CONTRACTS

Chapter 10

The Role of Contract Law

• Provides a mechanism to deal with others• Law of contracts has evolved in commerce

over the centuries• The concept of freedom of contract means

there are responsibilities to those who create binding relationships– Only laws limit the choices parties may

make

Definition of a Contract

Sir Wm. Blackstone: “An agreement, upon sufficient consideration, to do or not to do a particular thing”

Modern definition--centers on a promise: “A promise or set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes a duty.”

The promise itself creates a manifestation of intent Contracts form legal relationships and duties

between parties Not all promises are enforceable contracts--must

meet the requirements of a contract to create an enforceable promise

Concepts of Contract Law

• Common Law

– Judge-made law– Each state

differs– There is

uniformity about general contract principles that run throughout most states’ laws

• Years ago, English courts began to use lex mercatoria (“the law merchant”)

• UCC– Uniform

Commercial Code– All States have

adopted except Louisiana

– Covers contracts for sale of goods

• Many countries rely on Code Law only for their basic legal framework

Express and Implied Contracts

• Express Contracts– Direct statement

by the parties of the promises made

– May be oral or written

– All important terms are expressly stated between the parties

• Implied Contract– Actions and

circumstances infer and define the terms of the contract

– May be words, conduct, gestures

– These contracts are implied at law

– Ex: At a check out counter at a grocery story, actions of the parties create offers/acceptances

Elements of a Contract

• 1. An Agreement, through --– Offer– Acceptance

• 2. Consideration• 3. Contractual Capacity• 4. Legality• 5. Genuine Consent• 6. Writing (if necessary under the Statute of Frauds)• If all elements are present, the contract is generally

termed valid

Element #1: The AgreementThe Offer

(Mutual Understanding Between Parties) (Made of Offer and Acceptance)

• The Offer– Creates the Offeror and Offeree– 1. Manifestation of Intent

• Preliminary Negotiations vs. Intent to Offer

– 2. Definite– 3. Communication

Terminating an Offer

• Revocation– Withdrawing of offer by the Offeror

• Rejection– By Offeree– Through lapse of time (Option Contracts are

different)– Counteroffers are created by rejecting the original

offer but keeping negotiations open by presenting new conditions--result is a counteroffer

• Operation of Law– Intervening Illegality– Destruction of subject matter– Death or insanity of offeror or offeree

Element #1: THE AGREEMENTThe Acceptance

• The Acceptance– Expression of assent– 1. Unconditional

• Must be a mirror image of the offer

• If conditions are added, they create a counteroffer

– 2. Unequivocal– 3. Legally

Communicated

– See Parker v. Glosson

Parker v. Glosson

• Douglas and Sandy Glosson offered to sell 36 acres, including truck shop, warehouse and office.

• Douglas Glosson and Parker agreed on the terms.

• Two men signed the agreement.• Sandy Glosson didn’t sign; deal fell through.• Parker sued for breach of contract, requesting

specific performance or damages.• Trial court dismissed suit. Parker appealed.

Parker v. Glosson

• HELD: Affirmed. • Contract must have mutual assent and meeting of

the minds to be enforceable.• Clause 13 of Agreement provided “this agreement

shall become an enforceable contract when a fully executed copy has been communicated to both parties.” (Buyer and Sellers) (Emphasis added)

• This language indicates sellers did not intend to sell (nor a buyer to buy) until ALL parties signed the agreement.

• At the top of the page, “Sellers” were both Douglas Glosson and Sandy Glosson.

• Sandy didn’t sign; agreement was not fully executed.• No contract.

Bilateral & Unilateral Contracts(As With Other Types, Create the Offeror &

the Offeree)

• Bilateral Contracts• 2 promises• A promise in exchange

for a promise• Ex: I promise to pay

you $25 to mow my lawn; you promise to mow my lawn.

• If promises are broken, there may be responsibility if losses are incurred.

• Unilateral Contract• Only 1 promise• A promise in exchange

for a performance• Ex: I promise to pay

you $25 to mow my lawn; you go out and mow it.

• Once performance has been made, the other party’s duty arises to fulfill his/her promise.

Element #2: Consideration(If consideration is absent, neither party may enforce the promise or agreement)

• Definition: Something of value or something bargained for in exchange for a promise

• This element keeps contract from being a gift• Traditional Rule: Must create--

– Legal detriment to the promisee OR

– Legal benefit to the promisor – Actually the legal detriment and benefit usually

occur at the same time• See Caley v. Gulfstream Aerospace Corp.

Adequacy of Consideration

• Adequacy of Consideration– Courts generally don’t care!– If a party bargains poorly,

courts usually won’t interfere.

– Those who bargain take on the risk of their own errors.

– There are exceptions such as fraud, duress, etc.

– The main concern is an exchange of mutual promises and obligations by the parties.

– See Caley v. Gulfstream Aerospace Corp.

Caley v. Gulfstream Aerospace Corp.

• Gulfstream adopted a dispute resolution policy (DRP); policy is only procedure to resolve disputes between Gulfstream and the employees.

• Mailed policy to employees.• Policy said that DRP would begin in 2 weeks and

would be “a condition of continued employment.”• If an employee continued work, then she accepted

the DRP. • Group of employees sued, saying there was no

contract and DRP could not be enforced.• District Court held for Gulfstream. Employees

appealed.

Caley v. Gulfstream Aerospace Corp.

• HELD: Affirmed.• DRP is an offer and states it is a contract.• Terms of acceptance are continued employment by

employees.• Acceptance can be through a promise or an act.• Here the action of continuing employment =

acceptance of the offer and a contract.• Employees had a choice to 1) continue employment,

accepting DRP or 2) terminating employment.• There is “bargained for consideration” by mutual

promises and obligations.

Enforceable Promises Without Consideration

• Promissory Estoppel or Detrimental Reliance – Use of this doctrine avoids injustice due to the promisee's

reasonable reliance on the promisor’s promise.– Promisor is estopped (prevented) from denying a promise.– Equitable doctrine.– “A promise which the promisor should reasonably expect to

induce action or forbearance on the part of the promissee . . . and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.” Restatement (2nd) of Contracts

– Courts don’t impose the rule lightly.– Sometimes used in promises to charities, especially if

organizations rely on the donation to act in some way.• e.g. beginning construction based on promises of charitable

contribution.• See Hinson v. N&W Construction Company, Inc.

Hinson v. N&W Construction Company

• N&W Construction prepared bid to submit to Mississippi Job Corps Center (MJCC) to build facility at training center. N&W received bids from plumbing subcontractors in preparing its bid to MJCC.

• Hinson quoted $92,000 as bid as plumbing sub; next lowest bid was $139,000. N&W used Hinson’s bid to prepare its bid to MJCC.

• N&W was low bidder and awarded contract by MJCC. Then contacted Hinson that it needed plumbing work to begin. Hinson failed to sign and return plumbing subcontract and refused to due the job.

• N&W then hired next lowest bidder; paid added $47,000 to get work done. N&W sued Hinson based on promissory estoppel.

• Trial court granted summary judgment to N&W, awarding $47,000. Hinson appealed.

Hinson v. N&W Construction Company

• Ct. of Appeals held: Affirmed.• Hinson admits he provided a verbal quote. Also

testified that he reviewed plans & specs for the building, & was satisfied with his quote of $92,000.

• Hinson refused to do the plumbing because, “I just had a lot of other jobs going.”

• Promissory estoppel arises when “making of a promise, even though without consideration . . . “ that plaintiff (here N&W) relied. upon.

• “Refusal to enforce it would be virtually to sanction the perpetuation of fraud or would result in other injustice.”

Element #3Capacity

• Refers to the legal ability to create a contract

• Some have limited capacity to contract– Minors– Intoxicated persons– Insane persons

• If there is no capacity, the contract is void

• If there is partial capacity, the contract is voidable--may disaffirm

Void and Voidable Contracts

• Void: Contract does not exist at law– One of elements is missing--lacks a requirement of

a contract– i.e. contract with a legally insane person– i.e. contract for an illegal subject matter– Courts won’t accept disputes

• Voidable: One party to the contract has right to avoid legal obligation

• Is valid but capable of being voided by a circumstance– i.e. minors contracts– i.e. contracts with person under influence of drugs

or alcohol– i.e. fraud by one of the parties

Minors

• Defined as a person under the legal age of majority

• Traditionally, the age of majority was 21

• Now it is 18 years old in all states for most contracts

• Minors have partial capacity

• Contract is voidable• Legal policy to protect the

young from the “results of their own folly”

• General Rules– #1: Minors may disaffirm

contracts at their option– #2: If a minor disaffirms a

contract after receiving benefits, restitution must be paid for the benefit

– Some contracts may not be disaffirmed, i.e

• Enlistment contracts

• Marriage contracts • Educational loans• Insurance loans• Medical care

• After reaching majority, the minor may ratify the contract

International Perspective: “Problems Enforcing Contracts”

• Study by World Bank looked at problem of enforcing a contract in countries around the world

• Problem: Lack of effective contract law• Problem: Lack of honest and efficient judicial

enforcement• Effect: discouragement of foreign firms from

investing in poor countries• Effect: discouragement of foreign firms even to do

business in poor countries• See examples of comparisons of number of legal

procedures, duration and costs in China, India, Mexico, Germany, Canada, U.K. and U.S.

Element # 4: Legality

• If a contract is lacking legality, courts will not enforce it

• Subject Matter Must Be Lawful– Criminal activities; sale of prohibited drugs;

gambling activities in some states

• Interest rates on loans that violate usury laws– Court may strike entire bargain as unenforceable

or only a part that concerns illegal subject matter

Unenforceable Contracts

• Contract is actually valid when made, but courts won’t enforce it– i.e. unconscionable

contracts– i.e. exculpatory

agreements– Ex: Company agrees to

ship wheat to Iran. After shipment is at sea, U.S. government declares no U.S. firms may trade with Iran.

– Result: unenforceable under U.S. law even if seen as legal in Iran

Legality & Contracts Contrary to Public Policy (Unenforceable)

• Exculpatory Agreements (contracts written to escape liability)

• Unconscionable Agreements (unequal bargaining power)– Outcome is grossly unfair to an innocent party.

• Contracts in Restraint of Trade– That restrain trade or unreasonably restrict competition– Covenant not to compete may be restraint of trade

unless• Limited by time, territory and ancillary to the contract• Different states differ significantly on this subject

– Covenants not to compete often used in sale of business or employment contracts

DCS Sanitation Management v. Castillo

• DCS is DE company w/ main office in Ohio -- operates in 13 states. Cleans food processing plants, including Tyson Foods in Dakota City, Nebraska.

• Castillo and other employees signed noncompete agreements with DCS for “one year following the date of termination of employment for any reason, I will not directly or indirectly engage in, or in any manner be concerned with or employed by any person, firm or corporation in competition with [DCS] or engage in providing contract cleaning services within a radius of 100 miles of any customer of [DCS]. . . .”

• DCS lost contract with Tyson to a competitor.• Competitor hired Castillo and other former DCS employees to

work for it, doing about the same work as before.• DCS sued employees for breach of contract.• District court held for Castillo. DSC appealed.

DCS Sanitation Management v. Castillo

• HELD: Affirmed.• The Nebraska court will not reform an agreement to

make it enforceable.• Noncompete agreement is valid if 1) does not injure

public; 2) is not greater than reasonably necessary to protect the employer’s interests; and 3) “is not unduly harsh and oppressive to the employee.”

• These noncompete agreements were overbroad and unenforceable.

• Breadth of agreements effectively put former employees out of cleaning business within an extensive region.

Element #5Reality of Consent/Genuine

Consent• This deals with the choice of entering into agreements• If real consent is missing, there is no meeting of the

minds– If there is unilateral mistake over a simple error, then contract

usually can be avoided (i.e., typographical error - $20,000 instead of $200,000)

• Without reality of consent, the contract is void or voidable (depending on the circumstances)

• Examples: – Fraud– Misrepresentation– Duress– Undue influence

L&L Doc’s, L.L.C. v. Florida Division of Alcoholic Beverages and Tobacco

• Leuders and Latte formed L&L and bought Doc’s Saloon from Carlbob for a promissory note for $125,000.

• Doc’s had slot machines in it. Soon after, police arrested Latte for engaging in illegal gambling for having the slots.

• L&L defaulted on paying the note, so Carlbob, owned by Dressel, sued.

• L&L claimed Dressel engaged in fraud by representing slots were a good source of revenue, when they were actually illegal.

• Further Dressel had cheated on liquor taxes by illegally refilling bottles to avoid liquor taxes.

• Trial court gave summary judgment for Carlbob. L&L appealed.

L&L Doc’s, L.L.C. v. Florida Division of Alcoholic Beverages and Tobacco

• HELD: Affirmed. L&L lose.• The case does not look to the actual

misrepresentation. In this case, even if there was fraud, L&L “knew or should have known” the gambling activities were illegal.

• The fact that they are from another country, does not absolve them of the constructive notice given to them under Florida laws of the illegality of their activities.

• Ignorance of the law is no excuse.• Buyers also have no action on the contract since the

activity was illegal. Contracts in violation of public policy are void and unenforceable.

Element #6 (Sometimes Needed)

The Statute of Frauds (1677)

• Contracts do not have to be in writing to be enforceable, HOWEVER

• Written contracts are always good as evidence of the agreement, MOREOVER

• Some contracts require a writing– Sale of land or interests therein– Contracts that cannot be performed within 1 year– Promise to pay the debt of another, including

debts of an estate– Promises made in consideration of marriage

Sufficiency of the Writingand

The Parole Evidence Rule

• Sufficiency of Writing– Writing must set out the

material terms of contract– Names of parties– Consideration– Subject matter, etc.– Invoices, E-mails, sales

orders, checks, confirmations may satisfy this requirement

– See “Digital Signatures” • Electronic Signatures in

Global & National Commerce Act (E-Sign) 2000 federal law.

• Technology & contracts

• Parole Evidence Rule– Restricts use of oral

evidence when that evidence is contrary to terms of written contract.

– Oral evidence cannot contradict, change or add terms to written contracts.

– IF a written contract is incomplete, ambiguous, proves fraud, mistake, or misrepresentation, THEN

– Oral evidence may explain the problems.

– See Issue Spotter: “Liars’ Contest?”

“Contracting With The Japanese”

• U.S. contracts tend to try to cover everything.• Japanese view contracts as secondary to the

ongoing relationships of the parties.• Contracts with the Japanese should be brief

and flexible, not detailed.• Detailed contracts may be seen with suspicion.• Strong statement (“That just won’t work”)

likely to be viewed as an insult.• The Japanese often want “good faith clauses”

in contracts with Westerners.• Consensus among the negotiating teams is

very important.

Performance• Substantial Performance (Usually in good faith)

– Usual remedy is the contract price minus damages resulting from lack of complete performance

• Material Breach– Performance substantially less than required– Damages now due to non-breaching party

• Executed Contract– Fully performed; nothing left undone– If you have fully performed, damages for the price of

performance may be sought as a remedy• Executory Contract

– Not fully performed– If partial delivery of widgets, buyer need not pay total

contract price • See Issue Spotter: “Do You Have to Eat the Loss?”

Discharge of Contracts(Terminating Contractual Obligations)

• Assignment (transfer of rights to another) and delegation (transfer of duties to another)– Many contracts can be assigned or delegated; although

exceptions occur in contracts for services.• Third-Party Beneficiary is party not part of original contract who

acquires rights under the contract. – Usually occurs in credit contracts

• Performance– Total performance = discharge and payment accordingly– Substantial performance: Usual remedy is the contract price

minus damages resulting from lack of complete performance• Discharge by breach (non-breaching party is discharged)

– Material breach: Performance is substantially less than the contract provides

– Anticipatory breach or repudiation: A party indicates inability or lack of desire to perform

• Discharge by Agreement of the Parties: recission, novation, accord & satisfaction

Discharge by Impossibility

Discharge by Impossibility– An unforeseeable, unanticipated event occurs that

makes performance impossible • One party dies or is incapacitated• Law passed making performance illegal• Subject matter of contract is totally destroyed

– The impossibility doctrine has been extended to commercial impracticability or frustration (unforeseen event creates an “extreme or unreasonable difficulty, expense, injury or loss”)• Wartime shortages• Crop failures• Loss of needed supplies due to sudden internat’l

embargoes• VERY DIFFICULT to be enforced in courts – often courts

generally expect at least part performance

REMEDIES

• Monetary Damages ($$)– Compensatory

Damages– Actual Damages– Expectancy

Damages– Liquidated

Damages– Nominal Damages– Punitive Damages

(if there is tort related to breach of contract)

– Special Damages

• Equitable Remedies– Specific

Performance– Injunction– Restitution

• Mitigation of Damages– Injured party is

required to make efforts to mitigate or lessen losses

• See Logan v. D.W. Sivers Co.

Economic Loss Rule

• In breach of contract case, if there is no tort involved, damages are only those related to economic losses suffered by the breach.

• Rule based on three policies– 1. maintain fundamental distinction between tort and contract law– 2. protect commercial parties’ freedom to allocate risks by contract– 3. encourage the party best situated to assess the risk of loss

• Damages are only those related to lost profits and costs due to the breach.

• Accounting evidence and specific calculations are necessary evidence to be presented.

• No punitive damages or mental distress awards. (Parties often try to assert a tort along with breach of contract in order to get these damages.)

Logan v. D.W. Sivers Co.

• In 2003, Logan sold a piece of property for $3.9 million. She could avoid paying taxes under Section 1031 of the tax code, if she bought another piece of property of equal or greater value.

• To get tax break, Logan had to ID another property within 45 days and purchase it with 180 days.

• If not, she would pay taxes of $919,652 on the gain.• She found a piece of property owned by Sivers; worked out a

deal.• Before purchase was complete, Sivers sold property to another.• It was too late for Logan to ID another property to buy and she

had to pay the taxes.• Logan sued Sivers for breach and monetary losses.• Jury found for her and awarded consequential damages of

$919,652. • Judge overturned the jury verdict, holding Sivers was not

responsible for the tax liability. Logan appealed.

Logan v. D.W. Sivers Co.

• HELD: Reversed and remanded to reinstate the jury’s verdict in Logan’s favor.

• Jury determined that plaintiff had been damaged by the breach.

• Damages were foreseeable by Sivers.• Logan’s broker told the defendant’s president that

Logan was a 1031 buyer and on a short timeline. (Evidence showed the president was familiar with the idea of a “1031” buyer.)

• Reasonable people would know that if this contract failed, Logan could suffer damages.

• Jury’s finding that Sivers could have foreseen the damages is upheld.

Quasi Contract(Also called quantum meruit)

• Quasi (means “almost”)--not a true contract—an equity holding

• Legal concept used by courts to prevent injustice

• Courts apply this classification in equity (out of a sense of fairness) to give relief to innocent parties

• Example: You watch as a crew (in good faith) comes to your house and paves your driveway. Do you have to pay the bill when it is sent to you? Yes, under quasi contract.