CONTRACTS
I.
FORMATION OF CONTRACTS
A. MUTUAL ASSENT
1.
Offer And Acceptance
a. Offer
An offer is a communication that gives to the recipient of the communication the power to
conclude a contract by accepting. A statement is an offer only if the person to whom it is
communicated could reasonably interpret it as an offer. The primary test of whether a
communication is an offer is whether an individual receiving the communication would believe
that he or she could enter into an enforceable deal by satisfying the condition.
Another way of looking at an offer is as a “conditional promise,” meaning that a person
promises something if the other person either returns a promise or does an act. If a return
promise is requested, then the contract is called a “bilateral contract.” If an act is requested,
then the contract is a “unilateral contract.”
b. What is not an offer
Offers must be distinguished from statements of opinion. For example, a statement by a
physician that a person will be out of the hospital in two or three days is probably not an offer.
Offers must be distinguished from statements of intention. For example, the statement, “I
plan to sell my house for $25,000,” is probably not an offer.
Offers must be distinguished from invitations to deal or preliminary negotiations. When a
person says something like, “What is your lowest price?” this is not an offer but merely an
inquiry. A response to that question such as, “We can quote you $5 per gross for immediate
acceptance,” generally would be an offer.
Advertisements normally are not offers unless they offer a reward.
Statements made in jest or anger are not offers. Thus, if someone is disgusted with his or her
automobile and says, “I’ll sell it to you for $5,” this is not an offer.
c. Termination of offers
An offer must be accepted while it is still outstanding. Offers can be terminated in the following
ways:
1)
Lapse of time stated in the offer
If the offer states a date upon which it is terminated, then the offer terminates at midnight
of that day. If the offer is terminated after a certain number of days (“This offer terminates
in three days”), then the time starts to run from the time the offer is received, unless the
offeree knows of the offer and that its transmission was delayed.
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2)
Lapse of a reasonable period of time
What is a reasonable period of time depends upon the circumstances of the case. When
the parties are dealing face to face or over the telephone, and there is no acceptance at the
time they part, then the offer terminates.
3)
Incapacity
By majority rule, the offer terminates upon the death or mental incapacity of the offeror,
even though the offeree does not know of the death or mental incapacity.
4)
Revocation
The basic rule is that an offer can be terminated by the offeror at any time. This is true
even though the offeror specifically states that it will be held open for a specified period
of time. There are, however, some exceptions to this rule:
•
Firm or Irrevocable Offer. If consideration is paid for the promise to keep the offer
open (an option contract), then the offer cannot be revoked.
•
Promissory Estoppel. In some cases, it has been held that the doctrine of promissory
estoppel prevents revocation of the offer. This occurs when the offeree relies to his
detriment upon the offeror’s promise to keep the offer open.
•
Part Performance. When the offer is for a unilateral contract, once the offeree has
started performance of the act requested, the offeror cannot revoke.
•
U.C.C. Firm Offer Rule. When the offer is to buy or sell goods, the offer is irrevocable
if (1) the offeror is a merchant, (2) there are assurances that it will be held open, and
(3) the assurance is contained in a signed writing.
A revocation is not effective until communicated (it must be received by the offeree).
Even though the offeror does not directly inform the offeree of the intent to revoke, if the
offeree acquires reliable information that the offeror has taken definite action inconsistent
with the offer, then the offer is automatically revoked. A classic example of this occurs
when the offer is to sell real property, and the offeree discovers that the property has been
sold to someone else.
A general offer must be revoked by publishing the revocation in the same way in
which the offer was publicized. However, remember that actual notice of the intent to
revoke a general offer is effective as to the person who receives that notice, even though
equal publicity is not given to the revocation.
5)
Rejection or counteroffer
Rejection of the offer by the offeree or the making of a counteroffer by the offeree operates
to terminate the offer except rejection or a counteroffer by the offeree does not terminate
the offeree’s ability to accept an option contract thereafter.
He is still free to accept the original offer within the option period unless the offeror has
detrimentally relied on the offeree’s rejection.
6)
Impossibility or illegality
If the subject matter of the offer is destroyed, or if the contract becomes illegal, the offer is
terminated.
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d. Acceptance
1)
Generally
An acceptance is an exercise of the power to conclude a contract given to an offeree by
the offeror. The acceptance forms a contract between the parties.
Only a person to whom an offer is made may accept. There can be no assignments of
offers. There can, however, be assignments of options.
The offeree must know of the offer in order to accept. Thus, when offers cross in the
mail, there is no contract. However, the rule is that the offeree must know only at the time
that she completes the act. Hence, if the act is started without knowledge of the offer, but
completed after the offeree has learned of the offer, a contract is formed.
2)
Method of acceptance
The offeror is the master of the offer, and can specify how acceptance is to occur. In
determining whether there is a valid acceptance, the following points must be considered.
(a) Bilateral vs. unilateral offer
If the offer requests an act, then the act must be performed in order to accept. If the
offer requests a return promise, then a return promise must be given. However,
completion of the act will operate as an acceptance, even though a promise is requested
by the offeror.
(b) Means of acceptance
The traditional view is that if the offer is sent by letter, it must be accepted by letter; if
sent by telegram, it must be accepted by telegram, etc. The trend, however, is to find
any reasonable method of acceptance proper. When the same means of acceptance is
adopted as is used to communicate the offer, e.g., a letter offer is accepted by a letter,
then all risks of mistake or loss are upon the original offeror. Thus, if the acceptance
letter is lost or delayed in transit, a contract is formed. However, if the letter is
misaddressed, this rule does not apply and its delay or loss prevents the formation of a
contract.
3)
Silence as acceptance
Normally, silence does not operate as an acceptance of an offer. Thus, even when the
offer says, “If I don’t hear from you within 10 days, I will assume you have accepted,” no
contract is formed by the offeree’s remaining silent. However, a contract is formed if:
•
the offeror has given the offeree reason to believe that the offer can be accepted by
silence, the offeree has remained silent, and the offeree intended to accept by silence,
or
•
because of previous dealings or otherwise, it is reasonable that the offeree should
notify the offeror if she does not intend to accept, e.g., if the offeree has always accepted
offers from this offeror in the past.
4)
Notice of acceptance
If the offer is for a bilateral contract, the offeree must give notice of acceptance, i.e.,
notice must be given of the return promise. However, an acceptance becomes valid
when posted. Hence, a letter sent by the offeree operates as an acceptance as soon as it
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is placed in the mailbox, even though the offeror has not as yet received notice. This is not
true if the letter is misaddressed. If the offer is for a unilateral contract, notice of acceptance
is required only when the offeror is not likely to become aware that the act is being
performed.
e. Counteroffers
The basic rule is that the acceptance must be on the same terms as the offer. Any changes,
additions, or subtractions from the terms of the offer operate to make the attempted acceptance
a “counteroffer” which, in legal terms, is a rejection of the offer and the making of a new offer
by the offeree. However, suggestions or inquiries in a response by the offeree do not amount
to a counteroffer. Also, if the acceptance simply spells out the details of the transaction, this
does not make it a counteroffer. For example, if the offer does not note the kind of title to be
given in a sale of real property, and the offeree requires “marketable title,” the acceptance is
valid provided that marketable title would be required by law.
When the contract is for the sale of goods, Article 2 of the U.C.C. applies a different rule with
regard to counteroffers. Under a literal reading of the code (§2-207), a response by the offeree
that purports to be an acceptance operates as an acceptance even though it changes, adds to,
or subtracts from the terms of the offer. Cases, however, have held that a material change in
the terms will prevent the formation of a contract under the code provision.
2.
Excuse
a. Mistake
1)
In general
The law divides mistake into “unilateral mistake” and “mutual mistake.” In the unilateral
mistake cases generally, no relief is granted, whereas in the mutual mistake cases, a party
is excused from performance.
2)
Unilateral mistake
Unilateral mistake means that only one of the parties is mistaken. Here, either party can
enforce the contract on its terms unless the party knew or had reason to know that the
other party was making a mistake, or the party had a duty to disclose the fact as to which
the other party was mistaken.
A similar situation arises when there is a mistake in a telegraph transmission. The sender
may want to sell the goods at a specific price, but the telegraph company transmits the
telegram so that it contains a lower price term. Here, if the buyer accepts, a contact is
made at the lower price and it can be enforced in spite of the mistake.
3)
Mutual mistake
Mutual mistake means that both parties were mistaken as to an essential element of the
contract. There must be a substantial difference between the deal as contemplated and the
actual deal, with no intent by the parties to take a risk on this element of the transaction.
For example, in the leading case, there was a contract to sell a cow, with both parties
believing that it was a barren animal, fit only for meat. Actually, the cow was “with calf.”
As a meat animal, it was worth $80, whereas it was valued at $750 as a breeding animal.
Rescission of the contract was granted.
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4)
5
Reformation
When reformation of the contract is available to cure a mistake, neither party can avoid the
contract. For example, assume that A agrees to sell Redacre to B, with B agreeing to pay
$50,000 and to “assume a mortgage in the amount of $100,000.” If the parties fail to
include a provision regarding the assumption of the $100,000 mortgage, A can obtain
reformation of the agreement to reflect B’s promise. A has no right to avoid the contract
because reformation adequately remedies the mistake in drafting the written agreement.
b. Misunderstanding
If the prospective parties to a contract manifest think they are agreeing to the same terms but
in fact assent to different terms, and neither knows or should know that there is a
misunderstanding that causes them to assent to different terms, there is no contract.
c. Misrepresentation, nondisclosure, and fraud
1)
Relationship to tort law
In contract law, a misrepresentation made in connection with an agreement between parties
may prevent the formation of a contract or make a contract voidable.
2)
Elements of fraudulent misrepresentation
In general, a misrepresentation is an assertion that is not in accord with the facts. If the
misrepresentation is made knowingly (with scienter), it is clearly fraudulent. Under the
Restatement (Second) of Contracts §162, it is also fraudulent if the person either (a) does
not have confidence in the truth of her assertion, or (b) knows that she does not have a
basis for her assertion.
3)
Nondisclosure
A person’s nondisclosure of a fact known to him is equivalent to an assertion that the fact
does not exist only if: (a) he knows that disclosure is necessary to prevent some previous
assertion from being fraudulent; (b) he knows that disclosure would correct a mistake of
the other party as to a basic assumption, and nondisclosure would amount to lack of
good faith and fair dealing; (c) he knows that disclosure would correct a mistake of the
other party as to the contents or effect of a writing evidencing or embodying their
agreement; or (d) the other person is entitled to know the fact because of a confidential or
fiduciary relationship between them.
4)
Effect of fraudulent misrepresentation
(a) Fraud in the factum
Fraud in the factum, or as it is also called fraud in the execution, occurs when the
fraudulent misrepresentation prevents a party from knowing the character or essential
terms of the transaction. In such cases, no contract is formed, i.e., the apparent contract
is void. Where, however, the person could have discovered with the exercise of
reasonable diligence the character or essential terms of the transaction, he is estopped
from asserting that the contract is void.
In most cases, whether the contract is void or voidable is immaterial because the
person has a defense in both cases. The distinction is more important when the rights
of third parties are involved. A voidable contract can be ratified after the fraud is
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discovered, but a void one may not be.
(b) Fraud in the inducement
When the misrepresentation is used to induce someone to enter into a contract, it is
called “fraud in the inducement,” and the contract is voidable. The rationale of the
modern theory is that a contract is voidable whenever the misrepresentation is material,
regardless of fraudulent intent.
d. Undue influence and breach of a confidential relationship
A plaintiff need not meet the same standards to avoid a contract that must be met in the case of
fraud where there is a trusting relationship between the contracting party and a person in
whom she places trust and confidence.
1)
Undue influence
Undue influence occurs in a relationship between two parties where one is dominant,
usually because he is sophisticated in business relationships and the other is dependent,
either because of lack of education and experience in the financial world or because the
dependent person has diminished mental capacity many times caused by advanced age.
In addition, there is a relationship of trust between the dominant and dependent person.
Where that type of relationship exists, the person in the dominant position is held to a
higher standard of disclosure and fairness than in the ordinary world of arms-length
contracts. The dominant person may have the burden to show that a contract was fair to
the dependent person before he can withstand an action to avoid the contract. His
affirmative duty to disclose facts is much higher when there is a possibility of undue
influence. While most lawsuits in this area deal with situations where there is a contractual
relationship between the dominant and the dependent person, or where the dominant
person has assisted the dependent person in making a testamentary disposition, a person
who has been the subject of undue influence can also avoid a contract with a third person,
unless that person would be harmed because he is a bona fide purchaser.
2)
Breach of a confidential relationship
There are certain relationships between individuals, usually described as fiduciary
relationships, where the higher standards of conduct in contractual dealings (described
above in dealing with undue influence) arise out of the existence of the relationship itself.
These are generally described as fiduciary relationships and automatically impose of the
party who has the fiduciary obligation of fair dealing and full disclosure.
The most common examples of such fiduciary relationships occur between trustee and
beneficiary, lawyer and client, doctor and patient, financial advisor and client, and in
some cases parent and child. The burden of proving that the contract is fair is usually
placed upon the fiduciary.
e. Duress
Like fraud, duress can result in either a void or voidable contract. Generally, any wrongful act
or threat that deprives a party of meaningful choice constitutes duress. When a party’s agreement
is the result of physical duress, e.g., a strong person taking the other’s hand and compelling
her to sign a contract, the contract is void. When the duress is in the nature of a threat, then the
contract is voidable. However, not all threats are improper. For example, a “threat” that one
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“will never talk to the person again” if she refuses to enter into a contract is not duress.
3.
Problems Of Communication And Battle Of The Forms
Section 2-207 of the U.C.C. significantly changes the counteroffer rule in regard to contracts for
the sale of goods. Section 2-207 (1) provides:
A definite and seasonable expression of acceptance or a written
confirmation which is sent within a reasonable time operates as an
acceptance, even though it states terms additional to or different from those
offered or agreed upon, unless acceptance is expressly made conditional
on assent to the additional or different terms.
a. When a contract is formed despite varying terms in the acceptance
From a reading of §2-207(1), it appears that a contract is formed whenever there is a “definite
and seasonable expression of acceptance” or a “written confirmation,” unless acceptance
is expressly made conditional on assent to the additional or different terms. The extent to
which the terms of the acceptance vary or add to the offer does not seem to be relevant, except
that the changes may bear upon whether the writing can be construed to be a “definite”
acceptance or confirmation. It is only where the acceptance is expressly conditioned upon
the offeror’s assent to the new or different terms that a contract is not formed.
However, where the “expression of acceptance” deviates substantially from the offer, courts
have indicated a reluctance to find that a contract is formed.
b. When additional or different terms become part of the contract
Assuming that a contract has been formed even though the acceptance contains terms additional
to or different from the offer, the question arises whether these additional or different terms
become a part of the contract formed.
If both parties are merchants, additional or different terms do become a part of the contract,
unless they:
(1) materially alter the offer, or
(2) are objected to by the offeror in advance of the acceptance, or
(3) are objected to by the offeror within a reasonable time after the offeror obtains notice of
them.
Note that the U.C.C., by its terms, treats different and additional terms differently. Under the
plain wording of the U.C.C., different terms (those that vary or contradict a term of the offer)
never become part of the contract. However, courts have either ignored or avoided this rule,
presumably viewing it as too harsh and impractical. Thus, the rule applied on the Multistate
Bar Exam is that different terms are incorporated into a contract if they meet the criteria stated
above.
c. Acceptance by conduct
Subsection (3) of §2-207 provides for the formation of a contract by virtue of the conduct of
the parties. If the conduct includes some written expression of the parties’ agreement, then the
terms of the contract include whatever terms the parties agreed to in writing. As to other terms,
those implied by the code in the absence of agreement apply. For example, if the writings of
the parties agreed only to the description and quantity of the goods, the code would supply the
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price term, the place of delivery, warranties, and so on.
Lawyers have adapted to the U.C.C. provisions, and offeror’s forms now typically object in
advance to the addition of any new or inconsistent terms; the offeree’s response often proposes
new terms but states that the response is not an acceptance unless the original offeror expressly
consents to the new terms. In these situations, no contract arises unless performance begins.
Prior to performance, either party may back out of the deal. However, once the parties begin to
perform, a contract has been created under the U.C.C. consisting of all terms on which the
writings agree, plus supplementary terms supplied by the U.C.C. U.C.C. § 2-207(3).
Under §2-206 of the U.C.C., an offer to buy or sell goods may be accepted in any reasonable
manner; thus, the code has rejected the bilateral-unilateral distinction.
The section specifically says that an order for goods may be accepted either by shipping the
goods, or by promising to ship them. Under the section, the shipment of defective,
nonconforming goods is an acceptance, and a contract is formed unless the seller notifies the
buyer that they are not meant to fill the order. The buyer may reject them and sue for any
damages resulting from the seller’s failure to deliver conforming goods, or if the buyer accepts
the goods, he may have a remedy for any damages resulting from the nonconformity.
4.
Indefiniteness Or Absence Of Terms
At common law, the courts were reluctant to supply terms to a contract if the parties had not
agreed upon them and thus often held that an agreement which missed essential terms was not a
contract because it was indefinite.
The U.C.C. has taken a different approach with respect to contracts within its scope. Article 2
makes contracts somewhat easier to form. Under §2-204(1), a contract for the sale of goods may
be made in any manner sufficient to show agreement, including conduct by both parties that
recognizes the existence of a contract. For example, if the parties agree to the sale of a specific
quantity of goods but do not agree on a price, there is a contract for a reasonable price.
There is no need to determine the exact time when a contract is made. This provision obviates the
necessity of denominating a particular communication an “offer” and another an “acceptance.”
The general approach of Article 2 is to determine whether from the totality of the communication
it is clear that the parties intended to enter into a binding agreement; if so, a contract exists.
Under the Code, an offer to buy or sell goods normally can be accepted either by a return promise
or by a performance of the act requested. Note, however, that if the offeror specifically requires
a return promise or a completion of the act, this must be done to effectuate an acceptance. Under
the Code’s general rule, however, unless otherwise unambiguously indicated, an order from a
buyer for current shipment of goods may be accepted by the seller either by a return promise or by
actual shipping of the goods.
B. CAPACITY TO CONTRACT
Another requirement of a contract is that the parties be competent. Incompetency arises because of
infancy, mental illness or defect, intoxication, guardianship, and corporate incapacity.
1.
Infancy
a. Disaffirmance
When a contract is made by an infant, it is voidable. This means that the infant may disaffirm
the contract and avoid any liability under it. The disaffirmance can be effectuated for a
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reasonable time after the infant reaches majority. The infant must restore any benefits received
under the contract if possible, but if not possible, the infant still can disaffirm. Even if the
infant misrepresented her age, disaffirmance is still allowed.
b. Liability for necessities
When necessities are furnished to the infant, the infant must pay for them, but the recovery by
the person furnishing the necessities is on a quasi-contract theory. Thus, the supplier can
recover only the reasonable value of the services or goods, and not the agreed upon price.
Food, shelter, and clothing are clearly necessities, and, depending upon the status of the minor,
an automobile, an education, etc., may also be necessities.
2.
Mental Illness
If a party is adjudicated mentally incompetent and is under guardianship, the contracts made by
the individual are void. On the other hand, if there has been no adjudication or guardianship, the
contracts are voidable and must be disaffirmed. If a contract is made during a lucid period, the
contract is fully enforceable, unless the person has been adjudicated an incompetent.
3.
Intoxication
Technically, intoxication resulting from alcohol or drugs renders a contract voidable if the person
entering into the contract was unable to understand the nature of the transaction.
4.
Guardianship
A person has no capacity to incur contractual duties if his property is under guardianship by
reason of an adjudication of mental illness or defect, habitual intoxication, narcotics addiction, or
because the person is a spendthrift, aged, or a convict. The policy of appointing a guardian is to
preserve the property from squandering or improvident use. The powers of a guardian are usually
defined by statute. The guardianship proceedings are treated as giving public notice of the incapacity
of the ward. Property under guardianship may be reached to satisfy the torts or quasi-contractual
obligations of the ward.
5.
Corporate Incapacity
When a corporation acts ultra vires (outside its powers), the contract is voidable, but today most
states take the position that if one party has performed, there may be recovery in quantum meruit.
C. ILLEGALITY, UNCONSCIONABILITY, AND PUBLIC POLICY
1.
Illegality
If the performance that is to occur under a contract is illegal, the contract itself is illegal and is
unenforceable.
a. Types of illegal contracts
Clearly, in most states, wagering contracts, usurious bargains, etc., are illegal. By public
policy, contracts in restraint of marriage are illegal. Contracts in restraint of trade are illegal,
but covenants not to compete contained in a sale of a business or an employment contract will
be enforced if they are reasonable in time and geographical area. Contracts to bribe an official
and bribes themselves are illegal, as are contracts to commit a tort or a crime.
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b. Effect of illegality
The law will not enforce or even recognize transactions that are illegal. The contract itself
cannot be enforced; if one party performs under the contract, she cannot receive any
compensation for the performance, either in an action on the contract or an action in quasi
contract. The law also will not grant restitution if someone has paid another under an illegal
contract.
c. Exceptions
1)
Ultimate purpose illegal
If a contract has an ultimate purpose that is illegal, but its performance is legal in itself,
e.g., a contract to sell gambling equipment, a person can recover under the contract, provided
he does not participate in the illegal purpose of the deal. For example, the seller of gambling
equipment would be able to recover the price, provided he did not become involved in the
gambling. This is true even if the seller knows of the illegal purpose.
2)
Divisible contracts
In some instances, contracts are separable in that part of the consideration is legal and the
other part is illegal. For example, B painted A’s house in return for A’s promise to pay $500
and to smuggle goods into the country. In such cases, the courts may allow recovery of
the legal part of the promise, i.e., the $500, and deny recovery of any damages for A’s
failure to smuggle the goods into the country.
3)
Pari Delicto (equally at fault)
Where the parties are not in pari delicto (equally at fault), recovery may be allowed. For
example, a contract whereby an employer promises to pay an employee for overtime work
is enforceable by the employee, even though it is illegal to work overtime in the particular
occupation.
4)
Locus poenitentiae repudiation
If one of the parties repents of the illegal bargain prior to the time of the illegal performance,
she is normally allowed to recover whatever was given for the promised performance.
2.
Unconscionability
Article 2 of the code provides that a court may refuse to enforce a contract or part of a contract on
the grounds that it is “unconscionable.” Generally, unconscionability goes to unfair dealings by
one of the parties. Normally, it arises where the parties have unequal bargaining power, and the
more powerful party has attempted to limit severely the rights of the other party, or has taken
unfair advantage. The question whether a contract is unconscionable is for the court to decide,
and the issue does not go to the jury.
3.
Public Policy
Even if a contract is neither illegal nor unconscionable, it may be unenforceable if it violates a
significant public policy.
Many kinds of adhesion contracts are unenforceable because they are against public policy. A
contract requiring an individual who needs an essential public service, such as medical care, to
waive any claim for negligence on the part of the provider is likely to be found to violate public
policy and therefore be unenforceable.
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D. IMPLIED-IN-FACT CONTRACTS AND QUASI CONTRACTS
1. Implied-In-Fact Contracts
The agreement or mutual assent necessary for the formation of a contract most frequently results
from words expressed by the parties. When this is the case, the contract is called an “express
contract.” However, conduct may also indicate assent or agreement. Thus, if one takes a pack of
cigarettes from the counter of a drug store, this conduct indicates her intent to purchase the
cigarettes. When the agreement is formed by virtue of conduct rather than expressed words, this
gives rise to what is called an “implied contract.” Of course, in certain cases the terms of a
contract are determined both by the expressed words of the parties and by conduct on their part.
Whether the contract is express or implied does not affect the legal relationship between the
parties or the rules of law that apply to this relationship.
A primary characteristic of a contract, whether express or implied in fact, is that the law will
“enforce the promise.” Usually this is done by granting “benefit of the bargain” damages that will
attempt to put the plaintiff in the position that he or she would have been in had the contract been
performed. In some cases the court will specifically enforce the contract, i.e., will order the
defendant to perform his or her promise.
2.
Quasi Contracts
“Quasi contracts,” or, “contracts implied in law,” are not true contracts at all. They do not
depend upon assent between the parties, nor is recovery based upon a promise. In a quasi contract,
the law imposes an obligation because it appears just. Such an obligation is very close to the type
of obligation imposed by the law of torts, and it has become associated with contract law largely
because of the forms of action which were prevalent in early English law.
Since the defendant has not made a promise in cases seeking quasi-contractual recovery, the law
cannot “enforce the promise” as it does in contract actions. Rather, the law implies a promise
(establishes a duty) that the defendant must make restitution to the plaintiff of any benefit that the
plaintiff has conferred upon the defendant, otherwise the plaintiff will be unjustly enriched. This
is accomplished by awarding the plaintiff money damages in the amount of the value of the
benefit. Thus, the theory of the action is restitutionary in nature; the law will restore the plaintiff
to the position he or she was in prior to the transaction or event.
Although the theoretical distinction between contracts implied in fact and quasi contracts is clear,
the differences sometimes fade and even appear entirely nonexistent in certain fact situations. For
example: In a contract for services where no price term is agreed upon, the recipient of the services
is obligated to pay the reasonable market value of the services. In such a case, it is difficult to
determine whether the law finds this obligation because it assumes that the parties implicitly
agreed on the fair market value as the price for the services, or because it believes that it is just to
impose the obligation as a matter of law.
E. PRE-CONTRACT OBLIGATIONS BASED UPON DETRIMENTAL
RELIANCE
The general rule except for the case of firm offers under the U.C.C. is that an offer is revocable at any
time, even though the offeror has agreed to keep the offer open for a specified time. An offer can be
made irrevocable if the offeror promises to keep the offer open for a specific period of time and that
promise is supported by consideration. An option contract is then formed and the offeree usually pays
an agreed amount to the offeror in order to make the offer irrevocable.
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There is one set of circumstances where the promissory estoppel substitute for consideration is the
basis for keeping the offer open. This occurs in the construction industry where the owner puts a
contract out to bid. The construction of most modern buildings is supervised by a general contractor
who bids a specific price to the owner for the entire job. In order to complete the job, the general
contractor usually hires subcontractors to perform portions of the construction such as electrical and
plumbing work. Prior to submitting a bid to the owner for the entire job, the general contractor solicits
bids for portions of the work from subcontractors, which the subcontractors agree to leave outstanding
for a reasonable time after the contract for the entire job is awarded by the owner.
The agreement not to revoke the sub-bid offer is enforceable because it is supported by the substitute
for consideration known as promissory estoppel. When making the bid, the subcontractor knows that
the contractor is relying on it by using it in the calculation of his costs for the job in preparation for
making his bid as general contractor. It would be unjust to permit the subcontractor to revoke that bid
after inducing justifiable reliance. There, upon receiving the contract, the general contractor has a
right to accept the sub-bid, turning it into a contract even though the sub-bidder has attempted to
withdraw the sub-bid. The contractor must accept the sub-bid within a reasonable time to turn it into
a contract.
Since the sub-bid is only an outstanding offer, the general contract is not bound to accept it upon
becoming the successful bidder for the general contract. He can enter into a subcontract with someone
else for a lower price. The sub-bidder has no right to require that the general contractor accept his bid
if the general contractor is the successful bidder on the project.
If the general contractor attempts to negotiate a lower price with the sub-bidder, then he has made a
counteroffer and can no longer accept the original bid.
F. EXPRESS AND IMPLIED WARRANTIES IN SALE-OF-GOODS
CONTRACTS
There are three basic warranties of quality: (a) express, (b) merchantability, and (c) fitness for a
particular purpose. The trend is to allow a warranty action to lie even though there is no privity
between the parties.
1.
Express Warranty
All statements and promises made by the seller that form a part of the basis of the bargain are
express warranties unless merely the seller’s opinion or commendation of the value of the goods.
Express warranties include almost any positive affirmation by word or conduct, including
descriptions of goods, and disclaimer clauses are ignored when they conflict with these
representations.
2.
Warranty Of Merchantability
An implied warranty of merchantability is given whenever the seller is a merchant. Goods must
be fit for their ordinary purpose and pass without objection in the trade under the contract
description. The disclaimer may be oral, but must use the term “merchantability,” and must be
conspicuous if in writing. The warranty can be disclaimed in some instances by use of “as is” or
similar language.
3.
Warranty Of Fitness For A Particular Purpose
This implied warranty is given whenever the seller has reason to know that (1) the buyer has a
particular use for the goods, and (2) the buyer is relying upon the seller’s skill to select the goods.
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This warranty can be disclaimed by general language, but the disclaimer must be in writing.
II.
CONSIDERATION AND ITS SUBSTITUTES
A. BASIC CONCEPT
There are two basic elements of consideration: (1) legal detriment, and (2) bargained-for exchange.
You must look at the promise that the plaintiff is trying to enforce, and determine whether or not that
promise is supported by consideration. Generally, this means you must ask whether or not something
has been received for the promise, and whether this has been bargained for. Consideration can take
the form of:
•
a return promise to do something;
•
a return promise to refrain from doing something;
•
the actual doing of some act; or
•
refraining from doing some act.
B. LEGAL DETRIMENT
The basic concept of legal detriment is that there must be something of substance, either an act or a
promise, that is given in exchange for the promise which is to be enforced.
1.
Adequacy Of Consideration
Normally, adequacy of consideration is not an issue except when specific performance is being
requested. Even though the thing bargained for may be worthless, e.g., a promissory note which
cannot be enforced, so long as the promisor wanted that thing, the giving of it will constitute
adequate consideration. Section 2-302 of the Uniform Commercial Code provides that a court
may refuse to enforce a contract, or a part of a contract, on the grounds of unconscionability.
Cases have held that when a consumer agrees to pay far in excess of the value of goods to be sold
and there is some other indication of unfair dealing, a contract is unconscionable under this provision.
2.
Pre-Existing Duty Rule
The pre-existing duty rule arises when the “legal detriment” is something that the promisee is
already obligated to do. For example, if A says to B, “I will give you $100 in thirty days if you
will refrain from killing my cat,” there is no consideration for A’s promise to pay $100, because B
is already under an obligation not to kill the cat.
3.
Modification Of Contract
The traditional rule is that a modification of an existing contract must be supported by consideration.
The courts, however, allow enforcement of agreements to modify a contract under the following
three rules:
•
where there has been a rescission of the existing contract by tearing it up or by some other
outward sign, and then the entering into a new contract, whereby one of the parties must
perform more than he or she was to perform under the original contract;
•
where there are unforeseen difficulties, and one of the parties agrees to compensate the other
when the difficulties are discovered;
•
where there are new obligations on both sides.
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Article 2 modifies the doctrine of consideration in two ways:
•
A promise to keep an offer open made by a merchant need not be supported by consideration
if it is in writing and signed.
•
Under §2-209 of the Uniform Commercial Code, no consideration is necessary to modify a
contract for the sale of goods, but there is a requirement of good faith.
4.
Compromise Of Claims
If P claims that D owes her a thousand dollars, and P agrees to accept $500 in full satisfaction, the
payment of the $500 operates to discharge the entire $1,000 debt only where there is some dispute
either as to the validity of the debt or the amount of the debt. However, the debt will be discharged
if the $500 payment is earlier than it had to be, or if something in addition to the $500 is given to
P.
If P has an invalid claim against D, and D promises to pay money in return for P’s dismissing the
action or agreeing not to bring it, D’s promise to pay the money is enforceable, provided P had a
reasonable belief that she had a legitimate claim even though the claim turns out to be groundless.
5.
Illusory Promises
Some promises, although appearing to be real, are in fact illusory. Thus, if A says, “I will sell you
my car if I want to,” this is an illusory promise and does not constitute legal detriment. Where a
contract has been entered into but one party or the other may cancel, the general rule is that a
contract is enforceable so long as some notice must be given of the cancellation. Also, output and
requirements contracts are enforceable.
C. BARGAIN ASPECT OF CONSIDERATION AND PROMISSORY
ESTOPPEL
In order for the legal detriment to constitute good consideration, it must be bargained for in exchange
for the promise. Promissory estoppel is very similar to consideration, the only difference being that
the legal detriment must have been suffered in reliance upon the promise rather than having been
bargained for.
1.
“Gift” vs. “Bargain” vs. “Reliance”
If A says, “I will give you $1,000 if you attain the age of 21,” this promise is not enforceable. The
act of attaining the age of 21 is not bargained for; hence, it cannot operate as consideration.
Likewise, there is no reliance on the promise, so promissory estoppel does not apply.
If A says, “I will give you $1,000 if you graduate from high school,” this may or may not be
enforceable. It is possible that A wanted the promisee to graduate from high school and was
bargaining for this. If that is the case, the promise to pay the $1,000 is supported by good
consideration. It is also possible that the promisee may have relied upon the promise in completing
the act, and if this is the case, the promise is supported not by consideration, but by the doctrine of
promissory estoppel.
If A says, “I will pay you $1,000 if you give up smoking for a year,” this is an enforceable
promise. The law assumes that A was bargaining for the act.
The test in these cases is generally said to be whether the offeree could have reasonably believed
that the intent of the offeror was to induce the action. If that is the case, the promise is enforceable.
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2.
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Charitable Subscriptions
The doctrine of promissory estoppel is used frequently to enforce promises to charitable
institutions. For example, if A promises to give a university $1,000,000 in 1990, and the university
purchases land in reliance upon the promise, then the promise is enforceable under the doctrine of
promissory estoppel.
In charitable subscription cases, there is also the possibility of finding consideration from the
exchange of promises among a number of contributors. The concept is that the promise of each
contributor operates as the consideration for the promise of each other contributor. The donee is
treated as a third-party beneficiary of the promises.
3.
Past Or Moral Consideration
Past or “moral” consideration is generally not recognized in the United States. Thus, if P saves
D’s life and D then promises to pay $1,000 because P has saved his life, D’s promise is
unenforceable. P’s act of saving D’s life could not have been bargained for, nor could it have been
done in reliance upon the promise. However, there is a modern trend toward enforcing such
promises when necessary to “prevent injustice.”
4.
Debts Barred By The Statute Of Limitations
If D owes P $5,000, but the statute of limitations has run on the claim, a new promise by D to pay
the $5,000 made after the running of the statute is enforceable without any new consideration.
5.
Quasi-Contractual Recovery
Recovery may be available where the plaintiff’s performance was neither bargained for nor in
reliance on an offer, but it would be unjust to treat it as a gift. For example: P sees D’s horse
running free and knows that D is out of town. P feeds and houses the horse for two weeks
awaiting D’s return. When D returns, D thanks P and promises to pay P $50 at the end of the
month. This promise would not be enforceable in many courts because it is for “past consideration.”
There was neither any bargain for the act, nor could P have relied upon D’s promise in feeding the
horse. However, P may be able to recover in quasi contract. In order to recover, P would have to
show that she reasonably expected to be compensated, and that there was a benefit rendered to D
by virtue of taking care of the horse. The recovery in this case might be $50 if this were the
reasonable value of the services and food provided, but it would not be based upon D’s promise.
Rather, it would be based upon the theory that P rendered a benefit to D and, in justice, D ought
to compensate P for that benefit.
III.
THIRD-PARTY BENEFICIARY CONTRACTS
A. IN GENERAL
A third-party beneficiary contract results when two parties enter into a contract with the understanding
and intent that the performance to be rendered by one will go to a third person.
B. DEFINITIONS
An intended beneficiary is one to whom the promisee wishes to make a gift of the promised
performance or to satisfy an obligation to pay money owed by the promisee to the beneficiary. For
example, A agrees to paint B’s house in return for B’s promise to pay $500 to C. This is a third-party
beneficiary contract in which C is the beneficiary. Because C is an intended beneficiary, C has the
right to bring an action against B for the $500.
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An “incidental beneficiary” is one who just happens to be benefited by the contract, and there is no
contractual intent to benefit that person. For example, if A and B entered into a contract to build a
theater and C owned a restaurant across the street, C would be benefited by the theater but would not
gain any rights against A or B under the contract. C would be an “incidental beneficiary” because
there was no intent to benefit C.
C. VESTING OF BENEFICIARY’S RIGHTS
Only an intended beneficiary has a right to sue on the contract. A beneficiary of a “gift promise” may
sue only the promisor, but a beneficiary to whom the promisee owed money may sue either the
promisor or the promisee on the underlying obligation.
The rights of an intended beneficiary vest when he manifests assent to the contract, changes position
in reliance on the contract, or brings suit on the contract.
Once the rights of a beneficiary “vest,” the original parties to the contract cannot modify it in any way,
nor can the promisor be discharged by the promisee to the detriment of the third-party beneficiary.
Thus, in our first hypothetical, if C’s rights had vested, A could not discharge B from B’s obligation to
pay $500 to C, nor could A agree to a lesser payment in satisfaction of B’s obligation.
D. DEFENSES
The promisor can raise any defense against the third-party beneficiary that she had against the original
promisee. For example, in our first hypothetical, if A fails to paint the house, B can raise this as a
defense in an action brought by C.
The promisor, however, cannot raise rights of the promisee against the third-party beneficiary. Thus,
if C were a creditor beneficiary in our hypothetical, but the debt that A owed to C was barred by the
statute of limitations, a discharge in bankruptcy, or by virtue of the fact that A had a defense against C,
these defenses could not be raised by B in a suit brought by C. This would be a so-called jus tertii
(rights of a third party) defense.
IV.
ASSIGNMENT AND DELEGATION
A. IN GENERAL
Assignment refers to the transfer of rights under a contract, and delegation involves the obtaining of
someone else to perform a party’s obligations under a contract. Although the two are clearly distinct
in concept, the term “assignment” is often used to refer to both assignment of rights and delegation of
duties.
B. ASSIGNMENT OF RIGHTS
Almost all contract rights can be assigned. Partial assignments are permissible, as is the assignment of
future or unearned rights.
1.
When Allowed
There can be no assignment which: (a) materially increases the duty or risk of the obligor; or (b)
materially reduces the obligor’s chance of obtaining performance. Generally, prohibitions against
assignment in the contract are strictly construed, and the assignment is permissible. Even if validly
prohibited by the contract, the parties retain the power to assign, and the only consequence is that
an assignment operates as a breach of the contract.
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2.
Requirements
No formalities are needed for an assignment, but there must be a present intent to
transfer the right immediately. Thus, a statement, “When the money comes in I will give
you 10%,” is not an assignment. There is no consideration needed.
3.
Rights Of The Assignee
An assignee takes all of the rights of the assignor, but takes subject to any defenses that could be
raised against the assignor. The rights of the assignee are subject to set-offs if the transaction
giving rise to the set-off occurred prior to the time the obligor was given notice of the assignment.
The assignee is also subject to any modification of the contract made prior to the time the obligor
obtained notice of the assignment. Thus, payment by the obligor to the assignor can be raised as
a defense, provided the payment was made before the obligor had notice of the assignment.
C. DELEGATION
The general rule is that obligations under a contract can be delegated. However, there can be no
delegation when (a) the other party has a substantial interest in having the individual perform (for
example, in a personal services contract involving taste or a special skill); or (b) when delegation is
prohibited in the contract.
When obligations are delegated, the delegator is not released from liability, and recovery can be had
against the delegator if the delegatee does not perform. Also, the other party to the contract becomes
a third-party beneficiary to the contract of assignment and has a right to sue the delegatee immediately.
V.
STATUTE OF FRAUDS
A. GENERALLY
The Statute of Frauds requires that there be a written memorandum of the contract in certain
cases. The following contracts require a memorandum in most states:
• land contracts;
• sale of goods, if the price is $500 or more;
• contracts that cannot be performed within one year;
• suretyship contracts;
• promises by executors and administrators;
• contracts in consideration of marriage.
In addition, many states have writing requirements for contracts to make a will and real estate
brokers’ contracts.
B. MEMORANDUM
The memorandum that is required must be in writing, signed by the party to be charged, and it must
contain the essential elements of the deal. The memorandum need not be formal: receipts, telegrams,
exchange of correspondence, etc., can serve as memoranda. The essential elements may be in more
than one writing, but if so, one of the writings must contain something referring to the others. The
memorandum need not be delivered. If it is lost or destroyed, it still operates to satisfy the Statute of
Frauds, and its prior existence can be proved by oral evidence.
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C. TYPES OF CONTRACTS WITHIN THE STATUTE OF FRAUDS
1.
Land Contracts
a. Types
Practically all contracts and conveyances involving real property are included and must be in
writing, e.g., contracts to buy or sell, conveyances, mortgages, grants of easements, leases,
and interests created by restrictive covenants. Excluded are licenses, leases for less than one
year in most states, and assignments of mortgages.
b. Part performance
Once a vendor conveys, the contract is enforceable, and the vendee must pay the price even if
there is no memorandum. However, payment by the vendee alone is not sufficient to take the
transaction out of the Statute of Frauds. There must be some other act, such as taking of
possession, showing the existence of the contract.
2.
Sale Of Goods
a. Sufficiency of the writing
When the price of goods is $500 or more, the U.C.C. requires a memorandum of the sale.
Here, the memorandum need only: (1) indicate that a contract has been made; (2) identify the
parties; (3) contain a quantity term, and (4) be signed by the person to be charged. Specifically,
a mistake in the memorandum or the omission of other terms does not destroy its validity. An
omitted term, such as the price term, can be proved by parol evidence. There can be no
enforcement, however, beyond the quantity term actually stated in the memorandum. Thus, if
the memorandum calls for the delivery of 10,000 widgets, whereas the parties actually agreed
to 15,000, the contract can be enforced only to the extent of 10,000.
b. Exceptions
There are several exceptions to the sale of goods Statute of Frauds.
•
Specially Manufactured Goods. When (a) the goods are specially manufactured for the
buyer; (b) a substantial beginning has been made on their production, or a commitment
has been made to purchase them elsewhere by the seller; and (c) the goods are not salable
in the seller’s ordinary course of business, there is no requirement of a writing.
•
Part Payment. When part of the purchase price has been paid, the contract is taken out of
the statute to the extent of payment. Hence, if the contract calls for 200 widgets, and 10%
of the price has been paid, the contract can be enforced as to 20 widgets.
•
Receipt and Acceptance. The contract is taken out of the statute to the extent that goods
are received and accepted. Again, if only part of the goods are received and accepted, a
contract can be enforced only as to those goods.
•
Admission in Pleadings. If the party to be charged admits in the pleadings or otherwise
in court the existence of the contract, no writing is required as to the amount admitted.
•
Failure to Respond to Memorandum. If a memorandum sufficient against one party is
sent to the other party, who does not object within ten days, the contract is enforceable
against the other party even though he has not signed it.
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3.
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One-Year Provision
Contracts that cannot be performed within one year of their making must be in writing. The year
starts the day after the contract is made. It is the time that the contract is made that is important, not
the length of performance. For example, a contract made in October, with performance to begin
in December and to continue through November of the following year, is clearly covered by the
statute. If there is a possibility of performance within a year, no writing is required. Thus, a
contract “for life” is not covered by this provision of the Statute of Frauds because the employee
might die within the year. However, a contract whereby a person is to work for “two years” is
covered. Even though the person may die within the two years, his or her death would not constitute
full performance. Part performance of the contract does not take it out of the Statute of Frauds;
the only remedy is in restitution (quasi contract). Full performance by one of the parties, however,
does take it out of the statute, and recovery can be had on the contract.
4.
Suretyship Provision
When a person promises to answer for the debt of another, the person’s promise must be in writing
in order to be enforceable. This provision does not include “indemnity contracts,” i.e., those in
which there is a promise to reimburse someone if she loses money on a deal. The “main purpose
rule” provides that if the main purpose of the contract is to benefit the promisor (surety), rather
than the principal debtor, the contract may be enforced even though there is no writing. Neither
partial nor full performance takes the contract out of this section of the Statute of Frauds.
5.
Executor-Administrator Provision
This is simply a special application of the suretyship provision. Remember that the debt must be
a debt of the estate in order for this section of the Statute of Frauds to apply.
6.
Marriage Provision
This is practically obsolete. It applies to any agreement in consideration of marriage except mutual
promises by the two parties to marry each other.
VI.
PAROL EVIDENCE
The parol evidence rule provides that when parties have adopted a writing as their agreement, no evidence
can be admitted to vary, contradict, add to, or subtract from the obligations as they are stated in the
writing.
A. INTENT OF THE PARTIES
In order to invoke the parol evidence rule, it must be shown that the parties intended to adopt the
writing as their agreement. It is possible that there is:
•
total integration: the writing is the final and complete expression of the agreement between the
parties, and no evidence can be introduced as to any additional promises or representations made
prior to the time of the writing.
•
partial integration: the writing is a final expression of the parties’ agreement to the matters
covered in the writing, and no extrinsic evidence can be introduced that varies or contradicts the
parties’ agreement on those matters.
•
no integration: the writing in no way was intended to represent the agreement of the parties.
The intent of the parties determines whether there is total, partial, or no integration. This is a question
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of fact but is determined by the court. Generally, the court looks at the document to determine how
complete and how formal it is. Normally, the court will then consider the proffered evidence to see
whether it is covered by the agreement. If there is a “merger clause” (“this writing contains the entire
agreement of the parties and no evidence of other agreements is admissible”), the merger clause is
evidence of the intent to integrate.
B. OPERATION OF THE RULE
If the proffered evidence contradicts the writing, it is not admissible unless the court finds that there
was no intent whatsoever to integrate the agreement of the parties into the writing. If the evidence
merely supplements (adds to the agreement as written), it is normally admitted if it is consistent with
the writing, unless the court finds that there is total integration or that the matter is covered by the
agreement and the additional matters would naturally have been reduced to writing if the parties
intended it to be a part of their contract.
When the parol evidence rule is applicable, evidence may still be admitted under a number of theories:
• the court may find that there is only partial integration, that this matter is not covered by the
writing, that the evidence is consistent with the writing, and that it simply adds to the agreement
and does not contradict it.
•
even where there is full integration, the court may find that the evidence offered represents a
separate deal. For example, if the writing covers the sale of a house and the oral evidence goes to
show a sale of personal property in connection with the sale of the house, the court may find that
the oral evidence proves a distinct and separate contract.
•
if there is an ambiguity in the contract, the evidence may be admitted for the purpose of interpreting
the agreement.
•
the evidence may be admitted to prove a defense such as fraud in the inducement, mistake, failure
of consideration, failure of a condition, or that the contract is void or voidable.
The parol evidence rule does not apply in any way to evidence of agreements between the parties
subsequent to the time the writing was signed.
VII. CONDITIONS
A. EXPRESS CONDITIONS
1.
Creation Of Condition
Performance by one or both of the parties may be made expressly conditional in the contract. The
effect of such condition is that some event must happen before performance is due. For example,
a vendor and purchaser of real estate may provide that the contract is “conditioned upon the
purchaser’s ability to obtain a mortgage.”
Express conditions can be identified by the language used. Normally, such words as, “if,” “provided
that,” “on the condition that,” indicate an express condition. Also, such language as “when I get
my Christmas bonus . . . ” indicates a condition.
2.
Burden Of Proof On Performance
Express conditions can be “precedent” or “subsequent.” A condition precedent means the event
must occur before any obligation to perform arises. A condition subsequent, on the other hand,
means the obligation exists under the contract, but it will be discharged by the happening of an
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event. The only distinction between conditions precedent and subsequent is procedural. If the
condition is precedent, the plaintiff has the burden of proving that the condition occurred in
order to recover; whereas, if the condition is subsequent, the defendant must prove the happening
of the condition to avoid liability.
The Second Restatement does away with this distinction in terminology, but the language used in
making the condition or event of discharge and the policies involved in allocating the burden of
proof will be examined.
3.
Satisfaction
If a contract provides that performance will be “to the full satisfaction” of the other party, this
amounts to a condition. When the aesthetic taste of an individual is involved, e.g., when a contract
is for the enlargement of a photograph, the person is not liable if he or she in good faith determines
that the work is not satisfactory. If, however, the contract requires performance not involving
aesthetics but rather mechanical fitness, utility, or marketability, the question is whether a reasonable
person would be satisfied with the performance.
4.
Architect’s Certificate
When a construction contract calls for an architect’s certificate of performance, this is treated as an
express condition, and the builder will not be able to recover unless the certificate is procured and
presented to the landowner. There is no excuse for this condition, and no recovery will be granted
without it unless there is evidence of fraud or collusion between the owner and the architect.
Even if the architect makes a mistake or fails to exercise reasonable judgment in refusing to give
the certificate, recovery will be denied on the contract. In such cases, however, recovery can be
had by the builder in quasi contract for the reasonable value of the work and the materials.
B. CONSTRUCTIVE
1.
Constructive Conditions Of Exchange
When parties enter into a bilateral contract, the doctrine of constructive conditions of exchange
provides that a party to the contract cannot recover unless he or she has either performed or
tendered performance to the other party. Thus, if a builder agrees to construct a house on the
owner’s land, the builder will not be able to recover from the owner unless he completes the
building.
2.
Partial Performance
a. Meaning
To alleviate the harshness of the above rule when a party has almost but not fully completed
performance, the courts have developed the doctrine of substantial performance. This doctrine
provides that if a party substantially performs, he or she can recover on the contract even
though full performance has not been tendered. What constitutes “substantial performance”
varies from case to case, but it means something like “almost fully performing.”
b. Applicability
When the breach is a “willful breach,” no recovery is allowed under the doctrine of substantial
performance. A willful breach, however, requires something more than knowledge, and implies
some attempt to cheat the other party or to provide less than was called for by the contract.
The doctrine of substantial performance does not apply either to express conditions, or to
contracts for the sale of goods.
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c. Measure of damages
When a builder recovers under the doctrine of substantial performance, the primary measure
of damages is the contract price minus the cost of replacing or repairing any defect in the
builder’s performance. This gives to the owner sufficient money to get what she bargained
for. Where, however, constitutes “economic waste,” the measure of damages applied is the
contract price minus any diminution in value resulting from the defective performance.
d. Waiver
The owner may “waive the breach” by accepting the performance of the builder knowing that
the condition was not fulfilled. Waiver is defined as “a voluntary relinquishment of a known
right.” If there is a waiver by the owner, he can still recover damages for any defect in the
performance. Thus, the end result is similar to a situation where the substantial performance
doctrine is applied.
3.
Strict Performance By Seller Under The U.C.C.
The basic obligations of a seller are:
(1) to transfer ownership of the goods to the buyer; and
(2) to tender goods conforming to the warranty obligations.
a. Transfer of ownership
Unless the contract provides otherwise, the seller must convey clear title to the goods; otherwise,
there is a breach of the warranty of title.
b. Tender of the goods
The seller must tender the goods in accordance with the contract if there are specific provisions
on tender; otherwise, she must tender them in accordance with the code provisions. There are
basically four methods of tender stated by the code, the correct one in a particular transaction
depending upon the place of tender:
•
Seller’s place of business: the seller must place the goods at the disposition of the buyer
and give the buyer notice.
•
Shipment contract: the seller has a duty to ship the goods, but no duty to deliver them to a
particular place. The seller must deliver to the carrier, make a proper contract for their
shipment, and give the buyer notice that the goods have been shipped.
•
Destination contract: the seller must deliver the goods to a particular place, and tender
them there by holding the goods at the buyer’s disposition and giving the buyer notice.
•
Where goods in hands of bailee: the seller must negotiate a negotiable document of title or
obtain acknowledgment from the bailee of the buyer’s rights in the goods.
Mercantile terms – F.O.B., etc. – can affect the seller’s obligations. F.O.B. is the most common
term. If it is F.O.B. seller’s place of business or city, it is a shipment contract, and the seller is
obligated only to put the goods in the possession of the carrier. If it is F.O.B. buyer’s place of
business or some point other than seller’s place of business, it is a destination contract, and the
seller at her own expense and risk must transport the goods to the specified place.
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4.
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Buyer’s Obligations
When a conforming tender is made, the buyer is obligated to accept. If he accepts, this amounts
to performance of one of the buyer’s obligations. If the buyer rejects, he has breached the contract.
5.
Divisible Or Installment Contracts
a. At common law
A divisible or installment contract is one in which the various units of performance are divisible
into separate parts. In other words, part of the consideration by one person is set against part of
the consideration promised by the other. Typical divisible contracts are employment contracts
for a set period of time with payment to be made periodically. Thus, a contract for employment
during a six-month period, with a provision that the employee is to be paid at the end of each
week, is a divisible contract and the separate units are the individual weeks. A contract for the
construction of a building where the owner is to make progress payments when certain parts
of the building are completed, is not a divisible contract unless expressly made so. The theory
is that the payments are simply to allow the builder to continue construction, and that the
owner wants a completed building, not parts of a building.
If a contract is divisible, the doctrine of constructive conditions of exchange is applied to each
part of the contract separately. Hence, a person can recover the amount promised for a segment
of the contract, even though she does not perform the other segments, e.g., an employee can
recover the week’s salary even though she quits at the end of the week. Damages are recoverable
by the other party for breach of the other segments.
b. Installment contracts under the U.C.C.
1)
Defined
An installment contract is defined as one in which the goods are to be delivered in a
number of shipments, and each shipment is to be separately accepted by the buyer. Payment
by the buyer is due upon each delivery, unless the price cannot be apportioned.
2)
Effect of breach as to that installment
Where there is an installment contract and the seller makes a nonconforming tender or
tenders nonconforming goods under one segment of the contract, the buyer may reject
only if the nonconformity substantially impairs the value of that shipment to the buyer,
and if the nonconformity cannot be cured. Thus, in an installment contract, the strict
performance rule does not apply; rather, there is something like the substantial performance
rule. Of course, even if the buyer is forced to accept because the nonconformity does not
substantially impair the value of the shipment, the buyer may recover damages for any
loss resulting from the nonconformity.
3)
Effect of breach on rest of contract
Where there is a nonconforming tender or a tender of nonconforming goods under one
segment of an installment contract, the buyer may call off the rest of the contract, i.e.,
cancel the contract, only if the nonconformity substantially impairs the value of the entire
contract to the buyer.
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C. IMPLIED DUTIES OF GOOD FAITH AND FAIR DEALING
A duty of good faith and fair dealing is implied into all contracts. A subspecies of this duty is a duty
not to hinder the other party’s performance and a duty to cooperate, where necessary.
D. SUSPENSION OR EXCUSE OF CONDITIONS BY WAIVER, ELECTION, OR
ESTOPPEL
Even though a party to a contract would be unable to sue successfully on the contract because he has
not complied with an express or implied condition, he can postpone the time in which he must comply
with the condition if it is suspended. He can possibly sue successfully despite the existence of the
condition if he can show that it was waived, that the other party elected his rights in a way that
terminated the condition, or that the other party is estopped from raising the condition as a defense to
suit.
If a condition is suspended, the party having the benefit of the condition has only postponed the time
in which he can interpose the noncompliance with the condition as a defense to the contract. When
the period of suspension has expired, the condition is restored to its original effect.
On the other hand, if the condition is excused, then the party having the benefit of the condition can
never raise it as a defense.
1.
Waiver
A waiver occurs when a party, having the benefit of an express or implied condition which the
other party must comply with in order to perform her obligations under a contract voluntarily and
knowingly relinquishes that right. The relinquishment can occur explicitly by language or implicitly
by action. If a waiver occurs, an issue can arise concerning its scope. If the waiver is of a
condition that is effective at one time only, then the waiver is irrevocable and cannot be unilaterally
reinstated even if no consideration is given for the waiver. In some cases the waiver is not a total
relinquishment of the condition but only a postponement of it. After the period of postponement
has elapsed, the condition is reinstated.
If there is an installment or divisible contract, a waiver with respect to conditions on one installment
is not a waiver for all future installments unless the language of the waiver clearly indicates that
the waiver applies to future installments.
2.
Election
In some contracts, one party has the choice of alternative methods of performance from the other
party. For example, a contract could require a seller to deliver either red widgets or blue widgets
at the buyer’s election that is to be communicated at a specific time. If the buyer makes an election
for red widgets, then the seller has performed his contractual obligation by delivering red widgets
even though the seller later changes his mind and asks for blue widgets.
3.
Estoppel
A party is estopped to insist upon satisfaction of a condition as a defense to performance by the
other party, if she by her actions creates an impression that she will not insist on a condition, and
the other party reasonably relies on that impression to her detriment. She has taken a position
indicating that the condition will not be enforced and if estoppel applies, will not be able to take a
position inconsistent with her previous position.
Reasonable reliance is an essential element of estoppel. If the buyer realized that the seller was
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under the impression that she could deliver at a later date, and called the seller to correct that
impression before the seller reasonably relied on that impression, the seller would not have the
defense of estoppel.
If the contract were divisible, and one party created an estoppel so that she could not enforce the
condition with respect to one party of the contract, she could insist on the condition in later
portions of the contract if she insisted on the condition before the other party reasonably relied
with respect to later portions of the contract.
E. PROSPECTIVE INABILITY TO PERFORM, EFFECT ON
OTHER PARTY
Between the time a contract is made and the time for performance, each party should enjoy a reasonable
expectation that performance will be forthcoming when due. A party’s expectations of performance
may be diminished by the occurrence of some event after the contract was made. A common example
of this is a credit sale when the buyer becomes insolvent prior to the time the goods are delivered.
Such cases have generally been classified as examples of prospective inability to perform. The law is
less settled in the area of prospective inability to perform than it is in cases of anticipatory repudiation,
and in general, there is a reluctance to excuse a party from performing solely on the ground that he
does not expect counter-performance to be given.
1.
Seller’s Remedies Under The U.C.C.
The seller can cancel credit terms or stop goods in transit if the buyer becomes insolvent before
delivery of the goods.
Either party can demand assurance of performance if she has reasonable grounds for insecurity
about the other party’s ability or willingness to perform. Assurances must be in writing, and until
they are provided, the other party may suspend performance.
2.
Stoppage In Transit
A seller who has shipped goods to a buyer may stop the goods in transit if the buyer either
becomes insolvent or breaches the contract. If the ground is insolvency, then stoppage is available
even if the goods were sent in less than carload lots; otherwise, only if shipped in carload lots.
The right to stop in transit terminates where:
•
buyer has received the goods; or
•
carrier or warehouseman has acknowledged buyer’s rights; or
•
goods have been reshipped by carrier; or
•
a negotiable document of title has been given or negotiated to the buyer.
VIII. REMEDIES
A. TOTAL AND PARTIAL BREACH OF CONTRACT
1.
Buyer’s Remedies Under The U.C.C. For Breach Of Contract By The Seller
When the seller’s time for performance arises, the seller may do one of three things:
(1) nothing (breach by seller);
(2) make a nonconforming tender (breach by seller);
(3) make a conforming tender (performance by seller).
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The seller must strictly perform all obligations under the contract. There is no doctrine of substantial
performance, except in installment contracts.
a. If seller makes no tender
If the seller does not tender the goods when the time for performance arises, there is a breach
by the seller. The buyer has three basic remedies:
1)
Damages: (market price minus contract price);
2)
Cover: Purchase similar goods elsewhere and sue for cover price minus contract
price;
3)
Specific Performance: Unique goods; or
4)
Replevin: Identified goods where similar goods are unavailable in the marketplace.
The buyer also can obtain incidental and consequential damages where damages or the cover
remedy is sought.
The buyer can obtain the goods from the seller if partial payment has been made and the seller
becomes insolvent within ten days of payment. The buyer must tender the rest of the price.
b. If seller makes nonconforming tender
If either the tender is nonconforming or the goods are nonconforming, the buyer has the right
to reject all, accept all, or reject some and accept some.
The buyer has the right to inspect the goods before deciding whether to accept or reject.
Inspection can be at or in any reasonable time, place, and manner.
1)
Rejection
Rejection requires the buyer to give the seller notice that he is rejecting. If the buyer has
possession of the goods at the time of rejection, he must hold them for a reasonable time to
allow the seller to remove them. If the seller has no local agent at the place of rejection
(usually the city in which the buyer is located), the buyer’s obligations depend upon whether
the goods are perishable. In the absence of other instructions from the seller, (1) the buyer
must sell perishable goods for the account of the seller; and (2) the buyer may store nonperishable goods at the seller’s expense, reship them to the seller, or sell them for the
seller’s account.
If the buyer rejects, the buyer has the same basic remedies as if no tender was made by the
seller: (1) damages, (2) cover and cover damages, and (3) specific performance or replevin.
Incidental and consequential damages can also be recovered.
2)
Acceptance
Acceptance occurs when: (1) the buyer says she is accepting, (2) the buyer uses the goods,
or (3) the buyer fails to reject.
If the buyer accepts a nonconforming tender, the buyer can still recover for any damages
resulting from the defect, provided notice of the defect is given within a reasonable time.
If the nonconformity is in the goods (breach of warranty), then the measure of damages is
the value the goods would have had if as warranted, minus the actual value with the
defect. If the breach was in the tender obligation (e.g., delivered late), then the buyer may
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recover all losses resulting in the ordinary course of events.
The buyer can revoke acceptance (thus putting herself in the same position as if she had
rejected), if (1) she accepted with a reasonable expectation that the seller would cure and
the seller did not, or (2) the defect was hidden.
3)
Right to cure
The seller has a right to cure a defective tender if:
•
there is still time to perform under the contract; or
•
the seller had reasonable grounds to believe the buyer would accept despite
the nonconformity.
If the seller cures, it is just as though he had made proper a tender in the first place.
2.
Seller’s Remedies Under The U.C.C. For Breach by Buyer
a. Seller’s right to price upon acceptance
If the buyer has accepted the goods, the seller has a right to the price. The seller’s remedy
when the buyer refuses to pay the price is to sue for the price.
The amount is generally set by contract, but if not, the buyer must pay a reasonable price. The
parties can postpone agreement about the price when they enter the contract.
Payment by check is permitted unless the seller demands cash. If the seller demands cash, the
buyer is entitled to a reasonable time to obtain it.
The price is due after the goods are physically delivered to the buyer and the buyer has an
opportunity to inspect, unless the contract provides otherwise. The buyer has no right to
inspect before paying in the following cases:
•
C.O.D. contract;
•
C.I.F. or C.& F. contract;
•
payment is against documents.
Of course, payment does not constitute “acceptance” if there is no right of inspection before
payment.
b. Seller’s right to reclaim goods
If the buyer was insolvent when the goods were delivered and the price is not paid, the seller
can recover the goods if demand is made in ten (10) days, provided no good-faith subpurchaser
has bought the goods from the buyer.
In a C.O.D. sale, if the buyer has given a worthless check, the seller can reclaim the goods.
c. Seller’s remedies upon wrongful rejection
If the buyer wrongfully rejects, the seller has three basic remedies: damages, resale, or recovery
of the price. The seller may also recover incidental damages along with contract damages or
resale.
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d. Damages for wrongful rejection
The measure of damages is generally contract price minus market price. However, if Contract
Price minus Market Price does not fully compensate the seller, she can sue for lost profits as
an alternate measure of damages. In either case the seller is entitled to incidental damages and
the buyer must be credited with any partial payments and with expenses saved by the seller
(e.g., by the seller’s resale of the goods).
e. Resale
If the seller elects to resell and sue for contract price minus resale price, the resale must
be:
• only of goods identified to the contract, and
• commercially reasonable.
f. Price
The seller can recover the price after rejection only if the goods are not salable in the seller’s
ordinary course of business.
The seller can retain deposits paid by the buyer up to the amount stated in a liquidateddamages clause, or, in the absence of such a provision, (2) 20% of the value of performance,
or $500, whichever is less.
B. ANTICIPATORY BREACH
1.
At Common Law
a. Repudiation of promise
The doctrine of anticipatory breach is applicable when a promisor, before the time for
performance arises, repudiates his promise.
A repudiation must be “clear and unequivocal.” It may be by acts instead of words. The
bankruptcy of the promisor, prior to performance, has been held a repudiation. However, a
good-faith denial of an obligation under the contract is not a repudiation.
b. Promisee’s options
When a promisor repudiates, the promisee has the option of ignoring the repudiation and
demanding that the promisor perform at the agreed upon time, or treating the repudiation as a
breach of the contract.
If treated as a breach, the promisee may cancel the contract, sue for damages or, if appropriate,
seek specific performance.
If the promisee ignores the repudiation, he cannot continue to perform under the contract if
this will increase the damages of the promisor.
The repudiation relieves the promisee of any obligations under the contract. However, he
must be able to prove that he would have been “ready, willing, and able” to perform but for the
repudiation.
c. Retraction of repudiation
A repudiation may be retracted until the promisee: (a) acts in reliance on the repudiation; (b)
signifies her acceptance of the repudiation; or (c) commences an action for breach of contract.
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Notice of the retraction sufficient to allow the promisee to perform her contractual obligations
must be given.
d. Unilateral contracts
The doctrine of anticipatory repudiation does not apply to unilateral contracts and may not be
used if the promisee has completed performance prior to the repudiation.
2.
Anticipatory Repudiation Under The Uniform Commercial Code
Anticipatory repudiation occurs when there has been an unequivocal refusal of the buyer or seller
to perform, or when a party creating reasonable grounds for insecurity fails to provide adequate
assurances within 30 days of demand for assurances.
The repudiation can be retracted if the other party has not canceled the contract or materially
changed position. Repudiation allows the nonrepudiating party to resort to any remedy given by
the contract or code.
C. ELECTION OF SUBSTANTIVE RIGHTS AND REMEDIES
When the defendant induces the plaintiff to enter into a contract by fraud, or when the defendant
materially breaches the contract, the plaintiff has three types of remedies available to him.
•
In limited instances he can require that the defendant perform the contract by obtaining a decree
for specific performance.
•
He can seek damages for breach of contract.
•
He can rescind the contract and recover what he put into performing the contract.
The issues are when he can pursue more than one of these remedies, and when the election to pursue
one remedy bars him from changing his mind and pursuing another, and what action is considered an
election.
1.
Multiple Recoveries Not Permitted
One principle that is clear is that the plaintiff cannot pursue multiple remedies in order to obtain a
double recovery. For example the plaintiff could not obtain a decree for specific performance of a
land contract and at the same time obtain expectancy damages for breach of the contract to convey.
On the other hand, she would be able to obtain specific performance some incidental damages,
related to her equitable remedy.
In a lawsuit for breach of contract, a plaintiff under the Federal Rules of Civil Procedure and
similar state procedural rules can bring a lawsuit asking for inconsistent remedies such as specific
performance and damages, but at the successful conclusion of the lawsuit, she will only obtain a
judgment for one remedy. If her preferred remedy is specific performance, but the court in its
discretion refuses to order the contract performed, it can order the damage remedy in the alternative.
2.
When Does Election Occur
The most common situation involving election involves the choice between damages, where the
plaintiff affirms the existence of the contract and seeks monetary compensation for the difference
between the performance he bargained for and that which he received, and rescission where the
plaintiff seeks to restore the status quo which existed before the contract was formed.
It is clear that if one of these alternative remedies is pursued to judgment, the plaintiff cannot
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change his mind and pursue the other. The procedural rules of res judicata would bar such action.
Likewise, if the plaintiff communicates to the defendant that he is seeking one of these alternative
remedies and the defendant relies on that representation, the principals of estoppel will prevent
the plaintiff from abandoning one remedy and seeking the other.
Some courts have found an election at a much earlier stage, and prohibited the plaintiff from
changing his mind and seeking a different remedy once he has communicated his choice of
remedy to the defendant, even if the defendant has not relied upon that decision.
A plaintiff may also be denied the remedy of rescission if he has knowledge of the basis for
seeking rescission and fails to pursue that remedy for a period of time during which the defendant
changes his position. The plaintiff in this case would still be entitled to the damages remedy, as
long as the statute of limitations has not expired.
3.
Election Of Remedies Under The Uniform Commercial Code
Comment to U.C.C. Section 2-703 dealing with seller’s remedies provides that the article rejects
any doctrine of election of remedy as a fundamental policy and thus the remedies are essentially
cumulative in nature and include all of the available remedies for breach. Whether the pursuit of
one remedy bars another depends entirely on the facts of the individual cases. In dealing with
buyer’s remedies §2-711 of the code provides that the buyer may cancel and whether or not she
has done so may in addition to recover so much of the price as has been paid, obtain damages
based upon cover or otherwise.
D. SPECIFIC PERFORMANCE, INJUNCTION AGAINST BREACH,
DECLARATORY JUDGMENT
1.
In General
When damages are an inadequate remedy, equity will order specific performance of the contract.
If the equity decree is not observed, the breaching party is in contempt and may be fined or
imprisoned.
2. Factors Considered
In determining whether damages are adequate, the following factors should be taken into
consideration:
•
the difficulty of proving damages with reasonable certainty (e.g., the difficulty may be posed
by sentimental associations and aesthetic interests, not measurable in money, which would be
affected by breach);
•
the difficulty of procuring a suitable substitute performance by means of money awarded as
damages; and
•
the likelihood that an award of damages could not be collected.
3.
Real Property
Because every parcel of real property is considered unique, contracts involving the transfer of
an interest in real property may be enforced by an order of specific performance.
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4.
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Limitations On Court’s Powers To Order Specific Performance
Even if the remedy of damages is inadequate, specific performance will not be granted where the
court cannot supervise enforcement. Thus, courts do not grant specific enforcement of contracts
for personal services, although they may restrain the breaching party from working for another.
For example, if a performer agrees to sing in a particular theater, the court will not grant a decree
ordering the person to sing at that theater, but it will grant a decree restraining the performer from
appearing at competing theaters. Lumley v. Wagner, 42 Eng. Rep. 687 (1852).
Also, courts will usually refuse to grant specific performance in an action where the act or
forbearance will occur outside the jurisdiction of the court. Thus, if A agrees to sell land to B, and
both A and the land are located outside the jurisdiction of the court, the court will usually not grant
a decree of specific performance upon A’s refusal to deed the land.
Since a decree of specific performance is an equitable remedy, the usual rules for seeking equitable
relief apply, e.g., the clean hands doctrine. Whether the court will grant the relief requested is
always within the discretion of the court.
5.
Specific Performance Under The U.C.C.
In sale of goods cases, §2-716 of the Uniform Commercial Code provides that specific performance
may be granted where the goods are unique or in other proper circumstances, such as for breach
of a requirements contract where there is not another convenient supplier.
6.
Declaratory Judgment
If the rights and obligations of the parties under a contract are unclear, and an actual dispute exists
between the parties concerning those rights and obligations, either party may bring a declaratory
judgment action to obtain an adjudication of those rights and duties. It is not available, however, to
resolve moot issues or theoretical problems which have not risen to an actual dispute. For example,
this form of litigation can be brought even before a breach of contract, to adjudicate whether a
specific proposed action by one party would constitute a breach. If the court found that a specific
action constituted a breach and a party pursued that course of action, the principles of collateral
estoppel would constitute an adjudication of breach which could not be relitigated at a subsequent
action for damages. Thus a declaratory judgment action is often an effective, indirect way of
enforcing a contract prior to a breach.
E. RESCISSION AND REFORMATION
1.
Rescission
The non-defaulting party to a contract can choose the rescission remedy, which cancels the contract,
and requires a return of any deposits or other benefit conferred on the other party. The rescission
remedy is advantageous to the nonbreaching party when he has made a disadvantageous contract,
and will be better off if he can completely undo the contract. For example, if homeowner hires
contractor to paint his house for two thousand dollars, and gives contractor a five hundred dollar
contract, and contractor defaults on the contract by not starting to paint the house in a timely way,
homeowner can rescind the contract and get his five hundred dollars back, and then make a more
advantageous agreement with another painter to paint his house for fifteen hundred dollars.
Rescission can also occur by the mutual agreement of the parties.
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2.
Reformation
When reformation of the contract is available to cure a mistake, neither party can avoid the contract.
For example, assume that A agrees to sell Redacre to B, with B agreeing to pay $50,000 and to
“assume a mortgage in the amount of $100,000.” If the parties fail to include a provision regarding
the assumption of the $100,000 mortgage, A can obtain reformation of the agreement to reflect
B’s promise. A has no right to avoid the contract because reformation adequately remedies the
mistake in drafting the written agreement.
F. MEASURE OF DAMAGES IN MAJOR TYPES OF CONTRACT
AND BREACH
The primary objective of contract damages is to put the nonbreaching party in the same position that
she would have been in had the contract been performed. Thus, it is sometimes said that the
plaintiff in a contract action is entitled to the “benefit of her bargain” or her “expectancy damages.”
Although “expectancy damages” are the normal means of determining damages in a contract case,
two alternative types of damages are recognized: “restitution damages” and “reliance damages.”
In both of these the plaintiff is not to be put in the position that she would have been in had the contract
been performed, but rather to be put in the position she was in at the time the contract was made.
In addition, a plaintiff may have suffered damages that go beyond loss of the benefit of her bargain.
These are classified as “consequential damages.”
1.
Expectancy Damages
a. In general
Expectancy damages are normally measured by a formula that looks at the value of the
performance of the breaching party and the consideration promised for that performance. The
general formula is the market value of the promised performance less the consideration
promised by the nonbreaching party. For example, assume a contract were for the painting of
Homeowner’s house which was breached by Painter. The damages would be Homeowner’s
cost to hire a new painter less the original contract price. Thus, if the original contract price
was $2500 and Homeowner, after Painter’s breach, hired Brush to paint the house for $3000,
Homeowner’s damages would be $500. This $500 damages from Painter puts Homeowner in
the position he would have been in had the contract been performed – he has his home painted
for a net cost of $2500.
Conversely, assume that that Homeowner had breached in the example above, and Painter’s
cost of painting the house was $2000, Painter would be able to collect $500 in damages.
Even if no second contract is entered into by which to measure damages, the same basic
formula exists: In contracts for services; compare the difference between the value of the
services to be performed under the contract with the price that was promised for those services.
b. Partial performance
If one of the parties has partially performed at the time of the breach of the other party, the
performing party can recover for work done at the contract rate plus “expectancy damages”
for the work not yet performed. Thus, assume a contractor agreed to paint O’s house for
$10,000, with $9,000 representing the cost of performance and $1,000 representing the
contractor’s profit. If O breaches when Contractor is half finished, having thus far incurred
$4,500 in costs, Contractor could recover the $4,500 and the $1,000 in anticipated profit, for
a total of $5,500. She could not recover the remaining $4,500, which represents the costs not
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incurred by not yet finishing the contract.
2.
Nominal Damages
Damages are not an essential element in a cause of action for breach of contract. If no damages
are alleged or none are proved, the plaintiff is still entitled to a judgment for “nominal” damages:
usually six cents or $1.
G. CONSEQUENTIAL DAMAGES, CAUSATION, CERTAINTY,
AND FORESEEABILITY
1.
Consequential Damages
A breach of contract may result in damages to the nonbreaching party that go beyond the difference
between the value of the nonbreaching party’s performance and what the nonbreaching party
would have received had there been no breach. For example, if a contract calls for the construction
of a motel and the builder fails to perform, the basic measure of damages would be the difference
between the contract price and the amount that it cost the owner to have someone else construct
the building. However, the failure to construct the building may cause additional damages to the
owner in the way of lost profits because of delay, or by causing him to breach contracts he may
have made with third parties for the use of the building. If such damages can be proven by the
plaintiff and were foreseeable by the breaching party at the time of the contract, consequential
damages are recoverable.
2.
Causation
Contract law has a doctrine similar to the requirement of “but for” causation in tort law. If the
plaintiff is seeking damages, the defendant can defend on the ground that the losses that the
plaintiff seeks to recover would have occurred whether or not the defendant breached her contract.
This issue can be simply illustrated where the plaintiff seeks to recover damages from a components
supplier who delivered late, because that supplier knew that the plaintiff would be penalized if she
delivered the final product beyond a specified date. If the defendant delivered the parts late, but at
the time they should have been delivered the plaintiff’s employees were on strike so that the final
product could not have been delivered on time even if the parts were delivered on time, the
plaintiff could not recover for delay from the defendant, because the defendant’s breach was not a
“but for” cause of the plaintiff’s damage.
3.
Certainty
In order to recover damages, a plaintiff must prove the dollar amount of the damages with reasonable
certainty. To put this in the negative: the damages must not be too speculative. The Restatement
(Second) of Contracts §352 requires that the evidence of the amount of damage must afford “a
sufficient basis for estimating their amount with reasonable certainty.” This does not mean that the
plaintiff can recover nothing if part of the damages he attempts to prove fails to meet the requirement
of certainty; those damages that were proved with sufficient certainty can be recovered, although
others may not be allowed. The Restatement gives the following examples, among others, of the
application of this rule:
•
A and B contract to form a partnership and to continue it for a specified period. B dissolves
the partnership prior to the time specified. A could recover damages for lost profits by proving
what the profits were during the life of the partnership.
•
A contracts to allow B to operate his established coal mine and to pay B $25 per ton for coal
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produced. A breaches the contract by refusing B entry to the land. If the mine has been
operating for an extended period of time and the veins are well established, B can recover
damages by showing the cost of producing the coal, the amount that could have been produced
during the contract period, and the market price at which it could have been sold.
Courts are hesitant to award damages for lost profits because they are, in the eyes of most courts,
too speculative. This is particularly true in a new or relatively young enterprise. For example, if a
plaintiff is suing to recover lost profits because of the defendant’s failure to deliver a boiler necessary
for plaintiff’s new factory, a court may award the plaintiff the rental value of his factory during the
time it was inoperative, but will not grant an award on the presumption that the new enterprise
would have made a profit.
4.
Foreseeability And The Rule Of Hadley v. Baxendale
The leading case on consequential damages is Hadley v. Baxendale, 9 Exch. 341 (1854), which
involved an action by the owner of a factory against a carrier. The owner had contracted to have
a shaft needed to run machinery in the factory transported to a third party, who was to use it as a
model for the manufacture of a new one. The shipment was delayed by the defendant-carrier, and
the plaintiff asked damages to compensate for the loss resulting from the stoppage of work in the
factory during the delay. The court held that the damages recoverable in a contract action are
those which “may fairly and reasonably be considered either arising naturally, i.e., according to
the usual course of things, from such breach of contract itself, or such as may reasonably be
supposed to have been in the contemplation of both parties at the time the contract was made, as
the probable result of the breach of it.”
Thus, the rule under Hadley v. Baxendale is that damages are recoverable if they were the “natural
and probable consequences,” or if they were “in the contemplation of the parties at the time
the contract was made.” In other words, the damages must be “foreseeable.”
H. LIQUIDATED DAMAGES AND PENALTIES
Parties to a contract may fix the amount of damages that will be recoverable in the event of breach;
however, a party may not be “penalized” for her breach of contract. Therefore, penalty clauses in a
contract are unenforceable. A provision for liquidated damages will be enforced, and not construed
as a penalty, if the amount of damages stipulated in the contract is reasonable in relation to either
the actual damages suffered, or the damages that might be anticipated at the time the contract
was made.
I. RESTITUTION AND RELIANCE RECOVERIES
1.
Restitutionary Damages
Restitutionary damages restore to the plaintiff whatever benefit he has conferred upon the
defendant prior to breach. Restitutionary damages may be recovered even though the plaintiff
would have suffered a loss had the defendant not breached. They may be combined with expectancy
damages. Restitution may also be available in a quasi-contract action.
2.
Reliance Damages
Reliance damages may be recovered where the nonbreaching party has incurred expenses in
reasonable reliance upon the defendant’s performing her contractual obligations. Unlike
restitutionary damages, there is no requirement that the defendant have benefited from the plaintiff’s
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expenditures.
J. REMEDIAL RIGHTS OF DEFAULTING PARTIES
A party who commits a material breach of his contract obligations cannot sue for contract damages.
For example, assume Painter enters into a contract with Homeowner to paint Homeowner’s house for
$5,000 by July 1 payment to be made upon completion of the job. If Painter abandons the job after
the home is 60% painted, he may not collect $3,000, 60% of the contract price. However, if Homeowner
hires Brush who completes the work for $4,000, Painter has conferred a benefit upon Homeowner
for the fair value of his work in painting the house and can sue in quantum meruit for the fair value of
the benefit conferred. In this case the court would probably find that the benefit conferred was
$1,000 because Homeowner placed a value of $5,000 in having his house painted, and only expended
$4,000 to have Brush complete the job.
K. AVOIDABLE CONSEQUENCES
A party to a contract has the obligation of avoiding or mitigating damages to the extent possible by
taking such steps as do not involve undue risk, expense, or inconvenience. The nonbreaching party is
held to a standard of reasonable conduct in preventing loss. Thus, the plaintiff in a contract action
cannot recover damages which were foreseeable by her, and which she could have avoided by the
expenditure of reasonable effort. For example: A contracts to manage B’s farm for a year. Several
weeks before the planting season, A quits. If B could have found another manager by the exercise of
reasonable effort, B cannot recover for damages resulting from the fact that no crops were planted.
L. UNIFORM COMMERCIAL CODE ISSUES
1.
Risk Of Loss
a. General rules
Where the goods are lost or destroyed through no fault of the seller or the buyer, a determination
must be made as to who must initially suffer this loss. The basic rule is that the risk of loss is
on the seller until he or she completes his or her delivery obligations under the contract.
Thus, if there is a “shipment contract,” the seller completes the delivery obligations by tendering
the goods to the carrier, and making a proper contract for their shipment. At that time, there is
a shifting of the risk of loss from the seller to the buyer, and if the goods are destroyed or lost
while they are in transit, the risk of loss is on the buyer and the buyer must pay the contract
price.
b. Special rules
There are three “special” rules regarding risk of loss, all of which deal with situations
where one of the parties is in breach:
• Where the seller delivers nonconforming goods, the risk of loss remains on the seller until
the buyer accepts or there is a cure.
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•
Where the buyer rightfully revokes his or her acceptance, the risk of loss shifts back to the
seller to the extent of any lack of insurance coverage by the buyer.
•
Where the buyer repudiates or breaches after the goods have been identified to the contract
but before the risk of loss has shifted to him, the risk of loss is immediately shifted to the
buyer to the extent of any lack of insurance coverage on the part of the seller.
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2.
Insurable Interest
a. Seller’s insurable interest
In order for a person to insure goods, he or she must have an “insurable interest” in the goods.
Under Article 2, the seller retains an insurable interest as long as he or she has title to the
goods or has a security interest in them. Absent a contrary provision in the contract, the title
passes from the seller to the buyer when the seller completes his or her delivery obligations.
Thus, at that time, the seller’s insurable interest ceases unless the seller retains a security
interest in the goods. Remember that a seller does not automatically get a security interest,
even though the buyer is to pay sometime in the future. There must be a voluntary granting of
a security interest by the buyer to the seller in accordance with the provisions of Article 9 of
the code.
b. Buyer’s insurable interest
The code provides that the buyer obtains an insurable interest in the goods as soon as the
goods are “identified to the contract.”
c. Overlapping insurable interests
It is possible for both the seller and the buyer to have insurable interests at the same time under
the provisions of Article 2 of the code.
3.
Title And Good-Faith Purchasers
a. Entrusting provisions
The code provides that delivery of goods by the owner to one who sells goods of that kind
gives to the transferee the power to convey good title to a buyer in ordinary course. Thus, if I
give my watch to a jeweler to have it repaired and the jeweler also sells used watches, if the
jeweler sells the watch to a buyer in ordinary course, the buyer would get good title even
against me. A buyer in ordinary course is one who in good faith and without knowledge of a
third party’s ownership rights or security interest, buys from someone selling goods of that
kind.
b. Voidable title
Where the true owner of goods sells them to another, but the sale is voidable because of fraud
or because it was a cash sale and the buyer has not paid or has paid with a dishonored check,
the code takes the position that the buyer has the power to transfer good title to a good-faith
purchaser. This is true even though the fraud may be punishable as larceny under the local
law.
IX.
IMPOSSIBILITY OF PERFORMANCE
A. IMPOSSIBILITY
Impossibility of performance arises when the performance of one of the parties becomes impossible.
It is essential that the event giving rise to the impossibility be unforeseeable at the time the contract
was made. The typical situations are:
•
where the performance becomes illegal after the contract is made;
•
where there is a lease or sale of specific goods and they are destroyed;
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•
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where there is a personal services contract, and the person who is to provide the services dies or
becomes incapacitated.
When impossibility of performance arises, a party is excused from performing the contract. However,
a person cannot require that the other party accept substitute performance. If the parties desire, one or
the other can assume a greater risk in their contract, e.g., become liable to pay damages even if
performance becomes impossible. Also, a liquidated damages clause can be made to apply to
impossibility situations by specific agreement of the parties.
B. IMPRACTICABILITY OF PERFORMANCE
1.
Total Impracticability
Impracticability of performance provides an excuse (defense) for nonperformance of the contract
similar to impossibility in contract law. This excuse exists when:
•
goods identified at the time of contracting are destroyed;
•
performance becomes illegal; or
•
performance has been made “impracticable.”
The excuse applies only when the event was not foreseeable and when nonoccurrence of the
event was a basic assumption of the contract.
2.
Partial Impracticability
When impracticability affects only part of the seller’s ability to perform, the goods actually produced
must be apportioned among all the buyers with whom the seller has contracted. The buyer, however,
may refuse to accept and may cancel the contract.
When the agreed method of transportation or payment becomes impracticable:
• the performing party must use a commercially reasonable substitute if available, and
•
the substitute performance must be accepted.
C. FRUSTRATION OF PURPOSE
The doctrine of frustration of purpose applies when the value of the contract is totally or almost
totally destroyed for one of the parties. Again, the event destroying the value of a contract must have
been unforeseeable. If the doctrine applies, the party is excused from performing the contract.
However, American courts very rarely find the doctrine applicable.
X. DISCHARGE
A party’s duties under the contract may be discharged by full performance or without full performance by
operation of law or by act of the parties. Discharge by operation of law occurs when enforcement of the
obligor’s duty is discharged in bankruptcy or by the running of the statute of limitations. A duty may be
discharged by impossibility or frustration of purpose. Discharge may occur pursuant to the terms of the
contract by nonoccurrence of a condition precedent to performance or by occurrence of an event of
discharge. A duty may be discharged by merger into an award in arbitration, into a judgment, or into a
substituted contract or novation. The parties may also modify their duties by means of a mutual agreement
of rescission, an accord and satisfaction, or an account stated.
Unilateral forms of discharge, such as a renunciation of rights or a release, generally must be supported
by consideration. The most common exception today is that a renunciation or release contained in a
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signed and delivered writing will be effective under the Uniform Commercial Code without consideration.
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