by James C. Glassford, Attorney at Law

by James C. Glassford, Attorney at Law

Friday, December 30, 2011

Six Excuses for Avoiding Contract Liability: Part Two on Performance

     After the contract is made, a party might not be happy with the deal that was struck.  That party might try to avoid the contract by claiming it was never formed, the formation process was fatally flawed, or the court will not enforce it on technical grounds.  See Part One.  Failing in this effort, a party might try to duck performing his end of the deal on the excuses discussed below.


Definite Terms.
     Sometimes the terms of the contract are so indefinite or incomplete that a court would have difficulty in knowing what the parties intended.  The terms must be sufficiently definite for the court to find that a breach occurred and how to calculate damages for the breach or to scratch out some other remedy appropriate under the circumstances.  If the court cannot know what the parties intended, then it will not enforce the contract.  Indefiniteness can be fixed.  If the court believes that the parties intended to make a contract, then it will do what is allowed by law to fix the problem of indefiniteness.
     Indefiniteness may be caused by terms that are unclear or gaps in the contract.  

     When the parties use a term that is vague or ambiguous, the court will try to give meaning to that term according to the intention of the parties and enforce the contract accordingly.
     Before a court will waste a lot of time trying to decifer the meaning of a word or term in a contract, it must decide whether the term really is vague or ambiguous.  In California, this threshold question is not much of a hurdle.  The test is whether the language of the contract is reasonably susceptible to the meaning asserted.
     If the court finds that the language was susceptible to two different meanings, then the court must take evidence to determine whose meaning was intended by the parties at the time they struck their deal.
     Using the example of the trade of Milky White, the cow, for the magic beans, assume that Jack thought that the word "magic" meant that the beans would produce a golden crop.  The funny old man understood that the bean stalks would merely grow to the sky.   Upset by the enormity of the stalks, Jack demands his cow back.  The old man says, "No way."  The lawsuit is filed.
     First, the court must decide whether the word "magic" is reasonably susceptible to Jack's meaning.  On the face of it, Jack's meaning seems rather absurd.  On the other hand, the word "magic" suggests that the beans could do something in the supernatural.  A judge would likely want to look at the evidence of the understanding of the parties.
     Second, the court will attempt to determine whose meaning correctly represents the mutual understanding of the parties.
     If only the testimony of the parties is given to the court, the court will have a tough time choosing between the two meanings.  If so, the court can decline to enforce the term as it is understood by either of the parties.  This would leave the parties where they stand.  The old man would have the cow, while Jack would have the bean stalks reaching for the sky.  In the alternative, the court could declare the contract was never formed, because the parties never reached agreement on an important term.  The court would then order restitution.  The old man would return the cow to Jack, who would pay the reasonable value of the beans to the old man.
     This unsatisfactory result would not sit well with the court.  Courts like to find a way to keep the parties together in contract.  That is not to say that the court would re-write the contract for the parties.  Yet, the court has methods for finding the mutual understanding of the parties in cases of interpretation.
     The court will look at the facts and circumstances of the making of the deal.  Jack and the old man may have discussed the transaction in front of witnesses.  Jack may have asked the old man what he meant by "magic."  The old man may have explained that he meant the beans would grow into giant stalks.  If so, Jack's case would be tossed out of court.  On the other hand, Jack and the old man may have done business with each other in the past.  Every time Jack bought "magic" beans from the old man, the beans produced a golden crop.  Jack expected the new beans to do the same thing.  This evidence would tilt the scales of justice in favor of Jack.  In short, the court is looking for evidence that one party knew or had reason to know what the other party meant in the use of a word or phrase in a contract.  If found, the court will not allow a party to claim a different version of the meaning of a term.

Parol Evidence.
     When the parties put their contract in writing, the writing is often the final statement of the agreement.  If a party claims that a term agreed upon by the parties was left out, he will have an uphill battle.  The reason people put their contracts in writing is to have a record of the agreement.  Later, neither party can claim something was missing.  The record gives them an accurate statement of the contract down the road when memories fade and remorse seeks for a loophole.  The purpose of putting the agreement in writing is to avoid going to court later.  If everything that was agreed upon is right there in writing, the parties are protected against the unnecessary expense of hiring lawyers and fighting it out in court.  The courts traditionally have given much credence to the written contract and have turned a deaf ear to a party who wants to add something to the contract after signing it.  Of course, no contract is entirely complete.
     A party might claim that the parties agreed to a term that was left out of the contract, because they forgot to include it or it was a separate deal.  When this happens, a court will look at two questions.
     First, was the writing the final expression of the parties' agreement?  The law calls such a writing an integration, because it brings together all of the parties discussions and agreements and collects them into one document and tosses out what the parties did not agree to.  If the writing is not an integration, it is pretty much useless.  The court will give the party looking to add a term to the agreement his day in court.  If it is the final expression of the agreement, the court will ask a second question.
     Second, was the writing a partial or total (integration) expression of the parties?
     If total, the court will not allow evidence of the term allegedly left out of the agreement.
     If partial, the court will allow in evidence the new term, so long as it does not contradict any of the terms in the writing.
     Again, using the agreement between Jack and the funny old man, assume that the old man had Jack sign a 28-page agreement, which stated that it was the final and complete agreement of the parties.  Not satisfied, Jack wants to get his cow back.  He now claims that the old man promised that he could come back any time within five days and get his cow back for any reason whatsoever.  You guessed it.  The oral part of the agreement was not included in the writing.
     As to the first question, the court will likely find that the writing was an integration.  The parties signed it and immediately exchanged the beans for the cow.  A written contract followed by performance looks like a final expression of the parties.
     As to the second question, the court again would likely find that the writing is a total integration, rather than partial.  After all, it was 28 pages long and even said it was the complete agreement of the parties.  Realizing that no contract is really totally and conclusively complete, it might look at the evidence of the term itself and ask another question.  Is the term one that the parties would naturally omit under the circumstances?  If the old man had intended to be bound by such a cooling-off period, it is almost certain that the term would have been included in the contract.  Again, Jack would lose.
     Suppose the old man orally promised Jack he could get his cow back for any reason for the additional payment of five dollars.  This would be considered a separate contract, because it is supported by its own consideration.  Under these facts, a court would enforce this oral agreement.  Jack would be entitled to get his cow back on tendering the payment of five dollars to the old man.

Gap Filling. 
     In many cases, the parties leave out essential terms for various reasons.  They may have forgotten about it or assumed it would be part of the contract without actually discussing it.  Although the parties never agreed to one or more essential terms, they did intend to be bound in contract.  Without an essential term, the court will be unable to enforce the contract.  Yet courts are reluctant to throw up their hands and turn the parties loose without a resolution of the problem.  In many cases, the court can fill a gap in a contract with any number of off-the-shelf standard terms.  In other words, the court can fill a gap in a contract by implying a term that by law has been accepted for this purpose.  Sometimes, these are called "default" terms.  The Uniform Commercial Code, which has been adopted in California, has many "default" terms, such as price, delivery time and place, and payment time and place.
     A term that is implied in every contract is the duty of good faith and fair dealing.  The purpose of this term is to ensure that each party fully receives the benefits promised by the other party.  Using the transaction between Jack and the funny old man again, assume that the old man did in fact promise to return the cow to Jack in five days for any reason whatsoever.  The old man must in good faith protect against the theft of the cow, even though the contract says nothing about the old man's duty to prevent theft.  He cannot just leave the barn door unlocked and allow his brother to walk away with the cow.  When Jack comes to retake the cow on the fifth day, the old man cannot merely state that the cow was stolen.  When Jack comes back on the seventh day and sees the cow is back in the old man's barn, the old man cannot merely say you are too late.  Jack would have a good claim for the return of his cow, even though the contract said nothing about the old man's duty to secure the cow from theft.


Express Conditions.
     Although a contract is made up with promises, sometimes promises are conditional.  A condition is an event must happen before a party must perform on his promise.  Conditions can be express, meaning stated in words whether orally or in writing.  They can also be implied or constructive.
     A good example of an express condition is seen in your car liability insurance policy.  The insurance company promises to pay damages you owe to an injured person due to an accident caused by your negligence.  The event that must occur is an auto accident.  Not just any accident will qualify.  Your negligence must be the cause of the accident.  For this protection, you pay the insurance company a premium for coverage for the policy period, usually six months or a year.  If you have no accident during the policy period, your insurance company will pay you nothing.  The reason you get nothing back from the insurance company is that a condition did not happen.  The condition was an accident.  Another way of looking at it is the insurance company pockets your premium and you get nothing in return.
     You might wonder how insurance can be a contract.  It seems like nothing is exchanged.  Actually, there is an exchange.  You pay a premium in exchange for a promise.  The promise made by the insurance company is that they will stand behind you and protect you against economic ruin if a claim is made against you.
     Insurance is an example of an aleatory contract, one that is conditioned on a fortuitous event.  Such events are not certain to occur.  As a matter of law, a condition is an event that is not certain to occur.  Yet many conditions can be under the control of a party, even the promisor, or under the control of a third party, meaning a person not a party to the contract.
     A good example of a condition under the control of a party crops up in contracts for the sale of real property, like a home.  The buyer promises to pay the seller the purchase price for the home, if the buyer can get financing.  The terms of the financing, such as interest at 4.5% max, are spelled out in the contract.  If he does not get the financing, the condition does not occur, and the buyer will be discharged from the contract.  The law imposes an obligation on the buyer to use reasonable efforts or due diligence to get the financing.  He cannot just blow off the purchase of the house by doing nothing.  Therefore, the financing condition was not under the complete control of the buyer.  If it were, no contract would exist.
     If a party can decide whether or not to perform under a contract, the contract may lack consideration.  As explained in Part 1, almost all contracts must have consideration to make them binding and, therefore, enforceable.  If a party has the absolute power to back out of a contract for no reason at all, the promise made by that party is labeled illusory.  The contract lacks consideration and cannot be enforced.
     If a condition does not and cannot occur, then the party who made the conditional promise will be discharged from the contract.  That party, however, could waive the condition.  Take for example the purchase of a home subject to the financing condition.  If the best interest rate available to the buyer was 5%, the condition would fail, and the buyer would be discharged.  On the other hand, the buyer might be willing to pay 5% to get the home of his dreams.  If so, he could waive the condition and go through with the sale.  Unless a timely retraction of the waive is made by the buyer, the contract would be enforceable by the seller.
     A court might even excuse a condition under the proper circumstances.  Excuse means the condition will be deemed satisfied.  A court might look at a number of factors in judging whether to excuse a condition.  A party asserting the condition might act to prevent it from occurring or fail to cooperate to make it occur.  If so, the condition will be excused.  Moreover, the failure of the condition may cause a party to suffer a forfeiture.  In a case of extreme forfeiture, a court may excuse the condition, especially when the occurrence of the condition is no longer possible due an unexpected turn of events.
     A party may act in bad faith in asserting the condition.  In one case, a buyer of potatoes to be used in making potato chips specified that the potatoes chip to his satisfaction.  When the price of potatoes took a nose dive, the buyer refused to accept delivery, claiming that the potatoes were unsatisfactory.  He said "I can buy potatoes all day for $2.00" per hundredweight (the lower price).  By objective standards, the court found that the potatoes could be chipped, the buyer acted in bad faith, and ruled in favor of the seller.

Constructive Conditions.
     In many contracts, the promises made by the parties may be deemed dependent.  This means that what one party has promised to do is a condition of the duty of the other party to perform his return promise.  In an employment contract, the employee's doing the work is a condition to getting paid by the employer.  Usually, when the performance of one party will take time to complete, it must be done before the other party must pay.  In a real estate transaction, the buyer's paying for the property is a condition to the seller's duty to transfer title to the buyer.  Since both performances can be done in an instant, these conditions are concurrent.  In a real estate transaction, an escrow is set up to make sure both parties perform at the same time.
     With concurrent constructive conditions, neither party can be in breach until one has performed or tendered performance.  This highlights another benefit of an escrow in a real estate transaction.  If the buyer fails to put the purchase price in escrow and the seller fails to put the deed in escrow, the buyer is not in breach.  The seller's constructive condition, his promise to transfer title, has not occurred.  The seller must put the buyer in breach by tendering the deed, putting it in the hands of the escrow agent.  Once the deed is placed in escrow, then the buyer would be in breach.  At that point, the constructive condition of transferring title would be satisfied.  The buyer would be under an absolute duty to pay.  Failing payment, the seller would be in a position to sue the buyer for breach of contract.
     The flip side of this scenario occurs when the seller sells the property to a third party before the close of escrow.  Suppose the sale's price was $100,000 more than the contract price with the buyer.  The buyer would have plenty of incentive to sue seller for breach of contract.  Damages would be the loss of the benefit of the bargain.  This would be easy to calculate.  It would equal the $100,000 gain to the seller on the second sale.  The question would be can the buyer sue for breach of contract and recover his damages.  Not necessarily.  Buyer's performance is still a condition to the seller's duty to transfer title.  Buyer need not deposit the purchase price into escrow or even tender the purchase price.  The law does not require idle acts.  It would be an idle act in light of the fact that seller cannot perform.  All buyer must be able to prove, however, is that he was ready, willing, and able to pay the purchase price.  If he did not have the cash and was not able to get financing, he would lose his lawsuit.  In other words, the seller's duty to transfer title was still conditional upon the buyer having the capacity to pay the purchase price.  Unless that condition was satisfied, seller could not be put in breach.
     As long as promises made in contract are conditional, the promisor cannot be in breach.  When conditions have occurred, then promissory duties become absolute.  You should be in a position to sue and win your lawsuit--but not necessarily.

Impracticability and Frustration of Purpose.  
     Other events might occur that make performance under a contract impracticable to perform.   Sometimes an event might occur that substantially frustrates the principal purpose of the contract.  Either way such an event might discharge the promisor's duty to perform.
     Suppose a building contractor enters into a contract with the owner of a theater to refurbish a theater inside and out.  Two days later before work starts, the theater burns down.  The cause of the fire was unknown.  The theater is an old art deco structure from the 1930s and cannot be replaced.  From the point of view of the contractor, performance has been made impossible from the happening of the event.  From the point of view of the owner, the purpose of the contract has been frustrated.  Both might be able to raise a defense based on the the occurrence of fire.
     Both defenses, impracticability or frustration, depend on proof that the non-occurrence of the event was a basic assumption of both parties.  Proof of basic assumption here should be no problem.  Both parties expected the theater to continue to exist.  Otherwise they would not have entered into the contract.
     In addition, the party asserting the defense must show that he was not at fault in the cause of the event.  Here, the cause of the fire was unknown.  Either party should have no difficulty dodging this obstacle to their defense.
     Lastly, a party must show that he did not assume the risk of the happening of the event.  The court would look at the contract and other circumstances to see whether or not the parties assigned the risk of loss to one or the other.
     If a party can show all of the elements of the defense applicable to him, then a court would discharge the party from the contract.  The other party would be free from the contract as well.          

Breach of Contract.
     When all conditions have been satisfied or excused and duty has not been discharged by impracticability or frustration of purpose, the duty to perform what was promised becomes absolute.  A party's failure to perform an absolute duty when due is a breach of contract.  A party can breach by repudiation as well.  A repudiation is merely a clear statement or act indicating that the promisor will not perform.  A good example of a repudiation is the seller mentioned above who sells the property to a third party before close of escrow with the buyer.


Specific Performance and Injunction versus Damages.
     Generally, a court will not order a party to do what he promised (specific performance) or stop him from doing an act (injunction), unless the legal remedy is inadequate.  The legal remedy is money damages.  In other words, for breach of contract, the court will usually award the plaintiff a sum of money to compensate him for the breach.  The law does not want to force a person to serve a master involuntarily.  The rule is based upon the assumption that in most cases the plaintiff will be able to buy the goods and services from another source.  The court will award enough money for the plaintiff to get what he contracted for from someone else, even if it will cost more that the contract price.  Therefore, the goal of contract damages is to put the plaintiff in the same position he would have been in had the breaching party fully performed.  In other words, the law will make the innocent party whole.
     Specific performance and injunction are call equitable remedies.   When a substitute performance cannot be bought on the open market or damages are difficult to calculate or possibly the breaching party cannot pay damages, the court will turn to these equitable remedies.  A breach of contract for the sale of unique property is an example of case when damages would not be adequate.  Simple, the innocent party cannot take a sum of money and replace the property.  The property is unique and cannot be replaced.  It is often thought the real property is unique, and specific performance would be ordered to remedy a breach of contract for the sale of real property.   Keep in mind that money damages is the preferred remedy.

Certainty of Damages.
     For the court to make an award of money damages, the amount must be calculated.  Sometimes the calculation might be difficult or even speculative.  The law merely requires that damages be reasonably certain.  Exact calculations are not required as long as guesswork is avoided.  The benefit of the doubt will be given to the party not in breach.

Benefit of the Bargain.
     Keeping in mind that the law seeks to make the innocent party whole, first the law will give the innocent party the benefit of what he bargained for in the contract.  For example, if the buyer of a home agreed to pay $500,000 for the property with a market value of $600,000, the benefit of the bargain is $100,000.  The court would award the buyer $100,000 for the seller's breach of contract.  You might wonder why a court would award money damages in a case for the sale of real property.  If the buyer intended to buy on speculation and sell the property for a profit, then money should be adequate to compensate him for the loss.
Consequential Damages.
     Sometimes other damages flow from the breach of contract above and beyond the loss of the benefit of the bargain.  These are called consequential damages.  They must be foreseeable at the time of the making of the contract.  Damages are foreseeable in many cases when they naturally flow from the breach in the ordinary course of event.  If not, then the breaching party must be aware at the time of the making of the contract of special circumstances that might cause damages or losses.
     Returning to the example of the contract for the purchase of a home for $500,000, assume that the home is fully fitted out for use by a handicapped person and that the buyer is married to a handicapped spouse  The seller never meets or is told about the handicapped spouse.  After the breach, the buyer finds another home and buys it for the same price.  The home is not handicapped friendly, so the buyer spends $100,000 to upgrade the home.  Can the buyer recover the $100,000 as consequential damages?  These facts raise many thorny issues of fact that could make it difficult for the buyer to recover any damages.
     The first question that must be resolved is whether or not the claimed damages follow the breach in the ordinary course of events.  Perhaps they do.  The house was built to accommodate a handicapped person.  It may be reasonable for the seller to expect that a buyer of such a home was induced to buy because of the handicapped-friendly feature.  It might follow that the breaching seller would expect the buyer to spend money fixing up a substitute house for a handicapped person.  If not, the buyer might have to prove that the seller was aware of special circumstances that bare on this issue.  Although the seller knew that the house was handicapped friendly, the facts show that the seller was not aware of the buyer's handicapped spouse.  This absence of seller's knowledge could mean the difference between buyer proving his case for consequential damages or having to settle for just the loss of the benefit of the bargain.  We assumed that the substitute house was purchased for the same price as the contract price.  If the second house was a true substitute, buyer would have no damages for loss of the benefit of the bargain.    

Avoidance of Damages.
     Another limitation on recovery of damages is that the innocent party must take reasonable steps to avoid damages after the breach.  For example, seller agrees to sell a used BMW car for $25,000.  Buyer  fails to pay thereby breaching the contract.  Seller must use reasonable care to protect that car from loss.  He cannot just park the car on the street unlocked with the keys in the ignition, allowing the car to be stolen and wrecked by a joyrider.  If the car is a total loss, the court will not award the full value of the car to the careless seller.  Seller will be entitled to recover only the difference between the contract price and the market price.  If there is no difference, seller will absorb the entire loss of the car or submit a claim to his insurance company.

     In conclusion, although many defenses and obstacles can hinder or prevent your recovery in a lawsuit for breach of contract, the great majority of them will in all probability not work.  The basic policy of the law is to enforce contracts as written.  The policy encourages economic activity by providing security to contracting parties that the courts will stand behind them and enforce their bargains.

    Should you have any questions about contract law, please feel free to contact me at your convenience.

James C. Glassford
Attorney at Law            

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Saturday, December 24, 2011

Six Excuses for Avoiding Contract Liability: Part One on Formation


     In olden days, people often made transactions for the exchange of goods and services without contracts.  Recall the story of Jack who went to market with his cow, Milky White.  On the road, he met a funny old man.  The man offered Jack five magic beans for his cow.  Jack agreed.  The exchange was made.  Jack returned home with never a thought of seeing the funny old man again.  This is a classic example of a barter agreement.  The exchange occurred in real time without a contract.  The transaction is relatively risk free.  The old man assumes the risk that the cow will produce milk.  Jack assumes the risk that the beans will grow into stalks.
     Even this simple cow transaction could turn into a contract.  The old man told Jack that the beans were magical.  This may amount to a warranty, a promise that the beans have magic qualities.  If it turns out that the beans were plain old beans, Jack may have reason to complain.  He could sue the old man for breach of contract.  What removes this transaction from a barter agreement to a contract is the promise.
     A promise is simply a commitment to do or refrain from doing something in the future.  Not all promises, however, are contracts.  Only when a promise is legally enforceable do we say that a contract has been formed.  Usually, the word "promise" is not found in the contract.  A promissory note is an exception.  The parties merely state their promises in terms of what they will do or not do under the contract.  Sometimes, they don't even go that far.  If so, a court may imply a promise to keep the contract from falling apart.  Yet, a promise there must be, or there can be no contract.  Note, promise is futuristic.  
     In a contractual transaction, the exchange often will occur in the future.  For example, if the funny old man had promised to give Jack five beans in thirty days in exchange for the cow and Jack then gave the cow to the man, a contract would have been formed.  The problem with this contract is obvious.  A new risk is assumed by Jack.  Can Jack really trust the the man to do what he promised to do?  A contract will help lessen this feeling of insecurity.  If you have the courts to back you up on your contract, then maybe you will agree to make an exchange that calls for the other party to perform in the future.  Maybe, in this day and age, relying on contract transactions has become a necessity.
     We live in a commercial world.  Production of goods and services has become highly specialized.  Few people can produce everything they need to live.  We all depend on others for our very survival.  We know what we can produce, and we let others do the rest.  We take the risk that others will provide what he cannot do for ourselves.  Contracts make this world function.  Contracts allow us to shift the risks of dependency to others. 
     The law of contract provides security that both parties will perform their promises.  Although entering into a contract is not without risk, the law attempts to make the risk acceptable.   A policy of the law is to encourage efficiency in commerce through security in the market place.  This policy is served by the courts enforcing contracts as the parties made them.  It follows that courts are not in the business of re-writing contracts for the parties.  Nor are the courts interested in letting parties off the hook except in rare and thoroughly justified cases.
     A contract has two phases: formation followed by performance.  Formation is about putting the contract together and reaching an agreement.  When formed properly, the contract will contain a promise or set of promises.  For a unilateral contract, all of the promises are made by one party.  For a bilateral contract, both parties make promises.  Regardless, the promise is the essence of a contract.     
     In the performance phase, the parties do what they promised to do.  If a party fails to perform, then the excitement begins.  It may not be the excitement you bargained for, but at least you can go to court and enforce your agreement.
     This article is written in two parts.  Part One talks about excuses that arise out of the making of the contract.  Part Two talks about excuses that come up after the contract is formed and during the performance phase.
     The excuses to formation are the following:
     1.  We did not have a contract.
     2.  You conned me; I had no choice.
     3.  No court will make me do what you want.
     The excuses to performance are as follows:
     1.  The contract does not say that.
     2.  Maybe I am not in breach.
     3.  Sue me.  You've got nothing.
     If you're thinking about suing someone for breach of contract, these are the six excuses you need to worry about.  If you are being sued, these are the only excuses that might help you.  You need to determine which ones, if any, will work for you.
     With this in mind, let us discuss in detail how a party might avoid contract liability.

     This could be a valid excuse.  To be enforceable, contracts must be properly formed between the parties.  This requires mutual assent and consideration.  In some cases, even non-parties can enforce rights created by the contract.  Let us take a look at how this works.
Mutual Assent.
     One of the basic principles of contract law is a person is free to make a contract.  Likewise, a person is free not to enter into a contract.  Therefore, in making a contract, both parties must agree or assent to the same terms of the contract.  Also, the assent must be given freely without overreaching or deceit.
     The formation process is usually done through offer and acceptance.  One party will make an offer on the terms agreeable to that party.  An offer is defined as a manifestation of willingness to enter into a bargain.  A bargain is an agreement to make an exchange.  For example, the funny old man states to Jack, "I will give you these five beans in my hand, if you give me your cow right here and now on this spot."  Although no formal words were stated, the old man clearly made an offer.  He cannot later complain that he was merely starting up a negotiation that might lead to a transaction.  The law looks at the words or manifestation objectively.  If an objective person would understand that the old man intended to enter into a bargain with Jack and Jack had the power to close the deal, then an offer has been made.
     If the other party accepts all of the terms of the offer without change, then a contract has been formed.  Acceptance is the manifestation of assent to the terms of the offer.  If Jack states, "The cow is yours," and hands the tether to the cow to old man, then he has accepted.  Again, the acceptance is judged by an objective standard.  Further, acceptance must be made as specified by the offeror.  All the old man required was that Jack give him the cow then and there.  Jack did this by tendering the tether.    This method follows what is known as the mirror image rule.  
     In other cases, the parties may negotiate over a period of time.  Drafts of proposals and counter offers are exchanged.  Finally, a document is prepared, sometimes by a lawyer or lawyers for the parties, and the parties sign it.  Maybe they sign the document in places separated from each other by thousands of miles.  Nonetheless, the contract was formed.  Both parties gave their assent by signing the same document or copies of the document.  The exact time the agreement was made may not be known, but that does not matter in most cases.
     It is safe to say that a denial of the contract, if at all, will be made in most cases before either party has performed what was promised.  If so, it is equally safe to say that neither party has sustained any damage by the other not performing.  In the off chance that a party denies the contract before performance, then the parties will be forced to examine carefully the facts and circumstances of the making of the contract and the technicalities of the law.  Without going into more detail about the legal aspects of contract formation, the costs of litigating a formation issue may substantially outweigh the damages that could be proved for breach of the contract, if any.
     In the great majority of cases, the falling out usually happens after one of the parties has performed and the other party has accepted the benefits of that performance.  When this happens, the court would be impatient with an argument that the contract never existed.  The part performance and acceptance of the benefits is strong evidence that the parties had a contract.
     A much maligned concept, consideration is simply a test for the enforceability of the exchange agreed upon by the parties.  An exchange can be a promise for a promise or a promise for a performance.  The first represents a bilateral contract; the second, a unilateral contract.  Obviously, if no exchange was agreed to by the parties, then no consideration binds the parties to a contract.  If one of the parties agrees to give goods or services to another without getting anything in return, the party has merely promised to make a gift.  Usually, gift promises are unenforceable.  For example, if Jack agreed to give his cow to the funny old man merely because the man could use a cow, then Jack has done nothing more than make a gift.  A few exceptions do exist.  For example, a modification to a contract under the proper circumstances can be enforced without consideration.  If the parties have agreed to make an exchange, however, then we need to look at the exchange a little more carefully.
     The exchange must be bargained for by both parties.  More precisely, the promise of one party must induce the other to make a promise or give a performance in exchange for the first party's promise.  The reverse must be true as well.  In Jack's case, Jack must seek the five beans in exchange for the cow, and the funny old man must seek the cow in exchange for the beans.
     Lastly, the exchange must not be a sham, a pretense of a bargain.  In Jack's case, the five beans come close to a sham, but they were offered as magic beans.  As it turned out, they were magical.  Five ordinary beans offered in exchange for a cow would have been a sham and the cow would have been a gift.  Jack was induced to give up his cow, because the beans were magical.  The exchange of a cow for five magic beans would have passed the test for consideration.
Third Party Rights.
     Sometimes, a person who is not a party to a contract might have rights under the contract.  If so, it will not do you any good to tell this non-party to buzz off, so long as a contract was formed.  For example, you pay a premium to an insurance company for a life insurance policy on your life.  You name your business partner as the beneficiary under the policy.  When you die, your business partner has the right to collect the benefits under the policy.  The insurance company cannot defend the claim by asserting that it had no contract with your partner.  Your partner is an intended third-party beneficiary, and the law will allow him to enforce the contract even though he was not a party to the contract and gave no consideration for the benefit.
     Sometimes, rights under a contract might be assigned to a non-party.  For example, you buy a car from a dealer, signing a contract and promising to make monthly payments to the dealer for five years.  The next day, the dealer assigns the contract to a bank.  The bank now has the right to the monthly payments, and you have the obligation to make the payments to the bank.  It makes no difference that the bank was not a party to your contract with the dealer.  You still have to pay the bank.

     Once a contract has been formed, courts are reluctant to set aside the contract where the parties freely give their consent to the exchange.  Some circumstances in the formation process that come to light after the deal is struck may give the court good cause to grant relief in the form of rescission of the agreement.  These reasons for relief are called defense to formation.  Because the courts consider contracts sacrosanct, they require the party urging a defense to jump through many hoops in many cases.
Misrepresentation, Duress, and Undue Influence.
     Misrepresentation is the making of false statements that induce a party to consent to the exchange.  Under the proper circumstances, a court will rescind a contract for misrepresentation.  In Jack's case, if it had turned out that the beans were not magical, Jack might be able to get his cow back.  The statement of the funny old man would have been false.  The first step for Jack is to show that the representation was material in inducing Jack to make the exchange.  Certainly, the magical characteristic of the beans was material to the deal.  Nonetheless, Jack might not win his case.  He also needs to show that his reliance on the statement was reasonable.  The test of reasonableness is objective, meaning that the ordinary reasonable person would have been justified in relying on the statement in making the deal.  Clearly, in the real world, such reliance would not have been reasonable and Jack would lose.
     Duress used to induce consent to a transaction might be another way to avoid performance under a contract.  Duress is shown by the combination of an improper threat with no choice.  The threatened party must be left with no reasonable alternative but to consent to the exchange.  A threat to commit a crime, such as murder, mayhem, or assault and battery usually will be good enough to void the contract.  Again, however, the circumstances must be looked at carefully.  If a 125-pound woman threatens to kill a 200-pound man unless he signs a contract, the man has a reasonable alternative.  He can get up and walk away.  If she points a loaded revolver at him, the threat is real.  He should have no trouble getting out of the contract.
     Undue influence fits between duress and mental incompetence.  For this defense to work, the parties usually have a relationship of trust, confidence, or dependency.  The guilty party uses persuasive tactics to the extreme, while the victim is off guard due to his trust or confidence in the persuader or he cannot fend off the persuader due to lack of mental or physical strength.  For example, a care giver tells an elderly person in poor health that no one will take care of her in her last days but the care giver.  Then the care giver tells the elderly person that he will leave her unless she agrees to pay her 10 times the going rate for his services.  The elderly person, due to her poor health and advanced years, is easily persuaded that she must pay or live without any assistance.  The contract should be set aside without any doubt.                
     Mistake is a belief that is not consistent with the actual facts.  In Jack's case, let's change the scenario a little.  This time, the funny old man is a dealer in magic beans, and Jack knows this.  The man offers to give five beans to Jack, believing them to be magical.  Jack assumes they are magical, because the old man is a dealer in magical beans.  Nothing is said about the quality of the beans.  As it turns out, Jack tosses the beans out the window that night, but in the morning there is no bean stalk.  Both Jack and the man assumed that the beans were magical and that assumption was basic to the exchange.  Besides showing that both parties were mistaken, Jack must jump through two more hoops.  He must show that the magical quality was material to the exchange and that he did not assume the risk that the beans were not magical.  Jack should be able to win in the defense of mistake and get his cow back.
Lack of Capacity.
     Minors lack the capacity to enter into contracts.  They can rescind their contracts, so long as they can restore any benefits to the other party.  Once the minor reaches the age of majority, he can affirm the contract.  If he does, it will be enforceable against him just as if he had made it after reaching the age of majority.  In Jack's case, he could use this defense to get his cow back, so long as he could find and restore the beans to the funny old man.  Minority as a defense is straightforward, and courts will allow it to void the contract without much ado.
     On the other hand, lack of mental capacity is a defense to formation of a contract with difficult problems in proof.  The party seeking rescission must show that he lacked the ability in any reasonable manner to understand the nature and consequences of the transaction.  For example, a party who suffers delusions might be able to avoid contract liability if he believed that he was writing a sonnet when he signed the contract.  Alternatively, a party might show that he lacked the ability in any reasonable way to control his behavior in making the contract due to some mental illness.  For this alternative to work, the other party must know about the condition of the party with the mental ailment.
     These defenses will allow the court to rescind a contract and order restitution, the return of benefits to the party claiming the defense.  Let's take a look at contracts a court simply will not enforce.

     Sometimes a party who has the advantage of superior bargaining power will drive too hard a bargain.  Under the right circumstances, the courts will protect the weaker party by not enforcing a bad deal.  It cannot be just any bad deal.  The exchange must be so unfavorable to the weaker party that it shocks the conscience of the court.  This defense consists of two elements.  First, a party must show that the more powerful party abused the bargaining process in some way.  Second, a party must show that the contract was unreasonably favorable to the other.
     For example, suppose a car dealer insisted on the buyer signing a contract with 30 pages of boiler plate that nobody could read and understand due to the print and legalese.  Buried on the 17th page was a term that allowed the dealer to repossess the car, sell it, and force the buyer to pay a deficiency merely if the dealer heard from a gnome that the buyer was thinking of divorcing his wife.  Surely, no court would enforce such a term.
     Everyone knows that gambling and prostitution are illegal in most jurisdictions.  Bribing public officials is another example of conduct well known to be illegal.  Contracts arising out of such acts will not be enforced.  For example, suppose a defendant offers a bribe to a judge for a favorable outcome in a criminal prosecution.  The judge takes the money and reports the crime to the district attorney, who prosecutes and convicts the defendant of bribery.  Now suppose the defendant sues the judge for the return of his bribe.  Believe it or not, these facts come from an actual case.  The defendant won and got a judgment for the return of his bribe.  Have faith in the legal system.  The case went up on appeal and was overturned, because the contract made with the judge was illegal.
     Sometimes contracts that are not illegal but are closely connected to illegal activity will not be enforced either.  If the court finds that by enforcing the contract the court would be encouraging some illegal activity, then the court will step back and let the parties stew in their own juices.  For example, in a contract for the sale of a business involved in the manufacturing and sale of drug paraphernalia, a court will refuse to enforce it.  Of course, the sale of drug paraphernalia is illegal in itself now; but even before the legislature made it illegal, a court did in fact refuse to enforce such a contract.  This is an example of the public policy defense.
     The public policy defense does have its limits.  A court would likely enforce a contract even though the sale or service is related to some illegal activity.  For example, a madam operating a house of prostitution buys a high-tech sound system for her establishment on credit from a department store, but she fails to pay the debt.  A court would likely find that the sale was too remote from the prostitution and enforce the claim of the department store for payment for the sound system.      
Statute of Frauds.
     As Sam Goldwyn said, "An oral contract isn't worth the paper it is written on."  For the most part, oral contracts will be enforced in the courts.  During the reign of Charles II, Parliament in England thought that oral contracts invited fraud.  Anyone can say he had an oral contract with another, but that may not be the case.  For the person wrongfully accused of breach of contract, proof of no contract may be a problem.  With this in mind, Parliament enacted the Statute of Frauds, which requires that certain types of contracts must be in writing and signed by the party to be charged with liability for breach.  Four types of contracts are worth mentioning, although many others must be in writing too.
     First, it only makes sense that a contract for the sale of real estate must be in writing.  Otherwise, someone bent on making a killing through fraud could claim that the owner sold a piece of real property for a price $100,000 less than its market value.  In a suit for breach of such a contract, the fraudulent buyer could recover the difference between the market value and the assumed sales price.  The requirement of a writing puts an end to this kind of scam.
     Second, a writing is a means of keeping a record of the terms of the parties' agreement, protecting against the fading of memories over time.  The statute of frauds recognizes human failing and requires a writing for enforcement of contracts that cannot be performed within one year of their making.
     Third, a promise to pay the debt of another can be a trap for an innocent but well to do person.  Many times, the maker of such a promise receives no benefit from it, other than the satisfaction that their promise has made it possible for another who lacks good credit to borrow money.  Without a writing, people with wealth could easily fall victim to a fraudster.
     Lastly, the Uniform Commercial Code requires contracts for the sale of goods for $500 or more be in writing.
     Many rules of law provide relief from the harsh rule of the Statute of Frauds.  In the sale of goods, an oral contract can be enforced where the goods have been received and accepted by the buyer.  Even a written contract, however, will not survive the running of the statute of limitations.       
Statute of Limitations.
     A claim on a contract cannot be enforced in court after the time limit for bringing suit has run.  The statute of limitations can be tricky, however.  Usually, the time for bringing a lawsuit begins to run when the breach of the contract occurs.  For example, a contract may have been made and put in writing in 2001, but the breach of that contract may not occur until 2011.  The four-year time limit in California for enforcing a writing contract will not run until 2015.  It should be noted that the time limit for an oral contract is only two years from the date of the breach.
     Another feature of the statute of limitations is called tolling.  In ordinary language, tolling means the time is stopped from running for one or another reason.  One reason, for example, is the absence of the defendant from the state.

    If your contract survives attack based on the excuses to formation discussed above, you have come a long way towards winning your lawsuit.  But you may not be home free yet.  Go to Part Two for the discussion of excuses that arise during performance of a contract.

    Should you have any questions about contract law, please feel free to contact me at your convenience.

James C. Glassford
Attorney at Law  

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Wednesday, September 7, 2011

What You Should Know about Arbitration of Contract Disputes

What is arbitration?
     Arbitration is a way of settling a dispute outside of court.  An arbitrator or a panel of arbitrators is selected.  The arbitrator conducts a hearing much like a judge sitting without a jury.  The hearing usually takes place in an informal setting, like an office or conference room.  After the hearing, the arbitrator makes an award.  Usually, the award can be filed in court and becomes a judgment.  The judgement can be enforced like any other judgment following a full-blown trial.
Can you be forced into arbitration?
     In most cases, you must agree to arbitration.  Otherwise, your dispute must go to court.  Many contracts contain arbitration clauses. Without one, you cannot be forced to arbitrate.  With one, you can be compelled by court order to arbitrate your dispute.
Can you invalidate an arbitration clause?
     The short answer is not likely.  With all the lawsuit congestion in our courts, judges love to see their docket of cases reduced.    Arbitration does just that.  
    The main way to defeat an arbitration clause is by showing that it is too one-sided.  This proof is very difficult.  The Supreme Court of California tells us that the agreement must have only a "modicum of bilaterality."  Armendariz v. Foundation Health Psychcare Services, Inc. (2000) 24 Cal. 4th 83.  What this means is anybody's guess.  In a recent case, the court found that the arbitration term in question met this test.   Chin v. Advanced Fresh Concepts Franchise Corp. (2011) 194 Cal. App. 4th 704.  The court examined the clause closely and thought that both parties had equal rights under the clause.  For example, the clause allowed either party to go to court to seek injunctive relief instead of going through with arbitration.  It ignored the reality that the franchisor would most likely seek an injunction against the franchisee, while the franchisee would most likely want to recover damages.  If the franchisee wanted damages, he would have to go to arbitration.  In other words, the franchisor gets to go to court, but the franchisee must arbitrate.  In sum, "modicum of bilaterality" means whatever the court wants it to mean. 
How do you find an arbitrator?
     The arbitration term itself may designate the arbitrator or at least the means of picking one.  In construction contracts, the parties often agree to arbitration according to the rules of the American Arbitration Association.  The AAA will assign an arbitrator to the case on request.  Other clauses merely state that the parties must agree to an arbitrator.  Courts have lists of arbitrators.  Most of the time, the parties easily reach agreement by exchanging a list of names chosen from a court list.  If agreement is not possible, the court will appoint an arbitrator for the parties and order the parties to arbitrate with that arbitrator.
Are the powers of an arbitrator limited?
     Although not boundless, the powers of an arbitrator are surprisingly broad.  For example, judges must follow the rules of evidence.  Arbitrators are not required to do so.  Code of Civil Procedure §1282.4(d).  Judges can only award damages according the law.  Arbitrators can fashion remedies that are flexible, creative and fair, based on their own “ ‘honest judgment’ ” and “ ‘ “good conscience” ’ ” rather than on “ ‘ “dry law.” ’ ”  Advanced Micro Devices, Inc. v. Intel Corp. (1994) 9 Cal. 4th 362, 375.  In agreeing to arbitration, you should carefully limit the powers of the arbitrator to avoid a runaway award.  In the Chin case mentioned above, the parties agreed to limit the arbitrator's power to award damages to compensatory damages only, excluding noneconomic or punitive damages. 
Can you do discovery in arbitration?   
    Discovery can be quite limited in arbitration.  Code of Civil Procedure §§1283 et seq.  Discovery allows you to take depositions of witnesses and subpoena records before the hearing.  Sometimes your case will die on the vine if you cannot do discovery.  For example, in a case of wrongful termination based on discrimination, an employee may need to review all the employer's records relating to the claim.  Without the records, the employee may not be able to prove the claim.    Before agreeing to arbitration, you should give careful thought about this issue.  
Can you appeal the award of the arbitrator?
    The right to appeal is severely limited in arbitration.  It has long been held in our courts that the arbitrator is the sole judge of the facts and law, and his decisions in fact finding and applying the law cannot be reviewed on appeal.  Blue Cross of California v. Jones (1993) 19 Cal. App. 4th 220.  Appeal, however, can be taken when the arbitrator exceeds his powers or the award was procured by fraud, corruption or other undue means.  Code of Civil Procedure §1286.2.   
Should you agree to arbitration?
     If you have no bargaining power, this question really is whether you can walk away from the deal.  If you can negotiate for either the elimination of the arbitration term or revising it, by all means give it some thought.  Arbitrators have a lot of power, and their powers should be defined and limited.  Defining and limiting that power can be done in the arbitration term.  You may want the arbitrator to apply California law and not the justice of the wild west.  You may want to limit the remedies that he can apply.  You have many choices for taming the arbitrator.  Careful drafting of the agreement is the key to success down the road should any dispute be thrown up for arbitration.