I) Basics of Contract Law

By Francis Morris,2014-06-29 09:42
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I) Basics of Contract Law ...

Contracts Outline

    I) Basics of Contract Law

     A) Sources of law and purpose

     1) Much of contract law was created through the common law

     2) Today much of this has been codified (e.g. UCC for sale of goods contracts)

     3) Contracts are intended to be sure parties know their obligations to each other

     B) Elements of a contract

    1) Agreement between parties such that a third party could determine their obligations

    “a meeting of the minds”

    2) Consideration something of value exchanged

    3) Enforcement a common feature but not a necessary element

    4) Reliance separate issue from the terms of the contract (common with promises)

    5) Miscellaneous elements

     a) Need not be written (except for real estate in California)

    b) No requirement to have a response from the other party if their performance is

    sufficient as a response your agreement forms the contract “Do X and I’ll pay Y”

     C) Uniform Commercial Code (UCC)

     1) Applies only to sale of goods contracts

     a) Services are not covered, but principles of UCC are often applied

     2) Should be treated like code, basic principles are very important

     a) Many states are adopting the UCC in whole or in part into their codes

     3) Pittsley v. Houser

     a) Asks if laying carpet is a separate service or part of the good itself

     b) Tests used by the court:

    i) Predominant factor is the purpose mostly for sale of a good or a service

    (when selling carpet are you selling the good or the installation)

    ii) Severance of the contract separate the goods and services sections

    iii) Apply the UCC even if situation is a service rather than a good

     D) Rationales for forming contracts

     1) Many businesses actually operate under ineffective or improper contracts

     a) These often serve perfectly well for what the businesses need

     b) Many business relationships rely on trust and history

    c) Much of contract law doctrine has arisen form defects in these sort of


     2) Explicit contracts are generally only created when specific performance is critical

     3) Creating a legal forum for resolving debates stops private (or illegal) dispute resolution

     E) Contract law and public policy

     1) Courts do not want to act as complaint bureaus or interfere with free exchanges

     2) Courts step in to ensure that appropriate agreements are enforced

     3) Only certain deals are enforced by courts

     a) In their terms contracts can stipulate specific types of dispute resolution

    b) If alternative dispute resolutions are inadequate or inappropriate the state can

    take over

    4) Contracts can even stipulate, as a term, the no enforcement regime be applicable so

    long as the consideration is appropriate and the term is explicit

II) Promises

     A) Philosophical views

    1) Moral philosophers hold that promises should be enforceable as contracts (by making

    the promise you induce reliance and create harm by backing out) Page 1 a) They do allow certain actions abrogate the obligation to adhere to the promise

    2) Legal doctrine has gone the other way, holding promises as unenforceable absent

    reliance (or some other extraordinary factor)

     B) Simple donative promises (Gifts)

Contracts Outline

     1) Theoretical origins

     a) Restatement:

     i) ?17 bargain requires mutual assent to the exchange and consideration

     1. Parties must reach a mutual bargain and assent to the terms

     ii) ?71 requirement of exchange; types of exchange

    1) Consideration requires bargaining for a performance or return


    2) Consideration is bargained for if it is sought by the promisor in

    exchange for his promise and given by the promisee in exchange

    for his promise

    3) Performance may consist of: a) An act other than a promise; b) a

    forbearance of a legal right; or c) creation, destruction, modification

    of a legal relation

    4) Consideration may be made or given to the promisor or a


     b) Reasons to require consideration

    i) People often promise in the heat of the moment and courts are unwilling

    to hold them to such hasty promises

     a) Promisor might not be able to perform (changed circumstances)

     b) Promisor may not want to perform upon reflection

     c) Promisee may not deserve the promise

    ii) Consideration serves as evidence of an intent to form a contract

     c) Dougherty v. Salt

     i) Aunt Tillie gives her nephew a note for $3000 so he’ll be “taken care of”

    ii) She says this is for him always doing for her, now she wants to do for

    him (past consideration)

    iii) She does not honor the note when it comes due

    iv) Issues: was there consideration?

    v) Procedural History:

     a) Jury found for the nephew set aside by the judge

    b) Appellate Court found the note valid evidence of consideration

    under the theory that she wouldn’t have signed it if she didn’t think

    she was getting value for it

    c) Cardozo (writing for the majority) reverses the appellate court

    saying that formal writing was not sufficient to create a contract, it

    was a simple donative promise for an executory gift (gift in the


    1) There was nothing of value exchanged that was viewed

    as consideration by both parties

    2) Past consideration cannot support a contract no bargain

    vi) Black Letter: reciprocal consideration is required to enforce a donative


     2) Consideration

    a) Consideration must be bargained for, if an element is simply essential to

    fulfilling a promise there is no consideration

    i) There is a grey area when an element is bargained for apply common

    sense, is it reasonable that someone would bargain for that consideration

    b) Element of form

    i) Modern courts seldom look at the adequacy of consideration, but they will Page 2 not honor contracts based on truly token consideration

     a) This reinforces the evidentiary nature of consideration

     b) If the form of contract is fulfilled courts typically honor it

    ii) Schnell v. Nell

Contracts Outline

    a) Nell had contracted with several friends of his dead wife to pay

    them $200 in exchange for $0.01 each (form of a contract) to honor

    her wishes

     1) He then died and his estate would not pay

    b) Plaintiffs sued arguing:

     1) It had the form of a contract

     2) Love/affection of wife and her contribution to the marriage

     3) Wife’s intent to give the money

    c) Court disposes of reason 2 as past consideration and reason 3

    as a gift and was left with reason 1

    1) Court found that the consideration was so nominal that it

    satisfied the form but not the force of a contract, it was

    simply a donative promise and not an enforceable contract

    2) Today courts may honor it, although the consideration

    was very nominal especially since this was liquidated

    value where the inadequacy of consideration is very blatant

     d) Holmes suggested that form was sufficient nd iii) Restatement 2 requires a bargain in fact, not simply a bargain in form

    a) Nominal consideration makes contracts for options or guaranties

    enforceable (especially when the consideration is actually given)

     iv) Seals no longer hold any real importance, States have split three ways:

     a) No value

     b) Rebuttable presumption of enforceability

     c) Limited enforceability

     3) Reliance

     a) Elements of reliance

     i) Reliance can make a donative promise enforceable nd ii) Restatement 2 ?90

     a) Four elements for reliance to apply:

     1. A promise

    2. Promisor should reasonably expect promise to induce

    action or forbearance

    3. Promisee actually relied on the promise

    4. Failure to enforce would create injustice

     b) Promissory estoppel

     i) Originally reliance barred claims of lack of consideration

     ii) Today reliance substitutes for consideration

     iii) Important distinction for remedies

    a) If party is estopped from pleading lack of consideration he must

    honor the contract

    b) If reliance is treated as an equitable solution then the party is

    only liable for the value the promisee reasonably relied on

     c) Remedies

    i) Expectation damages (forward looking, standard remedy) puts injured

    party in the state they would have been in had the contract been performed

     a) Compensates for what was not gained as a result of breach

    ii) Reliance damages (backward looking) puts the injured in the state

    they would have been in had the promise never been made

     a) Compensates for activities not undertaken as a result of promise Page 3 b) Covers costs incurred because of the promise

    Contracts Outline

     d) Cases:

     i) Kirksey v. Kirksey a) Man invites his widowed sister-in-law to come stay on his land,

    sets her up for a while, then evicts her

    b) The Supreme Court of Alabama decided that her brother-in-law

    made a simple donative promise and owed her no damages

    1) Restatements undid this allowing reliance as


    2) By relying on the promise she lost the ability to plant

    crops and retain her old home, now that she is evicted she

    is in a worse place than she would have been in if he had

    never made the promise

     ii) Times-Mirror

    a) Los Angeles initiated condemnation procedures on the Times-

    Mirror’s land b) Times-Mirror secured a new site and began building a new

    facility, but the city stopped condemnation proceedings

    c) The court required the city to perform and buy the site

     iii) Feinberg v. Pfeiffer

     a) Facts:

    1) At a shareholders meeting the company decided to grant

    Feinberg a pension of half her salary upon retirement (at her


    2) She continued to work for a while but decided to retire

    early because she could support her family on her and her

    husband’s pension

    3) The company subsequently reduced then eliminated her


    b) Feinberg claimed reasonable reliance on the pension and asked

    the court to enforce the contract

    c) Defendants claimed that the pension was a gift, not a contract,

    and therefore had the right to terminate at will

    d) Court held it was a contract

    1) Without the promise of the pension she could and would

    have continued to work and earn her full salary

    2) The court could have simply ordered compensation for

    the amount of lost wages she did not receive after she


    3) The company could have argued they only needed to

    compensate her to the point where she got sick and could

    no longer work

    4) The court enforces the original promise, but treats it as a

    contract and essentially awards expectation damages (what

    shoe would have expected to receive if the contract was


     iv) Hayes v. Plantations Steel

    a) Hayes decided to retire and his employer promises to pay him an

    annual amount to take care of him

    b) After control of the company changes hands the payments stop Page 4 c) Hayes sues and loses for two reasons

    1. He had already decided to retire before the promise was

    made so there was no reliance on that promise to retire (he

    Contracts Outline

    could not reasonably rely on it because he was not sure it

    would continue)

    2. His ex-employer and the new proprietors did not have

    knowledge that he was relying on the money for his

    retirement (if they did, or that he was passing up work then

    they might have been liable)

     v) Goldstick v. ICM Realty

    a) Court argues that there may be times when expectation

    damages are appropriate in some reliance situations

     vi) D&G Stout

     a) Facts:

     1) Stout was a liquor distributor in Indiana

     2) Stout was relying on Hiram Walker and Bacardi

    3) Bacardi told Stout they intended to continue distributing

    through Stout after which Stout enters into negotiations to

    sell their remaining assets but rejects an offer

    4) Bacardi then pulled out causing Stout to lose $500,000 b) Stout claims that Bacardi owes them the decrease in value as a

    reliance measure for injuring their bargaining position

    c) Bacardi argued that the distribution agreement was at-will and

    could be terminated at any time, so any reliance was unreasonable

    d) Court’s holding

    1) Bacardi argued this was like lost wages in an at-will

    employment contract (not compensable)

    2) Court viewed this more like a moving expense there is a

    defined liquidated damage suffered by Stout, not

    expectation damages (although these were damages they

    expected to receive)

     a) Stout lost the increased offer value $500,000

    3) Once Bacardi made the promise they could not simply

    revoke it knowing that Stout was relying on that promise

    during their negotiations

     vii) Walters v. Marathon Oil

     a) Facts:

    1) Plaintiffs contact Marathon about starting a fueling station


    2) Marathon promised to give them a franchise and to

    supply them with gas

    3) The Walters spent significant funds improving the site, but

    Marathon breached the contract

    b) Court held that they should receive expectation damages for the

    amount of gas they could reasonably have expected to have sold

    had Marathon honored the promise

    c) The court treats this as a donative promise, but award

    expectation damages

    1) Court treats this as a lost opportunity cost type of damage

     the Walters could have gotten a different franchise, but

    since they relied on the Marathon franchise they should

    receive the reasonable benefit of that reliance this goes to Page 5 what they could receive as franchise owners, not simply

    what they paid to improve the site

    2) The court only awards a year’s worth of damages in the

    assumption that the Walters can find a new business in that

Contracts Outline

    time in a pure expectation damages award the court would

    look to the total life of the contract and what those profits

    would have been (minus mitigation)

    III) Bargain, Unconscionability, Duress

     A) Consideration must be bargained for to create a contract

    1) As long as the bargain form is followed courts will typically not look at the amount of

    consideration (except in cases of liquidated damages that are just facially inadequate) nd B) Restatement 2 Sections

     1) ?71 (see above)

    2) ?72 except as provided for in ??73 and 74 any performance bargained for is


     a) ?73 performance of a settled legal duty is not consideration

     b) ?74 Settlement of claims

     1) Forbearance of an invalid legal claim is not consideration

     2) Forbearance of a valid claim is consideration

    3) ?79 adequacy of consideration if the requirements of consideration are met there are

    no further requirements for:

    a) A gain, advantage, or benefit to the promisor or a loss, disadvantage, or

    detriment to the promisee

    b) Equivalence in the values exchanged

    c) “mutuality of obligation”

     C) Statute of Frauds (highlights)

     1) Common law doctrine that requires certain kinds of contracts be in writing

     2) Has only limited applicability

     3) In California it applies to real estate contracts

     D) Cases:

     1) Hammer v. Sidway

     a) Facts:

    i) Uncle promises nephew $5000 if he refrains from drinking, smoking, or

    gambling until he is 21

     a) This is a unilateral contract a promise for an act/forbearance)

    ii) At 21 boy tells his uncle he has performed and uncle offers to hold the

    money for his nephew

    iii) After the uncle dies the estate refuses to pay out the money

    b) The estate argued that the nephew benefited from the forbearance and there

    was no mutual consideration, therefore no contract

    c) The court holds that the promisor need not receive a tangible benefit from a

    bargain, the promisee simply must give up some legal right to make the contract

    enforceable the forbearance is sufficient consideration

    d) Key holdings:

     1. Things must be bargained for

     2. Promisee must actually forebear a legal duty

     3. The promisee need not suffer a detriment nor the promisor a benefit

     2) Davies v. Martel Laboratory Services

    a) Employee is promoted and sent for an MBA by the company, but the company

    fires her and stops paying for her to go to school

    b) The court holds that she gave up a legal right to serve on the board of the

    company and in exchange the company owed her the schooling (mutual Page 6 consideration)

     3) Hancock Bank v. Shell Oil

     a) Facts:

Contracts Outline

    i) Lessee could only renew the contract for 15 year periods while Shell

    could terminate it on 90 days notice

    ii) Hancock gained control of the lease and tried to evict Shell by arguing

    that the contract was so one-sided that it lacked mutuality

    b) The court holds that the contract is not void simply because the terms were bad,

    there was mutual consideration and Hancock knew the terms getting in

     4) Batsakis v. Demotsis

     a) Facts:

    i) Plaintiff (creditor) loaned Demotsis 500,000 drachma in exchange for


    ii) Demotsis was stuck in Greece during WWII when she made the contract,

    is starving, and doesn’t care what she has to pay to get the line of credit

    iii) After the war she pays Batsakis back the fair value of the loan (~$25)

    and thinks that should be enough

    iv) She argued that she only entered into the contract out of desperation

    and it was therefore executed under duress (lack of consideration)

    b) The court rejects the argument of lack/failure of consideration she received

    the benefit of her bargain

     i) Creditor receives the full contract amount plus interest

    ii) The actual value of the currency to her at the time was likely much

    higher than the simple exchange rate courts are not in the habit of re-

    evaluating the value of bargains made, they simply look to see if the form

    of the contract was made and if the bargain is manifestly unreasonable

     E) Duress

     1) Duress at the time of execution can be grounds to abrogate a contract nd 2) Restatement 2

    a) ?175 when a contract is voidable for duress

    1. If a party’s assent is induced by improper threat by the other party that

    leaves no reasonable alternative

    2. If the party’s assent is induced by improper threat by another non-party

    the contract is voidable unless the other contracting party does not know of

    the threat if good faith and gives value it may be enforceable

     b) ?176 improper threats

    a) A threat is improper if:

    1. Threat is a crime or tort, or would be if it resulted in gaining


     2. Threat is criminal prosecution

     3. Threat to use civil process is made in bad faith

     4. Threat is a breach of good faith and fair dealing

     b) A threat is improper if the resulting exchange is not on fair terms and:

     1. Threat would harm recipient and not greatly benefit maker

     2. Prior unfair dealings enhance the effectiveness of the threat

     3. Threat is an unfair use of power for illegitimate ends

     3) Duress without an improper threat (falls under unconscionability)

    a) Terms of the contract seem manifestly unfair, perhaps as the result of inequities

    in bargaining position (Ms. Demotsis, maybe)

    b) Inducement to make bad deals convince someone to make a very bad deal

    with terrible terms

     4) Cases: Page 7 a) Chouinard v. Chouinard

     i) Facts:

     a) Conflict over ownership of the company

    Contracts Outline

    b) Company gets into bad financial situation, one of the members

    secured financing contingent on resolution of the ownership dispute

    c) Other members agree to resolve if he buys them out at an

    inflated rate apparently a duress situation

     ii) Reasoning

    a) The court agrees that this is a duress situation but enforces the

    terms of the contract he entered the people extorting the high

    price were not responsible for putting him in the negative situation,

    they simply took advantage of it, since they did not create the

    duress they are not penalized for exploiting it

     b) Eisenberg “Bargain Principle and its Limits”

     i) Hypo: Symphony musician with broken ankle and passing geologist

     a) Under common law two principles of contract enforcement apply:

    1. Rescuer did not cause the duress, so he should receive

    the benefit of the bargain he struck (no duty argument)

    2. The court does not judge the value of a bargain the

    musician received consideration for the consideration he

    promised (even if given under duress, what is the value of

    his life?)

     b) Reasons not to enforce the contract

    1. The reward is grossly disproportionate to the cost and risk

    to the rescuer

    2. The musician received tremendous benefit, what is that


    ii) Contract law is a body of principles created by states to determine when

    private deals should be enforced intended to regulate and protect economic transactions

    a) As a policy matter we want to enforce contracts that promote

    desirable social activities (like rescues)

     i) How much reward is required to encourage rescuing?

     ii) Perhaps enforcement will also deter risky activity

    b) Eisenberg suggests a bonus system that is high enough to

    encourage rescue activity but not so high as to deter people from

    taking actions

     iii) How states implement Eisenberg’s ideas

     a) New York price-gouging statutes (see pg 59-61)

    1) Statute is intended to deter gouging, but does not create

    a bright-line rule to define gouging

    2) Everything is defined in reference to unconscionability

    without defining what unconscionable means either

    3) Application in People v. Two Wheel Corp.

     a) Price increases ranged form 4-67%

     b) Court’s determination of unconscionability

    i) No evidence of shortage, only that the

    market would bear higher prices

    ii) Fact specific instance of unconscionability

    c) Two kinds of unconscionability recognized by

    courts: (interaction is unclear)

    1. Procedural: created by unfair contract Page 8 practices, how the contract is obtained

    2. Substantive: contract terms are ridiculously

    high or unfair

Contracts Outline

     F) Unconscionability

     1) Factors for determining unconscionability by the court

     a) Was there meaningful consent (did the person understand the terms):

     i) Did they understand the consequences of breach

     ii) What was their level of mental competency or ability

    iii) If the seller tailors the contract to a specific market they cannot then

    argue that they were unsure what market they are selling to, or the abilities

    of that market

     b) Possible standards a party may be held to:

    i) Should the seller have objectively know the buyer didn’t understand the

    terms of the contract (how much is the seller responsible for the buyer?)

    ii) Should the buyer be responsible for being sure they understand (unless

    the contract is overtly deceptive)

     a) Does the buyer have a reasonable alternative choice?

    iii) Is this sort of contract customary in the area (would buyers be used to

    entering into similar contracts)

     2) UCC ?2-302 Unconscionability

    (1) If the court finds the terms of a contract unconscionable they may choose not

    to enforce it in its entirety or just the flawed portions, or limit the application as they

    see fit

    (2) If a contract is claimed/appears unconscionable the parties shall be given the

    opportunity about its commercial setting, purpose, and effect to aid the court

     3) Why have a contract of unconscionability

     a) Protect people form harmful contracts they may not understand

    b) Channeling of behavior we want merchants to act morally and consumers to

    seek out information to give them greater bargaining power

     4) Cases:

    a) Williams v. Walker-Thomas Furniture Co.

     i) Case of an unconscionable contract for furniture payments

    a) As long as a balance remains of any item ever bought from the

    store all of the items serve as collateral (miss a payment and

    everything can be repossessed)

     ii) How to determine unconscionability

    a) Is it unconscionable on its face? look at the facts and


    1) The people entering these contracts are generally poor,

    perhaps under-educated, and unlikely to make good

    financial judgments

    2) The store has a distinct incentive to ignore the person’s

    situation to improve its’ own financial situation

    3) Might even argue contract was obtained by fraud

    iii) Who should be responsible for ensuring the parties understand the

    terms of the contract?

    a) The court implies that because the store knew the plaintiff’s

    financial situation they knew that she could not afford the new items

    she bought and sold them to induce a default

    b) Conversely, she had always been a good customer and the store

    may have assumed she had alternative sources of income

    c) The trend is that buyers should be liable for contracts they sign, Page 9 but that enforceability can be rebutted by evidence of:

     1. Flawed process and no meaning choice of alternative OR

     2. The terms of the contract “shock the conscious”

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    iv) Note from Kirby sellers can make themselves liable if they

    affirmatively go after a customer rather than allowing the customer to come

    to them

     b) Maxwell v. Fidelity Financial

    i) Facts:

    a) The Maxwells bought a solar water heater (that never functioned)

    that was ridiculously expensive and required their house as


    b) Subsequently they required an additional loan and when they got

    that their entire contract was rewritten into a new contract

    1) This is called a “novation” – extinguishing the old contract

    an replacing it with a new one

    c) Fidelity argued that the novation extinguished any

    unconscionability in the original contract

     ii) At the trial and appellate levels the novation argument was accepted

     iii) The state Supreme court looks at two issues:

     1. Was the original contract unconscionable

     2. Did the novation erase any unconscionability

    iv) Court then enters into an analysis of procedural and substantive


    a) Holding that substantive unconscionability alone is sufficient to

    render a contract invalid means that no amount of procedure can

    protect a defendant some argue procedure should be a complete


    b) Contract’s channeling function is intended to ensure both good

    procedure and good substance (we want well informed consumers

    and moral sellers)

    c) The court holds that the substance of a contract can serve as

    evidence of an inherent procedural defect (which can be rebutted)

    combination of both procedural and substantive unconscionability

     i) There is no express need to have both kinds of defects

    ii) Substantive unconscionability is enough (this may not be

    true in all jurisdictions or situations)

    d) Novation cannot graft a dead branch to a life tree the

    novation did not extinguish the original unconscionability

    IV) Mutuality

    A) Under classical views of contract law mutuality was critical because it showed that both partied

    had obligations under the contract and therefore both were bound by its terms (each had an

    obligation or neither did)

     1) Unilateral promises are unenforceable contracts

     2) Lack of mutuality can make a promise unenforceable

    B) Bilateral vs. unilateral contracts

    1) Bilateral conventional contracts, at the time of creation both parties exchange

    promises for a stated performance

    2) Unilateral a promise in exchange for performance (a party exchanges a promise for a

    specific performance) the completion of the performance makes the contract binding

    a) The doctrine of mutuality does not really apply because the parties are not really

    bound by the promise, they are bound by the performance if a party performs Page 10 then you are bound, but they are not bound to perform

    b) Mutuality hinges on the exchange of promises

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