Acct'g 804 Week 3: Contracts


Administrative items

Questions regarding court visit assignment?

For week 4 on 9/25 assign Perlin v. Morse, 209 Cal. App. 3d 1289 (1989) [summarized on p. 250 case 16.6; available at http://www.kirschenbaumesq.com/california2.htm] and Donovan v. RRL Corporation, 26 Cal. 4th 261 (2001).


Chapter 9: Contracts

Theory:

Consider the various ways of organizing economic behavior:

  • Tradition: Do today what you did yesterday
  • Relationship: Do what is to mutual advantage
  • Command: Do what the boss tells you
  • Market: Do what prices provide incentives to do

Later in the course we look at the legal structure of business organizations, those based on relationship (such as partnerships) and based on command (corporations). For now we deal with markets -- those wonderful, decentralized abstractions where the self-interest of each participant, "as tho guided by an invisible hand", efficiently benefits all. {At least in an ideal world with perfect information and no externalities, where rent-seeking is instantly swept away by competition, and rational speculators stabilize against manias, panics and crashes. Reality is always somewhat messy.}

Contract law deals with economic promises, with arrangements voluntarily negotiated by independent private parties. By allowing economic actors to restrict their own future freedom of action, contracts give market transactions a time dimension. There is a general benefit -- it's economically efficient -- in being able to make deals that rely on future performance by others, knowing that one will at least receive compensation equal to the value of that performance. The "power of society is brought to bear thru the courts" so as to make parties pay if they fail to do what they promise.

The terms of any particular contract are "private law", arrived at by the parties and binding only on them. "Contract law" generally is a background structure of technical rules that provide context and give default "unless otherwise provided" terms for these privately negotiated bargains.

Contract theory crystalized during the 19th century. It is based on a vision of individualistic capitalism, an ideal "fair market", made up of numeous willing buyers and willing sellers, with both sides having knowledge of the facts and neither under compulsion to deal. To the extent that particular markets or transaction patterns deviate from the ideal, the theory may have to bend or be modified to accomodate reality.

Where to find Contract law

In US, contracts generally are State-level law. Federal courts usually apply state law

Sources of law include: written case decisions, and statutes enacted by legislatures. In California, contract law is in the Civil Code, starting at section 1549

Authoritative (not precedent) commentary: the 2nd Restatement

Uniform Laws project (attempt to standardize state laws: voluntary). Example: the Uniform Commercial Code

The Core Theory of Contract

Cal Civ Code Sec. 1549: "A contract is an agreement to do or not to do a certain thing." A and B each have the capacity to act in their own interest. A makes an offer to B -- a definite proposal for the exchange of promises about their future conduct. B informs A that B accepts the offer. Each receives legal consideration -- a future benefit or at least some restriction on the other's freedom of action. They have made a contract.

How definite must the proposal be?

It is hard and expensive for the parties to negotiate to cover every possibility in advance and define everything with the utmost precision, so there are default rules for interpretation. Often, one asks "what is reasonable under the circumstances."

Variants on the Core Theory

Unilateral (1-way) Contracts. Public Offers and Rewards

Offers to the general public didn't fit the core theory -- how does B communicate acceptance? Solution: treat them as offers to exchange A's promise for B's performance (not B's promise.) A: "If someone out there does X, I promise to do Y".

Rewards. A says: "If someone finds X/ solves X crime, I promise to give that person $$". Person claiming reward must have known of the reward offer before doing the requested act, and must not be otherwise obliged to do it.

Advertisements

Generally not considered offers but invitation to public to make offers. [possible reason for rule: to limit merchant liability for accidental errors in ad copy.]

Result: a need for consumer protection laws to prevent bait & switch advertising.

Contract legal jargon

"Offeror" and "Offeree"

"-or" = the person who does something.

"-ee" = the person to whom it is done.

"Express" - means the contract is stated in words, whether oral or written

"Implied in fact"

The parties don't say anything, but act as though they had a contract. Example: if you order a meal at a restaurant, you are promising to pay for it. Many everyday contracts are of this kind -- so routine they need not be expressly made

"Quasi-" ("as-if") contract is a gap-covering rule

There is no actual contract, but a court grants relief as tho there were, in the interest of fairness ("equity") and to prevent "unjust enrichment". Example: unconscious accident victim is admitted to hospital. But -- hospital cannot load victim up with expensive unneeded services, and include them in the as-if contract

Quasi contract may also be used when the actual contract is technically defective. Example: "Take care of me and I'll mention you in my will". If not in writing, it's not enforceable as a contract, but person who does the work should get the fair value for what they did.

Executed" versus "Executory"

"Executory" means still to be performed on one side or other or both. A has paid the $, but B hasn't delivered the goods. Whether there has been part performance may affect remedy

Enforceability words

  • Valid
  • Void
  • Voidable
  • Unenforceable

Chapter 10: Offer and Acceptance

Issues: How does B accept? How does A terminate ("revoke") an existing offer? What if acceptance and revocation overlap in time?

Agreement:

B accepts at a distance. How communicate to A?

If expressly stated in offer, must be by that mode, otherwise by same or faster mode than that used to make the offer

Unilateral contracts, rewards

Doing the requested deed is acceptance. Whether A can revoke may depend on whether B has acted or changed position in reliance

Rejection

Rejection terminates an offer

B's later attempt to accept is treated as new offer from B to A.

An offer must be accepted on its own terms

B crosses out the words B doesn't like and then signs. B has rejected the offer -- so it terminates -- and B has made a new counter-offer. (Tho may depend on materiality of terms)

Revocation

A: "You, B haven't accepted yet. I revoke my offer. I no longer promise X if you promise Y."

Generally, offer may be revoked at any time before it is accepted, by A communicating the revocation to B.

Public offers are revoked by same means as was used to make the offer. Example: reward publicity.

Exception: Irrevocable offers/options.

A side contract between A and B, w/ its own offer, acceptance and consideration, that prevents A from revoking the primary offer for X time.

Exception: "Promissory Estoppel"

A sort of "legal fiction" as to a "plug" stopping up a mouth. Where offeree has changed position in reliance on existence of offer. Example: subcontractor's bid is incorporated in prime contractor's bid: prime is relying on sub.

The "Mailbox" rule

Problem is one of distant communication, where B's acceptance and A's revocation cross in transit

"Acceptance is effective on posting, revocation only effective on receipt"

Like driving on the right, is "positive law": a clear, mechanical rule. The Internet is a comparatively minor change in modes of business compared to the development of a reliable postal service (prepaid postage stamps first used in UK in 1840) and the telegraph (@1840's)

Termination by lapse of time

If not expressly stated then offer lasts a "reasonable" time. Reward offers are presumed limited in time -- for example, the length of the statute of limitations for the crime.

Termination of offer by events

  • Destruction of subject matter.
  • Death or incompetency of offeror: No longer any one to contract with

Chapter 11: Consideration

Purpose of "consideration"

To distinguish contracts from unenforceable "non-economic" promises, such as future gifts or general expressessions of intent on which others should not rely. There could be other ways to identify which promises are legally binding (such as the ritual of a seal, or witnesses, or official registration) and it is an accident of English legal history that contract law focuses on "consideration"

"Consideration" is something of legal value in a bargained exchange

benefit to A or at least some limit on B's freedom of action (a "legal detriment" to B)

Nominal consideration

Recital in land sale contract "One dollar and other valuable consideration"

What if there's no consideration?

The illusory promise

"I promise to do it if I want to". Effect is to render an apparent contract invalid. Either party can terminate if no performance yet

However, "use best efforts" is not illusory, and "all output" or "all requirements" contracts are valid. If amounts not stated by parties, determine reasonable amounts from past history and course of dealing

Consideration for settlement of claims

Accord and satisfaction. A "compromise"

If liquidated (i.e. amount certain) debt, must be new consideration. For an unliquidated (disputed) debt, a new agreement on the amount suffices

Enforceable promises without consideration

Revive from limitations

Revive from bankruptcy

Promissory estoppel (see above) may apply if reasonable to expect other party would change position in reliance


Chapter 12: Capacity and lawful purpose

General rule: "a contract with a person lacking capacity is voidable by that person when capacity is gained"

Minors (under age 18) lack capacity

Purpose: protect the young from being taken advantage of by adults. Minor may disaffirm or affirm after reaching age of majority

Consequences of disaffirming:

  • Other party must restore minor to status quo before contract
  • Minor in general only need return whatever was received, in whatever condition it's in at the time
So an Adult deals with a minor at the adult's peril

Important exception: almost as big as the rule

Contracts for necessities of life by minors are valid.

Reason: so minor won't starve as result of unwillingness of others to make contracts. Obligation placed on minor by quasi ("as-if") contract is  to pay the reasonable value of benefits received

Insane persons

Distinction between those "insane in fact" -- actually crazy/senile -- and those already found by a court to be crazy or senile. The latter are "legally adjudged insane" or persons under conservatorship

  • Contracts of the merely insane are voidable.
  • Those of the adjudged insane are void

Reason for rule: whether there is a public record that someone's power to contract has been removed thru a court proceeding

Duties of the "merely" insane on disaffirmance

Same as minors, and same quasi-contract rule for necessities

Intoxication

A party so drunk or high that they were unable to comprehend what they were doing can affirm or disaffirm later

Illegal contracts

If goal of a contract is illegal, contract is void. No court enforcement one way or the other, just "leave the evil doers as one found them"

Examples:

  • Usury on loans, gambling debts, contracts to commit crime
  • Contracts to bribe officials, obstruct justice, commit torts
  • Contracts to restrain trade. Limit noncompete agreements to reasonable time, area, line of work

Examples: Everet v. Williams, Exchequer (Orders, vol. 34), Mich.T. 12 Geo. I, 1725 (No. 43); Flegenheimer v. Brogan, 248 N.Y. 268 (1940) [background: Dewey takes down the Dutchman]; Wong v. Tenneco, 39 Cal. 3d 126 (1985)

Unconscionability

Generally, hold parties to bargains, even if they turn out to be bad deals. Sometimes, tho, contract may be so unfair -- "got'cha" -- that courts abstain from or limit enforcement. What deviations from the fair market ideal are so great as to warrant this?

Characteristics:

Both a procedural element (surprise) and a substantive one (unfairness)

  • Unfair/hidden/unusual terms (the "fine print")
  • No reasonable alternative for weaker party (Q: what forced them to deal?)
  • Unequal bargaining power (take it or leave it contract forms)
Often involves a party unknowingly waiving a rule that exists for their own protection

Chapter 13: Mistake, Fraud & Duress

The common theme: agreement is only apparent, not "real". There was no "meeting of the minds" due to confusion, coercion or trickery

    Mistake as a defence to existence of contract

      Unilateral mistake of fact: by only 1 party

Generally "rescission" (unwinding) isn't allowed just because one party was wrong about the facts. Concern is that people will try to wiggle out of promises if they discover, in hindsight, they could have gotten a better deal.

Also, generally no remedies for mistakes as to value: don't protect people against their own bad bargains. The tradition of caveat emptor ("let the buyer beware") (tho now generally limited for consumer purchases, since buyers & sellers don't have equal knowledge in such transactions)

Maybe give relief if other party knows of the mistake and tries to take unfair advantage, or if the mistake is due to a "footfault": a clerical slip-up w/o gross negligence, such as a misplaced decimal point in a construction bid, corrected before anyone has acted in reliance on it.

Mutual mistake of material fact justifies rescission

Classic example: the Peerless case: two boats with the same name

Fraud

An intentional false statement of material fact that is intended to, and does, induce justifiable reliance, to the injury of the party relying

Fraud "in the inception"

"I was deceived as to the nature of this document." The papers were switched, the person thought they were signing something else

Fraud "in the inducement"

"I knew it was a contract, but I was deceived about what I would receive." A party signed because of false promises. "Inception" vs. "inducement" is significant when defending against the holder in due course of a promissory note

Concealment

Silence can be fraud if there is a duty to speak, or when more info is needed to prevent the info given from being misleading

Fraud does not usually include misrepresentation of law

Both parties are presumed to be able to know the law (Exception: client relies on lying attorney)

"Ignorance of the law is no defense", because if it were, there would be a premium on maximum ignorance

Duress: the coercive threat of a wrongful act

Q: how to distinguish hard bargaining (= OK) from extortion (= bad), esp. "economic duress" -- taking wrongful advantage of financial weakness. How far away must the transaction be from the "willing buyer, willing seller" ideal?

Undue influence

Taking advantage of age, infirmity, etc. by one in a fiduciary or confidential relationship.

Example: attorney-client dealings: note Cal rules limiting attorneys as beneficiaries of wills. (Probate Code Sec. 21350 ff.)


notes and format (c) 2001-08 Robert H. Daniels