Regulation and Administrative Law

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Chapter 5

Administrative Law Administrative law governs and de�ines the powers of government agencies. A number of political and technological factors have led to an explosion in the growth of government since the turn of the 20th century, at both the federal and state levels. Even though these bureaucracies fall under the executive or legislative branch, their rapid growth has given rise to what is commonly referred to as the "fourth branch of government": administrative agencies.

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The Internal Revenue Service is one example of an agency created by the federal government to expand its regulatory power.

5.1 What Is the Purpose of an Administrative Agency? Beginning in the 1930s, the federal government has been steadily expanding its regulatory powers over business and individuals through the creation of agencies such as the Federal Trade Commission, Internal Revenue Service, and Food and Drug Administration. Under the U.S. Supreme Court's broad interpretation of the Commerce Clause, Congress has the power to regulate nearly any matter that has an impact on interstate commerce. However, the 535 men and women that make up the 112th Congress have neither the time nor the expertise to become involved in the speci�ics of drafting regulatory rules for each federal agency. What Congress has done instead is to create administrative agencies to oversee or carry out speci�ic governmental functions and then empower those agencies to create the rules by which they will operate. The same holds true for the executive branch of government, where the president uses administrative agencies to help carry out the responsibilities of the of�ice.

When an agency is created, Congress gives the agency the power to draft its own agency rules—the guidelines under which the agency operates and that must be followed by persons over whom the agency is given regulatory powers. When federal agencies enact rules, they must follow the guidelines set forth in the Administrative Procedure Act (APA), which speci�ies the procedures agencies must follow in promulgating new rules. As long as an agency creates rules in accordance to the Administrative Procedure Act, such rules have the force of law.

Agencies have two main purposes: assisting in carrying out vital government functions and exerting regulatory control. They are the instruments through which Congress and the president institute policies and implement government regulation. As both government and government regulation have steadily grown, starting in the �irst half of the 20th century, agencies, as the instrumentality of that growth, have likewise swelled in size and power. While the titular seat of power may rest with legislative and executive branches of government, it is administrative agencies that carry out the day-to- day operation of governmental regulatory and service functions, and they often take on a life of their own.

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5.2 The Administrative Procedure Act An independent federal agency is created through an act of Congress that establishes the agency and empowers it to perform whatever duties Congress speci�ically delegates to the agency. The actual creation of the agency and the scope of its authority are detailed in the enabling legislation—the act of Congress that creates the agency. The details of the agency's operation are left to the agency, which creates its own rules in accordance with the guidelines set forth in the 1946 Administrative Procedure Act (APA). The APA gives agencies broad rulemaking powers, as long as they act within the guidelines that the APA provides. Federal executive agencies are usually created by presidential order. Like independent agencies, executive agencies are also subject to the guidelines of the APA.

What relevance does this have to you as a businessperson? One effect could be that if an act by an administrative agency exceeds the powers given to it by its enabling legislation, and this impacts your business, then the act by the administrative agency is unenforceable.

Rulemaking Requirements

Under the Administrative Procedure Act, agencies have the power to create rules that have the force of law provided that the guidelines of the APA are observed. The basic requirements that all federal agencies must observe in rulemaking are as follows:

Giving notice to the general public that a new rule or rule change is being considered by publication of the proposed rule in the Federal Register

Providing an opportunity for all interested parties to participate in the rulemaking process by conducting public hearings and giving all interested parties a reasonable opportunity to voice their views on the proposed new rule or rule change

Publishing in the Federal Register a draft containing the essential factors relating to the proposed rule and its purpose at least 30 days before the rule is to take effect

Once the requirements of the APA have been met, the proposed rule takes effect on its proposed effective date and has the force of law.

Limits on Administrative Agencies

As previously noted, federal agencies have far-reaching powers within the areas that they oversee. A congressional grant of authority to an agency often includes the ability to carry out investigations, create rules that are the functional equivalent of statutes, hold hearings to adjudicate alleged violation of agency rules, and assess punishment (usually by way of �ines) to those adjudicated to be in violation of the agency's rules. Agencies with such powers, such as the Internal Revenue Service, can act as legislator, police, judge, and jury.

While this concentration of power leads to the swift administration of justice, the average citizen facing an administrative hearing may take comfort in the knowledge that both agency rules and most agency decisions are subject to judicial review on any of the following grounds:

The agency acted beyond the scope of its authority under the agency's enabling act; The agency misinterpreted federal law (including its enabling act) in its rulemaking

or in the adjudication of any matter before the agency; Agency action violates the U.S. Constitution or any federal law; or Agency rules or the �indings of administrative law judges are arbitrary or capricious.

Agency rules and procedures, as well as the adjudications by administrative law judges of agency hearings conducted as informal trials, are upheld by the courts as long as they meet the noted requirements.

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Members of the president's cabinet direct executive agencies such as the Departments of State, Justice, and Homeland Security.

5.3 Types of Administrative Agencies Federal agencies fall into two basic categories: independent and executive. Independent agencies are created by Congress to assist it in exerting regulatory control or to carry out governmental administration. Once created, these agencies are headed by a director who is appointed by the president and con�irmed by the Senate. In order to distance these agencies from the political process, independent agency directors serve for set terms that are staggered so as to prevent any given administration from having too great an impact on such agencies through presidential appointments.

Independent Federal Agencies

Independent federal agencies can wield tremendous power. Congress often imbues these agencies with quasi-judicial, quasi-legislative, and quasi-executive powers: they create their own rules (a legislative power), enforce these rules and conduct investigations (executive powers), and adjudicate disputes relating to these rules or their applications in administrative hearings similar to trials (a judicial power). Administrative law judges (ALJs) preside over hearings, rule on issues of evidence, decide the outcome of cases, and write opinions. Independent agency directors are appointed by the president and con�irmed by the Senate.

Independent agencies perform a vital function in areas where speci�ic expertise is a requirement in order to perform a governmental function or regulate a speci�ic business. They include the Central Intelligence Agency, the Environmental Protection Agency, the Equal Employment Opportunity Commission, the Federal Communications Commission, the Interstate Commerce Commission, the Federal Trade Commission, the Nuclear Regulatory Commission (NRC), and the Securities and Exchange Commission, among many others. Although Congress may have the right to regulate aviation (because of aviation's impact on interstate and international commerce), the civilian and military use of nuclear energy, and intelligence gathering, few senators or representatives have the highly specialized knowledge necessary to effectively regulate any of these areas. Rather than regulating these areas directly, Congress can set up agencies staffed with experts who can promulgate rules by relying on their superior knowledge of the �ields they regulate or operate in, with appropriate congressional oversight. Consider the following examples.

1. The Nuclear Regulatory Commission (NRC), concerned about safety in the nation's nuclear power generating stations, wishes to impose new safety regulations affecting such power-generating plants. After issuing a notice to the general public that it is considering safety rule changes, the agency conducts hearings from interested persons in the industry as well as from the general public for a period of 60 days. At the conclusion of these hearings, it decides that it would be in the best interest of the industry to ban the sale of alcoholic beverages in counties where nuclear generating plants are located. It then publishes a copy of the proposed regulation as well as a general statement of the need for such regulation in the Federal Register 30 days before the regulations are to take effect. After the effective date of the regulations, it is challenged in a federal district court of appeals by liquor store owners in affected counties. What is the result?

2. In the last example, assume that the NRC followed the same procedure and promulgated a rule that forbade nuclear generating plant workers from working with a blood alcohol level of .05%, subjecting violators to a �ine of $5,000. Is such a regulation likely to be upheld if it is challenged in court? Explain.

3. The Federal Communications Commission, concerned with the increasing violence and hatred depicted in the popular media, decides to consider new rules affecting the broadcasting of material of a violent, sexual, or hateful nature. After following the established procedures for rulemaking under the APA, it promulgates the following new rules:

A. Material of a violent or sexual nature can be broadcast only between the hours of 12:00 a.m. and 6:00 a.m.;

B. Music that advocates physical violence, the degradation of women, or racial bigotry cannot be broadcast at any time.

Will these two regulations withstand court challenges? Explain.

Executive Agencies

Federal agencies have also been created to assist the executive branch in carrying out its responsibilities. Notable executive branch agencies include the Federal Bureau of Investigation (Justice Department), the U.S. Customs Service (Treasury Department), the Food and Drug Administration (Health and Human Services Department), the Bureau of Indian Affairs (Interior Department), the Immigration and Naturalization Service (Justice Department), the Secret Service (Treasury Department), the Federal Aviation Administration (Transportation Department), and the Social Security Administration (Health and Human Services Department), to name only a few. Consider the following example.

The Federal Aviation Administration wants to institute new safety regulations relating to the use of drugs and alcohol by pilots in civil aviation. After conducting a study, the agency decides that it would be in the best interest of the general public to begin weekly random drug testing of all airline pilots effective immediately. At the direction of the agency

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director, the FAA sends out notices to all airlines that a new drug testing program is now in effect. Is this regulation valid under the facts given? Explain.

Unlike independent agencies, executive agencies are under the control of the president, who can appoint and remove their directors at will. Executive agency directors, including members of the president's cabinet, serve at the pleasure of the president. These agencies are, therefore, much more responsive to political issues and subject to the winds of political change, at least at the top levels. Nonetheless, most agency workers are civil servants, not political appointees, and enjoy the relative job security that status conveys. Thus, while the heads of executive agencies may come and go with changing administrations, the bureaucracy itself is well entrenched and grows yearly as new agencies are created and existing agencies expanded to help implement government goals and programs.

State Agencies

Agencies are used not only by the federal government but also by state governments. State administrative agencies are set up to assist the executive and legislative branches to carry out their responsibilities. States use agencies to assist with such matters as the administration of workers' compensation, social services, tax collection, and the regulation of business. For example, each state has a tax division that not only oversees the collection of state taxes but also has a component with hearing boards that hold "trials" or hearings presided over by government ALJs. There is also an appeals component wherein the loser can take the tax issue to another level in the same agency. The decisions of the hearings are published and become stare decisis for further hearings. Businesses can easily consult these matters to see the current state of the law.

Workers' Compensation Boards

Because workers' compensation is such an important business-related topic, this section will focus on a "typical" workers' compensation board and how it makes law, but keep in mind that each state creates its own workers' compensation law, so the rules discussed next vary throughout the United States. If you want to view your own state's workers' compensation rules and procedures, search the words "workers' compensation State C." The Colorado workers' compensation can be found here (http://www.colorado.gov/cs/Satellite/CDLE-WorkComp/CDLE/1240336932511) ; Utah at laborcommission.utah.gov; and so on. Each state's website is detailed and provides information unique to its systems and rules. For an overview, the U.S. Small Business Administration website sets out links for business managers looking for workers' compensation information throughout the states found here (http://www.sba.gov/content/workers- compensation) .

How Workers' Compensation Boards Make Law

In the early 1900s, when the United States had a large industrial base, many employees who were injured or killed at work, or their families, could not pay their medical expenses and often lost their jobs if their injuries were serious. Workers' compensation laws serve an important social and political purpose in that they force employers to pay into an insurance fund to guarantee that employees will have medical and hospital coverage for injuries or death on the job. The trade-off is that the employee cannot sue the employer for negligence, a proceeding that would most likely result in much larger monetary compensation for the employee than the awards available through workers' compensation.

When an employee is injured at work, the employee submits any medical bills to the employer and the bills are then paid. On occasion, an employer may refuse to pay an injured employee's claim. Suppose, for example, that an employee suffers a heart attack at work. The employer may argue that the injury is not work related, and thus the employer is not liable. The employee, on the other hand, may disagree, contending that the job caused his heart attack, making him eligible for bene�its. Such a workers' compensation claim is deemed controverted. When this occurs, the employee may request a hearing before a workers' compensation administrative judge. At the hearing there will be doctors, the employer, the employee, and the judge, who will listen to the "testimony" and render a decision about whether or not the employee is entitled to payment. Thus, the hearing resembles a trial in which there are witnesses and testimony and a decision by a judge. Because the hearing is "like a trial" but does not have all the formalities of a trial, it is called quasi- judicial. The judge's decisions are written down and can serve as precedent, thereby providing some predictability. In this way, workers' compensation hearings "make law." The following case excerpt (with citations omitted) is an example of a controverted matter before the New York Workers' Compensation Board.

Cases to Consider: Richman v. Workers' Compensation Board

Richman v. Workers' Compensation Board, 936 N.Y.S. 2d 722 (Jan. 2012)

Appeal from a decision of the Workers' Compensation Board, �iled August 18, 2010, which ruled that claimant sustained a compensable injury and awarded workers' compensation bene�its.

On August 10, 2007, claimant, a court reporter, was found unconscious at her workplace and rushed to a local hospital, where she was diagnosed with a subarachnoid hemorrhage caused by a ruptured basilar artery aneurysm. Although claimant survived, she apparently remains unable to communicate. A workers' compensation claim subsequently was �iled on her behalf, and the employer and its workers' compensation carrier (hereinafter collectively referred to as the employer) controverted the claim, asserting that the ruptured aneurism was not related to claimant's employment. Following a hearing, a Workers' Compensation Law Judge (hereinafter WCLJ) found that the employer did not overcome the presumption of compensability set forth in Workers' Compensation Law § 21 (1). The Workers' Compensation Board af�irmed the WCLJ's decision, prompting this appeal by the employer.

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We af�irm. Pursuant to Workers' Compensation Law § 21 (1) a presumption of compensability exists where, as here, an unwitnessed or unexplained injury occurs during the course of the affected worker's employment. "The employer may overcome the presumption by presenting substantial evidence to the contrary."

Here, we �ind no basis upon which to disturb the Board's conclusion that the employer did not present suf�icient evidence to overcome the presumption. The record establishes that, prior to claimant's collapse, she was under considerable stress at work and her workplace was loud and overheated. While the employer's expert opined that claimant's ruptured aneurysm was unrelated to her employment, the Board agreed with the WCLJ that the expert's report and testimony were not credible—in large measure because he was evasive when questioned as to whether workinduced stress could raise a person's blood pressure high enough to cause an aneurysm to rupture. Notably, the expert acknowledged that high blood pressure could be a factor in the rupture of an aneurysm and conceded that he did not know what claimant's blood pressure was at the time the rupture occurred. Contrary to the employer's argument, the Board, which "is the sole arbiter of witness credibility" was not required to wholly credit the expert's opinion on this point simply because it was the only expert proof presented. The employer's remaining arguments on this point, to the extent not speci�ically addressed, have been examined and found to be lacking in merit.

ORDERED that the decision is af�irmed, without costs.

Read the full text of the case here (http://law.justia.com/cases/new-york/appellate-division-third-department/2012/512356.html) .

Questions to Consider

1. What did the court mean by a "presumption of compensability"? What does this mean?

2. How does the employer overcome this presumption? Did the employer succeed in this case? Why or why not?

How Workers' Compensation Boards Determine Payment

When an employee is injured on the job, the next step in the process is for that employee to receive medical attention. The doctor will make a determination about the extent of the injury, deeming it either temporary or permanent. For example, if the worker suffered a broken arm, the injury is temporary; if the worker suffered a spinal injury, the injury may be permanent. In the case of permanent injuries, the doctor (or doctors) will make an assignment of the percentage of injury, for example, 32% permanent partial disability. That number will then be converted using the state's permanent partial disability schedules to an actual dollar amount. For example, a right index �inger under the schedule might be worth $2,500. The complexities of determining a workers' compensation award are illustrated in the excerpts from the following case, which shows the ways in which claimants are classi�ied and paid:

Cases to Consider: Schmidt v. Falls Dodge, Inc.

Schmidt v. Falls Dodge, Inc. New York State Court of Appeals (2012)

Workers' Compensation Law §15(6) provides that compensation for any disability, partial or total, shall not exceed a �ixed maximum per week. At issue in this case is the application of the cap when an employee has received several awards for different injuries, at least one of which is a so-called "schedule loss of use" award being paid periodically pursuant to the pre–2009 version of Workers' Compensation Law §25. We hold that in such cases an employee's total weekly payment may not exceed the cap. The schedule award is not nulli�ied by the other awards, but must be deferred until the time comes when the cap will not be exceeded.

I

Plaintiff worked as a collision shop technician, repairing automobiles. He suffered several injuries on the job, of which three, all occurring in 2005, are relevant to this appeal. On February 21, he slipped on ice, injuring his hip and back. On March 18, he suffered a lower back sprain. He left his job on June 27, and later reported hearing loss beginning on that date, attributable to loud noise at his place of work. He applied for and received workers' compensation bene�its for all three injuries.

For the hip and back injuries, the workers' compensation carrier for claimant's employer was directed, in separate awards, to pay claimant a total of $400 per week—the maximum allowed, at the relevant time. . . . Though the disabilities caused by the hip and back injuries were designated as "temporary," nothing in the record indicates that these $400 weekly payments have ever been discontinued.

On September 21, 2007, a Workers' Compensation Law Judge made an award for the hearing loss claim. Claimant was found to have a permanent partial disability, entitling him to a schedule loss of use award under Workers' Compensation Law §15. . . .

The Judge in this case found that claimant's hearing loss entitled him to 32.145 weeks of bene�its at the rate of $400 per week; the award speci�ied a period from September 27, 2005 (the "date of disablement" found by the Judge) to May 10, 2006. After considering the carrier's objections, the Judge concluded on November 23, 2007 that the schedule award was "currently payable in full," notwithstanding the fact that claimant had received during the period in question, and was still receiving, $400 per week for his other claims. The Judge found the issue to be controlled by Matter of Miller v. North Syracuse Cent. School Dist. in which the Appellate Division held that because a schedule award "is not allocable to any particular period," it "cannot be deemed to overlap with" a temporary total disability award.

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II

Workers' Compensation Law § 15(6)(a) says, in relevant part:

Compensation for permanent or temporary partial disability, or for permanent or temporary total disability due to an accident or disablement resulting from an occupational disease that occurs . . . on or after July �irst, nineteen hundred ninety two [and before July one, two thousand seven], shall not exceed four hundred dollars per week.

The Board and the Appellate Division have held in this case that claimant was entitled to receive $800 per week for a period of roughly 32 weeks. That result cannot be squared with the cap imposed by section 15(6). The Appellate Division's decision in Miller, which upheld a similar award, is incorrect and should not be followed.

We therefore hold that periodic payments of a schedule loss of use award must be deferred to the extent that those payments, when combined with payments of another disability award, would exceed the cap imposed by Workers' Compensation Law § 15(6). We hold no more than this, and do not decide what implications, if any, our holding may or may not have for cases governed by the 2009 amendment to section 25(b): that section, as amended, now says that schedule loss of use awards "shall be payable in one lump sum, without commutation to present value upon the request of the injured employee."

Accordingly, the order of the Appellate Division should be reversed, with costs, and the case remitted to the Appellate Division with directions to remand it to the Workers' Compensation Board for further proceedings in accordance with this opinion.

Read the full text of the case here (http://www.nycourts.gov/ctapps/Decisions/2012/May12/76opn12.pdf) .

Questions to Consider

1. What different injuries did this employee suffer at work, and what were his workers' compensation awards for each?

2. This case is concerned with the cap that a worker may receive for workers' compensation. Why does the state impose a cap? And what possible effect does this have on an employee?

Workers' Compensation as the Exclusive Remedy

As mentioned above, workers' compensation serves an important social function by guaranteeing that workers hurt on the job are taken care of medically and that their bills are paid. There is a trade-off for this guarantee, however. Employees are not allowed to sue their employers for injuries on the job that are a result of the employer's negligence. Thus, we say that workers' compensation is the exclusive remedy, meaning it is the only remedy available to an injured worker against an employer. If an employer does not put up an adequate guard around a machine and an employee is seriously maimed, the employee's monetary award is limited to workers' compensation rather than a lawsuit in court. (However, the employee in such a situation could sue the manufacturer of the machine, who, of course, is not the employer.) (See Chapter 8, Negligence, Strict Liability, and Product Liability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec8.1#sec8.1) .) This is the maximum amount that an employee could recover under workers' compensation, whereas in a tort lawsuit, the same injury might be worth millions of dollars, �iguring in punitive damages, compensation for emotional distress, and so forth. There is usually no choice; workers' compensation is the only remedy afforded to employees against employers, except in rare exceptions.

One of those exceptions is if the employer intentionally injured the worker, as discussed in the Washington State case Brame v. Western State Hospital, excerpted here with citations omitted:

Cases to Consider: Brame v. Western State Hosp.

Brame v. Western State Hosp., 136 Wash. App. 740, 150 P.3d 637 (2007)

In 1911, the legislature passed the Industrial Insurance Act, which provided injured workers a system of certain, no-fault compensation for injuries on the job while granting employers immunity from civil suits by workers. The act generally bars employee lawsuits against employers for on-the-job injuries.

This bar is subject to a limited exception when an employer intentionally injures an employee:

If injury results to a worker from the deliberate intention of his or her employer to produce such injury, the worker or bene�iciary of the worker shall have the privilege to take under this title and also have cause of action against the employer as if this title had not been enacted, for any damages in excess of compensation and bene�its paid or payable under this title.

This exception prevents employers who engage in egregious conduct from burdening the industrial insurance risk pool. We interpret the deliberate intention exception narrowly. Neither gross negligence nor failure to observe safety laws or procedures rise to the level of deliberate intention. Even an act that has a substantial certainty of producing injury is insuf�icient to show a deliberate intent to injure.

The Birklid Test

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Until 1995, courts found deliberate intention only in cases where an employer or its agent physically assaulted an employee. But in Birklid our Supreme Court interpreted the exception to include conduct other than physical assaults. In that case, the plaintiffs alleged that a supervisor reported to management that fumes from a new product were making employees sick; management denied a request for improved ventilation before increasing use of the product; workers became ill after the product went into full production; and Boeing knew that the symptoms were the result of exposure to the product. The court, �inding that the employees had alleged suf�icient facts to �ind deliberate intent on the part of Boeing to injure them, held that deliberate intention exists where the employer (1) has actual knowledge that an injury is certain to occur and (2) willfully disregards that knowledge.

***

Since Birklid, the Supreme Court continues to emphasize the need to show actual, not substantial, certainty. For example, in Vallandigham employees alleged that the school district deliberately intended to injure them because it willfully disregarded its knowledge that a severely disabled special education student would injure them. The employees alleged that over the course of a school year the student had injured staff and other students about 96 times, resulting in 7 workers' compensation claims. The school district had taken numerous steps to try to modify the student's behavior, including implementing a behavior plan, hiring a one-on-one aide, and creating an isolation space. The court rejected the employees' claims, holding that they met neither prong of the Birklid test.

The court emphasized that the �irst prong "can be met in only very limited circumstances where continued injury is not only substantially certain [to occur] but certain to occur." Foreseeability is not enough to establish deliberate intent to injure an employee, nor is an admission that injury would probably occur. And the plaintiffs' case could not meet this test because "the behavior of a child with special needs is far from predictable"; no one knew that the violent behavior would not stop as quickly as it began. This was unlike Birklid where the employer knew that continued exposure to the chemical would make employees sick absent increased ventilation.

In addressing the second prong of the test, the court disapproved of two Court of Appeals cases that considered whether the steps the employer took to prevent injury were reasonable and whether they were effective. These tests, according to the court, adopted, at least in part, a negligence standard; the court again emphasized that the deliberate intent exception does not apply in cases of negligence, even gross negligence.

The Employees contend that the trial court erred in granting the Hospital summary judgment because issues of material fact exist as to whether the Hospital deliberately intended to injure them. They argue that the Hospital knew with certainty that patients would assault staff and that it willfully disregarded this knowledge. They point to the history of patient assaults on staff as proof that the Hospital knew with certainty that patients would assault staff in the future. And they assert that the Hospital willfully disregarded this knowledge because it did not effectively train staff in defending themselves against patient assaults and instead implemented a non-violence initiative aimed at eliminating the use of physical restraint of patients.

Even taking the facts in the light most favorable to the Employees, they cannot meet the stringent requirements of the Birklid test. The Employees do not contend that the Hospital knew that any speci�ic assault would occur. They rely instead on the history of patient-to-staff assaults. But past patient-to-staff assaults demonstrate, at the most, that such assaults are foreseeable, not that they are certain. Foreseeability is not suf�icient to establish deliberate intent to injure an employee. In Vallandigham, 96 prior assaults by one student were not suf�icient to predict with absolute certainty any particular future assault. Similarly, here the past assaults of hospital patients on hospital staff are not suf�icient to create a certainty that any individual patient will assault any individual staff member.

Read the full text of the case here (http://caselaw.�indlaw.com/wa-court-of-appeals/1432625.html) .

Questions to Consider

1. Under what circumstances may an employee sue his or her employer for injuries sustained at work under this court's theory?

2. Why does this court make an exception to the rule, allowing employees to sue their employers? Do you agree with this policy shift?

Employers' Duties Under Workers' Compensation Law

Employers have many responsibilities under workers' compensation too numerous to list here. Among the most important requirements, however, are that the employer must have in place insurance, either through a private carrier or through the state fund. In New York, for example, an employer's failure to provide workers' compensation coverage is a crime, punishable by �ines and/or criminal prosecution. If an employer does not have coverage and an employee �iles for workers' compensation, the employer will be liable for the actual cost of medical care and compensation payments, in addition to penalties. If a corporation has failed to secure workers' compensation coverage, the president, secretary, and treasurer of the corporation are personally liable for the medical care, compensation payments, penalties, and possible criminal prosecution. This applies to situations in which employers might hire someone "under the table." If that person is injured and is not listed on the books, there are numerous workers' compensation violations associated with such conduct, some of them criminal.

Workers' compensation rules are detailed, but each state has a website devoted to the issue. On it, the responsibilities of the employer are clearly spelled out.

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Key Terms

Click on each key term to see the de�inition.

administrative agencies (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

State and federal governmental entities set up to assist with the smooth operating of areas of business and industry and to provide special expertise.

administrative law judge (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Government employee (state or federal) who presides over agency hearings and writes opinions upon the conclusion of the hearing that resemble a judicial decision and are therefore quasi-judicial.

Administrative Procedure Act (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Speci�ies the procedures that administrative agencies must follow in promulgating new rules.

agency rules (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Guidelines under which an agency operates and that must be followed by persons over whom the agency is given regulatory powers.

controverted (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Refers to a workers' compensation case in which the employer refuses to pay following a worker's injury or death.

exclusive remedy (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The concept that employees may not sue their employers for injuries or death on the job but can seek a remedy only through the workers' compensation process.

executive agencies (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Agencies that have been created to assist the executive branch in carrying out its responsibilities.

independent federal agencies (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Agencies created by Congress to assist it in exerting regulatory control or to carry out governmental administration.

permanent partial disability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A determination in workers' compensation that the disability suffered by the employee covers part of the body but will be permanent, thereby converting it to a "schedule loss of use award." The injury is given a �ixed number of lost weeks' compensation according to the bodily member injured.

private insurance carrier (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An insurance carrier for an employer to cover matters like workers' compensation claims.

state fund (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A general statewide fund to which employers contribute and which then pays out workers' compensation claims.

workers' compensation board (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A state administrative agency that adjudicates cases requesting compensation to workers for death or injury on the job.

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Chapter 5 Flashcards

Critical Thinking and Discussion Questions

1. What is the basic purpose of government agencies?

2. What is the purpose of state administrative agencies?

3. What are the basic Administrative Procedure Act requirements that agencies must observe in rulemaking?

4. What are the quasi-judicial and quasi-legislative powers that some agencies are given in their enabling legislation?

5. Where does one look to �ind the exact power that Congress has given to an independent federal agency?

6. Although agency heads change from time to time as part of the political process, most agency employees are unaffected by changes in political administrations. Why?

7. Julian works in a shoe manufacturing plant putting the soles on leather shoes using a machine similar to a lathe, a rotating metal pipe. On the day in question, Julian was preparing to place the leather into the machine when a piece of his clothing became caught on the lathe, pulling on his arm and causing severe injuries. His employer refuses to pay for any of his injuries, claiming that the injury is completely the fault of Julian's negligence. What options for remedy would Julian have? Assume that another employee pushed Julian into the machine, and that is why he suffered the injuries. Now what would Julian's options for remedy be? Now assume the employer pushed him into the machine, and that is the sole reason he suffered the injuries. In this situation what would Julian's options for remedy be?

State and federal governmental entities set up to assist with the smooth operating of areas of C l i c k c a rd t o s e e t e r m 👆

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Unit II

Criminal Law and Torts

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Chapter 6: Criminal Law

In this chapter you will:

Understand the elements and classi�ications of different types of crime.

Identify defenses to criminal liability.

Chapter 7: Intentional Torts

In this chapter you will:

Understand the elements and classi�ications of intentional torts.

Chapter 8: Negligence, Strict Liability, and Product Liability

In this chapter you will:

Understand the elements of negligence and use of the "reasonable person standard."

Identify defenses to negligence.

Distinguish between strict liability and product liability.

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Chapter 9

Contracts, Part I: Introduction and Formation As a manager, you may �ind yourself dealing with contracts on a regular basis. For instance, contracts may be presented to you for signature or you may be asked to hire an employee. Perhaps you will enter into contracts to purchase goods for the business or to arrange insurance coverage. In any event, understanding the mechanics of contract law is essential to effectively carry out your obligations.

This chapter presents an overview of contract law. It is not meant to take the place of legal advice, nor will it make you an expert in contract law. What you should derive from these materials is an appreciation of the complexities of contract law and a mindset for acting preventively and strategically in your business dealings. Warding off the possibility of a contract lawsuit is a cost-saving measure. Furthermore, you should acquire an understanding of black letter law, that is, the theories of law in the context of business and employment contracts.

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9.1 What Law Governs Your Contract? Contract law is governed by either the common law or the Uniform Commercial Code (UCC). As a student, the �irst question you should ask yourself when contemplating a contract problem is: What body of law is this contract under? Fortunately, the answer is relatively simple:

If the contract involves the sale of goods, it is governed by the Uniform Commercial Code (whether the people involved are merchants or nonmerchants); and

If the contract deals with anything other than sales of goods (e.g., real estate, insurance, or personal services), then it is governed by the common law.

As a manager, you will need to know which body of law applies to a particular contract. For example, warranties apply to goods sold pursuant to the UCC but do not apply to contracts under the common law. When you hire an employee to join your staff, you enter into a contract that is governed by principles of common law. Selling food in your restaurant, however, creates a contract governed by the UCC. What difference does it make which set of rules applies? In the restaurant example, the UCC covers a warranty about the quality of goods, whereas the common law does not. An employee could not sue for breach of warranty for the quality of his or her of�ice, for example, but could for the quality of the food in your restaurant. Table 9.1 provides some examples of types of contracts covered under each body of law. Many other differences between the two regimes will be examined throughout this chapter.

Table 9.1: Contracts governed by common law or the Uniform Commercial Code

Examples of Common Law Contracts Examples of Uniform Commercial Code Contracts

Real estate (e.g., selling a house) Sale of goods (e.g., purchasing an automobile or of�ice equipment) between merchants or nonmerchants

Insurance

Personal services (e.g., hiring an employee or professional)

Sometimes a contract comprises both goods and services. For example, if you hired people to build your house, they would need to supply material goods, such as the bricks, cement, wiring, and wood, as well as services, that is, constructing the building. What law governs such a contract? The answer lies in the predominant test, which asks: Which is greater, the cost of the goods (UCC) or the cost of the services (common law)? If the cost of the goods is greater, then the contract is governed by the UCC; if the cost of the services is greater, then the contract is governed by the common law. For example, suppose that a buyer hires a contractor to construct a new factory. The goods to build the new plant cost $450,000 and the cost of the contractor's services total $1 million. Under the predominant test, the cost of the services is greater, and therefore, the contract is governed by the common law.

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The Nature of Contract Law

9.2 Elements of a Contract Although all contracts contain promises that are enforceable, not all promises rise to the level of a contract. Rather, only promises that meet certain criteria are considered to be valid contracts. For a valid contract to be formed that is enforceable by a court, each of the following criteria must be present:

1. Offer

2. Acceptance

3. Consideration (something of legal value given and received by each party to the contract)

4. Capacity (mental capacity or legal ability)

5. Legality (of purpose)

We will discuss each one of these elements in the following sections. The phrase enforceable by a court is signi�icant because it means that a court can assess monetary damages against a party who does not comply with the terms of the agreement. Thus, it is important to recognize these de�ining elements, for example, when a seemingly innocent statement becomes a binding statement leading to contract formation.

Because an offer and acceptance are sent over electronically by email, or in a Tweet or text message, they are in a tangible form or in writing. As such, the fact that it is an electronic form does not affect contract formation. What matters is that it is in writing—clearly an advantage over contracts made by the parties that are oral; for a writing, that means the terms are stated in the correspondence itself.

What has changed with regard to electronic contract formation is the signature. All states but three (New York, Illinois, and Washington) have adopted the Uniform Electronic Transactions Act. Although each state's law as adopted has different components, the following is an example of Montana's law:

30-18-104. Use of electronic records and electronic signatures—variation by agreement.

(2) This part applies only to transactions between parties[,] each of which has agreed to conduct transactions by electronic means. Whether the parties agree to conduct a transaction by electronic means is determined from the context and surrounding circumstances, including the parties' conduct.

(3) A party that agrees to conduct a transaction by electronic means may refuse to conduct other transactions by electronic means. The right granted by this subsection may not be waived by agreement.

(4) Except as otherwise provided in this part, the effect of any of its provisions may be varied by agreement. The presence in certain provisions of this part of the words "unless otherwise agreed," or words of similar import, does not imply that the effect of other provisions may not be varied by agreement.

(5) Whether an electronic record or electronic signature has legal consequences is determined by this part and other applicable law.

30-18-106. Legal recognition of electronic records, electronic signatures, and electronic contracts.

(1) A record or signature may not be denied legal effect or enforceability solely because it is in electronic form.

(2) A contract may not be denied legal effect or enforceability solely because an electronic record was used in its formation.

(3) If a law requires a record to be in writing, an electronic record satis�ies the law.

(4) If a law requires a signature, an electronic signature satis�ies the law.

Some states make the law expressly apply to commercial as applied to personal transactions. Others also state that an electronic signature is not applicable to documents such as wills.

ESIGN is a federal version of the same law that was enacted by Congress to facilitate the use of electronic records and signatures in interstate or foreign commerce. It holds that a contract relating to such a transaction may not be denied legal effect, validity, or enforceability solely because an electronic signature or electronic record was used in its formation. (See U.S. Government Printing Of�ice (GPO), Public Law 106-229—Electronic Signatures in Global and National Commerce Act (http://www.gpo.gov/fdsys/pkg/PLAW-106publ229/content-detail.html) .)

Offers

The two parties to a contract are the offeror (the person making the offer) and the offeree (the person who has the power to accept the offer). Suppose an offeror says, "I will sell you a basset hound puppy." This offer creates in the offeree the power of acceptance. Therefore, one can say that the offeror is the

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party who makes the offer, and the offeree is the party who has the power of acceptance. Imagine that you wish to purchase a new copier machine for your business and that you have been instructed to contact a particular supplier, which we will call Acme Business Supply Company. You would most likely begin by calling and inquiring about machine types and prices. Information would be exchanged about your business needs and what machines would meet those needs. Although informal, these discussions are called preliminary negotiations. Preliminary negotiations are the conversations, e-mails, telephone conversations, and other dialogue that occur before a contract is created. Note that these talks are completely unenforceable between the parties.

How, then, does one distinguish a preliminary negotiation from a legally binding offer? An offer has three characteristics that set it apart from a preliminary negotiation. First, the language of an offer is de�inite and certain. If you say to Acme Business Supply Company, "I offer to buy the 123C Machine for $5,000," that language is considered de�inite and certain and constitutes an offer because it clearly expresses the intent to purchase the goods. Second, the transaction between the parties must look like a contract and not something else. This is called the objective test. "Objective" means how it appears to a hypothetical reasonable third party. Third, the offer must be communicated to the offeree (see Table 9.2).

Table 9.2: Distinctions between a preliminary negotiation and an offer

PRELIMINARY NEGOTIATION OFFER

Language "I am thinking about . . ." "I offer . . ."

"I might sell my goats . . ." "I agree to sell you my goats"

"I am thinking about buying that car . . ." "I will buy that car from you..."

Objective Test Does not look like the two parties are entering into a contract.

Appears to a reasonable third party that the two parties are entering into a contract.

Communication to the Offeree

No offer is communicated. Offer is communicated.

Consider the following example: You opened your mail at work today and received this offer letter.

Carl Beethoven Real Estate

Dear Customer:

As you are aware, I am the owner of a substantial amount of real estate in the Pocono Mountains. I am thinking about retiring next year and need to sell off a substantial portion of my holdings. If you are interested, please contact me.

Sincerely,

Carl

If you wrote back and said, "I accept," would you have a contract with Carl? The answer is no. To have a contract, you must �irst have an offer, and to have an offer, the language must be de�inite and certain. The language in Carl's letter "If you are interested" and "I am thinking about" is instead vague and noncommittal. Therefore, this dialogue opening is a preliminary negotiation only.

Offers in Large Communicating Media

Sometimes, the language of an offer appears in a large communicating medium. This is a site like a newspaper, webpage, Tweet, or television advertisement, which potentially has thousands of people hearing or seeing the "offer." The problem is that when thousands of people hear an offer simultaneously, no one has the power of acceptance. And, if no one has the power to accept, then it is not considered an offer but rather a preliminary negotiation, even if it is couched in language that is de�inite and certain.

There is an exception to this rule, however. In these situations, a message in a large communicating medium does constitute an offer because the number of potential offerees is limited. For example, if the offer states, "First come, �irst served!" then only the �irst person has the power of acceptance. Or, if the offer limits the class of offerees to the �irst 100 callers, then only 100 people have the power of acceptance. Another example would be if it is a reward contract offered by a local police department; then only the person giving information leading to the arrest of the fugitive would have the power of acceptance.

Once it has been established that an offer has been made, four events may then take place, as illustrated in Figure 9.1.

Figure 9.1: Four events that can happen after an offer

In order for a contract to be made, an offer must be accepted. If an offer is initially rejected, a counteroffer can then be made and, if accepted, lead to a contract.

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Lapse

Lapse is the outcome that simply refers to the fact that an offer does not last forever. After a certain amount of time, the offer expires. How much time is that? The answer is, it depends on the situation. In most businesses, an offer is open for a reasonable amount of time, say, two weeks. However, if the business is a wildly �luctuating market, such as stocks or commodities, the offer can lapse after only a few seconds. An important exception to this rule is the option contract, a frequently used and highly valuable business tool. In an option contract, the offeree will pay money to hold the offer open for a certain amount of time.

Consider, for example, that the offeror agrees to sell the offeree a $10 million printing press. The offeree is not sure whether �inancing for the press is available and needs to meet with bankers to determine if he can obtain a loan. At the same time, the offeree does not want the offeror to sell the press to anyone else. In such a case, the offeree could pay a certain sum, e.g., $1,000, to the offeror to hold the offer open for 30 days contingent on getting a bank loan. If the bank does make the loan, the offeree still has the power of acceptance, but if the bank says no, then all the offeree has lost is the $1,000.

Rejection and Counteroffer

In rejection, the offeror makes an offer to the offeree. The offeree then either says "no," which is an express rejection, or the offeree makes a counteroffer, which is also a rejection of the original offer. In either case, both responses negate the original offer and make the offeree the offeror, as illustrated in Figure 9.2.

Figure 9.2: Rejection and counteroffer

This response by the offeree kills the original offer. Now the original offeror becomes the offeree and has the power to accept the offeree's offer of $75,000.

Revocation

In revocation, the offeror takes back the offer before the offeree has time to accept. See Figure 9.3.

Figure 9.3: Offer revocation

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Acceptance

Acceptance is one of the four events that can happen after a valid offer, but it is the only one that leads to contract formation (the second element). Suppose the offeror said, "I will sell you a puppy for $200." If the offeree says, "I'd love a puppy! I'll take it!" then he or she has assented to the terms of the offer and contract formation has begun.

The Mirror Image Rule

In the acceptance phase, it is signi�icant whether the contract is governed by the UCC or by common law. Under the common law, acceptance must mirror the offer. For example, if you offer to sell me a house for $450,000, I must use those exact terms in my acceptance. Any deviation from the terms of the offer in the terms of my acceptance constitutes a counteroffer, not an acceptance. Under the common law, the rule for acceptance is called the mirror image rule. This means that all the terms in the offer must match (mirror) all the terms in the acceptance. If the terms do not match, the parties are still engaged in preliminary negotiations. This is illustrated in Table 9.3 and in the examples that follow.

Table 9.3: Offer and acceptance

OFFER ACCEPTANCE

"I offer A and B and C." "I accept A and B and C." This is a mirror image acceptance.

"I offer A and B and C." "I accept." (It is implied that A and B and C are included in the acceptance.)

This is a mirror image acceptance.

"I offer A and B and C." "I accept, but I want D, too." This is not a mirror image acceptance but a counteroffer; there is no contract formation.

"I offer you employment for six months at a salary of $50,000."

"I accept, but I want health insurance, too." This is not a mirror image acceptance but a counteroffer; there is no contract formation.

Acceptance Under the UCC

Recall that the Uniform Commercial Code applies to contracts involving the sale of goods. This is a law that was adopted by all 50 states to make the sale of goods from people in one state to another relatively uniform.

Under the UCC, no mirror image acceptance is required. If the offeree changes the terms of the offer, there may still be a contract. If the parties are not both merchants, the new terms in the acceptance become a proposal that the offeror may accept or reject. If the parties are both merchants, the new terms automatically become part of the contract unless the offeror objects or states that the offer can be accepted only in mirror image fashion. We will look at this rule in much more detail in Chapter 10 (chapter_10.htm;#ch10) , Contracts, Part II: The UCC.

After the Offer

SLIDE 1 OF 7

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Consideration

Consideration is the third element required of all contracts. Despite its importance to contract law and its long and deep history, it has really become quite archaic. As a result, we will discuss it only brie�ly. The concept of consideration is what makes a gift different from a contract.

To have consideration means that the promise by the promisor gets the promisee to do something he or she was not previously legally bound to do. For example, if Glenda says to Bill, "I will give you $1,000 if you �ind my lost dog," the offer of $1,000 is causing Bill to do something he has no legal obligation to do. When Bill �inds the dog, his action is what causes Glenda to promise the $1,000. We say that the promise of the $1,000 caused Bill to �ind the dog, and conversely, Bill �inding the dog is what caused Glenda to promise the $1,000. A shorthand way to say this is, the promise (of $1,000) induced the detriment (�inding the dog), and the detriment (�inding the dog) induced the promise (of $1,000).

Compare this scenario with the following: Suppose Glenda said to Bill, a police of�icer, that she would give him $1,000 to �ind her dog. Did the promise of the $1,000 cause Bill to do anything he was not already previously, legally bound to do? No. As a police of�icer, he is already obligated to do many things, including �inding lost dogs, so her promise did not cause him to do something he wasn't already obligated to do; thus, there is no consideration. Her promise to give him the $1,000 is completely unenforceable.

In a gift, the bestower might announce, "I am getting you a new car for your birthday!" That statement is another example of a completely unenforceable promise. While the promise to get you a new car for your birthday might cause you to do something that you were not previously legally bound to do, such as sell your current car (the promise caused the detriment), selling your car is not why the promisor said he would get you a new car, and so the detriment did not cause the promise. Therefore, there is no consideration, so if you sued your would-be benefactor when your birthday came and went and no car arrived in your driveway, you would lose in court because a gift is not a contract. If that same person, however, had promised, "I am getting you a new car for your birthday if you get an A in your law class," then you would have a contract. What is the difference? The promise to get you a car induced or caused you to do something you were not previously, legally bound to do (work for an A). And your getting the A is what caused the gift giver to promise the car: The car caused the A, and the A caused the car. Or stated another way, the promise (of the gift of a car) induced the detriment (earning an A), and the detriment (earning an A) induced the promise (of the gift of a car).

Capacity

The fourth element of a valid contract is capacity. This relates to the mental state of the parties to the contract. A party who lacks capacity does not have the ability to understand the consequences of entering into a contract.

Mental Competence

With regard to lack of mental capacity, people generally fall into two different categories. First, some people are deemed mentally incompetent by a court because they may have a disease such as Alzheimer's, or they may be acting in such a way that their family members ask the court to appoint a guardian. In either scenario, the fact that someone has gone to court and been adjudicated insane is a �inding that a person is non compos mentis, or lacking mental capacity. As a general rule, a person lacks capacity if he or she is judged by the courts to be so mentally ill that he or she can no longer handle personal business, and thus is assigned a legal guardian. Other categories of persons who may be assigned a guardian by a court are "habitual drunkards," another special type of category lacking mental capacity, and minors (those under the age of 18).

Persons who have been adjudicated insane can enter into a contract only through their guardians; if the insane person enters into a contract on his or her own, it is void. As a result, the insane person would have no liability for any damages to the goods and would be entitled to his or her money back.

Minors

Businesses more often deal with minors since they may constitute a large segment of their consumers, in retail sales, for example. Contracts with minors are not void, but rather voidable.

The law confers special protection on minors when it comes to disaf�irming contracts. This attitude stems from the common law notion that children need special protection because, compared with adults, they are innocent, gullible, and easy to be taken advantage of. Thus, a minor who enters into a contract may choose to escape his or her contractual liability, which is why contracts with minors are called voidable; they may be avoided by the minor. Such avoidance is called disaf�irmance. A person may exercise this right only before reaching the age of 18 or for a reasonable time thereafter. Suppose that a 16-year-old purchases a car on credit, pays for two months, and then decides to return the car. The minor may disaf�irm the contract but must return the car. Then the seller must return to the minor his or her payments to date. In short, the minor is completely protected from liability when entering into a contract. Needless to say, few merchants are willing to enter into a contract with a minor.

Once a minor reaches 18, the minor reaches majority and may want to continue, rather than disaf�irm, any contracts entered into before the age of 18. In this case, the person now of majority is said to ratify the contract. Rati�ication can be implied (by retaining the goods, for example) or express (e.g., by agreeing orally or in writing to continue the contract). Either way, the person is now liable for performance of the contract (to ful�ill one's obligations under its terms) he or she entered into as a minor, just as any other adult would be.

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But are minors liable for anything? Yes, in some instances, they are liable for their contracts. Speci�ically, the courts have ruled that minors are liable for necessaries, which comprise food, drink, clothing, shelter, medical care, and education. In evaluating whether an item is a necessary or a luxury (and therefore not exempt from disaf�irmance), courts generally look at the minor child's needs in relation to his or her upbringing and the relative wealth of the minor's parents. The minor is liable, however, only for the fair market value of such services, which may be considerably less than the price charged by the provider.

Business contracts entered into by nonemancipated minors (minors who are still dependent on their parents or guardians) are also exempt from disaf�irmance. The rationale here is clear: a minor who is mature enough to run his or her own business is also mature enough to be held responsible for contracts entered into on behalf of that business. However, that same minor is still free to disaf�irm personal contracts he or she enters into that are unrelated to the business.

If a minor lies about his or her age in order to induce an adult to enter into a contract, legal opinion is split among the states. Some states allow the adult to recover damages from the minor for the tort of fraud, while others allow the minor to disaf�irm the contract, even when the minor offered fraudulent proof of age to induce the adult to enter into the contract.

So how can a business protect itself from the impact of minors' disaf�irmance? By either requiring minors to obtain an adult cosigner for any contract they enter into, or by refusing to deal with minors altogether. The second option is seldom exercised, because minors represent a very important market for most vendors. And, with the exception of large-ticket items, the �irst option is also often impractical. Why then do merchants deal with minors? Because the bene�it of courting this pro�itable consumer segment far outweighs the potential cost of disaf�irmance. As a businessperson, it is essential that you are aware of those persons with whom you are contracting and their potential for reneging on their contracts with you.

Legality

The �ifth and �inal element of a contract is the requirement that the contract be legal. So even if it ful�ills all other four elements, if it is for the transfer of goods or services that are illegal, it is invalid.

An illegal contract is one that is de�ined by the law of its state as being illegal. Each state has different laws on this topic, but all states agree, for example, that hiring someone to commit murder is an illegal contract, since the purpose of the contract is illegal. Similarly, if Bob orders "100 grams of cocaine" from Harriett, that too is an illegal contract and unenforceable by the courts.

Sunday Contracts

In some states, entering into a contract on a Sunday renders the contract void. These laws originated from the religious belief that entering into business transactions on Sunday (when one should be observing the Sabbath and attending church) is immoral. These beliefs were codi�ied into legislation known as Blue Laws and are still in force to varying degrees in some states.

Overly Broad Noncompetition Contracts

Suppose that the Fabulous Hotel hires you as head chef under a two-year employment contract. After two years, another hotel wants to hire you. However, in the original employment contract you signed with the Fabulous, the following paragraph appears:

22. The below-signed agrees not to work as a chef for another hotel in the same metropolitan area for a period of two years after leaving our employ.

This is called a covenant not to compete, or a noncompetition clause. As a general rule, these clauses have been held valid in court. Does this mean that you cannot work for another hotel? That depends on certain factors that a court will consider to determine whether the clause is enforceable. These include:

Whether the agreement stood alone or was contained in an employment contract. If alone, the agreement is void;

The length of time involved. If too great, the contract is void; and

The location or distance involved. If the contract prohibits you from working in the Western Hemisphere, that scope is too great, but the same county may be small enough to consider the agreement enforceable.

If you agreed never to be a chef on the entire East Coast for the rest of your life, a court would most likely �ind that agreement illegal because it is in force for too much time and over too great a distance. In contract law, a clear dividing line between reasonable and unreasonable terms does not exist but is a matter of judicial discretion, so a court will study each case individually. As an employee, you should be aware of the implications of signing such an agreement, and as a manager, you should make sure the language of your employment contracts is carefully drafted.

You may see this type of clause not only as an employee or manager but also when you sell a business. Part of the selling contract of your restaurant may include the requirement that you not open another restaurant in the same city. Here, too, the courts will look at the same factors mentioned above to determine whether the clause is enforceable.

Exculpatory Agreements

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Suppose that you have been injured while skiing. On the back of the lift ticket, the resort printed a clause stating, "In the event of injury, the resort assumes no responsibility." Such an exculpatory clause, or waiver of liability, states in writing that the owner is not liable for injury or harm to users of the facilities. Can you sue for your injuries nevertheless?

The good news is that, in many states, an exculpatory clause or waiver of liability is void. In New York State (and many others), these clauses are illegal in speci�ic settings. For example, an exculpatory clause given to attendees at a place of amusement is void. Thus, the owner can be sued even if the customer signed an agreement saying the owner would not be liable.

Failure to Follow Licensing Requirements

At law, there exist two types of licenses: One type is for the purpose of ensuring competency, and the other type is a government device for collecting revenues.

Doctors, lawyers, and other professionals must pass a test before the state will award them a license to practice. If these professionals do not obtain a license but nevertheless enter into a contract, that contract is voidable by the other party. For example, Dr. Jones never passed his medical examinations, but set up his own practice anyway. He sees a patient and sends the patient a bill for his services. That patient may avoid the contract. This means that the patient may choose not to pay because Dr. Jones is unlicensed. Economically, this is a powerful incentive to obtain a license.

The second type of license is one established for the purpose of raising revenue for the state. Suppose you want to start a business, such as a bar. As part of the process of setting it up, you would need to obtain, in this case, a liquor license. A liquor license is an example of the type of license the state uses to collect money rather than to establish competency. If a person subject to this type of licensing requirement fails to obtain a license, his or her contracts are still enforceable. Thus, a patron of your restaurant could not argue that your failure to obtain a liquor license excuses him or her from paying for a pitcher of beer.

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9.3 Defenses to Contracts Sometimes one party to a contract has a legal reason for being excused from contractual liability. This reason is called a defense to contracts. While we cannot study all the various defenses, we will examine the four most common ones: fraud, undue in�luence, duress, and impossibility.

Fraud in the Inducement and Fraud in the Execution

Fraud in the inducement occurs when one party enters into a contract because the other party knowingly lied. Suppose I come to look at your house, which is listed for sale. I ask you whether the creek in the back ever �loods. You say no. In reliance on your statement, I buy the house. The next spring, the creek �loods, causing extensive damage. Can I get out of the contract? Yes.

A case of fraud requires one to prove the following:

One party intended to deceive the other, that is, knowingly lied;

The innocent party relied on the lie; and

Reliance was justi�ied.

If all those elements are proven, the innocent party can withdraw from the contract in an act called recission. Fraud in the inducement makes the resulting contract voidable at the option of the defrauded party. In our example, I (the innocent party) would normally get back my money, and you (the guilty party) would get back your house. In other words, the parties would be restored to their precontract positions. However, if the defrauded party wishes to go through with the agreement even after learning about the fraud, he or she has the right to fully enforce the contract.

When fraud in the execution of a contract is involved, the defrauded party has been intentionally encouraged to execute a legal instrument by misrepresenting the nature of the instrument being signed. This is a different situation than fraud in the inducement, where one party is induced to enter into an otherwise valid agreement through the intentional misrepresentation of a material fact. Whenever fraud in the execution is involved, the victim does not intend to enter into an agreement at all. Thus, the agreement that appears to result from the fraud is completely void and unenforceable by either party, not only the victim.

Undue Influence

Parties to a contract sometimes have a special relationship to one another because of a state statute that de�ines their relationship as �iduciary. A �iduciary relationship is a relationship of special trust. Examples include the relationship between attorney and client or doctor and patient. In these relationships, the law recognizes that there is one party in a position of special trust and another party who is more vulnerable. As a result, the courts have held the �iduciary to a higher standard of care than an ordinary person.

For example, a trustee who manages the monies of a young bene�iciary is a �iduciary and will be held liable if he or she does anything unethical or illegal with the bene�iciary's money. If the trustee uses his or her in�luence to overcome the will of the other party, that is undue in�luence. Suppose a trustee talks a bene�iciary into investing in one of the trustee's enterprises, which is in fact a high-risk investment, and the bene�iciary agrees to the arrangement only because she trusts his judgment. This agreement could be voided if the court found that the trustee overcame the "will" of the bene�iciary. A party seeking to avoid a contract based on undue in�luence needs to show that the assent given to enter into the contract was not genuine, but rather was clouded by the other party's taking unfair advantage of the �iduciary relationship in inducing her to enter into the contract. As with contracts where there was fraud in the inducement, contracts involving undue in�luence by one of the parties are voidable only by the victim.

Duress

Duress consists of forcing a party to enter into a contractual relationship under threats. Generally, being threatened with physical or mental harm or with criminal prosecution constitutes a valid defense to the contract. Courts generally apply an objective test in determining whether a threat constitutes duress. Under an objective standard, a threat constitutes duress only if a reasonable person under the same circumstances would have deemed the threat believable and would have been motivated to act in order to avoid the consequences of the threat.

Some types of threats are not considered duress, however. For example, being threatened with a civil lawsuit or with economic need is not a valid defense. A contract entered into under those types of threats would still be enforceable.

Impossibility

Suppose a family made reservations at the Fabulous Hotel and then, because of illness, canceled. Or suppose a famous rock group did not show up for a concert you were managing because their bus broke down. Are these excuses for reneging on a contract recognized by the courts? The answer is— sometimes. Impossibility means, as a general rule, that the contract could be performed only at an "excessive or unreasonable cost," that is, that it would be impractical. For example, an earthquake, �lood, or emergency that interrupted electrical power at the hotel might make the performance of the innkeeper's contract with a guest impractical and, therefore, serve as an excuse for nonperformance.

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9.4 Contracts That Must Be in Writing to Be Enforceable Many students are surprised to learn that most oral contracts are enforceable. Of course, the problem with enforcing an oral contract is proving its existence. Even so, if this burden can be overcome in court (that is, if the court �inds that a contract existed), then an oral contract may be enforced.

With that said, there are six contracts that must be in writing to be enforceable, of which we will discuss three. Collectively, laws requiring certain contracts to be in writing fall under the category of the Statute of Frauds, a common law concept dating back to 1677.

Before we address the three contracts that must be in writing to be enforceable, it is useful to �irst study what it means to "be in writing." The phrase in writing does not necessarily mean written on a piece of paper. For contracts under the common law, it simply means that the contract has all of the following characteristics:

Identi�ies the parties;

Describes the subject matter;

Sets forth terms and conditions;

Sets forth the consideration; and

Contains the signature of the party to be charged ("charged" in this context means the party "to be sued, or the defendant." Thus, a breach of contract lawsuit will not be "winnable" unless the defendant has signed the contract—that is, if it is one of the types of contracts that must be in writing to be enforceable).

For contracts under the Uniform Commercial Code, "in writing" means that the contract has the parties, quantity, and enough information for a reasonable person to conclude it is a contract. Note that if a contract is missing any of these requirements, it will be considered oral, even if it is written on a piece of paper. For example, under the common law, a contract to sell real estate that is printed on a form but is not signed by the party to be charged is oral, and therefore unenforceable.

What contracts must be in writing to be enforceable? We will look at the three most important and common ones in the sections that follow.

Contracts for the Sale of Real Property

Real property is land and all things attached to the land (�ixtures). Personal property is all other property. If you enter into a contract to sell land, a building, or a house, that contract must be in writing to be enforceable. Are there any exceptions? Yes.

Suppose that the buyer and seller enter into an oral contract for the sale of a building. The buyer moves in and makes substantial improvements to the property. Although the agreement is oral, the courts will usually �ind that a contract exists, because people do not usually make improvements unless they own real property. Likewise, a seller would not normally allow such improvements unless the alleged buyer owned the property. This situation is called part performance, and it may be suf�icient proof of the contract's existence to make the oral contract enforceable.

Contracts for the Sale of Goods Greater Than $500

Under the Uniform Commercial Code, Article 2 (discussed further in Chapter 10 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec10.1#sec10.1) ), a contract to sell goods valued at $500 or more must be in writing to be enforceable. Exceptions include those with part performance. Suppose I agree over the telephone to sell you widgets worth $4,000. I deliver $2,000 worth of the devices, which you accept. You then become liable for the payment of $2,000, even though the contract should have been in writing.

Another important exception that is used frequently in businesses is the con�irming memorandum. Suppose the Fabulous Hotel calls a supplier and orders 1,000 luxury terry-cloth robes at $50 each. The contract is for more than $500 and therefore should be in writing. But the telephone call is, of course, oral. Such a contract may be enforceable if one of the parties sends a con�irming memorandum and the receiving party does not object to it within 10 days. The parties then have a contract even though it is not "in writing." (Remember that "in writing" under the UCC means, in part, that the quantity is stated.) If the seller sends a fax reading, "Order received. Will ship robes as per your order," even though the contract is not in writing by UCC standards (because the order to purchase the robes was oral and the con�irmation does not contain quantity), under the con�irming memorandum exception, it is enforceable. Note that, for this exception to apply, both parties to the contract must be merchants. That is, they cannot be private individuals, but must be businesspersons who "regularly deal in goods of this kind."

Contracts That Cannot Be Performed in a Year

The third contract that must be in writing is one that cannot be performed within a year. Suppose the Fabulous hires you on March 1, 2012, for one year. You will graduate in May 2012, but you want a little time off to see Europe before you start working. So you agree to begin your employment on August 1, 2012. Does this contract have to be in writing?

If you agreed to work for the Fabulous on March 1, the rule is that the time from which you start to count is the day after contract formation, or beginning on March 2. You agreed to work for a year from August 1, 2012, until August 1, 2013. However, March 2, 2012, through August 1, 2013, is almost 17 months —a period that exceeds one year. Therefore, this contract would have to be in writing to be enforceable.

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Contractual Remedies

9.5 Damages for Breach of Contract If the parties to the contract perform all their obligations under the agreement and have no obligations remaining, they are said to be discharged. Unfortunately, not all parties perform. Failure of a party to perform is a breach. The nonbreaching party may institute a lawsuit and, if so, can choose what to sue for. Damages come in two forms: monetary damages and nonmonetary damages.

Monetary Damages

The nonbreaching party may sue for compensatory damages. These damages will replace the loss to the injured party. For example, suppose a seller fails to deliver a shipment of tomatoes to a hotel client, and purchasing replacement tomatoes would cost the hotel an additional $1,000. This amount is suf�icient for compensatory damages, as $1,000 would compensate the buyer for the seller's breach.

Nominal damages are awarded when the court �inds for the nonbreaching party in theory but does not �ind that the nonbreaching party suffered any actual money loss. Usually, token damages of $1 are awarded in these cases.

Some types of monetary damages generally are not allowable for breach of contract. These include punitive damages, that is, damages whose purpose is punishment (also known as exemplary damages). Punitive damages are most often awarded in tort claims where there was malicious or willful misconduct, such as negligence actions, not for breach of contract cases.

Speculative damages are usually not allowed in breach of contract cases. These are damages remote from the actual agreement. Suppose that the tomatoes mentioned above were a special order and the chef now claims that because they did not arrive on time, the number of customers dining that evening fell by 10%. Damages for such a speculative claim are unlikely to be awarded unless the hotel had conveyed this possibility to the seller at the time the order was placed. However, it is highly unlikely that such a conversation ever took place. The point is, such damages would be considered too remote, that is, unless the buyer and the seller agreed otherwise about their liability at the time of contracting.

Nonmonetary Damages: Duty to Mitigate

Sometimes monetary damages are not suf�icient compensation for a party's breach of contract. In those instances, the nonbreaching party wants to enforce performance of the contract and sues for the remedy called speci�ic performance. Bear in mind that speci�ic performance is not available when monetary damages would compensate the nonbreaching party; nor is it available to force a party to perform. You cannot sue in order to make someone do his or her part under the contract. That would be slavery, which of course is illegal. Let's say that you hire a famous band for the New Year's Eve party at the hotel you are managing. If the band cancels, you can sue for monetary damages, e.g., lost customers and loss of provable income. But you cannot sue the band to make them give a command performance at the hotel.

So when is speci�ic performance available as a remedy? When the goods are unique, such as land, antiques, or paintings, you could sue to recover these speci�ic goods rather than monetary damages.

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Key Terms

Click on each key term to see the de�inition.

acceptance (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When the offeree agrees to the offeror's offer.

avoidance (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In contract law, to annul, cancel, or make void. Also called disaf�irmance.

black letter law (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Theories of law in the context of business and employment contracts.

Blue Laws (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Laws in some states, based on traditions of religious morality, that ban certain commercial activities on Sundays and render contracts entered into then invalid.

breach (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Failure of a party to perform part of a contractual agreement.

capacity (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The mental ability to understand that one is entering into a contract. Also, the ability of a person of average mental abilities who is above the age of 18 to enter into contracts.

compensatory damages (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Money awarded to the nonbreaching party to restore that person's position as though there had not been a breach of contract. The same as restitution.

consideration (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When the offeree does something that he or she was not previously legally bound to do because of the offeror's promise. Distinct from a gift.

counteroffer (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An offer by the offeree that kills the original offer and creates the power of acceptance in the offeror.

damages (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Monetary loss that results from the breaching parties' actions.

defenses to contracts (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Legally valid excuses for not performing a contract.

detriment (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Doing something that one is not previously, legally obligated to do.

disaf�irmance (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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When a minor opts out of a contract before the age of 18.

discharged (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The parties to a contract have performed all their obligations under the agreement and have no obligations remaining.

duress (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A defense to a contract that involves a threat of physical or mental harm to force a party to enter into a contract.

exculpatory clause (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Also known as a waiver of liability, states in writing that the owner is not liable for injury or harm to users of the facilities.

�iduciary relationship (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A relationship of special trust, carrying with it increased responsibilities toward the other party.

�ixtures (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Property that is �irmly attached to land that becomes characterized as real property.

fraud (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Intentional misrepresentation made for personal gain or to damage another individual.

fraud in the execution (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Causing a party to enter into a contract by intentionally encouraging that party to execute a legal instrument and misrepresenting the nature of the instrument being signed.

fraud in the inducement (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Causing a party to enter into a contract under false pretenses, e.g., when one party enters into a contract because the other party knowingly lied. The resulting contract is voidable at the option of the defrauded party.

gift (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A freely given, voluntary transfer of property without consideration.

impossibility (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In contract law, being unable to ful�ill the terms of the contract without undue hardship.

lapse (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The end of an offer; when too much time has gone by and the offeree has not accepted.

large communicating medium (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Means of broadcasting a message, e.g., television, the Internet, newspapers, webpage, Tweet, or radio advertisement.

majority (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Reaching the age of 18, at which time one's contracts are binding.

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merchant (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A person who regularly deals in goods of a certain kind.

minor (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A person under the age of 18.

mirror image rule (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Required by the common law for contract formation; when the offeree's response to an offer matches every aspect of the offer and changes nothing.

necessaries (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

What minors are liable for when entering into a contract: food, clothing, and shelter.

non compos mentis (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Not being of sound mind; insane. Deemed by a court to be legally incompetent and thus incapable of entering into contracts, for instance.

noncompetition clause (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Part of a contract establishing that, after employment ends, the employee can work for a competing business in the same market only after a certain amount of time or beyond a certain distance from the employer.

objective test (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

How an interaction appears to a reasonable third party and whether it appears that the parties involved in the interaction are entering into a contract.

offer (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A statement of intent to enter into a contract.

offeree (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The party to whom the offer is made.

offeror (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The party making an offer.

option contract (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In this contract, the offeree pays money to hold the offer open for a certain amount of time, pending acceptance.

part performance (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Suf�icient proof of an oral contract's existence (i.e., a party begins to ful�ill its terms) to make it enforceable.

performance (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Ful�illment of one's obligations under the terms of a contract.

power of acceptance (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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The inherent power that resides in the offeree to accept the offer or not.

predominant test (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The test used to determine whether a contract is under the common law or the UCC by asking which is greater: the cost of the sale of goods or the cost of the services rendered (the common law component).

preliminary negotiations (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Discussions that take place before contract formation that might lead to contract formation.

rati�ication (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When the minor agrees to remain in the contract upon reaching the age of 18.

real property (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Land and all things attached thereto.

recission (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When the innocent party who has been the victim of fraud withdraws from a contract.

rejection (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A response by the offeree that kills the offer.

revocation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When the offeror takes back the offer prior to acceptance.

speci�ic performance (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A remedy in which the court orders the breaching party to perform the contract.

undue in�luence (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

If the parties have a �iduciary relationship, when the �iduciary uses his or her in�luence to induce the other party to enter into a contract for the �iduciary's monetary bene�it.

voidable (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Capable of being later annulled, as in a contract by a minor.

warranties (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Guarantees that apply to goods sold pursuant to the UCC but do not apply to contracts under common law.

wildly �luctuating market (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A commodities market in which the prices change very quickly, sometimes in seconds.

Chapter 9 Flashcards

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Critical Thinking and Discussion Questions

1. What are the �ive elements that must be present in order for a contract to be formed?

2. What are the four most common defenses to contracts?

3. For contracts under the common law, what does the phrase "in writing" mean? For contracts under the Uniform Commercial Code?

4. As the manager of a small business, you receive a letter that says, "We are exploring our options in your market and wonder if you would be interested in purchasing our product for a low price." Discuss whether you have the power of acceptance and why or why not.

5. Your business wishes to purchase a costly machine for which you need to obtain �inancing. The seller has only one such machine, and the bank tells you that approval for �inancing may take 20 days. What type of contract could you enter into to guarantee that if you receive the �inancing, the machine will still be available for purchase?

6. Your company purchased a machine with a three-year warranty that also came with a service plan. Does this contract fall under the purview of common law or the UCC? How could you prove it is under the UCC? If the machine broke down within the three-year period, why would you be anxious to show it was governed by the UCC?

7. Your company purchased a telephone system for $45,670. After a few months, the system completely failed, and the party that sold it to you refused to �ix it. You seek bids from other companies willing to replace the system and provide you with equivalent services. The bids are as follows:

Company A = $56,750 Company B = $84,374 Company C = $52,049

If you sued the original telephone system in court and won, how would you determine your damages?

8. Your company sent out an offer to sell a complex machine for $403,093 and received back an acceptance, which one of your employees signed, binding you to the contract. The employee never bothered to read the acceptance, however, which stated, "This is our acceptance. We agree to all the terms of the contract and we add to this contract a 20-year warranty." The machine broke down and the buyer sues you to enforce the warranty that they added to the contract. Who will win and why?

When the offeree agrees to the offeror's offer. C l i c k c a rd t o s e e t e r m 👆

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Chapter 10

Contracts, Part II: The UCC The Uniform Commercial Code (abbreviated as UCC) is a law covering many aspects of business transactions. The UCC was written in 1949 in an effort to unify laws affecting business throughout the United States. By 1967, the UCC had been adopted with only minor changes by the legislatures of all the states, with the exception of Louisiana, which has not adopted Articles 2 or 2A. (Louisiana’s law is still heavily in�luenced by French civil law and tends to differ in signi�icant ways from those of the other 49 states.)

The UCC is divided into nine Articles, or sections, each of which covers a fundamental area of commercial law. For example, Article 2 deals with sales contracts, which we will discuss in this chapter.

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10.1 Why the Uniform Commercial Code Is Important to Businesses Can you imagine trying to conduct business in the United States if contract law differed from one state to another? The UCC ensures the uniformity and predictability of interstate commerce for companies that conduct business in more than one state. For example, if a seller in Nevada wishes to enter into a contract with a buyer in California, both parties can be reasonably certain that the law in their state is the same, because both states have adopted the UCC. As you read about the UCC rules and consider the impact they have on business transactions, remember that the UCC makes business transactions possible and predictable throughout the United States.

What Does Article 2 of the UCC Apply To?

Article 2 of the UCC deals with the sale of goods. Real estate, employment, insurance, and similar services are covered by the common law. To be considered goods, the subject matter of the contract must be movable and tangible, such as an automobile or a lawn mower. For the most part, whether something is a good is quite easy to determine, but there are exceptions. Consider electricity, for example. Do you think that is a good? Ask yourself whether it is movable and tangible. It moves through wires, and if you stuck your �inger in a plug you would �ind it very tangible, so yes, it quali�ies as a good that is subject to the UCC. Are animals, oil, and trees goods? The answer is that yes, animals are goods, but oil, gas, and trees are all goods only if they are removed from the land by the seller. They would be considered nongoods if removed by the buyer.

As discussed in Chapter 9 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec9.1#sec9.1) , Contracts, Part I: Introduction and Formation, if a contract is a mixture of both goods and services, which law applies is determined by the predominant test. That test states that whichever element is greater in price or intent prevails. For example, if the cost of the goods is greater than the cost of services, the contract is covered by the UCC. If the services are worth more, then the contract is governed by the common law.

To Whom Does the UCC Apply?

One major area of confusion for students is to whom the UCC applies. Students are apt to think that it applies only to merchants, but that is not true. The UCC applies to everyone in the United States who buys and sells goods, whether he or she sells them at a garage sale or at the Mall of America. It’s true that certain sections of the UCC apply only to merchants, but the vast majority of the law applies to merchants and nonmerchants alike. When there is a distinction, we will point it out throughout this chapter.

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10.2 Acceptance Under the UCC Recall that to form a valid contract, �ive elements must be satis�ied: offer, acceptance, consideration, capacity, and legality. If the contract is for the sale of goods, those same �ive elements apply under the UCC, largely as they do under common law, with one exception: acceptance.

Under the common law, acceptance is covered by the mirror image rule, which requires all the elements of the acceptance to mirror all the elements of the offer. Thus, if the offer were for a $450,000 house with a 5% mortgage and the buyer responded that he or she will "take it, but with a 4% mortgage," that would not be a mirror image, and there would be no contract.

Under the UCC, the opposite rule applies; however, the explanation is somewhat involved. For the rule of acceptance under the UCC, the UCC does distinguish (depending on who the parties are) between merchants and nonmerchants. According to the UCC §2-104, a merchant is a party who "regularly deals in goods of that kind." Think of a car dealership, for example, to envision who is a merchant. On a daily basis (regularly), the dealership is selling cars (goods) and nothing else (so, goods of that kind). Contrast the car dealership with someone selling a car on Craigslist. The item is still a good, but the person selling is selling one car just this one time, and so is not a regular dealer. Further, if that person is selling a car, a vacuum cleaner, and some old paintings, he or she is still not dealing in goods of that kind but in many different kinds of goods; thus, that person is a nonmerchant under the UCC.

To further complicate matters, when it comes to the rule of acceptance, the UCC distinguishes between transactions by two merchants, two nonmerchants, and a merchant with a nonmerchant.

First, we will look at what is called the rule of nonmerchants, which actually means either a contract between a merchant and a nonmerchant or a contract between a nonmerchant and a nonmerchant.

The Rule of Acceptance for Nonmerchants

For contracts between two nonmerchants, or between a merchant and a nonmerchant, the rule is this: if the offeree adds any new terms to the offer, the new terms become proposals to the contract, but the parties do have a contract for the terms they agreed upon.

Suppose that your business (a merchant, because it is commercial) sends an offer to a nonmerchant. The offer states that your business offers to sell to the buyer "10 crates of pineapples at $5.25 per pound" packed in green crates. The buyer responds, "Will take the pineapples at that price in green crates, but could you have them here by Monday?" You may be surprised to learn that, under the UCC, the parties have formed a contract for the terms they have agreed upon, namely, the quantity (10), the price ($5.25 per pound), and the green crates. When the buyer asked for a delivery time of Monday, that term became a proposal to the contract. Although the offeror can decide what to do with that term (accept it, reject it, or modify it), the parties do have a contract for the terms they agreed upon. See Table 10.1.

Table 10.1: Sample offer and acceptance between nonmerchants

OFFER ACCEPTANCE THE CONTRACT

Pineapple Pineapple Pineapple

$5.25 / lb. $5.25 / lb. $5.25 / lb.

Green crates Green crates Green crates

+ PROPOSAL

Monday delivery

Note from Table 10.1 that most of the terms of the offer and most of the terms of the acceptance in gray mirror each other. The terms that match form the contract. The term that doesn’t match is the proposal. The parties have a contract for the subject matter in gray but not for the "Monday delivery," which is the term proposed by the buyer/offeree.

Why is this signi�icant? In your negotiations as a businessperson with buyers, it is essential that you be aware that you could be forming a contract with a nonmerchant who accepts your offer but adds new terms. Under the UCC, that is no longer a negotiation but a contract, and you are bound to its terms. The way to avoid such contract formation is to use terms that make the contract conditional on certain events. You could use language like "On condition that . . ." or "Only if . . ." For example, you could say, "I will sell you ___ only if you agree to these terms," or "Take it or leave it" or "Without any changes to this offer." All of these phrases limit assent to a mirror image acceptance and make any changes into counteroffers rather than contracts.

The Rule of Acceptance Between Two Merchants

When both parties are merchants, the stakes are raised even higher. Now any new terms in the acceptance automatically become part of the contract unless:

(1) The offeror objects to them; (2) The offeror makes agreement conditional upon a mirror image acceptance; or

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(3) The new terms materially alter the contract.

For example, in the contract above, if both parties had been merchants, then the Monday delivery would have automatically become part of the contract unless the offeror objected to the term. The offeror could have made the offer subject to the mirror image rule with words like "Take it or leave it."

It is interesting to note that most offerors do not make their offers subject to a mirror image acceptance, nor do they object to the new terms. In fact, in most cases that are litigated, none of the parties have read the other’s response, and thus are unaware that new terms have been added to the contract.

Table 10.2 shows that, between two merchants, if the offeree adds any new terms to the acceptance, those new terms automatically become part of the contract, unless it falls under one of the exceptions.

Table 10.2: Sample offer and acceptance between merchants

OFFER ACCEPTANCE THE CONTRACT

Pineapple Pineapple Pineapple

$5.25 / lb. $5.25 / lb. $5.25 / lb.

Green crates Green crates Green crates

Monday delivery Monday delivery

How is this important in business? Suppose, for example, that the buyer and seller engaged in a written contract for a multimillion-dollar computer system. When the buyer accepted the offer, the buyer sent a written acceptance that added a warranty term of 10 years to the contract. The computer broke down after it was installed, and the seller was amazed to learn that the buyer had added a warranty in the acceptance, probably because the seller’s employees had never bothered to read the acceptance.

Now the parties have found themselves in court. Since they are both merchants, the warranty automatically became part of the contract. The seller had never objected to the warranty term, nor had he or she made the acceptance conditional on a mirror image acceptance. The only other exception the seller could invoke is that the addition of the warranty was a signi�icant economic change, but the court didn’t agree that it was. Therefore, the warranty term became part of the contract and the seller had to honor it. This would certainly be a harsh lesson for the employees in charge of that �irm’s contract negotiations.

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10.3 Contract Terms and Conditions Terms and conditions of a contract refer to the parts that make up the whole. Examples of terms are the price of the goods, when they will be delivered, the type of delivery carrier, how payment will be made, and how many units will arrive per shipment. Parties are free to, and should, negotiate all these aspects of their agreement. There are no rules for what price you have to charge or when you have to deliver goods. If the other party wants to pay you in gold coins and take delivery at three in the morning in Topeka, Kansas, wearing pink pajamas, and you agree to such terms, the law will honor your private, albeit eccentric, understanding. As long as it is constitutionally sound, private parties can and should craft their own contract terms.

Gap-Filling

Quite often, however, people put too little thought into contract formation and leave out important terms they should have negotiated. These contracts may end up in court when the parties sue one another to enforce what they thought was in their agreement. Under the UCC, if parties leave out a term, the court will �ill it in: a process called gap-�illing. For example, if a contract is concluded without agreeing on a price, the UCC provides that the price will be the going rate at the time the goods were delivered. This could have a signi�icant impact if the price of the goods changes signi�icantly between the time of making the contract and the time of delivery, which could be a few months. By the time the parties get to court to litigate the price, however, years could have gone by. Going to court, of course, also entails the parties hiring attorneys and spending thousands of dollars litigating a matter they could have agreed upon when they negotiated the contract in the �irst place. They do have an enforceable contract—it’s just that no one is going to get paid under its terms for many years to come, and then only after expenses that may exceed the cost of the contract.

Table 10.3 illustrates several contract terms under the UCC and how the process of gap-�illing would play out in court.

Table 10.3: Gap-�illing under the UCC in courtroom situations

TERM LEFT OUT OF THE CONTRACT GAP-FILLING UNDER THE UCC

Delivery Unless otherwise agreed, all goods called for by a contract for sale must be tendered in a single delivery.

Place of delivery Unless otherwise agreed: (a) The place for delivery of goods is the seller’s place of business or, if none, the seller’s residence.

Price In such a case, the price is a reasonable price at the time for delivery if: (a) Nothing is said as to price; (b) The price is left to be agreed upon by the parties and they fail to agree.

Quantity Court will not gap-�ill this term; the contract will fail.

The one term courts will not gap-�ill is quantity. If the parties leave out quantity, the contract fails. There is one very important exception to this rule, however, called an output-requirement contract. Suppose that you work for a manufacturer and your employer asks you to negotiate a contract to purchase enough bolts for all the machines your company will manufacture in 2015. The �irst question you will ask is, "How many bolts should I order?" Unfortunately, it may be quite impossible to divine how many bolts they will need in the future. Therefore, the UCC allows a special type of contract to exist without a speci�ic quantity, called an output-requirement contract. In these contracts, the buyer can order "All that I require in 2015" or "All that your company manufactures . . ." or "All that I need . . ." Underlying these contracts is the recognition that the contract must be carried out in good faith. For example, if the buyer becomes angry with the seller, the buyer cannot then order one bolt and protest, "But that was all I needed!" A look at the records for past years would show that the buyer usually ordered 10,000 or more per year, so "all that I need" would have to be closer to that number. The UCC describes a reasonable quantity in such a contract in this way: "no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded" (Uniform Commercial Code §2-306).

If there is one lesson to learn from judicial gap-�illing, it is to spend suf�icient time making sure that all of the terms are negotiated and written into the contract before goods are delivered. Otherwise, you may have a costly, time-consuming mistake to deal with.

Contracts

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Contract Modifications

Frequently, parties to a contract need to change the terms they agreed to initially when they formed the contract. Contract modi�ication occurs after contract formation. The UCC altered the rules for modi�ication by not requiring any new consideration to make the changes enforceable. Thus, no money has to be paid and no new work has to be carried out to make the changes enforceable. Consider the following example.

A lawn and garden store agrees to sell a garden tractor to a buyer but needs to order it from the manufacturer. The price is $1,000, and it has a written contract for the sale. After contract formation, the price of gas doubles and the cost to deliver the tractor rises dramatically. The lawn and garden store approaches the buyer and explains the situation, and they reach an agreement that the lawn and garden store will now receive $1,100 for the same tractor. This is a change or modi�ication to the original agreement. Notice that both parties agreed to the change, but they were under no obligation to do so. If this same contract were under the common law, a contract modi�ication would be enforceable only if consideration was given for the modi�ication.

Writing Requirements

The Statute of Frauds governs writing requirements: which contracts must be in writing to be enforceable. Generally speaking, most contracts can be oral and still enforceable. The problem with an oral contract, of course, is proving that it even exists, and if so, what its terms are. However, if that problem can be overcome, then contract enforcement is possible.

"In writing" doesn’t mean that the contract is literally written down on a piece of paper; rather, it means that it must have enough information to prove it is a contract. That is, it must state what the consideration is and include the signature of the party to be charged (the party sought to be bound by the contract). The "signature of the party to be charged" sounds like the party who is paying, but it does not mean that at all; rather, the party to be charged (to be burdened) is quite simply the defendant. So, to be in writing, the contract needs the signature of the defendant. Consider the following example. Note that under the UCC, a contract for the sale of goods greater than $500 must be in writing to be enforceable.

The seller, Bob, calls the prospective buyer and offers to sell his car for $3,400, to which the buyer agrees. The seller then e-mails the buyer, stating, "I am so glad you agreed to buy my car! Here is my address. Please send the check for $3,400 within �ive days. Signed, Bob."

Is this contract in writing? The answer is no—it is oral. To be "in writing," the contract needs the signature of the defendant (in this case, the buyer) because it is Bob who wishes to enforce it. However, since the buyer never signed the contract, it is not in writing. If, however, the buyer wanted to sue the seller, the contract would be "in writing" because the seller signed his name, and thus, the signature of the party to be charged is present.

Exceptions to Writing Requirements

Several types of contracts for the sale of goods greater than $500 can be oral and still enforceable. One is of particular importance to the businessperson: an oral contract for the sale of goods greater than $500 that is subsequently followed up by a written con�irmation. This is called the merchant’s con�irming memorandum exception. Consider the following example.

A merchant seller calls a merchant buyer and says, "I have a good deal on fruit that just arrived from Florida. I have mangos in crates for $200 per crate, and I can get them to you by Thursday. Are you interested?" The buyer replies by telephone, "Yes, certainly. I’ll take 300 crates."

Notice that the contract is for goods worth well over $500, which should normally be in writing. But if one of the merchants (it doesn’t matter which) sends the other a written con�irmation of the conversation, then this conversation (an oral agreement) becomes an enforceable contract. Although the e-mail might

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not meet all the requirements of a written contract (for example, it might be missing the signature of the party to be charged), it is nevertheless enforceable, unless the party receiving it objects to it in a record (in tangible form) within 10 days of receipt.

Another oral contract for the sale of goods greater than $500 that can be enforceable is a contract for specially manufactured goods, which are custom made. The rationale behind this rule is that, normally, a seller would not buy raw goods to begin manufacture, nor start manufacture without a reasonable belief that a contract existed. So if a seller begins working on the goods but the buyer then refuses to buy them, and the seller cannot market them elsewhere, the UCC allows the seller to recover their costs, even if the contract was not in writing.

Lastly, the UCC provides that if a contract was for more than $500 and should have been in writing, it will nonetheless be enforced if either payment has been made and accepted or the goods have been received and accepted. An example follows.

The buyer and seller enter into a contract for the sale of an automobile for $35,000 but do not put their agreement in writing. The seller delivers the car to the buyer, and the buyer pays for the goods. Then, after driving around town with the car, the buyer thinks twice about the transaction. Now the buyer claims he or she wants his or her money back and that there was no contract because it should have been in writing. Under the UCC, however, it is too late to raise the Statute of Frauds as a defense to the contract.

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Key Terms

Click on each key term to see the de�inition.

acceptance under the UCC (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

If both parties are merchants, the offeree can give a non–mirror image acceptance, and all new terms became part of the contract. If the parties are nonmerchants, then any new terms in the acceptance become proposals to the contract.

Article 2 of the UCC (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The section of the Uniform Commercial Code that governs contract law for the sale of goods.

contract modi�ication (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Changes to a contract after contract formation.

gap-�illing (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The rule under the UCC that the court will �ill in any term not agreed upon by the parties, other than de�inite quantity.

goods (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Items that are tangible and movable.

merchant’s con�irming memorandum (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A writing following an oral contract that con�irms the agreement between merchants for the sale of goods worth more than $500, thereby making the contract enforceable.

nonmerchant (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A person who does not deal regularly in goods of that kind.

proposal (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An offer for consideration or acceptance.

rule of nonmerchants (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Either a contract between a merchant and a nonmerchant or a contract between two nonmerchants.

specially manufactured goods (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Goods that are custom-made.

Statute of Frauds (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The law governing which contracts have to be in writing to be enforceable, e.g., under UCC Article 2, those for goods worth more than $500.

subject matter of the contracts (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Goods or services the parties are selling in the contract.

terms and conditions (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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Speci�ic parts of the contract that detail the parties’ agreement.

writing requirements (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The rules regarding what terms have to be in a contract for it to be considered "in writing." To be considered a contract, it must state what the consideration is and include the signature of the party to be charged.

Chapter 10 Flashcards

Critical Thinking and Discussion Questions

1. What does UCC stand for? What does the UCC apply to? To whom does the UCC apply?

2. What does "Article 2 of the UCC" govern?

3. How can you tell if a contract is governed by the UCC or the common law?

4. What is the signi�icance of being governed by the UCC or the common law?

5. Your company sent a written offer to a nonmerchant, to which the nonmerchant added, "All terms are agreed to. In addition, I need the parts delivered by next Thursday." What is your obligation to deliver the parts by that date?

6. Assume in the situation above that both the parties are merchants. What is your obligation to deliver the parts by that date? What actions could you take to ensure that the buyer’s additional terms do not become part of the contract?

7. You sent out a written offer to a seller to purchase 10 minivans, model #306945ZY, and concluded the contract negotiations except for the price of the goods. The seller accepted your contract and you put the agreement in writing. Because of �luctuations in transportation prices, however, you concluded the agreement without ever agreeing on a �inal price. You both decided that you would �igure out a price later on when the transportation markets settled down.

a. Do you still have a contract even if you never reach an agreement on the price? b. In the event that you go ahead with the contract, how will the price be set? c. Assuming you can never agree on a price, what will happen next? d. What would happen if you never agreed on the quantity? e. Does this contract need to be in writing? Why? Under what circumstances could this same contract be oral and still enforceable?

If both parties are merchants, the offeree can give a non-mirror image acceptance, and all new terms became part of the contract. If the parties are nonmerchants, then any new terms in the acceptance become proposals to the contract

C l i c k c a rd t o s e e t e r m 👆

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Chapter 11

Contracts, Part III: Risk of Loss Rules, Negotiating Contracts, and Working With an Attorney

In this chapter, which continues our examination of contract law, we are going to study what are commonly called risk of loss rules. These are the rules that apply to transactions between sellers and buyers when goods are lost, damaged, or destroyed between the time of purchase and actual receipt by the buyer. The question always is: Who will pay the cost of the goods—the seller, the buyer, or someone else—in the event that the parties suffer a loss? We will also discuss the role of a manager in entering contracts and working with an attorney.

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Elaine Thompson/Associated Press

A common carrier is a company that transfers goods for the general public, such as the U.S. Postal Service.

11.1 Risk of Loss Rules and Contracts Before a risk of loss problem can arise, the buyer must have enough ownership in the goods that he or she has rights in their loss. Such rights are often described as an insurable interest, that is, one that is worthy of �inancial remuneration in the event that the goods are lost, stolen, or damaged. To have an insurable interest, the goods must �irst be picked out of the larger mass, or identi�ied to the contract. If you actually went into a large appliance store, chose a particular �lat-screen television, and paid for it, the employees would go back into the warehouse and pull your set off the shelf. At the moment it was pulled off the shelf, it would be identi�ied to the contract as being your television.

A buyer obtains an insurable interest in goods that exist at the time of entering into the contract, like the television described above. But if future goods are involved (goods that are not in existence at the time of entering into the contract, such as those to be manufactured or ordered by the seller for the buyer), the buyer obtains an insurable interest as soon as the goods are "shipped, marked, or otherwise designated by the seller as goods to which the contract refers" (UCC §2[501]). If the future goods are crops or the unborn young of animals, for example, the buyer obtains an insurable interest as soon as the crops are planted or the animals conceived. Sellers, on the other hand, retain an insurable interest in goods for as long as they have title in the goods or for as long as they retain a security interest in them, which is a right by a creditor to have speci�ic property sold to satisfy the debt.

When goods are damaged, lost, or destroyed between the time that the buyer gains an insurable interest in them and actually receives them, we say there is a risk of loss problem. The easiest way to settle any dispute concerning a loss of goods is to negotiate a contract about the issue ahead of time, while purchasing the goods. The contract could say something like "In the event the automobile is damaged on the way to the dealership, the manufacturer agrees to bear all the costs of any such damages." This is, of course, the safest and simplest way to avoid any disagreements about damage or loss of the goods (personal property).

In the event that the parties do not have the foresight to agree about risk of loss before it occurs, the courts will look to see whether either party breached the contract. As a general rule, the party who breaches the contract will bear the risk of loss, as illustrated below:

A seller agreed to sell 1,000 pounds of beans to the buyer with delivery to be on or before May 15. However, the seller failed to deliver the goods on that date, and that night, the seller’s factory burned down. Since the seller breached the contract, the seller would incur the risk of loss.

In the event that the parties do not agree ahead of time who has the risk of loss, and if neither party breached the contract, then the courts next look at whether or not one of the parties is a merchant. Suppose, for example, that when you purchased your �lat-screen TV from a big-box store, you could not take it home that day but planned to return the next day with a truck to transport it. If the store burned down that night, the loss would be incurred by the merchant (store). If you purchased the same TV at a garage sale, however, or from a nonmerchant, then the loss would be borne by you (the buyer), as soon as you paid for the goods.

Common Carrier Contracts

With the advent of the Internet, much more commerce is being conducted via shipping companies, or common carriers. A common carrier is a company that offers transportation services to the general public, such as UPS; Federal Express; air, train, and bus transportation companies; and the U.S. Postal Service. The type of method chosen for delivering goods can have an effect on such factors as the risk of loss of goods in transit and the time when the buyer obtains an insurable interest in them.

There are two basic types of arrangements one can make with a common carrier: a shipment contract or a destination contract. Whether the contract is designated as a shipment or destination contract has important legal rami�ications for who bears the risk of loss between the buyer and the seller.

Shipment Contracts

In a shipment contract, the risk of loss passes from the seller to the buyer when the goods are placed on the carrier in the seller’s city. Suppose, for example, that the seller is located in Maryland and that the buyer is located in California. The seller is responsible for shipping the goods to the buyer, so the seller makes arrangements to place the goods onto the carrier in Maryland. The shipping terms are "FOB Baltimore, Maryland," the seller’s city. This scenario is illustrated in Figure 11.1.

Figure 11.1: Shipment contract

In a shipment contract the risk of loss passes from the seller to the buyer when goods arrive at their place of shipment, in this case when the goods are placed on the carrier in Baltimore.

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You can recognize this as a shipment contract because the seller is located in Baltimore and the FOB (free on board) location is also Baltimore. (Some students remember this rule by the device "S and S": Shipment/Seller. Both begin with the letter S.). Accordingly, because it is a shipment contract, when the seller places the goods on the carrier in Baltimore, the risk of loss passes to the buyer. Therefore, if the goods are damaged or destroyed between Baltimore and Los Angeles, the buyer will have to pay for the goods anyway.

How do you know whether a contract is a shipment or destination contract? Contracts with carriers have shipping terms. As noted above, the buyer and the seller entered into a contract "FOB Baltimore, Maryland." Since it speci�ies FOB Baltimore, which is the seller’s city, it is a shipping contract. If it had said "FOB Los Angeles," we would recognize it as a destination contract, because Los Angeles is the buyer’s city, as discussed in more detail below. Thus, the shorthand FOB [seller’s city] is part of a shipment contract in which the risk of loss is on the buyer once the seller places the goods on the carrier in the seller’s city.

Destination Contracts

In a destination contract, the seller must, at his or her own expense, deliver the goods to the buyer’s city and make the goods available for pickup there. You can recognize a destination contract by looking at the city designated after the shipping terms. In Figure 11.2 the city designated is Los Angeles, where the buyer lives, so it is a destination contract. In a destination contract, the risk of loss is on the seller until the goods are tendered to the buyer. Tendered means that the seller has noti�ied the buyer that the goods are available for pickup.

Figure 11.2: Destination contract

In a destination contract the seller bears the risk of loss until a shipment of goods reaches its destination, in this case Los Angeles.

Shipping terms are shorthand initials that designate what type of contract is involved and various details regarding cost and insurance of the goods. For example, FOB and FAS are shipping terms that mean free on board and free alongside a vessel, respectively. When FOB and FAS, combined with the seller’s city, are involved, the seller bears the responsibility (and cost, if any) of transferring the goods into the possession of the carrier. However, once delivered, the risk of loss is on the buyer. If the contract calls for FOB or FAS at a speci�ic destination or the buyer’s city (e.g., FOB buyer’s plant or FAS buyer’s port), then the seller bears the cost and risk of loss of getting the goods to the named destination.

The acronyms CIF and C&F stand for cost, insurance, and freight and cost and freight, respectively. In a CIF contract, the cost of shipping and the cost of insurance are included in the sale price, whereas in a C&F contract, the cost of shipping (freight) is included in the sales price but not the cost of insurance, which the buyer must pay for and procure on his or her own, if desired.

Sale on Approval Contracts

Another type of contract used frequently in business is a sale on approval contract. In this type of contract, the seller ships goods to the buyer so that the buyer can try the goods and then decide whether or not to keep them; if the buyer decides not to keep them, the buyer ships the goods back to the seller. Throughout the transaction, all the costs and risk are borne by the seller, including shipping to and from the buyer. If, however, the buyer decides to keep the goods, the buyer has to pay for them.

Why would a seller enter into such a contract? In many instances, it is just good business. If buyers are reluctant to try out a product, the seller may be willing to pay the expenses to get the goods into their hands, con�ident that once they have enjoyed the products, they will want to purchase them.

In some instances, the seller will offer the goods for something like a "15-day trial period." In this scenario, if the buyer keeps them for more than 15 days without shipping them back, the buyer will have accepted the goods, and the risk of their loss will shift to him or her.

Sale or Return Contracts

In a sale or return contract, the seller ships goods to a buyer who is also a seller, as illustrated below:

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A music manufacturer ships CDs to a gas station to sell. The gas station is buying the CDs from the manufacturer and selling to the general public. If the gas station does not sell the CDs, then under the sale or return contract, the gas station can return the goods, but only at its own (the buyer’s) risk and expense.

As you can see from this illustration, the gas station is a buyer because it is purchasing the goods from the manufacturer; but the gas station is also a seller since it is then offering the CDs for sale to the general public. In cases such as these, the manufacturer is providing the CDs to the gas station for sale, and the gas station is taking the business risk that its customers will be interested in purchasing music at a gas station. The gas station is willing to try selling the CDs because if it does not sell them, it can return the CDs without paying for them. In the event of returning the goods, however, if they are lost, stolen, or accidentally destroyed in transit or while in the buyer’s (gas station’s) possession, the buyer (gas station) must pay for them, since the risk of loss for goods in a sale or return rests with the buyer (gas station).

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11.2 The Role of Managers Entering Into Contracts Employees’ duties regarding entering into contracts run the gamut. They can range from an entire of�ice that procures goods for the business, and therefore enters into multiple contracts every day, to those who are involved in one contract during their entire employment, which might be their hiring contract. With the wide range of activities in mind, the purpose of this chapter is to address some concerns that might arise for you as a manager if you are asked to become involved in the contract process.

Recommendation number one is to get legal advice and make your contract subject to such review. Based on what you learned in Chapters 9 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch09#ch09) and 10 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch10#ch10) about contracts, it should be clear that entering into a contract can be fraught with peril. The cost of hiring an attorney up front is well spent when you form a contract. Nevertheless, there is a great deal you can do without an attorney. For example, you can negotiate a contract and then make it subject to attorney approval. That way, if you made any mistakes, the escape clause of attorney review will allow you to get out of the contract, or have your attorney correct any errors, before implementing the contract. For example, an employee could add a phrase like this to an employment contract: "This contract is subject to attorney approval and, in the event such attorney approval is not obtained, this contract will be considered null and void."

Many people think that informal conversations on the telephone or by e-mail are completely harmless, but they are not. Oral conversations can become contracts, as can e-mails. In addition, even if they don’t rise to the level of an enforceable contract, such written documents, voice mails, or text messages may be admissible in court as exhibits. When dealing in business, it is best to remember that joking around, using profane language, or making discriminatory remarks may all come back to haunt you in a court case. Think of every Tweet or Facebook posting as possibly "going viral" and being embarrassing, at the least, or evidence that can be used against you in court, at the worst.

A Closer Look: Contract Best Practices

Entering into a contract is a serious business, and if you have been given this responsibility by your employer, you may be entering into a binding agreement to which your employer must comply. Obviously, you need to apprise your employer of all conversations and tentative agreements you are making. Phrases such as "subject to my employer’s approval," "I will have to get permission to agree to that," or similar language that makes the contract provisional will release you if there is a problem with the agreement or the speci�ic language. Keep in mind that the best written contracts are plain and simple, and never be fooled by anyone involved in the contract process who asks you to "just initial this—it’s not the same as a signature." Or by anyone telling you, "this is just between you and me," "This doesn’t count, it is just preliminary," or similar language. Initialing is the same as a signature, and no agreement is just between "you and me." It is always better to check any agreements with your supervisors and to make any agreements subject to another’s approval. Click here (http://smallbusiness.�indlaw.com/business-contracts-forms/how-to-write-a-business-contract.html) to learn more tips for writing contracts.

Working With an Attorney

Prudent business practice recommends that you work closely with an attorney when entering into a contract. This section is not meant to take the place of legal advice, but it will show you steps you can take that will be helpful and cut costs:

Keep all written material that pertains to the contract in an orderly folder for easy reference.

Make sure your attorney knows about all paper, tangential agreements, and conversations that have taken place with regard to the transaction.

Save all e-mail and cell phone texts or any other transmissions. At the very least, the attorney can sort through what he or she believes to be important correspondence.

Read all contracts carefully and thoroughly. It is surprising how many people in business fail to do so. Treating a contract with such utter disregard will only present problems later on.

As you carefully and thoroughly read any contracts presented to you, make notes in the margin about any changes you want to make or questions you have about the language.

Strive to understand every single part of the contract, and insist on a clearly written document. There is no need for any obscure or confusing language in a document, and you should insist that any ambiguous language be explained to you.

Unfortunately, some attorneys can act impatient when asked questions. Remember that you, or your company, are paying legal fees and have hired the attorney to provide you with a service. Part of that service is to clearly explain what is going on in a way that is respectful of your concerns. It is usually not unreasonable to have explanations written into the contract so that its clear meaning is spelled out. It is, after all, an agreement, and it should clearly enunciate the intentions of the parties. If anyone involved in the contract negotiations tells you, "Don’t worry about that," then you need to be alarmed. In short, a contract should be a simply and clearly written statement of what each party is expected to do and when.

Negotiating a Contract and the Parol Evidence Rule

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In Chapter 9 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec9.2#sec9.2) , Contracts, Part I: Introduction and Formation, you learned about the elements of a contract, how to form one, and some of the defenses (how to get out of a contract). You will recall that to start contract formation, you must �irst have an offer and an acceptance. These can be made orally or in writing. For this reason, it is important to remember throughout your negotiations that both oral and written information is signi�icant. At this point in your studies, you should be aware of the parol evidence rule (parol comes from the French for word). On its face, the rule seems daunting and dif�icult, but it actually makes a lot of practical sense. Here is the rule in a nutshell: All prior or contemporaneous, oral or written agreements, that vary or contradict the �inal written contract, are inadmissible.

Suppose that you entered into a negotiation with a seller to purchase a large, complex computer system for your of�ices. Table 11.1 illustrates the discussions that take place, leading to a contract.

Table 11.1: Sample purchase negotiations using the parol evidence rule

January 15 January 18 January 18 January 19 January 21

Telephone conversation in which you discuss "specs" for computer.

Seller tells you the computer comes with a 12-month warranty.

You agree that this is a good term.

Seller sends you an e-mail that says in part, "Also, this computer has an outer shell that is guaranteed against corrosion."

You reply, "That’s good, because that is a requirement of our of�ice."

Telephone conversation in which seller tells you that the computer can be delivered "on or before February 1."

You reply, "That’s good, because we must have it by that date."

You send the seller an e-mail asking, "Will technical support be available after installation?"

The seller sends back an e-mail that says, "Yes."

You sign the written contract, which describes a �ive-month warranty and a delivery date of March 15, on behalf of your company.

Note that, on January 21, the parties signed a contract that was supposed to memorialize or represent the entire agreement they made with one another. If they had read the contract before signing it, however, they would have noticed that the warranty in the �inal contract was for only �ive months (not the 12 months agreed to on January 15), nothing was said about the outer shell (which was discussed on January 18), and the computer would not be delivered until March 15, not February 1 (as requested on January 18).

The law assumes that when people enter into a �inal, written contract, as these parties did on January 21, they will incorporate all their understandings into that agreement. The law also assumes that if the parties have not agreed on a particular item, then this lack of agreement will also be represented in the contract by being absent. Note how the January 21 contract fails to include some of the oral and written agreements. These are the prior oral or written agreements referred to in the rule. Then note how the prior oral or written agreements vary or contradict the �inal written contract. For example, the parties "agreed" on January 18 that goods would be delivered on February 1, but the �inal written agreement stated a delivery date of March 15. The January 18 delivery date varies or contradicts the delivery date in the �inal agreement. Because the parties entered into a �inal written agreement, however, this contradiction is resolved because the parol evidence rule holds that those previous understandings of January 15, 18, and 19 are not part of the agreement and are thus inadmissible in court. "Inadmissible" means that the jury cannot hear any evidence about the previous agreements, rendering them useless: it is as though they had never taken place.

Why is the parol evidence rule a good one? This rule gives integrity to written contracts by preventing people from coming into court and saying, "Yes, I did sign that contract, but we also agreed to something else that should have been in the contract." If the parties agreed to it, it should be in the contract. The law challenges you to answer the question (if you agreed to something else): Why didn’t you put it in the contract? It therefore keeps all previous understandings out of evidence unless one of the parties can show that fraud was involved and that one of the parties was duped. This rule is another important reason you should carefully read all contracts before you sign them and make sure they include all of the terms agreed upon between you and the other party.

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Key Terms

Click on each key term to see the de�inition.

C&F (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Cost and freight (a shipping term). The cost of shipping (freight) is included in the sales price but not the cost of insurance.

CIF (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Cost, insurance, and freight (a shipping term). In a CIF contract, the cost of shipping and insurance are included in the sale price.

common carrier (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A form of transportation for goods or people that is available to the public.

destination contract (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of contract for the sale of goods in which the risk of loss is on the seller until the goods are tendered at the buyer’s city or destination.

escape clause (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Contract language that says, if you made any mistakes before the contract has been reviewed by an attorney, you can be released from the contract.

FAS (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Free alongside a vessel (a shipping term). The seller bears the responsibility (and cost, if any) of transferring the goods into the possession of the carrier or to a named destination.

FOB (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A shipping term that means "free on board." The seller bears the responsibility (and cost, if any) of transferring the goods into the possession of the carrier or to a named destination.

future goods (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Goods that are not in existence at the time of entering into a contract, such as goods to be manufactured or ordered by the seller for the buyer.

identi�ication of goods to the contract (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The moment at which a buyer’s goods are selected and picked out as that particular buyer’s.

inadmissible (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Evidence that a jury cannot hear because it is not part of the �inal contract. Under the parol evidence rule, a previous but unwritten agreement between two parties to a contract.

insurable interest (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Suf�icient property interest in goods so that one can obtain insurance against his or her loss.

parol evidence rule (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Holds that all prior or contemporaneous oral or written agreements that vary or contradict the �inal integrated contract are inadmissible in court.

risk of loss rules (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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Guidelines for determining who must pay for damages or loss of goods in a contract or exchange.

sale on approval contract (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A contract in which the buyer may try the seller’s goods and keep them or send them back at the seller’s expense.

sale or return contract (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A contract in which the buyer sells the goods to a third party and returns whatever goods are not sold at his or her own expense to the original seller.

security interest (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The right of a creditor to have speci�ic property sold to satisfy a debt.

shipment contract (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of contract for the sale of goods in which the risk of loss is on the buyer once the seller places the goods on a carrier in the seller’s city.

tendered (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

As part of a shipping agreement, the seller has noti�ied the buyer that the goods are available for pickup.

Chapter 11 Flashcards

Critical Thinking and Discussion Questions

1. What are the differences between shipment contracts and destination contracts?

2. In what situation would a sale on approval contract be used?

3. What protection does the parol evidence rule offer?

4. Stephanie went to a hair salon for a wash, cut, and perm. While performing these services the hairstylist used a variety of products on Stephanie’s hair, including shampoo, conditioner, and permanent solution. Does the contract between Stephanie and the hair salon fall under the UCC or the common law? What test would the court use to determine this? Suppose that Stephanie was severely injured by the solution and wanted to sue the hair salon for breach of warranty. Why would it make a difference if the contract was under the UCC or the common law?

5. Blake decided that he needed to purchase a new automobile. He went to a dealership and looked at a new car. "How much is the car?" he asked. The salesperson told him. "Does it come with torsion bar suspension?" Blake asked. "No, but we can order it installed on the car for you," the salesperson responded. "Can I have it delivered on August 15?" Blake asked. "Yes," the salesperson said. After concluding their conversations, Blake met with the salesperson and signed a written contract that he did not read. The car could not be delivered until December 1 due to manufacturing problems, and when it did arrive, it did not have torsion bar suspension. Blake was furious, and he actually sat down and read the contract. He noticed that there was

Cost and freight (a shipping term). The cost of shipping (freight) is included in the sales price C l i c k c a rd t o s e e t e r m 👆

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no mention of adding the torsion bar suspension and that the delivery date in the written contract was September 2. Discuss the application of the parol evidence rule to this problem.

6. Lindsay owns a gift shop where she sells all sorts of new and used products to customers. Business is good, but she needs to be cautious in terms of what products she offers, so as not to be stuck with inventory that does not sell. Alicia approaches Lindsay with a new line of products that she thinks will sell very well in Lindsay’s store. Lindsay is not sure and is worried about taking on the new line of inventory. Advise Lindsay on what type of contract she could enter into with Alicia to sell the goods with the lowest risk.

7. You are the manager for a large appliance big-box store and have many customers who purchase goods and return later to pick them up. On the night in question, a customer purchased a washer and dryer set and agreed to return the next day with a truck. The customer paid in full for the purchase. That night, the store burned down and all the inventory was destroyed.

a. Who has the risk of loss in this situation? Why? What rule applies?

b. Assume the same set of facts as above, but this time the buyer purchased the washer and dryer at a garage sale and agreed to return the next day to pick them up. The buyer paid in full for the washer and dryer. That night, the seller’s garage burned down. Who has the risk of loss in this situation? Why? What rule applies?

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Unit IV

Commercial Paper, Banks, and the Banking System

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Chapter 12: Introduction to UCC Article 3: Commercial Paper

In this chapter you will:

Distinguish between an assignment and a negotiation.

Identify the types of commercial paper.

Identify the criteria that make an instrument negotiable.

Chapter 13: Transfer and Negotiation of Commercial Paper and Rights of Holders

In this chapter you will:

Understand how different types of commercial paper are issued and negotiated.

Identify the requirement of endorsements.

Explain how to negotiate paper to a holder in due course and the signi�icance of this negotiation.

Chapter 14: Liability of Parties to Commercial Paper and Warranties of Transfer and of Presentment

In this chapter you will:

Identify all of the parties on a negotiable instrument and their respective rights and liabilities.

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Chapter 15: Banks, the Banking Process, and Electronic Transfers

In this chapter you will:

Identify the types of checks commonly seen in banking.

Understand the debtor–creditor relationship as it relates to businesses and banks.