FINANCE EXPERTS ONLY

When Is a Contract Over?

By Charles Stephen Treat

Two recent decisions from the California courts have addressed whether, when, and how California law will identify and honor provisions in a contract concerning how long the contract will last and when it may be terminated. The two decisions do not cite each other and do not overlap very noticeably in their analyses. Nevertheless, if you have a case presenting contract-duration issues, it is important to read both cases and to recognize that the second decision establishes two major exceptions to the broad rule upheld in the first decision. The first case is the First District Court of Appeal's decision in Zee Medical Distributor Ass'n, Inc. v Zee Medical, Inc. (2000) 80 CA4th 1. This case, following a lengthy line of precedents, held that the California courts must strive to identify the parties' intentions concerning duration, either by express agreement or by implication. If such an intention is identified, it will be honored, even if it measures duration by contingent events. It thus rejects an argument that courts should be hostile to or skeptical of so-called perpetual contracts. A few weeks after the court of appeal decided Zee, the California Supreme Court handed down its decision in Asmus v Pacific Bell (2000) 23 C4th 1. Asmus has gotten attention principally as an employment-law decision. Its content, however, is almost pure contract law, applicable to ordinary commercial contracts. And although the case makes only brief mention of the principles developed in Zee and its precedents, Asmus is nevertheless a central case for analysis of contract-duration issues. Its holdings establish two key limitations on the Zee methodology: a "void for vagueness" principle for durational agreements, and a virtual negation of such clauses when they appear in unilateral contracts. The Zee Case At issue in Zee (in which I represented one of the parties) was the duration of the distribution contracts that Zee Medical Inc. had with its distributors. The legal principles at issue, however, were not specific to distribution contracts but were a matter of general contract law. After collecting and summarizing the legal principles inherent in prior California case law, including the seminal decision in Consolidated Theatres, Inc. v Theatrical Stage Employees Union (1968) 69 C2d 713, the Zee court distilled its holdings into a useful three-step methodology for analyzing contract-duration issues. (1) The court first seeks an express term. (2) If one is absent, the court determines whether one can be implied from the nature and circumstances of the contract. Courts will imply an ascertainable term of duration when reasonably possible. (3) If neither an express nor an implied term can be found, the court will generally construe the contract as terminable at will after a reasonable time of duration has elapsed. 80 CA4th at 10. Step three is really more a matter of a court-made gap-filler rule, to be resorted to when it is not possible to ascertain what the parties intended. The courts must first uphold the principle of enforcing the contracts as the parties wrote them. The Zee court ruled in the defendant manufacturer's favor on the basis of step one. The contracts provided detailed lists of termination grounds and specified that the contracts "shall continue" until terminated. That, said the court, was an express agreement that termination was limited to the stated grounds. 80 CA4th at 10-11. The opinion further suggested that it would have reached the same result under step two. Even if there had been no express "shall continue" language, the parties' express recitation of particular termination grounds-and even more, the creation of specific conditions and limitations on when those grounds could be used (such as cure periods for defaults)-necessarily implied that the parties did not intend terminability at will. 80 CA4th at 11. The Asmus Case At issue in Asmus was an employer's ability unilaterally to withdraw a unilaterally promised employment security policy. Pacific Bell had promulgated a management employment security policy (MESP), stating: "It will be Pacific Bell's policy to offer all management employees who continue to meet our changing business expectations employment security through reassignment to and retraining for other management positions, even if their present jobs are eliminated.... This policy will be maintained so long as there is no change that will materially affect Pacific Bell's business plan achievement." 23 C4th at 7. As Pacific Bell explains, when it created its MESP, the document referred to changes that would have a significant negative effect on the company's rate of return, earnings, and "ultimately the viability of [its] business." The company noted that if the change were to occur it would result from forces beyond Pacific Bell's control and would include "major changes in the economy or the public policy arena." 23 C4th at 17. Several years later, however, Pacific Bell terminated this policy and notified its managers that it would adopt a layoff policy instead. A federal district court held that the MESP had become part of the employees' employment contracts and ruled that Pacific Bell could not terminate it unless it could prove that the specified termination event had occurred, that is, that there had been a change materially affecting Pacific Bell's business plan achievement. Asmus v Pacific Bell (ND Cal May 5, 1997) No. CV 96-00067 (order granting summary judgment). Pacific Bell declined to try to prove that that condition had been satisfied but nevertheless contended on an interlocutory appeal that it was entitled unilaterally to terminate a unilaterally granted policy. The Ninth Circuit certified a question to the California Supreme Court, asking it to decide whether, once the MESP was incorporated into an employment contract, the employer had the right unilaterally to terminate it before the specified termination event occurred. Asmus v Pacific Bell (9th Cir Oct 23, 1998) 159 F3d 422. The California Supreme Court held that the employer had that right, provided that the employer made the change after a reasonable time, on reasonable notice, and in a way that did not interfere with employees' vested rights. Asmus, 23 C4th at 6. The employer thus did not have an unqualified right to modify or terminate the employment contract; such an unqualified right would have rendered the contract illusory. 23 C4th at 15-16. The Asmus Analysis To assess the impact of Asmus on contract duration provisions generally, it is important to recognize a point that the Supreme Court did not raise: The contract at issue in Asmus had two durational provisions, not just one. The underlying contracts were the employment contracts of each management employee. Under the MESP, the employment was promised to last as long as the employee continued to meet Pacific Bell's business expectations, a fancy way of saying that termination would be only for cause. This, however, was subject to the proviso that the whole MESP (and hence its incorporation into each individual employment contract) could be terminated if there was a change materially affecting Pacific Bell's business plan achievement. This duration clause within a duration clause was not as exotic as it might appear at first glance; it was just a contract of stated duration, subject to a condition subsequent. Structurally it was the same as a contract in which X promises to sell Y stated onthly quantities of widgets at fixed prices for as long as Y needs them for Y's product, except that the contract can be terminated if the market price of widgets goes up or down by 20 percent. The Asmus court addressed the economic-conditions provision in traditional Consolidated Theatres terms, though somewhat cursorily. The employees argued that because the MESP had a stated durational provision, the contract was not terminable without the occurrence of the stated event. The Asmus court, like the Zee court, agreed that a stated durational provision need not be chronologically fixed: "[A] 'specified condition' may be one for either definite or indefinite duration." 23 C4th at 17. Asmus thus confirmed California's principle of enforcing the parties' durational agreements, even if they may potentially leave contracts in force indefinitely. Void for Vagueness? The Asmus majority, however, said there is a catch. The "specified condition" must be sufficiently ascertainable "that it could be measured in any reasonable manner." 23 C4th at 17. Although the court cited no authority discussing this requirement, it appears to track the established principle that contract terms or promises will be deemed unenforceable if they are too vague. See, for example, Ladas v Calif. State Auto. Ass'n (1993) 19 CA4th 761, 770-72; Rochlis v Walt Disney Co. (1993) 19 CA4th 201, 213-14.Without extended discussion, the court held that the condition of a change materially affecting Pacific Bell's achievement of its business plan did not qualify as a sufficiently ascertainable and measurable termination event to be given effect. Thus, although there was an express termination provision stated in the contract (Zee's step one), the provision didn't count because it was too vague for enforcement. With the express duration clause excised, that left the contract, in the court's analysis, without any duration provision, putting it into Zee's step three-terminability at will. 23 C4th at 17 (citing Consolidated Theatres). Chief Justice Ronald M. George, joined by Justices Stanley Mosk and Joyce L. Kennard, argued vigorously in dissent that the condition was ascertainable but had not yet occurred, so the policy could not yet be unilaterally terminated. 23 C4th at 19. The Asmus court's statement about the vagueness of the MESP does not cast much light on what kinds of terminal events will be deemed sufficiently clear, and which too vague, to be enforced. The court noted that the events there contemplated were beyond Pacific Bell's control, and presumably beyond the control of its employees, too. But shortly before this passage, the court had cited approvingly a case upholding a termination provision cast in terms of the end of World War II, surely something further outside the parties' control than whether Pacific Bell can run its own business profitably or not. 23 C4th at 16-17 (citing La Jolla Casa de Manana v Hopkins (1950) 98 CA2d 339). This passage should probably be read as referring to the ascertainability, not the controllability, of the stated termination event-whether the event "could be measured in any reasonable manner." The concept of a "material" change in Pacific Bell's ability to "achieve" its business plan is pretty mushy; one winces to think of a jury sitting in judgment on whether Pacific Bell's business conditions had changed sufficiently to justify it in conducting management layoffs. This appears to be the consideration that led the Supreme Court to find this provision insufficiently "ascertainable." But given the absence of any articulation of how courts are to judge ascertainability versus nonascertainability, this holding is likely to give the courts some trouble in finding the dividing line in future cases. For example, if courts cannot be trusted to determine whether there has been a material change in a business's ability to achieve its business plan, then are they any better situated to sit in judgment over whether there has been "cause" for termination of a contract, whether for employment, distribution, or anything else? The Asmus court found no vagueness problem in the MESP's provision that managers would be employed, so long as they met "changing business expectations." Worse yet, contractual provisions making contracts terminable only for cause (or the like) are often found by implication rather than from express words, leaving the court without any textual measuring stick, even a vaguely worded one. It is unlikely that the Asmus court meant to abolish the concept of contracts terminable only for cause. But it will take substantial further case law development to outline which termination events are ascertainable and which ones are void for vagueness. Unilateral Promises Even with the "business plan achievement" proviso excised, there still remained a durational term in Pacific Bell's management employment contracts, namely the MESP's assurance that employees would be offered employment security so long as they "continue to meet our changing business expectations." This was basically just a termination-for-cause provision, of the kind routinely upheld in employment contracts, distribution contracts, and many other contractual settings in California. This duration provision did not stand up in Asmus, however. The court focused on the fact that many employment contracts are unilateral contracts, in which a promisor promises a benefit (such as salary) in return for a stated performance (such as performing duties as an employee), and the promisee accepts not by giving a reciprocal promise but by rendering the requested performance. 23 C4th at 9-11. The most important holding in Asmus thus is that in a unilateral contract the promisor may unilaterally modify or terminate the terms of its promise, without providing further consideration for the modification or termination, provided that it gives reasonable notice. The court reasoned that the consideration is the employer's continued employment of the employee. 23 C4th at 14-15. Accordingly, Pacific Bell was permitted to modify its employees' contracts by terminating the MESP and substituting a layoff policy. It is not novel in California to allow an employer to unilaterally change the terms of at-will employment, for example by decreasing compensation or reassigning job duties. The courts have reasoned that whenever the employer has the right to terminate employment entirely, it necessarily has the lesser right to condition future employment on acceptance of different terms. See, for example, DiGiacinto v Ameriko-Omserv Corp. (1997) 59 CA4th 629 (reduction of wages was offer of contract under new terms, accepted by employee continuing to work). The remarkable innovation in Asmus is the extension of this principle to include modification of durational terms in a unilateral contract. It is one thing to say that because I can lay you off any time, I can cut your pay as a condition of keeping you on. It is another thing to say that I can condition your further employment on you allowing me to retract my prior promise not to lay you off. But that is what Asmus held when it reasoned that Pacific Bell gave consideration for the elimination of the MESP by continuing to employ its managers. In this light, it becomes hard to see how any durational provision in a unilateral contract can survive. In effect, Asmus held that any unilateral contract is terminable at will (subject only to reasonable notice), even if the contract expressly says it is not terminable at will. That does not impeach the correctness of Zee or Consolidated Theatres themselves, which involved bilateral (promise-for-promise) contracts. However, it does mean that the method of contract formation-promise-for-promise versus promise-for-performance-is apt to be more important in assessing contract duration provisions after Asmus. If an ascertainable promise of protected duration is made (even by implication) as part of an exchange of promises between the contracting parties, then under Zee that promise will be upheld, and the contract may not be terminated before the specified termination event occurs. But if the duration promise is part of a unilateral promise accepted by performance, then under Asmus it appears that the durational term will not stand up. Charles Stephen Treat is a partner at the San Francisco office of Latham & Watkins, where he is a member of the appellate practice group.