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Chapter Overview

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5.1 Valid, Voidable, Unenforceable, and Void Agreements

5.2 Capacity • Capacity and Age: Minors • Capacity and Mental Incompetence

5.3 Genuine Assent • Mutual Mistake of Material Fact • Fraud • Duress • Undue Influence

5.4 Unenforceable Contracts and the Statute of Frauds

• A Promise to Pay the Debt of Another • A Promise That by Its Terms Cannot Be Performed

Within One Year of the Date the Contract Is Made • A Promise in Consideration of Marriage • Contracts for the Sale of Goods With a Price of $500

or More • Contracts Creating an Interest in Real Estate • Requirements of the Writing Under the Statute

of Frauds

5.5 Illegality • Contract Interpretation and the Parol Evidence Rule

5.6 Chapter Summary • Focus on Ethics • Case Study: Lamle v. Mattel, Inc. • Case Study: Sherman v. Burton • Critical Thinking Questions • Hypothetical Case Problems • Key Terms

Learning Objectives

After studying this chapter, you will be able to:

1. Distinguish between voidable, unenforce- able, and void agreements.

2. Explain the requirement of capacity and describe why a person might lack it.

3. Describe mutual mistake, duress, undue influence, and fraud.

4. List the types of contracts required to be in writing.

5. Give examples of illegal agreements.

Contracts: Capacity, Genuine Assent, the Statute of Frauds, and Illegality

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CHAPTER 5Section 5.1 Valid, Voidable, Unenforceable, and Void Agreements

After determining that an offer and acceptance are valid, and that there is valid consideration, each party to the contract must have the capacity to enter into a binding contract and must give his or her genuine assent to enter into a binding agreement. To put it another way, the parties must fully understand that they are entering into a contract, and they must willingly enter into a contractual relationship with each other. To use a simple example, if Felipe holds a gun on Heather to persuade her to sell him her car, there may be offer, acceptance, and consideration, but the contract is defec- tive due to lack of mutual assent. Heather was not truly agreeing to sell her car; she just wanted to avoid getting shot.

In this chapter we will examine a number of impediments that might invalidate what oth- erwise appear to be valid contracts. These include lack of capacity, defective assent issues (mutual mistake of material fact, duress, undue influence, fraud), illegality, and having an oral agreement in one of the few situations in which the law requires a writing.

But first, it’s time for some more terminology!

5.1 Valid, Voidable, Unenforceable, and Void Agreements

A valid contract is one that meets all legal requirements. It’s what people generally aim for when they seek to make a contract. Sometimes, though, it’s not what they end up with. A voidable contract results from lack of either capacity or genuine assent. Voidable means that at least one of the parties, and sometimes both, can get out of the contract without being liable for breach, generally because of some circumstance present when the contract was made. Contracts made by minors (people under a statutory age) are voidable at the option of the minor. Contracts made under duress or undue influence, or contracts that involve fraud by one party, are voidable at the option of the victim. However if the victim wishes to go through with the contract, he or she can hold the “bad guy” to the deal. Sup- pose that Heather, in the above example, discovers that Felipe actually contracted to pay more than market value for her old car. If she decides to forgive him for the whole gun thing and hold him to the contract rather than voiding it, she can. Lastly, a contract made when there was a mutual mistake of material fact is voidable at the option of either party.

A contract that is unenforceable is one that was legally required to be in writing and is not. A law called the statute of frauds (which is not the same as the fraud mentioned above) requires that five types of contracts be evidenced by writing.

Lastly, an agreement that is illegal is void, which generally means it will be given no legal effect.

Now that we understand the terminology, let’s begin with a closer look at the voidable contracts, followed by an examination of unenforceable and void agreements.

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CHAPTER 5Section 5.2 Capacity

5.2 Capacity

There are two separate issues that may arise with regard to contractual capacity: age and mental competency. First, let’s look at age. Capacity and Age: Minors Minors are people who have not reached the age of majority, which is set by statute in any given state. The most common age for majority is 18. By law, minors’ contracts are voidable at the option of the minor, because minors have the right of disaffirmance. This means that a person can get out of the contract he or she made while a minor without being liable for breach. Why have such a rule? The theory is that minors, young and inex- perienced, might be lured into making unfair and unnecessary contracts by older, sneaky types. Picture, if you will, a fast-talking, slick salesman persuading a teenager to buy a car on a complicated installment contract she is unlikely to understand!

Of course, the law could have chosen to just let minors void their unfair and unnecessary contracts. The problem with this type of rule is that it would be unpredictable and almost every case would go to trial on the question of fact of whether the contract was unfair. The general rule that minors can disaffirm at least has the advantage of being easy to apply and it gets rid of many conflicts before they go to trial.

Example 5.1. Mary, age 16, buys a used car from Dan for $3,000. She drives the car for six months, crashes it, has the wreck towed back to Dan’s house, and shows up on his doorstep, demand- ing her money back.

Can Mary actually get away with this? Yes, she can. She is a minor and she has disaffirmed. When a minor dis- affirms, she has the duty to return the consideration in whatever shape it’s in. In exchange, in a majority of juris- dictions, the other party must return the minor’s full con- sideration. So Dan must give Mary back her $3,000. The law even allows a person to disaffirm within a contract made while a minor within a reasonable time after attain- ing majority age.

Example 5.2. Michael, age 17, buys a car from Cathy for $2,000. A week later, he turns 18, the age of majority in that state. A few days later, he begins to have transmission trouble, goes to a garage, and is told it will cost $800 to repair the car. Michael decides to disaffirm instead.

If the boy decides he doesn’t like this flavor, can he get his money back? Once an offer is accepted, a contract has been formed, but the contracts of a minor are voidable.

Glow Images, Inc./Getty Images

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CHAPTER 5Section 5.2 Capacity

How long is a reasonable time? This is a question of fact that depends on the individual case, but clearly in the example above Michael can disaffirm. It’s been less than two weeks since he made the contract, and a few days since he came of age.

How does a minor disaffirm? By saying anything, or doing anything, that would indicate to a reasonable person that the minor does not intend to go through with the contract.

Example 5.3. Renaldo, a minor, buys a car from the local dealership, on an installment payment plan. He makes the down payment of $1,000 and has made three monthly payments when the car is stolen. Renaldo stops mak- ing payments to the dealer.

Renaldo’s cessation of payments would indicate he does not intend to be bound to the contract, so this is an implied disaffirmance. He does not have a legal duty to return the car, because he does not have it.

What if Renaldo lied to the dealer about his age in order to get the car? The states have a variety of rules dealing with a minor’s misrepresentation. Some still allow disaffirmance, some allow it under some circumstances, and some don’t allow it at all. Also, states differ on whether the minor can be held liable for fraud in such situations.

If a person makes a contract while a minor, comes of age, and ratifies the contract, he or she is now bound. Once you ratify, you lose forever the right to disaffirm. Ratification can be either express or implied.

Example 5.4. Mary the minor buys that car from Dan. Then she turns 18. Now of majority age, Mary tells Dan she considers the contract to be bind- ing. A week later, she changes her mind and wants to disaffirm. Mary can- not disaffirm, because she came of age and expressly ratified the contract.

Example 5.5. Renaldo the minor buys the car from Dealer. He turns 18. He makes a payment on the car. Now the car is stolen, and Renaldo wants to disaffirm. He cannot, because he has already ratified. He must continue to pay for the car.

The right of minors to disaffirm contracts can place a heavy burden on merchants who sell goods to minors on a regular basis. Yet most merchants are quite happy to deal with minors. The reason? It makes good business sense to bear the risk that a minor may disaf- firm a contract, since only a very small percentage of minors ever do so. One way around this potential risk is to have an adult cosign any contract with a minor. If this is done, the adult contracting with a minor has a greater measure of protection, since she may recover the full price of the contract from the cosigner in the event that the minor decides to dis- affirm the contract. It should also be noted here that only the minor has the right to void a contract entered into during minority—the adult who contracts with a minor is fully bound by his contract. (If both parties to the contract are minors, then either may void the contract at her option, but neither has any special rights of enforcement.) Likewise, a cosigner or guarantor of a contract entered into by a minor may not exercise the minor’s right to disaffirm the contract—only the minor may do so.

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CHAPTER 5Section 5.2 Capacity

Emancipated Minors Sometimes a person who is still a minor may be treated legally as an adult. In some states, the minor may petition the court to have the power of disaffirmance legally removed.

Example 5.6. Mary Lou wins the Olympic gold medal for all-around gym- nastics. She is a hot commodity for endorsement contracts, but no one wants to do business with her because she’s a minor. Mary Lou petitions for and is granted emancipation. Now she can make binding contracts, so she signs to promote a soft drink for a fee of $1 million.

In some states, if a minor is independent and self- supporting, the minor is considered to be emancipated and contracts are no longer voidable.

Example 5.7. John, a minor, works full time, is married, and has a baby. John has not spoken with his own parents for more than five years; neither has he received any support from them. In states that view independence as emancipa- tion even without a court procedure, John’s con- tracts are binding.

By statute in every state, there are some types of con- tracts that minors cannot disaffirm for public policy reasons. The typical examples are insurance contracts, contracts with financial institutions (which also issue most credit cards), and contracts made to fulfill a legal duty. For example, regardless of your age, if you are yourself a parent, you have a duty to supply necessi- ties for a minor child. If you own real estate, you have a legal duty to pay the taxes on it. If you make a contract to carry out such a legal duty, it is binding even if you are a minor.

Example 5.8. Mary, age 15, has a baby. One night the baby gets very sick and Mary takes her to the emergency room of the hospital for treatment. Mary then refuses to pay the bill. Mary will be liable, because as a parent she had a duty to pro- vide medical care for her child.

Contracts for Necessities Another exception to the general rules for minors involves necessities purchased by the minor. A necessity can be defined as anything that a minor reasonably needs to live and covers such essential items as food, clothing, shelter, medical care, and credit in most states. Educational expenses are also treated as necessities in some states. While minors can disaffirm these contracts, they can still be held liable for the fair market value of the necessity.

Olympic gymnast Mary Lou Retton sought emancipation in order to take advantage of endorsement contracts. Because she was under the age of majority, companies did not want the risk of a voidable contract. Emancipation meant that Retton could no longer disaffirm her contracts.

Associated Press

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CHAPTER 5Section 5.3 Genuine Assent

Example 5.9. Michael, a minor, comes home from boarding school to find his family home locked up and deserted. None of his friends are around, so he goes to a hotel for a few nights. Michael will be held liable for the rea- sonable value of staying in the hotel, since shelter was a necessity for him and he had to provide it for himself.

What constitutes a necessity depends in part on the facts of each case. If a minor’s parents are willing to provide him with housing, an apartment is not a necessity for the minor, even if he would prefer to have his own place. On the other hand, if the minor is an orphan and must provide his own housing, the apartment would be deemed a reasonable necessity. If a minor needs a job to help support herself and her family, and she cannot reach work without a car, the car is a necessity. But if she could have just as easily walked or ridden her bike to work, the car is not a necessity, and she would not be liable in quasi contract if she disaffirms the contract for the car.

Capacity and Mental Incompetence To have a valid contract, both parties, at the time the contract is made, must have sufficient mental competency to understand the nature and circumstances of the transaction. This does not necessarily mean they would understand every clause of legalese in a long, com- plicated written contract, but does require that they know basically what they are doing.

Example 5.10. Cassandra’s landlord comes to her door to ask if she intends to renew her lease for another year. Cassandra, a paranoid schizophrenic who is not taking her meds, is suffering from complex hallucinations and thinks he is an alien asking her to sign a peace treaty on behalf of Planet Earth. Not wanting to be responsible for a war with aliens, Cassandra signs the new lease. Cassandra lacks capacity and can void the contract when she realizes what she has done.

If Cassandra had already been declared mentally incompetent by a court, her contract would be void rather than voidable.

The relevant time period for capacity is when the contract is made. The law generally pre- sumes both parties to have capacity unless there is something in evidence that puts it in question. Then the burden is on the party who wants the contract to stand to show that the other really did understand what he was doing. People can lack capacity for a variety of reasons: mental illness, senility, even intoxication! (This is one of the few times in your life when being drunk is actually a legal excuse.) But the issue is not whether you are mentally ill, or too drunk to drive; the issue is whether because of your condition, you were unable to understand the contract.

5.3 Genuine Assent

Sometimes it appears that there is an agreement, but when we examine the circum-stances more closely, we can see that one or both parties did not truly have a “meet-ing of the minds.” Such defective assent makes a contract voidable. Let’s take a closer look at the specific grounds for voiding a contract on this basis.

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CHAPTER 5Section 5.3 Genuine Assent

Mutual Mistake of Material Fact If both parties to a contract make a mistake about a material fact (something a reasonable person would consider in choosing to make the contract), either one can void the contract.

Example 5.11. If Jeremy contracts to sell his yacht to Keisha for $1 million, and unknown to either at the time the yacht has already sunk to the bottom of the slip where it was moored, the contract is voidable.

A classic case involving mutual mistake had a seller contracting to sell bales of cotton to a buyer. The contract seemed very specific, calling for the 125 bales of cotton to be shipped from Bombay, India, to Liverpool, England, on a ship called Peerless. How could there be a misunderstanding? It turns out there were two ships called Peerless, both carrying Surat cotton, both sailing from Bombay to Liverpool. One was scheduled to arrive in October, and the other in December. The buyer was thinking of the October ship, and when his cargo isn’t on the Peerless, he sues for breach. But all along the seller had the December ship in mind. The parties never truly agreed on the terms, because of their factual mistake. Thus the contract is voided by the seller, and the buyer is out of luck.

Note that a mistake in value is not a mistake of fact. If you are simply ignorant of the sub- ject matter, you are not making a mistake. If you buy a painting on eBay that is correctly identified as being by Juan Picasso, paying $5,000 for it because you did not know that the famous Picasso’s name is Pablo, you will not be able to void the contract when you dis- cover you can only resell the painting for about $500 instead of the millions you planned on getting. Enjoy your painting!

A unilateral mistake by one party to the contract generally will not void the agreement. If Bret offers to sell milk wholesale to Organic Grocery for $1.44 per gallon when he meant to type in $1.55 and Organic accepts his offer, Bret cannot get out of the contract. There is a possible exception if the other party knew or should have known about the mistake. For example, if Sam offers to sell his deluxe mansion in Beverly Hills for $50,000, it is quite obvious that some zeros were left out, and a court might let Sam avoid the contract.

Fraud In addition to being a tort, fraud is also a way to avoid a contract. Review the elements in Chapter 2! We will add a few details here. For simplicity, since either party could be plain- tiff or defendant in a contract fraud case, we will refer to the person committing the fraud as “Bad Guy” and the person seeking to void the contract as “Victim.”

There are two basic types of contract fraud. The first is fraud in the execution, where Vic- tim is deceived in such a way he does not even realize he’s made a contract. For example, suppose Vic is asked by Bad Guy to sign a guest book, but there is a carbon sheet under- neath that transfers Vic’s signature to a contract to buy BG’s car. The contract will be void- able at Vic’s option: he could still buy the car if he wanted to.

The second type of fraud is fraud in the inducement, where Vic knows he is making a contract but is deceived as to some aspect of the subject matter. The remainder of our examples deal with this type, which is far more common.

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CHAPTER 5Section 5.3 Genuine Assent

Note that while generally silence is not making a false statement and thus not fraud, if Bad Guy owed victim a fiduciary duty (discussed previously), silence might be fraud. Another situation where silence can be fraudulent is when Bad Guy’s original statement, though true at the time, ends up giving Victim a mistaken impression.

Example 5.12. Bad Guy tells Victim, who is considering buying BG’s house, “Accord- ing to the last inspection, there is no sign of termites.” This is true, but before Vic makes an offer, BG discovers termites in the house. Because it was BG’s statement that has given Vic the idea the house is termite free, BG is committing fraud by not giving Vic an update.

Silence can also be fraud if there is active conceal- ment of information; in other words, if Bad Buy is doing something to cover up a material fact.

Example 5.13. Bad Guy’s house has a bad fire. Rather than make real repairs, BG takes the insurance money and makes cos- metic repairs, painting over the smoke dam- age, installing some new sheetrock, but not replacing burnt out support beams. Vic buys the house, and two weeks later falls through the living room ceiling when a beam col- lapses. Vic can void the contract and get his money back, or sue for damages to repair the house properly.

The final situation where silence can be fraud is where the information is unusual, something Victim would not normally check out, and Bad Guy is aware it could be a deal-breaker.

Example 5.14. Bad Guy’s house has no usable water source. The well is contaminated with industrial pollutants, and the house is too far from the center of town to connect with a water main. BG “forgets” to tell Vic this fun fact about the house. When Vic discovers the problem, he will have a good case against BG for fraud.

Keep in mind that predictions and opinions are generally not statements of fact, and there- fore not fraudulent. If another student tells you to sign up for Business Law because it’s dead easy and you later decide it’s actually a really hard class, you cannot sue, because that is an opinion. If your advisor tells you “Business Law is the greatest class in the whole world! A life-changing experience! Fantastic!” this is called puffery, and is not a basis for

In February 2012, Proview Electronics Co. filed a lawsuit against Apple for intentional misrepresentation, fraud by concealment, fraudulent inducement, and unfair compensation. Apple purchased the “iPad” trademark from the Taiwanese company using a United Kingdom–based proxy called “IP Application Development,” which later turned the trademark over to Apple. The lawsuit was thrown out in May of that same year.

Dong Jinlin – Imaginechina/Associated Press

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CHAPTER 5Section 5.4 Unenforceable Contracts and the Statute of Frauds

fraud. If your stockbroker tells you, “This one will be a winner,” and the stock you buy tanks, your broker was merely making a prediction, and this is not fraud.

In addition to an intentional misrepresentation of a material fact, made with intent to deceive, remember that Vic must also show he reasonably relied on BG’s statement. In a contract case, to prove the final element of damage, Vic does not have to have an economic loss to avoid the contract. His damage is that the deal he thought he was getting is not the one he wound up with!

Remember, fraud is intentional. Sometimes negligent or innocent misrepresentation may affect the legal status of a contract, but the rules differ from state to state.

Duress Duress occurs when one party (shall we keep calling him Bad Guy?) uses wrongful coercion to get the other (yes, Victim) to make a contract. For example, BG shows Vic a gun/threatens to beat him up/burn his house down/beat up his girlfriend/file criminal charges against Vic, in order to get Vic to pay $10,000 for BG’s car. All of these threats are unlawful coercion and would be duress, allowing Vic to void the contract (once he feels safe!). If BG threatens Vic with a civil lawsuit, that is perfectly lawful and Vic cannot void the bargain. That is an example of what lawyers call “tactics”; in other words, do what I want or I’ll sue you.

Undue Influence The concept of undue influence is difficult to define but easy to recognize, since it almost always is going to involve one of two fact patterns: (1) the parties have a fiduciary rela- tionship, or (2) one party is highly dependent on another due to illness, age, infirmity, etc. In these situations the dominant person is seeking to take advantage of the weaker person. For example, suppose Mabel is an elderly woman who is a shut-in, unable to leave her condo. Her neighbor David gets her groceries, picks up her prescription medications, and does her yard work. Now David suggests that Mabel sell him the condo for 40 percent under market value. He does not have to threaten her; Mabel knows she will be in a des- perate situation if he stops helping her. David has a perfect right to stop helping, but he cannot use Mabel’s dependence on him to get a benefit for himself in this fashion.

5.4 Unenforceable Contracts and the Statute of Frauds

Most oral contracts are valid and enforceable. If Juan offers in a phone conversation to sell Kaylie his scooter for $400 and Kaylie accepts, the contract is binding. Of course, it is usually easier to prove a contract that the parties put into a written form, and it is definitely recommended if the contract involves anything much at stake! Also, the process of drafting a written agreement will often help the parties to think more specifically about the transaction and may minimize the chances of a misunderstanding. Nonetheless, the law typically requires a written document in only five types of contracts, namely those involving:

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CHAPTER 5Section 5.4 Unenforceable Contracts and the Statute of Frauds

1. A promise to pay the debt of another; 2. A promise that by its terms cannot be performed within one year of the date the

contract was made; 3. A promise in consideration of marriage; 4. A promise for sale of goods with a price of $500 or more; and 5. A contract creating an interest in real estate.

The reason for the writing requirement in these situations goes back to the original statute of frauds, passed by the English Parliament in 1677. The law was concerned with fraud on the courts, rather than the tort of fraud such as we examined in Chapter 2. In other words, the authorities were concerned that people were suing for breach of contract and lying in court about having an oral agreement. It seemed as though whoever could bribe the most witnesses would win the case! The English legislature decided that in cases where it was difficult to understand why a person would have promised something (for example, why would you want to pay someone else’s debt?) or where the stakes were high (such as the sale of land), the law should require that the parties put their agreement in writing, or it would be unenforceable.

Note that unenforceable simply means that if one party refuses to go through with the deal, the other cannot sue successfully for breach. In many situations the parties will go ahead and perform the oral contract. Once they have performed, it no longer matters that the contract was oral when it should have been written. These contracts are not voidable.

One tricky thing about the statute of frauds is that with regard to each type of contract, there are exceptions. In other words, there may be situations where even though the con- tract was supposed to be in writing, the oral contract can still be enforced. But the excep- tions are different for the different types of contracts!

In the Media: “MAN SIZED KLEENEX” and Other Interesting Requests in Celebrity Performance Contracts

Just because a contract isn’t covered by the statute of frauds doesn’t mean that it shouldn’t be in writ- ing, particularly when one party to the contract has many performance obligations. Consider a music group’s contract with the venue where it will be performing. Often called a “backstage rider,” this con- tract includes the personal and often idiosyncratic desires of the group for wherever it is to perform. The greatest band in history, The Beatles, had simple tastes. Their backstage accommodations included “four cots, mirrors, an ice cooler, portable TV set and clean towels.” And they asked for two limousines, which meant they shared rides.

But times have changed. For Paul McCartney’s 2002 rider, he demanded a stretch limousine with- out leather seats (due to his vegan lifestyle), and made sure that “There will be no meat, or meat by-products allowed to be served in the dressing room . . . or within the backstage area.” (But his “24 large bars of Ivory Soap” seems an odd demand, since Ivory has animal fats in it.) Meat-loving rocker Ted Nugent’s 2002 rider included that he be provided one box of “MAN SIZED KLEENEX.” Katy Perry’s 45-page rider for her 2011 world tour requires both a dressing room and a “Glam Room.” In the dressing room, Perry’s contract requires the following flower arrangement: “White (continued)

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CHAPTER 5Section 5.4 Unenforceable Contracts and the Statute of Frauds

A Promise to Pay the Debt of Another A contract whereby one person promises to answer for the debt of another must be evi- denced by a signed writing in order to be enforceable. This section of the statute of frauds applies to agreements guaranteeing payment, also known as secondary promises, such as the following:

Example 5.15. Janet promises Sam, a car dealer, “If you will sell this car to my son Eric, if he doesn’t pay you, I will pay whatever balance is due.” Janet is guaranteeing Eric will pay. Eric has the primary obligation; Janet’s promise is secondary. The key language is the “if he doesn’t pay you” phrase. If Sam sells Eric the car and Eric defaults on the payments, Sam will only be able to hold Janet to her promise if he has it in a writing signed by Janet.

It is important to distinguish a contract to answer for the debt of another from a contract entered into for another’s benefit; only the former need be in writing.

Example 5.16. Jenna promises Roman, “If you’ll deliver this bicycle to my son Aaron in time for his birthday, I’ll pay you the full price of $400 next Thursday.” This agreement need not be in writing since it is not a contract to answer for the debt of another—Jenna is the buyer in this agreement, and the debt created is her own, not Aaron’s.

In the Media: “MAN SIZED KLEENEX” and Other Interesting Requests in Celebrity Performance Contracts (continued)

and purple hydrangeas, pink & white roses and peonies. OR if the above is not available selection of seasonal white flowers to include white orchids— ABSOLUTELY NO CARNATIONS.” Carrot Top, the flame-haired prop comedian, has a dessert prohibition for his dressing room: “Please no Carrot Cake—It’s Still Not Funny!”

Perhaps the most famous demand of all time was the Van Halen 1982 concert rider insisting that the band’s backstage supply of M&Ms have “ABSOLUTELY NO BROWN ONES.” The curiosity over the band’s candy discrimination was satisfied in 2012 when lead singer David Lee Roth said the ban was simply a way to tell if each concert promoter was actually reading the fine print in the contract. If there were no brown M&Ms in the bowl, then the stage was likely set up according to the rider’s specifications.

Even where a contract is not required to be in writing for Statute of Fraud purposes, a contract may be put in writing. In fact, when considering the pur- poses behind the statute of frauds, it is advisable to reduce to writing—and signatures—as many contracts as is practicable.

Sources: www.thesmokinggun.com http://www.npr.org/blogs/therecord/2012/02/14/146880432/the-truth-about-van-halen-and-those- brown-m-ms

The band Van Halen requested no brown M&Ms be included backstage, possibly to see if the concert promoter had read the fine print of the contract.

Jack Wolf/PR Newswire/ Associated Press

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www.thesmokinggun.com

http://www.npr.org/blogs/therecord/2012/02/14/146880432/the-truth-about-van-halen-and-those-brown-m-ms

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CHAPTER 5Section 5.4 Unenforceable Contracts and the Statute of Frauds

One type of promise to pay the debt of another arises when the executor of an estate promises personally to pay debts of the deceased. If, for example, Edward, an executor, agrees to pay for funeral expenses out of his own funds, rather than from estate funds, the contract would have to be in writing and signed by him in order to be enforceable.

A general exception to the statute of frauds is when the party trying to avoid performing makes an admission that he or she did indeed make that promise. For this exception to apply, the admission must be in pleadings, or in testimony under oath. Suppose in the example above, Sam sues Janet to make good on her oral promise, and on the witness stand, Janet says, “Well, we did have that conversation, but there’s nothing in writing so it doesn’t count.” Janet, who should have taken business law, is now bound to her promise.

An exception unique to the promise to pay the debt of another is where the promisor’s primary motive is to secure a benefit for himself, rather than the person getting the benefit. For example, suppose Janet is wholly dependent on her son Eric for transportation, and the only reason he is purchasing this car is to drive her around, since Eric has a motorcycle for his personal use. In that situation, it is not difficult to understand why Janet would guarantee Eric’s debt, and the law will enforce Janet’s oral promise.

A Promise That by Its Terms Cannot Be Performed Within One Year of the Date the Contract Is Made If ABC Co. offers to employ Ahmad for three years at a salary of $100,000 per year, this contract must be in writing to be enforced, because obviously Ahmad cannot work for three years within a year of accepting ABC’s offer. Likewise, if on February 3, 2011, State University offers to employ Professor Wu to teach business law for one academic year (nine months) beginning on September 1, and Professor Wu accepts on February 8, 2011, the contract must be in writing because Professor Wu will not have performed until May of 2012.

Note that we decide if a contract can be performed within a year simply by looking at whether it is hypothetically possible to complete the performance within that time frame. For example, under the traditional rule, if Angela Attorney promises to handle any and all legal matters for the BCA Corporation for the rest of her life in exchange for a yearly retainer of $100,000, her promise need not be in writing. This is because it is hypothetically possible that Angela could go to work for BCA, work six months, and die. In that case, she would have worked the rest of her (regrettably short) life. This is true even if Angela is 29 years old and is likely to live at least another 50 years. It is true even if Angela in fact lives and works for BCA for ten or fifty years!

Some states, however, have become uneasy with oral lifetime contracts and now require them to be in writing.

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A Promise in Consideration of Marriage The most common type of agreements that come under this section of states’ statutes of frauds are prenuptial agreements in which parties agree as a precondition to marriage how assets will be distributed in case the marriage ends in divorce. The following exam- ples would both need to be in writing and signed by the promisor to be enforceable:

Example 5.17. Ben Billionaire and Greta Gorgeous sign a prenuptial agree- ment whereby Greta will receive a lump sum of $1,000,000 if the marriage ends in divorce regardless of who sues for divorce and will not be entitled to any other compensation, including alimony or other distribution of mar- ital assets.

Example 5.18. John promises to employ Dana as a vice president for adver- tising if she will marry his son, Harold.

Each of the above promises may be enforced if made in writing and signed by the promi- sor. However, it should be noted that many states have special statutes governing prenup- tial agreements, which may have other limits and requirements in addition to the writing provision.

Contracts for the Sale of Goods With a Price of $500 or More Article 2 of the Uniform Commercial Code (UCC) contains a statute of frauds (§2-201(1)) that requires any contract involving the sale of goods for a price of $500 or more to be evi- denced by a signed writing in order to be enforceable. Goods can be defined as tangible personal property that is capable of being moved and includes pets and other domestic animals. Consider the following examples:

1. Charles agrees to sell his butterfly collection to Sandra for $600. 2. Harry agrees to sell his motorcycle to Jessica for $500. 3. Mark agrees to sell his piano to Robin for $2,900. 4. Kim agrees to sell her horse to Bret for $1,000.

Each of the above examples involves the sale of goods for a price of $500 or more that must be evidenced by a signed writing in order to be enforceable. An important exception exists for specially manufactured or custom-made goods. Contracts for such goods are enforce- able even without a writing regardless of their price, provided that the goods are not read- ily saleable in the manufacturer’s regular course of business and that the manufacturer has taken some steps to begin manufacturing the special-order goods.

Example 5.19. John orders 25 shirts for his son’s baseball team from Peter’s Printers Inc. for a total price of $500. The shirts are to be printed with the team’s name, the Pittsfield Pioneers, and their logo, a covered wagon atop a pitcher’s mound. If Peter either makes a substantial beginning on the order (such as printing up ten shirts) or makes a substantial commitment to get the goods (such as contracting to buy special fabric that John wanted for the shirts), the contract is enforceable despite being oral.

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Under the UCC, there is also an exception that applies only to a contract between two merchants, known as the confirming memo exception. If ABC Co. orders 100 boxes of copier paper from Wood Inc., at a price of $10 per box, clearly the contract falls within the statute of frauds and ordinarily if the order was placed via phone, the contract would be unenforceable. But if, after that telephone conversation, Wood sends ABC an invoice that states the material terms, and ABC fails to object within ten days, the oral contract com- bined with the confirming memorandum makes the contract enforceable.

Contracts Creating an Interest in Real Estate A contract that creates an interest in land must be evidenced by a signed writing in order to be enforceable.

Example 5.20. In a telephone conversation, Lucas agrees to sell Juan his house for $200,000. Later Lucas changes his mind and refuses to sell. Juan cannot enforce the contract.

Of course, in this example, if it was Juan who changed his mind, Lucas could not enforce the contract either.

That a contract concerns real estate in and of itself does not mean that it must be in writing; only contracts that create an interest in realty fall within this section of the statute of frauds. A contract to lease an apartment for a period of less than one year, for example, need not be in writ- ing in order to be enforceable; although a lease obviously concerns itself with real estate, it does not create an owner- ship interest in realty, and therefore need not be in writing to be enforceable. If the lease runs for one year or more, however, it does need to be in writing—not because it transfers an interest in real estate, but because it is a contract that cannot be per- formed within one year and is covered by the statute of frauds for that reason as previously discussed.

Common examples of contracts that must be in writing because they are deemed to create an interest in realty include the following:

1. Contracts for the sale of real estate 2. Express easements, or right-of-ways across another’s land 3. Contracts transferring mineral rights 4. Contracts transferring air rights 5. Mortgages

The above will be covered in detail in the chapter on real estate.

A contract for sale of a house must be in writing under the statute of frauds.

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Requirements of the Writing Under the Statute of Frauds Suppose a contract falls within the statute of frauds and thus must be in writing. The next question is, what must this writing contain? The necessary components are that it must identify the parties, the subject matter, and the material terms of the contract, and have the signature of the party to be charged. Note that both signatures are not necessary; only that of the person now attempting to avoid going through with the contract is required. Furthermore, the legal definition of a signature is simply marks made by persons to sig- nify themselves: initials, for example, will qualify.

For example, Lucas contracts orally to sell Juan his house for $250,000. Lucas then sends Juan a letter: “Dear Juan, this is to confirm our deal for sale of my house at $250,000, clos- ing to be within 60 days. Best, Lucas.” If Lucas now refuses to sell, Juan has the necessary writing to enforce the contract. But if Juan backs out, Lucas has nothing signed by Juan, and the deal is unenforceable.

5.5 Illegality An agreement may be considered illegal if it would

1. violate a statute; 2. result in commission of a tort; or 3. violate public policy.

The first two are quite easy to identify. Some common examples of agreements that violate statutes would be usurious loan agreements and gambling arrangements. Usury statutes set the permissible amount of interest that can be charged on a loan or credit transaction. If a creditor charges a higher amount, the agreement is void for illegality.

At least some types of gambling are illegal in most states. For example, in a jurisdiction that allows only state-sponsored lotteries and charity bingo, you could not sue to enforce your status as winner of the office Super Bowl pool.

An example of the second type of illegality occurs when the contract subject matter might not be illegal, but the circumstances are such that performing the contract will result in a tort.

Example 5.21. Lena hires Dan to sink a well on what Dan believes is her property. When Dan discovers that in fact the location Lena specified is on her neighbor Kai’s property, Dan refuses to perform. Lena cannot sue Dan for breach, because their agreement would have resulted in a trespass on Kai’s real estate.

Agreements that violate public policy can be more difficult to determine. For example, an agreement not to compete can be either a lawful contract or void as against public policy. Such clauses, sometimes called restrictive covenants, can serve a valid purpose. If ABC Company hires Sarah and gives her specialized training and supervision for six months, ABC has made an investment in Sarah. If Sarah quits after six months and takes her

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newfound skills to a competitor of ABC, it seems unfair, and ABC has the right to prevent this by putting noncompetition clauses in their employment contracts. But the key is that these restrictions must be reasonable, because the employee also has a valid interest to protect—that of earning a living!

Example 5.22. ABC hires and trains Sarah, under a contract that specifies if Sarah leaves ABC, she cannot work in the same industry in the state of Wisconsin for five years.

The law will typically scrutinize both time and geographic limit. This contract appears to be overly broad. Forbidding her from working in an entire state and for such a long period will seriously impact Sarah’s ability to work. Some jurisdictions will invalidate the con- tract completely, leaving Sarah free to set up shop next door to ABC and compete directly with them, tomorrow! Others take a “blue pencil” approach, and rewrite the clause and enforce it as a reasonable restriction, such as barring Sarah from competing in the Milwau- kee metro area where ABC is located, for one year.

Another example of a contract clause that is sometimes void against public policy is an exculpatory clause, which says that one party will not be liable, even if he is negligent. These clauses will not be enforced if the situation involves deliberate misconduct, gross negligence, or a public duty.

Sometimes a contract is so unfair to one party that it is said to be unconscionable and void as against public policy. This generally comes up only in cases where there is disparate bargaining power; that is where one party is not able to bargain for better terms. These types of contracts will be examined in more detail in the unit on the UCC.

Generally, an illegal bargain will be void. There may be an exception if the illegal part can logically be severed from the legal portion, or if voiding the contract would result in a protected party being injured. For example, if Acme Insurance is not licensed to do business in Rhode Island but nonetheless issues a home- owner’s policy to Fred, who lives there, Acme will not escape liability on the policy when Fred’s house burns down by claiming it was void for illegality.

Frittelli’s Doughnuts and Coffee, the famous designer doughnut shop in Beverly Hills, California, sued its landlord for damages after it went out of business. Frittelli’s claimed that the landlord’s 2008 renovation of the storefront caused a decrease in sales and destroyed the company. Due to an exculpatory clause in the lease which stated the landlord would not be liable for injury to the tenant’s business or any loss of income or profit, the landlord was protected in the lawsuit.

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Contract Interpretation and the Parol Evidence Rule Before we leave this chapter, there is one more rule that must be mentioned. Although it does not relate to the legal status of a contract in terms of voidability and the like, the parol evidence rule as a practical matter often determines what the parties’ obligations are under a contract. The rule states that if the parties have a written contract, then other evidence—either written or oral—that arose either before or at about the same time the written contract was made, that varies from what is stated in the written contract, cannot be admitted into evidence.

Example 5. 23. Ashley has found a great apartment to rent, and is on the verge of signing a one-year lease when she notices a clause that says “No pets are permitted.” Ashley stops and tells the landlord that she can’t rent there after all, because she has a cat, Fluffy. The landlord tells her that he doesn’t mind if she brings her cat. Happy once more, Ashley signs the lease. She and Fluffy move in and pay their rent on time, but three months later the landlord serves Ashley with an eviction notice, because she is vio- lating the lease by having a cat.

Poor Ashley! Even if she had a dozen witnesses, the landlord’s statement could not come into court, and she would be stuck with the written lease that clearly says no pets. This is the parol evidence rule in action. The moral of the story is clear: Before you sign that writ- ten contract, make sure it has everything you need it to contain!

There are some exceptions to the parol evidence rule, where extrinsic evidence may be allowed. These include situations involving fraud, duress, undue influence, or mutual mistake of material fact, as well as those where a precondition to the contract was not met, where the contract itself is ambiguous, or where a subsequent modification is involved.

5.6 Chapter Summary

Once we know how a contract is formed, it is necessary to understand how differ-ent circumstances can affect the legal status of the contract. Contractual capacity issues, whether relating to a person’s age or mental competence, may make a con- tract voidable or even void. Even when an offer and acceptance are present, if the situation involves fraud, duress, undue influence, or a mutual mistake of the same material fact, the contract is nonetheless voidable. While oral contracts are generally perfectly legal, a few types of contracts must be in writing to be enforceable.

Some of these circumstances may be beyond our control, but others can be anticipated and avoided. Whether making a contract that is personal or on behalf of a business, the wise person will try to anticipate all the things that might go wrong, and contract in such a way as to minimize the impact, should the worst-case scenario materialize.

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Focus on Ethics

This chapter raises many issues concerning things are legal but may or may not be ethical. Consider the rules on minors’ contracts. What if Mathew, a minor, buys Stephanie’s car for $7,000 and then enters it in a demolition derby? The law permits Mathew, under the majority rule, to then disaffirm the contract and get back his money for the now-wrecked car. Is Mathew behaving ethically? Is this a situation of “seller beware” rather than caveat emptor/buyer beware?

Suppose Ron organizes the office betting pool on the Super Bowl, collecting money from everyone, including you, to constitute the prize. After you are found to have picked the winning team and point spread, Ron tells you he’s sorry, but he can’t pay you because he just discovered gambling is illegal. Is Ron acting ethically? If you turn him in to the police for running an illegal gambling ring, are you acting ethically or simply getting revenge?

There may also be situations where an act is ethical but not legal. The classic example involves the woman who is too poor to buy food for her starving children, and so she steals a loaf of bread. Clearly the theft is illegal, but most would say not unethical, since the children going hungry is a greater evil than the baker’s loss of one loaf. But the baker has a right to press charges against the woman. Is he acting unethically in doing so?

Case Study: Lamle v. Mattel, Inc.

394 F.3d 1355 (Fed. Cir. 2005)

Facts: Lamle invented and patented a board game called Farook. From May 1996 to October 1997, Lamle and Mattel, Inc. engaged in negotiations regarding the licensing of Farook by Mattel for distribu- tion outside the United States. The parties reached an oral agree- ment at a meeting on June 11, 1997, which covered the terms of a license, including a three-year term, the geographic scope, the schedule for payment, and the percentage royalty.

Mattel asked Lamle to “draft a formal document memorializing” this agreement and “promised [that] it would sign a formal, written con- tract before January 1, 1998” (Pl.App. at 59). Mattel employee Mike Bucher subsequently sent Lamle an e-mail entitled “Farook Deal” on June 26 that substantially repeated the terms agreed to at the June 11 meeting. The salutation “Best regards Mike Bucher” appeared at the end of the e-mail. On August 13, Mattel sent Lamle a fax indicating it was waiting for the written document. Lamle sent the requested writ- ten contract on August 19. However, Mattel decided it did not want to license Farook after all. Lamle sued for breach of contract.

Issue: Did the contract fall within the California statute of frauds? If so, can the writing requirement be satisfied by the Bucher e-mail?

Discussion: The court emphasized that it was not deciding whether the parties had the actual intent to contract or were still engaged in preliminary negotiations. But because the trial court had ruled for Mattel as a matter of law, dismissing the case in part because any such contract would

Lamle sued Mattel, the world’s largest toy company, in 1997 for breach of contract.

Reed Saxon/Associated Press

(continued)

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Case Study: Sherman v. Burton

165 Mich. 293 (Mich. 1911)

Facts: Burton injured his knee while riding on the Detroit United Railroad Company, and sought medi- cal treatment from Sherman, a physician. At the urging of Dr. Sherman, the two men made a written contract that said Burton would pay Sherman one-third of any damages that Burton would receive from his lawsuit against the Detroit United Railway Company. If the sum recovered was $2,000 or more, Burton would also pay Sherman an additional $90. According to Burton, Sherman told him that Burton’s knee was “bad” and may contain tuberculosis (yes, tuberculosis). Sherman also mentioned his influence with the Detroit Railway Company, which Sherman said would pay Burton “many thousands of dollars right away.” Sherman never mentioned the unique payment agreement to Burton until the time Sherman asked that it be signed. Burton received an $1,800 settlement and paid Sherman $290 for his services. Burton claimed that he and Sherman finally agreed “to destroy the agreement,” and that the amount Burton paid to Sherman constituted a full settlement between them. Sherman filed a lawsuit against Burton to collect the remaining $310 under the agreement. The circuit judge ruled in favor of Burton on the ground that the agreement was against public policy, and Sherman appealed.

Issue: Was this contingency fee contract between a doctor and his patient enforceable?

Case Study: Lamle v. Mattel, Inc. (continued)

have to be in writing, the appeals court examined whether the fax could satisfy California’s statute of frauds. It noted that whether or not the terms in the e-mail constituted all the material terms was likewise a question of fact for trial.

However, whether the e-mail met the signature requirement was a question of law. The party to be charged was Mattel, and the June 26 e-mail was written by Bucher, an employee of Mattel, and his name appeared at the end of the e-mail, which concludes with “Best regards Mike Bucher.” Mattel did not dispute that Bucher had the authority to represent the company. The California Supreme Court had not decided whether electronic signatures satisfied the statute, but it had noted that other states had relaxed the signature requirement considerably to accommodate various forms of electronic com- munication. California law also provided that typed names at the end of telegrams were adequate as signatures. The court concluded that there was no meaningful difference between telegrams and an e-mail, and found that the Bucher signature could satisfy the statute of frauds requirements. The court remanded the case for trial on the remaining questions of fact.

Holding: The contract is clearly within the statute of frauds, and thus a writing is required. The fax could legally meet the requirements.

Questions for Discussion

1. Why would this contract need to be in writing? Which one of the five types is it? 2. Why did the court decline to decide whether a contract existed between Lamle and Mattel? 3. Do you think the court’s finding, that the e-mail could satisfy the writing requirement, makes

sense? Why or why not?

(continued)

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Critical Thinking Questions

1. Why do you think the law allows people to avoid liability on their agreements under rules like the statute of frauds and the parol evidence rule?

2. Why is it that mutual mistake and duress both allow a contract to be voided, when duress clearly involves wrongful behavior and mistake doesn’t?

Hypothetical Case Problems

Case 1. Olivia and Brad are on a nature hike when Olivia suddenly bends down and picks up a sparkly stone. Neither has any idea what the stone might be. Brad offers to buy it from Olivia for $20, and Olivia accepts. The sparkly stone turns out to be a rough diamond worth about $5,000.

A. If Olivia wants to keep the stone, what will she argue? Is a court likely to agree with her?

B. If instead both Brad and Olivia were geology majors who believed the stone to be a particularly nice chunk of quartz, would the outcome be different?

Case 2. Michelle is an 80-year-old widow who is going senile. Antoine, her neighbor, thinking Michelle probably can’t manage living alone much longer, offers to buy her house for $80,000. Michelle is confused and has mistaken Antoine

Case Study: Sherman v. Burton (continued)

Discussion: The appellate court concluded that the contract was unenforceable because it violated public policy. The court stated that a “contract must be measured by its tendency, and not merely by what was done to carry it out.” At the time of the contract, Sherman and Burton were contemplating Burton’s lawsuit against the railway company, and the payment for Sherman’s services was proportion- ate to any award Burton would get. In order to win money at trial, an expert witness like Dr. Sherman would be critical and the two men were considering that Sherman would testify at the trial. Sherman’s direct interest in the case provided him with a strong motive for misrepresentation and exaggeration to the jury. The appellate court concluded that “a temptation to swell the damages” would likely affect Sherman’s testimony and be “inimical to the pure administration of justice,” even though Sherman never testified.

Holding: The judgment of the circuit court is affirmed.

Questions for Discussion

1. What were the terms of the agreement between Sherman and Burton? 2. Why do you think Sherman succeeded in convincing Burton to sign the agreement? 3. Why did the appellate court rule against Sherman, if Burton wasn’t forced to sign a contract

whose terms were clear? 4. If a lawyer can have a contingency agreement to take one-third of a jury’s verdict or of a set-

tlement with a defendant, then why can’t a doctor?

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capacity Required mental state to make a valid contract.

disaffirmance The ability of a minor to avoid a contract without liability for breach.

duress Wrongful coercion that overcomes another person’s free will.

emancipation Legal adulthood.

exculpatory clause A clause in a contract exempting a party from liability. Some- times violates public policy and is void.

parol evidence rule Where the parties to a contract have expressed their agreement in a writing, with the intent that the writ- ing embody the full and final expression of their bargain, any other evidence, either written or oral, which arose prior to or contemporaneously with the making of the writing, is inadmissible to vary the terms of the writing. The parol evidence rule does not apply in cases of defective assent.

undue influence Abuse of position of power or trust in order to gain a benefit for oneself at the other’s expense.

for her nephew Douglas, who manages her bills for her. Michelle thinks he is talking about paying the property taxes, and so she signs the contract Antoine has prepared, believing it to be a property tax document. When Douglas discovers what happened, he tells Antoine that Michelle will not be selling him the house.

A. What will Michelle and/or her family argue to get out of the contract? B. Would this contract be valid, voidable, unenforceable, or void? Explain. C. If Douglas had already had Michelle declared mentally incompetent,

would your answer change? Why or why not?

Case 3. Robert crashes his car into one driven by Tanya. Shortly after the accident, Robert’s father William comes along. Robert assures Tanya that he will pay for the damage, but Tanya seems reluctant to accept this. William, who wants Robert to learn about responsibility but doesn’t want his son to be sued, tells Tanya that if Robert does not pay her within two weeks of the repairs being made to her car, William will pay her instead.

A. Does this agreement fall within the statute of frauds so that it is required to be in writing? Why or why not?

B. Would it be different if William promised Tanya, “If you won’t sue my son, I’ll pay for the damage to your car” instead? Explain.

Case 4. Robert offers to sell his car to Sarah, telling her it has never been in an acci- dent (which, as we all know from the previous question, it has!). Sarah has the car examined by her usual mechanic, who tells her that the car has had considerable body work. Nonetheless, Sarah still thinks the car is a good deal, so she accepts Robert’s offer. Two weeks later she finds the same type of car for sale on Craigslist for less than she paid Robert. Can Sarah return the car and get her money back, based on fraud? Explain.

Key Terms

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unenforceable A contract that may be legally performed by the parties, but if one chooses not to perform, the other will have no remedy for breach.

valid contract A contract that satisfies all legal requirements.

void contract An agreement that will not be given legal effect.

voidable contract An agreement that one or both parties can avoid without being liable for breach. A completed contract can be voided after the fact.

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