Module 2
Legal Environment of Business and Contract Law
A. Law Definition
A fundamental but difficult question regarding law is this: what is it? Numerous
philosophers and jurists (legal scholars) have attempted to define it. American jurists and
Supreme Court Justices Oliver Wendell Holmes and Benjamin Cardozo defined law as
predictions of the way that a court will decide specific legal questions. William
Blackstone, an English jurist, on the other hand, defined law as “a rule of civil conduct
prescribed by the supreme power in a state, commanding what is right, and prohibiting
what is wrong.” Similarly, Austin, a nineteenth-century English jurist, defined law as a
general command that a state or sovereign makes to those who are subject to its authority
by laying down a course of action enforced by judicial or administrative tribunals.
First, we may mean the legal order, that is, the regime of ordering human
activities and relations through systematic application of the force of politically organized
society, or through social pressure in such a society backed by such force. We use the
term “law” in this sense when we speak of “respect for law” or for the “end of law.”
Second, we may mean the aggregate of laws or legal precepts; the body of authoritative
grounds of judicial and administrative action established in such a society. We may mean
the body of received and established materials on which judicial and administrative
determinations proceed. We use the term in this sense when we speak of “systems of
law” or of “justice according to law.” Third, we may mean what Mr. Justice Cardozo has
happily styled “the judicial process.” We may mean the process of determining
controversies, whether as it actually takes place, or as the public, the jurists, and the
practitioners in the courts hold it ought to take place.
At a general level, the primary function of law is to maintain stability in the
social, political, and economic system while simultaneously permitting change. The law
accomplishes this basic function by performing a number of specific functions, among
them dispute resolution, protection of property, and preservation of the state. Disputes,
which inevitably arise in a society as complex and interdependent as ours, may involve
criminal matters, such as theft, or noncriminal matters, such as an automobile accident.
Because disputes threaten the stability of society, the law has established an elaborate and
evolving set of rules to resolve them. In addition, the legal system has instituted societal
remedies, usually administered by the courts, in place of private remedies such as
revenge.
Although moral and ethical concepts greatly influence the law, morals and law are
not the same. They may be considered as two intersecting circles, as shown in Figure 1-1.
The area common to both circles includes the vast body of ideas that are both moral and
legal. For instance, “Thou shall not kill” and “Thou shall not steal” are both moral
precepts and legal constraints. On the other hand, the part of the legal circle that does not
intersect the morality circle includes many rules of law that are completely unrelated to
morals, such as the rules stating that you must drive on the right side of the road and that
you must register before you can vote. Likewise, the portion of the morality circle which
does not intersect the legal circle includes moral precepts not enforced by law, such as the
moral principle that you should not silently stand by and watch a blind man walk off a
cliff or that you should provide food to a starving child.
Because the subject is vast, classifying the law into categories is helpful. Though
a number of classifications are possible, the most useful categories are (1) substantive and
procedural, (2) public and private, and (3) civil and criminal. Basic to understanding
these classifications are the terms right and duty. A right is the capacity of a person, with
the aid of the law, to require another person or persons to perform, or to refrain from
performing, a certain act. Thus, if Alice sells and delivers goods to Bob for the agreed
price of $500 payable at a certain date, Alice has the capability, with the aid of the courts,
of enforcing the payment by Bob of the $500. A duty is the obligation the law imposes
upon a person to perform, or to refrain from performing, a certain act. Duty and right are
correlatives: no right can rest upon one person without a corresponding duty resting upon
some other person or, in some cases, upon all other persons.
Substantive law creates, defines, and regulates legal rights and duties. Thus, the
rules of contract law that determine when a binding contract is formed are rules of
substantive law. This book is principally concerned with substantive law. On the other
hand, procedural law establishes the rules for enforcing those rights that exist by reason
of substantive law. Thus, procedural law defines the method by which one may obtain a
remedy in court.
Public law is the branch of substantive law that deals with the government’s rights
and powers in its political or sovereign capacity and in its relation to individuals or
groups. Public law consists of constitutional, administrative, and criminal law. Private
law is that part of substantive law governing individuals and legal entities (such as
corporations) in their relations with one another. Business law is primarily private law.
The sources of law in the U.S. legal system are the Federal and State
constitutions, Federal treaties, interstate compacts, Federal and State statutes and
executive orders, the ordinances of countless local municipal governments, the rules and
regulations of Federal and State administrative agencies, and an ever-increasing volume
of reported Federal and State court decisions. The supreme law of the land is the U.S.
Constitution. The Constitution provides that Federal statutes and treaties shall be the
supreme law of the land. Federal legislation and treaties are, therefore, paramount to State
constitutions and statutes. Federal legislation is of great significance as a source of law.
Other Federal actions having the force of law are executive orders of the President and
rules and regulations of Federal administrative officials, agencies, and commissions. The
Federal courts also contribute considerably to the body of law in the United States.
A constitution—the fundamental law of a particular level of government—
establishes the governmental structure and allocates power among the levels of
government, thereby defining political relationships. One of the fundamental principles
on which our government is founded is that of separation of powers. As detailed in the
U.S. Constitution, this means that the government consists of three distinct and
independent branches: the Federal judiciary, the Congress, and the executive branch.
The U.S. legal system is a common law system, first developed in England. It
relies heavily on the judiciary as a source of law and on the adversary system for the
adjudication of disputes. In an adversary system, the parties, not the court, must initiate
and conduct litigation. This approach is based upon the belief that the truth is more likely
to emerge from the investigation and presentation of evidence by two opposing parties,
both motivated by self-interest, than from judicial investigation motivated only by official
duty. Other English-speaking countries, including England, Canada, and Australia, also
use the common law system. In distinct contrast to the common law system are civil law
systems, which are based on Roman law. Civil law systems depend on comprehensive
legislative enactments (called codes) and an inquisitorial method of adjudication. In the
inquisitorial system, the judiciary initiates litigation, investigates pertinent facts, and
conducts the presentation of evidence. The civil law system prevails in most of Europe,
Scotland, the State of Louisiana, the province of Quebec, Latin America, and parts of
Africa and Asia.
Administrative law is the branch of public law that is created by administrative
agencies in the form of rules, regulations, orders, and decisions to carry out the regulatory
powers and duties of those agencies. Administrative functions and activities concern
matters of national safety, welfare, and convenience, including the establishment and
maintenance of military forces, police, citizenship and naturalization, taxation, coinage of
money, elections, environmental protection, and the regulation of transportation,
interstate highways, waterways, television, radio, trade and commerce, and, in general,
public health, safety, and welfare.
Decisions in State trial courts generally are not reported or published. The
precedent a trial court sets is not sufficiently weighty to warrant permanent reporting.
Except in New York and a few other States where selected trial court opinions are
published, decisions in trial courts are simply filed in the office of the clerk of the court,
where they are available for public inspection. Decisions of State courts of appeals are
published in consecutively numbered volumes called “reports.” Court decisions are found
in the official State reports of most States. In addition,
B. Business Ethics and the Social Responsibility of Business
Business ethics is a subset of ethics: no special set of ethical principles applies
only to the world of business. Immoral acts are immoral, whether or not a businessperson
has committed them. In the past few years, countless business wrongs—such as insider
trading, fraudulent earnings statements and other accounting misconduct, price-fixing,
concealment of dangerous defects in products, reckless lending and improper
foreclosures in the housing market, and bribery—have been reported almost daily.
Philosophers have sought for centuries to develop dependable universal methods
for making ethical judgments. In earlier times, some thinkers analogized the discovery of
ethical principles with the derivation of mathematical proofs. They asserted that people
could discover fundamental ethical rules by applying careful reasoning a priori. (A priori
reasoning is based on theory rather than experimentation and deductively draws
conclusions from cause to effect and from generalizations to particular instances.) In
more recent times, many philosophers have concluded that although careful reasoning
and deep thought assist substantially in moral reasoning, experience reveals that the
complexities of the world defeat most attempts to fashion precise, a priori guidelines.
Nevertheless, reviewing the most significant ethical theories can aid analysis of business
ethics issues.
Under ethical fundamentalism, or absolutism, individuals look to a central
authority or set of rules to guide them in ethical decision making. Some look to the Bible;
others look to the Koran or the writings of Karl Marx or to any number of living or
deceased prophets. The essential characteristic of this approach is a reliance upon a
central repository of wisdom. In some cases, such reliance is total. In others, it occurs to a
lesser degree: followers of a religion or a spiritual leader may believe that all members of
the group have an obligation to assess moral dilemmas independently, according to each
person’s understanding of the dictates of certain fundamental principles.
Utilitarianism is a doctrine that assesses good and evil in terms of the
consequences of actions. Those actions that produce the greatest net pleasure compared
with the net pain are better in a moral sense than those that produce less net pleasure. As
Jeremy Bentham, one of the most influential proponents of utilitarianism, proclaimed, a
good or moral act is one that results in “the greatest happiness for the greatest number.”
Deontological theories (from the Greek word deon, meaning “duty” or
“obligation”) address the practical problems of utilitarianism by holding that certain
underlying principles are right or wrong regardless of calculations regarding pleasure or
pain. Deontologists believe that actions cannot be measured simply by their results but
must be judged by means and motives as well. Our criminal laws apply deontological
reasoning. Knowing that John shot and killed Marvin is not enough to tell us how to
judge John’s act. We must know whether John shot Marvin in anger, in self-defense, or
by mistake
Social ethics theories assert that special obligations arise from the social nature of
human beings. Such theories focus not only on each person’s obligations to other
members of society but also on the individual’s rights and obligations within society. For
example, social egalitarians believe that society should provide all persons with equal
amounts of goods and services regardless of the contribution each makes to increase
society’s wealth. Two other ethics theories have received widespread attention in recent
years. One is the theory of distributive justice proposed by Harvard philosopher John
Rawls, which seeks to analyze the type of society that people in a “natural state” would
establish if they could not determine in advance whether they would be talented, rich,
healthy, or ambitious, relative to other members of society.
The preceding theories do not exhaust the possible approaches to evaluating
ethical behavior, but represent the most commonly cited theories advanced over the
years. Several other theories also deserve mention. Intuitionism holds that a rational
person possesses inherent powers to assess the correctness of actions. Though an
individual may refine and strengthen these powers, they are just as basic to humanity as
our instincts for survival and self-defense. Just as some people are better artists or
musicians, some people have more insight into ethical behavior than others. Consistent
with intuitionism is the good persons philosophy, which declares that individuals who
wish to act morally should seek out and emulate those who always seem to know the
right choice in any given situation and who always seem to do the right thing. One
variation of these ethical approaches is the “Television Test,” which directs us to imagine
that every ethical decision we make is being broadcast on nationwide television.
Adherents of this approach believe an appropriate decision is one we would be
comfortable broadcasting on television for all to witness.
In their efforts to resolve the moral dilemmas facing humanity, philosophers and
other thinkers have struggled for years to refine the various systems discussed previously.
No one ethical system is completely precise, however, and each tends occasionally to
produce unacceptable prescriptions for action. But to say that a system has limits is not to
say it is useless. On the contrary, many such systems provide insight into ethical decision
making and help us formulate issues and resolve moral dilemmas.
Because corporations are not persons but rather artificial entities created by the
State, it is not obvious whether they can or should be held morally accountable. As Lord
Chancellor Thurlow lamented two hundred years ago, “A company has no body to kick
and no soul to damn, and by God, it ought to have both.” Clearly, individuals within
corporations can be held morally responsible, but the corporate entity presents unique
problems.
As explained and justified by Adam Smith in The Wealth of Nations (1776), the
capitalistic system is composed of six “institutions”: economic motivation, private
productive property, free enterprise, free markets, competition, and limited government.
Economic motivation assumes that a person who receives an economic return for his
effort will work harder; therefore, the economic system should provide greater economic
rewards for those who work harder. Private productive property, the means by which
economic motivation is exercised, permits individuals to innovate and produce while
securing to them the fruits of their efforts.
In addition to the broad demands of maintaining a competitive and fair
marketplace, another factor demanding the ethical and social responsibility of business is
the sheer size and power of individual corporations. The five thousand largest U.S. firms
currently produce more than half of the nation’s gross national product. Statutorily, their
economic power should be delegated by the shareholders to the board of directors, who in
turn appoint the officers of the corporation.
Profitability, as economist Milton Friedman and others have argued, businesses
are artificial entities established to permit people to engage in profit-making, not social,
activities. Without profits, they assert, there is little reason for a corporation to exist and
no real way to measure the effectiveness of corporate activities. Businesses are not
organized to engage in social activities; they are structured to produce goods and services
for which they receive money. Their social obligation is to return as much of this money
to their direct stakeholders as possible. In a free market with significant competition, the
selfish pursuits of corporations will lead to maximizing output, minimizing costs, and
establishing fair prices. All other concerns distract companies and interfere with
achieving these goals.
Whenever companies stray from their designated role of profit-maker, they take
unfair advantage of company employees and shareholders. For example, a company may
support the arts or education or spend excess funds on health and safety; however, these
funds rightfully belong to the shareholders or employees. The company’s decision to
disburse these funds to others who may well be less deserving than the shareholders and
employees is unfair. Furthermore, consumers can express their desires through the
marketplace, and shareholders and employees can decide independently whether they
wish to make charitable contributions. In most cases, senior management consults the
board of directors about supporting social concerns but does not seek the approval of the
company’s major stakeholders. Thus, these shareholders are effectively disenfranchised
from actions that reduce their benefits from the corporation
C. Civil Dispute Resolution
The district courts are the general trial courts in the Federal system. Most cases
begin in a district court, and it is here that issues of fact are decided. The district court is
generally presided over by one judge, although in certain cases, three judges preside. In a
few cases, an appeal from a judgment or decree of a district court is taken directly to the
Supreme Court. In most cases, however, appeals go to the Circuit Court of Appeals of the
appropriate circuit, the decision of which, in most cases, is final. Congress has
established ninety-four judicial districts, each of which is located entirely in a particular
State. All States have at least one district; about half of the States contain more than one.
For instance, California and New York each have four districts, Illinois has three, and
Wisconsin has two, while about half of the States each make up a single district.
The nation’s highest tribunal is the U.S. Supreme Court, which consists of nine
justices (a Chief Justice and eight Associate Justices) who sit as a group in Washington,
D.C. A quorum consists of any six justices. In certain types of cases, the U.S. Supreme
Court has original jurisdiction (the right to hear a case first). The Court’s principal
function, nonetheless, is to review decisions of the Federal Courts of Appeals and, in
some instances, decisions involving Federal law made by the highest State courts. Cases
reach the Supreme Court under its appellate jurisdiction by one of two routes.
The special courts in the Federal judicial system include the U.S. Court of Federal
Claims, the U.S. Tax Court, the U.S. Bankruptcy Courts, and the U.S. Court of Appeals
for the Federal Circuit. These courts have jurisdiction over particular subject matter. The
U.S. Court of Federal Claims has national jurisdiction to hear claims against the United
States. The U.S. Tax Court has national jurisdiction over certain cases involving Federal
taxes. The U.S. Bankruptcy Courts have jurisdiction to hear and decide certain matters
under the Federal Bankruptcy Act, subject to review by the U.S. District Court.
Each State has trial courts of general jurisdiction, which may be called county,
district, superior, circuit, or common pleas courts. (In New York, the trial court is called
the Supreme Court.) These courts do not have a dollar limitation on their jurisdiction in
civil cases and hear all criminal cases other than minor offenses. Unlike the inferior trial
courts, these trial courts of general jurisdiction maintain formal records of their
proceedings as procedural safeguards.
The two types of concurrent Federal jurisdiction are Federal question jurisdiction
and diversity jurisdiction. The first arises whenever there is a Federal question over
which the Federal courts do not have exclusive jurisdiction. A Federal question is any
case arising under the Constitution, statutes, or treaties of the United States. For a case to
be treated as “arising under” Federal law, either Federal law must create the plaintiff’s
cause of action or the plaintiff’s right to relief must depend upon the resolution of a
substantial question of Federal law in dispute between the parties. There is no minimum
dollar requirement in Federal question cases.
When a State court hears a concurrent Federal question case, it applies Federal
substantive law but its own procedural rules. The second type of concurrent jurisdiction
—diversity jurisdiction—arises in cases in which there is “diversity of citizenship” and
the amount in controversy exceeds $75,000. Then private litigants may bring an action in
a Federal district court or a State court. Diversity of citizenship exists (1) when the
plaintiffs are all citizens of a State or States different from the State or States of which the
defendants are citizens, (2) when a foreign country brings an action against citizens of the
United States, or (3) when the controversy is between citizens of a State and citizens of a
foreign country. The citizenship of an individual litigant is the State in which the litigant
resides or is domiciled, whereas that of a corporate litigant is both the State of
incorporation and the State in which its principal place of business is located. On the
other hand, a non-corporate entity, such as a limited partnership, takes the citizenship of
each of its members.
Courts in a State have the jurisdiction to adjudicate claims to property situated
within the State if the plaintiff gives those persons who have an interest in the property
reasonable notice and an opportunity to be heard. Such jurisdiction over property is called
in rem jurisdiction, from the Latin word res, which means “thing.” For example, if
Carpenter and Miller are involved in a lawsuit over property located in Kansas, then an
appropriate court in Kansas would have in rem jurisdiction to adjudicate claims with
respect to this property so long as both parties are given notice of the lawsuit and a
reasonable opportunity to contest the claim.
Civil disputes that enter the judicial system must follow the rules of civil
procedure. These rules are designed to resolve the dispute justly, promptly, and
inexpensively. In addition, the Federal court system and most State court systems provide
for class action lawsuits in which one or more plaintiffs may file suit on behalf of
similarly situated individuals who are referred to as “the class.”
When a class action is permitted, the group files the lawsuit with a representative
plaintiff, called the “named plaintiff” or “lead plaintiff.” If the court certifies an action as
meeting the criteria for a class action lawsuit and the plaintiffs prevail or reach a
settlement, members of the class may obtain relief without bringing their own lawsuits.
Conversely, if the defendant prevails in a certified class action lawsuit, members of the
class may be bound by the decision and thus precluded from bringing their own lawsuits
with respect to the claims in the class action lawsuit.
The pleadings are a series of responsive, formal, written statements in which each
side to a lawsuit states its claims and defenses. The purpose of pleadings is to give notice
and to establish the issues of fact and law that the parties dispute. An “issue of fact” is a
dispute between the parties regarding the events that gave rise to the lawsuit. In contrast,
an “issue of law” is a dispute between the parties as to what legal rules apply to these
facts. Issues of fact are decided by the jury, or by the judge when there is no jury,
whereas issues of law are decided by the judge.
Conciliation is a nonbinding, informal process in which the disputing parties
select a neutral third party (the conciliator) who attempts to help them reach a mutually
acceptable agreement. The duties of the conciliator include improving communications,
explaining issues, scheduling meetings, discussing differences of opinion, and serving as
an intermediary between the parties when they are unwilling to meet.
D. Constitutional Law
As the fundamental and organic law of particular jurisdictions, constitutions serve
a number of critical functions. They are the supreme law of their respective jurisdictions.
In addition, they establish the structure of and allocate power among the various levels of
government. They also impose restrictions upon the powers of government and
enumerate the rights and liberties of the people.
Federalism is the division of governing power between the Federal government
and the States. The U.S. Constitution enumerates the powers of the Federal government
and specifically reserves to the States or the people the powers it does not expressly
delegate to the Federal government. Accordingly, the Federal government is a
government of enumerated, or limited, powers, and a specified power must authorize
each of its acts. The doctrine of enumerated powers does not, however, significantly limit
the Federal government because a number of the enumerated powers, in particular the
power to regulate interstate and foreign commerce, have been broadly interpreted.
Judicial review describes the process by which the courts examine government
actions to determine whether they conform to the U.S. Constitution. If government action
violates the U.S. Constitution, under judicial review, the courts will invalidate that action.
Judicial review extends to legislation, acts of the executive branch, and the decisions of
inferior courts. Such review scrutinizes actions of both the Federal and State governments
and applies to both the same standards of constitutionality. The U.S. Supreme Court is
the final authority as to the constitutionality of any Federal and State law. The U.S.
Constitution does not expressly provide for judicial review, but in 1803, Chief Justice
John Marshall, speaking for the Court, declared the existence of such authority in the
landmark case of Marbury v. Madison, 5 U.S. (1 Cranch) 137 (1803).
As previously stated, the U.S. Constitution created a Federal government of
enumerated powers. Moreover, as the Tenth Amendment declares, “[t]he powers not
delegated to the United States by the Constitution, nor prohibited by it to the States, are
reserved to the States respectively, or to the people.” Consequently, legislation Congress
enacts must be based on a specified power granted to the Federal government by the
Constitution or be reasonably necessary to carry out an enumerated power.
The Constitution of the United States grants certain enumerated powers to the
Federal government while reserving other powers, without enumeration, to the States.
The Constitution and its amendments, however, impose limits on the powers of both the
Federal government and the States. This part of the chapter discusses those limitations
most applicable to business: (1) the Contract Clause, (2) the First Amendment, (3) due
process, and (4) equal protection. The first of these— the Contract Clause—applies only
to the actions of State governments, whereas the other three apply to both the Federal
government and the States.
Property, for the purposes of procedural due process, includes not only all forms
of real and personal property but also certain entitlements conferred by the government,
such as social security payments and food stamps. In Logan v. Zimmerman Brush Co.,
455 U.S. 422 (1982), the Supreme Court stated, “The hallmark of property … is an
individual entitlement grounded in state law, which cannot be removed except ‘for
cause.’” Under this interpretation of property, the Court has, for example, found protected
property interests in high school education, when attendance is required; welfare benefits,
when the individual has previously been found to meet the statutory requirements; social
security payments; and a driver’s license. On the other hand, if a public employee’s job is
terminable at any time, he has no property interest in his employment; accordingly, he
may lose his job without any procedural due process protections.
E. Administrative Law
Administrative law is the branch of public law that is created by administrative
agencies in the form of rules, regulations, orders, and decisions to carry out the regulatory
powers and duties of those agencies. Administrative agencies are government entities—
other than courts and legislatures—having authority to affect the rights of private parties
through their operations. Such agencies, often referred to as commissions, boards,
departments, administrations, government corporations, bureaus, or offices, regulate a
vast array of important matters involving national safety, welfare, and convenience. For
instance, Federal administrative agencies are charged with responsibility for national
security, citizenship and naturalization, law enforcement, taxation, currency, elections,
environmental protection, consumer protection, regulation of transportation,
telecommunications, labor relations, trade, commerce, and securities markets, as well as
with providing health and social services.
Most administrative agencies perform three basic functions: (1) rulemaking, (2)
enforcement, and (3) adjudication. The term administrative process refers to the activities
in which administrative agencies engage while carrying out their rulemaking,
enforcement, and adjudicative functions. Administrative agencies exercise powers that
the Constitution has allocated to the three separate branches of government. More
specifically, agencies exercise legislative power when they make rules, executive power
when they enforce their enabling statutes and their rules, and judicial power when they
adjudicate disputes. This concentration of power has raised questions regarding the
propriety of having the same bodies that establish the rules also act as prosecutors and
judges in determining whether those rules have been violated. To address this issue and
bring about certain additional procedural reforms, Congress enacted the Administrative
Procedure Act (APA) in 1946.
Rulemaking is the process by which an administrative agency enacts or
promulgates rules of law. Under the APA, a rule is “the whole or a part of an agency
statement of general or particular applicability and future effect designed to implement,
interpret, or process law or policy.” Section 551(4). Once promulgated, rules are
applicable to all parties. Moreover, the rulemaking process notifies all parties that the
agency is considering the impending rule and provides concerned individuals with an
opportunity to be heard.
After concluding an investigation, the agency may use informal or formal
methods to resolve the matter. Because the caseload of administrative agencies is vast, far
greater than that of the judicial system, agencies adjudicate most matters informally.
Informal procedures include advising, negotiating, and settling. In 1990, Congress
enacted the Administrative Dispute Resolution Act to authorize and encourage Federal
agencies to use mediation, conciliation, arbitration, and other techniques for the prompt
and informal resolution of disputes. The Act does not, however, require agencies to use
alternative dispute resolution, and the affected parties must consent to its use.
The legislature may exercise control over administrative agencies in various
ways. Through its budgetary power, it may greatly restrict or expand an agency’s
operations. Congress may amend an enabling statute to increase, modify, or decrease an
agency’s authority. Even more drastically, it may completely eliminate an agency. Or
Congress may establish general guidelines to govern agency action, as it did by enacting
the APA. Moreover, it may reverse or change an agency rule or decision through specific
legislation. In addition, each house of Congress has oversight committees that review the
operations of administrative agencies. Finally, the Senate has the power of confirmation
over some high-level appointments to administrative agencies.
Requiring administrative agencies to disclose information about their actions
makes them more accountable to the public. Accordingly, Congress has enacted
disclosure statutes to enhance public and political oversight of agency activities. These
statutes include the Freedom of Information Act (FOIA), the Privacy Act, and the
Government in the Sunshine Act.
F. Criminal Law
Criminal law, by comparison, is designed to prevent harm to society by defining
criminal conduct and establishing punishment for such conduct. In a criminal case, the
defendant is prosecuted by the government, which must prove the defendant’s guilt
beyond a reasonable doubt, a burden of proof significantly higher than that required in a
civil action. Moreover, under our legal system, guilt is never presumed. Indeed, the law
presumes the innocence of the accused, and the defendant’s failure to testify in her own
defense does not affect this presumption. The government still has the burden of
affirmatively proving the guilt of the accused beyond a reasonable doubt.
A crime is any act or omission forbidden by public law in the interest of
protecting society and made punishable by the government in a judicial proceeding
brought by it. Punishment for criminal conduct includes fines, imprisonment, probation,
and death. In addition, some States and the Federal government have enacted victim
indemnification statutes that establish funds, financed by criminal fines, to provide
indemnification in limited amounts to victims of criminal activity. Crimes are prohibited
and punished on grounds of public policy, which may include the protection and
safeguarding of government (as in treason), human life (as in murder), or private property
(as in larceny). Additional purposes of the criminal law include deterrence, rehabilitation,
and retribution.
In general, a crime consists of two elements: (1) the wrongful or overt act (actus
reus) and (2) the criminal intent (mens rea). For example, to support a larceny conviction
it is not enough to show that the defendant stole another’s goods; it also must be
established that he intended to steal the goods. Conversely, criminal intent without an
overt act is not a crime. For instance, Ann decides to rob the neighborhood grocery store
and then really “live it up.” Without more, Ann has committed no crime. Historically,
corporations were not held criminally liable because under the traditional view, a
corporation could not possess the requisite criminal intent and, therefore, was incapable
of committing a crime. The dramatic growth in size and importance of corporations
changed this view. Under the modern approach, a corporation may be liable for violation
of statutes imposing liability without fault. In addition, a corporation may be liable in
cases in which the offense is perpetrated by a high corporate officer or the board of
directors. Embezzlement is the fraudulent conversion of another’s property by one who
was in lawful possession of it. A conversion is any act that seriously interferes with the
owner’s rights in the property, such as exhausting the resources of the property, selling it,
giving it away, or refusing to return it to its rightful owner. This statutory crime was first
enacted in response to a 1799 English case in which a bank employee was found not
guilty of larceny for taking money given to him for deposit in the bank because the
money had been handed to him voluntarily. Thus, embezzlement is a crime intended to
prevent individuals who are lawfully in possession of another’s property from taking such
property for their own use.
Under the common law as well as most statutes, robbery is a larceny with the
additional elements that (1) the property is taken directly from the victim or in the
immediate presence of the victim and (2) the act is accomplished through either force or
the threat of force, which need not be against the person from whom the property is
taken. For example, a robber threatens Sam, saying that unless Sam opens his employer’s
safe, the robber will shoot Maria. Moreover, the victim’s presence may be actual or
constructive. Constructive presence means that the defendant’s actual or threatened force
prevents the victim from being present. For example, if the robber knocks the victim
unconscious or ties her up, the victim is considered constructively present.
Bribery, on the other hand, is the act of offering money or property to a public
official to influence the official’s decision. The crime of bribery is committed when the
illegal offer is made, whether accepted or not. Thus, if Andrea offered Edward, the mayor
of New Town, a 20 percent interest in Andrea’s planned real estate development if
Edward would use his influence to have the development proposal approved, Andrea
would be guilty of criminal bribery. In contrast, if Edward had threatened Andrea that
unless he received a 20 percent interest in Andrea’s development he would use his
influence to prevent the approval of the development, Edward would be guilty of criminal
extortion. Bribery of foreign officials is covered by the Foreign Corrupt Practices Act,
discussed in Chapters 43 and 46. Some jurisdictions have gone beyond traditional bribery
law by adopting statutes that make commercial bribery illegal. Commercial bribery is the
use of bribery to acquire new business, obtain secret information or processes, or receive
kickbacks.
Individuals may use reasonable force to protect their property. This defense
enables a person to commit, without any criminal liability, what the law would otherwise
consider the crime of assault, battery, manslaughter, or murder. Under the majority rule,
deadly force is never reasonable to safeguard property, because life is deemed more
important than the protection of property. For this reason, individuals cannot use a deadly
mechanical device, such as a spring gun, to protect their property. If, however, the
defender’s use of reasonable force in protecting his property is met with an attack upon
his person, then he may use deadly force if the attack threatens him with death or serious
bodily harm.
Although the particulars of criminal procedure vary from State to State, the
following provides a basic overview. After arrest, the accused is booked and appears
(first appearance) before a magistrate, commissioner, or justice of the peace, where
formal notice of the charges is given, the accused is advised of his rights, and bail is set.
Next, a preliminary hearing is held to determine whether there is probable cause to
believe the defendant is the one who committed the crime. The defendant is entitled to be
represented by counsel.
G. Intentional Torts
In a tort action, the injured party sues to recover compensation for the injury
sustained as a result of the defendant’s wrongful conduct. The primary purpose of tort
law, unlike criminal law, is to compensate the injured party, not to punish the wrongdoer.
In certain cases, however, courts may award punitive or exemplary damages, which are
damages over and above the amount necessary to compensate the plaintiff. In cases in
which the defendant’s tortious conduct has been intentional—or, in some States, reckless
—and outrageous, exhibiting “malice” or a fraudulent or evil motive, most courts permit
a jury to award punitive damages. The allowance of punitive damages is designed to
deter the defendant and others from similar conduct by punishing and making an example
of the defendant.
A number of established and specifically named torts protect an individual from
various intentional interferences with his person, dignity, property, and economic
interests. Because the law of torts is dynamic, new forms of relief continue to develop. To
guide the courts in determining when they should impose liability for intentionally
inflicted harm that does not fall within the requirements of an established tort, Section
870 of the Restatement provides a general catch-all intentional tort: “One who
intentionally causes injury to another is subject to liability to the other for that injury, if
his conduct is generally culpable and not justifiable under the circumstances. This
liability may be imposed although the actor’s conduct does not come within a traditional
category of tort liability.”
The law provides protection against intentional harm to the person. The primary
interests protected by these torts are freedom from bodily contact (by the tort of battery),
freedom from apprehension (assault), freedom from confinement (false imprisonment),
and freedom from mental distress (infliction of emotional distress). Generally, intentional
torts to the person entitle the injured party to recover damages for bodily harm, emotional
distress, loss or impairment of earning capacity, and reasonable medical expenses as well
as for harm the tortious conduct caused to property or business.
The tort of defamation is a false communication that injures a person’s reputation
by disgracing him and diminishing the respect in which he is held. An example would be
the publication of a false statement that a person had committed a crime or had a
loathsome disease. In Beckman v. Dunn, 276 Pa.Super. 527, 419 A.2d 583 (1980), the
court stated, “A communication is defamatory if it tends to harm the reputation of another
so as to lower him in the estimation of the community or deter third persons from
associating or dealing with him, and necessarily involves the idea of disgrace.”
Real property is land and anything attached to it, such as buildings, trees, and
minerals. The law protects the possessor’s rights to the exclusive use and quiet enjoyment
of the land. Accordingly, damages for harm to land include compensation for the
resulting diminution in the value of the land, the loss of use of the land, and the
discomfort caused to the possessor of the land.
A person who would otherwise be liable for a tort is not liable if he acts pursuant
to and within the limits of a privilege. Restatement, Section 890. Conditional privileges,
as discussed in the section on defamation, depend upon proper use of the privilege.
Absolute privilege, on the other hand, protects the defendant regardless of his purpose.
Examples of absolute privilege include untrue, defamatory statements made by
participants during the course of judicial proceedings, by legislators, by certain
governmental executives, and between spouses. Absolute immunity also protects a public
prosecutor from civil liability for malicious prosecution.
H. Negligence and Strict Liability
Strict liability is not based upon the negligence or intent of the defendant but
rather upon the nature of the activity in which he is engaging. Under this doctrine,
defendants who engage in certain activities, such as keeping animals or carrying on
abnormally dangerous conditions, are held liable for the injuries they cause, even if they
have exercised the utmost care. The law imposes this liability to effect a just reallocation
of loss, given that the defendant engaged in the activity for his own benefit and is in a
better position to manage, by insurance or otherwise, the risk inherent in the activity.
As stated previously, the general rule is that a person is under a duty to all others
at all times to exercise reasonable care for the safety of the others’ person and property.
On the other hand, subject to several exceptions, a person (A) does not have a duty of
care when the other’s (B’s) person or property is at risk for reasons other than the conduct
of A. Third Restatement, Section 37. This rule applies even though the person may be in
a position to help another in peril. As William Prosser, an authority on tort law, has
stated, “The law has persistently refused to recognize the moral obligation of common
decency and common humanity, to come to the aid of another human being who is in
danger, even though the outcome is to cost him his life.” For example, Toni, an adult
standing at the edge of a steep cliff, observes a baby carriage with a crying infant in it
slowly rolling toward the edge and certain doom.
The right of possessors of land to use that land for their own benefit and
enjoyment is limited by their duty to do so in a reasonable manner; that is, by the use of
their land, they cannot cause unreasonable risks of harm to others. Liability for breach of
this obligation may arise from conduct in any of the three areas of torts discussed in this
and the preceding chapter: intentional harm, negligence, or strict liability. Most of these
cases fall within the classification of negligence.
As a matter of social policy, legal responsibility has not followed all the
consequences of a negligent act. Tort law does not impose liability on a defendant for all
harm factually caused by the defendant’s negligent conduct. Liability has been limited—
to a greater extent than with intentional torts—to those harms that result from the risks
that made the defendant’s conduct tortious. Third Restatement, Section 29. This “risk
standard” limitation on liability also applies to strict liability cases.
The plaintiff must prove that the defendant’s negligent conduct proximately
caused harm to a legally protected interest. Certain interests receive little or no protection
against such conduct, while others receive full protection. The courts determine the extent
of protection for a particular interest as a matter of law on the basis of social policy and
expediency.
For example, negligent conduct that is the proximate cause of harmful contact
with the person of another is actionable. Thus, if Bob, while driving his car, negligently
runs into Julie, a pedestrian who is carefully crossing the street, Bob is liable for physical
injuries Julie sustains as a result of the collision. On the other hand, if Bob’s careless
driving causes the car’s sideview mirror to brush Julie’s coat but results in no physical
injuries to her or damage to the coat, thus causing only offensive contact with Julie’s
person, Bob is not liable because Julie did not sustain harm to a legally protected interest.
I. Contracts Definition
That law arises from social necessity is clearly true of the law of contracts. The
vast and complicated institution of business can be conducted efficiently and successfully
only upon the certainty that promises will be fulfilled. Business must be assured not only
of supplies of raw materials or manufactured goods but also of labor, management,
capital, and insurance. Common experience has shown that promises based solely on
personal honesty or integrity do not have the reliability essential to business. This
experience has driven the development of the law of contracts, which is the law of
enforceable promises. Contract law, like law as a whole, is not static. It has undergone—
and is still undergoing—enormous changes. In the nineteenth century, virtually absolute
autonomy in forming contracts was the rule. The law imposed contract liability only
where the parties strictly complied with the required formalities. The same principle also
dictated that once a contract was formed, it should be enforced according to its terms and
that neither party should be lightly excused from performance
General contract law governs all contracts outside the scope of the Code. Such
contracts play a significant role in commercial activities. For example, the Code does not
apply to employment contracts, service contracts, insurance contracts, contracts involving
real property (land and anything attached to it, including buildings as well as any right,
privilege, or power in the real property, including leases, mortgages, options, and
easements), and contracts for the sale of intangibles such as patents and copyrights. These
transactions continue to be governed by general contract law.
A contract is a binding agreement that the courts will enforce. Section 1 of the
Restatement more precisely defines a contract as “a promise or a set of promises for the
breach of which the law gives a remedy, or the performance of which the law in some
way recognizes as a duty.” The Restatement provides further insight by defining a
promise as “a manifestation of the intention to act or refrain from acting in a specified
way.”
The terms executed and executory pertain to the state of performance of a
contract. A contract fully performed by all of the parties to it is an executed contract.
Strictly, an executed contract is in the present tense no contract, as all duties under it have
been performed; but it is useful to have a term for a completed contract. (The word
executed is also used to mean “signed,” as in to execute or sign a certain document.) The
term executory, which means “unperformed,” applies to situations in which one or more
promises by any party to the contract are as yet unperformed or where the contract is
wholly unperformed by one or more of the parties. Thus, David and Carla make a
contract under which David is to sell and deliver certain goods to Carla in ten days and
Carla is to pay the agreed price in thirty days. Prior to the delivery of the goods by David
on the tenth day, the contract is wholly executory. Upon David’s delivery of the goods to
Carla, the contract is executed as to David and executory as to Carla. When Carla duly
pays for the goods, the contract is wholly executed and thereby completely fulfilled.
J. Mutual Assent
The manner in which parties usually show mutual assent is by offer and
acceptance. One party makes a proposal (offer) by words or conduct to the other party,
who agrees by words or conduct to the proposal (acceptance). A contractual agreement
always involves either a promise exchanged for a promise (bilateral contract) or a
promise exchanged for an act or forbearance to act (unilateral contract), as manifested by
what the parties communicate to each other.
An offer need not take any particular form to have legal validity. To be effective,
however, it must (1) be communicated to the offeree, (2) manifest an intent to enter into a
contract, and (3) be sufficiently definite and certain. If these essentials are present, an
offer that has not terminated gives the offeree the power to form a contract by accepting
the offer.
An offer confers upon the offeree a power of acceptance, which continues until
the offer terminates. The ways in which an offer may be terminated, other than by
acceptance, are through (1) lapse of time, (2) revocation, (3) rejection, (4) counteroffer,
(5) death or incompetency of the offeror or offeree, (6) destruction of the subject matter
to which the offer relates, and (7) subsequent illegality of the type of contract the offer
proposes.
Because acceptance manifests the offeree’s assent to the offer, the offeree must
communicate this acceptance to the offeror. This is the rule as to all offers to enter into
bilateral contracts. In the case of an offer to enter into a unilateral contract, however,
notice of acceptance to the offeror is usually not required. If, however, the offeree in a
unilateral contract has reason to know that the offeror has no adequate means of learning
of the performance with reasonable promptness and certainty, then the offeree must make
reasonable efforts to notify the offeror of acceptance or lose the right to enforce the
contract.
K. Conduct Invalidating Assent
There are two basic types of duress. The first occurs when one party compels
another to manifest assent to a contract through actual physical force, such as pointing a
gun at a person or taking a person’s hand and compelling him to sign a written contract.
This type of duress, while extremely rare, renders the agreement void, and the party
exerting the duress is liable in restitution as necessary to avoid unjust enrichment.
Undue influence is the unfair persuasion of a person by a party generally in a
dominant position based upon a confidential relationship. The law very carefully
scrutinizes contracts between those in a relationship of trust and confidence that is likely
to permit one party to take unfair advantage of the other. Examples are the relationships
of guardian-ward, trustee-beneficiary, principal-agent, spouses to each other, parent-
child, attorney-client, physician-patient, and clergy-parishioner.
Negligent misrepresentation is a false representation that is made without
knowledge of its falsity and without due care in ascertaining its truthfulness. Innocent
misrepresentation is a false representation made without knowledge of its falsity but with
due care. To obtain relief for nonfraudulent misrepresentation, all of the other elements of
fraud must be present and the misrepresentation must be material. The remedies that may
be available for nonfraudulent misrepresentation are rescission, restitution, and damages.
Somewhat related to mistakes of facts is the situation in which the parties
misunderstand the meaning of each other’s manifestations of mutual assent. A famous
case involving this problem is Raffles v. Wichelhaus, 2 Hurlstone & Coltman 906 (1864),
popularly known as the “Peerless Case.” A contract of purchase was made for 125 bales
of cotton to arrive on the Peerless from Bombay. It happened, however, that there were
two ships by the name of Peerless, each sailing from Bombay, one in October and the
other in December. The buyer had in mind the ship that sailed in October, whereas the
seller reasonably believed the agreement referred to the Peerless sailing in December.
Neither party was at fault, but both believed in good faith that a different ship was
intended. The English court held that no contract existed.
L. Consideration
Legal detriment means (1) doing (or undertaking to do) that which the promisee
was under no prior legal obligation to do or (2) refraining from doing (or the undertaking
to refrain from doing) that which he was previously under no legal obligation to refrain
from doing. On the other hand, legal benefit means the obtaining by the promisor of that
which he had no prior legal right to obtain. Most, if not all, cases involving legal
detriment to the promisee also will involve a legal benefit to the promisor. Nonetheless,
the presence of either is sufficient.
Words of promise that make the performance of the purported promisor entirely
optional constitute no promise at all. Consequently, they cannot serve as consideration. In
this section, such illusory promises will be distinguished from promises that impose
obligations of performance upon the promisor and thus can be legally sufficient
consideration. An illusory promise is a statement that is in the form of a promise but
imposes no obligation upon the maker of the statement. An illusory promise is not
consideration for a return promise. Thus, a statement committing the promisor to
purchase such quantity of goods as she may “desire,” “want,” or “wish to buy” is an
illusory promise because its performance is entirely optional.
The law does not regard the performance of, or the promise to perform, a
preexisting legal duty, public or private, as either a legal detriment to the party under the
prior legal obligation or a benefit to the other party. A public duty does not arise out of a
contract; rather, it is imposed upon members of society by force of the common law or by
statute. As illustrated in the law of torts, public duty includes the duty not to commit an
assault, battery, false imprisonment, or defamation. The criminal law also imposes
numerous public duties. Thus, if Cleon promises to pay Spike, the village ruffian, $100
not to abuse him physically, Cleon’s promise is unenforceable because both tort and
criminal law impose on Spike a preexisting public obligation to refrain from so acting.
Consideration is the inducement for a promise or performance. The element of
bargained-for exchange is absent where a promise is given for a past transaction.
Therefore, unbargained-for past events are not consideration, despite their designation as
“past consideration.” A promise made on account of something that the promisee has
already done is not enforceable. For example, Noel gives emergency care to Tim’s adult
son while the son is ill. Tim subsequently promises to pay Noel for her services, but his
promise is not binding because there is no bargained-for exchange.
Under the common law, when a person desired to bind himself by bond, deed, or
solemn promise, he executed his promise under seal. He did not have to sign the
document, his delivery of a document to which he had affixed his seal being sufficient.
No consideration for his promise was necessary. In some States, the courts still hold a
promise under seal to be binding without consideration. Nevertheless, most States have
abolished by statute the distinction between contracts under seal and written unsealed
contracts. In these States, the seal is no longer recognized as a substitute for
consideration. The Code has also adopted this position, specifically eliminating the use of
seals in contracts for the sale of goods.
M. Illegal Bargains
An essential requirement of a binding promise or agreement is legality of
objective. When the formation or performance of an agreement is criminal, tortious, or
otherwise contrary to public policy, the agreement is illegal and unenforceable (as
opposed to being void). The law does not provide a remedy for the breach of an
unenforceable agreement and thus “leaves the parties where it finds them.” It is
preferable to use the term illegal bargain or illegal agreement rather than illegal contract,
because the word contract, by definition, denotes a legal and enforceable agreement. The
illegal bargain is made unenforceable (1) to discourage such undesirable conduct and (2)
to preclude the inappropriate use of the judicial process in carrying out such socially
undesirable bargains.
The reach of a statute may extend beyond its language. Sometimes, the courts, by
analogy, use the statute and the policy it seeks to serve as a guide in determining the
private contract rights of one harmed by a violation of the statute. In addition, the courts
must frequently articulate the “public policy” of the State without significant help from
statutory sources. This judicially declared public policy is very broad in scope, it often
being said that agreements having “a tendency to be injurious to the public or the public
good” are contrary to public policy. Thus, the term public policy eludes precise
definition. Contracts raising questions of public policy include agreements that (1)
restrain trade, (2) exempt or exculpate a party from liability for his own tortious conduct,
(3) are unconscionable, (4) involve tortious conduct, (5) tend to corrupt public officials or
impair the legislative process, (6) tend to obstruct the administration of justice, or (7)
impair family relationships. This section focuses on the first five of these types of
agreements.
“A promise to commit a tort or to induce the commission of a tort is
unenforceable on grounds of public policy.” Restatement, Section 192. The courts will
not permit contract law to violate the law of torts. Any agreement attempting to do so is
considered contrary to public policy. For example, Andrew and Barlow Co. enter into an
agreement under which Andrew promises Barlow that in return for $5,000, he will
disparage the product of Barlow Co.’s competitor Cosmo, Inc., in order to provide
Barlow Co. with a competitive advantage. Andrew’s promise is to commit the tort of
disparagement and is unenforceable as contrary to public policy.
N. Contractual Capacity
Almost without exception, a minor’s contract, whether executory or executed, is
voidable unless the contract has been ratified. Restatement, Section 14. A minor, also
called an infant, is a person who has not attained the age of legal majority. At common
law, a minor was a person who was under twenty-one years of age. Today the age of
majority has been changed in nearly all jurisdictions by statute, usually to age eighteen.
Thus, the minor is in a favored position by having the option to disaffirm the contract or
to enforce it. The adult party to the contract cannot avoid her contract with a minor. Even
an “emancipated” minor, one who because of marriage or other reason is no longer
subject to strict parental control, may avoid contractual liability in most jurisdictions.
Consequently, businesspeople deal at their peril with minors and in situations of
consequence generally require an adult to cosign or guarantee the performance of the
contract.
If a person is under guardianship by court order, her contracts are void and of no
legal effect. Restatement, Section 13. A guardian is appointed by a court, generally under
the terms of a statute, to control and preserve the property of a person (the ward or
adjudicated incompetent) whose impaired capacity prevents her from managing her own
property. Nevertheless, a party dealing with an individual under guardianship may be
able to recover the fair value of any necessaries provided to the incompetent. Moreover,
the contracts of the ward may be ratified by her guardian or by herself upon termination
of the guardianship.
A person may avoid any contract that he enters into if the other party has reason
to know that, because of intoxication, he is unable either to understand the nature and
consequences of his actions or to act in a reasonable manner. Restatement, Section 16.
Such contracts are voidable, although they may be ratified when the intoxicated person
regains his capacity. Slight intoxication will not destroy one’s contractual capacity, but
neither is it essential that one be so drunk as to be totally without reason or
understanding.
O. Contracts in Writing
When the parties do reduce their agreement to a complete and final written
expression, the law (under the parol evidence rule) honors this document by not allowing
the parties to introduce any evidence in a lawsuit that would alter, modify, or vary the
terms of the written contract. Nevertheless, the parties may differ as to the proper or
intended meaning of language contained in the written agreement where such language is
ambiguous or susceptible to different interpretations. To ascertain the proper meaning
requires an interpretation, or construction, of the contract. The rules of construction
permit the parties to introduce evidence to resolve ambiguity and to show the meaning of
the language employed and the sense in which both parties used it.
Many more types of contracts are not subject to the statute of frauds than are
subject to it. Most oral contracts, as previously indicated, are as enforceable and valid as
a written contract. If, however, a given contract is subject to the statute of frauds, the
contract is said to be within the statute; to be enforceable, it must comply with the
statute’s requirements. All other types of contracts are said to be “not within” or
“outside” the statute and need not comply with its requirements to be enforceable.
The executor-administrator provision applies to the contractual promises of an
executor of a decedent’s will, or to those of the administrator of his estate if the decedent
dies without a will, to answer personally for a duty of the decedent. An executor or
administrator is a person appointed by a court to carry on, subject to order of court, the
administration of the estate of a deceased person. If the will of a decedent nominates a
certain person as executor, the court customarily appoints that person. (For a more
detailed discussion of executors and administrators, see Chapter 50.) If an executor or
administrator promises to pay personally a debt of the decedent, the promise must be in
writing—or in proper electronic form—to be enforceable. For example, Brian, who is
Ann’s son and executor of her will, recognizing that Ann’s estate will not provide funds
sufficient to pay all of her debts, orally promises Curtis, one of Ann’s creditors, that he,
Brian, will personally pay all of his mother’s creditors in full in return for valid
consideration from Curtis. Brian’s oral promise is not enforceable. This provision does
not apply to promises to pay debts of the deceased out of assets of the estate.
Oral contracts modifying previously existing contracts are unenforceable if the
resulting contract is within the statute of frauds. The reverse is also true: an oral
modification of a prior contract is enforceable if the new contract is not within the statute.
Thus, examples of unenforceable oral contractual modifications include an oral promise
to guarantee additional duties of another, an oral agreement to substitute different land for
that described in the original contract, and an oral agreement to extend an employee’s
contract for six months to a total of two years. On the other hand, an oral agreement to
modify an employee’s contract from two years to six months at a higher salary is not
within the statute of frauds and is enforceable.
Under both the statute of frauds and the Code, the basic legal effect is the same: a
contracting party has a defense to an action by the other party for enforcement of an
unenforceable oral contract—that is, an oral contract that falls within the statute and does
not comply with its requirements. For example, if Kirkland, a painter, and Riggsbee, a
homeowner, make an oral contract under which Riggsbee is to give Kirkland a certain
tract of land in return for the painting of Riggsbee’s house, the contract is unenforceable
under the statute of frauds. It is a contract for the sale of an interest in land. Either party
can repudiate and has a defense to an action by the other to enforce the contract.
Although a written agreement may not be contradicted by evidence of a prior
agreement or of a contemporaneous agreement, under the Restatement, Section 216, and
the Code, Section 2-202, a written contract may be explained or supplemented by (1)
course of dealing between the parties, (2) usage of trade, (3) course of performance, or
(4) evidence of consistent additional terms, unless the parties intended the writing to be a
complete and exclusive statement of their agreement.
P. Third Parties to Contracts
Whereas prior chapters considered contractual situations essentially involving
only two parties, this chapter deals with the rights or duties of third parties, namely,
persons who are not parties to the contract but who have a right to, or an obligation for,
its performance. These rights and duties arise by (1) an assignment of the rights of a party
to the contract, (2) a delegation of the duties of a party to the contract, or (3) the express
terms of a contract entered into for the benefit of a third person. In an assignment or
delegation, the third party’s rights or duties arise after the contract is made, whereas in
the third situation, the third-party beneficiary’s rights arise at the time the contract was
formed. We will consider these three situations in that order.
A contract in which a party (the promisor) promises to render a certain
performance not to the other party (the promisee) but to a third person (the beneficiary) is
called a third-party beneficiary contract. The third person is not a party to the contract but
is merely a beneficiary of it. Such contracts may be divided into two types: (1) intended
beneficiary and (2) incidental beneficiary. An intended beneficiary is intended by the two
parties to the contract (the promisor and promisee) to receive a benefit from the
performance of their agreement.
An incidental third-party beneficiary is a person whom the parties to a contract
did not intend to benefit but who nevertheless would derive some benefit from its
performance. For instance, a contract to raze an old, unsightly building and replace it
with a costly, modern house would benefit the owner of the adjoining property by
increasing his property’s value. He would have no rights under the contract, however, as
the benefit to him would be unintended and incidental.
Q. Performance, Breach, and Discharge
A condition is an event whose happening or nonhappening affects a duty of
performance under a contract. Some conditions must be satisfied before any duty to
perform arises; others terminate the duty to perform; still others either limit or modify the
duty to perform. A promisor inserts conditions into a contract for her protection and
benefit. Furthermore, the more conditions to which a promise is subject, the less content
the promise has. For example, a promise to pay $8,000, provided such sum is realized
from the sale of an automobile, provided the automobile is sold within sixty days, and
provided the automobile, which has been stolen, can be found, is clearly different from,
and worth considerably less than, an unconditional promise by the same promisor to pay
$8,000.
Implied-in-fact conditions are similar to express conditions in that they must fully
and literally occur and in that the parties understand them to be part of the agreement.
They differ in that they are not stated in express language; rather, they are necessarily
inferred from the terms of the contract, the nature of the transaction, or the conduct of the
parties. Thus, if Fernando, for $1,750, contracts to paint Peggy’s house any color Peggy
desires, it is necessarily implied in fact that Peggy will inform Fernando of the desired
color before Fernando begins to paint. The notification of choice of color is an implied-
in-fact condition, an operative event that must occur before Fernando is subject to the
duty of painting the house.
Breach of contract is the unexcused failure of a party to perform her promise.
While breach of contract always gives rise to a cause of action for damages by the
aggrieved (injured) party, it may have a more important effect: an uncured (uncorrected)
material breach by one party operates as an excuse for nonperformance by the other party
and discharges the aggrieved party from any further duty under the contract. If, on the
other hand, the breach is not material, the aggrieved party is not discharged from the
contract, although she may recover money damages. Under the Code, any deviation
discharges the aggrieved party.
A mutual rescission is an agreement between the parties to terminate their
respective duties under the contract. Literally a contract to end a contract, it must contain
all the essentials of a contract. In rescinding an executory, bilateral contract, each party
furnishes consideration in giving up his rights under the contract in exchange for the
other party’s relinquishment of his rights under the contract. Where one party has already
fully performed, a mutual rescission may not be binding at common law because of lack
of consideration.
R. Contract Remedies
When one party to a contract breaches the contract by failing to perform his
contractual duties, the law provides a remedy for the injured party. Although the primary
objective of contract remedies is to compensate the injured party for the loss resulting
from the breach, it is impossible for any remedy to equal the promised performance. To
an injured party, a court can give as relief what it regards as an equivalent of the
promised performance.
The right to recover compensatory money damages for breach of contract is
always available to the injured party. Restatement, Section 346. The purpose in allowing
compensatory damages is to place the injured party in a position as good as the one she
would have occupied had the other party performed under the contract. This involves
compensating the injured party for the dollar value of the benefits she would have
received had the contract been performed less any savings she experienced by not having
to perform her own obligations under the contract.
As an alternative to compensatory damages, a party injured by total breach or
repudiation may seek reimbursement for foreseeable loss caused by his reliance upon the
contract as measured by the cost or the value of the injured party’s performance. The
purpose of reliance damages is to place the injured party in a position as good as the
position he would have held, had the contract not been made. The Restatement of
Restitution provides that reliance damages for cost of performance include the injured
party’s uncompensated expenses incurred in preparing to perform, in actually performing,
or in forgoing opportunities to enter into other contracts. Section 38. Recovery based on
cost of performance, however, is reduced by any loss the breaching party can prove with
reasonable certainty that the injured party would have suffered had the contract been
performed.
A contract may contain a liquidated damages provision by which the parties agree
in advance to the damages to be paid in event of a breach. Such a provision will be
enforced if it amounts to a reasonable forecast of the loss that may or does result from the
breach. If, however, the sum agreed upon as liquidated damages bears no reasonable
relationship to the amount of probable loss that may or does result from breach, it is
unenforceable as a penalty.
Specific performance is an equitable remedy that compels the defaulting party to
perform her contractual obligations. Ordinarily, where a seller breaches her contract for
the sale of personal property, the buyer has a sufficient remedy at law. If, however, the
personal property contracted for is rare or unique, this remedy is inadequate. Examples of
such property would include a famous painting or statue, an original manuscript or a rare
edition of a book, a patent, a copyright, shares of stock in a closely held corporation, and
an heirloom. Articles of this kind cannot be purchased elsewhere. Accordingly, should
the seller breach her contract for the sale of any such article, money damages will not
adequately compensate the buyer. Consequently, in these instances, the buyer may avail
herself of the equitable remedy of specific performance.
One remedy that may be available to a party to a contract is restitution.
Restitution is the act of returning to the aggrieved party the consideration, or its value,
which he gave to the other party. The purpose of restitution is to restore the injured party
to the position he occupied before the contract was made. Therefore, the party seeking
restitution must return what he has received from the other party. Restitution is available
in several contractual situations: (1) as an alternative remedy for a party injured by
breach, (2) for a party in default, (3) for a party who may not enforce a contract because
of the statute of frauds, and (4) for a party wishing to rescind (avoid) a voidable contract.
