Principles of Contract Law – Burton 2009

Chapter 1: Autonomy and Security Principles

Autonomy: “The law empowers people to make and receive enforceable promises when they commu-nicate decisions to act or refrain from acting in some definite way in the future, subject to other princi-ples.”

Security: “The law requires each party to a contract formation or performance to do its part to respect the other party’s reasonable expectations and reliance.”

§1 – Promises

Contract: An enforceable promise/set of promises remedied by law if breached; govern transac-tions in the unregulated sector of the economy (RSC §1)

“Enforceable” – most often compensatory damages (monetary compensation for harm done to P) for breach; sheriff may seize property to recover damage costs; no punitive damages in K

“Promise” – involves commitment to do something; manifestation of intent: what a reasonable person would understand from words/gestures expressed; can be done unintentionally (RSC §2)

“Agreement” – manifestation of mutual intent between 2+ persons (RSC §3)

• Hawkins v. McGee (1929): Guaranteed good result from operation not performed as promised; damages = value of hand as promised – value of hand as given (RSC §§1-3)

“Freedom of Contract” – parties decide when/where to contract; court cannot make a contract – parties must

K law applies only to the unregulated sector of the economy

Look at ALL words of a K to determine the meaning of the terms therein

Interests, rights and duties

Rights/duties may be predictions of what a court will do; only some interests are protected by law

• K laws protect: expectation, reliance, and restitution; Expectation + reliance = possible harms of K

♦ RSC §344 – Purpose of Remedies: expectation, reliance, and restitution defined

Expectation – put in position would have been in had K been performed

Reliance – put in position would have been had K never been made

Restitution – return of benefits conferred onto the other party

One person has a right when they have an interest strong enough to justify imposing a duty on another to act with respect for that right

§2 – Promissory Agreements

Party’s Intentions: Understood by distinguishing between intention of words and their practical meaning

Subjective intent – true “meeting of the minds”; actual assent

Objective intent – agreement ascertained from manifestations of assent; thoughts irrelevant

• Conduct/words can show consent to contract (Lucy v. Zehmer – “joke” contract honored as reasonable man would take conduct as true consent) (RSC §201(1) – promise interpreted as decidedly understood by both parties)

• Neither “contract” nor “promise” need be spoken to guarantee them (Embry v. Hargadine, McKittrick, 1907 – “Go and get your men” = contract) (RSC §201(2)(a) – meaning as one party understands and other party knows first party believes)

• Ambivalent terms in a contract may preclude an agreement if parties do not agree on a meaning (Oswald v. Allen, 1969 – two meanings of “Swiss Coins” = no contract/not bound; no subjective intent) (RSC §201(3))

♦ Context/past meetings may signal what parties mutually understand words/actions to mean

To determine if a contract was made: 1) Offer? 2) PofA alive? 3) Acceptance?

Offer: promise manifesting a commitment to some specified future action in return for promise/performance

Need 1) manifestation of willingness to bargain AND understanding of manifestation by offeree;

2) Reasonable certainty (RSC §33)

Creates a “power of acceptance”- legal power to conclude the deal; can accept (binding) or re-ject (terminates); RSC §41(3) - offer by mail = acceptance if sent before midnight on day of of-fer

Offer made in course of conversation terminated at its close unless offeree asks for extension (Akers v. Sedberry, 1955 – offer to resign terminated at close of meeting) (RSC §41, comment (d))

Proposal ≠ offer unless it specifies consideration to be given

Non-descript advertisement = invitation to offer, not offer itself (Mesaros v. United States, 1988 – ad from Mint ≠ offer) (RSC §26 – manifestation of willingness to enter bargain ≠ offer if offeree knows further assent is needed)

• Multiple Acceptance Problem : amt. of acceptances > amt. of goods ≠ manifestation of intent

• Specific ads may = offer where certainty of terms gives basis for remedy (Lefkowitz v. GMSS, 1957 – “first come, first served” = offer) (RSC §33(b))

Offeror is “master of the offer” – decides how acceptance is done (promise or performance)

Power of Acceptance: given to offeree via offer (RSC §35); terminated by rejection (§38), counter-offer (§39), lapse of reas. time (§41), revocation (§43), death/incapacity; or by non-occurrence of any condition in terms of offer (RSC §36)

♦ Rationale: Protects rights of offeror; allows alternate plans – reliance interest protected

Counter-offer: terminates PofA, rejects contract, makes new offer (Ardente v. Horan – request for furniture in sale of real estate = counter-offer)

These cases

together make RSC

§201

RSC §24

• Request for a better offer ≠ counter-offer; first offer may stay “under advisement” while CO is considered

• Reply to offer adding/changing conditions = CO (Ardente – request for furniture = CO) (RSC §59)

Revocation: may occur indirectly when offeror acts inconsistent with intention of contract (Pet-terson v. Pattberg, 1928 – revoke ok even w/offeree on doorstep, cash in hand) or if through re-liable 3rd party (e.g. broker)

• Can occur directly when offeror communicates manifestation of intent not to enter K (RSC §42)

• Cannot revoke once performance has begun (in an option-contract – where acceptance by performance is not allowed) (Marchiondo v. Scheck) (RSC §45(1))

Acceptance: Need: 1) Manifestation of assent to terms of offer; 2) Must conform to offer’s terms for acceptance or qualify for “silence as acceptance” rule; 3) Must conform to requiring notice/dis-patch of acceptance

To have a contract, court must have reason to accept agreement as contract

Agreement = fact; contract = matter of law

When in doubt, it is assumed an offer allows for acceptance by either promise or performance (Davis v. Jacoby, 1934 – letter asking for help = offer for bilateral contract; promise = accep-tance) (RSC §32)

Silence can = acceptance if 1) Expectation of compensation; 2) Offeree knows silence = accep-tance; 3) In previous dealings, silence = acceptance (Houston Dairy v. JHMLI Co. – no previous dealings, no reason for silence to = acceptance); (Cole-McIntyre v. Holloway, 1919 – as delay causes unmarketability of goods, previous dealings allow silence as acceptance)

• Mirror-Image Rule : acceptance of offer must directly match offer made; difference = counter-offer

♦ Rationale: Protects offeror from assenting to terms involuntarily

Kinds of Contracts

“Expressed” – made by words leading to agreement/promise

“Implied-in-fact” – made by conduct leading to an agreement/promise

“Implied-in-law” (quasi-Ks) – conduct leading to unjust enrichment; may be no manifestation of intent

• Occurs when 1) benefit conferred by one party on another; 2) occurs at first party’s ex-pense; and 3) benefit of second party unjustly obtained/retained

• Fair play: obliges parties to cooperate to keep benefits coming; consent based on parties’ knowing and intentional undertakings (Seaview v. Williams, 1987 – implied K to pay for ser-vices w/purchasing of property)

Battle of the Forms – essential terms must be identical, rest left to trust between parties; “last shot” effect allows final form sent to be terms used for contract

RSC §69

UCC Article 2

Supersedes common law; to make commercial laws uniform; applies only to transactions of “goods” - “All things moveable at time of identification to the contract in which price is to be paid”

• If mixed goods + services look to primary purpose

§1-201: Contract = legal relations to parties; Agreement = bargains of parties in fact

UCC §2-207(1) abolishes “mirror-image rule” and “last shot” effect; §1-102(2)(b) finds agree-ment w/o identical terms

• Additional terms in acceptance ≠ CO; become part of K unless acceptance made conditional on new terms or notification of objection is given in reasonable time (§2-207(2))

♦ Conduct that recognizes a K = K established even if written terms do not agree; terms will be those agreed upon in K + UCC terms to fill the gaps

• Seller can opt out of §2-207 by making new terms conditional upon acceptance goes to common law (the above rules become applicable again)

Every word matters – interpretation must account for all terms/words

Formation involves three questions:

♦ 1) Was there an agreement? (§2-201(3))

♦ 2) If open terms, did agreed on terms provide reasonably certain basis for remedy agreed upon? (§2-204(3))

♦ 3) If offer and acceptance, did expression of acceptance operate as acceptance? (§2-207(3))

§2-206 – if language is ambiguous, offer still invites acceptance if in reasonable man-ner/medium

“Shrinkwrap” licenses are enforceable unless terms are objectionable on grounds applicable to contracts in general (ProCD v. Zeidenberg – “Buy now, terms later” for CD ok – agreement upon use of software)

• Buy now, terms available only inside box not ok – buyer must be able to return item if not happy w/terms

Conduct may recognize existence of a contract; needn’t find exact moment of creation (Empire v. Litton – deposit check cashed, retained = waiver of signature requirement and acceptance of offer) (UCC §§2-204(1,2))

UCC §2-207(2) – conflicting terms/conditions of parties “knock out” each other from the K (Ion-ics v. Elmwood); UCC’s terms serve as “gap-filler”

• §2-207 allows agreement based on words/forms (1) or by conduct (3)

♦ Rationale: §2-207 serves to loosen a contract’s strictness, not reinforce it

Price/time = essential issues necessary to form valid K (Sun Printing v. Remington Paper); UCC §2-305 – if open price, price set at market standard; §2-309 – if open time, reas. time allowed for delivery; based on commercial standards

• Together allow successful UCC governing of Sun Printing

Preliminary Agreements/Negotiations: often include “agreements to agree” – no actual agree-ment; no promise laid out

• Prelims. can show intent to be bound if there is a signed letter of intent formed during/be-fore agreements (Palmer v. Fuqua – parties’ intent showed a contract via memo, press re-lease; enforceability a question for jury)

• Agreements to agree ≠ valid agreements – too uncertain, no intent to be bound law says you need both

• Agreements on essential terms, contract to follow = valid contract

♦ Changes in agreement written in pencil/pen = binding – only re-typing is left

♦ Single points not enforceable until whole agreement is decided; courts will-/can-not im-pose terms

• Negotiations are not legally regulated; begin w/first counter-offer

• Agreements to negotiate in good faith = valid, BUT do not necessitate an agreement will fol-low (Itek Corp. v. Chicago Aerial Indus., Inc – agreement to “make reas. effort” to reach agreement ≠ agreement MUST follow)

♦ No duty to negotiate in good faith, but parties can agree to it; liability for misconduct still exists

“Merger Clause” – standard clause; non-essential term, cannot invalidate a contract if a dis-agreement

§ 3 - Requirement of Writing: three main issues to consider:

1) Does the K in question fall w/in the statute? (Must it be in a writing?)

• Essential categories in RSC §110; UCC §2-201 shows SofF involving goods; vary by state

• One-year provision applies to K incapable of being performed in one year (construction, etc.) (RSC §110(e))

• Applies to goods > $500 in value

2) Conditions – must ID parties, show K was made, ID subject matter, state ALL essential terms, be signed

• RSC §131; UCC §2-201 is more flexible than RSC (only essential term is quantity)

• Electronic signatures (e-mail) counts as signature (Cloud Corp. v. Hasbro, Inc.)

3) Legal consequences of failure to satisfy SofF

• Oral agreement can bring tort action – RSC §§138-44 (Unenforceability)

♦ UCC §2-201 requires no additional writing to protect from fraud, so long as there is ad-mission of a K

• Exceptions from SofF under UCC §2-201:

♦ Admission of K in legal proceedings (§2-201(3)(b)) (Radke v. Brenon)

Admission outside proceedings still allows use of SofF defense (Chomicky v. Buttolph – over phone)

♦ Failure to object to a memo w/in 10 days (§2-201(2)) (Cloud Corp. v. Hasbro, Inc.)

♦ Part-performance for specially-manufactured goods (§2-201(3)(a)) (Cloud v. Hasbro)

♦ Where goods are paid for, shipped, and accepted (§2-201) (Cloud v. Hasbro)

The SofF allows for further deliberation on a K (deliberative function); protects unwanted agreements from being formed; protects from fraud – writing is further evidence that K exists (evidentiary function)

• Acts as “sword” from fraud but “shield” from true Ks – SofF not popular

♦ Often courts put aside the SofF and look to the purpose – was the agreement intended?

Chapter Two: Justification Principle

Justification Principle: “The law enforces promises when prima facie there are sufficient legal rea-sons for a court to enforce this promise.”

§1 - Bargained-For Exchange: requires consideration in exchange of promises, promise for per-formance, etc.

Within contracts, there are four main reasons for enforcing a bargain:

• 1) Formality of some kind (RSC §90(2) – charitable subscription/marriage settlement) (Con-gregation Kadimah-Tores v. DeLeo – no writing, no consideration = no K)

• 2) Consideration – a bargained-for exchange needs to be in place (RSC §§17, 71)

♦ Must have relationship of inducement; must be understood; must be “more than a pre-tense” of K – must be what is sought by the promisor and exchanged (§71(2))

♦ Promise = consideration IF performance of would also be (RSC §75) (Hamer v. Sidway – nephew promised to refrain from activities; valid consideration – actual refraining would be valid too)

ANY performance bargained for is consideration (RSC §72)

♦ “Benefit/Detriment” test – either benefit to promisor or detriment to promisee is suffi-cient, so long as it is bargained for – an inducement for the promise of the first (Newman & Snell’s State Bank v. Hunter – note/stock worthless – no loss, no benefit = no consideration)

♦ May have value not determinable by traditional/nominal means (Batsakis v. Demotsis – money amt. was nominal, but higher value in D having the money made consideration valid)

Favoring settlements allows this policy; little to do w/K law

Courts do not determine adequacy or fairness of consideration

♦ Formal/Peppercorn Theory – only need form of an exchange; Substantial Theory – need more than nominal consideration (Schnell v. Nell – 1¢ for $600 nominal – formalities/past consideration also insufficient)

Unlike Batsakis, no indeterminable value in bargain – only monetary exchange

Hypo: $200 paid for rotten casebook worth $2 – form alone is not good enough; un-enforceable

Public should be served by the exchange – should benefit society

♦ Forbearance to bring a claim, so long as done so in good faith, even if the claim is in-valid, is valid consideration (Dyer v. Nat’l By-Products) (RSC §74(1)(b))

Like Batsakis, nominal consideration but has indeterminable value = sufficient con-sideration

♦ At-will employment Ks ≠ consideration; forbearance to discharge at-will employee = con-sideration (Lake Land v. Columber)

♦ Consideration can come via a promise implied in the K (Wood v. Lucy, Lady Duff-Gordon – implied promise to promote products was sufficient consideration to leave K enforce-able)

• 3) Reasonable reliance by promisee or promisor (RSC §§87, 90); looked to if no exchange exists

♦ Reliance must induce P’s actions, must be detrimental (Devocmon v. Shaw – nephew re-lied on uncle’s promise to pay for his expenses during trip – would not have spent $ w/o reliance)

Neither theory of BF-exchange exists; inducement of promise caused reliance = en-forceable

Hypo: Uncle to send Nephew on trip; before N leaves, U discovers N uses drugs and repudiates; enforceable? – NO, N took no actions based on reliance

If N buys a plane ticket for the trip = an action based on reliance – would be en-forceable

♦ Promissory Estoppel (RSC §90)

1) Promise sued upon; 2) Promisor expects reliance; 3) Inducement of reliance; 4) In-justice - reasonable reliance, U.E., formalities, of a definite/substantial character

2) Must be intent to induce reliance (So. CA. Acoustics v. C.V. Holder – printing by D that P may use D for sub-K work not done voluntarily – required by law = no intent to induce reliance)

• 3) Promise must induce reliance/action or does not apply (Feinberg v. Pfeif-fer – promise of payment induced act to retire = enforceable); (Hayes v. Plan-tations Steel Co. – action to retire came before “promise” to give pension – did not induce act in reliance)

Amicable working environment is desired – forbearance to fire = consideration

Precludes detrimental action done in reliance

(injustice)

§2 – Reliance on a Promise

§3 – Unjust Enrichment

Problem – how to decide reasonable reliance or definite/substantial character?

Bidding: Implied-in-fact K – option stays open, binding/irrevocable by promisor (RSC §87(2)) (Drennan v. Star Paving – D knew P may use his bid – reasonable expectation that P would act in reliance)

To create an option: 1) Bargain K, w/sufficient consideration; 2) Reliance on an offer (RSC §87(2)); 3) Put it in writing w/consideration stating option to be kept open(RSC §87(1)); or UCC §2-205 – author via merchant sends writing of option to be kept open (for 3 months)

• §2-205 – merchant: one who deals in goods of that kind; not revocable for lack of consideration for time stated (or 3 mos.), so long as offeror has signed it

• 4) Unjust enrichment (only sometimes enough)

♦ Hypo: H writes check for $1,000 instead of $100 – can he get funds returned? – Yes; promise to make restitution is implied-in-law (quasi-K); must prove below requirements

♦ Requirements: 1) Benefit conferred at P’s expense; 2) Non-gratuitously/non-officiously; 3) Benefit retained; 4) Unjust retainment (as based on 2))

Gratuitous – done w/o expecting payment; based on nature of services/relationship btwn. parties (Sparks v. Gustafson – extensive services given of type for which one would expect to be paid = U.E.); Officiously – “thrust upon”; done through one’s dom-inance/authoritativeness

Moral obligation ≠ consideration, not performing ≠ U.E. (Mills v. Wyman – P cared for son, father to pay back – not paying ≠ breach – no consideration)

Saving human life = material benefit (consideration!) (Webb v. McGowin – man saved from injury at cost of injury to other – saving his life = consideration = en-forceable)

There are other reasons outside of K law to make a bargain enforceable (e.g. keeping of pledges)

Nominal consideration is considered a “sham” and ≠ consideration; moral obligation ≠ consider-ation; writing/signing/sealing only formalities ≠ consideration (Schnell)

Illusory Promise – hollow offer (to buy as many widgets as B chooses to – may not have to buy any); leaves party w/no commitment, no real promise – unenforceable

Standing Offer – no end to offer stated, open after completion of performance

Exclusive Dealing – must complete K/promise before branching out; even if B does not buy maxi-mum (or any if he can choose not to), still valid consideration – enforceable (UCC §2-306(2))

Gains of Trade: The public good must be served by an exchange between parties; agreement must have form and substance

Exchange moves resources to higher valued uses; consequently, society becomes wealthier; GDP rises

Contract Modification

Preexisting Duty Rule (RSC §73): doing what one is already legally obligated to do ≠ consid-eration

• W/o new item of value added to deal, seller can accept a new value and sue for the differ-ence (Levine v. Blumenthal – oral agreement for reduced rent w/o add’l consideration not valid – full rent required to be paid)

• Often used to prevent “hold-up” game

• Formalist courts – direct application of rule; Non-formalists – may constrict the reach

RSC §89 - Modification if made before full performance is rendered can be binding if 1) there are new/unanticipated circumstances; 2) voluntarily reached and fair and equitable (Angel v. Murray)

UCC §2-209(1) – no consideration needed for modification to be binding in sales of goods; re-quires good faith - legitimate commercial belief in necessity of adjustment (Gross Valentino v. Clarke)

Chapter 3: The Justice Principle

Justice Principle: “The law refrains from enforcing promises when the prima facie justification for en-forcing the promise is overridden by considerations of justice.”

Perfect justice is impossible; practical conceptions:

• Formal Justice : like cases treated alike; consistent rule application; all persons treated equally; nothing about content of just laws

• Corrective Justice : underlies U.E.; compensation aimed at righting skewed equality between persons derived from uninvited takings

• Distributive Justice : wealth/power distributed equally; U.E. from rich dominating poor, ex-ploiting weak

§1 - Domain of Freedom of Contract: people are neither disabled from K-ing on chosen terms (Freedom of K) nor forced to K on terms imposed by 3rd party or state (Freedom from K); state lim-ited to protecting rights

Invalidating Causes: lack of capacity, illegality of performance, Public Policy, misrepresentation/fraud, unconscionability, duress – can override reasons to enforce (Ch. 2)

• K voidable if 1) actor does not reasonably understand their actions OR 2) cannot act in a rea-sonable manner AND the other party knows of such condition (Ortelere v. Teachers’ Retire-ment Board) (RSC§15(1))

♦ Need to balance/protect interests of mentally incompetent and innocent relying parties

• Some things should not be bought/sold(Matter of Baby M – surrogacy K denied on, inter alia, PP matters); statutes often take rights outside of the freedom to K (e.g. minimum wage)

♦ Public policy often dictates if a K should be allowed; e.g.: RSC§191 – cannot enforce promise involving right of custody unless consistent w/best interests of child

Lack of Capacity

Public Policy

Strength of policy, likelihood of furtherance, misconduct seriousness, and directness of connection between misconduct and term not enforced taken into account (RSC§178)

§2 - Mistake: courts are hesitant to change due to mistake – reliance/expectation interests must be protected; mistake ≠ regret; Mistake – belief not in accord w/fact (RSC§151); reform may cor-rect w/o undue prejudice

• Reformation is allowed if mistake in how agreement is written (RSC§155)

Non-disclosure leading to a mistake

• Seller withholds information from buyer – rescission allowed (Stambovsky v. Ackley – B made mistake of thinking house was not haunted – granted rescission); goes against norm of caveat emptor – “buyer beware” (but may only apply to real transactions or haunted property)

“Where a condition created by S materially impairs value of K and is peculiarly w/in knowledge of S or unlikely to be discovered by prudent purchaser, nondisclosure = rescission as matter of equity”

♦ “Active concealment” of an issue may be grounds for rescission

♦ Outside of stocks/futures trading, insider information needn’t be disclosed

♦ Hypo: S takes car to seller; he says it is worth $450; S sells; finds out later it is worth $5k; can S rescind? – NO; she made a mistake (thinking car was worth $450) but hind-sight mistakes not allowed

If not fraud and no concealment, no rescission allowed

Mutual Mistake

• Requires: 1) Basic assumption on which mistake was made; 2) mistake has material effect on the exchange; 3) no assumption of risk by buyer (RSC§152(1))

♦ Assumption of risk – “conscious ignorance” of facts of mistake (RSC§154(b)) (Wood v. Boynton – dealer and seller did not know stone’s worth; no restitution allowed where S could have discovered value)

♦ Risk may be allocated by the agreement itself, precluding rescission (RSC §154(a)) (Lenawee County v. Messerly – K for land “same as is” – risk allocated to B; no rescission regardless of mistake)

May also be reasonable to charge risk to B (§154(c)) – they should have had it in-spected

Unilateral Mistake

• If 1) – 3) above are met and effect would be unconscionable, OR other party knew of or caused the mistake, rescission allowed (RSC§153)

♦ Courts will often allow reformation of a drafting error where the error 1) materially af-fects the agreement 2) the other party is unharmed by it and 3) knows of the error (Elsi-nore Sch. v. Kastorff)

Terms involving mistakes are squishy, but still often applied; precedent looked to for decision

• Assent to K has limits – can only foresee so far

• If the mistake arises from the occurrence of a situation which the K-ing parties are ignorant to at the time of the K and this situation materially affects the agreement, it may allow for rescission (Sherwood v. Walker – “barren cow” – parties had not decided what to do if she was indeed fertile; rescission granted)

§3 - Unconscionability: seriously unfair K; also a defense of enforcement of such a K

Most often used for: 1) Arbitration clauses; 2) Covenants not to compete; 3) Cases treating farmers as unsophisticated; rarely used to help a stronger/wealthy party

Elements: 1) No meaningful choice, perhaps due to bargaining power (Procedural Uncon-scionability) (Williams v. Walker-Thomas Furniture – P had no reas. opportunity to understand terms = unconscionability)

2) One-sided terms that “shock the conscience” (Substantial Unconscionability) (Toker v. West-erman – fridge sold at 2 ½ times real value deemed unconscionable); (Frostifresh Corp. v. Reynoso – terms showing excessive price in different language = Procedural and Substantial Unconscionability)

3) No justification for the unconscionability – look to commercial setting to determine

♦ Power imbalance alone will not invalidate a K – must have grossly inadequate terms; UCC §2-302(1)/RSC§208 – may enforce K w/unconscionable term if term is removed

♦ Most jurisdictions require both 1 and 2 – puts burden on seller to have correct prices

♦ Buyer can always walk away; fine print may be “no meaningful choice” – assumes those w/more power always beat out those w/less

• Vague term, subject to manipulation by courts – may imply a need for “justice” w/o meeting all elements

§4 - Standard-form Contracts: only a few terms added in, most printed in advance; usually favor-able to drafting party – may make it unconscionable (if so, other party may read it and walk away); presumed enforceable

May misrepresent a party’s true intentions when they agree; difficult balance to hold – they did sign it

• Adhesion K: party must “adhere” to terms or walk away; most stand-form Ks are adhesive

• Duty to Read: parties assumed to read/understand ; can have it read to you; illiteracy not a defense (Washington Mutual v. Bailey)

♦ Giving the illiterate a way out would be burdensome on other party - must be sure K was read to them

♦ Unconscionability if WM knew party was illiterate v. Assumption of Risk – knew they could not read but signed it anyways w/o asking for help in understanding it

Arbitration Clauses: commit parties to arbitration privately rather than litigation publically; can file motion for refusal to comply – judgment may be entered compelling compliance; award is final/binding

• Courts come into play before Arb. – force Arb. before any litigation; order compelling Arb. – and after – enforcement of award if refusal

♦ Why Arb? 1) Faster, cheaper than litigation; 2) Parties can choose arbitrator; 3) Proce-dure tailored to dispute; 4) Less formal, rules of evidence loosened; 5) Private award not published

♦ Why not? 1) No jury – no persuasion; 2) No discovery – harder to prove facts; 3) Does not set precedents – law will not develop; 4) May be disadvantageous to “little guy”

Broemmer v. Abortion Services – AA held unconscionable – P not told what it was; re-quired to have doctors as arbitrators; is a lay person expected to understand com-mercial business matters?

We Care Hair v. Engen - when party that enters agreement to arbitrate are business people who understand nature of agreement and agreement causes no “unfair sur-prise” on them ≠ unconscionable

Chapter 4: The Compensation Principle

Compensation Principle: “The law enforces promises mainly by compensating nonbreaching par-ties for unavoidable, foreseeable, and reasonably certain harms causes by a breach.”

Remedies are mild – aim is to help non-breaching party for other’s failure to perform; available remedies: Compensatory Damages (Expectation Damages, Reliance Damages [Restitution]), Specific Performance, Cancelation, Reformation, Nominal Damages, Rescission

• Punitive damages (if breach = tort): imprisonment, fines, treble damages - thrice deter-mined amt.

Rationale: want to be able to hold Ks enforceable – need to promote commerce/trade

§1 - Compensate v. Punishment: Penalty – agreed to in K; Punitive Damages – awarded after the act to hurt/deter

♦ Punitive damages create a moral hazard – disincentive to enter future K; may also be in-centive to enter K and watch them closely (the other side might blink first…)

Breaching party not always seen as wrong-doer – may simply have option to perform or breach

Punitive damages only granted if breach is also a tort (White v. Benkowski – no punitive damages for D shutting off water – not a tort)

• Efficient Breach Theory: if when a party breaches at least one party is better off AND none are worse off; breaching party compensates non-breaching – indifference to breach (they get same value as if no breach)

♦ Act of breaching ≠ a wrong – they have option to breach or perform

♦ Assumes parties are rational – would only breach if it would make one party better off

• Agreed Damages: Penalties – above what would compensate; Liquidated Damages – fixed in amt.; equal to what would efficiently compensate

♦ Must be a reasonable forecast of actual damages to be enforceable (City of Rye v. Public Serv. Mut. Ins. – developers unable to find financing; not purposeful breach – unreason-able agreed damages not enforced)

Hypo: Agreed damages = $100k; actual damages = $150k; can non-breaching party get $150k? – Yes, if the goal is efficiency; clause here is under-compensatory (Rye test is unclear)

♦ RSC§356: unreasonable liquidated damages not enforceable under public policy

§2 – Expectation Remedies – seek to put non-breaching party in the position they would have been in had the K been performed as contracted; give “benefit of the bargain”

• Can 1) Order Specific Performance; or 2) Order compensatory, monetary damages

• Components: 1) Value of out-of-pocket expenses sustained due to reliance; 2) Value of op-portunity costs

Specific Performance – breaching party ordered to do/not do something; available when dam-ages are insufficient/inappropriate; equitable relief is discretionary (not for “dirty hands”)

• Appropriate when goods are unique, in land sales Ks, where the goods have no substitute, where there is an inability to cover, etc.

♦ The law deems every parcel of land to be unique – P needn’t show a specific one is differ-ent/unique

♦ A seller may be able to get SP if he proves he could not re-sell the item; UCC §2-716 - extends SP for when B cannot cover

• Difficult to obtain ≠ Unique (McCallister v. Patton – car hard to get; not unique enough to qualify for SP); may have been construed differently after UCC

• Specific performance for services? – Not usually; only if no substitute servicer is available

♦ Non-breaching party may get the difference in costs between two servicers (Market Price – K Price)

• Parties cannot force subject matter jurisdiction on the court via the contract

♦ Cannot have a clause agreeing to specific performance laid out in the instrument – need good reason

• Spec. Perf. + Efficient Breach: Does spec. perf. block propelling a good to its marketable pre-mium?

♦ If the right to Spec. Perf. is deemed worth more than the amount gained from damages for the breach, advise a negotiation – damage amount + some amount less what seller would gain from a new sale

Buyer will get the car + some amount to pay the difference of MP – KP; seller will not lose more than what he would have gotten – KP – Damages

At any MP below KP, the seller will not be worse off; when MP rises, Seller has incen-tive to breach – can make more selling the item in the market

At any MP above KP, buyer will not be worse off; if MP falls, B has incentive to buy at MP – can spend less for same item

♦ Efficiency is not a defense for a breach K – it is part of the rationale for compensation over punishment

General Damages – to put non-breaching party in position it would have been in but for the breach

• Seller’s Remedies: a) Withhold delivery; b) Stop subsequent delivery; c) UCC §2-704 (re-sell or scrap); d) resell & recover; e) recover damages for non-acceptance or the price (UCC §2-709); f) cancel

♦ Resale = Resale Price – K Price + Incidental Damages (must be reasonable) (UCC §2-706(1))

Seller must act in good faith in making a resale - may be at private or public place (auction); must notify buyer of resale (§2-706(3,4))

♦ Non-acceptance/Repudiation Damages = MP – Unpaid KP + Incidental Damages (must be adequate) – Expenses saved by breach (UCC §2-708(1))

If inadequate, damages = profit lost + incidental damages (§2-708(1))

• Buyer’s Remedies: a) Price paid; b) “cover” of goods; c) damages for non-delivery; d) spe-cific performance (if appropriate – see above); e) if goods given, may hold and resell

♦ “Cover” – purchase in substitution for that breached upon; Damages = cost of cover – KP + Inc. damages – expenses saved by breach (UCC §2-712)

Similar to right of seller to resell – must have reasonableness/good faith

Buyer may cancel and recover both expenses paid and cover price differential (UCC §2-711(1)(a))

♦ Non-delivery damages = MP – KP + Inc. Damages – expenses saved (UCC §2-713(1))

Alternative to cover; MP determined by time of repudiation (UCC §2-713(2))

♦ Breach of warranty = value of goods – value as warranted (UCC §2-714)

♦ Buyer may recover damages for restitution lost even if they are the breaching party (§2-718(3))

“Avoidable Consequences” – non-breaching party must take reasonable steps to reduce the breaching party’s damages – do not want to punish breaching party, just compensate non-breaching one

• Typically seller can choose between Resale (§2-706(1)) and Repudiation Damages (§2-708(1))

• When the difference in prices to seller (§2-706(1)) is inadequate to put the seller in as good a position as they would have been, seller is entitled to its lost profit + Inc. damages and allowance for costs incurred

♦ Neri v. Retail Marine – breach of K = lost chance to sell two boats instead of one (“Lost Volume”) (§2-708(2))

As long as supply > sales, seller can always get more goods and make another sale; only when no more are manufactured will recovery for lost profits be unjust

• Recovery for lost profits depends on both supply and output abilities of the seller; lost profits where supply > demand AND §2-708(1) is inappropriate

♦ Decrease in price increases amount S should get for lost profits – compensate for re-duced amt. AND lost volume; no two profits where S has only ONE of the good – cannot overcompensate

♦ It is presumed you can always make another sale so long as you have the goods to sell

When B resells a retained shipment and also seeks cover for shipment delivered late by the breaching S, B may sue for the difference of KP - cover AND may retain any profits earned from the resale of the retained goods (Fertico v. Phosphate Chemicals)

• Buyer entitled to lost profit under §2-712; §2-711 allows diff. in cover and amount already paid

♦ UCC §2-711(3) – permits breached-upon buyer to hold or resell goods even after getting reimbursed

Goods v. Services – Three formulas for recovery by performing, non-breaching party:

1) KP – Salvage Value – Payments Made; No Cost of Completion saved

2) Lost Profit + Unrecoverable Losses Sustained – Payments Made

• Unrecoverable Losses = work not yet performed that would have been paid for

3) Gains unrecovered – losses prevented

Overhead costs factored into lost profits (§2-708(2)); recoverable by non-breaching seller (Vitex v. Caribtex)

• Reduces profitability of future Ks by forcing larger allocation of overhead (fixed) costs into present Ks

Employer/Employee

Employee can recover value of breached upon K by employer: employee gets K price (what would have been earned w/o breach) – earnings from subsequent employment

♦ Employee must use reasonable efforts to mitigate w/new work

• Substitute must be of a similar nature; if different/inferior, employee needn’t use to mitigate damages and can recover full value of the KP (Parker v. 20th Century Fox)

♦ Court looks at subjective interests: preferences, characteristics particular to one em-ployment; and objective interests: similar enough, same pay

♦ For breach: Seller – KP-RP or KP-MP; Buyer – KP-CP or KP-MP

G.F. imports condition that RP cannot be too low; resale/cover are mitigation: what the S/B could have received

Mitigation in Construction Ks – builder gets 2) (Lost Profit + Unrecoverable Losses); sal-vage costs = mitigation costs; cannot mitigate lost profits

• If builder enters into new K, second profit not deducted – assumed they could have done both jobs (Neri)

♦ Court will vary the measure to maintain the goal (putting non-breaching party where they would have been)

• For owner: Primary Remedy is the reasonable cost of completion

♦ If cost of completion is substantially greater than what the result would be worth, only get difference of what was promised – what is given (Peevyhouse v. Garland Coal) (like Hawkins v. McGee)

Value of promise to restore = “diminutive value” – this should go to P

More likely to get completion costs if P more likely to repair land (if highly valued); if valued, why allow coal-mining in the first place??

Subjective interest can be protected where they are foreseeable by the other party

• Can add “whereas” clause to make this interest obvious and get completion costs

§3 – Limitations on Damages

Expectation Damages – costs P expects to obtain in the future from K; put P where they would be if K were performed

• Where P has a reasonable certainty of profit from K, breach should compensate for that lost profit

♦ (1) Causation must be shown w/reasonable certainty; (2) Amt. of loss shown w/rea-sonable basis of computation (Locke v. US – K gave P a chance of obtaining ¼ of busi-ness – compensated for lost chance)

RSC §352 – damages for loss beyond reasonable foreseeable amount are not recov-erable

♦ Cannot speculate as to what amount would be (Kenford v. County of Erie – no reasonable basis for comparison, no recovery of speculated future profits)

Court rejected “reasonable certainty”, required certainty; no “rational basis” al-lowance

Never really is complete certainty – court overruled to bring back “reasonable” allowance

Justification for speculation ban: Court decisions should be 1) justified, not arbitrary; 2) predictable; speculation denies these – more weighty than Compensation Principle; 3) some Ks will overcompensate and even out under-compensating ones

• Needn’t prove General Dmgs. to be entitled to Expectation Dmgs; do have to prove Conse-quential Dmgs.

Preferred recovery except cases like Algernon (below)

♦ For Expectation Damages need: 1) Causation – degree of likelihood that must be proven; 2) Calculation – what is the degree determining the amt. of damages?; 3) Foreseeability – was it foreseeable damage?

• Hadley v. Baxendale Rule: Where two parties have a K which one has broken, damages to other party as may fairly/reasonably be considered arising naturally (according to usual course of things), or as reasonably supposed to have been in contemplation of both parties, at the time the K was made, would likely result from a breach

♦ 1) Ordinary course of events – if foreseeable, can be expected to happen; OR 2) Notice – both parties were informed as to the circumstances

Foreseeability marked from time K is made, not time of breach

♦ Why loss borne by P? Did D assume the risk of lost profits?

Did not know of the risk – no foreseeability; shows boundary of Autonomy Principle – parties’ liability limited to foreseeableness of the breach (Ch. 7)

Like mutual mistake – if neither expected the event, neither can be liable; burden on who has the information to share or be liable!

Rationale: precluding recovery w/o proper disclosure promotes disclosure, facilitates trade – parties can alter bargain if they know about a risk assumed

HYPO: shipping w/UPS – will not buy insurance if you decide it is not worth it – will bear the burden if damaged or find better price elsewhere

Risk should end up on cheapest-cost avoider (like in Torts)

§3 - Reliance Damages: expenses incurred based on reliance on other party to perform their end of the K; put P in position they would have been had K not been entered

• Available where expectation damages are too speculative (Security Stove v American Ry. – failed shipment of furnace, P reimbursed for expenses – no lost profits)

♦ Still have ban on speculative damages from Kenford

• Promissory estoppel: reneging on a promise that a K would come up; losses from work in preparation (reliance) of K (Goodman v. Dicker – franchise K promise reneged – no expec-tation damages, only reliance costs)

If business could have been taken elsewhere, Exp. Damages are recoverable as “Lost Opportunity Damages” (Walters v. Marathon Oil – no service station for P – could have bought a different one)

No expectation damages in Goodman – lost profits are again speculative; in Wal-ters, P could have invested in a new station proven to be profitable

RSC §90: Reliance recoveries allowed; may be partial recovery; under this section, reliance damages often meet expectation damages; allows both but courts are split

May include harms caused due to breach of K that would not have happened but for the breach (Sullivan v. O’Connor – P got diff. in noses + P&S from 3rd surgery not agreed to in K)

§4 - Restitution – an element of Reliance; if no rest., no reliance; restitution adds the element of expenditures to the other party (in reliance on K) (UCC §2-711(1) – recovery of price paid)

• Alternative to other two where the breach is “serious” and $$ is only thing owed

• “Full Performance Rule” – can only recover value of K performed but not paid

♦ If rest. amt. > amt. due in the K, full perf. rule puts a ceiling on the rest. recovery – can only recover up to the full K amt. (Olliver v. Campbell – att’y only given rest of K price rather than quantum meruit cost)

Why go back to K? Policy of finality – if K is over, end litigation on the subject

Where U.E. is fully disgorged and K not fully performed, P may recover reasonable value of services rendered (quantum meruit) (US v. Algernon Blair – crane rental costs re-covered; K only 23% performed)

Algernon received full restitution value, Olliver did not – former had partially per-formed; aggrieved party cancelled the K; latter K fully performed, cancelled by non-aggrieved party

• Expectation = Gains prevented + Loss incurred – put in position as if no breach

Reliance = Losses Sustained + Expenses to 3rd parties – put in position as if no K

Restitution = Benefits to breaching party but NO 3rd party expenditures – may also be SP

Chapter 5: The Autonomy Principle (Again!)

Why use a writing? 1) Reliable (for parties’ interests); 2) Authoritative Record; 3) S/F – makes it enforceable; 4) Finality – negotiations fall out of the picture

§1 – Identifying Express K Terms

Parol Evidence (PA) Rule – applies only to prior oral/written agreements and contemporaneous oral ones

Where cause of action rests entirely on oral understanding concerning a subject dealt w/in writ-ten K, it is presumed that the writing intended to set forth entire agreement (Gianni v. R. Rus-sel & Co.)

4-Corners Rule: look only to the writing to discern if it is completely integrated; court looked to objective intent – manifestations derived from the written instru-ment

4-Corners Rule may miss intent/U.E. of K – still must follow to have “facial reliance” on Ks

• If parol evidence (oral agreement) would have been involved (naturally), written agree-ment discharges oral one; if partially OR completely integrated K, PA will be discharged from interpreting K terms

If partial integration, PA operative if it does not contradict writing; if complete inte-gration, PA operative if does NOT add-to or contradict terms (is outside the writ-ing’s scope) (RSC §213)

• PA Rule: Discharges prior agreements that are inconsistent (partial integra-tion) or w/in scope of writing (complete integration)

RSC §209 - Integrated Agreement: final expression of term(s), taken as such un-less evidenced by other sources (PA evidence)

RSC §210 – Completely/Partial Integration: complete if adopted as exclusive statement of all terms; partial if not complete – if any terms are left open or evi-dence shows no completeness

♦ Discharged to protect integrity of written agreements; parties’ intent appears as is in writing

♦ Best way to supersede oral agreement – look to face (“w/in 4 corners”) of the K

♦ Cannot contradict or add-to a final/completely integrated writing with PA

♦ PA not always excluded due to PA Rule – may be due to 4-Corners Rule

Where a merger clause is found to be well-drawn, it shows the complete agreement of the par-ties and the oral agreements (PA) are not operative (Nelson v. Elway – well-written clauses bound w/in 4-corners of writing)

Can admit PA for other reasons if not for a K term (RSC §214 – to establish level of integration, meaning, illegality/fraud/duress/mistake/lack of consideration, or ground for denying rescission/reformation)

• Look to PA, experience in type of situation, parties thoughts at time of signing, etc. to see if party had intent to supersede writing with PA (Context Rule) (Masterson v. Sine)

♦ Context Rule: Court looked to subjective intent – context/circumstances surrounding K

Must look to what parties would have understood when making the K – not an ordinary reasonable person (Interform v. Mitchell – intent derived from documents, circum-stances, and conduct of parties)

§2 - Interpreting K Terms – need to decide which of several meanings are meant in K’s terms

Words do not necessarily have fixed meanings – no such thing as literalism; must put self in shoes of parties at time of K to determine which meaning was meant (Pacific Gas & Electric v. Thomas Drayage); in favor of Autonomy Principle over Security

• When parties offer competing interpretations, judge should:

♦ 1) Admit PA conditionally, outside presence of jury

♦ 2) In light of evidence, decide if the language in the K is “reasonably susceptible” to the meanings put forth by the parties

♦ 3) If language is unambiguous, give K that meaning and keep PA from jury – instruct jury as to meaning given to questioned term OR

♦ 4) If language is ambiguous, present PA to jury/fact finder – allow them to resolve ambi-guity

Separate decision: 1) Determine if terms are ambiguous; 2) Only if it is should PA come in to help discern (W.W.W. Assoc. v. Giancontieri); more in favor of Security Principle than Au-tonomy

• 3 Rules in play: 1) PA Rule; 2) 4-Corners Rule; 3) Plain Meaning Rule

♦ 1) Used when K is integrated (to throw out PA); 2) Used to determine if term is unam-biguous (based on instrument alone); 3) Used when language is unambiguous (to give K that meaning)

Plain meaning rule (like 4-corners) may impose unintended meaning on the parties; also imparts stability – precludes fraud by regretful party

• Court looks to “manifest intent” or “evident purpose” of the clause to determine term’s meaning – not parties’ minds (stays w/in 4-corners – consider whole document together)

Discharging PA violates Autonomy Principle, upholds Security Principle – protects K from being undermined by hard-to-prove parol agreements; writing must be reliable

PA may reveal an existence of ambiguity of a term – custom/trade usage may show a different meaning than that given by a party (Brinderson-Newberg v. Pacific Erectors)

• Term must be “reasonably susceptible” to this other meaning to be applied as such

• Specific terms govern general rules when interpreting (in all cases) (RSC§203(c)); written pre-ferred to printed

Context that may be looked at: Negotiations, trade usage, Gov. regulations/statutes; course of performance

• UCC “hierarchy” of elements: 1) Express terms – a) Course of Performance – parties’ actions during K; b) Course of Dealing – parties’ actions prior to performance; c) Usage of Trade – what similar others do in similar transactions (inference of what parties may have meant) (UCC §1-205/RSC §203)

Terms > Course of Performance > Course of Dealing > Usage of Trade

♦ PA Rule: when a K is integrated, some PAs are discharged

4-Corners Rule: whether a K is integrated depends on the writing alone (Gianni/Nelson)

Context Rule: whether a K is integrated depends on writing in context (Masterson/Inter-form)

♦ Plain Meaning Rule: when a K is unambiguous, judge gives the K its unambiguous meaning

4-Corners Rule: whether a K is unambiguous depends on the writing alone (Giancontieri)

Context Rule: whether a K is unambiguous depends on the writing in context (PG & E)

• Most courts adopt PMR and 4CR – allow PA only if terms are facial ambiguous; others (CA) may find terms ambiguous after looking at PA

♦ Under both, must ask question of ambiguity – trier of fact must resolve on a basis of in-strument + PA

§3 - Implication of K Terms – may have to imply parties’ presuppositions – what they would have implied at the time the K was made

• Terms implied if: 1) agreement is silent on point at issue – implied to implement intentions/Autonomy Principle; 2) agreement is silent AND parties had no intentions/expectations about resolutions – implied to prevent U.E., forfeiture, harm to PP, etc.

Implied from purpose, circumstances, for justice/public policy, reasonableness, etc.

• RSC §204 – court implies reasonable term based on circumstances if essential to defining par-ties’ rights/duties

Express terms best show the intent; others are mere default rules that apply where parties otherwise agree

• Using the purpose of the K is the best way to imply a term (Spaulding v. Morse – Dad to pay support while in Mother’s care; son into armed forces – no longer in M’s care, purpose implies D needed pay)

• Doing what is reasonable/obligations in a K may change if the situations of the K change as well (Wood v. Lucy, Lady Duff-Gordan – if she trashed her image, Wood would be reason-able to do nothing)

♦ Autonomy may only require one has a choice among opportunities; no imposition if one is bound to comply w/ordinary business practices for the kind of deal involved

Good Faith Performance: Implied in every K; involves two questions:

• 1) Under what circumstances do courts apply good faith? 2) Where it does, what does good faith/fair dealing require?

♦ Bad faith requirements are the same as any other breach

• GF performance can add to express terms but cannot contradict them – “default rule”: ap-plies only unless otherwise expressly agreed by parties in the K

• Must know why D breached, not just that they did

♦ Foregone Opportunity: agreement on a fixed term means S gave up the opportunity to look around for a better deal on that term

Acting to recapture a Foregone Opportunity is acting in Bad Faith (Greer v. LaSalle Bank – GF breached due to shopping around, not due to economic impracti-cability)

♦ 1) Courts apply GF where one party has discretion – discretion is limited by GF; GF con-strains discretion

2) What does it require? Party must act for reasons allowed by the K – NOT reasons given up by the K (Greer) (Fry v. George Elkins – failing to finance due to want to move to Hawai`i = BF)

• GF can be found by a subjective or objective standard

♦ Subjective: matters of taste, judgment; Objective: commercial value, fitness, utility

♦ Ask if Sub – was the party motivated by ulterior means? If Obj. – was the party reason-able/justified w/in expectations of the party?

• One party may be required to inform the other of any idiosyncrasies that would affect the terms of the K (Pannone v. Grandmaison – radon test sensitivity = GF; but was it just?)

♦ Reminiscent of Hadley v. Baxendale – to be GF, both parties should know of such con-ditions

§4 – Promises and Conditions

K “Construction” – take express + implied terms; decide if they are promises, conditions, or both – what are the consequences?

Determines legal operation of terms (promise, condition, or promissory condition)

What language makes a condition?

• “If…”; “Provided that…”; consequence? Not meeting condition is NOT A BREACH – only dis-charges other party’s obligation based on that condition

♦ Ex: Wood will keep marketing Lucy’s designs provided that Lucy keeps designing them – if Lucy stops, Wood no longer has the obligation to market her other designs

What language makes a promise?

• “Promises…”; “Guarantees/warrants…”; “Shall…” – promises are not conditional; breaking = breach

What language makes a promissory condition?

• “…shall pay if other party does so…” – shows remedy in case of broken condition; now be-comes breach rather than discharge of obligation

• Need promissory conditions where products/interests must be protected

Exact Occurrence Rule: express conditions must occur exactly; “just as good” will not do – harm is irrelevant where terms are express (Jungmann & Co. v. Atterbury – “by cable” means “by cable!”)

• May lend to a harsh result; exceptions have been developed

♦ 1) If the condition can be interpreted as a promise, can do so (Peacock Construction v. Modern Air – small sub-Ks do not generally assume risk on non-payment – allow as prom-ise to prevent forfeiture) (RSC §227(1))

♦ 2) If the condition is excused by the other party (Burger King Corp. v. Family Dining, Inc. – history of late openings had been excused – showed express K terms were not be-ing followed by either party)

Waiver or forfeiture can excuse a condition’s non-occurrence (BK)

♦ 3) Where bad faith is shown by the other party (Fry v. George Elkins – BF made prom-ise to buy come due)

Failure to act in GF precludes breaching party from relying on condition to discharge obligation

♦ 4) Implied conditions need only be substantially performed (Godburn v. Meserve – P breached first by walking out; D becoming crotchety was in contemplation of parties ≠ breach)

When interpreting terms, interpret them as similar writings do – want uniform treatment of like terms across different Ks (RSC §211(2))

• If condition can be interpreted as a promise, can do so to prevent forfeiture (RSC §227(1))

♦ Same results even if the party that would lose can “afford it” – want uniformity!

♦ In unusual circumstances, risks may be shifted and be assumed by parties who usually do not (RSC §227(1)) – these circumstances needn’t be explicitly stated

• If a condition is excused, the duty attached to it is excused as well (RSC §225)

♦ Non-occurrence of a condition is excused if discharging would involve disproportionate forfeiture AND condition is not material part of the agreed exchange (RSC §229)

Waiver: intention relinquishment of a known right; independent of forfeiture doctrine

Where a condition is implied, it is a constructive condition; performances may be conditional on each other such that one needn’t occur w/o the other (Godburn v. Meserve)

Chapter 6: The Security Principle

Security Principle: “The law requires each party to a contract formation or performance to do its part to respect the other party’s reasonable expectations and reliance.”

In a bi-lateral K, when one party breaches, must the other party perform?

• Law often constructs conditions of exchange so one parties’ duty to perform is discharged when the other party breaches – like a remedy in addition to damages (non-breacher always gets damages)

§1 – Interests of the Parties Impaired by a Breach (in Executory Phase of K)

RSC §238 – if performances are due simultaneously, each party has condition to perform so that other will too

• If promises constitute mutual conditions, second party is obligated to perform once first party has done so (Kingston v. Preston – where P was to provide security for stake in D’s busi-ness, requires security to be delivered first to avoid injustice of P getting a stake w/o proof of security)

♦ Types of covenants: Mutual and Independent: breach of one does not bar action for breach of the other; Conditions and Dependent: performance of one depends on prior performance of the other;

Mutual Conditions: requires simultaneous performance; action of one for other’s non-perfor-mance

If covenants are independent of each other, they are not conditional - breach of one does not discharge the duty of the other to perform

• Can still get damages if covenants are independent of one another

If covenants are dependent of each other, they are conditional - one party breaches so other needn’t perform

• Law often inserts this condition to protect one party’s enhanced security

Expectations can exist before they really “kick in” – difference between future perfor-mance and present performance (Hochster v. De la Tour – repudiation/breach by D can be recovered upon before date performance was due)

• Law protects both – future performance expectation begins at moment of K signing; pro-tected by Doctrine of Anticipatory Repudiation (UCC §2-610 – aggrieved party can await performance, seek remedy (even if awaiting performance), and suspend its own per-formance

♦ The repudiating party cannot do anything to impair the other’s contractual security be-tween the time the K is made and performance is due (Hochster)/(UCC §2-609(1))

♦ If one party repudiates anticipatorily, the other can “close the door” of allowing retrac-tion either at the time the reliance shifts OR by acceptance of the repudiation (US v. Seacoast – act of taking bids for replacement = repudiation taken as final – D cannot re-tract repudiation)

Acceptance may be a clearer way to show the reliance interests have shifted before performance was due – interests have “materially changed” (UCC §2-611(1))

RSC §250(a)/(comment b) – “mere expression of doubt” is insufficient to constitute a repudiation; must have clear expression/notice of repudiation for it to count

This notice must go from obligor to obligee – 3rd parties do not count!!

A voluntary, affirmative act that renders or apparently renders the obligor unable to perform constitutes a repudiation (RSC §250(b))

Request for a guarantee is a request for insurance – RSC §251/UCC §2-609 allows this, but only allows adequate assurances; cannot “re-write” the K to ask for more than this (PDM v. Brookhaven – request for personal guarantee/escrow payments goes beyond security of K – not getting ≠ breach)

• What is adequate? – Note of credit-worthiness from bank; financial statement to show sol-vency; loan application copy; etc.

• Lack of adequate assurances can turn insecurities into a repudiation; need reasonable grounds and a written demand for these assurances w/o going beyond the K

• No assurances w/in 30 days = party has breached by anticipatory repudiation (UCC §2-610, comment 2)

Hypo, p. 497(a) – C agrees to make improvements on O’s house; O pays C $5,000 of $27k to-tal at start; C does $6,500 of work, then quits; should C recover lost profits or $1,500?

• Even w/material breach, want to avoid U.E. – need to return restitution, may get $1,500 back; not doing so would result in moral hazard for O (jurisdictions are split); O will get full compensation

§2 - Cancellation in Response to a Breach (during Performance Period)

Cancellation ends the K, discharges all executive duties of the parties

• A material breach triggers the power to cancel; if not material, only “partial” or “imma-terial”

• RSC §241 – Circumstances to determine if breach is Material

♦ 1) Deprivation of benefit to injured party; 2) extent to which injured party can be ade-quately compensated; 3) extent to which breaching party will suffer forfeiture; 4) likeli-hood that breaching party will cure failure; 5) extent to which behavior of breaching party comports w/GF/fair dealing

Comments allow this section to be flexibly applied to each case to provide security

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What is a material breach?

• Material breach = insubstantial performance; if performance is substantial, there is no mate-rial breach; exists only where covenants of a K are mutually dependent on each other (con-ditional)

♦ Where performance gives a nominally or not-at-all different result from performance as contracted, it is considered a substantial performance (Jacob & Youngs v. Kent – Cohoes pipe (not Reading) is good enough)(we did not read this case)

• Material breach implicitly discharges the other party’s obligation (cancellation) AND allows damages

♦ Non-breaching party always gets damages

• Allowing cancellation protects expectation interest in two parts:

♦ Interest in Present Performance: harmed when breaching party fails to perform on time

Remedied w/compensatory damages; given to pay for net loss of value

♦ Interest in Future Performance: security that other will perform when agreed

Cancellation + compensatory damages given; may worry the non-breaching party that future shortcomings will occur; law allows non-breacher to replace security by cancelling

• How to determine if breach = material?

♦ Look at breaching party’s willfulness, trivialness of the breach; the “purpose to be served, desire to be gratified, excuse for deviation, and cruelty of enforced adherence” – “All-Purpose Test” (Jacob & Youngs v. Kent)

No information about how to use the test – which factors are weighed more heavily??

Applied to problem b, p. 502 (“rose garden hypo)”- not willful, not cruel to enforce, needs to be served; ambiguous decision – need to know how to weigh them!!

♦ “Where a performance meets the essential purpose of the K, less-than perfection is needed for one to substantially perform their end of a K” – “Essential Purpose Test”

(Plante v. Jacobs – house built incompletely, still livable – essential purpose met = sub-stantial performance [unless details are of the essence])

To p. 502 – harder to decide; need more facts to know what the essential purpose of the K was

♦ Using the six factors from RFC – “Six Factors Test” (Walker & Co. v. Harrison – sign not cleaned ≠ breach – P had discretion of when to clean, did not show BF – did not breach)

Protects both parties’ interest; still do not know how to use!!! Depends on which fac-tors are weighed heavier on case-to-case basis

To p. 502 - Like “All-Purpose test” – may cut both ways w/o knowing how to weigh the factors!

♦ Ask “Is cancellation appropriate/required/desired by non-breacher?” What does it add?

May protect future interest of non-breacher; avoids further insecurity of future mess-ups; damages may be inadequate to fully protect the non-breaching party

1) Insecurity does not allow one to calculate damages; 2) Specific performance is not desired – do not want to allow breaching party to continue; 3) Allows for mitigation – can fire first party and get a new one, reducing damages by cover amount

♦ RSC§241 – “5-Factors & Purpose Test” – five factors may still cut both way; but adding purpose makes materiality of breach more clear

The five factors may bear on the security principle (1, 2); some do not (3)

To p. 502 – need to know what the purpose was; ask why roses were destroyed

• What if the worker who destroyed them was drunk? What if Charlie then fired him? May add to or take from P’s security depending on these conditions

♦ Two prong test: 1) Non-payment makes it hard for S to perform; 2) Causes “reasonable apprehension” that performance is not coming (like PDM) - “Reasonable Apprehension” Test” (Plotnik v. PA Smelting & Refining – S could perform, no basis for apprehension = no material breach)

Under UCC §2-703(f) – S can cancel if B’s breach is of the whole K - where default on payment “substantially impairs” the value (§2-612)

Substantial impairment may mean same thing as Plotnik – this case is the best guid-ance for §2-612

Must be “absolute and unequivocal refusal to perform or a distinct and positive state-ment of an inability to do so” to be a repudiation (McCloskey & Co. v. Minweld Steel – notice of difficulties in obtaining steel ≠ repudiation; action by P to cancel = AR)

P demanded “unqualified assurances” – under UCC §2-609/RSC §251 can only ask for “adequate” assurances – demand was beyond security of K

Hypo: Same facts but letter says D “certainly cannot perform w/o help”; same re-sult? – May qualify as a distinct statement; would be BF by general in failing to mitigate

♦ Breach by anticipatory repudiation is ALWAYS material

• GF and Material Breaches - GF demands mitigation of harm of future performance where possible as an implied condition for the right to cancel

• Non-Breacher can elect to treat a breach as immaterial/partial or total

♦ If a total breach - cancellation granted; breacher’s duty is discharged and replaced w/duty to pay ALL past & future damages from K

♦ If partial - non-breacher gets past damages ONLY; K stays alive

K&G Construction v. Harris – sub-K breaches by not working in “workmanlike manner” – treated as partial breach; abandonment of later work = repudiation = ma-terial breach)

• HYPOS, p. 524

♦ D bulldozes wall, considered material breach; P files an action; should D keep working? – Depends on if P requests past + future damages

If requests both = total breach - stop working; if only past = partial breach - keep working

♦ Same facts but breach considered immaterial and P withholds payment – obligation to pay was not discharged – D can treat it as partial or total breach

If partial, may keep working and sue for damages (payment); it total, can sue for fu-ture damages

♦ Considered immaterial and P withholds payment; D works for 3 weeks and quits – contin-uation of work was an election of partial breach by D

He cannot walk off later – P can sue for cancellation + future damages

§3 – Agreed Enforcement Terms: GF in Enforcement of the K (rather than performance)

Enforcement rights (material breach, A.R., etc) are default rules – parties can vary/supplement them in their K to provide more security than these rules alone give

• BF in K performance disables a party from exercising agreed enforcements; GF is a condition to their use

Whereas performance terms show a parties’ rights/enforcements/duties, enforcement terms make it more likely that performance will go through (ex. “Acceleration Clause”)

• When a breach leaves payment installments in the future as the only remaining duty, breach by non-performance ≠ total breach - no acceleration (RSC §243(3))

GF turns on the parties’ reasons for cancelling a K and why terms of a K were in the K in the first place (Baker v. Retzlaff – term to allow S to retain extra goods so they could sell at a better price later = BF - no cancellation allowed)

• GF is a condition to the right to this cancellation term – was not met here; S was still obli-gated to deliver due to BF in falsely exercising power to retain goods – could not rely on the term any longer

GF is an implied condition to the valid exercise of agreed enforcement powers (UCC §1-203); required in both performance and enforcement

• Requires enforcement power to be exercised for the purpose for which it was put in the K

♦ Baker v. Ratzlaff – condition as pretext to option of a better deal, not to ensure pay-ment

♦ Brown v. Avemco - acceleration clauses are to protect insecurity of one party – w/o showing of insecurity, benefitted party’s exercising of this term shows BF (D repossessed plane; P was not insecure)

UCC §1-208 – acceleration clause only allowed when party feels, in GF, that security is impaired

♦ Burne v. Franklin Life Ins . – 90-day limit for double indemnity unallowable due to PP; purpose of term to aid those who lost, not to preclude recovery for those who stay alive longer

All cases require court to look at the purpose of the terms rather than the formal meaning (will often get to same result)