BUSI_561 Contracts in Writing and Third-Party Contracts WEEK_4..pdf

BUSI 561 WEEK 4

Contracts in Writing and Third-Party Contracts

In the United States, the term statute of frauds is somewhat misleading because there is no federal

statute of frauds; rather, such legislation exists at the state level, with the exception of Louisiana.

Maryland and New Mexico have statutes of frauds created by judicial decision rather than by legislation.

The term statute of frauds is also misleading in another way: The statute of frauds does not relate to

fraudulent contracts, nor does it address the issue of illegal contracts. Rather, the statute addresses the

enforceability of contracts that fail to meet the requirements set forth in the statute. Furthermore, the

statute serves to protect promisors from poorly considered oral contracts by requiring certain contracts

to be in writing.

Statute of Frauds

The statute of frauds has three main purposes. The first is to ease contractual negotiations by requiring

sufficiently reliable evidence to prove the existence and specific terms of a contract. The second is to

prevent unreliable oral evidence from interfering with a contractual relationship. Requiring a written

contract prevents the admittance of oral evidence denying or substantially altering the contract. (This

chapter discusses the admissibility, or lack thereof, of oral evidence later, in the section on the parol

evidence rule.) The third is to prevent parties from entering into contracts with which they do not agree.

The statute’s requirements impose on parties the need to consider the terms carefully, agree to them,

write them down, and sign the contract.

Contracts Falling within the Statute of Frauds

As previously stated, only specific types of contracts fall within the statute of frauds and thus are

required to be evidenced in writing. These types of contracts are (1) contracts whose terms prevent

possible performance within one year, (2) promises made in consideration of marriage, (3) contracts for

one party to pay the debt of another if the initial party fails to pay, and (4) contracts related to an

interest in land. Although required to be in writing under the Uniform Commercial Code (UCC), and not

the statute of frauds, a related fifth category is contracts for the sale of goods totaling more than $500.

CONTRACTS WHOSE TERMS PREVENT

POSSIBLE PERFORMANCE WITHIN ONE YEAR

Contracts whose performance, based on the

terms of the contract, could not possibly

occur within one year fall within the statute

of frauds and, therefore, must be in

writing.4 It is important to realize that the

one-year period begins to run the day after

the contract is created, not when the contract

is scheduled to begin.

The test for compliance with the one-year

rule is not related to the likelihood of the

completion of the contract within one year.

Rather, the test considers the possibility of

completing the contract within one year.

CONTRACTS FOR ONE PARTY TO PAY THE DEBT OF ANOTHER IF THE INITIAL PARTY FAILS TO PAY

The contracts involving promises to pay a debt that are within the statute of frauds are of a very limited

kind. These promises are referred to as secondary promises, collateral promises, or suretyship

promises. All of these terms refer to agreements in which a third party agrees to pay the debt owed by

another party if that other party fails to pay his or her debt.

CONTRACTS FOR ONE PARTY TO PAY THE DEBT OF ANOTHER IF THE INITIAL PARTY FAILS TO PAY

The contracts involving promises to pay a debt that are within the statute of frauds are of a very limited

kind. These promises are referred to as secondary promises, collateral promises, or suretyship

promises. All of these terms refer to agreements in which a third party agrees to pay the debt owed by

another party if that other party fails to pay his or her debt. For example, Helen enters into a contract

with Tom to sell Tom her car. Subsequently, Diana agrees to pay Tom’s debt if he fails to pay Helen the

money he owes her. To be enforceable, Diana’s promise needs to be in writing because it is within the

statute.

It is important to understand the distinction between primary and secondary obligations to know when

the statute necessitates a written agreement. Primary obligations are debts entered into in an initial

contract

Secondary obligations, however, are within the statute and need to be in writing. A secondary

obligation, as explained earlier, arises when a party outside a primary agreement promises to fulfill one

of the original party’s (the primary debtor’s) obligations if the original party (primary debtor) fails to

fulfill his or her obligation.

A specific instance of a secondary obligation involves the administrator or executor of an estate.

Administrators and executors of estates are responsible for paying the debts of an estate and then

dividing the remaining wealth among the heirs. Although an agreement to pay the estate’s debts with

the estate’s funds need not be in writing, promises the administrator or executor makes to pay those

debts personally are within the statute of frauds and must be in writing. Because the administrator or

executor is paying with his or her own money, and not the estate’s, the promises must be in writing to be

enforceable—the administrator or executor has assumed a secondary obligation.

There is an exception concerning when a promise to pay someone else’s debt needs to be in writing: the

main-purpose rule. If the main purpose for incurring a secondary obligation is to obtain a personal

benefit, the promise does not fall within the statute and need not be in writing. The assumption is that a

party attempting to achieve a personal benefit will not back out of the agreement; thus there is no need

for a written record of the agreement. The court’s job is to use the context surrounding the agreement

to determine the third party’s main purpose for entering the agreement.

equal dignity rule

A rule requiring that contracts that would normally fall under the statute of frauds and need a writing if

negotiated by the principal must be in writing even if negotiated by an agent.

promissory estoppel

The legal enforcement of an otherwise unenforceable contract due to a party’s detrimental reliance on

the contract. Under certain circumstances, when a party relies on an oral contract that is within the

statute of frauds, and therefore should have been in writing, the reliance can create a situation in which

the contract is enforceable. Promissory estoppel is the legal enforcement of an otherwise unenforceable

contract due to a party’s detrimental reliance on the contract

EXCEPTIONS UNDER THE UCC

In addition to the exceptions under the statute of frauds, exceptions also exist under the UCC about

when a contract ordinarily required to be in writing need not be in writing. For instance, under the UCC,

oral contracts between merchants need not be in writing to be enforceable. Therefore, if one merchant

agrees to sell goods to another, the contract is enforceable even if it is not in writing.

Likewise, oral contracts for customized goods are enforceable even if they would normally have to be in

writing. The reasoning is that customized goods are not likely to be able to be sold to a general

audience.

The requirements under the UCC for sales contracts vary slightly from those under the statute of frauds.

The UCC does not require the parties to be named in the agreement. Rather, the UCC requires the

writing to state clearly the quantity to be sold. Similar to the statute of frauds, the UCC allows a variety

of written documents to constitute a writing

parol evidence rule

A common law rule that states that oral evidence of an agreement made prior to or contemporaneously

with a written agreement is inadmissible when the parties intend the written agreement to be the

complete and final version of their agreement.

A cautionary note is in order: “Parol evidence rule,” on its face, is a misnomer. First and foremost, parol

evidence applies to both parol (spoken words) and written speech. The parol evidence rule covers

evidence extrinsic to the original writing and is not limited to spoken words. Second, the parol evidence

rule is not a rule of evidence but, rather, relates to substantive legal issues, namely, what constitutes a

legally binding agreement and how we know what the agreement is. Third, the parol evidence rule is not

a unitary concept or rule but an amalgamation of different rules and conditions.

merger clause

A clause in a written agreement within the statute of frauds that states that the written agreement

accurately reflects the final, complete version of the agreement.

Exceptions to the Parol Evidence Rule

As with the statute of frauds, there are exceptions to the general applicability of the parol evidence rule.

That is, there are situations in which parol evidence, which is normally excluded, may be admissible in

court. These exceptions pertain to (1) contracts that are subsequently modified, (2) contracts

conditioned on orally agreed-on terms, (3) contracts that are not final because they are part written and

part oral, (4) contracts with ambiguous terms, (5) incomplete contracts, (6)

condition precedent

In a contract, an event that must occur for a party’s duty to arise.

Integrated contracts are written contracts intended to be the complete and final representation of the

parties’ agreement. When the courts deem a contract integrated, unless one of the above exceptions

applies, parol evidence is inadmissible. With partially integrated contracts, parol evidence is admissible

to the extent it clarifies part of the contract or addresses the enforcement of the contract.16 Therefore,

the easiest test to determine the admissibility of parol evidence is to check whether the written contract,

within the statute of frauds, is an integrated contract.

One way parties can indicate their desire to create an integrated contract is through the use of a merger

clause. A merger clause explicitly states that the written contract is intended to be the complete and

final version of the contract between the parties and that other possible agreements between the

parties, besides the one in question, are not part of the final written agreement. In essence, a merger

clause seeks to blend other agreements either into the final agreement or into something explicitly

stated as being outside the final agreement.

Assignments and Delegations

Contracts typically involve an agreement between two parties in which each party agrees to do

something for the other. That is, both parties are obligors (contractual parties who agreed to do

something for each other) and obligees (contractual parties who agreed to receive something from each

other). Consequently, contracts create a situation in which each party has a duty to perform the agreed-

on action and a right to be the recipient of the other party’s duty. These rights and duties can be

transferred to third parties—parties not part of the original contract. The following sections discuss both

the transfer of rights (assignment) and the transfer of duties (delegation) to third parties.

First, the rights to a contract cannot be assigned when the contract is personal in nature. For a contract

to be personal in nature, the obligor must have promised something specific to the person receiving it.

Because the subject matter of the contract is personal, a third party cannot legally become the recipient.

Assignment occurs when

a party to a contract

(an assignor) transfers

her rights to a contract to

a third party

(an assignee). In other

words, the assignor gives

to the assignee the right

to collect what was

contractually agreed on

in the original contract

Rights That Cannot Be Assigned

The one exception occurs when the only part of a contract left to be fulfilled is the payment,22 because

rights to payment can always be assigned.

Second, rights cannot be assigned when the assignment would increase the risk or duties the obligor

would face in fulfilling the original contract. For example, Ben agrees to replace the siding on Erin’s two-

bedroom rancher. Erin cannot assign her right to Ben’s services to Chris, who lives in a three-story, five-

bedroom house, because Ben’s (the obligor’s) duties would be greatly increased from the work required

in the original contract with Erin to the work required in an agreement with Chris.

Third, rights cannot be assigned when the contract expressly forbids assignments. When parties include

an antiassignment clause in their contract, the parties are attempting to limit their ability to assign their

rights under the contract. However, the wording of the antiassignment clause is determinative regarding

the effectiveness of the clause. That is, if worded improperly or ambiguously, the clause does not

effectively limit assignments.

Most courts consider contractual prohibitions against assignments to be promises. Consequently, courts

consider an assignment made despite an antiassignment clause to be effective, but the party who makes

the assignment will still be liable for breaching the terms of the contract. Moreover, unless the clause is

very specific in what it prohibits, the court will generally interpret the antiassignment clause as

preventing delegation of duties, not assignment of rights.23 A clause stating “All assignments are void

under this contract” would be considered effective. In contrast, when a contract includes a clause

explicitly permitting assignments, the parties may assign rights, even when assignments would normally

be considered improper because of an increased duty, risk, or burden to the obligor.24

Even in the presence of an antiassignment clause, there are exceptions in which assignments can still be

made. For instance, antiassignment clauses do not affect assignments made by operation of law. That is,

if a law necessitates an assignment, such as in bankruptcy cases, the assignment is effective regardless of

any contractual agreement to the contrary. Likewise, as previously stated, the right to assign monetary

payments cannot be denied. Therefore, even when a contract has an antiassignment clause, either party

may still assign his or her right to receive payment.25 Part of the reason the law does not bar the right to

receive payment is that businesses often transfer rights to payments in the regular course of business.

Also, one’s duty to pay is not affected when the party to whom one must make a payment changes. That

is, no added burden is placed on the obligor when the recipient of a payment changes, requiring that

payment be sent to a different party.

In addition, assignments for the right to receive damages for a breach of contract to sell goods or

services are unaffected by antiassignment clauses.26 Therefore, if one party breaches the contract, the

other party can sue the breaching party and transfer the right to recovery to a third party.

Fourth, rights cannot be assigned when law or public policy forbids such assignments. Various state and

federal statutes prohibit the assigning of specific rights. Even when no statute prohibits an assignment, if

the assignment is determined to be against public policy, the assignment is deemed ineffective.

Except as outlined in this section, all other rights are presumed to be assignable. Once it has been

established that an assignment is valid, notice should be given to the obligor regarding the assignment.

first-assignment-in-time rule

A rule that states that the first party granted the assignment is the party correctly entitled to the

contractual right.

English rule

A rule that states that the first assignee to give notice of assignment to the obligor is the party with

rights to the contract.

The Restatement (Second) of Contracts states a view between the first-assignment-in-time rule and the

English rule.27 The Restatement grants legal right to the first assignee in most situations. If the first

assignment is legally voidable or revocable by the assignor, subsequent assignments are considered

evidence that the first assignment was voided or revoked, and the later assignee has legal right to the

contract. Also, the later assignee is considered the legal owner of the contractual right if she offers

something to the assignor as consideration and then obtains (1) performance by the obligor on his duty,

(2) judgment requiring performance by the obligor, (3) a new contract with the obligor, or (4) evidence

frequently used to signify a contractual right (e.g., a writing indicating a contractual obligation).

DELEGATION

Instead of the third party receiving something, as in an assignment, delegations require the delegatee to

fulfill the delegator’s contractual obligation to the obligee—the party to the contract to whom a duty is

owed.

Duties That Cannot Be Delegated Delegation vs Assignment

As with assignments, the starting assumption is that duties to a contract can be delegated. However,

courts tend to examine delegations more closely than assignments. The reasoning is that an assignment

usually does not affect the party to the contract who is not involved in the assignment (the obligor),

whereas a delegation forces the party to the contract who is not involved in the delegation (the obligee)

to receive performance of the contract from a party with whom the obligee did not directly contract.

Also, just as with assignments, in certain situations duties cannot be delegated to a third party

Duties That Cannot Be Delegated

Duties that are personal in nature.

Duties for which the delegatee’s performance will vary significantly from the delegator’s.

Duties in contracts that forbid delegations.

PARTIAL PERFORMANCE

Although the statute of frauds requires a writing for sales of interests in land, there is an exception based

on the theory of partial performance. Under partial performance, if the buyer in an alleged contract for

the sale of land has paid any portion of the sales price and either has begun to improve the land

permanently or has taken possession of the land, the courts will consider the contract partially

performed, and this partial performance will amount to proof of the contract.

Accordingly, partial performance can override the statute’s requirement for a written agreement. The

logic is that the actions of both parties demonstrate the existence of their agreement, so the agreement

no longer needs to be in writing to be enforceable, even though a writing would otherwise be needed.

Integrated Contracts

Integrated contracts are written contracts intended to be the complete and final representation of the

parties’ agreement. When the courts deem a contract integrated, unless one of the above exceptions

applies, parol evidence is inadmissible. With partially integrated contracts, parol evidence is admissible

to the extent it clarifies part of the contract or addresses the enforcement of the contract.16 Therefore,

the easiest test to determine the admissibility of parol evidence is to check whether the written contract,

within the statute of frauds, is an integrated contract.

A merger clause explicitly states that the written contract is intended to be the complete and final

version of the contract between the parties and that other possible agreements between the parties,

besides the one in question, are not part of the final written agreement. In essence, a merger clause

seeks to blend other agreements either into the final agreement or into something explicitly stated as

being outside the final agreement.

Contracts are typically private agreements, in the sense that the focus of the contract is the two parties

involved and no one else. Accordingly, parties not in privity of contract (i.e., parties other than the

contracting parties) usually do not have rights to a contract. However, as frequently is the case in the law,

there are exceptions to the general rule.

There are two main situations in which a third party gains rights to a contract to which she or he is not a

party. In the first, one of the contracting parties transfers rights or duties to a third party. In the second,

the third party is a direct beneficiary of a contract involving two other parties. The remainder of this

chapter examines both of these situations.

When an assignor transfers her rights to an assignee, the assignor legally gives up all rights she

previously had to collect on the contract.17 Now the assignee may legally demand performance from

the other party to the original contract.

for assignments to be valid, certain restrictions exist. First, although assignments may be given orally or

in writing,18 the UCC requires assignments to be in writing when the amount being assigned is greater

than $5,000.19 Furthermore, assignments covered by the statute of frauds also must be in writing.

Because it is difficult to prove the existence of assignments given orally, it is usually suggested that

assignments be in writing.

Second, an assignee must agree to accept the assigned rights. An assignee may decline an assignment if

he has not legally agreed to the assignment and he declines in a timely fashion after learning about the

assignment and its terms.20 There is no protocol an assignee must follow to reject an assignment, but

once the assignment is rejected, it is considered rejected from the time it was first offered. Third, in

some situations contractual rights cannot be assigned.21

INTENDED BENEFICIARIES

LO 13-6

Early in the common law, courts had difficulty when contracts were written to benefit third parties. The

courts were not sure how to treat these contracts and usually deemed third parties to have no rights to

contracts to which they were not in privity. Now, however, third parties who are intended beneficiaries

have the right to enforce contracts. An intended beneficiary is a third party to a contract whom the

contracting parties intended to benefit directly from their contract.

Intended beneficiaries may enforce their rights to a contract when both parties to the contract intended

for the third party to benefit. In determining whether a third party is an intended beneficiary, courts ask

whether the contracting parties intended the third party to be the “direct,” “primary,” or “express”

beneficiary of the contract.