by James C. Glassford, Attorney at Law

by James C. Glassford, Attorney at Law

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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