral agreement. In a unilateral contract, one party makes a promise that the other party can accept only by actually doing something.

A contract is executory when it has been made, but one or more parties has not yet fulfilled its obligations. The moment the parties strike their bargain, they have an executory bilateral express contract. A contract is executed when all parties have fulfilled their obligations.

A valid contract is one that satisfies all of the law’s requirements. It has no problems in any of the seven areas listed at the beginning of this chapter, and a court will enforce it. An unenforceable agreement occurs when the parties intend to form a valid bargain but a court declares that some rule of law prevents enforcing it. A voidable contract occurs when the law permits one party to terminate the agreement. This happens, for example, when the other party has committed fraud, or when an agreement has been signed under duress. A void agreement is one that neither party can enforce, usually because the purpose of the deal is illegal or because one of the parties had no legal authority to make a contract.

Mr. W. Fireworks, Inc. v. Ozuna

Facts: Mr. W sells fireworks. Under Texas law, retailers may only sell fireworks to the public during the two weeks immediately before the Fourth of July and during two weeks immediately before New Year's Day. And so, fireworks sellers like Mr. W tend to lease property.

Mr. W leased a portion of Ozuna's land. The lease contract contained two key terms:

"In the event the sale of fireworks on the aforementioned property is or shall become unlawful during the period of this lease and the term granted, this lease shall become void."

"Lessor(s) agree not to sell or lease any part of said property including any adjoining, adjacent, or contiguous property to any person(s) or corporation for the purpose of selling fire-works in competition to the Lessee during the term of this lease, and for a period of ten years after lease is terminated."

A longstanding San Antonio city ordinance bans the sale of fireworks inside city limits, and also within 5,000 feet of city limits. Like all growing cities, San Antonio sometimes annexes new land, and its city limits change. One annexation caused the Ozuna property to fall within 5,000 feet of the new city limit, and it became illegal to sell fireworks from the property. Mr.W stopped selling fireworks and paying rent on Ozuna's land.

Two years later, San Antonio's border shifted again. This time, the city disannexed some property and shrank. The new city limit placed Ozuna's property just beyond the 5,000 foot no-fireworks zone. Ozuna then leased a part of his land to Alamo Fireworks, a competitor of Mr. W.

Mr. W sued for breach of contract, arguing that Ozuna had no right to lease to a competitor for a period of ten years. The trial court granted Ozuna’s motion for summary judgment. Mr. W appealed.

Issue: Did Ozuna breach his contract with Mr. W by leasing his land to a com-petitor?

Argument for Ozuna: Your honor, as soon as San Antonio's city limits changed and my client's land fell within 5,000 feet of the city, it became illegal to sell fireworks on his property. The lease is quite clear. By its own terms, it became void. Mr. W therefore had no continuing right to enforce any part of it.

Mr. W seeks to selectively enforce one portion of a void lease that it finds advantageous. The company shows no desire to pay rent, or to live up to any other parts of the lease.

When the city's boundary changed again, my client was free to lease his property to any seller of fireworks he wished.

Argument for Mr. W: Your honor, my client paid for several things when he leased Ozuna's land. He was buying more than the right to sell fireworks; he was also paying for exclusive rights. The fact that selling fireworks became illegal on the property does not require that the court void the non-compete agreement.

Before San Antonio's city limits shifted, Mr. W lived up to its part of the bargain by paying rent each month. Mr. Ozuna has certainly not offered to return those payments. Yet he is trying to get out of his promise not to lease the land to any other fireworks company.

It is Ozuna who seeks to escape selected parts of the contract. He should be held to his agreement, and he should not be permitted to lease his land to a competitor of Mr. W.

NOTE: The court held that the agreement was in fact void, and that Ozuna was free to lease the land to another fireworks seller.

Question: When did the lease become void?

Answer: as soon as San Antonio’s city limited changed and Ozuna’s land fell within 5,000 feet of the city.

Question: Contracts requiring an illegal act will be held?

Answer: Void.

Question: What is the effect of the lease becoming void?

Answer: Neither party can enforce the lease.

Express and Implied Contracts

In an express contract, the two parties explicitly state all important terms of their agreement. The vast majority of contracts are express contracts. Some express contracts are oral, and some are written. In an implied contract, the words and conduct of the parties indicate that they intended an agreement.

Students often find implied contracts difficult to understand, perhaps because the other paired terms introduced in this section present two faces of some aspect of contract: bilateral and unilateral, executory and executed. People do not enter negotiations with intent to form an implied contract. Implied contract is not another method of forming a contract, but a remedy a court may apply after the fact if there was no valid contract between the parties but their words and conduct manifest implied intent that certain promises would be legally enforceable.

You Be the Judge: DeMasse v ITT Corporation[1]

Facts: Roger DeMasse and five others had been hourly employees-at-will at ITT Corporation for many years. ITT issued an employee handbook, which it revised four times over two decades. The first four editions of the handbook stated that within each job classification, any layoffs would be made in reverse order of seniority. The fifth handbook made two important changes. First, the document stated that the handbook did not guarantee continued employment. Second, the handbook stated that “ITT reserves the right to amend, modify or cancel this handbook, as well as any or all of the various policies [or rules] outlined in it.” Four years later, ITT notified its hourly employees that layoff guidelines for hourly employees would not be based on seniority but on ability and performance. About ten days later, the six employees were laid off, though less senior employees kept their jobs. The six employees sued.

You Be The Judge: Did ITT have the right to unilaterally change the layoff policy?

Holding: Judgment for the employees. The case came to the Arizona Supreme Court from the Ninth Circuit, which certified this question: Once a seniority-layoff policy becomes part of the employment contract based on the employee’s reliance on the company handbook, may the employer thereafter unilaterally change the handbook policy and layoff employees without regard to seniority? The Arizona Supreme Court said the answer was “no.”

The court emphasized that an implied contract carries just as much force as an express contract. The manner of contract formation does not matter. Assuming that the handbook created reasonable expectations of a seniority-layoff plan, it was binding on the company. The company had no right unilaterally to modify the agreement.

Additional Case: Britt v. Chestnut Hill College[2]

Facts: Joseph Britt, a detective, enrolled in a Master’s Degree program at Chestnut Hill College in Pennsylvania. Chestnut Hill promised students credit for life experience. The college promised Britt important credits for his life experience if he enrolled, and after he did enroll, the school awarded the promised credits.

Britt took a one-week required course entitled “Gender Stereotyping,” taught by Professor Klee. As part of a classroom exercise, Klee directed another student, who Britt claimed was a "known" homosexual, to make physical advances toward Britt. The student complied by telling Britt that he was attracted to him and by touching Britt above the knee. Britt rejected the student’s advances. The next day, Klee assigned that same student to serve as a "facilitator" to "deal with Britt’s anger." Klee became openly critical of Britt’s attitude and performance in the class and awarded him a "C" grade for the course.

Britt claimed that Klee thereafter did everything within his power to sabotage Britt’s reputation and academic career. Klee arranged to have himself assigned as Britt’s academic advisor and, after doing so, personally revoked, and successfully persuaded other instructors to revoke, the life experience credits that had been granted to Britt upon admission to the college. The revocation of those credits caused Britt not to graduate as scheduled.

Britt sued. The trial court dismissed his contract claim, essentially ruling that a college had an absolute right to award and revoke credits as it saw fit. Britt appealed.

Issue: Did Britt have an implied contractual right to receive credits from the college for life experience?

Holding: Judgment for the college reversed. The court reinstated Britt’s contract claim. In the words of the court:

The economic reality is that colleges and universities are competing to attract non-traditional age students and many of those institutions have designed programs to cater to them. Through advertising and recruitment campaigns, an increasing number of colleges and universities are inducing students who wish to return to school with flexible schedules, evening and weekend classes, and academic credit for life experience. Students, in turn, attracted by these options, may seek to apply to a particular institution and inquire as to the requirements they will have to meet in order to achieve their degree. Where an individual is induced to enroll in a university or college based upon an award of certain life experience credits, the institution cannot then, after the student’s enrollment, revoke those credits.

We point out that, by reaching this conclusion, we are in no way attempting to interfere with an academic institution’s rights to develop its curriculum and set requirements for a given degree. However, where a college or university promises a student, upon enrollment, a certain amount of life experience credits, the purpose of which is to enable that student to graduate at an accelerated rate, provided that he or she successfully completes the course chosen, the institution cannot breach its promise. Where a student can prove that such an agreement was made, the university or college cannot revoke the life experience credits.

Question: What should Britt argue to convince the court of his implied contract claim?

Answer: The college made a deal and should be forced to stick to it. This college, like many, is using the idea of “life experience credits” as a lure to attract older students. If a college chooses to advertise such credits to attract students, and promises to award them when a student applies or enrolls, it should be held to its promise.

Question: What should the college argue to refute Britt’s claim?

Answer: This is not a business deal. All we have here is an unhappy college student. If Britt wins on the contract issue, can he also sue to have his grade of “C” raised to an “A”? Can all students file suit just because they are unhappy with grades, credits, or class schedule? Is a student entitled to a refund because she does not like her dorm roommate, or had an unhappy date on Friday, or thought that last night’s chicken pot pie was overcooked? A college is a collegial place of learning, and both professors and the administration must have wide latitude in assigning grades and credits. Britt’s aggressive reaction to an innocuous in-class exercise demonstrated that he was desperately in need of some sensitivity training–the precise purpose of the course! Should students like Britt decide a course’s content? A college’s curriculum? Must we reward Britt’s immature conduct by appointing him provost?

General Question: Has your college, or that of a friend, made any promises that it has failed to keep? In your view, did the promises create a contract? Was the contract express or implied?

Promissory Estoppel and Quasi-Contract

Courts created promissory estoppel and quasi-contract as “fall-back” remedies for cases in which the plaintiff cannot prove a valid contract with the defendant. They are not equivalent to a claim of breach of contract for at least two reasons: both require a plaintiff to convince the court, as an essential element of the claim, that justice requires a judgment for the plaintiff, and in both a successful plaintiff will almost invariably receive a smaller award of damages—reliance damages or restitution damages, as the case may be—than would be the case in a claim for breach of contract.

Promissory Estoppel

Even when there is no contract, a plaintiff may use promissory estoppel to enforce the defendant’s promise if he can show that:

The defendant made a promise knowing that the plaintiff would likely rely on it;
The plaintiff did rely on the promise; and
The only way to avoid injustice is to enforce the promise.

Additional Case: Norton v. Hoyt[3]

Facts: Gail Norton met Russell Hoyt when Norton, who was single, worked as an elementary school teacher. Hoyt told her he was also single, and they began an affair. She later learned that he was married, but he assured her he was getting a divorce, and they continued their relationship.

Six years later, Hoyt, who was rich, convinced Norton to quit her job so that they could travel together. The couple lived lavishly and Hoyt repeated his promises to divorce his wife and marry Norton. He did neither and, after 23 years, ended the relationship. Norton became ill, and saw various doctors for anxiety, depression, headaches, stomach maladies, and weight loss. During one joint therapy session, Hoyt told Norton and the psychiatrist that he would continue to support her with $80,000 a year. He did not.

Norton sued, claiming promissory estoppel. Hoyt moved for summary judgment. In ruling on the motion, the court assumed that Norton’s allegations were true.

Issue: Was Norton entitled to support, based on promissory estoppel?

Holding: Summary judgment for Hoyt. Excerpts from the court’s opinion:

Even viewed most favorably to the Plaintiff, the record fails to reveal a clear, unconditional, and unambiguous promise. Plaintiff's vacillations have not helped her cause. First, she claimed that Hoyt promised to divorce his wife, marry her and provide lifetime support to her. Then she changed her mind and the promise became one to provide lifetime support to her regardless of whether Hoyt divorced his wife or not. Finally at the hearing on this motion, counsel argued that Hoyt had simply promised to take care of Norton for life. There can be many interpretations of the phrase, "take care of for life.” It could refer to care in a social, emotional, or financial context. This is certainly not a clear and unambiguous promise.

Even assuming arguendo that there was a clear and unambiguous promise, Norton's reliance upon that promise was unreasonable. Plaintiff knew that Hoyt was married, and that he spent time at the marital domicile with his wife and children. Norton and Hoyt never openly associated as husband and wife, their friends and family knew that they were not married and they did not exclusively cohabitate. Norton knew that Hoyt had lied in the past, was in an adulterous relationship, and apparently had made little effort to fulfill the terms of the promise. Reliance upon an unclear and ambiguous promise made by an apparently unreliable man was imprudent.

Question: The trial court granted Hoyt’s motion for summary judgment. If Hoyt had not won the motion for summary judgment, would Norton have won her promissory estoppel claim?

Answer: No. Denial of Hoyt’s motion for summary judgment would have allowed Norton to present her case to the trier of fact (a jury or the judge in a bench trial), which would then rule on her claim.

Question: What is the purpose of promissory estoppel?

Answer: Promissory estoppel can provide a remedy to someone who relied on the promise of another when there was no contract between the parties.

Question: What does “estoppel” mean?

Answer: Estoppel is a word used only by lawyers, and perhaps also by those who regularly complete crossword puzzles. To “estop” someone means to bar them from taking a position or asserting something that is contrary to what they’ve said or done previously. You will see the concept of estoppel again when we cover other topics.

Question: What promise of Hoyt’s was Norton trying to enforce?

Answer: One of the problems with Norton’s claim was that she was not attempting to enforce a clear promise. Hoyt’s promises ranged from divorcing his wife to providing Norton with continued support.

Question: But Hoyt did promise Norton a number of things over the years and Norton relied on them by staying in the relationship. Why isn’t that enough to constitute promissory estoppel?

Answer: Proving promissory estoppel requires more than proving there were promises. In addition to proving that the defendant made a promise knowing the plaintiff likely would rely on it and that the plaintiff did rely on the promise, there must also be proof that the enforcing the promise is the way to avoid injustice to the plaintiff.

Question: What does that mean—“avoiding injustice to the plaintiff?”

Answer: It means it must have been reasonable for the plaintiff to rely on the promise, and that it is very unfair to allow the defendant to walk away from the promise without providing some compensation to the plaintiff.

Question: What remedy does a court order to a successful plaintiff in a promissory estoppel case?

Answer: The court does not award expectation damages—“the benefit of the bargain”—which are the typical remedy in breach of contract cases. Instead it awards reliance damages, to compensate the plaintiff for out of-pocket expenses she incurred in reasonable reliance on the defendant’s promise.

Question: So even if Norton had won her promissory estoppel claim, the court would not have ordered Hoyt to support her financially?

Answer: Probably not.

Quasi‑Contract

Even when there is no contract, a court may use quasi-contract to compensate a plaintiff who can show that:

The plaintiff gave some benefit to the defendant
The plaintiff reasonably expected to be paid for the benefit and the defendant knew this; and
The defendant would be unjustly enriched if he did not pay.

Additional Case: Novak v. Credit Bureau Collection Service [4]

Facts: David Novak suffered a brain aneurysm and was unconscious. An ambulance took him to Saint Regional Medical Center, where doctors successfully operated. Novak remained in the hospital for two months and then was discharged.

Novak did not pay the Medical Center’s bill, and the claim was assigned to a collection agency which sued Novak for the debt.

The trial court found that Novak owed the debt under quasi-contract because Novak was unconscious and could not consent to the treatment, and the medical services were necessary to avoid serious bodily injury or death

Issue: Was the credit bureau entitled to damages based on quasi-contract?

Holding: Yes, judgment for the credit bureau affirmed. According to the court, Novak relies on earlier cases which state the person must impliedly or expressly request the benefits. The court disagrees and relies on Galloway v. Methodist Hospital where the court held:

To recover on the basis of quasi-contract, the party seeking recovery must demonstrate that a benefit was rendered to the other party, under circumstances which equity demands compensation in order to prevent unjust enrichment.

Novak argued that unlike him, the Galloway’s went to the hospital voluntarily when Mrs. Galloway experienced toxemia and needed an emergency caesarian section, whereas he was taken to the hospital without his knowledge or consent. Therefore, he neither expressly nor impliedly requested care.

In response, the trial court correctly held:

A person who has supplied things or services to another, although acting without the other’s knowledge or consent, is entitled to restitution therefore from the other if:

he acted [in an official capacity] and with intent to charge therefore, and
the things or services were necessary to prevent the other from suffering serious bodily harm or pain, and
the person supplying them had no reason to know that the other would not consent to receiving them, if mentally competent, and
it was impossible for the other to give consent or, because of extreme youth or mental impairment, the other’s consent would have been immaterial.

Here, a benefit was rendered to Novak to prevent serious bodily injury, thus in fairness the credit bureau must be compensated to prevent unjust enrichment.

Question: In this case, Novak never agreed to the services. Isn’t one element of a contract that there must be an agreement; an offer and acceptance?

Answer: Yes, those are elements of a contract; however, quasi-contract is a theory of recovery when there is no contract. In this case, there is no contract, but that does not necessarily mean the credit bureau should not get paid.

Question: The court laid out some specific reasons why people like the Medical Center should be paid under these circumstances. Can you think of any non-legal reason why the decision makes sense?

Answer: There are several public policy reasons why this decision makes sense. First, it is fair: this is the Medical Center’s work, they routinely provide these services, and they reasonably expect to get paid for these services. If a court denied them compensation for services that are the heart of what they do, it would seriously undermine the Medical Center’s, and facilities like it, ability to stay in business. Also, if the medical center did not get compensated for rendering life saving assistance in these circumstances, they would stop rendering life saving help (or any other kind) to patients who enter the emergency room unconscious. On a larger level, how would our system of emergency care be different if hospitals and medical centers refused such treatment?

Sources of Contract Law

Common Law

We have seen the evolution of contract law from the twelfth century to the present. Express and implied contracts, promissory estoppel, and quasi-contract were all crafted, over centuries, by appellate courts deciding one contract lawsuit at a time. Many contract lawsuits continue to be decided using common law principles developed by courts.

Uniform Commercial Code

Unit 3 of the text addresses commercial transactions, with Chapters 19-22 covering Article 2, contracts for the sale of goods, in some detail. References to the UCC in Unit 2, Contracts, primarily point out where the UCC changes the common law rule. One way to discuss the UCC in the context of the contracts unit is to make students aware of the UCC’s variations from the common law, but to reserve detailed discussion of the provisions of UCC Article 2 until students read Chapters 19-22.

Additional Case: Fallsview Glatt Kosher Caterers, Inc. v. Rosenfeld[5]

Facts: During the Jewish holidays, Fallsview Glatt Kosher Caterers organized programs at Kutcher’s Country Club, where it provided all accommodations, food and entertainment. Fallsview sued Willie Rosenfeld, alleging that he had requested accommodations for 15 members of his family, agreeing to pay $24,050, and then failed to appear or pay. Rosenfeld moved to dismiss, claiming that even if there had been an agreement, it was never put in writing. Under UCC section 2-201, any contract for the sale of goods worth $500 or more can only be enforced if it is in writing and signed. Fallsview argued that the agreement was not for the sale of goods, but for services. The company claimed that because the contract was not governed by the UCC, it should be enforced even with no writing.

Issue: Was the agreement one for the sale of goods, requiring a writing, or for services, enforceable with no writing?

Holding: Rosenfeld’s motion to dismiss to denied. Mr. Rosenfeld contends that the "predominant purpose" and "main objective" of the agreement alleged by Fallsview was the "service of Kosher food,” while the hotel accommodations and entertainment were merely "incidental or collateral" services.

Defendant argues that “the essential religious obligation during this eight day period [Passover] and the principal reason why people attend events similar to the Program sponsored by plaintiff is in order to facilitate their fulfillment of the requirement to eat only food which is 'Kosher for Passover'. It is the desire to obtain these 'goods' and not the urge for 'entertainment' or 'accommodations' that motivates customers to subscribe to such 'Programs'."

However, a review of the characteristics of Fallsview’s daily activities program leads the Court to conclude that the "essence" of the family and communal "experience" is defined primarily by "services" and not by "goods".

Question: What was the basis for the Caterer’s claim?

Answer: Breach of contract because Rosenfeld failed to pay $24,500 for Passover accommodations.

Question: On what law was the Caterer’s claim based?

Answer: Common law.

Question: Then why does this court’s opinion discuss the UCC?

Answer: Because Rosenfeld argued that the contract is governed by the UCC.

Question: Why does he argue that?

Answer: Because his agreement with the plaintiff was oral, the UCC requires contracts for more than $500 be in writing, and thus this contract is unenforceable and the court should dismiss the lawsuit.

Question: When a contract involves both goods and services, how does a court typically determine whether the UCC applies?

Answer: Most courts use the predominant purpose test: that is, if the predominant purpose of the contract was the sale of goods, then the UCC governs. If the predominant purpose of the agreement was provision of services, then the common law governs.

Question: On what basis does Rosenfeld claim that this contract is governed by the UCC?

Answer: He argues the contract was primarily for the plaintiff to provide Kosher food in connection with observance of the Passover holiday, and that the hotel accommodations and entertainment were incidental.

Question: What did the court decide here—was the predominant purpose of the contract for goods or services?

Answer: Services.

Question: Why?

Answer: The court looks at the totality of what the contract would have provided Rosenfeld, pointing to a lengthy list of activities and entertainment available as part of the accommodations.

Question: Does it rely on anything else?

Answer: The court also notes that under the UCC “quantity is even more important than price” but that a contract of the type in this case would rarely specify the quantity of goods to be provided; it would not, for instance, state how many briskets or noodle kugels Rosenfeld would be served during his stay.

Question: What is the result of this decision?

Answer: As an oral contract governed by common law, the statute of frauds does not apply and the contract is enforceable. The plaintiff’s claim can thus proceed to trial.

The Agreement

Meeting of the Minds

Agreements that have a problem in any of the key areas do not amount to valid contracts

Parties can form a contract only if they have a meeting of the minds. For this to happen, one side must make an offer and the other must make an acceptance.

Offer

As the text notes, an offer is an act or statement that proposes definite terms and permits the other party to create a contract by accepting those terms. Sometimes we forget that by making a valid offer, we give that power to the other person. Sometimes corporate officers forget the point. Nationwide Mutual Insurance Company wanted to energize a regional meeting, so it announced a contest for the best company slogan, to be used at the convention. “Here’s what you could win: His and Hers Mercedes. An all-expense-paid trip around the world. Additional prizes to be announced. (All prizes subject to availability.)”

David Mears and 184 other employees entered. Mears’s slogan, “At the Top and Still Climbing,” was the winner. One company officer told Mears that he had won the two cars, while another one said that the cars were just a joke. Ultimately, Nationwide informed Mears that the prizes were never meant seriously. The company did, however, use his slogan for its convention, and banners, booklets, and balloons all echoed with his phrase.

Mears failed to see the joke, and filed suit in federal court. The jury didn’t laugh, either. They awarded Mears $60,000, the value of two of the least expensive Mercedes. The trial judge gave a judgment n.o.v. for Nationwide, ruling that the terms of the agreement were too vague to enforce. On appeal, however, the Eighth Circuit Court of Appeals agreed with the jury, and reinstated the $60,000 damage award.

Question: Was this a bilateral or unilateral contract?

Answer: Unilateral.

Question: How can you tell?

Answer: Mears accepted the offer by tendering performance, not by making a promise in response to Nationwide’s offer.

Question: Did Nationwide intend this offer to be taken seriously?

Answer: Nationwide apparently wanted employees to suggest slogans but considered the prizes to be a joke.

Question: If Nationwide didn’t intend it to be taken seriously then why did the jury find that Mears’ accepted it and created a contract?

Answer: There is a difference between subjective intent and objective intent. Subjective intent is what people believe or feel in themselves; objective intent is what a reasonable, neutral, third-party believes to be a person’s intent based on their words and conduct when making the offer.

Question: Aren’t the terms of this offer fairly vague?

Answer: The trial court thought so—it entered a judgment n.o.v. (non obstante veredicto) after the jury decided in favor of Mears.

Question: What is a judgment n.o.v.?

Answers: It is a procedure that allows a judge to overrule a jury’s verdict if the judge does not believe the evidence supports it.

Question: What happened on appeal?

Answer: The court of appeals reversed the judgment n.o.v. and reinstated the jury’s verdict awarding $60,000 to Mears.

Question: What lesson should we draw from this example?

Answer: Be careful proposing anything that a court might construe as an offer.

Statements That Usually Do Not Amount to Offers

An invitation to bargain is not an offer. A price quote is generally not an offer. An advertisement is generally not an offer. One thing invitations to bargain and price quotes have in common is that if they were offers, then the offeror would almost invariably be unable to perform if everyone who received the invitation or price quote could form a contract by accepting its terms. Suppose a homeowner sends a letter to friends and neighbors expressing interest in selling his home, an asking price of $200,000, and a closing on a date three months hence. If two recipients respond by saying “I accept” can the homeowner perform both agreements? Obviously not, he only has one house to sell. Is he therefore in breach of one of the agreements? Which one? If invitations to bargain and price quotes are understood in this fashion then there should be no problem in recognizing why they are not offers.

Placing an item up for auction is not an offer, it is merely a request for an offer. The bids are the offers. Most auctions are with reserve, meaning that the items for sale have a minimum price. The law assumes that an auction is with reserve unless the auctioneer clearly states otherwise. The rules are different in an auction without reserve. Here there is no minimum. Once the first bid is received, the auctioneer must sell the merchandise to the highest bidder.

Landmark Case: Carlill v Carbolic Smoke Ball Company [6]

Facts: In the early 1890s, English citizens greatly feared the Russian Flu. The Carbolic Smoke Ball Company ran a newspaper ad that contained two key passages:

"£100 reward will be paid by the Carbolic Smoke Ball Company to any person who contracts the influenza after having used the ball three times daily for two weeks according to the printed directions supplied with each ball."

"£1000 is deposited with the Alliance Bank, shewing our sincerity in the matter."

The product was a ball that contained carbolic acid. Users would inhale vapors from the ball through a long tube.

Carlill purchased a smoke ball and used as directed for two months. She then caught the flu. She sued, arguing that, because her response to the ad had created a contract with the company, she was entitled to £100.

The trial court agreed, awarding Carlill the money. The company appealed.

Issues: Did the advertisement amount to an offer? If so, was the offer accepted?

Excerpts from Lord Justice Lindley's Decision:

The first observation I will make is that we are dealing with an express promise to pay £100 in certain events. Read the advertisement how you will, and twist it about as you will, here is a distinct promise expressed in language which is perfectly unmistakable.

We must first consider whether this was intended to be a promise at all. The deposit is called by the advertiser as proof of his sincerity in the matter - that is, the sincerity of his promise to pay this £100 in the event which he has specified. I say there is the promise, as plain as words can make it.

Then it is contended that it is not binding. In the first place, the performance of the conditions is the acceptance of the offer. Unquestionably, as a general proposition, when an offer is made, it is necessary that the acceptance should be notified. But is that so in cases of this kind? I think that in a case of this kind that the person who makes the [offer] shews by his language and from the nature of the transaction that he does not expect and does not require notice of the acceptance apart from notice of the performance.

We, therefore, find here all the elements which are necessary to form a binding contract enforceable in point of law.

It appears to me, therefore, that the defendants must perform their promise, and, if they have been so unwary as to expose themselves to a great many actions, so much the worse for them. Appeal dismissed.

Question: Is an advertisement considered an offer?

Answers: No, generally an advertisement is not an offer.

Question: Why was this advertisement considered an offer?

Answer: In the ad, the Carbolic Smoke Ball Company made a very specific promise to pay £100 to any customer who followed the instructions and still caught the flu. Carlill complied but still caught the flu, so under the terms of what amounts to a unilateral contract, Carlill was entitled to the £100.

Question: How could the Carbolic Smoke Ball Company have avoided this problem?

Answers: The ad should have simply described the product, its features, and the price.

Letters of Intent. Letters of Intent pose a different problem. A letter of intent is between two parties and does not raise the problem of multiple acceptances discussed above. The concern is that if negotiations break down one party will treat the letter of intent as a binding agreement and seek its enforcement.

Business people often want letters of intent near the start of negotiations because they serve valuable business purposes. Letters of intent can indicate areas of agreement and expose open terms, provide comfort that the distance between the parties’ positions is small enough to warrant the time and expense of continued negotiations, interest investors to consider providing financing, and serve as the template for a definitive contract, if and when the parties reach agreement. Lawyers protect clients from the other side’s undue reliance on the letter of intent as a binding agreement by peppering it with language disclaiming its creation of legal obligations and expressing its temporary nature—what is often called “weasel language,” because its purpose is to leave one’s client with a way out of the deal.

Additional Case: You Be the Judge: Cochran v. Norkunas[7]

Facts: Eileen Norkunas owned a home in Baltimore, Maryland. The Groves and the Cochrans expressed an interest in buying the house. The two couples drafted a handwritten letter, stating:

Letter of Intent

We, Rebecca Cochran, Robert Cochran, Hope Grove and Robert Grove, Buyers-offer to buy 835 McHenry Street, Baltimore, Md. 21230 for $162,000. Payment by $5,000 check, this date and $157,000 by certified or cashiers funds no later than April 17, 2004.

A standard form Maryland Realtors contract will be delivered to Seller within 48 hours. Seller to pay only ½ normal transfer taxes and a 3% commission to Long & Foster. All other costs of closing to be paid by buyers.

The contract will contain a financing requirement for buyers, but buyers will guarantee closing and not invoke the financing contingency.

We will delete the standard home inspection contingency.

They buyers and their broker signed the Letter. Norkunas accepted the buyers’ check for $5,000 but never deposited it. A few days later, the agent sent Norkunas a package of documents including a “Residential Contract for Sale.” Norkunas signed the contract but never returned it to the buyers. A week later, Norkunas informed the buyers that she would not sell the property and took the property off the market.

The buyers sued claiming the letter of intent entitled then to the house. The trial court gave summary judgment for the buyers, but an intermediary appellate court reversed holding that the letter of intent was not binding. The buyers appealed.

You Be the Judge: Did the letter of intent create a binding agreement?

Holding: No, judgment of the intermediary court affirmed. The court found that the letter of intent did not indicate that the parties would be bound by it but was an agreement to make an agreement. Moreover, Norkunas did not manifest an acceptance of any offer, especially since she did not return the documents sent to her.

According to the court a letter of intent is a preliminary agreement. Although some letters of intent are signed with the belief that they are letters of commitment and, assuming this belief is shared by the parties, the letter is a memorial of a contract. In other cases, the parties may not intend to be bound until a further writing is completed.

Here, the buyers argue that the letter of intent is an enforceable contract because it was formed by offer and acceptance, supported by consideration, contained all definite and material terms, and was signed by the parties. Norkunas claims that the letter of intent was not an enforceable contract because it was not intended to be the parties' final expression of their agreement, the promised “Residential Contract for Sale” was to be their final expression.

The court concluded that a reasonable person would have understood the letter of intent to mean that a formal contract offer was to follow the letter of intent. The letter states that a "standard form Maryland Realtors Contract will be delivered to Seller within 48 hours." Thus the language in the letter of intent is indicative of intent to memorialize the property sale through a final standard form contract. The clear language of the letter demonstrates that the parties did not intend the letter to constitute a binding agreement for the purchase and sale of Norkunas’ property.

Question: The parties agreed to a letter of intent with the purchase price, payment terms, and contingency clauses. Why wasn’t that enough to create a binding agreement?

Answer: The letter of intent left also stated that a contract would follow in the future. The court found that because both parties agreed that a contract would come in the future, the parties did not intend for the letter of intent to be a binding agreement to buy the property

Question: Why did they go to the trouble of writing and signing a letter of intent if it had no legal effect?

Answer: The letter of intent captured the state of their negotiations, showing where the parties agreed. In complex negotiations such as one for the purchase of real estate, it is critical to keep track of the terms of the proposed deal. That is a major reason for creating a letter of intent. Another reason may also have been because the buyers did not want Norkunas to sell the property to anyone else. They may have believed that if they had a letter of intent singed, Norkunas would not sell the property before they had the contract drafted.

Question: You say the letter of intent is often important for business people. Do lawyers like to use them, too?

Answer: Lawyers use them for the same reasons, to narrow down the field of open issues and keep track of all of the deal points. While lawyers recognize their value, they are also wary of creating a letter of intent that the other party can construe as a binding agreement.

Question: How do lawyers deal with those concerns?

Answer: By adding language stating that the agreement is not binding and creates no legal obligations.

Problems with Definiteness

It is not enough that the offeror indicates that she intends to enter into an agreement. The terms of the offer must also be definite.

Additional Case: Baer v Chase[8]

Facts: David Chase was a television writer-producer with many credits, including a detective series called The Rockford Files. He became interested in a new program, set in New Jersey, about a "mob boss in therapy," a concept he eventually developed into The Sopranos. Robert Baer, a prosecutor in New Jersey interested in writing for television, met Chase and pitched his own idea for a television series about the New Jersey mafia. Baer didn’t know that Chase was pursuing a similar idea. Baer arranged meetings for Chase with local detectives and prosecutors, who provided Chase with information about their experiences with organized crime and showed him various New Jersey locations. Baer also met with Tony Spirito, who gave Chase colorful background information about the local mafia. After returning to Los Angeles Chase wrote and sent Baer a draft for The Sopranos’ pilot, which Baer commented on. After The Sopranos became a hit show Baer sued chase, alleging that on three separate occasions Chase had agreed that if the program succeeded, Chase would "take care of" Baer, and would "remunerate Baer in a manner commensurate to the true value of his services." The District Court dismissed the case, holding that the alleged promises were too vague to be enforced. Baer appealed.

Issue: Was Chase’s promise definite enough to be enforced?

Holding: Judgment for Chase affirmed. New Jersey law deems the amount of compensation an essential term of any contract. A contract lacking a definite price may still be enforceable if the parties specify a practicable method by which they can determine the amount. In the absence of an agreement as to the manner or method of determining compensation the purported agreement is invalid. A definite duration for the contract is also essential under New Jersey law. New Jersey law does not support Baer’s argument that “submission-of-idea” cases create an exception to these rules. There is no proof the parties agreed on how, how much, where, or for what period Chase would compensate Baer, the value of Baer’s services, how the “success” of The Sopranos would be measured, how profits were defined, or the duration of the contract.

Question: Chase said he would “take care of” Baer and pay him “in a manner commensurate with the true value of his services.” Don’t those statements show Chase’s intent to compensate Baer?

Answer: Yes.

Question: Then why does the court rule in favor of Chase and let him avoid payment?

Answer: The issue in this case is not Chase’s intent but the definiteness of the offer.

Question: There are methods to determine what fair compensation would be. The trial court could hear evidence about what others who’ve made similar creative contributions to television shows are paid, or hear expert testimony from people in the business about the customary payment for services similar to Baer’s. Why doesn’t the court try to arrive at a method of fair compensation?

Answer: It is not the court’s job in a breach of contract case to substitute its judgment for the parties’ judgment about what the contract’s terms should be.

Question: Why?

Answer: Because to separate enforceable promises from unenforceable promises, contract law imposes certain formal rules about how a contract is formed. And one of those rules is that the parties must have taken time and care to define their agreement so a third party can understand whether it has been performed.

Question: How does the court arrive at its decision?

Answer: It looks to New Jersey law, which says that the price or amount of compensation is an essential term in any contract.

Question: Does that mean the parties must specify a dollar amount in the contract for its terms to be definite?

Answer: Not necessarily, as long as the parties do specify a method by which compensation can be determined. If a contract fails to state the dollar amount of compensation or a practicable method to determine it, the contract is invalid.

Question: So Chase and Baer could have agreed, say, that Baer would be compensated in an amount equal to the average paid for screenwriting services for the pilots of the three most popular HBO television serials within the previous two years?

Answer: If it is practicable to ascertain the facts necessary to calculate this average, then the answer is yes.

Termination of Offers

Offers may be terminated by revocation, rejection, expiration or by operation of law.

Termination by Revocation

There is asymmetry in the rules for when an offeror’s revocation of an offer is effective and when an offeree’s acceptance of an offer is effective: the former is effective when the offeree receives it, the latter is effective when it is out of the offeree’s control. These rules are not intuitive, require special emphasis, and provide excellent fodder for exam questions.

Some offers cannot be revoked… at least for a stated period. Option contracts allow the interested purchaser to buy the right to have the offer held open for a time. Firm offers are those that the offeror has promised to not revoke for a particular time.

Case: Nadel v. Tom Cat Bakery[9]

Facts: A Tom Cat Bakery delivery van struck Elizabeth Nadel as she crossed a street. Having suffered significant injuries, Nadel filed suit. Before the trial began, the attorney representing the bakery's owner offered a $100,000 settlement, which Nadel refused.

While the jury was deliberating, the bakery’s lawyer again offered Nadel the $100,000 settlement. She decided to think about it during lunch. Later that day, the jury sent a note to the judge. The bakery owner told her lawyer that if the note indicated the jury had reached a verdict, that he should revoke the settlement offer.

Back in the courtroom, the bakery’s lawyer said, "My understanding is that there's a note…. I was given an instruction that if the note is a verdict my client wants to take the verdict."

Nadel's lawyer then said, "My client will take the settlement. My client will take the settlement."

The trial court judge allowed the forewoman to read the verdict, which awarded Nadel – nothing. She appealed, claiming that a $100,000 settlement had been reached.

Issue: Did Nadel's lawyer accept the settlement offer in time?

Excerpts from Judge Figueroa's Decision:

Plaintiff's motion to enforce "the settlement" has generated considerable debate between the parties. Plaintiff asserts that the defendant is bound to a settlement. Plaintiff's problem is that there was no "agreement" to speak of. To be sure, there was an offer from defendant. During the above-quoted colloquy, clearly there were also words of acceptance from plaintiff. But when the words, "my client will take the settlement" were uttered, it was too late for them to be effective. By that time, defense counsel had made it clear that if the jury had already come to a verdict, the offer was off the table. That condition could not be ignored, as the verdict that would mean all bets were off had already been reached. For the foregoing reasons, plaintiff's motion is denied.

The parties did not reach a binding settlement agreement. We deny Nadel’s motion.

Question: What does the court say is the fatal flaw in Plaintiff’s argument?

Answer: That there is no “agreement” to speak of.

Question: What else does the court find faulty in Plaintiff’s case?

Answer: The court said when the Plaintiff’s attorney said “my client will take the settlement” it was too late for them to be effective.

Termination by Rejection

Rejection may be clearly stated, and immediately terminates the offer. A counteroffer also terminates the original offer.

Termination by Expiration. An offeror may set a time limit on an offer; if she does not, the offer expires after a “reasonable time.”

Termination by Operation of Law. An offer terminates if the offeror dies or becomes mentally incapacitated, or if the subject matter of the offer is destroyed.

Acceptance

The offeree must communicate acceptance for it to be valid. Silence is NOT golden!

Mirror Image Rule

Under common law, acceptance must be precisely the same terms as the offer (the mirror image rule).

UCC and the Battle of Forms

Under the UCC, merchants using different preprinted forms have a way to reach agreement. This is known as “the battle of the forms.”

The battle of forms provisions of UCC §2-207 provide an excellent illustration of how the UCC alters common-law rules. While one may choose not to explore these provisions in depth unless and until one covers the UCC in Unit 3, it is useful to mention §2-207 to contrast with the common law’s mirror-image rule.

Additional Case: Bayway Refining Co. v. Tosco Corp.[10]

Facts: Bayway Refining and Oxygenated Marketing and Trading A.G. (OMT) were both in the business of buying and selling petroleum products. Bayway agreed to sell OMT 60,000 barrels of gasoline, and OMT faxed a confirmation letter stating that it represented the full understanding of the parties. The next day, Bayway faxed its own confirmation letter, which stated that the document canceled and superseded any other correspondence. Bayway’s fax incorporated by reference Bayway’s own “General Terms and Conditions.” Those general terms were not sent with the fax, but were available for OMT to examine if it wished. One of those terms stated that the buyer would be responsible for any federal taxes.

OMT, which never objected to the “general terms,” received the gasoline but refused to reimburse Bayway for the federal taxes, which amounted to $464,035. Bayway sued. OMT claimed that the tax clause materially altered the contract and, under section 2-207, never became part of the agreement. The District Court gave summary judgment for Bayway, and OMT appealed

Issue: Was the tax clause a material alteration of the contract?

Holding: Judgment for Bayway affirmed. Under UCC §2-207(2)(b) the party opposing the inclusion of additional terms shoulders the burden of proving they were a material alteration of the contract, which is an alteration that would result in surprise or hardship if incorporated without express awareness by the other party. To carry the burden of showing surprise, a party must establish that under the circumstances, it cannot be presumed that a reasonable merchant would have consented to the additional term. OMT’s executives testified they were amazed by the “contract by ambush” and “sleight-of-hand proposal,” but OMT introduced no evidence to show that a reasonable petroleum merchant would be surprised by the Tax Clause. Two industry experts offered unchallenged testimony that it is customary for the buyer to pay all the taxes resulting from a petroleum transaction. An additional term creates hardship when it creates or allocates an open-ended and prolonged liability. That is not the case here.

Question: What is the disputed clause?

Answer: The tax clause, which requires the buyer to pay all federal taxes.

Question: Which party proposed this term?

Answer: Naturally, the seller, Bayway.

Question: When did OMT first see the tax clause?

Answer: After it had received the gasoline.

Question: But Bayway sent a fax confirming the agreement. Didn’t that fax contain the tax clause?

Answer: No. Bayway’s fax referred to its General Terms and Conditions and incorporated them by reference.

Question: What does “incorporate by reference” mean?

Answer: It means that one party can propose contract terms without even showing the other side all the terms proposed. The proposal could be for the sale or purchase of goods. As long as the proposal clearly states what terms are being incorporated by reference, and makes those terms available to the other side, it is a legitimate proposal between merchants. In general, that method would not work in a consumer contract.

Question: You mean that OMT can supposedly agree to terms it never saw?

Answer: Yes.

Question: Isn’t that crazy?

Answer: No. These parties are both sophisticated merchants, dealing in an expensive commodity. Courts presume that they will do their homework. OMT should have read the proposal carefully and demanded to see all terms. Further, OMT should realize that somebody is going to pay the taxes.

Question: Doesn’t the mirror image rule preclude a contract here?

Answer: No. This contract is governed by the UCC because it is for the sale of goods. Under UCC 2-207, a party may accept an offer on different terms, and still create a contract.

Question: Under 2-207, the offeree might include additional terms or different terms. What is the distinction between those terms?

Answer: Additional terms bring up new issues; different terms contradict those in the offer.

Question: Which are we dealing with here, different or additional terms?

Answer: Additional terms.

Question: Additional terms become part of the contract between the parties except in three cases. What are they?

Answer: When 1) the offer insisted on its own terms; 2) the additional terms materially alter the old terms; or 3) the offeror promptly rejects the additional terms.

Question: Which is at issue here?

Answer: Material alteration.

Question: The court holds that OMT has the burden of proof. What does that mean?

Answer: It is OMT’s burden to show that the tax clause was a material alteration; it is not Bayway’s burden to show that the clause was not.

Question: What must OMT demonstrate to prove material alteration?

Answer: Surprise and/or hardship.

Question: How does OMT fare in proving surprise and hardship?

Answer: Poorly. The court holds there is no surprise, even though OMT’s executive claimed amazement. OMT had to show objective and subjective surprise, and there is no evidence of objective surprise. The industry standard required buyers to pay taxes. There was no hardship because this is a one-time loss of revenue, not an ongoing, crushing loss.

Clickwraps and Shrinkwraps

When downloading or installing software, consumers often encounter a screen requesting them to check their agreement to the terms of the contract. Most consumers click without having read any of the terms, yet courts have ruled that such agreements are indeed binding.

Additional Case: Specht v. Netscape Communications Corporation[11]

Facts: The plaintiffs sued Netscape, claiming that its SmartDownload software illegally captured private information about files they downloaded from the Internet. Plaintiffs downloaded the SmartDownload software from a page on Netscape’s web that promoted the program’s benefits and, at the bottom, bore a button labeled “download.” If, instead of downloading, they had scrolled further down the page, they would have seen a hyperlinked invitation to "review and agree to the terms of the Netscape SmartDownload software license agreement." Clicking through the hyperlinks would have led plaintiffs to the license agreement governing the software’s terms of use. Among the license terms was an agreement to settle any dispute through arbitration rather than through a lawsuit. The plaintiffs never read the license terms. In response to their suit Netscape moved the district court to stay the proceedings and compel arbitration. The District Court denied Netscape's motion, ruling that the plaintiffs had not agreed to the terms of the license.

Issue: Had the plaintiffs agreed to arbitrate their claims?

Holding: Denial of Netscape’s motion to compel arbitration affirmed. Netscape argued that plaintiffs must be held to a standard of reasonable prudence and that, because notice of the existence of SmartDownload license terms was on the next scrollable screen, plaintiffs were on "inquiry notice" of those terms. The court disagreed with the proposition that a reasonably prudent offeree in plaintiffs' position would necessarily have known or learned of the existence of the SmartDownload license agreement prior to downloading the software. Plaintiffs did not have constructive notice of its terms. The court agreed that the concept of inquiry notice applies generally to contracts formed online, but not in this case. Plaintiffs were responding to an offer that did not carry an immediately visible notice of the existence of license terms or require unambiguous manifestation of assent to those terms. The placement of the “download” button above the portion of the screen bearing the invitation to view the license terms did not put plaintiffs on inquiry notice of the existence of the license.

Question: What is Netscape asking the court to do?

Answer: Netscape wants the court to stay (suspend) its proceedings and order the plaintiffs to submit their claim to arbitration.

Question: Why does Netscape want to deny plaintiffs their day in court?

Answer: Because Netscape says that when they downloaded the free “SmartDownload” software the plaintiffs agreed to resolve any disputes with Netscape through arbitration.

Question: What do plaintiffs say?

Answer: They say that they didn’t agree to arbitrate disputes because they didn’t see Netscape’s license terms when they downloaded the software.

Question: Where were the arbitration provisions?

Answer: In the license on a separate website page from the download.

Question: If they were on a separate page how did Netscape expect users to see them?

Answer: Netscape argued that the plaintiffs had “inquiry notice” of the terms because a portion of the screen below the download button invited users to review and agree to the license terms.

Question: What does that mean—“inquiry notice?”

Answer: It is the concept that a reasonably-prudent software downloader would have known to inquire further into the existence of license terms.

Question: What did the court think of Netscape’s argument?

Answer: It didn’t buy it. The court said that the contractual nature of the download offer was not obvious because it didn’t contain an immediately visible notice of the existence of license terms.

Question: In other words . . .

Answer: In other words, the plaintiffs could download the software without even knowing its use was subject to a license.

Question: What does that mean in contract law terms?

Answer: It means the plaintiffs never accepted Netscape’s terms of use.

Question: What should Netscape have done differently?

Answer: This 2002 decision was instrumental in leading web sites to redesign the ways in which clickwrap contracts are presented. Now a user must scroll through the terms of use or move the mouse cursor to a button stating “I accept these license terms” or something equivalent before the site provides access to licensed material or allows the user to initiate a download.

Consideration

There are three rules of consideration:

Both parties must get something of measureable value from the contract..
A promise to give something of value counts as consideration.
The two parties must have bargained for whatever was exchanged and struck a deal: "If you do this, I'll do that."

What is Value?

As we have seen, an essential part of consideration is that both parties must get something of value. That item of value can be either an "act"(doing something not required by law) or a "forbearance” (an agreement to NOT do something that is otherwise allowed by law.)

A Bargain and an Exchange

Consideration does not require counteroffers. Students may equate “bargained-for” with “haggled-over.” A simple example can demonstrate the meaning of “bargained-for” in this context: Curt offers to mow Pedro’s lawn once a week for $50 beginning May 1 and ending November 1. Pedro accepts. Where is the bargained-for exchange? Curt promised to mow Pedro’s lawn to induce Pedro to promise in return to pay Curt $50 a week. Pedro responded to Curt’s inducement by promising to pay Curt $50 per week if Curt mows Pedro’s lawn.

To determine whether there was a bargained-for exchange, students should ask “did the offeree make its promise or tender its performance in response to the offer?” One St. Patrick’s Day, Mark Trieste was walking on the beach when he saw a body in the sand. Trieste reported the body to police. Police identified the body as that of 21-year-old Brian Wilson, who had been missing since New Year's Eve. Distraught over his disappearance Wilson's family had offered a $25,000 reward for information leading to his whereabouts. When Trieste found the body and notified police he did not know about Wilson’s disappearance or the offer of reward money. Looking at these facts strictly as a matter of contract law, is Wilson’s family obligated to pay Trieste the reward? [12]

Question: What kind of contract did the reward offer seek to form—bilateral or unilateral?

Answer: Unilateral. Wilson’s family offered to pay the reward in exchange for performance: information about Wilson’s whereabouts.

Question: Trieste’s information led to discovery of Wilson’s body. What is the family’s argument that it has no obligation to pay the reward?

Answer: Trieste’s call to police was not induced by the reward offer. Trieste may have been a good citizen, but he was not tendering performance in response to an offer to form a unilateral contract.

Question: What is Trieste’s response to this consideration argument?

Answer: He doesn’t have one based on contract law—if he never knew of the offer, how can he claim that it induced his performance?

Landmark Case: Hamer v. Sidway[13]

Facts: William Story wanted his nephew to grow up healthy and prosperous. In 1869, he promised the 15-year-old boy $5,000 if the lad would refrain from drinking liquor, using tobacco, swearing and playing cards or billiards for money, until his twenty-first birthday. The nephew had a legal right to do those things. The nephew agreed and kept his word. When he reached his twenty-first birthday, the nephew notified his uncle that he had honored the agreement. The uncle congratulated the young man and promised to give him the money, but said he would wait a few more years before handing over the cash, until the nephew was more mature. The uncle died and his estate refused to pay. Hamer, to whom the nephew had transferred his rights, sued. The estate argued that the nephew had given no consideration for the uncle’s promise. The trial court found for the plaintiff and the uncle’s estate appealed.

Issue: Did the nephew give consideration for the uncle’s promise?

Holding: Judgment for plaintiff affirmed. The nephew gave valid consideration by refraining from doing things he was legally entitled to do. The estate argued that there was no consideration because the nephew benefited from avoiding the proscribed actions, but the court was unpersuaded: “Courts will not ask whether the thing which forms the consideration does in fact benefit the promisee or a third party, or is of any substantial value to anyone. It is enough that something is promised, done, forborne, or suffered by the party to whom the promise is made as consideration for the promise made to him.”

Question: Before we discuss the contracts issue, can you explain how Hamer wound up as the plaintiff?

Answer: The nephew assigned—transferred—to Hamer his right to receive payment from the uncle. Assignment is discussed in Chapter 16, Third Parties.

Question: Why did the uncle’s estate deny payment to Hamer?

Answer: The estate argued that the nephew gave nothing to the uncle in exchange for the uncle’s promise; therefore there was no consideration and no contract.

Question: How did the estate characterize this transaction?

Answer: As a promise to make a gift, not enforceable as a contract.

Question: What was Hamer’s argument?

Answer: Hamer argued that the nephew did give something to the uncle in exchange for the uncle’s promise: the nephew’s promise to refrain from alcohol, tobacco, swearing, and cards until he turned 21.

Question: The uncle received no benefit from the nephew’s promise. Why does the court hold that the nephew gave consideration?

Answer: Because the nephew promised to suffer a detriment.

Question: The nephew gave up activities that were bad for his health. What detriment did he suffer?

Answer: “Detriment” here does not mean that the nephew experienced adverse consequences. One suffers a detriment for purposes of consideration by promising to refrain from something one has a legal right to do, or promising to do something one is not obligated to do.

Question: Which of these concepts applies here?

Answer: The nephew promised to refrain from alcohol, tobacco, etc., all things that, when these promises were exchanged in 1875, the nephew had the legal right to enjoy.

Question: Still, how is the nephew’s detriment a benefit to the uncle?

Answer: It is not a benefit in any economic sense, but that does not matter. What matters is that the uncle’s promise to pay $5,000 if the nephew refrained from these activities—money the uncle was not otherwise obligated to pay the nephew—induced the nephew to promise in return to refrain from these activities, which he otherwise had the legal right to enjoy. These promises thus involved the bargained-for exchange of legal value.

Question: Would a similar exchange of promises today between an adult and 15-year-old also result in a contract?

Answer: No. In the U.S. persons under the age of 18 cannot purchase tobacco products and persons under the age of 21 cannot drink or gamble legally. Therefore a promise to refrain from these activities is not a detriment for purposes of contract law.

Legality

Noncompete Agreements

Noncompete agreements violate public policy against restraints of trade. It is often useful in the midst of a discussion of noncompete cases, when students may lose sight of the reason for analyzing a clause’s reasonableness, to ask why a noncompete clause raises the issue of legality. Returning to the big picture can put the discussion of the reasonableness of a clause in a new light.

Ancillary to the Sale of a Business

Students may want mechanical rules-of-thumb to determine whether a noncompete clause ancillary to the sale of a business is reasonable: Is a distance of ten miles too close? Too far? Just right? Whether a noncompete clause ancillary to the sale of a business is reasonable requires case-by-case analysis of the geographic area from which the business draws its customers, the nature of businesses that compete with it, and the time necessary for the new owner to create (or fail to create) its own goodwill.

Students will often ask, in a case where a court rules a noncompete clause to be invalid, whether that leaves the person subject to the clause free to open a competing business across the street from its former location. While the following case concerns a noncompete clause in employment, the way in which the court instructs the trial court to refashion the invalid clause provides an answer to this question.

Case: King v Head Start Family Hair Salons, Inc.[1]

Facts: For the most recent 16 years, Kathy King had worked at Head Start, which provided hair cuts, coloring and styling for men and women. King was primarily a stylist, though she had also managed one of the Head Start facilities. King quit Head Start and began working as manager of a Sports Clips shop, located in the same mall as the store she just left. Head Start sued King, claiming that she was violating the noncompetition agreement that she had signed. The agreement prohibited King from working at a competing business within a two-mile radius of any Head Start facility for 12 months after leaving the company. The trial court issued an injunction enforcing the noncompete and King appealed.

Issue: Was the noncompetition agreement valid?

Holding: Reversed and remanded. Excerpts from the court’s opinion:

King has been in the hair-care industry for 25 years, and that it is the only industry in which she is skilled and the only industry in which she can find employment. Head Start has 30 locations throughout the Jefferson County and Shelby County area, making it virtually impossible for her to find employment in the hair-care industry at a facility that does not violate the terms of the noncompetition agreement. The geographic restriction constitutes a blanket prohibition on practicing her trade. It isn’t reasonable to assume King can learn a new job skill that would allow her to be gainfully employed and meet her family’s needs. Enforcement of this noncompetition agreement works an undue hardship upon King.

Head Start is nevertheless entitled to some of the protection it sought in the noncompetition agreement. King may be able to attract many of her former Head Start customers if she is allowed to provide hair-care services unencumbered by any limitations. To prevent an undue burden on King and to afford some protection to Head Start, the trial court should enforce a more reasonable geographic restriction--such as one prohibiting King from providing hair-care services within a two-mile radius of the location of the Head Start facility at which she was formerly employed, or imposing some other limitation that does not unreasonably interfere with King's right to gainful employment while, at the same time, protecting Head Start's interest in preventing King from unreasonably competing with it during the one-year period following her resignation.

Question: How does the court analyze the reasonableness of this noncompetition agreement?

Answer: It looks at the impact of the noncompetition provisions in light of King’s ability to earn a living given her age, job experience, and prospects.

Question: Why does it rule that the noncompetition is invalid?

Answer: It would bar King from working within a two-mile radius of any Head Start facility. Head Start has 30 facilities in two counties and the effect of the noncompetition clause would be to make it extremely difficult for King to find employment in the only field she knows.

Question: Since it ruled the clause to be invalid, is King free to take a job anywhere?

Answer: No. The court recognized that it would be unfair to Head Start to throw out the entire agreement. It instructs the trial court to enforce a more reasonable restriction, suggesting that King be limited from working within a two-mile radius of the Head Start facility where she worked formerly.

Question: What effect would that have on King?

Answer: Ironically, it would result in King losing the job to which she moved from Head Start, because it is located in the same mall as her old job.

Question: Courts tend to be antagonistic to noncompetition agreements. Why is that?

Answer: They restrain trade and injure the public. The primary goal is to protect the public, though the secondary aim is to protect a worker’s right to use his skills and energy to his best advantage.

Question: Suppose an employer could request any restrictions it wanted on future employment. What problems could that create?

Answer: An employer might demand that the employee not work anywhere in the particular field after leaving. That would mean that, the more experienced the worker, the more difficult it would be for him to leave, since he would be forfeiting his skill and his chance to earn a living. The employer, aware of the employee’s inability to leave, could impose increasingly arduous and unfair work requirements.

Question: But if an employee agrees to certain conditions, why shouldn’t they be enforced? If a worker knowingly agrees he will never work for another employer, anywhere, in the same field, why not require him to live up to his word?

Answer: Contemporary courts will not do so, because they consider such agreements harmful to the general public. Giving an employer the power to prohibit future employment would diminish competition and job mobility, both considered essential for a healthy economy.

Question: If a court is free to ignore a contract provision, such as a noncompete agreement, doesn’t that render the contract worthless?

Answer: It does not make a contract worthless, but it does diminish the ability of the parties to predict the future, and to use a contract to control the future. The more flexibility a court shows, enforcing some contracts while rejecting others, the less predictable the law, and business, become.

Drafting Exercise: Noncompete Clause

If students completed the exercise to draft a noncompete clause they could review their treatment of these issues:

Trade Secrets. The bakery is entitled to protect trade secrets. The contract may prohibit Sandra from making any use of recipes or formulas, she may not take them to a competitor or use them herself.
Confidential Information. The bakery is entitled to protect any other truly confidential information, such as the bakery's own costs and profits, how much each of its customers spends, how much it pays its chefs, and products it has developed that have succeeded and failed, and the reasons for each.
Customer Lists. The bakery is entitled to protect customer lists developed over an extended period. A customer list that has grown slowly, based on sales calls, word of mouth, and so forth, can be protected. A customer list derived from the Yellow Pages cannot be protected.
Other Issues. A court is unlikely to enforce other noncompete clauses. If a contract prohibits Sandra from working for a bakery in St. Louis, a court is likely to reject it. The law will also permit Sandra to take with her any general baking knowledge she acquired.

Comment: Note that, if Sandra leaves to establish her own business, a court may allow additional restrictions. In analyzing such noncompete agreements courts often apply the standard used for the sale of a business–that prohibitions will be valid if reasonable in time, geography, and scope of activity.

Exculpatory Clauses

An exculpatory clause is generally unenforceable when it attempts to exclude an intentional tort or gross negligence.
An exculpatory clause is usually unenforceable when the affected activity is in the public interest, such as medical care, public transportation, or some essential service.
An exculpatory clause is generally unenforceable when the parties have greatly unequal bargaining power.
An exculpatory clause is generally unenforceable unless the clause is clearly written and readily visible.

You Be The Judge: Ransburg v Richards[2]

Facts: Barbara Richards leased an apartment at Twin Lakes, a complex owned by Lenna Ransburg. The written lease declared that:

Twin Lakes would “gratuitously” maintain the common areas.
Richards’ use of the facilities would be “at her own risk.”
Twin Lakes was not responsible for any harm to the tenant or her guests, anywhere on the property (including the parking lot), even if the damage was caused by Twin Lakes’ negligence.

It snowed. As Richards walked across the parking lot to her car, she slipped and fell on snow-covered ice. Richards sued Ransburg, who moved for summary judgment based on the exculpatory clause. The trial court denied Ransburg’s motion and she appealed.

Issue: Was the exculpatory clause valid?

Argument for Tenant: An exculpatory clause in a contract for an essential service violates public policy. When an ill person seeks medical care, his doctor cannot require him to sign an exculpatory clause. In the same way, a person has to live somewhere. Her landlord cannot force her to sign a waiver.

Landlords tend to be wealthy and powerful. There is generally no equality of bargaining power between them. The tenants are not freely agreeing to the exculpatory language.

Moreover, if a landlord fails to maintain property, not just the tenant is at risk. Visitors, the mail carrier, the general public, could all walk through theTwin Lakes parking lot. The public's interest is served when landlords maintain their properties. They must be held liable when they negligently fail to maintain common areas and injuries result.

Argument for Landlord: Ms. Richards does indeed have to live somewhere, but she does not have to live on the plaintiff's property. Surely there are many dozens of properties nearby. If Richards had been dissatisfied with any part of the proposed lease – excessive rent, strict rules, or an exculpatory clause - she was free to take her business to another landlord.

Landlords may generally be wealthier than their tenants, but that fact alone does not mean that a landlord is so powerful that leases are offered on a "take it or leave it" basis. Here, the landlord stated the exculpatory clause plainly. This is a clear contract between adults, and it should stand in its entirety.

Holding: Judgment affirmed. Excerpts from the court’s opinion:

Resolving the question of whether this lease provision is void as against public policy turns on fairly balancing the parties' freedom to contract against the policy of promoting responsibility for damages caused by one's own negligent acts. A tenant’s choices may be limited; he can accept one landlord or go to another who charges the same rent and asks the tenant to sign the same standard form lease. We conclude that five factors weigh in favor of not enforcing this type of clause in residential leases: (i) the nature of the subject matter of the contract; (ii) the strength of the public policy underlying the statute; (iii) the likelihood that refusal to enforce the bargain or term will further that policy; (iv) how serious or deserved would be the forfeiture suffered by the party attempting to enforce the bargain; and (v) the parties relative bargaining power and freedom to contract.

Given the vast number of people clauses like these affect, the inequality of bargaining power caused by the need for housing, the fact that people who are not parties to the contracts could suffer as a result of such clauses, and the desire to promote responsible maintenance by landlords to avoid personal injuries by tenants and third parties, we find that the factors weigh in favor of public policy.

Dissent: The majority ignores the plain meaning of the exculpatory clause and violates the well-settled common law right of the parties to make such a provision and to have it enforced according to its terms.

Question: What is an exculpatory clause?

Answer: A contract provision that one party uses to avoid liability, generally for negligence or other torts.

Question: Why did the court hold this exculpatory clause to be unenforceable?

Answer: It relied on the disparity in bargaining power between landlords and tenants, stating that the latter’s choices may be limited, and thus tenants have little leverage to bargain for better terms.

Question: Is that always true?

Answer: No. The relative leverage between landlords and tenants will depend on many factors including vacancy rates, tenants’ economic status, and the strength of local landlord/tenant laws

Question: Many of the examples in the text show exculpatory clauses to be unenforceable. Is that the general rule?

Answer: Note that the text distinguishes between exculpatory clauses in consumer contracts, or those between individuals and businesses such as here, and exculpatory clauses in business-to-business contracts.

Question: Why is that distinction important?

Answer: Courts may, as in this case, be more willing to take an active role in determining the fairness of consumer or other contracts between individuals and businesses. However courts will generally not look beyond the terms of a contract between businesses, particularly in sophisticated contracts or those in which the parties were represented by counsel.

Question: Why?

Answer: Courts should rarely second-guess the fairness of decisions made by businesspeople in the pursuit of business interests. Business contracts frequently allocate risk, or expose one party willingly to risk, in ways that reflect careful assessment of business opportunities.

Question: Can you explain further?

Answer: The text makes this point on p. 310, Economics & the Law. A valid exculpatory clause may enable a business to offer products or services at a lower cost than it would charge if it had to cover the cost of potential liability. A customer may choose to enter into a contract with that business because of the cost advantage provided by the exculpatory clause. If the customer wants to protect itself against the risk of the business’s negligence it may be able to do so through insurance, self-insurance, risk-mitigation practices, or other means. Courts should, as a general rule, not inject themselves into the midst of these calculations.

Role Play: Exculpatory Clauses

An exculpatory clause is one that attempts to release one party from liability in the event of injury to the other party. These clauses have an obvious attraction to many companies, but they carry one major risk: a court may ignore them. Courts frequently reject exculpatory clauses that they consider overbroad. In this exercise students will hear the facts of a case and then formulate and respond to various arguments about an exculpatory clause.

Divide the classroom into three sections. One section will represent the injured plaintiffs in this automobile accident case, the second will represent the defendant, Hertz, and the third will judge the arguments and ask questions. The case is Hertz Corp v. Garrott.[3]The standard Hertz lease, used in Illinois, included a provision stating that the rented vehicle would be driven only by the customer and certain authorized persons who had the customer's permission. One such authorized person was an immediate family member who was a licensed driver over the age of 25.

Angelique Garrott rented a Hertz car. The next day Angelique's husband, Rodney, was driving the vehicle when it struck a Chicago taxicab, injuring the cab's passengers and damaging both cars. Regrettably, Rodney was under age 25, intoxicated, and driving without a license, which had been suspended several months earlier. All of the injured parties sued Hertz.

The standard lease, which Ms. Garrott signed, contained a provision for Hertz to provide liability insurance for the car. But Hertz argued that its coverage did not apply in this case. On the back of the lease form, in small print, an exculpatory clause stated that if the customer permitted an unauthorized or prohibited use of the vehicle, the insurance would be voided and the customer would be responsible for all losses. Hertz claimed that since Rodney, unlicensed, underage, and drunk, was obviously an unauthorized driver, the insurance was void, and the company was off the hook. The taxi company and the injured passengers argued that Hertz’s insurance still applied.

Question for Hertz Lawyers: Make an argument for Hertz that its insurance coverage did not apply to this accident.

Possible Answer: This argument is simple and straightforward. The lease agreement explicitly stated that the car could be driven only by an authorized driver, meaning a sober, licensed driver over age 25. Rodney was unlicensed, drunk, and underage. Consequently this was unauthorized use. As the back of the form stated, unauthorized use voided the insurance coverage. That was the agreement Angelique Garrott made, and that is the contract the court should enforce.

Question for Injured Parties' Lawyers: Make an argument for the taxi company and its passengers that Hertz’s insurance coverage did apply.

Answer. The policy should be void as against public policy. The primary purpose of this liability insurance is to protect innocent third parties. Hertz should not be entitled to void a policy, causing innocent people to suffer. Rodney's use was foreseeable, even if it was illegal and in violation of the contract. Hertz should pay.

Suggested Additional Questions:

For Hertz: If Hertz can avoid paying damages because of this violation of the law (driving without a license and drunk driving), couldn't Hertz rewrite the contract so that its insurance is voided by any improper driving, such as speeding, an illegal turn, and so forth? Couldn't Hertz in fact make the policy useless if it chose to?

Answer: It would be unfair and unjust to write insurance that became void whenever there was an accident. What Hertz is trying to do here is perfectly reasonable: to limit the people who drive its cars.

For Injured Parties: The Garrotts knew perfectly well that Rodney should not be driving. Even without reading the contract, they could have guessed that a drunk, unlicensed driver did not have permission to use the car. Further, both driving without a license and drunk driving are serious violations of the law. Why should a court help people who violate the contract and break the law?

Answer: A court probably should not help such people, but it must protect innocent parties such as the taxi company and the passengers who could easily be injured by the car–and injured again by the exculpatory clause.

For Judges: Who should win and why?

Answer: The trial court ruled in favor of Hertz on the insurance issue, declaring the exculpatory clause valid and the insurance void. But the Illinois court of appeal reversed, holding that Hertz's exculpatory clause was void for two reasons. First, the exculpatory clause was on the back of the form. A customer would not be likely to know that certain acts invalidated the insurance coverage. Second, and more importantly, Hertz had no right as a private entity to impose sanctions on an unlicensed, intoxicated driver, when the effect of the action would be to harm the general public and to benefit the company. In other words, Hertz is not free to include an exculpatory clause, nullifying insurance coverage, when the result is to penalize and harm the general public. The exculpatory clause has no effect, and this vehicle is covered by Hertz's liability insurance.

Unconscionable Contracts

An unconscionable contract is one that a court refuses to enforce because of fundamental unfairness. Even if a contract does not violate any specific statute or public policy, it may still be void if it "shocks the conscience" of the court.

Additional Case: Worldwide Insurance v. Klopp[4]

Facts: Ruth Klopp was permanently injured in a serious auto accident. The other driver was uninsured, so Klopp filed a claim with her insurer, Worldwide, under her “uninsured motorist” coverage. Her policy required arbitration of such a claim, and the arbitrators awarded Klopp $90,000. But the policy also stated that if the arbitrators awarded more than the statutory minimum amount of insurance ($15,000), either side could appeal the award and request a full trial. Worldwide appealed and demanded a trial. In the trial court, Klopp claimed that the appeal provision was unconscionable and void. The trial court agreed and entered judgment for the full $90,000. Worldwide appealed.

Issue: Is the provision requiring arbitration and then permitting appeal by either party void as unconscionable?

Holding: Judgment for Klopp affirmed. Public policy favors arbitration. But here, although the contract provision theoretically allows either party to appeal any arbitration award over the statutory minimum, common sense dictates that only the insurance company will appeal a large award. The clause is unconscionable because it enables one side only–the insurance company–to escape arbitration.

Question: What is an “unconscionable” contract?

Answer: An unconscionable contract is one that a court refuses to enforce because of fundamental unfairness.

Question: What are the two factors that courts most often look at in deciding whether a contract is unconscionable?

Answer: The two factors that most often lead to a finding of unconscionability are oppression, meaning that one party used its superior power to force a contract on the weaker party, and surprise, meaning that the weaker party did not fully understand the consequences of its agreement.

Question: Evaluate the Klopp case in terms of those two criteria.

Answer: As to oppression, the insurance company drafted the contract and presented it to Klopp as a “take it or leave it” agreement. She had no opportunity to bargain any terms. As to surprise, Klopp probably gave little or no attention to the arbitration clause. Even if she read the arbitration clause, she would have been unlikely to appreciate the effect of the appeal provision. Both parties had the right to appeal a large award, which makes the provision seem eminently fair. It would take a very sophisticated consumer to realize that only one side–the insurance company–would be likely to exercise the appeal right, and to understand that in the case of a low award, the consumer would have no appeal right.

The UCC: Unconscionability and Sales Law

With the creation of the Uniform Commercial Code (UCC), the law of unconscionability got a boost. The Code explicitly adopts unconscionability as a reason to reject a contract. Although the Code directly applies only to the sale of goods, its unconscionability section has proven to be influential in other cases as well, and courts today are more receptive than they were 100 years ago to a contract defense of fundamental unfairness.

Voidable Contracts: Capacity and Consent

Capacity is the legal ability to enter into a contract.

Minors

The rule that a minor may avoid a contract will come as news to many students and may generate a great deal of discussion on ways in which this rule could be abused. The authors provide the best response to this concern in their answer to discussion question 1 later in this manual: “[i]t is true that some minors are street smart, and might take advantage of the rule. However, the answer, in the opinion of most courts, is that a concerned seller can easily protect himself by not making the sale.”

Additional Case: Star Chevrolet Co. v. Green[5]

Facts: Kevin Green paid $4,600 cash for a used Camaro from Star Chevrolet. When the car blew a gasket, the dealer refused to give Kevin his money back. Kevin repaired the car himself and drove it on the highway, where it was wrecked. Kevin sued Star, and the trial court awarded him the full price of the car, because he was a minor when he bought it. Star appealed.

Issue: Is Kevin Green entitled to disaffirm the contract even though the Camaro has been destroyed?

Holding: The appeals court affirmed judgment for Green but reduced the award to $3,100, based on the car's salvage value. A minor may disaffirm a contract. He is required to return the consideration only if it is still in his possession. If the minor has wasted, squandered, or otherwise destroyed the consideration, he need not return it and is still entitled to his money back.

Question: Star Chevrolet either did not know that Green was entitled to his money back, or knew but refused to honor it. Why was that a particularly costly mistake by Star?

Answer: If Star had returned Green's money when he first asked, it would have received a basically sound car with a blown gasket. Because it failed to do so, it ended up with a car of only salvage value.

Question: Why was Kevin Green permitted to keep the insurance proceeds and his purchase price?

Answer: Because of the collateral source rule, which states that a defendant that is found to owe a plaintiff money cannot reduce its liability by an amount the plaintiff will be compensated by another source. See fn. 1, p. 320.

Question: Kevin Green knew that he was a minor. Why should he be allowed to make an agreement, wreck a car, and then get his money back?

Answer: The policy behind the court's ruling was to discourage businesses from entering into agreements with minors. If a minor were barred from rescinding whenever a business could prove he was sophisticated, that would encourage companies to make deals with minors in the expectation that many or most could be enforced. It is that temptation that the court wishes to remove.

Reality of Consent

Fraud

The distinction between misrepresentation and fraud lies in intent. Misrepresentation can occur innocently, without awareness of a statement’s falsity. If the defendant knows a statement of fact is false, or is uncertain whether it is true and intends that the other party rely on the statement, then there is fraud.

To recover from fraud, the injured person must show the following:

The defendant knew that his statement was false, or that he made the statement recklessly and without knowledge of whether it was false.
The false statement was material.
The injured party justifiably relied on the statement.

Additional Case: Hoffman v. Stamper[6]

Facts: Plaintiffs alleged that Robert Beeman purchased dilapidated houses in poor sections of Baltimore, searched for unsophisticated, low-income buyers, and promised them a renovated home for a mere $500 down payment. Beeman had the buyers sign contracts for greatly inflated prices and arranged 100% purchase financing through an accomplice working in a mortgage company. To support this financing Arthur Hoffman, a real estate appraiser, supplied an appraisal at exactly the sales price. When the buyers took possession they found none of the promised repairs had been made. They sued multiple defendants for fraud and the trial court awarded them compensatory and punitive damages. Hoffman appealed.

Issue: Did Hoffman commit fraud?

Holding: Judgment affirmed. Hoffman’s fraud was amply supported by the evidence. The court stated “[p]laintiff Beeman purchased a property for $14,500 and sold it three weeks later to McFadden for $52,000, without any change in its physical condition. Knowing these facts Hoffman appraised the property’s value at $52,000. Hoffman misstated the zoning applicable to and physical condition of properties. He reported distant and dissimilar properties as comparable sales. [The court recited other evidence showing Hoffman’s knowledge of the falsity of material statements of fact and his willing participation in the fraudulent scheme.]”

Question: What is “flipping?”

Answer: “Flipping” is buying property and then quickly selling it for more than the purchase price.

Question: Is flipping illegal or inherently fraudulent?

Answer: No. Flipping can be a legitimate method for taking advantage of market inefficiencies.

Question: What made this flipping scheme fraudulent?

Answer: The defendants colluded to (a) purchase run-down housing, (b) locate unsophisticated buyers, (c) enter contracts with these buyers to make substantial repairs to and sell the properties at inflated prices without ever intending to perform the repairs, (d) procure 100% financing from a government loan program, (e) obtain false appraisals to support the loans at the prices buyers had agreed to pay, and (e) sell the properties at the inflated prices, pocket the proceeds, and leave the buyers with mortgage loan obligations and run-down housing for which they had grossly overpaid.

Question: What is “100 percent financing?”

Answer: That is a loan that covers the entire purchase price of the property and (often) closing costs in the form of attorney’s fees, title searches, appraisals, etc., without requiring the buyer to make a down payment or contribute equity toward the purchase.

Question: What was Hoffman’s role in this scam?

Answer: Hoffman supplied the appraisals.

Question: What is an appraisal?

Answer: An appraisal is an independent expert assessment of the market value of property, based on the property’s location, physical attributes, physical condition, and the recent sales prices of property of comparable location, attributes, and condition.

Question: Why were Hoffman’s appraisals fraudulent?

Answer: Hoffman’s appraisals were not independent—he reported values according to what was necessary to support the purchase loan, not on legitimate factors. He also lied about the factors supporting his appraised value.

Plaintiff’s Remedies for Fraud

In the case of fraud, the injured party generally has a choice of rescinding the contract or suing for damages or, in some cases, doing both.

Mistake

A mistake can take many forms. It may be a basic error about an essential characteristic of the thing being sold, as in Rose’s case. It could be an erroneous prediction about future prices, such as an expectation that oil prices will rise. It might be a mechanical error, such as a builder offering to build a new home for $300 when he clearly meant to bid $300,000. Some mistakes lead to voidable contracts, others create enforceable deals. The first distinction is between bilateral and unilateral mistakes.

Bilateral Mistake

A bilateral mistake occurs when both parties negotiate based on the same factual error. If the parties contract based on an important factual error, the contract is voidable by the injured party

Unilateral Mistake

Sometimes only one party enters a contract under a mistaken assumption, a situation called unilateral mistake. In these cases it is more difficult for the injured party to rescind a contract.

Duress

If one party makes an improper threat that causes the victim to enter into a contract, and the victim had no reasonable alternative, the contract is voidable.

Written Contracts

Common Law Statute of Frauds: Contracts That Must Be in Writing

A plaintiff may not enforce any of the following agreements, unless the agreement, or some memorandum of it, is in writing and signed by the defendant. The agreements that must be in writing are those:

For any interest in land
That cannot be performed within one year
To pay the debt of another
Made by an executor of an estate
Made in consideration of marriage; and
For the sale of goods worth $500 or more.

Purpose of the Statute of Frauds

Question: What is the purpose of the statute of frauds?

Answer: The purpose of the statute of frauds is to provide a court with the best possible evidence of whether the parties intended to make a contract.

Question: Why has the statute of frauds historically included the six types of contract listed in the text?

Answer: The statute of frauds dates from 1677. Historically, these six agreements were the most important. Parliament was attempting to avoid fraud in the most valuable business deals.

Question: What is the effect of the statute of frauds?

Answer: It makes an oral agreement to which it applies unenforceable.

Question: Is unenforceable the same as void?

Answer: No. Unenforceable means that if one party fails to perform its promise the other party will not be able to enforce the agreement in court.

Question: What is the difference between an unenforceable contract and a void contract?

Answer: The difference is that if the parties do perform the contract, it makes no difference that it was oral. If the seller delivers the deed to the property and the buyer pays for it, the sale is fully executed, and neither party may rescind it.

Question: Is it still true today that the most valuable contracts must be in writing?

Answer: Not necessarily. For example, employment contracts need not be in writing unless they could not be performed within one year.

Ethics and Oral Agreements

The text poses these questions, based on the hypothetical appearing in the chapter opening:

The law permits Perry to keep all of the lottery money. Is that right? Does Perry have a moral right to deny Oliver his half-share, when we know the two friends had agreed? Is the statute of frauds serving a useful purpose here? Remember that Parliament passed the original statute of frauds believing that a written document would be more reliable than the testimony of alleged witnesses. If we permitted Oliver to enforce the oral contract, based on his testimony and that of the witnesses, would we simply be inviting other plaintiffs to conjure up lottery “contracts” that had never been made?

There are no perfect answers to the questions posed. Clearly the British Parliament is persuaded that the evil of the statute largely outweighs the good, which is why it has eliminated the writing requirement for most contracts. In support of eliminating the statute:

Oliver and Perry had many unbiased witnesses who could demonstrate that the parties arrived at a clear agreement. There is no ethical reason for Perry to get all the money.
Why should a judge or jury be unable to determine the existence vel non of a contract, when we entrust the factfinder with far more difficult decisions, such as who committed a murder, whether a corporation has dominated a market, whether two musical pieces are “substantially similar,” and so forth?

In support of retaining the statute:

A writing forces one to be cautious in making deals. The statute of frauds reminds the parties that they are engaging in serious business, and forces them to think through details and anticipate problems and unexpected issues.
Writing an agreement may encourage When the parties read the first draft of an agreement, they may realize that certain topics that seemed settled are filled with ambiguity. Far better to resolve the ambiguities now, rather than in court.

Additional Case/Landmark Case: The Lessee of Richardson v. Campbell [7]

Facts: A tenant had rented land from Richardson. However, Campbell claimed the property was really his. Unless the tenant could prove that Richardson owned the land, he would have no right to stay there. Richardson's tenant offered a deed (which was then called a patent) to support his claim; Campbell provided receipts as evidence that he had bought the property. To prove that the receipts were for the disputed property, Campbell wanted to introduce statements from an important person -- Thomas Penn, whose father, William, had founded the Pennsylvania colony. Obviously, the tenant did not want that evidence admitted in court.

Issue: Was oral evidence about the ownership of land admissible in court?

Excerpts from Justice Coleman's Decision: PLAINTIFF supported his Title by a Patent. The Defendant produced Receipts several Years prior to Plaintiff's Patent; but the Plaintiff contend[ed] that the Receipts were only for Money paid on an adjacent Tract; the Defendant produced a Witness to prove a parol Declaration of Mr. Thomas Penn that the Land in dispute was sold to Defendant. This piece of Evidence was opposed by the Plaintiff, and refused BY THE COURT.

Agreements for an Interest in Land

A contract for the sale of any interest in land must be in writing to be enforceable. Notice the phrase “interest in land.” This means any legal right regarding land

Additional Case: Baker v Daves[8],

Facts: Tommy and Eleanor Daves gave their daughter Lisa Baker the deed to a two-acre property with a house on it, keeping for themselves a life interest in the parcel. When they died, the property returned to their daughter. Two years later Tommy and Eleanor divorced and settled their affairs amicably. In court, with Baker watching from the second row, their lawyers informed the court of an agreement that all three parties had allegedly made to sell the 2 acre property. Baker would be reimbursed for taxes and insurance paid during her ownership and the three of them would split the remainder of the sale proceeds. After the agreement was announced in court Baker put the property on the market, but then withdrew it and refused to sell. Tommy sued Baker and she defended based on the Statute of Frauds. The trial court acknowledged that Baker had signed nothing, but found that the courtroom statements proved the parties had formed a binding contract. The judge ordered Baker to sell the house and she appealed.

Issue: Was Lisa obligated to sell the house??

Holding: Judgment for Daves reversed and remanded. The record of the court proceedings, introduced as an exhibit, showed that there was testimony in open court reciting the details of the purported sales transaction. Baker contends that she never agreed to sell the property and that "even if some of the parties thought there was an agreement to sell the land, it cannot be enforced since it was not in writing." The record does not reveal any writing signed by Baker, or by any other person properly authorized by her, to sell the property. The fact that appellant was present in the courtroom when the property-settlement agreement was read into the record during the Daves's divorce proceedings is of no benefit to Daves under these circumstances.

One judge dissented and would have affirmed the trial court’s decision, arguing that Baker was present in court when the agreement was discussed and that she admitted listing the property for sale pursuant to the agreement.

Question: What is a life interest?

Answer: A life interest is the right to use property for the rest of one’s life. In this case, the Daves gave Lisa ownership of the property but kept life interests for themselves.

Question: What evidence does the court rely on in ruling for Baker?

Answer: It relies primarily on the lack of any writing signed by Baker or anyone acting on her behalf evidencing the agreement to sell the property.

Question: What argument did the Daves make based on the courtroom testimony?

Answer: They argued that Baker heard the deal discussed in court and did not refute it.

Question: Did they rely on anything else?

Answer: They relied on the fact that Baker listed the property for sale, although she soon took it off the market.

Question: What is the significance of Baker listing the property for sale?

Answer: Daves argued that it amounted to partial performance of the oral transaction

Question: What is partial performance?

Answer: Partial performance is an exception to the Statute of Frauds in the sale of land. If makes an oral contract enforceable if the seller fully performs the oral agreement or the buyer partially performs the oral agreement by paying part of the purchase price and either occupying or improving the land.

Question: Why didn’t partial performance apply here?

Answer: Baker was the seller and she did not fully perform the agreement.

Question: Can’t the court construe listing the land for sale as proof of the oral agreement with her parents?

Answer: Baker might have been listing the property pursuant to the agreement, or she might have been listing it for some other reason. The facts are susceptible to more than one interpretation.

Question: Isn't that unethical for Baker to ignore her promise? Shouldn't the law support ethics?

Answer: The rationale for not enforcing an oral agreement is that this will protect all buyers and sellers more effectively in the long run. Other buyers and sellers know that no one will be able to go into court and fraudulently claim there was an oral agreement for one of these important contracts. The Statute of Frauds is not some recent development in the law. If the Daves wanted to make a binding agreement concerning the land with their daughter they should have put it in writing.

Agreements That Cannot Be Performed Within One Year

Additional Case/You Be The Judge: Sawyer v. Mills[9]

Facts: Barbara Sawyer worked as a paralegal for Melbourne Mills, assisting him in a large class action lawsuit against the maker of diet drug Fen-Phen. Mills promised Sawyer a large bonus, but never specified how much he would pay her. When Mills settled the case, he later met with Sawyer and her husband to discuss her bonus. The Sawyers secretly taped the conversation.

During the meeting, Mills orally agreed to pay Sawyer $1million dollars on monthly installments for the next ten years, plus a $65,000 payment for a luxury car. Mills agreed to sign a document confirming this agreement, but when Sawyer’s lawyer drafted a contract, Mills refused to sign. Mills made nine monthly payments and an extra payment of $100,000.

A jury heard the tape recorded conversation and concluded that the parties reached a binding agreement and awarded Sawyer $900,000. The court granted a judgment notwithstanding the verdict, ruling that the agreement was barred by the Statute of Frauds. Sawyer appealed.

You Be the Judge: Does the statute of frauds prevent enforcement of Mills’ promise?

Holding: Yes, the order for JNOV is affirmed. According to the court, the undisputed testimony from Sawyer, her husband, and her attorney and a draft agreement of the parties' conversation regarding the bonus, coupled with the tape recording of that conversation, all confirmed that the parties agreed the bonus would be paid in monthly installments over 107 months. The tape recording clearly showed that Mills never intended to pay Sawyer the bonus as a lump sum and Sawyer was recorded agreeing to the monthly payments. Thus, the parties never contemplated that the bonus would be paid within one year, and therefore the oral promise is not enforceable.

Question: Didn’t Mills agree to pay Sawyer $10,000 for ten years?

Answer: Yes.

Question: Is it fair that he can make that promise then not honor it?

Answer: Perhaps not. But the point of Statute of Frauds is to force people to be wary of relying on oral promises. In this case, the court noted that Sawyer did have a lawyer draft a contract memorializing the agreement, but Mills refused to sign it. That, according to the court, is evidence that the parties knew that performance was not to be completed within one year, and thus the promise had to be in writing. Question: What about the checks that Sawyer received? Doesn’t nine months of checks constitute a “writing”?

Answer: Sawyer tried to make this clam, but the court did not agree. According to the court, the nine checks merely confirm the parties’ oral agreement that Mills was to pay Sawyer $10,000 on the first of every month.

Additional Case: Bed, Bath & Beyond of La Jolla, Inc. v La Jolla Village Square Venture Partners[10]

Facts: From May 1992 through January 1993 plaintiff Bed, Bath & Beyond negotiated with defendant La Jolla Village Square Venture Partners (“La Jolla”) for a lease of retail space in La Jolla Village Square, a shopping center La Jolla was then in the process of building. In February 1993 La Jolla's legal representative in the negotiations presented plaintiff with four copies of a proposed written lease agreement and guaranty agreement to be executed by plaintiff and its guarantor, plaintiff's parent corporation. The cover letter accompanying these documents requested they be executed by plaintiff and its guarantor and returned to La Jolla's legal representative for "execution by the Landlord." Plaintiff signed the lease and its parent corporation signed the guaranty. The documents were then returned to defendant for execution. Defendant never executed the lease. In late March 1993 defendant informed plaintiff that it intended to lease the subject premises to Linens 'N Things, plaintiff's competitor. Prior to that communication plaintiff was unaware that La Jolla had been negotiating with Linens 'N Things. Plaintiff sued defendant for specific performance, breach of contract, and fraud and asked the court to enjoin defendant from proceeding with the Linens ‘N Things lease. Defendant moved for summary adjudication on plaintiff's claims and injunctive relief. The factual predicate to each of the causes of action is a valid, enforceable lease. The court granted defendant’s motion and plaintiff appealed.

Issue: Was the lease between plaintiff and defendant subject to the statute of frauds?

Holding: Judgment for defendant affirmed. Excerpts from the court’s opinion:

Three different "statutes of fraud" apply to bar enforcement of the alleged lease agreement in this case.

Civil Code section 1624, subdivision (d) specifies, as a type of contract which is invalid unless it is in writing and subscribed by the party to be charged, "[a]n agreement . . . to lease real estate for a longer period than one year . . . ."
Civil Code section 1091 provides: "An estate in real property, other than an estate at will or for a term not exceeding one year, can be transferred only by operation of law, or by an instrument in writing, subscribed by the party disposing of the same, or by his agent thereunto authorized by writing."
Similarly, Code of Civil Procedure section 1971 provides, in pertinent part: "No estate or interest in real property, other than for leases for a term not exceeding one year, . . . can be created, granted, assigned, surrendered, or declared, otherwise than by operation of law, or a conveyance or other instrument in writing, subscribed by the party creating, granting, assigning, surrendering, or declaring the same, or by the party's lawful agent thereunto authorized by writing."

Plaintiff contends the lease agreement is not subject to the statute of frauds because it possibly could have been performed within one year from the date of its making. Plaintiff's argument rests on two provisions in the unexecuted written lease. The first provided the tenant could terminate the lease before the rental term commenced if the landlord failed to begin certain preparatory work on the leased premises by June 1, 1993, or substantially complete that work by December 31, 1993. The second gave the landlord the right to terminate the lease before commencement of the rental term if the landlord was unable to obtain the various governmental permits and approvals required for construction of the premises despite exercising diligence and good faith in attempting to do so.

The provisions of Civil Code section 1624, subdivision (d), along with Civil Code section 1091 and Code of Civil Procedure section 1971, render the alleged lease unenforceable despite its pre-commencement termination provisions because the actual term of the lease exceeds one year. We hold that an agreement to lease real property for a term exceeding one year is within the statute of frauds of Civil Code section 1624, subdivision (d) regardless whether such agreement provides that it may be canceled or terminated within one year of the date of its making and prior to commencement of the lease term.

Common Law Statute of Frauds: What the Writing Must Contain

The writing may consist of more than one document, written at different times, with each document making a piece of the puzzle. But there are some general requirements: the writing

Must be signed by the defendant, and
Must state with reasonable certainty the name of each party, the subject matter of the agreement, and all of the essential terms and promises.

Incompleteness

Additional Case: Ahrens v. Dodd[11]

Mr. and Ms. Ahrens wanted to buy a trailer court owned by Charles Dodd. The Ahrenses drafted and signed a contract to buy “Blue Bell Trailer Court” for $305,000. The contract stated that the trailer court included 31 acres. Dodd held the deed to a 33.72‑acre tract of land; the land included the 31 acres of Blue Bell Court and two more acres on which Dodd lived. The Ahrenses wrote a check to Dodd for $65,000, noting “trailer park” on the check. Dodd cashed the check. Later, Dodd refused to sell the trailer park to the Ahrenses, who sued.

Question: This case raises two issues under the statute of frauds. What are they?

Answer: The two issues are, first, whether there was a writing and, second, whether the writing was clear and complete.

Question: The court held that the contract, together with the check, satisfied the writing requirement. Was the writing clear and complete?

Answer. No, it was not. It was unclear exactly where the land's boundaries lay. “Blue Bell Court” indicated the existing trailer park, but it was clear from the contract that the Ahrenses did not expect to obtain all 33.72 acres described in Dodd's deed. Exactly how much land were the Ahrenses buying? Precisely what were its boundaries? There was no way of knowing from the agreement. Such vagueness about a critical element of a land sale is fatal. The court denied the Ahrenses claim for specific performance.

Electronic Contracts and Signatures

What happens to the writing requirement, when there is no paper? The present statute of frauds requires some sort of “signature.” Today, an “electronic signature” could mean a name typed (or automatically included) at the bottom of an e-mail message, a retinal or vocal scan, or a name signed by electronic pen on a writing tablet, among others.

E-signatures are valid in all 50 states. Almost all states have adopted the Uniform Electronic Transactions Act, which declares that electronic contracts and signatures are as enforceable as those on paper. In other words, the normal rules of contract law apply, and neither party can avoid such a deal merely because it originated in cyberspace. A federal statute, The Electronic Signatures in Global and National Commerce Act (E-SIGN), also declares that contracts cannot be denied enforcement simply because they are in electronic form, or signed electronically. It applies in states that have not adopted UETA.

In many states, certain documents still require a traditional (non-electronic) signature. Wills, adoptions, court orders, and notice of foreclosure are common exceptions.

The UCC’s Statute of Frauds

The UCC requires a writing for the sale of goods worth $500 or more. The Code’s requirements are easier to meet than those of the common law. UCC §2-201, the statute of frauds section, has three important elements:

The basic rule
The merchants’ exception
Special circumstances

UCC §2-201(1)—The Basic Rule

A contract for the sale of goods worth $500 or more is not enforceable unless there is some writing, signed by the defendant, indicating that the parties reached an agreement. The key difference between the common law rule and the UCC rule is that the Code does not require all of the terms of the agreement to be in writing. The Code looks for something simpler: an indication that the parties reached an agreement.

Sale of Goods Distinguished from Other Contracts

Under UCC §2‑201(1), a contract for the sale of goods worth $500 or more is not enforceable unless there is some writing, signed by the defendant, indicating that the parties reached an agreement. The common law requires that all terms of the agreement be in writing; the UCC does not. It requires writing containing an indication that the parties reached an agreement, and a statement of the quantity of goods being sold.

For example, suppose Antonia has just made two excellent business deals on the phone. In the first she agreed to buy Natalie's condominium in Fort Myers, Florida. In the second she ordered 1,000 tons of gravel from Butch's Gravel Co.

Natalie faxes this memo to Antonia:

Dear Antonia–This will confirm our agreement that you will buy my condo in Ft. Myers, Florida

[Signed] Natalie.

Butch faxes this memo to Antonia:

Toni–This confirms I'm selling 1,000 tons of Grade 3 gravel.

[Signed] Butch.

Question: What is missing from each fax?

Answer: Natalie's fax omits the price, a description of the unit, the time, and place of performance, and almost all other details. Butch's fax omits price, place, and date of delivery, and time and method of payment.

Question: Natalie and Butch both refuse to go through with their agreements, and Antonia sues both. Who will win her suit against Natalie?

Answer: Natalie wins. The agreement is in writing and signed by the defendant--Natalie--but it is not complete. If Natalie owns only one Fort Myers condominium, the unit may be adequately described. If she owns more than one such condo, the description is incomplete. But the fax states no price, and that omission is fatal.

Question: Who will win Antonia's suit against Butch?

Answer: Antonia wins. Butch's fax is no more specific than Natalie's, but the UCC does not demand completeness. The fax clearly indicates that the parties reached an agreement, and it specifies quantity. That is all UCC §2‑201 requires.

UCC §2-201(2)—The Merchants’ Exception

When both parties are “merchants,” that is, business people who routinely deal in the goods being sold, the Code will accept an even more informal writing. Within a reasonable time of making an oral contract, if a merchant sends a written confirmation to another, and if the confirmation is definite enough to bind the sender herself, then the merchant who receives the confirmation will also be bound by it unless he objects in writing within 10 days.

UCC §2-201(3)—Special Circumstances

An oral contract may be enforceable, even without a written memorandum, if:

The seller is specially manufacturing the goods for the buyer, or
The defendant admits in court proceedings that there was a contract, or
The goods have been delivered or they have been paid for.

Parol Evidence

The parol evidence rule: When two parties make an integrated contract, neither one may use parol evidence to contradict, vary, or add to its terms.

If a court determines that a written contract is incomplete or ambiguous, it will permit parol evidence.

A court will permit parol evidence of fraud, misrepresentation, or duress.

Case: Mayo v North Carolina State University,[12]

Facts: Dr. Robert Mayo was a tenured faculty member of the engineering department at North Carolina State University (NCSU), and director of the school's nuclear engineering program. In July, he informed his department chair, Dr. Paul Turinsky, that he was leaving NCSU effective September 1. In October, after Mayo had departed, the university's payroll coordinator informed him that he had been overpaid because for employees who worked 9 months but were paid over 12 months, the salary checks for July and August were prepayments for the period beginning that September. Because Mayo had not worked that September he was not entitled to the money. Mayo refused to refund the money.

At an internal hearing on the University’s claim for the money Turinsky and the university's payroll director, explained that the "pre-payment" rule was a basic part of every employee's contract. This rule was not stated in any of the documents that formed Mayo’s contract and these officials used other evidence to establish the prepayment policy. Based on the additional evidence, the hearing ruled that NCSU was entitled to its money. Mayo appealed the agency’s decision to court and the trial judge declared that he owed nothing because the university was not permitted to rely on parol evidence to establish its policy. The University appealed.

Issue: What evidence could NCSU rely upon to establish its pre-payment rule?

Holding: Judgment for Mayo affirmed. Excerpts from the court’s opinion:

Here, the language of the employment agreement is clear and unambiguous-petitioner is to be paid in twelve monthly installments for his service as a nine-month, academic year, tenured faculty member. Dr. Turinsky testified that petitioner's written employment agreement is comprised of terms found in petitioner's appointment letter, annual salary letter, and written policies adopted and amended by the UNC Board of Governors and the NCSU Board of Trustees. However, none of these documents forming the employment agreement set forth the compensation policies upon which NCSU bases its claim. The payroll director admitted at the agency hearing that the policies were "not stated anywhere specifically.” Dr. Turinsky testified he did not know of the existence of the terms until September, after petitioner left his employment with NCSU. The parol evidence rule prohibits the admission of parol evidence to vary, add to, or contradict a written instrument intended to be the final integration of the transaction.

Question: What does the parol evidence state?

Answer: When two parties make an integrated contract, neither one may use parol evidence to contradict, vary, or add to its terms.

Question: What is an integrated contract?

Answer: An integrated contract is a writing that the parties intend as the final, complete expression of their agreement.

Question: What is the source of this dispute?

Answer: Mayo voluntarily left his tenured position at the University effective September 1. After he left the University claimed Mayo owed it the salary he received for the July and August before he resigned.

Question: Why?

Answer: The University relied on its “prepayment” rule, under which salary received in July and August by persons who worked for 9 months but were paid over 12 months was actually prepayment for the period beginning the following September 1,

Question: Was this rule part of Mayo’s employment agreement with the University?

Answer: That was the University’s problem. This rule was not stated in writing anywhere in any of the documents constituting Mayo’s employment agreement.

Question: How does the parol evidence rule arise in this case?

Answer: Mayo argued that the parol evidence rule barred the University’s oral testimony about existence of the prepayment rule.

Question: Did the court agree?

Answer: Yes.

Note: The court affirmed in part, ruling that Mayo owed the university nothing, and reversed in part, declaring that Mayo was also entitled to his tax refund.

Performance and Discharge

If a party is discharged, she is "finished", and has no more duties under a contract. Most contracts are discharged by full performance. In other words, the parties generally do what they promise. Sometimes the parties discharge a contract by agreement.

Performance

People speak of “dotting the i’s and crossing the t’s” when discussing contract performance, yet that is not the standard the law generally imposes to determine whether a party has performed or breached its contract obligations. A party is generally not required to render strict performance unless the contract expressly demands it and such a demand is reasonable.

In a contract for services, a party that substantially performs its obligations will generally receive the full contract price, minus the value of any defects.

Additional Case: Strategic Resources Group v. Knight-Ridder^{^[1]}

Facts: Brighton Homes developed residential housing in the Miami area and contracted with Knight-Ridder to run advertisements in the Miami Herald newspaper. The contract required Brighton to designate the size of the ad and stated that Knight-Ridder would print them and “bill for the exact space published.” Brighton assigned to Strategic Resources Group all rights the developer might have for overpayments made to Knight-Ridder and Strategic sued Knight-Ridder, claiming that for three years the newspaper had routinely printed ads that were 3.83% smaller than the copy submitted by Brighton. The trial court ruled that Knight-Ridder had substantially performed and granted its motion for summary judgment. Strategic appealed.

Issue: Did Knight-Ridder substantially perform its advertising contract?

Holding: Judgment for Knight-Ridder affirmed. Substantial performance is that performance of a contract which, while not full performance, is so nearly equivalent to what was bargained for that it would be unreasonable to deny the promisee the full contract price subject to the promisor's right to recover whatever damages may have been occasioned him by the promisee's failure to render full performance. For six years, Knight-Ridder ran the advertisements without any complaint from Brighton.

Brighton never requested tear sheets or advertising proofs before publication, nor did it measure the advertisements after publication. The size reduction was not easily discernible, even in a side-by-side comparison. Even after discovering the reduction, Brighton continued its business relationship with Knight-Ridder, using the same advertisements under the same terms and conditions. While Knight-Ridder intentionally reduced the size of the advertisements, it did not intentionally breach the contract. It relied on contractual language which authorized it "to revise, alter, or reject any advertisement."

Question: Why is Strategic the plaintiff in this case when the dispute arose with Brighton’s ads?

Answer: Brighton assigned to Strategic its rights in overpayments made to Knight-Ridder for the ads. See Chapter 16, Third Parties. Strategic stepped into Brighton’s shoes in asserting its claims.

Question: What if the ads had been 10% smaller? Would the result have been different?

Answer: We don’t know. The court doesn’t address at what point Knight-Ridder’s performance would not have been substantial. It limits itself to asking whether Knight-Ridder’s performance on these facts was substantial.

Question: What facts does the court rely on in ruling for Knight-Ridder?

Answer: The court notes that the practice which is the basis for Strategic’s claims continued for six years without complaint from Knight-Ridder, which made no attempt to double-check the size of the ads. The court also notes that the size difference could not be easily noticed.

Question: In some of the other contract chapters we discussed cases in which the rules favored form over substance. Is it fair to say the opposite is true here—that courts do not favor a standard of strict performance?

Answer: Yes. In these cases the law looks, quite literally, at the substance of the performance.

Good Faith

The parties to a contract must carry out their obligations in good faith. This sounds easy enough, but courts wrestle with the question of just what defines good faith.

Case: Brunswick Hills Racquet Club Inc. v. Route 18 Shopping Ctr. Associates^{^[2]}

Facts: Brunswick Hills Racquet Club (Brunswick) owned a tennis club on property that it leased from Route 18 Shopping Center Associates (Route 18). The lease ran for 25 years, and Brunswick had spent about $1 million in capital improvements. The lease expired, and Brunswick had the option of either buying the property or purchasing a 99-year lease, both on very favorable terms. To exercise its option, Brunswick had to notify Route 18 no later than September 30, and had to pay the option price of $150,000. If Brunswick failed to exercise its options, the existing lease automatically renewed as of September 30, for 25 more years, but at more than triple the current rent.

Nineteen months before the option deadline, Brunswick’s lawyer wrote to Rosen Associates, the company that managed Route 18, stating that Brunswick intended to exercise the option for a 99-year lease. He requested that the lease be sent well in advance so that he could review it. He did not make the required payment of $150,000.

Rosen replied that it had forwarded Spector’s letter to its attorney, who would be in touch. In April, Spector again wrote, asking for a reply from Rosen or its lawyer.

Over the next six months, the lawyer continually asked for a copy of the lease, or information, but neither Route 18’s lawyer nor anyone else provided any data. Eventually, the September deadline passed.

Route 18’s lawyer notified Brunswick that it could not exercise its option to lease, because it had failed to pay the $150,000 by September 30.

Brunswick sued, claiming that Route 18 had breached its duty of good faith and fair dealing. The trial court found that Route 18 had no duty to notify Brunswick of impending deadlines, and gave summary judgment for Route 18. The appellate court affirmed, and Brunswick appealed to the state supreme court.

Issue: Did Route 18 breach its duty of good faith and fair dealing?

Holding: Judgment for Route 18 reversed.

Excerpts from Justice Albin’s Decision: Courts generally should not tinker with a finely drawn and precise contract entered into by experienced business people that regulates their financial affairs. [However,] every party to a contract is bound by a duty of good faith and fair dealing in both the performance and enforcement of the contract. Good faith is a concept that defies precise definition. Good faith conduct is conduct that does not violate community standards of decency, fairness, or reasonableness. The covenant of good faith and fair dealing calls for parties to a contract to refrain from doing anything which will have the effect of destroying or injuring the right of the other party to receive the benefits of the contract.

Our review of the undisputed facts of this case leads us to the inescapable conclusion that defendant breached the covenant of good faith and fair dealing. Nineteen months in advance of the option deadline, plaintiff notified defendant in writing of its intent to exercise the option to purchase the 99-year lease. Plaintiff mistakenly believed that the purchase price was not due until the time of closing.

During a 19-month period, defendant, through its agents, engaged in a pattern of evasion, sidestepping every request by plaintiff to discuss the option and ignoring plaintiff’s repeated written and verbal entreaties to move forward on closing the 99-year lease despite the impending option deadline and obvious potential harm to plaintiff.

Defendant never requested the purchase price of the lease. Indeed, as defendant’s attorney candidly admitted at oral argument, defendant did not want the purchase price because the successful exercise of the option was not in defendant’s economic interest.

Ordinarily, we are content to let experienced commercial parties fend for themselves and do not seek to introduce intolerable uncertainty into a carefully structured contractual relationship by balancing equities. But there are ethical norms that apply even to the harsh and sometimes cutthroat world of commercial transactions. We do not expect a landlord or even an attorney to act as his brother’s keeper in a commercial transaction. We do expect, however, that they will act in good faith and deal fairly with an opposing party. Plaintiff’s repeated letters and telephone calls to defendant concerning the exercise of the option and the closing of the 99-year lease obliged defendant to respond, and to respond truthfully.

[Plaintiff is entitled to exercise the 99-year lease.]

Question: Brunswick failed to pay the option price of $150,000 when it notified Route 18 of its exercise of the 99-year lease option. Why doesn’t that end the case, in favor of Route 18?

Answer: The court states that Brunswick’s failure to pay arose from a mistaken belief. Implicit in this statement is recognition that had Route 18 responded to any of Brunswick’s repeated entreaties for a copy of the lease the mistake would have been discovered and could have been corrected.

Question: The definition of good faith is nebulous. What standard does the court apply?

Answer: It looks at whether one party destroys or injures the other parties’ ability to receive the benefits of the contract.

Question: What does that mean in practical terms?

Answer: It means that courts must examine each claim of breach of the covenant of good faith and fair dealing case-by-case, analyzing the basis of the claim against the benefits flowing to the injured party under the contract.

Question: It seems in these cases that courts could wind up interfering with legitimate competitive business practices.

Answer: That is a valid concern, one that courts recognize. As the court states here, “courts generally should not tinker with a finely drawn and precise contract entered into by experienced business people that regulates their financial affairs.”

Additional Case: Hinc v. Lime-O-Sol Company^{^[3]}

Facts: Through his experience in the paint industry and as an employee handling claims for the Sherwin-Williams Company, a paint manufacturer, Hinc became aware of the recurring problems of surfactant leaching and tannin bleeding, which cause brown surface stains on painted exteriors. Often, because of this discoloration, paint manufacturers and insurance companies were forced to repaint entire commercial complexes at their own expense. Hinc's product, which he named Less Work Painted Surface Stain Remover ("Stain Remover"), combined a certain proportion of a secret ingredient with a shower-cleaning product manufactured by LOS ("Shower Cleaner"). Lacking knowledge of the Shower Cleaner formula but understanding the commercial potential of Stain Remover, Hinc contacted LOS about his invention in early 1999.

The parties discussed whether Hinc’s product would be viable. Hinc visited LOS's facility in Ashley, Indiana at least two times to discuss potential applications of Stain Remover. Negotiations led to a contract providing that while Hinc would retain ownership of the secret ingredient, he would divulge it to LOS. LOS would manufacture and distribute the product while keeping Hinc’s secret ingredient confidential. Without discussion between the parties as to its meaning, the contract contained a term obligating both parties to use their "best efforts" to market the product "in a manner that seems appropriate."

Hinc supplied LOS with the secret ingredient and secured orders for Stain Remover with Sherwin-Williams. LOS filled these orders with its Shower Cleaner, not the combined product containing Hinc's secret ingredient. LOS claims production difficulties prohibited filling the orders with Stain Remover, and, in order to deliver the orders on time, Hinc agreed to allow LOS to ship Shower Cleaner instead of Stain Remover. Hinc denies he ever agreed to this. Ultimately, LOS never produced, marketed, or sold Stain Remover during the duration of the contract.

The relationship between the parties eventually broke down and Hinc sued LOS for breach of contract. The district court granted LOS's motion for summary judgment and dismissed Hinc's suit, ruling that the "best efforts" clause was vague and unenforceable under applicable law.

Issue: Was the “best efforts” clause vague and therefore unenforceable?

Holding: Judgment for LOS reversed. After ruling that Indiana law governed the contract the court stated “[w]here possible, Indiana courts will construe contracts as being valid, rather than void.” The phrase "in a manner that seems appropriate," is obviously indefinite and could mean different things to different people, but we do not believe that the clause as a whole is so vague as to be unenforceable as a matter of law. LOS, which drafted this provision of the contract, agreed to put forth its "best efforts" to market Stain Remover and required the same of Hinc. "Best efforts," as commonly understood, means, at the very least, some effort. It certainly does not mean zero effort --the construction LOS urges here to escape any obligation under its contract. Cf. E. Allen Farnsworth, On Trying to Keep One's Promises: The Duty of Best Efforts in Contract Law, 46 U. Pitt. L. Rev. 1, 8 (1984) (noting that fifty years ago it was generally accepted that a duty defined only in terms of best efforts was too indefinite to be enforced, but that such a view is no longer widely held today). We believe that Indiana's highest court would take the approach that "best efforts" provisions can be contractually enforced.

Note: As the quote from the Farnsworth law review article cited above points out, the trend in recent decades has been to define and enforce concepts such as “best efforts” and good faith.

Time of the Essence Clauses

If a contract indicates that time is of the essence, then deadlines will be strictly enforceable. Without such a clause, stated dates for performance are usually interpreted as flexible.

Breach

When one party breaches a contract, the other party is discharged. The discharged party has no obligation to perform and may sue for damages.

As we know, parties frequently perform their contract duties imperfectly, which is why courts accept substantial performance rather than strict performance, particularly in contracts involving services. In a more general sense, courts will only discharge a contract if a party committed a material breach.

Case: O’Brien v. Ohio State University^{^[4]}

Facts: The Ohio State University (OSU), experiencing a drought in its men’s basketball program, brought in coach Jim O’Brien, to turn things around. The plan was successful.. In only his second year, he guided the team to its best record ever. The team advanced to the Final Four, and O'Brien was named national coach of the year. OSU’s athletic director promptly offered the coach a new, multiyear contract, worth about $800,000 per year.

Section 5.1 of the contract included termination provisions. The University could fire O’Brien for cause if (a) there was a material breach of the contract by the coach, or (b) O’Brien’s conduct subjected the school to NCAA sanctions. OSU could also terminate O’Brien without cause, but in that case it had to pay him the full salary owed.

O’Brien began recruiting a talented 21-year-old Serbian player named Alex Radojevic. While getting to know the young man, O’Brien discovered two things. First, it appeared that Radojevic had been paid to play briefly for a Yugoslavian team, meaning that he was ineligible to play college basketball. . Second, it was clear that Radojevic’s family had suffered terribly during the strife in his homeland.

O’Brien concluded that Radojevic would never play for OSU or any major college. He also decided to loan Radojevic’s mother some money. Any such loan would violate an NCAA rule if done to recruit a player, but O’Brien believed the loan was legal, since Radojevic could not play in the NCAA anyway. Several years later, the University learned of the loan, and realized that O’Brien had never reported it. Hoping to avoid trouble with the NCAA, OSU imposed sanctions on itself. The University also fired the coach, claiming he had lied, destroyed the possibility of postseason play, and harmed the school’s reputation.

O’Brien sued, claiming he had not materially breached the contract. The trial court awarded the coach $2.5 million, and the University appealed.

Issue: Did O’Brien materially breach the contract?

Holding: No, judgment for O’Brien affirmed.

Excerpts from Judge Tyack’s Decision: OSU argued that it was substantially injured by the self-imposed sanctions, which included a ban from post-season and NCAA tournament play [during the current season], and relinquishing two basketball scholarships from the [next] recruiting class. Contrary to OSU’s argument, however, the trial court found these sanctions to be insubstantial. [Athletic Director] Geiger announced the one-year post-season ban in December, and it appears from the timing of that announcement that Geiger made the decision based on the fact that the team was unlikely to be invited to a post-season tournament in the first place.

The second alleged harm was harm to OSU’s reputation. The trial court found that any reputational harm was similarly exaggerated, at least as it specifically related to the Radojevic matter. Radojevic never enrolled at OSU, and never played a single second for OSU’s basketball team.

NCAA violations happen all the time. It’s the nature of the beast. Also relevant to the issue of OSU’s allegedly-damaged reputation is the fact that almost immediately after firing O’Brien, OSU was able to lure one of the nation’s top coaching prospects, [Thad Matta], to assume O’Brien’s former position. Shortly thereafter, Matta successfully recruited possibly the best recruiting class ever. Based on this evidence, the trial court could reasonably find the Radojevic loan did not cause serious harm to OSU.

OSU argues that O’Brien acted in bad faith by covering up his misconduct for several years. In the words of OSU’s counsel at oral argument: “If lying to your employer for four years is not a material breach, it’s hard to imagine what would be!” Although the premise for counsel’s argument is sound, it is unsound in application because it assumes facts not in evidence. Counsel for OSU assumes for the purposes of the argument that O’Brien systematically either denied allegations about the Radojevic loan, or took affirmative steps to conceal it from OSU. The evidence does not support such a conclusion. After Radojevic was drafted by the NBA, there is not a single inference that can be drawn from the record to suggest that O’Brien even thought about the loan. In O’Brien’s own mind, he did not believe he had done anything wrong, thus, he would not have had a motive to conceal what he had done.

[There was no material breach.]

Affirmed.

Question: How did O’Brien breach the contract?

Answer: O’Brien breached the contract by engaging in conduct that subjected the school to sanctions.

Question: If he breached the contract, why does OSU have to pay anyway?

Answer: Because O’Brien’s breach was not a material breach, one that substantially harmed OSU.

Question: But, if the parties agreed to the terms of the contract, and O’Brien did not honor those terms, isn’t it unfair that he collects damages?

Answer: The theory of material breach recognizes the fact that frequently performance of a contract is not perfect. Thus in order for the non-breaching party to be discharged, the breach must have been material.

Statute of Limitations

A party injured by a breach of contract should act promptly. A statute of limitations begins to run at the time of injury and will limit the time within which the injured party may file suit. These laws set time limits for filing lawsuits.

Impossibility

If performing a contract was truly impossible, a court will discharge the agreement. But if honoring the deal merely imposed a financial burden, the law will generally enforce the contract.

True Impossibility

These cases are easy—and rare. True impossibility means that something has happened making it literally impossible to do what the promisor said he would do.

Commercial Impracticability and Frustration of Purpose

It is rare for contract performance to be truly impossible, but very common for it to become a financial burden to one party.

Commercial impracticability means some event has occurred that neither party anticipated and fulfilling the contract would now be extraordinarily difficult and unfair to one party.

Frustration of purpose means some event has occurred that neither party anticipated and the contract now has no value for one party

Remedies

Someone breaches a contract when he fails to perform a duty without a valid excuse.

There are four principal contract interests that a court may seek to protect:

Expectation Interest. This refers to what the injured party reasonably thought she would get from the contract. The goal is to put her in the position she would have been in if both parties had fully performed their obligations.
Reliance Interest. The injured party may be unable to demonstrate expectation damages, perhaps because it is unclear he would have profited. But he may still prove that he spent money in reliance on the agreement and that in fairness he should receive compensation.
Restitution Interest. The injured party may be unable to show an expectation interest or reliance. But perhaps she has conferred a benefit on the other party. Here, the objective is to restore to the injured party the benefit she has provided.
Equitable Interest. In some cases, money damages will not suffice to help the injured party. Something more is needed, such as an order to transfer property to the injured party (specific performance) or an order forcing one party to stop doing something (an injunction).

Expectation Interest

Courts typically divide the expectation damages into three parts: (1) direct (or “compensatory”) damages, which represent harm that flowed directly from the contract’s breach; (2) consequential (or “special”) damages, which represent harm caused by the injured party’s unique situation; and (3) incidental damages, which are minor costs such as storing or returning defective goods, advertising for alternative goods, and so forth.

Landmark Case: Hawkins v. McGee^{^[5]}

Facts: Hawkins suffered a severe electrical burn on the palm of his right hand. After years of living with disfiguring scars, he went to visit Dr. McGee, who was well-known for his early attempts at skin grafting surgery. The doctor told Hawkins "I will guarantee to make the hand a hundred per cent perfect." Hawkins hired him to perform the operation.

McGee cut a patch of healthy skin from Hawkins' chest and grafted it over the scar tissue on Hawkins' palm. Unfortunately, the chest hair on the skin graft was very thick, and it continued to grow after the surgery. The operation resulted in a hairy palm for Hawkins. Feeling rather…embarrassed…Hawkins sued Dr. McGee.

The trial court judge instructed the jury to calculate damages in this way: "If you find the plaintiff entitled to anything, he is entitled to recover for what pain and suffering he has been made to endure and what injury he has sustained over and above the injury that he had before."

The jury awarded Hawkins $3000, but the court reduced the award to $500. Dissatisfied, Hawkins appealed.

Issue: How should Hawkins' damages be calculated?

Excerpts from Justice Branch's Decision: The jury was permitted to consider two elements of damage, (1) pain and suffering due to the operation, and (2) positive ill effects of the operation upon the plaintiff's hand. [T]he foregoing instruction was erroneous.

By damages as that term is used in the law of contracts, is intended compensation to put the plaintiff in as good a position as he would have been in had the defendant kept his contract. The measure of recovery is what the defendant should have given the plaintiff, not what the plaintiff has given the defendant or otherwise expended.

We conclude that the true measure of the plaintiff's damage in the present case is the difference between the value to him of a perfect hand and the value of his hand in its present condition, including any incidental consequences fairly within the contemplation of the parties when they made their contract. The extent of the plaintiff's suffering does not measure this difference in value. The pain necessarily incident to a serious surgical operation was a part of the contribution which the plaintiff was willing to make to his joint undertaking with the defendant to produce a good hand. It furnished no test of the difference between the value of the hand which the defendant promised and the one which resulted from the operation.

[Remanded for a] new trial.

Direct Damages

Direct damages are those that flow directly from the contract. They are the most common monetary award for the expectation interest.

Consequential Damages

Consequential damages reimburse for harm that results from the particular circumstances of the plaintiff. These damages are only available if they are a foreseeable consequence of the breach.

Students who performed the consequential damages research could discuss their findings here.

You Be the Judge: Bi-Economy Market, Inc. v. Harleysville Ins. Co. of New York.^{^[6]}

Facts: Bi-Economy Market, a family-owned meat market, was insured by Harleysville Insurance. The “Deluxe Business Owner’s” policy provided replacement cost for damage to buildings and inventory. Coverage also included “business interruption insurance” for one year, meaning the loss of pre-tax profits plus normal operating expenses, including payroll.

A fire destroyed the Market’s building and its inventory. The Market immediately filed a claim with Harleysville, but the insurer responded slowly. Harleysville eventually offered a settlement of $163,000, and a year later an arbitrator awarded the market $407,000. During that year, Harleysville paid for 7 months of lost income, but refused to pay more. The Market never recovered or re-opened.

Bi-Economy sued claiming that Harleysville’s slow, inadequate payments destroyed the company and also sought consequential damages for the permanent destruction of its business. Harleysville claimed that it was only responsible for damages specified in the contract: the building, inventory, and payroll. The trial court gave summary judgment for Harleysville. The appellate court affirmed holding that when they entered into the contract, the parties did not contemplate damages for termination of the business. Bi-Economy appealed.

You Be the Judge: Is Bi-Economy entitled to consequential damages for the destruction of its business? Holding: Yes, judgment for Harleysville reversed.

To determine whether consequential damages were reasonably contemplated by the parties, courts must look at the nature and purpose of the contract between the parties, and what liability the parties reasonable expected Harleysville to take on in the event of a loss. Here, according to the court, the purpose of business interruption coverage was to ensure that Bi-Economy had the financial support necessary to sustain its business in the event disaster occurred. Thus, the very purpose of business interruption coverage would have made Harleysville aware that if it breached its obligations under the contract to investigate in good faith and pay covered claims it would have to pay damages to Bi-Economy for the loss of its business as a result of the breach.

Implicit in the insurance contract was an obligation on Harleysville to honestly and promptly evaluate the claim. Harleysville knew that failure to do this would defeat the very purpose of the insurance contract, and would cause more damage to Bi-Economy. When an insured, like Bi-Economy, suffers additional damages as a result of an insurer's excessive delay or improper denial, the insurance company should be liable for these damages. This is not to punish the insurer, but to give the insured its bargained-for-benefit.

Harleysville argued that consequential damages were only appropriate where an insured suffered a loss that was not in the contract. However, according to the court, consequential damages are not “losses” bargained for by the parties. Consequential damages are in addition to the losses caused by a calamitous event, and include those additional damages caused by an insurance company’s failure to timely investigate, adjust and pay the claim. Therefore, the court the court found that Bi-Economy's claim for consequential damages including the demise of its business, was reasonably foreseeable and contemplated by the parties, and thus cannot be dismissed.

Question: What are consequential damages?

Answer: Consequential damages are damages that result from the unique circumstances of this particular party.

Question: What were the unique circumstances of Bi-Economy?

Answer: That it could not stay in business in the event of a disaster if there was a long delay in the investigation or a denial of its claim.

Question: Wasn’t the unique circumstance that it went out of business?

Answer: No, and that was what Harleysville tried to tell the court: Bi-Economy went out of business--that is not covered by business interruption insurance. What Bi-Economy was saying was that it went out of business because Harleysville unfairly delayed the investigation and unfairly failed to pay its entire claim. The court agreed with Bi-Economy.

Question: What point was the court trying make by explaining the difference between a loss and damages?

Answer: What the court was saying was a loss was something contemplated by the parties when they made the insurance contract, and thus was something both sides bargained for. Damages, on the other hand, result from a loss, and are in addition to a loss.

Question: Why is Harleysville liable for Bi-Economy going out of business?

Answer: Because, according to the court, it was reasonably foreseeable to Harleysville that if there was a delay in the investigation or if they did not fairly pay Bi-Economy’s claim, Bi-Economy would go out of business. This was foreseeable because the point of business interruption insurance is to pay business expenses during the time of a calamity. Thus Harleysville knew that Bi-Economy did not have the funds to pay the expenses, and therefore could go out of business if Harleysville did not pay the claim promptly.

Incidental Damages

Incidental damages are the relatively minor costs that the injured party suffers when responding to the breach.

Reliance Interest

The reliance interest is designed to put an injured party in the position he would have been in had the parties never entered into a contract. This remedy focuses on the time and money the injured party spent performing his part of the agreement.

Additional Case: Toscano v Greene Music^{^[7]}

Facts: Joseph Toscano was the general manager of Fields Pianos (Fields) in Santa Ana, California. He was unhappy with his job, and decided to seek other employment. In July, Greene offered Toscano a sales management job, starting September 1. Toscano relied on Greene’s offer and quit his job at Fields on August 1. Greene withdrew the job offer in mid-August. Toscano sued Greene for breach of contract and promissory estoppel. Greene argued that Toscano was not entitled to any expectation damages, because his employment with Greene would have been at-will, meaning he could lose the job at any time and could, at most, recover one month's lost wage. The trial court ruled that Toscano was entitled to reliance damages at Fields starting August 1 through his anticipated retirement in 2017 and awarded him damages of $536,833. Green appealed.

Issue: Was Toscano entitled to reliance damages?

Holding: Judgment for Toscano’s entitlement to reliance damages affirmed, but damage award vacated and remanded for new trial on amount of damages. Promissory estoppel permits Toscano, who relinquished his job in reliance on an unfulfilled promise of employment, to prove he is entitled to recover the lost wages he would have expected to earn from his former employer but for the defendant's promise. The at-will nature of Toscano's former employment with Fields is not a strict impediment to recovery of future wages that Toscano would have earned at Fields had he not relied on Greene's promise. The evidence, however, was too speculative to support the trial court’s award of Toscano’s future lost earnings from September 1 until his retirement. Toscano’s damages-expert’s testimony does not establish Toscano had a definite expectation of continued employment with Fields for any particular period of time.

Question: On what claim did the trial court award damages to Toscano?

Answer: Promissory estoppel.

Question: On what promise did Toscano rely?

Answer: He relied on Green’s promise to employ Toscano in a sales management job beginning on September 1.

Question: What harm did Toscano suffer in reliance on Green’s promise?

Answer: He quit his job with Fields on August 1, then Greene withdrew its offer and left Toscano without a job. He found subsequent employment but at a lower salary.

Question: Why wasn’t Toscano successful on his breach of contract claim?

Answer: The appellate court decision doesn’t explain why; the only issue before it was the trial court’s award of reliance damages on the promissory estoppel claim. It seems likely that the trial court rejected the breach of contract claim because Greene’s offer was for employment-at-will under which Greene could have terminated Toscano’s employment at any time.

Question: Toscano relied on Green’s promise and sued Greene. Why does the damages discussion focus on what Toscano would have earned at Fields?

Answer: Toscano’s harm is that he quit his job at Fields in reliance on Greene’s promise of employment, soon revoked. Had the court recognized Toscano’s breach of contract claim it would have calculated his damages based on what he would have earned at Greene. It didn’t recognize his breach of contract claim and the court’s focus instead is on what Toscano would have continued to earn at Fields’, had Greene’s promise not induced him to quit.

Question: Why does the court rule that the damage award is too speculative?

Answer: Because the trial court relied on expert testimony that assumed Toscano would have stayed at Fields until he retired in 2017—16 years after Greene’s 2001 promise. Toscano’s employment at Fields’ would have continued to be at-will, though, and Fields could have terminated it at any time. The trial court erred in assuming Toscano could expect to remain at Fields until 2017.

Public Policy

Question: Is it fair to permit Greene to escape all liability? What is the purpose of the remand? What might Toscano demonstrate on remand? What practical difficulties will he encounter?

Answer: Although it seems unfair to permit Greene potentially to avoid all liability, the court’s holding merely demonstrates the precarious position of all employees-at-will. Neither at Field’s nor at Greene’s did Toscano have job security. However, the court is giving Toscano the chance, on remand, to prove that his employment at Fields was in fact secure, and that he could have—and would have—stayed there either to retirement or until something more lucrative turned up. The best evidence for Toscano would be the testimony of Fields’s owner, but that may be difficult to obtain, given the fact that Toscano quit.

Restitution Interest

The restitution interest is designed to return to the injured party a benefit that he has conferred on the other party, which it would be unjust to leave with that person. Restitution is a common remedy in contracts involving fraud, misrepresentation, mistake, and duress. In these cases, restitution often goes hand-in-hand with rescission, which means to “undo” a contract and put the parties where they were before they made the agreement.

Additional Case: Putnam Construction & Realty Co. v. Byrd^{^[8]}

Facts: Putnam Construction owned the University Square Business Center (USBC), an office complex with several major tenants. William Byrd and some partners (the "buyers") agreed to pay slightly over $17 million for USBC. They financed the purchase with a $16.2 million loan from Northwestern Mutual Life, which was secured with a mortgage on the property. Shortly after the sale closed, Byrd learned that several of the major tenants were leaving. The buyers sued Putnam. The trial court rescinded the contract and ordered the sellers to assume liability for the mortgage. The trial court did not, however, order restitution of the buyers' expenses, such as the closing costs. The sellers appealed.

Issue: Were the buyers entitled to rescission and/or restitution?

Holding: The court affirmed rescission of the contract, but also awarded over $1 million, representing closing costs, interest, and nonrefundable fees. The sellers knew that major tenants were planning to leave but repeatedly assured the buyers that all tenants were staying. Compensatory damages are not adequate because the property is operating at an increasing loss. Rescission is appropriate. In addition, the buyers are entitled to their expenses in completing the deal.

Excerpts from Justice Steagall’s Decision:

With the departure of its major tenants, the USBC does not have the profit potential the buyers bargained for and is, in fact, a liability to them. While the buyers could receive money damages to approximate the value of the lost leases, such an award would be speculative at best and would not abrogate the fact that the buyers now have a property that operates at an increasing loss. The equitable remedy of rescission, while difficult to execute, would more completely provide the buyers with the compensation they seek. The jury was, therefore, correct in determining that rescission is the proper remedy to be applied in this case.

We agree with the trial court that a reconveyance of USBC to the sellers, subject to the mortgage, “constitutes the most equitable result which can be achieved.” Accordingly, we affirm those portions of the court’s order relating to the reconveyance of USBC subject to the mortgage. We must also recognize, however, that the buyers incurred other substantial out-of-pocket costs to finance a transaction that was born out of the sellers’ fraud. After carefully considering the evidence in this case, we conclude that repayment of the following costs is necessary to more equitably restore the buyers to the position they occupied before the sale: $483,006.75 in closing costs on the purchase of USBC; $121,000 in interest payments they paid to the sellers on the $1.5 million note; and the $500,000 in nonrefundable fees the buyers paid to Northwestern to obtain the loan. We remand this case for the trial court to enter a judgment ordering repayment of these costs.

Question: What is the difference between rescission and restitution?

Answer: Rescission means "undoing" a contract–that is, discharging the parties' obligations and returning them to the position they were in before they made the agreement. Restitution means returning to the injured party a benefit that he has conferred on the other party. Courts often used the two remedies together.

Question: Were the plaintiffs in this case entitled to rescission, restitution, or neither?

Answer: The plaintiffs obtained both remedies. They were entitled to rescind the contract, meaning they conveyed the property back to the sellers, who had to assume liability for the mortgage. The court also ordered the sellers to pay over $2.5 million to the buyers for various expenses associated with the sale.

Question: What’s the best way to characterize Putnam’s failure to tell Byrd that major tenants were leaving the property?

Answer: Fraud.

Question: How does that relate to the court’s decision to award restitution to Byrd?

Answer: Restitution is an appropriate remedy when the injured party has conferred a benefit on the other party and it would be inappropriate for the other party to keep it.

Question: Byrd didn’t pay these closing costs to Putnam, so how were they a benefit to Putnam?

Answer: They were not paid to Putnam, but Byrd incurred them as a result of Putnam’s fraud. This is not a straightforward breach of contract in which the injured party assumed the risk of the other’s nonperformance. Putnam induced Byrd to incur these expenses to close a sale based on fraud that benefited Putnam.

Question: Let’s assume that the officer from Putnam in charge of negotiating the sale of USBC was required by her boss to tell Byrd that all tenants would be staying. Isn’t it a matter of ethics whether she disobeys her boss or plays along with the ruse?

Answer: Unlike most of the ethical questions in the book, this one does not seem to have two answers. It is unethical to lie to the buyers about the tenants' intentions; it also happens to be fraud that subjected the company to a large damage award. A result such as this harms a number of stakeholders within the company itself, such as shareholders and employees. It is difficult to imagine a valid system of ethics in which committing fraud is one accepted alternative.

Other Remedies

In contract lawsuits, plaintiffs are occasionally awarded the remedies of specific performance, injunction, and reformation. A court will award specific performance, ordering the parties to perform the contract, only in cases involving the sale of land or some other asset that is considered “unique.”

Case: Milicic v Basketball Marketing Company, Inc.^{^[9]}

Facts: The Basketball Marketing Company (BMC) markets, distributes, and sells basketball apparel and related products. BMC signed a long term endorsement contract with a 16-year-old Serbian player, Darko Milicic, who was virtually unknown in the United States until, two years later, he was the second pick in the NBA draft and became immensely marketable. Four days after his 18th birthday, Milicic made a buy-out offer to BMC, seeking release from his contract so that he could arrange a more lucrative one elsewhere. BMC refused and Milicic then disaffirmed the contract, returning all money and goods he had received from BMC. Believing that Milicic was negotiating an endorsement deal with either Reebok or Adidas, BMC sent both companies letters informing them it had an enforceable endorsement deal with Milicic that was valid for several more years. After receiving this letter Adidas stopped negotiating with Milicic just short of signing a contract. Milicic sued BMC, seeking a preliminary injunction that would prohibit BMC from sending such letters to competitors. The trial court granted the preliminary injunction and BMC appealed.

Issue: Was Milicic entitled to a preliminary injunction?

Holding: Judgment for Milicic affirmed. Excerpts from the court’s opinion:

Milicic met the four essential prerequisites necessary for injunctive relief. 1. Likelihood of success on the merits: Pennsylvania law recognizes, except as to necessities, the contract of a minor is voidable if the minor disaffirms it at any reasonable time after the minor attains majority. Milicic stated his unequivocal revocation and voidance of the agreement within a reasonable time after reaching the age of majority. 2. Irreparable harm: Top N.B.A. draft picks generally solicit, negotiate and secure endorsement contracts within a short time after the draft to take advantage of the publicity, excitement, and attendant marketability associated with the promotion. BMC blocked these efforts by Milicic. These business opportunity and market advantage losses may aptly be characterized as irreparable injury for purposes of equitable relief. 3. Denying the injunction would cause greater injury: BMC’s refusal to acknowledge Milicic’s ability to disaffirm is at odds with public policy. Because infants are not competent to contract, the ability to disaffirm protects them from their own immaturity and lack of discretion. Under Pennsylvania law BMC should have had a guardian appointed for Milicic to oversee his affairs. 4. The injunction restored the parties to the status quo.

Question: How did this dispute arise?

Answer: Milicic disaffirmed his contract with BMC shortly after his 18^th birthday.

Question: On what basis did he disaffirm?

Answer: He entered into the contract as a minor, at the age of 16.

Question: Did he fail to disaffirm properly?

Answer: No. Milicic disaffirmed in writing shortly after his 18^th birthday and returned to BMC all money and goods it had given him.

Question: Then why didn’t BMC honor his disaffirmance?

Answer: Good question. It did not appear to have any legitimate grounds for doing so, and the court said BMC’s stance was “at odds with public policy.”

Question: In this part of its opinion does the court really refer to Milicic as an “infant?” Why?

Answer: Yes. It is using that term to describe anyone under the age of 18, although “minor” would convey the same meaning.

Question: What test does the court apply to evaluate the preliminary injunction?

Answer: Milicic had to prove four things to obtain the preliminary injunction:

Likelihood of success on the merits (i.e., that his legal claim is strong enough to win at trial),
Injunctive relief was necessary to prevent immediate and irreparable harm that could not be adequately compensated by awarding monetary damages,
Greater injury would have occurred from denying the injunction than from granting the injunction, and
The preliminary injunction restored the parties to the status quo that existed prior to the wrongful conduct

Question: Did Milicic prove each of these things?

Answer: Yes.

Drafting Exercise: Injunctions

If you chose to assign to students the injunction drafting exercise described above, this is a good place to discuss it. The injunction might simply say:

Defendant Francis Bacon is hereby ordered to immediately cease and desist from keeping or maintaining on his premises at 123 Main Street, City, any pigs, goats, ostriches, or any other livestock or animals that are prohibited by any zoning regulation or any other law, rule, or regulation of this State or any political subdivision.

Discussion Problem: Employment Injunctions

This hypothetical is based on a real case. Bob Bluebonnet is a television news anchor. He has three years remaining on his four-year contract with station WIMP. The contract contains two clauses:

WIMP will pay Bluebonnet $125,000 per year to work as a news anchor.
WIMP will assign Bluebonnet to anchor the 6:00 and 11:00 P.M. local news broadcasts.

After Bluebonnet has worked at WIMP for a year, the station decides that the “chemistry” is bad between Bluebonnet and his co-anchor, Samantha Margarine. It demotes Bob to the less prestigious 12:00 noon and 5:00 p.m. broadcasts, while continuing to pay him his full salary. Bob refuses these broadcasts. WIMP continues to pay Bluebonnet his full salary.

Bluebonnet files suit, seeking an injunction that would force WIMP to reinstate him as the co-anchor on the 6:00 p.m. and 11:00 p.m. broadcasts.

Question: Make an argument that a court should grant Bluebonnet’s injunction.

Answer: The contract is crystal clear: WIMP is legally obligated not only to pay him, but to give him the two most prestigious broadcast slots as well. His career will suffer greatly if he is shunted off to less important broadcasts.

Question: Make an argument that a court should deny Bob’s injunction.

Answer: Historically, courts never force a worker on a given employer. Judges assume that forcing people to work together, such as Bob and Samantha, will create constant fighting and be bad for all concerned. The court does have the power to force WIMP to pay Bob his full salary, but the station is already doing that.

The Winner? WIMP. In the real case, in Connecticut, the court denied the injunction, for the reason given above. The court also noted that clause #2 is common in the television industry, and traditionally does not mean that the employee is entitled to a specific broadcast, but rather that the station may not force the employee to accept a different broadcast. Here, the station had asked Bob to work the other broadcasts, but was paying him even though he was not working.

Special Issues

Mitigation of Damages

A party injured by a breach of contract may not recover for damages that he could have avoided with reasonable efforts.

Liquidated Damages

It can be difficult or even impossible to prove how much damage the injured party has suffered. So lawyers and executives negotiating a deal may include in the contract a liquidated damages clause, a provision stating in advance how much a party must pay if it breaches.

Chapter Overview

Chapter Theme

You have been studying the theory of contract law. This chapter is different – its purpose is to demonstrate how that theory operates in practice. We will look at the structure and content of a standard agreement and answer questions such as: Do you need a written agreement? What does all these legal terms mean? Are any important provisions missing? By the end of the chapter, you will have a roadmap for understanding a written contract.[1](Note that we do not repeat here what you have learned in prior chapters about the substantive law of contracts.) This chapter has another goal, too: We will look at the relationship between lawyers and their clients and their different roles in creating a contract.

Do You Need a Written Contract?

Some cases work out well without a written contract, but there are times when you should definitely have a signed written agreement. You should have a signed written agreement when: (1) The Statute of Frauds requires it, (2) The deal is crucial to your life or the life of your business, (3) The terms are complex, or (4) You do not have an ongoing relationship with the other party.

The Lawyer

Businesspeople often expect deals to go well. Lawyers are trained to be pessimists. Their primary goal is to protect their clients by avoiding litigation, now and in the future.

Lawyers also prefer to negotiate touchy subjects at the beginning of a relationship when everyone is on friendly terms and eager to make a deal, rather than waiting until trouble strikes.

The Contract

How to Read a Contract

Reading a contract should be a focused, multi-step process, asking yourself “what-if” questions and determining the answers to those questions.

Mistakes

There are many common mistakes.

Vagueness

Businesspeople sometimes deliberately choose vagueness. They do not want the terms of the contract to be clear. It may be that they are not sure what they can get from the other side, or in some cases, even what they really want. So they try to form a contract that leaves their options open. However, as the following case illustrates: Vagueness is your enemy.

Case: Quake Construction v. American Airlines.[2]

Facts: Jones Brothers Construction was the general contractor on a job to expand American Airlines facilities at O'Hare International Airport. Jones Brothers invited Quake Construction to bid on the employee facilities and automotive maintenance shop ("the project”). After Quake bid, Jones Brothers orally informed Quake that it was awarding Quake the project and would soon forward a contract. Jones Brothers wanted the license numbers of the subcontractors that Quake would be using, but Quake could not furnish those numbers until it had assured its subcontractors that they had the job. Quake did not want to give that assurance until it was certain of its own work. So Jones Brothers sent a letter of intent that stated, among other things:

We have elected to award the contract for the subject project to your firm as we discussed on April 15. A contract agreement outlining the detailed terms and conditions is being prepared and will be available for your signature shortly.

Your scope of work includes the complete installation of expanded lunchroom, restaurant and locker facilities for American Airlines employees as well as an expansion of American Airlines existing Automotive Maintenance Shop. A sixty (60) calendar day period shall be allowed for the construction of the locker room, lunchroom and restaurant area beginning the week of April 22. The entire project shall be completed by August 15.

Subject to negotiated modifications for exterior hollow metal doors and interior ceramic floor tile material as discussed, this notice of award authorizes the work set forth in the [attached] documents at a lump sum price of $1,060,568.00

Jones Brothers Construction Corporation reserves the right to cancel this letter of intent if the parties cannot agree on a fully executed subcontract agreement.

The parties never signed a more detailed written contract, and ultimately Jones Brothers hired another company. Quake sued, seeking to recover the money it spent in preparation and its loss of anticipated profit.

Issue: Was the letter of intent a valid contract?

Excerpts from Justice Calvo’s Decision: [A]lthough letters of intent may be enforceable, such letters are not necessarily enforceable unless the parties intend them to be.

In determining whether the parties intended to reduce their agreement to writing, the following factors may be considered: whether the type of agreement involved is one usually put into writing, whether the agreement contains many or few details, whether the agreement involves a large or small amount of money, whether the agreement requires a formal writing for the full expression of the covenants, and whether the negotiations indicated that a formal written document was contemplated at the completion of the negotiations.

[We conclude that] the letter was ambiguous. The letter of intent included detailed terms of the parties’ agreement. The letter stated that Jones awarded the contract for the project to Quake. The letter stated further "this notice of award authorizes the work." Moreover the letter indicated that the work was to commence approximately 4 to 11 days after the letter was written. This short period of time reveals the parties intent to be bound by the letter so that work could begin on schedule. We also agree that the cancellation clause exhibited the parties’ intent to be bound by the letter because no need would exist to provide for the cancellation of the letter unless the letter had some binding effect. The cancellation clause also implies the parties’ intention to be bound by the letter at least until they entered into the formal contract. These factors evinced the parties’ intent to be bound by the letter.

On the other hand, the letter referred several times to the execution of a formal contract by the parties, thus indicating the parties’ intent not to be bound by the letter. The cancellation clause could be interpreted to mean that the parties did not intend to be bound until they entered into a formal agreement.

Thus, we hold that the letter of intent in the case at bar is ambiguous regarding the parties’ intent to be bound by it. Therefore, on remand, the circuit court shall allow the parties to present parol evidence regarding their intent. The trier of fact must then determine, based on the parties’ intent, whether the letter of intent is a binding contract.

NOTE: The court stated that letters of intent are enforceable only if the parties intend them to be. In determining the intent of the parties, the following factors are important: is this type of agreement usually put into writing, how detailed the letter is, how much money is involved, whether the letter indicates that the parties intended a more formal agreement would follow.

Because the letter of intent in this case was so ambiguous, the appellate court remanded to the trial court to determine the intent of the parties when they signed the document.

Question: Can letters of intent be binding?

Answer: Yes, if the parties intend so.

Question: What is another type of incomplete bargaining?

Answer: An agreement to agree – where the parties have reached agreement on a number of matters, but have left one or more terms for the future.

Ambiguity

Ambiguity occurs in contracts when the parties think only about what they want a provision to mean, without considering the literal meaning or the other side’s perspective.

Any ambiguity is interpreted against the drafter of the contract.

Case: Cipriano v. Patrons Mutual Insurance Company of Connecticut[3]

Facts: Juacikino Cipriano purchased an insurance policy on his house from Patrons Mutual Insurance Company. The policy stated that the company would not pay for any damage to the residence caused by vandalism or burglary if the residence was vacant for more than 30 days in a row just before the loss. Furthermore, the company would not pay for damage to personal property caused by fire, lightening or vandalism.

After Cipriano’s house had been vacant for more than 30 days, an arsonist burned it down. Patrons denied his claim on the grounds that arson is vandalism, which his policy did not cover. Cipriano filed suit against Patrons. The insurance company filed a motion for summary judgment.

Issue: Is arson a type of vandalism?

Excerpts from Judge Devine’s Decision: [T]here are no genuine issues of fact that the fire was the result of arson and that the dwelling house was vacant for more than 30 days prior to the fire. The defendant contends that the term "vandalism" includes the act of arson. The plaintiff argues that, in reviewing the insurance policy as a whole, an insured may not be able to discern what "vandalism" means, as that term is used in the separate sections of the insurance policy.

Under our law, the terms of an insurance policy are to be construed according to the general rules of contract construction. It is a basic principle of insurance law that policy language will be construed as laymen would understand it and not according to the interpretation of sophisticated underwriters, and that ambiguities in contract documents are resolved against the party responsible for its drafting; the policyholder's expectations should be protected, as long as they are objectively reasonable from the layman's point of view. However, a court will not torture words to import ambiguity where the ordinary meaning leaves no room for ambiguity, and words do not become ambiguous simply because lawyers or laymen contend for different meanings.

In the present case, the defendant has drafted an insurance policy where "vandalism" and "fire" are undefined terms. Reading the insurance policy as whole, the terms "vandalism" and "fire" are found to be included as separate perils covered under the personal property coverage. In the exclusionary provision for the coverage of the residence, "vandalism" is listed as an excluded loss. "Fire" is not mentioned.

Because the terms "vandalism" and "fire" are undefined, and are listed as two distinct perils, it is ambiguous as to which peril, "vandalism" or "fire," covers arson. Therefore, "vandalism," is susceptible of two reasonable interpretations. As such, the insurance policy must be construed against the party responsible for its drafting.

ORDER: The defendant's motion for summary judgment is hereby denied.

Question: What is a preventive measure in negotiating and drafting contracts?

Answer: Records should be kept concerning the parties negotiations and the parties’ communications before, during, and after the contract signing.

Typos

What is the law of typos? First of all, the law has a fancier word than typo – it is scrivener’s error. A scrivener is a clerk who copies documents. In the case of a scrivener’s error, a court will reform a contract if there is clear and convincing evidence that the mistake does not reflect the true intent of the parties.

You Be the Judge: Heritage Technologies v. Phibro Tech[4]

Facts: Heritage wanted to buy a substance called TBCC from Phibro but, because of uncertainty in the industry, the two companies could not agree on a price for future years. It turned out, though, that the price of TBCC tended to rise and fall with that of copper sulfate, so Heritage proposed that the amount it paid for TBCC would increase an additional $15 per ton for each $0.01 increase in the cost of copper sulfate over $0.38 per pound.

Two top officers of Heritage and Phibro met in the Delta Crown Room at LaGuardia Airport to negotiate the purchase contract. At the end of their meeting, the Phibro officer hand wrote a document stating the terms of their deal and agreeing to the Heritage pricing proposal.

Negotiations between the two companies continued, leading to some changes and additions to their Crown Room agreement. In a draft prepared by Phibro, the $.01 number was changed to $0.1, that is, from 1¢ to 10¢. In other words, in the original draft, Heritage agreed to a first increase if copper sulfate went above 39¢ per pound, an additional price rise at 40¢, and so on. But in the Phibro draft, Heritage’s first increase would not occur until the price of copper sulfate went to 48¢ a pound, with a second rise at 58¢. In short, the Phibro draft was much more favorable to Heritage than the Heritage proposal had been.

At some point during the negotiations, the lawyer for Heritage asked his client if the $ 0.1 figure was accurate. The Heritage officer said that the increase in this amount was meant to be payment for other provisions that favored Phibro. There is no evidence that this statement was true. The contract went through eight drafts and numerous changes but, after the Crown Room meeting, the two sides never again discussed the $0.1 figure.

After the execution of the agreement, Heritage discovered a different mistake. When Heritage brought the error to Phibro’s attention, Phibro agreed to make the change even though it was to Phibro's disadvantage to do so.

All was peaceful until the price of copper sulfate went to $ 0.478 per pound. Phibro believed that, because the price was above $.38 per pound, it was entitled to an increased payment. Heritage responded that the increase would not occur until the price went above $.48. Phibro then looked at the agreement and for the first time noticed the $ 0.1 term. Phibro contacted Heritage to say that the $ 0.1 term was a typo and not what the two parties had originally agreed in the Delta Crown Room. Heritage refused to amend the agreement and Phibro filed suit.

You Be the Judge: Should the court enforce the contract as written or as the parties agreed in their Crown Room meeting? Which number is correct -- $.10 or $.01?

Argument for Phibro: In the Delta Crown Room, the two negotiators agreed to a $15 per ton increase in the price of TBCC for each 1¢ increase in copper sulfate price. Then by mistake, the contract said 10¢. The two parties never negotiated the 10¢ provision and there is no evidence that they had agreed to it. The court should revise this contract to be consistent with the parties’ agreement, which was 1¢.

Also, the 10¢ figure makes no economic sense. The point of the provision was that TBCC went up at the same rate as copper sulfate. One cent for each ton is a much more accurate reflection of the relationship between these two commodities than 10¢ per ton.

Argument for Heritage: The Delta Crown Room agreement was nothing more than a draft. The contract went through eight rounds of changes. The change in price was in return for other provisions that benefited Phibro. The parties conducted negotiations by sending drafts back and forth, rather than by talking on the phone. Both parties were represented by a team of lawyers, the agreement went through eight drafts and this pricing term was never altered despite several other changes and additions. There is no clear and convincing evidence that both parties were mistaken about what the document actually said. Ultimately the parties agreed to 10¢ and that is what the court should enforce.

Ethics: When Heritage found a different mistake in the contract, Phibro agreed to correct it, even though the correction was unfavorable to Phibro. But when a mistake was found in Heritage’s favor, Heritage refused to correct it. Is Heritage behaving ethically? Does Heritage have an obligation to treat Phibro as well as Phibro behaved towards Heritage? Is it right to take advantage of other people’s mistakes? What principles would you apply in this situation?

Holding: The Court finds in favor of the plaintiff, Heritage Technolgies, L.L.C. The court declares that the term means a dime, $0.10.

Question: What does this case teach us?

Answer: To carefully draft and proof-read documents!

Preventing Mistakes

Before signing a contract, check carefully and thoughtfully the names of the parties, the dates, dollar amounts and interest rates.

Suggested rules for a sensible client:

Complain if your lawyer gives you a contract with provisions that are irrelevant to your situation.
If you do not know what a provision means, ask.
Remember that a contract is also a reference document. During the course of your relationship with the other party, you may need to refer to the contract regularly.

The Structure of a Contract

Title

Contracts have a title, which generally is in capital letters, underlined and centered at the top of the page, and should be as descriptive as possible.

Introductory Paragraph

The introductory paragraph includes the date, the names of the parties and the nature of the contract and should also include specific language indicating that the parties entered into an agreement. Traditional contracts tended to use archaic words– whereas and heretofore were common. Modern contracts are more straightforward, without so many linguistic flourishes.

Definitions

Most contracts have some definitions. Usually, the names of the parties are defined [eg, “Joe Jones (Seller)”] in the introductory paragraph. Other definitions are included in a separate section or they can appear throughout the contract.

Covenants

Now we get to the heart of the contract: What are the parties agreeing to do? Failure to perform these obligations constitutes a breach of the contract and damages will result. A legal term for a promise in a contract is covenant. To clarify who exactly is doing what, covenants in a contract should use the active, not passive voice. For important issues where disputes are likely to arise, the language should be precise, detailed and complete.

Breach

To constitute a violation of the contract, the breach must be material. A material breach is important enough to defeat an essential purpose of the contract.

Many of the covenants in a contract provide that the right must be exercised reasonably or theta decision must be made in good faith. Reasonable means ordinary or usual under the circumstances. Good faith means an honest effort to meet both the spirit and letter of the contract. A party with sole discretion has the absolute right to make any decision he wants on that issue.

Case: LeMond Cycling, Inc. v. PTI Holding, Inc. [5]

Facts: American Greg LeMond won the Tour de France, cycling’s most prestigious race. Sports Illustrated named him one of the forty most influential people in sports during the prior forty years. He formed LeMond Cycling, Inc. (LCI) to handle his business dealings. Protective Technologies International, Inc. (PTI) sold cycling accessories under brand names like Barbie, Playskool and Tonka to retailers such as Target, Walmart, K-Mart and Toys R Us.

LeMond and PTI signed a contract (the Deal Memo) providing that PTI would use LeMond’s name to sell bicycle accessories. In return, PTI would pay LCI $500,000 a year plus a six percent royalty on annual sales exceeding $8.33 million. The Deal Memo required PTI to

use commercially reasonable efforts to produce and market LeMond bicycle accessories
keep LCI apprised of PTI's efforts, including information about marketing and media plans

PTI tried to sell LeMond products to Target, Walmart and Toys R Us. Only Target was interested and then only in a minor way. It agreed to allocate just six feet of shelf space to LeMond products. It also rejected PTI's proposal to install a video kiosk that featured LeMond. PTI did not tell LCI about this deal.

LeMond accessories sold poorly at Target. PTI itself did not do any promotional activities or advertising for the products beyond the initial video for the kiosk that Target rejected. PTI argued that it was Target’s role to advertise them.

Because of poor sales, Target reduced the amount of shelf space for LeMond items to just four feet. Ultimately, Target discontinued these products altogether. In neither instance did PTI inform LCI. PTI did try to sell LeMond accessories to Wal-Mart, Toys R Us and other stores, but there were no takers.

Shortly thereafter, PTI began to sell Schwinn bicycle accessories to the retailers that had rejected LeMond products. PTI earned over $30 million from Schwinn sales. The company then abandoned all effort to sell LeMond items.

LCI filed suit against PTI for breach of contract. In response, PTI filed a motion for summary judgment, seeking to have the suit dismissed.

Issue: Did PTI breach its contract with LCI?

Excerpts from Judge Magnuson’s Decision: To prevail on a breach of contract claim, LCI must prove that PTI breached a material term of the contract. A material breach goes to the root or essence of the contract, and is so fundamental to the contract that the failure to perform that obligation defeats an essential purpose of the contract. Even when express conditions of the contract are violated, the breach is not necessarily material.

LCI contends that PTI's alleged failure to provide LCI with annual marketing and media plans was material. LCI submits that these documents serve a critical purpose in licensing agreements, because they allow the licensor to monitor sales and corresponding royalty payments.

The Court disagrees. The fact that PTI failed to give reports or other documents to LeMond does not frustrate the essential purpose of the contract. Furthermore, there is no causal connection between PTI's failure to provide LCI with these reports and LCI's lost profit. Therefore, these terms of the Deal Memo, by themselves, are not material as a matter of law.

However, whether or not PTI used commercially reasonable efforts to produce [and] market the Product Line is a material term of the contract, as it is the primary purpose of the contract itself. Thus, the issue is whether PTI breached this duty.

The Deal Memo fails to define commercially reasonable. LCI is convinced that commercially reasonable requires an examination of customary practices within the licensing industry. LCI's broad argument that only industry standards are relevant to the commercial reasonableness determination is unpersuasive. Although an objective component is instructive as to whether or not PTI acted with commercial reasonableness, there must be a subjective evaluation as well. No business would agree to perform to its detriment, and therefore whether or not PTI performed with commercial reasonableness also depends on the financial resources, business expertise, and practices of PTI.

The Complaint also alleges that PTI breached its implied covenant of good faith and fair dealing with LCI. Good faith requires a party to act honestly. Bad faith exists when a party's refusal to fulfill its obligations is based on an ulterior motive. LCI submits that PTI abandoned LCI and its obligations under the Deal Memo when it engaged in its relationship with Schwinn. Indeed, LCI has submitted evidence that PTI narrowly focused on its Schwinn obligations, despite its continuing obligation to LCI under the Deal Memo. There is a dispute of fact as to whether PTI exercised good faith in its performance under the terms of the Deal Memo. Thus, PTI's Motion on this point is denied.

IT IS HEREBY ORDERED that:

Defendants' Motion for Summary Judgment is GRANTED in part and DENIED in part as set forth in this Order.

Question: The court denied what part of the motion?

Answer: Whether PTI exercised good faith in its performance of the contract.

Question: What action by PTI could be considered bad faith?

Answer: Entering into a relationship with Schwinn, a competitor of LCI.

Reciprocal Promises and Conditions. A contract may provide a list of what each party promises to do. In this format, each party is responsible for performance whether or not the other party breaches. These provisions are reciprocal promises, which means that they are each enforceable independently.

The better approach is for the covenants to be conditional – a party agrees to perform them only if the other side has first done what it promised.

Representations and Warranties

Covenants are the promises the parties make about what they will do in the future. Representations and warranties are statements of fact about the past or present– they are true when the contract is signed (or at some other specific, designated time)[6].

Exam Strategy

Question: Producer does not want Artist to pilot an airplane during the term of the contract. Would that provision be a warranty and representation or a covenant? How would you phrase it?

Strategy: Warranties and representations are about events in the past or present. A covenant is a promise for the future. If, for example, Producer wanted to know that Artist had never used drugs in the past, that provision would be a warranty and representation.

Result: A promise not to pilot an airplane is a covenant. The contract could say, “Until Artist completes all services required hereunder, he shall not pilot an airplane.”

Boilerplate

These standard previsions are typically placed in a section entitled Miscellaneous; they play an important protective role. In essence, boilerplate creates a private law that governs disputes between the parties.

Choice of Law and Forum. Choice of law provisions determine which state’s laws will be used to interpret the contract. Choice of forum determines the state in which any litigation would take place. (One state’s courts can apply another state’s laws.)

Modification. Contracts should contain a provision governing modification.

If a contract has a provision requiring that amendments be in writing, there are three ways to amend it:

Signing an amendment (or rider)
Crossing out by hand the wrong language and replacing it with the correct terms. It is good practice for both parties to initial each change. This method is typically used before the document is signed, say, at the closing if the parties notice a mistake.
Rewriting the entire contract to include the changed provisions. In this case, the contract is typically renamed: The Amended and Restated Agreement. This method is most appropriate if there are many, complex alterations.

Assignment of Rights and Delegation of Duties. An assignment of rights is a transfer of your benefits under a contract to another person, while delegation of duties is a transfer of your obligations.

Arbitration. Some contracts prohibit the parties from suing in court, and require that disputes be settled by an arbitrator. Arbitration has its advantages – flexibility and savings in time and money. It also has downsides.

Attorney’s fees. As a general rule, parties to a contract must pay their own legal fees, no matter who is in the wrong. But contracts may override this general rule and provide that the losing party in a dispute pays the attorney’s fees for both sides.

Integration. During contract negotiations, the parties may discuss many ideas that are not ultimately included in the final version. The point of an integration clause is to prevent either side from later claiming that the two parties had agreed to additional provisions.

Exam Strategy

Question: Daniel and Annie signed a contract providing that Annie would sell craft beers to Daniel’s grocery stores at a price of $20 per case. During negotiations, Daniel and Annie agreed that the price would go up to $22 per case once he had bought 1,000 cases. This provision never made it into the contract. After the contract had been signed, Daniel agreed to a price of $23 per case once volume exceeded 1,000 cases. The contract had an integration provision but no modification clause. What price must Daniel pay for cases in excess of 1,000?

Strategy: If a contract has an integration provision, then side agreements made during negotiations are unenforceable unless included in the written contract. Without a modification provision, oral agreements made after the contract was signed may be enforceable.

Result: A court would not enforce the side agreement that required Daniel to pay $22 a case. It is possible that a court would enforce the $23 agreement – which leaves Daniel with a choice of paying $23 a case or the cost of having his lawyer defend a lawsuit.

Severability. If, for whatever reason, some part of the contract turns out to be unenforceable, a severability provision asks the court simply to delete the offending clause and enforce the rest of the contract.

Force Majeure. A force majeure event is a disruptive, unexpected occurrence for which neither party is to blame that prevents one or both parties from complying with the contract. Force majeure events typically include war, terrorist attack, fire, flood or general Act of God.

Additional Note: Force Majeure Clauses

You are an executive vice-president of StikM, a company that manufactures various adhesive products and sells them to manufacturers and retailers. Your company uses large quantities of Apocryphonium, an essential chemical that is manufactured by only one corporation, ToxIck. You are negotiating with ToxIck for a three-year requirements contract for Apocryphonium.

Question: First, a refresher: what is a requirements contract?

Answer: In a requirements contract, the buyer (StikM) agrees to purchase 100 percent of its needs for a particular product from the seller (ToxIck). The seller agrees to supply whatever the buyer reasonably needs.

You are able to agree with ToxIck on most of the important contract terms, including the quantities that you expect to require, the price ToxIck will charge, and delivery times. Then ToxIck requests a force majeure clause, excusing the company from performing its contract obligations in the event of “acts of God, fire, labor disputes, accidents, or transportation difficulties.”

Question: What problems might this force majeure clause cause you?

Answer: Its language is quite broad. Although such open-ended clauses are very common, you may desire greater specificity. Exactly what are the “acts of God”—hurricanes? tornados? floods? blizzards? What types of labor disputes would it cover—strikes? work stoppages? picketing? What kinds of accidents excuse performance? What transportation “difficulties” does it cover—fuel shortages? increases in fuel costs?

None of these is a rare event—which means agreeing to a force majeure clause can expose one to non-performance that the other party claims is justified. Such clauses are commonly found in “boilerplate” language, however, and it will often be difficult to reach agreement on a contract without one.

Question: What steps can one take to protect against nonperformance based on force majeure?

Answer: Attempt to pass through the risk in contracts with your own buyers with a clause that discharges your obligations if you are unable to obtain necessary materials, such as Apocryphonium. You can also purchase insurance to cover any losses caused by ToxIck’s failure to deliver Apocryphonium. Resolution of these issues is ultimately a business decision.

Notices. After a contract is signed, there may be times when the parties want to send each other official notices – of a breach, an objection, or an approval, for example. In this section, the parties list the addresses where these notices can be sent.

Closing. To indicate that the parties have agreed to the terms of the contract, they must sign it. A simple signature is sufficient, but contracts often contain flourishes.

When a party to the contract is a corporation, the signature lines should read like this:

Company Name, Inc.

By:______________________

Name:

Title:

[1] For further reading on practical contracts, see Scott Burnham, Drafting and Analyzing Contracts, LexisNexis; Charles M. Fox, Working with Contracts, Practical Law Institute; George W. Kuney, The Elements of Contract Drafting, Thomson/West.

[2] 141 Ill. 2d 281, 565 N.E.2d 990, 1990 lll. LEXIS 151 Supreme Court of Illinois, 1990

[3] 2005 Conn. Super. LEXIS 3577 SUPERIOR COURT OF CONNECTICUT

[4] 2008 U.S. Dist. LEXIS 329 United States District Court for the Southern District of Indiana

[5] 2005 U.S. Dist. LEXIS 742 US DISTRICT COURT FOR THE DISTRICT OF MINNESOTA

[6] Although, technically, there is a slight difference between a representation and a warranty, many lawyers confuse the two terms and the distinction is not important. We will treat them as synonyms, as many lawyers do.