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CONTRACTS

Chapter 10

Meiners, Ringleb and Edwards The Legal Environment of Business, 13th Edition

THE ROLE OF CONTRACT LAW

∗ Provides a legal mechanism to deal with others

∗ Law of contracts has evolved in commerce over the centuries.

∗ Freedom of contract means responsibilities to those who agree to create binding relationships.

CONTRACT LAW

∗ Common Law ∗ Judge-made law ∗ Each state differs some ∗ There is uniformity about general

contract principles that run through state laws

∗ Years ago, English courts drew guidance from lex mercatoria (the law merchant).

∗ It originated in Roman law of contracts covering the Roman Empire and was comprehensive.

∗ UCC:

∗ Uniform Commercial Code. Article 2. (next chapter)

∗ All States have adopted except Louisiana

∗ Covers contracts for sale of goods

∗ Many countries rely on Code Law only for their basic legal framework.

DEFINITION OF A CONTRACT

n Sir Wm. Blackstone: “An agreement, upon sufficient consideration, to do or not to do a particular thing.”

n Modern definition centers on a promise: “A promise or set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes a duty.”

n The promise itself creates a manifestation of intent—a willingness to be bound.

n Contracts form legal relationships and duties between parties.

n Not all promises are enforceable contracts – must meet requirements of a contract to be an enforceable promise.

Types of Contracts

Express Contracts

Direct statement by the parties of the promises made

May be oral or written

Key terms expressly agreed upon by the parties.

Implied Contracts

Actions and circumstances infer and define the terms of the contract.

May be words, conduct, gestures

Contracts are implied at law.

Ex: At a check out counter at a grocery store, actions of the parties create offers/acceptances.

ELEMENTS OF A CONTRACT 1. An Agreement, through

 Offer and Acceptance

2. Consideration

3. Contractual Capacity

4. Legality

5. Genuine Consent

6. Writing  If necessary under Statute of Frauds

RULE: If all elements are present, the contract is generally termed valid.

Element #1: Agreement ∗ The Offer ∗ Creates the Offeror and Offeree ∗ 1. Manifestation of Intent

∗ Preliminary Negotiations vs. Intent to Offer ∗ Most advertisements are regarded as invitations for others to submit an offer to buy

∗ 2. Definite Terms & Conditions ∗ 3. Communication

∗ Person returns a dog but does not know of an award

Sometimes terms are presumed i.e. shipped computer is packed properly

Restatement (2nd) of Contracts: “The manifestation of willingness to enter into a bargain, so made as to justify another person in understanding that his assent to the bargain is invited and will conclude it.”

TERMINATING AN OFFER ∗ Revocation ∗ Withdrawing of offer by the Offeror

∗ Rejection ∗ By Offeree ∗ Through lapse of time (Option Contracts are different) ∗ Counteroffers are created by rejecting the original offer but

keeping negotiations open by presenting new conditions – a counteroffer.

∗ By Operation of Law ∗ Intervening Illegality ∗ Destruction of subject matter ∗ Death or insanity of offeror or offeree

ELEMENT #1: THE AGREEMENT

∗ The Acceptance – Expression of Assent

∗ 1. Unconditional ∗Must be a mirror image of the offer ∗If conditions are added, that creates a

counteroffer

∗ 2. Unequivocal

∗ 3. Properly Communicated

Pena v. Fox

• Pena and Fox were in an auto accident. Pena injured. • Pena’s attorney sent settlement offer to Fox’s insurer, USAA. • The offer was for payment of Fox’s policy limits to Pena. Exchange for her release of claims against Fox.

• Offer letter stated the release would apply to Fox only. USAA replied that payment would mean release of all claims against anyone related to the accident.

• Pena considered reply as a rejection of offer and sued Fox. • Fox requested trial court to enforce settlement agreement

offered by USAA. • Trial Court Held: Valid agreement precluded lawsuit by Pena. • She appealed.

Pena v. Fox continued

∗ Settlement agreements are governed by contract law. ∗ Formed when mutual assent and “meeting of the

minds.” ∗ Acceptance must be “mirror image” of offer in all

material respects. ∗ Otherwise it is a counteroffer that rejects the original

offer. ∗ USAA’s reply (for Fox) did not mirror Pena’s offer. It

changed who would release claims. ∗ No meeting of the minds and no settlement agreement

to bar Pena’s suit. ∗ REVERSE AND REMANDED. ∗ Case can go forward for further proceedings.

BILATERAL & UNILATERAL CONTRACTS

Bilateral Contracts

∗ 2 promises ∗ A promise in exchange for

a promise ∗ Ex: I promise to pay you

$250 to trim my trees; you promise to trim my trees.

∗ If promise is broken, there may be responsibility if losses are incurred.

Unilateral Contracts

∗ Only 1 promise ∗ A promise in exchange for a

performance ∗ Ex: I promise to pay you $250

to trim my trees; you say nothing but later trim them.

∗ Once performance has occurred, the other party’s duty arises to fulfill his/her promise.

ELEMENT #2: CONSIDERATION • Definition: Something of value or something

bargained for in exchange for a promise.

• This element keeps contract from being a gift.

• Traditional Rule: Must create – • Legal detriment to the promisee or • Legal benefit to the promisor • The legal detriment and benefit usually occur at

the same time.

ADEQUACY OF CONSIDERATION

∗ Courts generally do not care if not fair market value.

∗ If a party bargains poorly, courts usually will not interfere.

∗ Those who bargain take on the risk of their own errors.

∗ There are exceptions such as fraud, duress, etc.

∗ The main concern is an exchange of mutual promises and obligations by the parties.

Caley v. Gulfstream Aerospace Corp. • Gulfstream adopted a dispute resolution policy (DRP) to resolve all

disputes between Gulfstream and employees. • Mailed policy to employees. • Policy said DRP would begin in 2 weeks and would be “a condition of

continued employment.” If an employee continued work, the DRP was accepted as binding.

• Some employees sued, saying there was no contract because no consideration so the DRP could not be enforced.

• District Court held for Gulfstream. Employees appealed.

• HELD: Affirmed. • DRP is an offer and states it is a contract. • Acceptance is continued employment by employees. Acceptance can be

through a promise or an act. • Here the act of continuing employment = acceptance of the offer and a

contract. • Employees had a choice to 1) continue employment, accepting DRP or 2)

terminate employment (quit). • There is “bargained for consideration” by mutual promises and

obligations.

ENFORCEABLE PROMISES WITHOUT CONSIDERATION

∗ Promissory Estoppel or Detrimental Reliance

∗ Use of this equitable doctrine avoids injustice due to promisee‘s reasonable reliance on the promisor’s promise.

∗ Promisor is estopped (prevented) from denying a promise.

∗ “A promise which the promisor should reasonably expect to induce action or forbearance on the part of the promissee . . . and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.”

Restatement (2nd) of Contracts

∗ Courts do not impose the rule lightly.

∗ Sometimes used in promises to charities, especially if organizations rely on the promises to act in some way.

Hinson v. N&W Construction Company • N&W Construction prepared to submit a bid to Mississippi Job Corps Center

(MJCC) to build kitchen facility at training center. N&W received bids from plumbing subcontractors in preparing its bid to MJCC.

• Hinson quoted $92,000 as bid as plumbing sub; next lowest bid was $139,000. N&W used Hinson’s bid to prepare its bid.

• N&W was low bidder and awarded contract by MJCC. N&W contacted Hinson that it needed plumbing work to begin. Hinson refused to do the job.

• N&W then hired next lowest bidder; paid additional $47,000 to get work done. N&W sued Hinson based on promissory estoppel.

• Trial court granted summary judgment to N&W, awarding $47,000. Hinson appealed.

Ct. of Appeals Affirmed. Hinson admits he provided a quote. Testified

that he reviewed plans and specs for the building and was satisfied with his quote of $92,000.

Hinson refused to do the plumbing because “I just had a lot of other jobs going.”

Promissory estoppel arises when “making of a promise, even though without consideration . . .” that plaintiff (N&W) relied upon.

“Refusal to enforce it would be virtually to sanction the perpetuation of fraud or would result in other injustice.”

Hinson v. N&W Construction Company Continued

ELEMENT #3 CAPACITY

∗ Refers to the legal ability to create a contract

∗ Some have limited capacity to contract ∗ Minors ∗ Intoxicated persons ∗ Insane persons

∗ If there is no capacity, the contract is void

∗ If there is partial capacity, the contract is voidable – may disaffirm

Void and Voidable Contracts

VOID ∗ Contract does not exist at

law ∗ One of elements is

missing – lacks a requirement of a contract

∗ i.e. Contract for an illegal subject matter

∗ Courts won’t accept disputes

VOIDABLE Is valid but capable of being

voided by a circumstance

One party to the contract has right to avoid legal obligation

 i.e. Minors contracts

 i.e. Contracts with person under influence of drugs

 i.e. Fraud by one of the parties

MINORS

∗ Defined as a person under the legal age of majority

∗ Traditionally, the age of majority was 21

∗ Now it is 18 years old in all states for most contracts

∗ Minors have partial capacity

∗ Contracts are voidable

∗ Policy to protect the young from the “results of their own folly”

∗ General Rules ∗ #1: Minors may disaffirm contracts

at their option

∗ #2: If a minor disaffirms a contract after receiving benefits, restitution must be paid for the benefit

∗ Some contracts may not be disaffirmed, i.e. ∗ Enlistment contracts ∗ Marriage contracts ∗ Educational loans ∗ Insurance loans ∗ Medical care

∗ After reaching majority, the minor may ratify the contract

Element # 4: Legality

∗ If a contract is lacking legality, courts will not enforce

∗ Subject Matter Must Be Lawful ∗ Criminal activities; sale of prohibited drugs; gambling activities

in some states

∗ Interest rates on loans that violate usury laws

Court may strike entire bargain as unenforceable or only a part that concerns illegal subject matter

Unenforceable Contracts

∗ Contract is actually valid when made, but courts will not enforce it

∗ i.e. Unconscionable contracts

∗ i.e. Exculpatory agreements

∗ Subsequent Illegality: Ex: Company agrees to ship wheat to Iran. After shipment is at sea, U.S. government declares no U.S. firms may trade with Iran. Result: Unenforceable under U.S. law even if seen as legal in Iran

CONTRACT CONTRARY TO PUBLIC POLICY Exculpatory Agreements (types of those contracts written to

completely escape liability)

Unconscionable Agreements (unequal bargaining power)  Outcome is grossly unfair to an innocent party.

Contracts in Restraint of Trade  Contracts that restrain trade or unreasonably restrict competition

 Covenant not to compete may be restraint of trade unless Limited by time, territory and ancillary to the contract Different states differ on this subject

 Covenants not to compete often used in sale of business or employment contracts

ELEMENT #5 REALITY AND GENUINENESS OF CONSENT

∗ Concerns people entering into agreements of knowingly with free will. ∗ If real consent is missing, there is no meeting of the minds. ∗ If there is unilateral mistake over a simple error, the error can

be avoided. (typographical error - $100,000 instead of $10,000; the $100,000 not enforceable).

∗ Without this element, the contract is void or voidable. ∗ Examples: ∗ Fraud ∗ Misrepresentation ∗ Duress ∗ Undue influence

ELEMENT #6 CONTRACTS IN WRITING & THE STATUTE OF FRAUDS (1677)

Contracts do not always have to be in writing to be enforceable, however written contracts are always good evidence of the agreement in case of dispute.

Some contracts require a writing:  Sale of land or interests therein

 Contracts that cannot be performed within 1 year

 Promise to pay the debt of another, including debts of an estate

 Promises made in consideration of marriage

∗ Writing must set out the material terms of contract

∗ Names of parties ∗ Consideration ∗ Subject matter ∗ Invoices, E-mails, sales orders, checks,

confirmations may satisfy this requirement; need not be a formal contract

Sufficiency of Writing

 Restricts use of oral evidence when that evidence is contrary to terms of written contract.

 Oral evidence cannot contradict, change or add terms to written contracts.

 If a written contract is incomplete, ambiguous, or there is evidence of fraud, mistake, or misrepresentation, then oral evidence may explain the problems or agreement beyond what was written.

Parol Evidence Rule

Deschamps v. Treasure State Trailer Court • Rasmussen sold Deschamps a mobile home trailer park in Great

Falls, Montana. 96 residential spaces for $1,445,000. • Contract explained how Rasmussen would be paid over time. • After sale was completed, Rasmussen died. His estate inherited the

asset (revenue from sale). • Deschamps found significant problems with park’s water system.

Required $400,000 in repairs. • Deschamps stopped making payments to the estate. Claimed the

cost of the water system repairs made payments impossible.

• Estate sued; Deschamps countersued: contract breach/fraud. • Deschamps contended Rasmussen said that water system was in

good condition and that occupancy rate was higher than in fact it was.

• Trial Court held for estate, finding Deschamps’ claims were precluded by parol evidence rule. He appealed.

Continued

Deschamps v. Treasure State Trailer Court, cont.

• HELD: Affirmed. When language of contract is clear and unambiguous, look at the substance of the contract.

• Contract said Deschamps did not rely on any oral assurances or presentations by Rasmussen. He cannot claim otherwise.

• Deschamps signed a contract prepared by his real estate agent, containing statement that Deschamps did not relied on assurances by Rasmussen.

• Agreement provided • 1) Rasmussen had not conducted an inspection nor warranted property’s

condition. • 2) Deschamps had right/duty to inspect property prior to purchase. • 3) Special disclaimer of reliance on Rasmussen’s assurances. • 4) Inspection was waived or satisfied. • 5) Clause in agreement said this was entire agreement and superseded any oral

agreements. • 6) Agreement could only be amended by a writing.

∗ Substantial Performance (Usually in good faith) ∗ Usual remedy is the contract price minus damages resulting from lack of complete

performance

∗ Material Breach ∗ Performance substantially less than required ∗ Damages now due to non-breaching party

∗ Executed Contract ∗ Fully performed; nothing left undone ∗ If fully performed, damages for the price of performance may be sought as a remedy

∗ Executory Contract ∗ Not fully performed ∗ If partial delivery of products, buyer need not pay total price

DISCHARGE OF CONTRACTS

Assignment (transfer of rights to another) and Delegation (transfer of duties to another)  Many contracts can be assigned or delegated;

exceptions are contracts for services. Third-Party Beneficiary is a party not part of original

contract who acquires rights under the contract. Common for credit contracts. Performance  Total performance = discharge and payment

accordingly  Substantial performance: Usual remedy is the

contract price minus damages resulting from lack of complete performance

Breach (non-breaching party is discharged)  Material breach: Performance is substantially

less than the contract provides  Anticipatory breach or repudiation: A party

indicates inability or lack of desire to perform Discharge by Agreement of the Parties: Rescission— parties agree to walk away, Novation—parties agree to substitute new contract, Accord & Satisfaction—parties are satisfied by alternative performance.

DISCHARGE OF CONTRACTS

Discharge by Impossibility

∗ An unforeseeable, unanticipated event occurs that makes performance impossible ∗ “Extreme or unreasonable difficulty, expense, injury or loss . . . .”

(Restatement (Second) of Contracts) ∗ One party dies or is incapacitated. ∗ Law passed making performance illegal ∗ Subject matter of contract is destroyed

∗ The impossibility doctrine has been extended to commercial impracticability or frustration ∗ Wartime shortages ∗ Extreme weather causes crop failures ∗ Loss of needed supplies due to sudden international embargoes ∗ Difficult to be enforced in courts – courts generally expect at least part

performance

Equitable Remedies

 Specific Performance

 Injunction

 Restitution

Mitigation of Damages  Injured party must make

efforts to mitigate or lessen losses.

∗ Monetary Damages ($$) ∗ Compensatory Damages

∗ Actual Damages

∗ Expectancy Damages

∗ Liquidated Damages

∗ Nominal Damages

∗ Punitive or Exemplary (if there is tort related to breach of contract)

∗ Special Damages

Remedies

Economic Loss Rule • In breach of contract, if no tort involved, damages are only those

related to economic losses suffered by the breach.

• Rule based on three policies • 1. Maintain distinction between tort and contract law • 2. Protect commercial parties’ freedom to allocate risks by contract • 3. Encourage the party best situated to assess the risk of economic loss

• Damages are only those related to lost profits and costs due to the breach.

• Accounting evidence and specific calculations are necessary evidence to be presented.

• No punitive damages or mental distress awards. (Parties often try to assert a tort, usually fraud, along with breach of contract to try to get these damages.)

DeRosier v. Utility Systems of America  DeRosier owned land on a hillside. Before house could be built, lot needed to

be filled with dirt.  Asked Utility Systems of America (USA), working nearby, if it would dump some

of their excess dirt on his lot.  USA saved money doing this instead of hauling the dirt away.  DeRosier obtained permit from city to allow 1,500 cubic yards of fill to be

dumped on his property. Gave permit to USA. USA dumped 6,500 cu. yd., so 5,000 cu. yd. had to be removed.

 USA denied responsibility; offered to remove the excess for $9,500. DeRosier hired another firm for $22,829 to remove excess dirt.

 DeRosier sued USA. Trial Court granted him $22,829 damages paid to remove the dirt. Also awarded him $8,000 in consequential damages for delay of time lost in constructing new house.

 USA appealed, saying DeRosier failed to mitigate damages by not having USA move the dirt for only $9,500 rather than $22,829 paid to another contractor.

DeRosier v. Utility Systems of America Continued

• Consequential damages refers to damages distinguished from general damages.

• Consequential damages flow naturally from the breach, but are not recoverable unless they are reasonably foreseeable by parties at time of breach.

• USA contended no claim for delay damages was in evidence.

• HELD: District Court erred in awarding DeRosier $8,000 in consequential damages.

• HELD: District court had sufficient basis for calculating and granting $22,829 in general damages.

• HELD: Regarding DeRosier’s duty to mitigate: Non-breaching DeRosier could decline the offer of USA to remove dirt for $9,500. Did not unreasonably reject USA’s offer and did not fail to mitigate his general damages.

• Reversed in part; affirmed in part.

Quasi Contract (Also called quantum meruit)

∗ Quasi (means “almost”) – not a true contract

∗ Equity concept used by courts to prevent injustice

∗ Example: You watch as a crew (in good faith) come to your house and pave your driveway. You cannot let them do the job and not pay them anything for their work.

Scheerer v. Fisher • Scheerer, a real estate agent, helped arrange $20 million deal between

Seller and buyer (Fisher). Was due 2% commission from each. Deal fell apart.

• But Fisher formed a new company and had 3rd party buy the property and then sell it to Fisher’s company.

• Scheerer learned of deal and sued for compensation based on quantum meruit.

• Trial Court held no contract or basis of payment. Scheerer appealed.

• HELD: Reversed. • Defendants acted to deny Scheerer compensation for services rendered. • Although original contract failed, law implies a promise to pay some

reasonable compensation for services rendered. • Allegations state a valid quantum meruit claim.