Contracts Outlines Ii Spring 2002
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CONTRACTS OUTLINES II SPRING 2002.
AVOIDING ENFORCEMENT MISREPRESENTATION
R2d §161. When Non-Disclosure is Equivalent to an Assertion [silence] A person’s non-disclosure of a fact know to him is equivalent to an assertion that the fact does not exist in the following cases only: a) Where he knows that disclosure of the fact is necessary to prevent some previous assertion from being a misrepresentation or from being fraudulent or material b) Where he knows that disclosure of the fact would correct a mistake of the other party as to a basic assumption on which that party is making the contract and if non-disclosure of the fact amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing. (§161(b) is broad) c) Where he knows that disclosure of the fact would correct a mistake of the other party as to the contents or effects of a writing, evidencing or embodying an agreement in whole or part d) Where the other person is entitled to know the fact because of a relation of trust and confidence between them [fiduciary].
Note: Good faith and fair dealing means, not taking more than the legitimate fruits of the exchange/contract. However, there is no contract here. What does the term mean? Perhaps to create a level playing field. Courts are supportive of 2 situations: where the parties had a pre-existing and related contract, and a hidden defect in the item of purchase (where buyer cannot find the defect through ordinary diligence.
Rest. § 162: When misrepresentation is fraudulent or material. 1) Misrepresentation is fraudulent [subjective] if it induces another party agree and the maker, a) knows or believes that the statement is not true. b) does not have confidence that he states or implies the truth of the assertion, c) knows there is no basis that he states or implies the assertion.
Note: Fraudulent is when one party intended to misrepresent and/or had knowledge that the acts may not be adequately represented. There must be intent to mislead.
2) Misrepresentation is material if it would likely induce a reasonable person (objective) to manifest assent, or if maker knows that it would be likely to induce the other party to do so.
Note: Materiality means that statement must be significant enough for other party to rely on. In 2), party may be liable even if party does not know statement is not true.
In both §162, a plaintiff can satisfy a misrepresentation allegation by proving either materiality or fraud (scienter). A contract may be subject to rescission even if there is an innocent but material misrepresentation.
Rest. §164: When a misrepresentation makes a contract voidable. 1) If the party manifest assent induced by justified reliance in either a fraudulent or material misrepresentation, the contract is voidable. 2) If party manifest assent induced by justified reliance in either a fraudulent or material misrepresentation made by one who is not a party to the transaction, the contract is voidable. Exception: not voidable if the other party transacted in good faith and has no reason to know of misrepresentation either gives value or relies materially on the transaction.
1) If it is reasonable to do so, the recipient of an assertion of a person’s opinion as to facts not disclosed and otherwise known to the recipient may properly interpret it as an assertion a) That the facts known to that person are not incompatible with his opinion, or b) That he knows facts sufficient to justify him forming it (does he have the basis for making the statement?).
Note: Opinions are generally not actionable. Opinions can be actionable if the factual basis is contradictory to the opinion. Statement of opinion amounts to an implied representation that the person giving the opinion does not know any facts that would make the opinion false and that the person making the opinion knows sufficient facts to render the opinion.
A statement of opinion also amounts to misrepresentation of fact if the person giving the misrepresented his state of mind, ie. stating the he holds a certain opinion when in fact he did not). §159 see p. 650 of text.
Rest. §169: When reliance on an assertion of opinion is not justified. As recipient is not justified in relying on an opinion unless the recipient, a) is in a relation of trust and confidence to the person whose opinion is asserted that the recipient is reasonable in relying on it, or b) reasonably believes that, as compared with recipient, the person whose opinion is asserted has special skill, judgment or objectivity with respect to the subject matter, or c) is for some special reason particularly susceptible to a misrepresentation of the type involved.
Syester v. Banta p. 641 - an affirmative misrepresentation case Dft sold Plt thousands of hours of dance lesson while assuring Plt that she would become a pro. Dft used Plt's instructor to influence Plt into signing release from a prior suit. Current suit was brought for fraud and misrepresentation of sales and in the signing of release.
Court affirm jury verdict finding fraud.
Notes: - An 'out-of-pocket' rule allows plaintiff to recover the difference between what she parted with and what she received, plus consequential damages that she suffered prior to the discovery of the fraud. - A 'benefit of the bargain' rule; the plaintiff is put in the position she would have been in if the defendant had spoken truthfully. The court in Syester followed this rule. For examples see pg 651.
Hill v. Jones p.652 - Undisclosed information Plt were sold house that was infested by termites. Dft did not say anything about termite infestation. Plt did not explicitly ask. However, Plt did ask whether a ripple in the wooden floor was a termite problem, Dft said no, it was water problem.
Court held that there is a duty to disclose material facts in accord to §161. There is a duty to disclose material facts affecting the value of property known to the seller but no reasonably capable of being known to the buyer. A matter is material if it is one to which a reasonable person would attach importance in determining the choice of action in the transaction in question.
Notes: - In an affirmative misrepresentation case, the asserter is liable even if the assert id not know of the falsity as long as the statement is material. However, in a non-disclosure, courts normally will not enforce against the defendant if defendant did not know. It is when the defendant should have known that becomes a problem. Courts are split on this issue. Some look to see whether it was reasonable for the defendant not to know.
2 - Factors to help determine whether defendant acted in accordance to good faith and fair dealing: 1) The difference in degree of intelligence of the parties to the transaction, 2) The relation that the parties bear to each other, 3) The manner in which the information is acquired. Information that affects the value of the subject matter of the contract may be acquired by chance, by effort, or by illegal act. It makes a difference on the ethical quality of non-disclosure, 4) The nature of the fact no disclosed. If a vendor conceals an intrinsic defect not discoverable by reasonable care, there is a greater likelihood of the existence of a duty to disclose, 5) The general class to which the person who is concealing the information belongs. It is much more likely that a seller will be required to disclose information than a purchaser, 6) The nature of the contract itself. In releases, and contracts of insurance, practically all material facts must be disclosed; 7) The importance of fact no disclosed, 8) Any conduct of the person not disclosing something to prevent discovery. The active concealment of any material fact - anything that might prevent the purchaser from buying at the price agreed on is, and should be, as a matter of law fraudulent.
- In Laidlaw, the buyer somehow knew that the peace treaty was signed and the blockade was lifted. This would increase the price of tobacco. In the course of the exchange, the seller questioned on whether there is any news on anything that would affect the price of tobacco. The buyer did not answer. The seller later sues buyer for failure to disclose. The Supreme Court argued that the seller waived the disclosure by not pressing the buyer to answer. Although this might not seem equitable, the parties in Laidlaw are in a commodity trading market where the market prices are expected to fluctuate. Also, there is no incentive to have the parties do research on the developments of these markets. This would hinter the research market development sector.
- Prof. Kronman, on p. 661, argues that disclosure of deliberately acquired information should not be required because it is socially desirable to give parties an incentive to acquire information. Nondisclosure protects a party’s investment in the acquisition of such information. Casually acquired information, however, does not reflect an investment of resources and disclosure should be required when the holder knows that the other party is without such information, because disclosure is the least costly method of reducing mistaken contracts.
- Integration clauses: Hill court ruled that contract integration clause did not bar the purchasers’ action to rescind the contract on the basis of fraud because “any provision in a contract making it possible for a party thereto to free himself from the consequences of his own fraud in procuring its execution is invalid and necessarily constitutes no defense.”
- But, some courts distinguish between General (vague merger clauses) and Specific Disclaimers. General disclaimers that say you can’t rely on all verbal representations usually won’t free X from fraud action. But in Danann Reality v. Harris, it had a specific disclaimer “seller made no representations about expenses and profits”, and the buyer couldn’t win.
UNCONSCIONABLILITY
UCC §2-302: Unconscionable contracts or clauses 1) If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may [a] refuse to enforce the contract, or [b] may enforce the remainder of the contract without the unconscionable clause, or [c] may so limit the application of any unconscionable clause as to avoid any unconscionable result.
2) When it is claimed or appears to the court the contract or any clause maybe unconscionable the parties shall be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination.
3 Commentary to 2-302 - The basic test is whether, in the light of the general commercial background and the commercial needs of the particular trade or case, the clauses involved are so one-sided as to be unconscionable under the circumstances existing at the time of the making of the contract. - The principle is one of prevention of oppression and unfair surprise and not the disturbance of allocation of risks because of superior bargaining power. - Section 2 is for the court's consideration, not the jury's.
Notes: Restatement §208 express the same ideas as UCC 2-302 1).
Williams v. Walker p.669 The Plt bought household goods from Dft under installment payment plan. The installment contract had an add-on clause, whereby installments are made on pro-rata basis; failure to pay for one item results in repossession of all items not fully paid off. Each new item became security for all items not fully paid off. Plt failed to pay installment, Dft sought to replevy all items purchased by Plt.
Court reasoned that unconscionability is recognized to include an absence of meaningful choice on part of one of the parties and with terms that are unreasonably favorable to the other party. - Meaningful choice can be determined by examining the circumstances surrounding the transaction, such as a gross inequality of bargaining power, manner in which the contract was entered into (did each party to the contract, considering his education, have a reasonable opportunity to understand the terms of the contract). Court noted that normally one who signs a contract would be held to assume the risk of entering a one-sided contract. However, when a party has little bargaining power, hence little real choice, signs an unreasonable contract with little or no knowledge of the terms, an exception may apply.
- Reasonableness or fairness is considered in the light of the circumstances existing when the contract was made. The terms are then considered in light of the general commercial background and the commercial needs of the particular trade or case. Corbin suggest the test as being whether the terms are 'so extreme' as to appear unconscionable according to the more and business practices of time and place.'
Notes:
- Look at contract as of signing: the contract must be judged as of the facts existing at the time of signing it. The fact that one of the parties (usually the seller) acted in bad faith after the contract was signed has no effect on whether the contract itself was unconscionable (but the post-contract actions may constitute a violation of the party’s duty to perform in good faith, imposed by §1-203.
- Procedural unconscionability may refer to either lack of choice by one party or some defect in the bargaining process (such as quasi-fraud or quasi-duress). Substantive unconscionability relates to the fairness of the terms of the resulting bargain.
- Unconscionability is normally used as a defense (a shield not a sword). In other words, unconscionability can be use to rescind contracts or strike out unconscionable clauses, but is not normally use to provide restitution
- (Should the doctrine also apply price term in addition to provisional terms?) Ahern v. Knecht p. 677. The air- conditioner case. Plt called Dft to repair air-conditioner. Dft required $154 for the service call and told Plt that the charge was $762. Plt paid because she had an appointment. But, repairer did not repair the air-conditioner. Plt brought suit. Court allowed Plt to recover the remainder of her money minus the price of the service actually performed by Dft.
- Courts have divided in cases alleging unconscionable price terms because of the different views about how to determine when a price is excessive. Recently, courts have allowed for restitution and rescission of unconscionable contracts. However, compensatory damages are still normally avoided. 4 America Software v. Ali p. 683 Ali’s salary was composed of salary and commissions. The company allowed her to take a regular draw against commissions. If it exceeded the draw, she would get the commissions. If she didn’t meet the draw, then she was still allowed to take the draw, but the balance would carry over. If ultimately, she didn’t meet the draw, they wouldn’t make her return the payment. Commissions were only payable if the customer she recruited made actual payment with American Software. With voluntary resignation, her entitlement to commissions would cut 30 days thereafter. Her big clients didn’t pay within 30 days and American Software refused to pay. She sues under a theory of unconscionability.
Court discussed 2 elements in analyzing unconscionability: procedural and substantive. - Substantive unconscionability focus on the actual terms of the agreement while procedural unconscionability focuses on the manner in which the contract was negotiated and the circumstances of the parties.
- Indications of procedural unconscionability include 'oppression, arising out of inequality of bargaining power and the absence of real negotiation or a meaningful choice and “surprise, resulting from the hiding the disputed term in a prolix document.”
- Indication of substantial unconscionability include by contract terms so one-sided as to “shock the conscience.” Trade usage, whether the terms are commonplace. Ali court rejected the lower std. that the terms were unreasonable. Must shock the conscience.
- Procedural: Ali was an sophisticated businesswoman who had successfully negotiated several big contracts. Contract was not hard to understand, she acknowledged that she knew of the clause and what it meant. It was not a standard adhesion contract. She changed some provisions and had some bargaining power. She also had an attorney to review the contract.
- Substantive: Must be looked at at the time the contract was entered into. It is irrelevant what happened in hindsight. It is irrelevant that she was entitled to a large commission, but for the fact that client didn’t pay. Substantively, the ct. looks at allocation of risks. For π, risk was that she would be extremely successful and wouldn’t get all of the commissions. The risk to American was that if she was lousy and didn’t meet the draw, they would have to take a loss. It was not one-sided. Plus, the term was commonplace.
Notes: - Courts will generally emphasize that contracts should not be judged in hindsight. Subsequent performance may constitute breach of duty of good faith but has no bearing on unconscionability at time contract was made.
PUBLIC POLICY
Contracts that are unenforceable because of 'illegality' in that they violate or runs directly contrary to public policy.
Karlin v. Weibberg p 716 - post-employment restrictive covenant Plt, a doctor, entered into an employment contract with Dft, a new doctor, which contain terms restricting the Dft's ability to practice in a 10 mile radius of Plt's practice after the employment was terminated. After employment agreement ran, Dft stayed as a partner with Plt. However, partnership later ended and Dft opened up a new practice near to the Plt.
The Court held that restrictive covenants are not per se violations of unconscionability. - A restrictive covenant will be found to be reasonable when [1] it protects the legitimate interest of the employer, [2] imposes no undue hardship on the employee, [3] is not injurious to the public. - The Court distinguishes Dwyer, a case holding attorney restrictive covenant as per se unreasonable. Court argued that in Dwyer the covenant denies clients the right to seek an attorney of her choosing, where as in this case the patients could travel to see the Dft. Also, the ABA specifically disallows such practices and the courts have been
5 given the power to regulate lawyers. In this case, the American medical association does not disallow restrictive covenants.
Considerations & Limitations: - After it is determined that employer has a legitimate interest to protect, the covenant will be unenforceable beyond the period of time which the employer needs to protect his practice. - Nor will the covenant be enforceable beyond the geographical area needed to protect the employer’s practice. Whether the geographical dimensions of the covenant make it impossible, as a practical matter, for existing patients to continue treatment. - The covenant will be unenforceable if it restricts the employee from engaging in activities not in competition with those of his former employee. - Also, must consider undue hardship. A showing of personal hardship, without more, will not amount to an “undue hardship.” But, if you’re denying him the right to earn a livelihood within the relevant community then it seems suspect. - Must examine the effect that enforcement of the covenant would have on public interest. The public interest being taken into account is patient choice to choose which physician they want to see. If the covenant completely excludes patient choice, it will favor striking the covenant.
Notes: - Examples of covenants that could be enforced. 1) Buyer purchases business, doesn’t want seller to compete with buyer in the business he just sold. 2) partners being prevented from competing with the partnership after he leaves 3) prevents an employee from disclosing or using trade secrets gained from employer - California Ct. in Howard v. Babcock acknowledges that its law firms are not stable and partners leaving are a problem and the interest is legitimate so they decide although going against weight of authority, the preventing partners from competing with the firm is enforceable. - Traditionally courts have been willing to adopt a blue-pencil approach. If they felt that a covenant was overbroad, the approach was to redraft it so it was reasonable. Most will enforce overly-broad non-compete up to reasonable limits. There is a backlash against this recently. In Kolani v. Gluska: will reform contracts on the grounds of mistake, but wont blue-pencil to save an “illegal” contract. - The blue-pencil approach gives employers the incentive to create an overbroad covenant and wait for employee to bring a lawsuit and rely on the courts to reform it.
R2d §187 Non-Ancillary Restraints on Competition [clearest example is an agreement between competitors to fix prices] A promise to refrain from competition that imposes a restraint that is not ancillary to an otherwise valid transaction or relationship is unreasonably in restraint of trade.
R2d §188 Ancillary Restraints on competition 1) A promise to refrain from competition that imposes a restraint that is ancillary to an otherwise valid transaction or relationship is unreasonably in restraint if a) the restraint is greater than is needed to protect the promisee’s legitimate interest, or b) the promisee’s need is outweighed by the hardship to the promisor and the likely injury to the public. 2) Promises imposing restraints that are ancillary to a valid transaction or relationship include the following: a) a promise by the seller of a business not to compete with the buyer in such a way as to injure the value of the business sold; b) a promise by an employee or other agent not to compete with his employer or other principal c) a promise by a partner not to compete with the partnership.
R.R. v. M.H. p 730 Agreement provided that surrogate will be inseminated with semen from Natural Father. Natural Father will have full legal parental rights. Mother’s rights, however would not terminate automatically by letting Father take the child, but if she sought to enforce her parental right, by way of custody or visitation rights, she would forfeit her rights under the
6 agreement and would be obligated to reimburse father for all expenses and fees. The mother ended up wanting to keep the baby and did not give the money paid to her back.
Court cited to a NJ case Matter of Baby M, where the court held that surrogacy is not illegal when the surrogate mother volunteers, without any payment, to act as surrogate and is given right to change her mind. The Court here noted that the MA law also states that payments towards expense of birth may be made but no direct payment for the custody rights. As a practical matter, court noted that although the money was paid for expenses, mother had virtually surrendered her parental rights because she has to pay back the money and reimburse the natural father for all expenses should she revoke the contract. Court also noted that by statute, the mother cannot be make the decision to give up the baby until 4 days after giving birth to the baby. Here the mother had decided before becoming pregnant.
Notes:
- The court held that if there is no money involved and that the mother has at least 4 days after delivery to make the decision, the surrogate would be enforceable. But, for all practical purpose this will not induce people to enter into such a contract.
- In contrast to this case, Johnson v. Calvert: Calverts supplied both egg and sperm to Johnson. The court reasoned that gestational surrogacy does not involve surrender of parental rights for money because the surrogate is being paid for gestating service and not for surrender of parental rights. It was not involuntary servitude b/c woman could abort. They felt that prior decisions were too paternalistic. They felt that women could enter into these contracts know what they are doing. The court puts alot of weight on who is the biological parent (R.R. court recognize this in footnotes). - Presents the purest of form of public interest. None of the principles of avoiding enforcement would apply (no unconscionability, no fraud, no duress etc) there is no question on the voluntary and fully informed nature of the case.
R2d 178: When a Term is Unenforceable on Grounds of Public Policy 1) A promise or other term of an agreement is unenforceable on grounds of public policy if legislation provides that it is unenforceable or the interest in its enforcement is clearly outweighed in the circumstances by a public policy against enforcement of such terms. 2) In weighing the interest in the enforcement of a term, account is taken of a) the parties’ justified expectations, b) any forfeiture that would result if enforcement were denied, c) any special public interest in the enforcement of the particular term 3) In weighing a public policy against enforcement of a term, account is taken of a) The strength of that policy as manifested by legislation or judicial decisions, b) The likelihood that a refusal to enforce the term will further that policy c) The seriousness of any misconduct involved and the extent to which it was deliberate, and d) The directness of the connection between the misconduct and the term.
JUSTIFICATION FOR NONPERFORMANCE
I. MISTAKE
Mistakes may constitute an excuse from performance if, when the contract was made, facts not known makes the desirability of the contract unfavorable to one party. In order for the mistake doctrine to apply, the facts must be in existence at the time the contract was made, but was unknown to at least one of the parties. These are normally not easy cases to win. Parties normally enter into a contract with some degree of incompleteness of information and foreseeability. Any thing could occur to make a contract unfavorable to one party. People take risks and if the law is liberal in letting people out of a contract b/c some risks manifested, a lot of contracts would be void. The courts are quite skeptical about allowing rescission of such contracts.
7 Mutual mistakes In a mutual mistake case, there is a problem of whether there was mutual assent necessary to the formation of valid contracts.
Rest. §152: When mistake of both parties makes a contract voidable 1) Where a mistake of both parties at the time a contract was made as to the basic assumption on which the contract was made has a material effect on the agreed exchange of performances, the contract is voidable by the adversely affected party unless he bears the risk of the mistake under §154.
2) In determining whether the mistake has material effect on the agreed exchange of performances, account is taken of any relief by way of reformation, restitution, or otherwise.
Rest. §154: When a party bears the risk of a mistake A party bears the risk of a mistake when a) the risk is allocated to him agreement of the parties, or b) he is aware, at the time the contract is made, the he has only limited knowledge with respect to the facts to which the mistake relates but treats his limited knowledge as sufficient, or c) the risk is allocated to him by the court on the ground that it is reasonable in the circumstances to do so.
Leenawee County Board of Health v. Messerly p. 747 A small apartment was sold to the Plts. At one time, the plot was an acre and if it was still that big, the parties could fix the problem by installing a new septic tank. The Plts bought the apt and days after they found out that the septic tank did not satisfy legal criteria and the city condemned the property. There was no way to make the property habitable. The Plts wanted the court to rescind the contract because of mistake.
Court rejected the categorization of mistakes as those that affect the essence of the consideration from those which go to its quality or value (essence/collateral distinction). The court adopted the approach of Rest. §152 and 154.
The elements of §152(1) are: 1) Requirement that the mistake be mutual, 2) Fact is in existence at the time the contract was made, 3) The mistake goes to the basic assumption of the contract.
Here, the basic assumption was that the property would generate revenue. Court applied §154 and pointed out that the first section applies to this case because there was a clause in the contract that the purchaser accepts the property 'as is.'
Notes: - Looking at Rest 154, the drafters addressed the allocation of risk as a factor that should be considered, 'did the agreement state an allocation of risk.' if there were no allocation of risk in the agreement, the rest. look to whether one party was lacking in diligence in finding out. Finally, if these fail, the rest. looks to who is the better bearer of the cost of mistake or risk.
- In the Gartner case (p754), the court argued that the wet land regulations is difficult to determine. It was not very fair for the buyer to bear the risk in this case. The court argued that the clause that buyer take the land and all regulations subjected to, is not fair. The court emphasized that the seller's agent had told the buyer that property zone was ok for what the buyer would want to do. (the agent was not aware of the zoning regulations). In this case the buyer could have used a misrepresentation to recide the contract see Rest 164. (you don't need intentional misrepresentation to succeed.) The Garnter case probably fit better under the misrepresentation argument.
- Derouin v. Granite p.757. The buyer had allowed too much time to run and made changes to the property and the court refused to rescind the contract. (buyer bought a house with a defective chimney). Court would have granted rescission, but b/c of the extensive improvements, wouldn’t give rescission. Can’t put the parties back to status quo. 8 - In a residential case, the result would be quite different. Implied warranty of habitability. Landlord has superior control, and it’s only fair that he can’t lease out property that is not habitable. But in the Lenawee case, it is a commercial setting and the Pickles aren’t considered to need that kind of protection.
Unilateral mistakes
Rest. §153: When mistake of one party makes a contract voidable Where a mistake of one party at the time a contract was made as to a basic assumption on which he made the contract has a material effect on the agreed exchange of performances that is adverse to him, the contract is voidable by him if he does not bear the risk of the mistake under the rule stated in §154, and a) the effect of the mistake is such that enforcement of the contract would be unconscionable, or b) the other party had reason to know of the mistake or his fault caused the mistake.
Wil-Fred v. Metropolitan Sanitary District p.758 Wil-fred’s subcontractor, Ciaglo, was mistaken and thought that large gravel trucks could drive across plastic pipes, and so submitted a low bid. 2 days after submitting its bid, Wilfred’s realized Ciaglo’s error and tried to withdraw. Sanitary Dept. forced the bid on them. Wil-Fred wanted rescission alleging that the company would be irreparably injured if forced to perform the contract at such an unconscionably low price or if forced to forfeit its $100,000 bid deposit. Sub, Cialgo claimed that it would go bankrupt if forced to perform.
The court cited four factors for determining whether a unilateral mistake may offer grounds for rescission. 1) Unilateral mistake relates the material feature of the contract? 2) Mistake occurred notwithstanding the exercise of reasonable care, 3) Mistake is of such grave consequence that enforcement of the contract would be unconscionable, 4) Other party can be placed at status quo.
The court noted that for 1), the Plt stands to lose $100,000 or 10% of the contract price. As for 2), the court noted that Ciaglo had a good track record and their mistake was partially the result of the District's misleading specifications. (Under §153(a), if the mistaken party is negligent, the party might not be able to get rescission. However, Ciaglo might satisfy 153(b) where it is possible that District is responsible for the mistake. The court thought that Dft had exercised reasonable care by reviewing the price quotations twice and relying on Ciaglo which had honored its past price bids. The court believed that the Plt and Ciaglo would suffer grave consequences (loss of bonding capacity and bankruptcy). Finally, court noted that the District was notified by Plt that there was an error before the opening of the bids.
Notes: - If one party were in fact aware of the other's material mistake (or should have known because of the contract being 'too good to be true'), this would be a factor militating in favor of a duty to disclose (§161). §153 permits avoidance of a contract for 'mistake of one party' by either 1) a mistake such that enforcement would be unconscionable or 2) that other party either has reason to know of or be responsible for causing the mistake. - Unconscionability in context of §208 or UCC §2-303 is complex. However 'unconscionable' in the context of §153 seems to mean merely severe enough to cause substantial loss (Wil-Fred "substantial hardship.") - Many courts have held that a unilateral mistake must be 'non-negligent,' but there is a clear tendency to relax this requirement where the proof of mistake is strong and the effect of enforcement will be devastating or at least severely injurious to the mistaken party. See §157, expressly negates any requirement that the mistaken party be non-negligent, requiring only that its conduct not fall below the level of good faith and fair dealing.
II. CHANGED CIRCUMSTANCES: IMPOSSIBILITY, IMPRACTICABILITY AND FRUSTRATION
[Rules on Impracticability]
Rest § 261. Discharge by Supervening Impracticability
9 Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary. Rest §261, Comment d.: makes clear that mere lack of profit under the contract is insufficient: “Impracticability means more than impracticality. A mere change in the degree of difficulty or expense due to such causes as increased wages, prices of raw materials or costs of construction, unless well beyond the normal range, does not amount to impracticability since it is by this sort of risk that a fixed price contract is intended to cover.” . Comment d also provides: a severe shortage of raw materials or of supplies due to war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, which either causes a marked increase in cost or prevents performance altogether may bring the case within the rule stated in this Section. . Comment b, “basic assumption”: is also simple enough in the cases of market shifts or the financial inability of one of the parties. The continuation of existing market conditions and of the financial situation of one of the parties are ordinarily not such assumptions, so that mere market shifts or financial inability do not usually effect discharge under the rule stated in this Section. [i.e. unexcused from performance and liable for breach]
UCC §2-615. Excuse by Failure of Presupposed Conditions Except so far as a seller may have assumed a greater obligation and subject to the preceding section on substituted performance [UCC § 2-614]:
(a) Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty under a contract for sale if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.
(b) Where the causes mentioned in paragraph (a) affect only a part of the seller's capacity to perform, he must allocate production and deliveries among his customers but may at his option include regular customers not then under contract as well as his own requirements for further manufacture. He may allocate in any manner which is fair and reasonable.
(c) The seller must notify the buyer seasonably that there will be delay or non-delivery and, when allocation is required under paragraph (b), of the estimated quota thus made available for the buyer.
[Rules on Impossibility]
Rest. § 262. Death or Incapacity of Person Necessary for Performance If the existence of a particular person is necessary for the performance of a duty, his death or such incapacity as makes performance impracticable is an event the non-occurrence of which was a basic assumption on which the contract was made.
Rest. § 263. Destruction, Deterioration or Failure to Come into Existence of Thing Necessary for Performance If the existence of a specific thing is necessary for the performance of a duty, its failure to come into existence, destruction, or deterioration as makes performance impracticable is an event the non-occurrence of which was a basic assumption on which the contract was made.
Rest. §264. Prevention by Government Regulation or Order If the performance of a duty is made impracticable by having to comply with a domestic or foreign government regulation or order, that regulation or orders is an event the non-occurrence of which was a basic assumption on which the contract was made.
UCC §2-613. Casualty to Identity Goods Where the contract requires for its performance goods identified when the contract is made, and the goods suffer casualty without fault of either party before the risk of loss passes to the buyer, or in a proper case under a "no arrival, no sale" term (Section 2-3240 then
(a) if the loss is total the contract is avoided; and
10 (b) if the loss is partial or the goods have so deteriorated as no longer to conform to the contract the buyer may nevertheless demand inspection and at his option either treat the contract as avoided or accept the goods with due allowance from the contract price for the deterioration or the deficiency in quantity but without further right against the seller.
[Rules on Frustration]
Rest. §265 Discharge by Supervening Frustration Where, after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary.
See also UCC §2-615
Impossibility: Some intervening event that was unforeseen (not = unforeseeable) that renders the performance impossible. [Usually applies to destruction of unique goods, such as a racehorse]
Impracticability: performance is not literally impossible, just extremely burdensome and difficult to the we point we call it impracticable. . Mineral Park Land v. Howard: ∆ agreed to extract all the gravel from π’s land to build a bridge. They began digging, then hit water. It was demonstrated to the court that it would cost 10x-12x as much to continue extracting wet gravel. Court said that neither party contemplating extracting gravel under water, and that the burden on ∆ was too high. Not a risk he assumed. [Wilmarth note: this seems like a mutual mistake case. But we’re focusing on intervening impracticability. For the exam, if it is a condition that exists before the contract forms, and one or both of the parties don’t know about it, assume it is a mistake case.
Frustration of purpose: sort of a subset of impracticability. . Krell v. Henry (p. 772): ∆ wanted to view Edward VIII’s coronation parade. Was called off. Court let ∆ off, said that both parties understood that the entire purpose of renting the hotel suite was to view the coronation parade. Contract had lost all its value to ∆ because of a supervening change in extrinsic circumstance.
. R2d incorporates the doctrine of impossibility (§262, 263, 264), impracticability (§§261, 266) and frustration (§§265, 266). . Unless it was a likely occurrence, the courts haven’t required perfect foresight because hindsight is always 20/20. . UCC 2-617 addresses impracticability. . If it is a scrivener’s mistake, the court can reform the contract, but can’t re-allocate risks
Karl Wendt Farm Equipment Co. v. International Harvester Co. F: IH sold their farming machinery business to Case. Case picked which dealerships they wanted in areas of “conflict” where they already had dealerships set up. Did not pick Wendt. IH acknowledges that the contract had a standard clause that if either party wanted to voluntarily terminate, have to give 6 months notice.
To make out a claim for the defense of frustration, according to a South Dakota Ct. followed by this ct.: 1) The purpose frustrated by the supervening event must have been the principal purpose (the object must be so completely the basis of the contract that, as both parties understand, without it the transaction would make little sense. (§265 Comment a). 2) The frustration must be “substantial” (it is not enough that the contract has become less profitable for the affected party or even that it will sustain a loss. The frustration must be so severe that it is not fairly to be regarded as within the risks that he assumed in the contract. (§265, Comment a) 3) The frustrating event must have been a “basic assumption of the contract”
H: . Appellate court felt that impracticability did not apply—need more than a market downturn. “neither market shifts nor the financial inability of one of the parties changes the basic assumptions of the contract such that it may be 11 excused under the doctrine of impracticability. R2d §261, Comment b. To hold otherwise would not fulfill the likely understanding of the parties as to the apportionment of risk under the contract. IH had alternatives. In accordance with good faith and fair dealing, the court felt that there should have been some negotiation, and only in an emergency situation could termination be appropriate. . Frustration of Purpose wasn’t allowed to go to jury. IH appealed, but court said that “mutual profitability” was the “primary purpose.” This Ct. rejected this argument b/c the “primary purpose” analysis would be meaningless b/c “mutual profitability” would be implied as the primary purpose of every contract. . Section II of the opinion. IH argued that under the contract they could either add or subtract different lines of equipment at its discretion. This meant that they could delete all of them. Court said that if it were read that way, the 6 mos. Termination clause would be meaningless. In contract interpretation: interpret it to make all the clauses mean something.
Dissent: takes a different view on how severe the market shift was and felt that the jury should have been able to decide.
Northern Corp. Chugach Electric Co. (Alaska 1974): Two parties agreed that a rock needed to be dug up from the land and that the rock would then be dragged on the ice. The winter was particularly warm, and the ice would not support the weight of the rock. Alternative transportation would be expensive. Contract was rescinded by arguing that the parties did not assume this unforeseen intervening cause.
12 Notes: pp. 783 - 786 Elements of the doctrine of impracticability of performance and frustration of purpose are essentially the same. They require the disadvantaged party to show: 1) substantial reduction of the value of the contract (“performance is made impracticable” or ”a party’s principal purpose is frustrated 2) because of the occurrence of an event, the nonoccurrence of which was a basic assumption of the contract; 3) without the party’s fault; and 4) the party seeking relief does not bear the risk of that occurrence of the event either under the language of the contract or the surrounding circumstances. [Compare R2d §§261 and §§265; UCC §2-615 is also very similar b/c it predated Rest.]
Harriscom v. Harris (p. 789) [impracticability due to government interference] F: ∆ contracted with π to sell radios. Π is a foreign firm that distributes radios to Iran. US Gov. refused to let ∆ export model 2301 to Iran. After negotiations, ∆ was allowed to fulfill 3 out of remaining 8 outstanding orders to Iran. Π sustained a loss in performance bond to Iran, and to ∆. Π alleged that ∆ made a voluntary settlement with the government. Π sues for breach of k for the five remaining unfilled orders.. H: The court argued that ∆ did not have a meaningful choice but to submit to the governments demands. Also, the contract specifically contained force majeure clauses to excuse ∆ from performance under present circumstances, namely “governmental interference.”
Notes: . As the case suggests, when the event on which the claim of impracticability rests is some form of governmental action, the courts have been much more willing to grant relief than cases in which the event is war, natural disaster, or market change. . UCC §2-615 makes specific mention of “compliance in good faith with any applicable foreign or domestic governmental regulation or order” as the basis for relief . R2d §264: recognizing compliance with foreign or domestic governmental order as a basis for excuse under the doctrine of impracticability. . Examples: contract to convey easement discharged when govt. condemned land; performance of strip mining lease frustrated by “public outcry” and “flood of environmental legislations and litigation” that followed . It is important to note that under the analysis in Harriscom, it is not necessary that the law require or prohibit conduct, so long as the party seeking relief is acting in good faith compliance with the law (International Minerals & Chemical Corp v. Llano, Inc.: buyer of natural gas under long-term supply contract excused by compliance with governmental environmental regulation, even though buyer took action earlier than law required it to.) . Despite this strong policy in favor of excuse where performance is prevented by supervening governmental action, UCC in Comment 11 to §2-615 also states generally that the excused seller “must fulfill his contract to the extent that the supervening contingency permits.” Do you think ct. in Harriscom gave too little consideration to π’s contention that ∆ might have been able to conduct some of its Iranian business through its Indian licensee? . If relief for impossibility b/c of governmental regulation should be available to buyers as well as sellers, it seems that the court might at least have granted Harriscom’s claim for refund of the deposit it paid on the sale contracts. R2d §272 comment b, suggesting the appropriateness of restitution in cases where one party has rendered some performance under a contract which is later discharged for reasons of impracticability or frustration. . Ct. in Harriscom relies on the force majeure clauses in the k. Besides governmental regulation, force majeure clauses also cover other excusing events such as windstorm, fire, flood strikes, and labor disputes. Force majeure clauses for the most party track ground now covered by UCC §2-615 and Rest. But may attempt to go further and permit excuse where the law would not do so. Cases have shown that this is permitted. But of course, sweeping “exculpatory clauses” can be struck down and tested against good faith. . Impossibility, impracticability, and frustration of purpose are excuses from performance, but courts will not go further and reform the contract to acct. for changes in circumstance.
Modification
Problem 9-3
Alaska Packers’ Association v. Domenico (p. 800) 13 H: Pre-existing duty rule: Where a party merely does what he is already obligated himself to do, he cannot demand an additional compensation there. Rest. §73: No consideration, no binding modification.
Notes:
R2d §89. Modification of Executory Contract A promise modifying a duty under a contract not fully performed on either side is binding a) if the modification is fair and equitable in view of circumstances not anticipated by the parties when the contract was made; or b) to the extent provided by statute; or c) to the extent that justices requires enforcement in view of material change of position in reliance on the promise.
. R2d §89(a): relief from “unanticipated difficulties” can be sufficient consideration for a modification benefiting the affected party. §89 Illustration 1: when solid rock unexpectedly encountered making removal 9 times more expensive, owner’s promise to pay increased amount for excavation is binding). . Basically, R2d §89doesn’t go as far as UCC, but simply says that there are some circumstances where a modification may be binding w/o consideration. §89(c): modification will induce a material change in position such that injustice will result if enforcement is not forthcoming . Schwartzreich v. Bauman-Basch (p. 808): Employee reported to employer that he had a better salary offer. The parties tore up old contract and wrote a new one. So, there was mutual rescission followed by a new and valid contract (fresh consideration).
Kelsey-Hayes Co. v. Galtaco Redlaw Castings Corp. (p. 809) F: Galtaco supplied castings to KH a supplier of brake assemblies. KH agreed to 2 price modifications. They had a req. k on a fixed price basis—Galtaco had agreed to fulfill KH’s needs. H: Galtaco made an improper threat and KH had no other reasonable alternatives except to assent. This is sufficient for a claim of duress. R: . Although Galtaco was losing money, but they had no legitimate defense to nonperformance. They didn’t argue impracticability or change circumstance that would justify recission. . For duress, a buyer coerced into executing a modification to an existing agreement must “at least display some protest against the higher price in order to put the seller on notice that the modification is not freely entered into.” The court felt KH by protesting informally had given Galtaco enough notice that the matter was unsettled.
UCC §2-209(1): The drafters of the UCC express the view that one-sided modifying agreements, do not support consideration, are commonplace occurrences and should be routinely enforced except in the present of special circumstances. Of course “any modification must meet the test of good faith. Any modification exhorted without good faith would be invalid.”
UCC §2-209. Modification, Rescission and Waiver 1) An agreement modifying a contract within this Article needs no consideration to be binding. 2) A signed agreement that has a “no oral modification” clause, the NOM clause is ineffective (i.e. not binding) if it is contained on a form supplied by a merchant unless either 1) the other party is also a merchant or 2) the other party (usu. customer) has separately signed the NOM clause. This permits parties to make their own statute of frauds. 3) If falls under statute of frauds, must be in writing 4) Although attempt of modification does not satisfy the requirements of subsection 2 or 3 (a valid no-oral- modification clause), it can operate as a waiver 5) Party who has made a waiver can retract the waiver by reasonable notification that strict performance will be required of any term waived, unless other party has materially changed their position in reliance on waiver.
Comments to UCC: Comment 2: . No consideration, but modifications must meet the test of good faith. Use of bad faith to escape performance is barred and the extortion of a modification without legitimate commercial reason is a violation of duty of good faith.
14 . The test of “good faith” btwn merchants or as against merchants includes observance of reasonable commercial stds. of fair dealing in the trade (§ 2-103), and in some situations may require an objectively demonstrable reason for seeking a modification. . The reason need not rise to the level to be excused from performance under 2-615, 616 Comment 3: . Subsections (2) and (3) are intended to protect against false allegations of oral modifications. . The Statute of Frauds provisions of the UCC are expressly applied to modifications under subsection 3. The “delivery and acceptance” test is limited to goods that have been already accepted (in the past). Modification cannot be proven with oral testimony if the price is more than $500 since the modification must be shown by an authenticated memo. . Subsection 2 permits parties to make their own Statute of Frauds in regards to any future modification. If a consumer is held to it, must be separately signed. Comment 4: . Subsection 4: gives legal effect to the parties’ actual later conduct such that can waive no oral modification (subsections 2 & 3). Subsection 5 regulates how the waiver works. Example: Buyer and seller have k that has NOM clause and also sets firm delivery date. Buyer tells Seller orally, “I won’t insist on adherence to firm delivery date— you can take an extra 3 wks.” Buyer will probably be held to have waived the benefit of the no-oral-modification clause, and will thus be held to have effectively modified the contract to provide for a later delivery date.
Roth Steel Products v. Sharon (cited by Kelsey-Hayes) applies a two-part test. 1. A party may in good faith seek modification when “unforeseen economic exigencies existed which would prompt an ordinary merchant to seek modification in order to avoid a loss on the contract 2. Even where circumstances do justify asking for a modification it is nevertheless bad faith conduct to attempt to coerce one, by threatening breach. . On this point, the court conceded that the inference of bad faith arising when bad faith is threatened may be rebutted if the party has a good faith, legitimate defense/excuse for not performing. Under the UCC, “honesty in fact” is required.
. Most courts are more relaxed than the Roth Ct. and only require that there be a good faith reason for asking for the modification. . “secret intention to never pay the higher prices” may amount to bad faith on the buyer’s part. In KH, informal protest, not formal reservation of rights, was enough, but in United States ex rel. Crane Co. v Progressive Enterprises, Inc., buyer’s secret intention never to pay higher price not in keeping with good faith’s requirement of “honesty in fact.” This decision was limited later by 4th Cir. by recognizing that ∆ asking for modification was asking in good faith, and there was no duress. The problem of π not being honest was not the focal point of the decision. . Some cts. seem to suggest that if there ia good faith reason for requesting modification, there is a duty on both sides to make some concessions.
Brookside Farms v. Mama Rizzo’s, Inc. [interaction of modifications & Statue of Frauds] F: Fixed price k for delivery of basil. The supply conditions changed and the basil supplier requested various increases in prices. Π sues Mama to recover $ on the basil that Mama accepted but did not pay for. H: . As to first price increase, Mama promised to put it in writing and a valid writing under Statute of Frauds only requires “some writing” signed by the party against whom it is to be enforced (here, Mama). Since they made one promise, they made an implied promise to change the other two and Brookside relied on this promise. On estoppel grounds, they made a valid written modification of the contract (not too convincing). Based on these actions, MRI cannot now invoke the NOM clause to bar π’s claim that no valid modification occurred. . Also, regular statute of frauds 2-201 should apply to 2-209 (Wilmarth not wholly convinced, but court rests decision on this). An exception to the Statute of Frauds is that Mama ordered, paid and accepted the goods. Actual performance can override statue of frauds b/c that is proof that a contract exists. Thus, the payment due on the 3,041 lbs. shipped is enforceable. ∆ is entitled to payment. The “no waiver” clause could not save ∆ here. Their argument that the NW protected them from waiver of the NOM clause fails although they could still argue that they didn’t waive NOM clause because this falls outside of statute of frauds the transaction need not be in writing.
Notes: 15 . Waivers are one-sided concessions: “ok, you can be 5 days late on this shipment.” Waivers, by their nature don’t require consideration. If something was given for the waiver, however, it is binding just like a little contract on its own. Absent consideration, waivers are generally retracted up until the time a particular performance is to occur. Of course, if the other party has detrimentally relied, then you can no longer retract under PE. . 2-209(4) and (5) can be implied by conduct or communications. It is not clear that a NOW clause has any real standing under 2-209, it is not clear that parties can contract to make the a no waiver clause such that it cannot be binding unless it is in writing and signed. . UCC 2-209 imposes no formal requirement on modifying an agreement, except that 2-205 does impose a writing requirement for a firm offer. Most courts have held that a modification must be in writing not when the modification brings an oral contract within the statute. . Commentators have disagreed: under 2-201 memorandum only need specify quantity and price can be expressed orally. Thus, oral modification would be enforceable unless it would change the quantity term or increase the price above $500 UCC threshold. . 2-209(4): although an attempt at modification or rescission does not satisfy the requirements of 2-209(2) and (3), it can operate as a waiver. Most courts have generally held that the NOM clause may be waived, by oral agrmt to that effect, or by some combination of words and conduct that in the circumstances evidences the parties’ willingness to dispense with its protection. . Merger clauses prevent parol evidence of earlier or contemporaneous agrmts. But, parol evidence does not bar subsequent agmts. That’s where NOM comes in. Thus, when both merger clause and NOM are employed by the drafter, this is an attempt to ensure that any dispute btwn the parties will be resolved in writing only. . Accord and Satisfaction: two parties dispute how much is owned on a particular obligation. A offers B less than full amount but this amt. represents how much A acknowledges is owing and probably includes a bit more to induce B to agree to settle the dispute. In 1990, UCC §1-207 was amended and says that you cannot reserve your rights on an accord and satisfaction. Today, 1-207(2) makes clear that cashing a full payment check even with reservation of rights still constitutes an accord and satisfaction, barring the creditor from collecting the unpaid balance, unless creditor can establish a ground for avoiding the accord and satisfaction such as duress. . Accord and Satisfaction will generally not work unless there is a good faith legal excuse for not paying the full amt.
16 CONSEQUENCES OF NONPERFORMANCE
When performance of a duty under a contract is due any non-performance is a breach. See Rest. §235(2). However, performance is not considered to be 'due' if nonperformance is justified. There are three important situations in which a party's nonperformance may be justified and therefore not a breach.
I. MATERIAL BREACH
Most contracts are bilateral in nature, with both parties obligated to perform at a specified time. Ins such cases, when the time for performance arrive, one party may fail to render all or some of its promised performance. The issue raised in this instance is: when does one party's failure to perform justifies the other party in refusing to render a performance of his own?
Most breach fails into three categories: partial breach (technical breach), material breach and total breach.
Partial breach: these are normally trivial breaches. The general rule is that in a partial breach, the non-breaching party may not stop performing. However, they may sue for past and present damages.
Material breach: Rest. §241 lists factors that are used in determining whether a breach is material. If a breach is material, the non-breaching party may suspend performance until the breach is cured. See Rest §237.
Total breach: Rest. §242 requires a total breach to first be material (§241) along with an analysis of a low likelihood of cure and 2) the prejudice to the non-breaching party. When a total breach occurs, the non-breaching party does not need to perform and may sue for future damages in addition to any past and present damages.
Rest. § 234: Order of Performances (1) Where all or part of the performances to be exchanged under an exchange of promises can be rendered simultaneously, they are to that extend due simultaneously, unless the language or the circumstances indicate the contrary.
(2) Except to the extent stated in Subsection (1), where the performance of only one party under such an exchange requires a period of time, his performance is due at an earlier time than that of the other party, unless the language or circumstances indicate the contrary.
Note: §234 set forth the constructive conditions that performances that can be rendered at the same time are due simultaneously. However, if performances cannot be rendered at the same time, the performances requiring the longer period of time must be rendered before the performance requiring a shorter period of time will be due.
Rest. §237: Effect on Other Party's Duties of a Failure to Render Performance Except as stated in §240, it is a condition of each party's remaining duties to render performances to be exchanged under an exchange of promises that there be no uncured material failure by the other party to render any such performances due at an earlier time.
Note: Here the restatements place a constructive condition that there is no previously uncured breach in a contract.
Rest. §240: Part Performances as Agreed Equivalents If the performances to be exchanged under an exchange of promises can be apportioned into corresponding pairs of part performances so that the parts of each pair are properly regarded as agreed equivalents, a party's performance of his part of such a pair has the same effect on the other's duties to render performance of the agreed equivalent as it would have if only that pair of performances had been promised.
Note:
17 If a contract is divisible, this allows the court to provide another form of recovery. The doctrine of divisibility applies when the overall contract can be divided into a number of part performances and a portion of the contract price allocated to each of the part performances. To be divisible, it must first be possible to apportion the performances of the parties into corresponding pairs of part performances. Secondly, it must be proper to treat the pairs as 'agreed equivalents.'
Rest. §241: Circumstances Significant in Determining Whether a Failure is Material In determining whether a failure to render or to offer performance is material the following circumstances are significant:
(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected;
(b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived;
(c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture;
(d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;
(e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.
Rest. §242: Circumstances Significant in Determining When Remaining Duties are Discharged In determining the time after which a party's uncured material failure to render or to offer performance discharges the other party's remaining duties to render performance under the rules stated in §237 and 238, the following circumstances are significant:
(a) those stated in §241;
(b) the extent to which it reasonably appears to the injured party that delay many prevent or hinder him in making reasonable substitute arrangements;
(c) the extent to which the agreement provides for performance without delay, but a material failure to perform or to offer to perform on a stated day does not of itself discharge the other party's remaining duties unless the circumstances, including the language of the agreement, indicate that performance or an offer to perform by that day is important.
Note: - It is not sufficient to simply state in the contract that time is of the essence. See Foundation Development, p902 (time of the essence clause does not permit landlord to terminate lease since a two day delay in paying common area charge is trivial.).
Jabob Young v. Kent p.881 - partial breach case Owner of property had contracted to build a mansion. Specified that he wanted Reading pipe installed. The house is completed and the owner's architect is supposed to issue a certificate of completion before the last payment is made. It was found that some pipes were not made of Reading manufactures. The evidence suggest that 60% of the pipe were not Reading. The owner wanted the builder to replace the non-Reading pipes. The builder refuses and sues for payment.
The question was whether there was material breach by the builder. (This case was decided before the 2nd Rest.) The court argues that the breach was not material. First, the court noted that the mistake was innocent (quality and intent of the motivation of non-performance). Also, the court argued that there was no functional or utilitarian difference between the pipes since they are of similar quality. Court reasoned that the plaintiff had substantially performed and the defendant's injuries as a result of the defect are almost nonexistent; this does not justify having the plaintiff replace the pipes.
Notes:
18 - This case, the court adopted the doctrine of 'substantial performance,' which provides that each party's duty of performance is implicitly conditioned on there being no uncured material failure performance by the other party. Minor or immaterial deviations from the contractual provisions do not amount to failure of a condition to the other party's duty to perform. - What is substantial? " There is substantial performance where the variance from the specifications of the contracts does not impair the building or structure as a whole… or where the defects can be remedied without great expenditure… but defect must not run through the whole work." The magnitude of defects in performance will be important. - The modern view is that of reasonableness of what affects the breach had. If the pipe was worth less than the specified model, there would be a consequential clause to the case. In this case, it is reasonable that the contractor assume the owner is concerned with the quality of the product (since most of the pipes will not be visible). If the owner is concerned about other reasons (such as environmental-friendliness) for the product, the owner should inform the contractor. - The restatement recognizes three categories of conditions: express conditions, implied-in-fact conditions (inferred from the conducts of the parties), and constructive conditions (created by the court for reasons of justice).
Sackett v. Spindler p895 - determining material and total breach Spinder owns a newspaper co. and wanted to sell it to Sackett. Sackett was to pay installments. Sackett pays the first two installments and did not pay future installment. Spindler kept extending and finally revokes the contract. Sackett later sued for restitution. He argued that purchase price was $85000, Sackett paid around $30,000. He wanted to get back the money. Spindler counterclaimed for breach of contract.
The issue here for the court to determine was whether Sackett's conduct constituted total breach. If so, Spinder would be justified in repudiating the contract. If not, Spindler was not entitled to consider himself discharged under the contract; this means that Spindler's repudiation would mean a total breach on his part. The court ran through the factors for determining materiality in the 1st Rest. Court determined that the breach was material and total. However, the court also noted that even if the breach was not total, Spindler was justified in not perform (until cure occurs). His repudiation did not constitute a total breach on his part because he retracted it before Sackett relied on it.
Notes:
- The current factors to consider for materiality are under §241: (a) To what extent does the breach of the contract deprive Spindler of benefits? - This seem to be quite significant. Spindler was forced to reduce his newspaper to a weekly publication because of cash flow problems. As a result the value of his business deteriorated. (b) To what extent could Spindler be compensated without giving him damages for total breach? - Here we have to go to (d) and figure out to what extent is the likelihood that the breaching party would cure the breach. If the breaching party was not going to cure, than (b) would not be likely to be applicable. However, it is not likely that Spindler will get a cure because Sackett kept failing the deadlines. (c) To what extent will Sackett suffer from forfeiture? - He loses the $30,000. (e) To what extent of Sackett's behavior purports with good faith and fair dealing? - Here Sackett appears to be making promises that he cannot meet and did not inform Spindler of his financial siutation.
- Having determined that Sackett's breach was material, we must still look to see if the breach was total. Only then, may Spindler be justified in repudiating the contract. Rest. §242 adds two more factors to consider in addition to §241. 1) Does the delay appear to hinder the injured party's ability to make substitute arrangements? In this case, there is a likelihood that Spindler's business is likely to lose value if he kept waiting. The longer he waits, perhaps the less alternative he might have. 2) Does the agreement provide for performance without delay (i.e. was time of the essence)? In this case, it is hard to argue that time is of the essence in this contract. Such provisions are normally applicable to fast moving markets such as the equities market.
19 - Note that it is not sufficient to simply state in the contract that time is of the essence. See Foundation Development, p902 (time of the essence clause does not permit landlord to terminate lease since a two day delay in paying common area charge is trivial.).
- Note that this is a balancing test. In part (d) of §241, forfeiture by the non-performing party is taken into consideration. There is a risk that the non-breaching party will make a premature declaration of repudiation which in turn would constitute a breach.
ANTICIPATORY REPUDIATION
Before the date specified for performance, if one party declares or makes clear by conduct that it cannot or will not perform, this is in itself repudiation. The repudiating party can change its mind. If the repudiator retracts its repudiation, the contract is still value except that the other party had relied on the repudiation or had brought an action against it.
Rest. §250: When a Statement or an Act is a Repudiation A repudiation is (a) a statement by the obligor to the obligee indicating that the obligor will commit a breach that would of itself give the obligee a claim for damages for total breach under §243 or
(b) a voluntary affirmative act which renders the obligor unable or apparently unable to perform without such a breach.
Rest. §251: When a Failure of Give Assurance May be Treated as a Repudiation (1) Where reasonable grounds arise to believe that the obligor will commit a breach by non-performance that would of itself give the obligee a claim for damages for total breach under §243, the obligee may demand adequate assurance of due performance and may, if reasonable, suspend any performance for which he has not already received the agreed exchange until he receives such assurance.
(2) The obligee may treat as a repudiation the obligor's failure to provide within a reasonable time such assurance of due performance as is adequate in the circumstances of the particular case.
Rest. §256: Nullification of Repudiation or Basis for Repudiation (1) The effect of a statement as constituting a repudiation under §250 or the basis for a repudiation under §251 is nullified by a retraction of the statement if notification of the retraction comes to the attention of the injured party before he materially changes his position in reliance on the repudiation or indicates to the other party that he considers the repudiation to be final.
(2) The effects of events other than a statement as constituting a repudiation under §250 or the basis for a repudiation under §251 is nullified if, to the knowledge of the injured party, those events have ceased to exist before he materially changes his position in reliance on the repudiation or indicates to the other party that he considers the repudiation to be final.
UCC 2-609: Right to Adequate Assurance of Performance (1) A contract for sale imposes an obligation on each party that the other's expectation of receiving due performance will not be impaired. When reasonable grounds for insecurity arise with respect to the performance of either party the other may in writing demand adequate assurance of due performance and until he receives such assurance may if commercially reasonable suspend any performance for which he has not already received the agreed return.
(2) Between merchants the reasonableness of grounds for insecurity and the adequacy of any assurance offered shall be determined according to commercial standards.
20 (3) Acceptance of any improper delivery or payment does not prejudice the aggrieved party's right to demand adequate assurance of future performance.
(4) After receipt of a justified demand failure to provide within a reasonable time not exceeding thirty days such assurance of due performance as is adequate under the circumstances of the particular case is a repudiation of the contract.
UCC 2-610: Anticipatory Repudiation When either party repudiates the contract with respect to a performance not yet due the loss of which will substantially impair the value of the contract to the other, the aggrieved party may (a) for a commercially reasonable time await performance by the repudiating party; or
(b) resort to any remedy for breach (Section 2-703 or Section 2-711), even though he has notified the repudiating party that he would await the latter's performance and has urged retraction; and
(c) in either case suspend his own performance or proceed in accordance with the provisions of this Article on the seller's right to identify goods to the contract nonwithstanding breach or to salvage unfinished goods (Section 2- 704).
UCC 2-611: Retraction of Anticipatory Repudiation (1) Until the repudiating party's next performance is due he can retract his repudiation unless the aggrieved party has since the repudiation cancelled or materially changed his position or otherwise indicated that he considers the repudiation final.
(2) Retraction may be by any method which clearly indicates to the aggrieved party that the repudiating party intends to perform, but must include any assurance justifiably demanded under the provisions of this Article (Section 2-609).
(3) Retraction reinstates the repudiating party's rights under the contract with due excuse and allowance to the aggrieved party for any delay occasioned by the repudiation.
Truman Flatt v. Schupf - p903 Flatt contracted to purchase a land from Schupf. The purchase was conditioned on obtaining appropriate zoning approval of the land. The contract contained an express condition that if the buyer did not get the zoning approval the buyer could have the option of voiding the contract. (Here the court did not appear to focus on the fact that the buyer just gave up on making the zoning change). Flatt, failing to get the zoning change, proposed a new price (modification) of the land. Schupf answered that it will not sell. Later Flatt agreed to buy the land at the original price. Schupf responded by saying that the contract was already repudiated.
The court held that Schupf could not make anticipatory repudiation. The doctrine of anticipatory repudiation must be clear and unequivocal. Although there might be an implied inference that Flatt repudiated, an implied is not enough for clear and unequivocal. The court also argued that even if Flatt had repudiated, the contract was still valid because Flatt's subsequent letter to purchase at the original price was a retraction of the repudiation. Schupf did not make any formal acceptance of repudiation; Schupf simply said it would not sell at the new price. There was no apparent change in the party's situation. According to the restatement and the UCC, if there is no material change in position, the only other option for the aggrieved party to indicate to the other party that it is electing to treat the contract as rescinded.
Note: - Financial difficulty, even to the level of insolvency, does not constitute an anticipatory repudiation. Rest. §252, Comment a. However, insolvency does constitute a ground for demand of adequate assurance of performance. Rest. §252.
Hornell Brewing v. Spry p913
21 Dft, Spry entered into an oral agreement with Plt for distributorship in Canada. Spry was constantly late in his payments and Plt finally refused to sell Spry more goods until Spry pays the remaining balance. Spry told Plt that he had obtained financing but did not disclose that the financing company, Metro was actually a factoring company. Plt agreed to give Spry $300,000 credit for 14 days. After getting Metro to pay the balance, Spry ordered a shipment of over $300,000. Plt refused to sell unless Spry obtained a letter of credit and provides a personal guarantee. Spry failed to do so, Plt brought action to terminate agreement of distributorship.
The issues here are: whether Plt had reasonable grounds for insecurity and whether Plt made reasonable request for assurance. The court here applies UCC-609 and notes that the standard of reasonableness is determined according to commercial standards.
"Reasonable grounds for insecurity can arise from the sole fact that a buyer has fallen behind in his account with the seller, even where the items involved have to do with separate and legally distinct contracts, because this impairs the seller's expectation of due performance." (p917) The court pointed to Dft's poor payment history and that Plt only guaranteed credit of up to $300,000. Thus, by placing a single order of over this limit, the Dft has given the Plt the reasonable ground for insecurity. Dft's failure to respond to the demand for assurance constitute a repudiation and Plt is entitled to suspend performance and terminate agreement.
With regards to the reasonableness of the request for assurance, Plt here is asking for something that this not originally dictated in the contract. While this might strain the limits of reasonableness, the court held that Plt is commercially justified in demanding personal guarantee and letter of credit because there are indications that the Dft is engaging in illegitimate dealings.
Notes: - Pittsburgh-Des Moines Steel case (cited in Hornell and on p.921), Plt had contracted to extend credit to the buyer. The contract required a bank loan to guarantee payment, but after some time the buyer still could not obtain a loan. At this point, Plt demanded a personal guarantee or credit advance. The court that Plt had no reasonable ground for requiring assurance. The court introduced the two prong analysis: whether there was reasonable grounds for insecurity and whether the demand for assurance was reasonable. The court was in dispute over the first prong. The majority argued that there is no reasonable ground for insecurity because there is no material change in Dft's credit worthiness. However, the court unanimously agreed that Plt's demand for personal guarantee or advance payments were not reasonable. (Wilmarth - Plt should have asked Dft to show alternative source of financing.)
- Determining what constitute reasonable assurance depends on facts and circumstances'; Rest and UCC both utilizes this approach. However, demand for assurance must be made in good faith.
- Breaches of related contracts to the current contract may be adequate grounds for insecurity. However, mere rumors are not enough. This is also a fact intensive approach to determining when there are grounds for reasonable insecurity.
- UCC 2-609 indicates that the demand should be in writing, this requirement has not been strictly enforced. The Restatement however adopts a flexible approach: "the demand need not be in writing. Although a written demand is usually preferable to an oral one…" Rest. 251 comment d.
- Under the UCC, after a justified demand for adequate assurances, the demanding party must wait a reasonable time not to exceed 30 days. The Restatement requires a party to respond to a demand for assurances within a "reasonable time" but does not set maximum time period.
III. EXPRESS CONDITIONS
When an express condition is spelled out in a contract, it will often be a condition to the duty of only one of the parties, because that term has been included in the agreement to protect that party from having to perform in a situation where
22 performance is for some reason less advantageous to her. An express condition may not have to be in the control of the parties.
A condition is different from a promise. A duty is discharged when a condition is not met, but under a promise there is still a duty for the promisee to perform although the promisee can bring suit for damages. For example, "if you go to the superbowl and file a report, we will pay you X amount." Here there is a condition for payment. The person is not under a duty to make those things happen.
However, it may sometimes be difficult to distinguish between a promise and a condition. If the contract, states "we want you to go to the superbowl and file a report, and if you do that we will pay you $20,000." Here there is a promise and a condition. Not only can the promisor withhold the payment if promisee failed to perform, promisor can also sue for damages. Another example: "Buyer shall give the instruction by X date, if not, the seller's duty to sell the rice is discharged.' Here the buyer is subject to damages for breaking the promise ("buyer shall give…") while discharging seller from shipping the rice. Internatio-Rotterdam, v. River Brand Rice Mills [p.932].
The party whose performance is so conditioned is referred to as the 'obligor,' the one whose performance obligation is at issue. The other party, the one to whom the performance obligation is owed, usually also the party who is attempting to enforce obligation, is the 'obligee.'
Rest. §224: Condition Defined A condition is an event, not certain to occur, which must occur, unless its non-occurrence is excused, before performance under a contract becomes due.
Rest. §227: Standards of Preference with Regard to Conditions (1) In resolving doubts as to whether an event is made a condition of an obligor's duty, and as to the nature of such an event, an interpretation is preferred that will reduce the obligee's risk of forfeiture, unless the event is within the obligee's control or the circumstances indicate that he has assumed the risk.
(2) Unless the contract is of a type under which only one party generally undertakes duties, when it is doubtful whether (a) a duty is imposed on an obligee that an event occur, or (b) the event is made a condition of the obligor's duty, or (c) the event is made a condition of the obligor's duty and a duty is imposed on the obligee that the event occur, the first interpretation is preferred if the event is within the obligee's control.
(3) In case of doubt, an interpretation under which an event is a condition of an obligor's duty is preferred over an interpretation under which the non-occurrence of the event is a ground for discharge of that duty after it has become a duty to perform.
Rest. § 228: Satisfaction of the Obligor as a Condition When it is a condition of an obligor's duty that he be satisfied with respect tot the obligee's performance or with respect to something else, and it is practicable to determine whether a reasonable person in the position of the obligor would be satisfied, an interpretation is preferred under which the condition occurs if such a reasonable person in the position of the obligor would be satisfied.
Rest. §229: Excuse of a Condition to Avoid Forfeiture To the extent that the non-occurrence of a condition would cause disproportionate forfeiture, a court may excuse the non- occurrence of that condition unless its occurrence was a material part of the agreed exchange.
Note: - There are three possibilities stated in Rest. §227(2): 1. Pure promise
23 2. Pure condition 3. Promisory condition
Preference in language construction is given to promise and not condition (reducing risk of forfeiture for the obligee). This is done to allow the contract to go forward.
- In a case of a pure condition there is a risk of forfeiture on the obligee if the obligee had relied on the contract (making investments in anticipation of performance). The third possibility, promissory condition, is the worst. Courts prefer pure condition to promissory condition contract because in a pure condition the contract is discharged and that's the end of it. In promissory condition, the obligee is both discharged of duty while still suing for damages (getting best of both worlds).
Oppenheimer & Co. v. Oppenheim, Appel, Dixon & Co. p. 924
Plt moved into a new building but still has 3 years left to its lease in the old location. Owners of new building agreed to pay for Plt's remaining lease. Plt subleased it to the Dft. There were two conditions: Plt must get the landlord's written consent to the sublease and the landlord must consent to Dft performing 'tenant work' on the premise. The first written consent was obtained although only after an agreed deadline extension between Plt and Dft. The second consent letter did not come on time (but Plt did give oral notice that consent was obtained). The Dft cancelled the sublease.
Plt argued that they have substantially performed and the Dft should not be allowed to cancel on a technical basis. The court held that under an express condition, there is no room for the doctrine of substantial performance. This is very formal and Willistonian view of contract and appears to conflict with the equitable principles of modern contract. One reason is that the forfeiture on Plt is low. Plt did not have to bear the loss of the sublease because the owner of the Plt's new building agreed to bear the cost of the lease.
The court's analysis up to bottom of p928 seems to be very Willistonian but (p929) the court suggested that it might be willing to decide differently if there had been a big forfeiture. This case is really a special case. The person wanting a condition to be enforced normally has something to lose. Here, the Plt had nothing to lose.
Notes: - Restatement definition of "forfeiture": the denial of compensation that results when the obligee loses [its] right to the agreed exchange after [it] has relied substantially, as by preparation or performance on the expectation of that exchange."
- The court in Oppenheimer cites Rest. §237 which continued the general rule of strict enforcement of express conditions. "If parties 'have made an event a condition of their agreement, there is no mitigating standard of materiality or substantiality applicable to the non-occurrence of that event." Substantial performance not applicable. However, there are instances where the express condition might be excused.
- Conditions that are merely 'technical' - not related in substance to the real reason for the Dft's nonperformance but asserted solely for the purpose of defeating the plaintiff's claim - are generally excused under various theories such as adverse interpretation, waiver, prevention or avoidance of forfeiture.
- Restatement §84 expresses the concept of waiver. An obligor whose duty is expressly dependent on a condition may be under a duty to perform despite the non-occurrence of that condition, if a court finds that he has, by word or conduct, "waived" the right tot insist on fulfillment of the condition before performing the duty. A waiver is effective without either consideration or reliance, but only if the condition waived was not a material part of the performance that the obligor was to receive in exchange or a material part of the risk assumed. If the waiver pertains to a material condition, there must be some form of consideration given in return. 24 - If a waiver of a material condition is made in return for consideration, it is effective and non-retractable. If the waiver of a non-material condition is made after the time for fulfillment of the condition passed or the recipient of the waiver had detrimentally relied on the waiver, then the waiver is non retractable.
- The Doctrine of prevention states that a condition is excused if the promisor wrongfully hinders or prevents the condition from occurring. Restatement §245 recognizes this doctrine. Even if the event or condition is not within the obligor's control, she may be under an obligation (express or implied) to cooperate with the obligee in causing the condition to happen or not impede in the efforts (Recall Wood v. Lady Duff-Gordon).
- The remaining theory of avoidance of forfeiture is examined in JNA Realty (below) and adverse interpretation is examined in Morin (below).
J.N.A. Realty Corp. v. Cross Bay Chelsea p.939
JNA was a landlord who had a lease with a prior tenant who, in turn, subleased the premise to Chelsea. The new sublease terms required Chelsea to give 6 mths notice of intention to renew before the lease ran out. It doesn't appear that the original lease was attached to the new lease but the court found that Chelsea would was aware for 6 mth notice. Chelsea did not give timely notice to renew and JNA did not mention this to Chelsea when the period for extension was over.
Trial court excused the failure to make a timely notice. JNA argued that they had negotiated with another potential tenant. Trial court argued that it was not relevant. The appellate division argued that Chelsea's conduct was not excused.
The Court of Appeals noted that Chelsea had made improvements during the tenancy a total of $15,000 and that Chelsea will also lose the goodwill of their customers (if Chelsea had to move elsewhere they would have lose a good chunk of their customers). [This suggests that the notion of forfeiture is fairly broad. it does not only include unjust enrichment on the landlord. It includes reliance type of investments.] Court reasoned that because of these factors, the degree of forfeiture is quite high.
However, the Court took a balancing approach by also looking to the harm to JNA. The Court held that the case had to be remanded to find out what the landlord had suffered in terms of prejudice.
The court further noted that it will not permit willful or gross neglect on part of the tenant. If the tenant had stalled to speculate the market to seek better deals would be bad faith. The majority of the court seemed pretty comfortable that they could tell the difference. However the dissent argued that there is no bright line and its hard to find out whether Chelsea acted in good faith. A real smart tenant could just act quietly and there would be no finding of what the tenant really thought. The dissent noted Chelsea is a sophisticated business entity and not a mere individual tenant. However, JNA's conduct probably induced the majority to find for Chelsea: the landlord was always studious in informing the tenant about lease dues and tax dues, they had been quiet about this issue.
Notes: - Rest. §229 states a general proposition that a court may excuse the non-occurrence of a condition where forfeiture would otherwise result, unless the conditioning event was a material part of the parties' exchange. In other words, the court, in finding undue forfeiture, may exercise discretion to excuse the condition unless the condition is material. Note that the Restatement's definition of forfeiture is broad enough to include no just enrichment by also reliance losses.
- JNA suggest that 'undue forfeiture' is determined by balancing the prejudice to both parties. This approach appears to agree with the Restatement, which uses the term 'disproportionate forfeiture.' Rest. §229.
25 - The court in JNA did not focus on materiality. The problem arises on how materiality should be determined since Rest. §229 does not explain how materiality is to be determined. If we determine materiality at the day the contract was made, it is hard to argue that the renewal term is not a material part of the lease. However, if we look at materiality from the perspective of prejudiced suffered, the landlord in this case did not appear to suffer much prejudice (but, case was remanded to further determine this factor). The court in JNA appeared to have adopted this later approach. [Question: I remember that in another part of the course, there is something that courts generally look to the time contract was form to determine.]
- Traditionally express conditions are supposed to be different from constructive conditions in that courts will strictly enforce express conditions. However, with the advent of Rest §229, it is no longer clear that this is the case.
Morin Building Products v. Baystone Construction p. 947 General Motors hired Baystone to extend factory, Baystone hired Morin to perform the extension. The contract allowed for workmanship to be based on the acceptability rested strictly with the owner and that usual customs in erecting is not consideration for the decision. General Motors is dissatisfied with the work, Morin did not get paid and Morin sued. The district court argued that the standard should be objective and based on a reasonable person standard.
This case brings up a condition that is often placed in construction contracts: A has to perform to the satisfaction of B. B is not satisfy, how do we decided whether B acted within his rights. What standards do we use? Is this an objective or a subjective test? The problem is the clash between freedom to contract and the efficiency principle.
The Circuit Court: Posner held that the objective standard should be used. Subjective standard, Posner argued, should be reserved for contracts involving purely aesthetic purposes. In this case, the construction materials involved make it difficult for Plt to achieve a uniform finish and there is no indication the Plt's replacement contractor did a better job. More importantly, Posner noted that the building was intended to be used as a factory and the materials were not designed to be artistically pleasing. Posner cites Rest. §228, stating that an objective standard of reasonableness based on observance of reasonable standard by persons in the obligor's position.
The law prefers the objective std because there is a less risk of forfeiture. If satisfaction is purely subjective there is a higher risk of forfeiture. However, parties could contract around this. There is a freedom of contract and if party really intended to contract in such a manner, then the courts will uphold it. But, in this case the contract did appear to be pretty unequivocal that the standard is subjective. Posner argued around this by saying that it was a form contract and it was not certain that the parties bargained over these terms. This forms is probably used in all construction contracts by GM. Posner is trying to manufacture ambiguity here. He tries to say that the term 'first class' is not clear. But this is not very convincing. Rather, Posner is thinking about the realistic effects of this case and he probably correct. If the parties had really bargained about it, Morin would probably be insisting on an objective standard. However, there is no evidence on these conjectures. Yet, it is probably a rational economic result, in addition it is also a just result. Posner is really saying that the language in this contract does not make sense and he is overruling it, despite his alleged upholding of the freedom of contract.
Notes: - Contracts frequently contain terms that obligate one party to perform to the 'satisfaction' of the other. Court generally do not allow parties to interpret these terms as conferring an unlimited power on the obligor to determine and declare his own dissatisfaction without external check.
- UCC §2-103 requires 'good faith': "honesty in facts and the observance of reasonable commercial standards of fair dealing in the trade."
26 - The Restatement §228 continues the first Restatement's objective approach but with some change of emphasis. It declares that the objective test should be preferred when it is "practicable to determine whether a reasonable person in the position of the obligor would be satisfied." Comment a of §228 further indicates that the subjective standard should be used only where "the agreement leaves no doubt that it is only honest dissatisfaction that is meant and no more." However, note 3. p.953, even if on the subjective standard, if the Dft is not being honest about being dissatisfied, this might be grounds for enforcing the contract .
- Where personal services are involved, the courts are more likely to approve of the subjective test. Also where the contract conditions performance by one party on the other's performance to the satisfaction of a independent third party, the Restatement indicates a greater tolerance for a subjective test. Rest. §227 comment b.
REMEDIES AT LAW
Remedies at law (money damages): Three principal purposes of awarding contract money damages: 1. Restitution: Plaintiff had, in reliance on the promise of the defendant, conferred some value on the defendant. The defendant fails to perform his promise. We award damage to prevent unjust enrichment.
2. Reliance: Plaintiff has in reliance on the promise of the defendant, changed his position. We award damage for the purpose of undoing the harm of reliance. We are attempting to put plaintiff in as good a position prior to the making of the contract.
3. Expectation: Give the Plaintiff value of the expectancy, which the promise has created. Objective is to put plaintiff at position he would have occupied if the defendant had performed.
I. EXPECTATION DAMAGES
Rest. §347. Measure of Damages in General Subject to the limitations stated in §§350-53, the injured party has a right to damages based on his expectation interest as measured by (a) the loss in the value to him of the other party's performance caused by its failure or deficiency, plus (b) any other loss, including incidental or consequential loss, caused by the breach, less (c) any cost or other loss that he has avoided by not having to perform.
Rest. §348. Alternatives to Loss in Value of Performance (1) If a breach delays the use of property and the loss in value to the injured party is not proved with reasonable certainty, he may recover damages based on the rental value of the property or on interest on the value of the property.
(2) If a breach results in defective or unfinished construction and the loss in value to the injured party is not proved with sufficient certainty, he may recover damages based on (a) the diminution in the market price of the property caused by the breach, or (b) the reasonable cost of completing performance or of remedying the defects if that cost is not clearly disproportionate to the probable loss in value to him.
(3) If a breach is of a promise conditioned on a fortuitous event and it is uncertain whether the event would have occurred had there been no breach, the injured party may recover damages based on the value of the conditional right at the time of breach.
UCC §2-708. Seller's Damages for Non-acceptance or Repudiation (1) Subject to subsection (2) and to the provisions of this Article with respect to proof of market price (Section 2-723), the measure of damages for non-acceptance or repudiation by the buyer is the difference between the market price at the time and place for tender and the unpaid contract price together with any incidental damages provided in this Article. (Section 2-710), but less expenses saved in consequence of the buyer's breach.
27 (2) It the measure of damages provided in subsection (1) is inadequate to put the seller in as good a position as performance would have done then the measure of damages is the profit (including reasonable overhead) which the seller would have made from full performance by the buyer, together with any incidental damages provided in this Article (Section 2-710), due allowance for costs reasonably incurred and due credit for payments or proceeds of resale.
UCC §2-710 Seller's Incidental Damages Incidental damages to an aggrieved seller include any commercially reasonable charges, expenses or commission incurred in stopping delivery, in the transportation , care and custody of goods after the buyer's breach, in connection with return or resale of the goods or otherwise resulting from the breach.
UCC § 2-713 Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods (1) where the seller fails to make delivery or repudiates or the buyer rightfully rejects or justifiably revokes acceptance then with respect to any goods involved, and with respect to the whole if the breach goes to the whole (Section 2-612), the buyer may cancel and whether or not he has done so may in addition to recovering so much of the price as has been paid (a) "cover" and have damages under the next section as to all the goods affected whether or not they have been identified to the contract; or (b) recover damages for non-delivery as provided in this Article (Section 2-713).
(2) Where the seller fails to deliver or repudiates the buyer may also (a) if the goods have been identified recover them as provided in this Article (Section 2-502); or (b) in a proper case obtain specific performance or replevy the goods as provided in this Article (Section 2-716).
(3) On rightful rejection or justifiable revocation of acceptance a buyer has a security interest in goods in his possession or control for any payments made on their price and any expense reasonably incurred in their inspection, receipt, transportation, care and custody and may hold such goods and resell them in like manner as an aggrieved seller (Section 2-706).
Note: UCC allowed for damages to be calculated by measuring the difference between market price and contract price of the goods at time of breach (time and place for tender). However, this application often does not accurately reflect loss suffered. Suppose at time of breach market price = contract price, so non-breacher suffers no damages. However, when the seller tries to resell, the market price has fallen.
Drafters recognized this problem and put in UCC §2-706 (for non breaching sellers) and UCC §2-712 (for non breaching buyers). In case of sellers, the UCC allows seller who complies with provisions to recover from a breaching buyer damages measured by the difference between the contract price and the seller's resale price. In case of the buyer, the UCC allows buyers to 'cover' her loss by purchasing substitute good and measuring damages by difference between the cost of those goods and the contract price.
What does expectation damages consist of? Plaintiff is awarded 1) out of pocket cost incurred and 2) the profit which she would have made had the contract been completed.
Expectation Damages = Loss Value of Performance (LVP) + Other Loss - Cost avoided - Loss avoided
Loss Value of Performance = Value performance that should be received - Value of performance received. (Generally the contract price if no performance is rendered).
Other loss = incidental damages (additional costs incurred by plaintiff after breach in a reasonable attempt to avoid loss [efforts to mitigate]) + consequential damages (injury to person or property caused by breach.)
Cost avoided = Savings on further expenditure that would have been incurred if contract was performed.
Loss avoided = Loss avoided by salvaging or reallocating some or all resources that would otherwise be devoted to performance of contract [mitigation].
28 What are the restrictions (see section on restrictions)? Reasonable certainty, FOS and causation. Expectation damages may only be recovered if the plaintiff proves them with 'reasonable certainty.' Incidental and consequential damages must be reasonably FOS. There is also a duty to mitigate, which falls under the cost avoided and loss avoided categories.(damages not recoverable to the extent that they could have been avoided or minimized by reasonable effort.)
Turner v. Benson Dft totally breached contract to buy Plt's house. The Plt waited for Dft to secure financing before going out to buy another house. Dft secured financing but never showed up to close the deal. Plt resold house to another buyer for $76,000. Original contract price with Dft was $75,000.
Interestingly the extra $1000 the Plt got from reselling the house at $76,000 instead of $75,000 was not calculated by the court. Apparently the market value being used is that of the date of the sale not the later resale. It is doubtful why the court did this.
Court argued that LVP = $75,000. But LVP - LA = 0 instead of - $1000.
Consequential damages The plt argued that they lost income from the day care center that they closed in the old house. The court did not buy this argument because Plt made decision to sell the house because plt wanted to stop running the day care center. Since both Plt and Dft knew about this, it is not reasonable for the Dft to foresee that this consequential damage would occur.
The Dft knew that the Plt bought a new house before the closing date. As a result, Plt had to take out a loan to pay for the new house. The court awarded the lost interest rates paid by the Plt from sept. 2 to Dec 16 for the loan. This amounted to $11,059. (14 1/2% of $45,000).
There is also a moving cost. The Plt moved from their new house to the old house and later to the new house again as a result of the breach.
Incidental damages The Plt spent $415 on advertising for selling the property at auction. The was also cost to repair the utilities of the house (however this part is a bit doubtful since the Plt could easy avoided the need for repairs). Court did not buy Plt's argument of having to sell their car. The court also did not give Plt the $60 paid to real estate agent because Plt came out ahead by $1000.
Loss avoided Finally we must subtract the rent Plt got from renting the house $1,125 from expenses make the house rentable.
Handicapped Children Education Board v. Lukaszewski p.975 Plt, school board sued Dft for reneging on contract to teach. Dft got a better job offer at a day care center and broke her contract with school to teach there. Dft argued that Plt got a replacement teacher who is more qualified and there were no damages (arguing that Dft was in a better position and thus suffered no net loss). Court argued that Plt should not be forced to pay for a more qualified teacher because the Plt wanted the Dft, a less qualified one. The Plt had tried their best to mitigate the damages and the only option is to get a more qualified (more expensive) replacement. However, Court noted that while Plt should use their best effort to mitigate damages, Plt cannot go out and pile up damages. Here Court felt Plt used reasonable mitigation.
American Standard v. Schectman p.980 In this case the Plt had contracted with Dft to have an industrial site demolished in return the Dft will get the equipments. The Plt's purpose in this contract was to get the property ready for resale. Dft took the equipments but did not properly demolish the buildings in accord to the contract. It would take Plt over $100,000 to get the job done. The jury was given a cost of completion damage instruction and returned damages for Plt for $90,000 (less work performed by the Dft).
For this case, an alternative way to compute LVP is stated in the Rest. § 348(2). There are two possibilities 1) diminished value damage: the difference, in market value, between value of property if contract fully performance and
29 value of property if contract not fully perform; 2) cost of completion: cost of completing the performance (measured by how much plaintiff would have to pay for someone else to perform).
The problem with this case is that Plt had sold the property before damages were awarded.
Note:
- Cost of completion can also be applied to cost avoid. For example, where plaintiff has not finished his performance at the time of defendant's breach, the cost of completion is the amount Plt has saved by not having to finish performance. Courts normally held that Defendant will not be allowed to include plaintiff's overhead into the cost of completion (cost avoided). That is Plaintiff's expectation damages is Contract price (LVP) - cost of completion (cost avoided). Overhead which are fixed will not be saved by the plaintiff regardless of whether contract is completed or not are not included in calculations.
- Most of the time, cost of completion method is use in construction contracts. Rest. § 348(2) hints at this. Outside of construction, cost of completion is difficult to apply because it is difficult to determine what the 'thing' is that the plaintiff is entitled to completion.
- In Jacob Young, the court applied diminished value damages for Plt. (Plt wanted non-Reading pipes replaced, court gave the price difference instead.). Both are construction cases. How do we determine whether to apply diminished value damages or cost of completion? In Jacob Young the Dft showed good faith, while in this case, the Dft intentionally breached. Also, the breach in Jacob is not material, in this case the breach is material. In commercial case, courts generally do not want to go beyond compensating for more than what is necessary. In Peevyhouse, there was a collateral contract whereby Plt leased out land to Dft for strip mining provided that Dft restore the land. Dft fails to restore. Cost of restoration was around $29,000 while diminution of value is only $300 (price of farm is only $5000). Court awarded diminished value damages. The Rest. appears to follow this approach. Rest. § 348(2) states that cost of remedying defect should not be granted if it is "clearly disproportionate".
- Court in American Std argued using the Chamberlain v. Parker case where it was decided that a person may do whatever he wants with his property and contractor may not argue that the action would devalue property and not perform. However, in Groves, Posner argued that in commercial cases, the objective standard should apply since there is usually no aesthetics involved. Cost of completion tends to over compensate owner and most of the time owner will not use money to restore or complete the contract. - Note that in Rest. §348(2) the cost of completion may be awarded if cost is not "clearly disproportionate to the probable loss of value to him." This appears to be a subjective standard.
Restrictions on Recovery of Expectation Damages
Rest. § 350 Avoidability as Limitation on Damages (1) Except as stated in Subsection (2), damages are not recoverable for loss that the injured party could have avoided without undue risk, burden or humiliation.
(2) The injured party is not precluded from recovery by the rule stated in Subsection (1) to the extent that he has made reasonable but unsuccessful efforts to avoid loss.
Rest. §351 Unforeseeability and Related Limitations on Damages (1) Damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made.
(2) Loss may be foreseeable as a probable result of a breach because it follows from the breach (a) in the ordinary course of events, or (b) as a result of special circumstances, beyond the ordinary course of events, that the party in breach had reason to know.
30 (3) A court may limit damages for foreseeable loss by excluding recovery for loss of profits, by allowing recovery only for loss incurred in reliance, or otherwise if it concludes that in the circumstances justice so requires in order to avoid disproportionate compensation.
Rest. §352 Uncertainty as to Limitation on Damages Damages are not recoverable for loss beyond an amount that the evidence permits to be established with reasonable certainty.
UCC §2-715 Hadley v. Baxendale p. 989 The Plt operates a mill and the shaft breaks. The mill's employee brings the shaft to the Dft's clerk to have it sent to the repair shop immediately. The delivery was delayed and Plt sued for loss profits. The Court remanded the case for retrial in accord to standards articulated: 1) if damages were typical to the contract of this type (arising naturally) than there can be damages awarded without having to resolve FOS of damages because both parties should be at notice of the probable results of breach. 2) if damages are not typical, then plaintiff must have communicated the special circumstance to the defendant in order to recover without FOS (otherwise, special circumstances must be subject to FOS test) Here Court felt that loss profit is not a normal result of a broken shaft and special circumstance was not communicated.
- This case, the court distinguishes between general and special damages. General damages are those that naturally arise out from breach of contract. (This can be thought of as LVP and/or incidental damages). Special damages are those that flow from the specific circumstances of the injured party. (These normally fall under consequential damages. For ex. Loss of profit in collateral contracts.)
- Rule in Hadley is codified in Rest. §351 and UCC §2-715(2). FOS is determined at the "time [parties] made the contract." Also, it is only necessary that the type of loss be FOS, not the manner in which loss occurs. Standard for FOS is party objective; breaching party liable for losses about which it had reason to know. Loss must be FPS as a 'probable' result of breach.
- The rules requires that Dft knows of the special circumstances, but this could be actual and constructive knowledge.
Florafax International v. GTE Market Resources p. 995 Florafax operates telemarketing flower sale as an intermediary. Flora contracted with Bellrose to handle Bellrose's calls and Bellrose would carry out the orders. Florafax entered into another agreement with GTE to let GTE handle Flora's consumer calls. The jury found that the contract between GTE and Flora is a long term contract and the parties cannot get out in the interrim. GTE later could not make profit on the deal and started to pull out by not answering order calls. Belllerose cancelled contract with GTE and Flora terminated contract with GTE. Flora sued GTE.
The issue here is what damages should be awarded. The juries returned two verdicts. Florafax spend $820, 000 to set up a new call center. This amount is awarded as direct damages. Florafax is paying to make the service that GTE promised to do. Juries also awarded flora damages of $750,000 for lost profits.
GTE did not raise contest the $820,000 [This is because this is a direct damage and it is FOS that Flora would need to get another call center if GTE failed to performed.]
The main contested issue is lost profits. GTE argued that Flora cannot get loss profits for a collateral contract. The Court countered that alot of collaterals contracts affect profits and this is a typical result for breach. GTE next argues that it was not FOS. The Court pointed out GTE was aware of the contract between Flora and Bellerose. Although it is unclear how much they knew, the reason GTE is being hired is to satisfy the Bellerose contract and GTE was aware of this.
There is an unusual provision in the contract that if GTE does not perform GTE would be responsible for consequential damages (normally consequential damages are excluded in the terms of contract). [Notice that this provision is not
31 required for 351 to apply. 351 is a std default rule.] Here GTE went further to accept the consequential damages. why did GTE do this? Probably to win contract over from a competitor.
GTE also argued that even if the damages are awardable, damages cannot be for more than 60 days because the contract with Bellerose may be terminated in 60 days at any time. The court argued that GTE has no right to pull the plug on Bellerose' contract. The probability that Bellerose will not terminate the contract is evidenced by Bellerose's president testimony that he would have upheld the contract if Flora could answer the calls satisfyingly.
The jury here decided that it was reasonably certain that the damage should be $750,000. Since this is inside the range offered by the experts of Flora and GTE and the court said that it is reasonable exercise of jury's discretion/ reasonable certainty does not mean mathematical precision.
Notes: - UCC §2-316 (exclusion or modification of warranty), 2-719 (modification or limitation of remedy) are rules governing contractual disclaimers of warranties or limitation of remedies for breach.
- Rest § 351(3) proposes a limitation on consequential damages in case where "justice so requires in order to avoid disproportionate compensation."
- Rest. §352 states that parties must be able to prove their amount of damages with a reasonable certainty.
- In Contemporary Mission v. Famous music (p1006), Catholic music organization sued producers for backing off on contract to promote records. Here the court allowed for the recovery of loss profits. After the promotion was cut off the songs went on to sell well. However, the court refused a recovery of concert sale damages. This is because it is too far flung. If you have no track record in a particular business it is unlikely that you will be given loss profits if the business never even got off. Here not a single ticket was sold since there still wasn't a concert yet.
- In the Ishin Speed sports (1008), the promoters backed out of opening a driving school. The court awarded the dft loss profits because there had been similar instances where other celebrity racers had done well in the case.
- In a Pauline chicken v. KFC, KFC backed out of giving Pauline a license franchise. The court allowed Pauline to recover because Pauline already operated franchises elsewhere. It wasn't like someone who never ran a franchise before. The court argued that the other franchise locations are comparable enough to estimate that Plt's business might make it. However in general it is still very hard case to argue if you never got into the business.
Rockingham County v. Luten Bridge p.1010 Dft made a contract with Plt for Plt to build a bridge. However, halfway through the construction Dft's county Commission changed members and Plt was told to stop construction. (Dft concedes breach of contract). Plt, however, gambled on a more amenable commission to take over, continued to construct the bridge. The court held that Plt had no right proceed on with his performance and pile up damages for the Dft.
Notes: - This case is really about cost avoidance. The Plt should have stopped since it is the cheapest way to avoid loss. However it is not always so that the Plt has to stop production. For manufacturing items, Plts might be allowed to continue making so they can resell it to another.
Boehm v. American Broadcasting p.1014 Plt was a VP for ABC for some 15 years. ABC fired plt but immediately offered him another job at the same contract price. They placed another person in the position he once held. Plt refused to take this job. Facts are not clear as to the efforts Plt made to find another job. Plt brought a suit for wrongful discharge. The jury awarded him damages of past pay to date of trial and also front pay (potential pay till his retirement). The jury also added emotional distress. The trial court threw out emotional distress but uphold all compensatory claim. ABC appealed arguing that Plt did not mitigate and also opt himself out of the job market. The Court held that the plt only had a duty to mitigate and accept replacement 32 employment which is comparable or substantially similar. The Court held that ABC's new employment offer is not comparable .
The problem with the replacement job is that plt had to report back to the replacement for his position. Also, there the replacement job did not previously exist (a phony job).
But what about the allegation that Plt removed himself from the job market? Here the court deferred to the jury's decision that plt did not remove himself from the market. The court's reasoning here is pretty thin. The plt argued that he had reached an age that would not allow him to find a job. The juries bought this argument and awarded him front pay. But, this is highly unusual event, courts normally don't hand out front pay.
Notes - If the ptl accepted the replacement employment Plt would probably not be able to sue for offsetting recovery. Marshall Schoool District v. Hill, teacher took another job that is not comparable [working in shirt factory], the court reduced damages recoverable by income earned from other jobs.
- Parker case, the court argued that plt, who was suppose to star in a big name musical was given a role in a western film instead, was not being offered a comparable employment. However the dissent argued that this doesn't make sense because we shouldn't encourage people to sit out and eliminate obligation to minimize damages. Why are courts unwilling to adopt this stance? Dignitary aspects are important to the court's consideration. Rest. 350, says Plts don't have to mitigate where it would involve some humiliation.
- The UCC has no provision imposing a general responsibility of mitigation on the parties to a sales contract. Comment 1 to UCC§1-106 indicates that this notion was intended to be subsumed in the more general principle that remedies are to be limited to compensation. Comment also suggest that minimization of damages may be implicit in the obligation of good faith. See UCC §2-704(2) (seller's privilege to complete manufacture where commercially reasonable despite buyer's repudiation).
- Bourne v,. Johnson (p1029) the plt got kicked out of his job and took a new employment as a night shift liquor seller. The dft tried to argue that this is mitigation and the damages should be deducted . However, the court argued that the plt could have done both jobs since it is not mutually exclusive and it is not a mitigating job.
- In Boehm, it is the dft's burden to prove that plt did not mitigate. In the employment area, the court provided addition protection to employees by shifting burden of proof to dft.
Jetz Service v. Salina Properties p.1023 Plt is a provider of laundry equipments. Plt got a lease with Dft for 6 years to operate laundry service. With 16 months remaining to the contract, Dft breached the contract inorder to operate the laundry by themselves. Plt had to take out their machines. 6 months after breach, Plt placed the machines in another building to operate. Dft argued that Plt had mitigated by reusing the machines. Plt argued that they had lost volume because they had other machines in the warehouse and the replacement contract is not a replacement contract because plt could have done both contracts. Court upheld the lost volume theory.
Notes - As oppose to an alternative contract where plt could only provide one contract or the other, lost volume hinges on the Plt's ability to get more than two contracts at the same time. Here Plt has a warehouse full of laundry machines and could have used the remaining machines to operate the new contract. - Rodriguez p.1029 Look at three factors 1) Did plt have capacity to perform new additional sale? 2) Would have the additional sale be profitable? 3) Is it probable that the additional sale would be made absent buyer's breach?
33 - There are two types of cost, the fixed overhead cost that incurs regardless of the contract, and there are variable costs. The profits of loss contract would be determined from revenue - variable cost. In the Jetz case, the plt is arguing that they lost royalty from the machines (what the Dft were going to pay... what they would earn from the contract). This is LVP. LA (loss avoided) does not come into play because the plt could have expanded its business by using other machines. Overheads are normally not recoverable in expectation damages.
- In wired music p 1027, the dft broke the lease with plt by moving out off the building and a new tenant took over the lease with wired music. Court argued that dft moved to another area where wired music could have supplied music, so there was loss volume because plt could have sold to another person in plt's new place. As oppose if we hire a personal trainer and breached the contract, the trainer's subsequent contract with a new customer is and alternative contract.
- In M&R contractors (p1030). Dft broke contract with plt for plt to drill oil. dft argued that plt got another contract with a customer and there was mitigation. However, court said contract did not require plt to be there and plt could have operated two contracts.
Non-recoverable Damages: Items commonly excluded from damages
Rest. § 353 Loss due to Emotional Disturbance Recovery for emotional disturbance will be excluded unless the breach also caused bodily harm or the contract or the breach is of such a kind that serious emotional disturbance was a particularly likely result.
Rest. §355 Punitive Damages Punitive damages are not recoverable for a breach of contract unless the conduct constituting the breach is also a tort for which the punitive damages are recoverable.
Three types of damages usually denied to plaintiff: damages to compensate for attorney fees, damages for mental/emotional distress, punitive damages.
Note of Attorney's fee - The American Rule on recovery of attorney's fees makes each party bears its own expense of litigation. The policy is that to grant attorney's fees would unjustly discourage the poor from instituting actions to vindicate their rights. - Where contract at issue expressly provides for an award of attorney fees to the prevailing party in a dispute, the courts have enforced the terms. However, courts occasionally will decline to enforce the provision if circumstances appear to warrant (Cable Marine, Plt had refused 'generous settlement offer' by Dft. Provisions is denied enforcement). - In 'battle of the form' cases, attorney's fee provision may fail to become part of the contract because it amounts to material alteration of the contract.
Gaglidari v. Denny's Resturant p. 1042 - emotional distress There were two handbooks, first one says "fighting on duty would result in termination without process." The second handbook says "fighting on premises would result in termination without process." (Courts have increasingly view employment handbooks as a type of contracts. Conditions of termination are treated as offer of unilateral contract , if the employee perform their duties they have accepted the offer.) In this case, it was reasonable that Plt had notice of the change in rule. Plt came to the resturant after hours and got into argument with a rowdy customer. A fight ensued. Dennys fires plt. Plt went through emotional stress. Plt sue for breach of contract without rightful cause and also emotional distress. Plt won at trial level. At appeal, the court determined that the Dft did not breach the contract if Dft's conclusion that Plt had fought were reasonable and in good faith. Case remanded for retrial.
The Court here held that if trial court give emotional distress damages in two circumstances.
34 Rest 353: 1) Plt can get emotional distress if breach caused direct bodily harm (see eg. p. 1050, Sullivan case, surgeon messed up nose surgery), or 2) if the contract or breach is of such a kind that serious emotional disturbance was a particularly likely outcome.
The Court here found that for employment contract, it is not the type of contract that emotional distress is the likely outcome because it is an economically motivated contract.
Notes: - Ex. of type of contracts that may qualify: contracts of carriers, innkeepers, contracts dealing with carriage or disposition of dead bodies, contracts of delivery of messages concerning death. Why common carriers and innkeepers? These relationships involves people giving their protection or care to the hands of the carriers. Also courts recognize contracts for delivery of message of death or handling of dead bodies are emotionally involving.
- The majority in this case stuck to this traditional classes of contracts that qualify and refused to expand it. Dissent argued that Rest. §353 inserted the words "contract or breach is of such kind that serious emotional disturbance was particularly likely to result." This indicates that the Restatement intend emotional distress to be recoverable outside of the traditional classes of contracts that qualify.
- Other courts have picked up on this difference. If the type of breach is of such a kind (willful, wanton, reckless) to impose emotional distress, then there might be damages. If you willfully humiliate someone by firing her, you should be subject to emotional damages.
- Wilmarth: it is odd that the majority in Dennys is saying on one hand, that the employment contract is not personal, but then it is personal because allowing recovery in such cases will open up the pandora's box of people bringing out suits of these breaches.
Freeman & Mills v. Belcher Oil p. 1053 - Punitive Damages In freeman mills, the Dft owed the Plt money for services rendered. Dft changed its new general counsel and the company refused to recognize a previous contract with plt's contractor.
In deciding this case, the S. Ct. of CA overruled its prior holding in Seaman. In Seaman, Plt was a supplier of goods to maritime buyers. Plt obtained a contract as a fuel dealer in a city. A condition for this is that Plt needed a long-term supplier. Plt got Dft, Standard oil to be its supplier. There are some indications that Standard oil was secretly willing to walk away from the deal if it is not favorable. Along came the oil shortage of the 70s. Fed law allows old customers to get oil in proportion to their previous share. Problem is Plt is a new customer. Seaman appealed to the agency to make an exception for them. The exception was given just as long as there is a binding contract. Dft refused to acknowledge the deal. The S. Ct. of CA held that if there is a denial of contract in bad faith there can be punitive damages.
In Freeman, the jury found bad faith in denial. The Court of Appeals didn't like Seaman and distinguished it because there is a special relationship between the plt and Dft in Seaman. In present case, Plt and Dft did not have that special or singular relationship as in Seaman.
The S. Ct. of CA (perhaps getting the hint from so much criticism) decided instead to overrule Seaman in entirety. However the Ct. noted that it would not disturb the insurance contract exception. In doing so, Ct. is in conformity with the general view that restricts punitive damages for contracts
Notes:
- Punitive damages generally aren't available in contract cases. Contract claims are given to compensate harm caused by breach and not to deter breach. There is no state of mind required for a breach of contract case. The first major exception to this notion arose in Communale v Trader & General insurance (p. 1064) where the court determined that when an insured a policy holder is being sued by 3rd party and the insurer acted in bad faith in denying coverage, punitive damages can be awarded against insurer. Other wise, punitive damages may be
35 available if there is a tort claim in conjunction to the breach of contract claim. See Rest. §355. There are indications that some court are willing to allow for punitive damages where there is a breach of fiduciary duty or fraudulent conduct. (Sullivan, Law review article, p. 1068)
- Why the insurance exception? They are the classic deep pocket entities. Also the nature of insurance is to cover people who are unsure that they could cover for losses. Also the incentive structure of the insurance business is to reduce payouts. The policyholder is unlikely to be able to mitigate the loss if the insurer fails to pay. In such situation the insurer had a large amount of leverage. Thus, if even if the insured successfully sued the insurer, the insurer ended up paying just about what they had to pay anyways. There is incentive to cheat. Given this unique situation, courts are willing to give compensatory damages and punitive damages.
- In Foley, a subsequent case after Seaman, employee alleged wrongful bad faith termination of employment contract. Trial court refused to grant punitive damages for bad faith breach of contract. (Employer did not deny existence of contract). The court argued that the employee could mitigate by seeking other employment, this is different from the insurance context. Also there is no fiduciary duty where the party in breach had to protect the other. (Interestingly in an agent relationship there is a fiduciary relationship.) It is unlikely that there were perverse incentive for the employer to fire the employee as in the insurer's case.
Roth v. Speck p.1085 - Disgorgement of profits Plt sued ex-employee hairdresser who broke contract of employment. Here, unlike Lukaszewski, it was argued by Plt that there is no suitable replacement. The court held that there is no way to grant damages within a reasonable range of certainty because the business was seasonal value and there were conflicts over which operators customers requested to be served by. However, the court noted that there was indirect evidence as to the value of Dft's service. The second salon hired Dft for more than $100 (Plt hires Dft for $75/week). The court remanded the case for retrial with instructions that Plt would be entitled to the difference between Dft's new salary and old salary (disgorgement of Dft's profit from breach).
Notes: - Disgorgements are normally not given by courts. Where they are given, disgorgement is usually limited to cases where there are 'abuses of contract.' That is, where the Dft breached in order to profit from the breach. The court may order the Dft to give up the 'ill earned' profit. The remedy of disgorgement may be used where there is a strong moral argument in its favor and that breach damages alone creates a significant risk of under compensation to the non-breacher.
- In Earth info v. hydrosphere p. 1091, the court allowed disgorgement of profit made by plt because of breach. In this case, Dft broke a software development contract by refusing royalty payments. The court ordered disgorgement of derivative software contracts.
- Wilmarth: Partners or joint ventures do owe fiduciary duties and in such cases disgorgement because of a breach might be appropriate. But, in Roth, the court appeared to be going off into a disgorgement approach. This is not the usual remedy given by courts.
II. RELIANCE DAMAGES
Rest. § 349 Damages Based on Reliance Interest As an alternative to the measure of damages stated in §347,the injured party has a right to damages based on reliance interest, including expenditures made in preparation for performance or in performance, less any loss that the party in breach can prove with reasonable certainty the injured party would have suffered had the contract been performed.
Reliance damages are usually used when expectation damages cannot be determined due to a lack of certainty or difficulty of determining what the replacement (specific performance) should be. Generally situations where plaintiffs will try to get reliance damages are: 1) Plaintiff cannot show loss profit with sufficient certainty but can show items of expenditure. 36 2) There is no legally enforceable contract but the plaintiff is invoking the doctrine of promissory estoppel.
In reliance damages, the court focuses on the time between formation of contract and breach, to determine plaintiff's losses. Primary damages in reliance are: 1) Preparation for performance [Essential reliance] 2) Part performance [Essential reliance] 3) Foregone opportunities (must be FOS by Dft and reasonably certain) [Incidental reliance] 4) Collateral investments (must be FOS by Dft and reasonably certain) [Incidental reliance]
All these damages must be subtracted from net loss to the plaintiff for full performance. If Dft can prove that full performance will result in a net loss to Plt, then Plt may not recover for reliance damages. The burden of proof is on the Dft.
Notes: - Pre-contract costs are normally not included into the reliance cost. In Chicago Coliseum Club p. 1104, the court did not allow the fight promoter to recover sunk expenses incurred before Dft signed the contract). However, in Security Stove v. American Railway Express p. 1104, the court allow Plt to recover cost of booking the exhibition hall before contracting Dft to ship the display item The court argued that the Dft knew losses from pre-contract are hinged upon the contract's performance.
- In Security Stove, it appears that Dft had to have notice or the loss is highly foreseeable by the Dft that the Plt would suffer the loss if breach occurs. It is hard to argue that the contract had induced the Plt to rely and make those pre-contract expenses. But, courts are willing to argue that while the Dft did not induce the Plt to rely, Dft did induce the Plt to choose Dft and to rely on Dft rather than another contractor.
Watzman v. Hightower Production p. 1093 The Dft did not arrange properly to incorporate Plt's company. Plt sued Dft for malpractice on grounds that Dft failed to provide the adequate incorporation advice to Plt. Dft tried to argue that the net loss should be deducted from the reliance. However, the burden of proof here was on the Dft. [The reason why the plt did not try to get expectation damages is because they were unsure of the profits expected. This is the Woody Hightower venture.] However, the flip side was that the Dft could not show that Plt would have incurred a net loss.
Secondly, Dft argued that the Plt did not mitigate. The court held that it would be an undue cost and burden to the Plt to mitigate since they have to give back the money to the investors and hire a securities expert to get the structure fixed. It was not unreasonable for the Plt to decide to close up their business since Plts are not required to take undue risk to mitigate. Also, the court argued that the Dft also could have chance to mitigate since Dft also have the same opportunity to employ and pay securities specialists an equal opportunity notion. Dft didn't mitigate and it is not reasonable for them to demand the Plt to do so.
Notes: - Equal opportunities to mitigate only apply when both parties are in equally good positions to do so.
- Wilmarth: In Rest. § 350, Plts do not have to mitigate if it is unduly risky or burdensome. What standards should apply? Most of the time it is an objective standard where the court will look to what a reasonable person in Plt's position would do. However, in employment or service contracts, sometimes some subjectivity is allowed.
- The original restatement indicated that reliance damages should not exceed the contract price. However the 2nd Restatement made changes to this concept. It follows the modern distinguishing between 'essential' and 'incidental' reliance.
- Essential reliance damages consists of: preparation of performance and part performance. These types of reliance damages are limited to contract price. The reason is that if Plt spend more than what he would get from the contract, the Plt is not making reasonable reliance and would have loss if no breach occurred.
37 - Incidental reliance damages consist of: foregone opportunities and collateral investments. These are not directly need to perform the contract, but follows from it. Such reliance damages are not limited to the contract price. However, incidental reliance have to be FOS and reasonably certain to occur. See Rest § 349.
- The Restatement indicates that the doctrines that normally applies to limit recovery of expectation damages - causation, mitigation, FOS and certainty - also apply to recovery of reliance damages. Comment a, Rest. §352 (requirement of certainty).
Promissory estoppel in reliance damages Originally promissory estoppel is used as a substitute for consideration in contracts and was applied to gifts. However, as the theory grows, it extends into quasi-bargains [see Katz and Greiner] and to cases where there are bargains but no contracts [Pops Cones]. Originally, reliance are also restricted to monetary damages. The modern trend is encoded under Rest. §90, which provides that enforcement of promise is to be made "as justice requires." Thus, in the modern trend, courts have undertaken the discretion choose amongst a range of remedies for promissory estoppel: expectation damages, reliance damages, restitution, along with equitable remedies such as specific performance and injunctions.
Nevertheless in reliance promissory estoppel cases, courts are more unwilling to allow remedies outside of reliance damages. Most promissory estoppel cases are really cases where expectation damages would not have been readily available.
Walser v. Toyota Motor Sales p.1104 Plt sues Toyota for expectation and reliance damages. Plt claims that Toyota's representative induced Plt to incur cost of buying land for new dealership site by promising that a letter of intent had been issued and Plt would have the dealership. However, the letter of intent was not the last 'step' in securing dealership. There must be further approvals by Toyota that Plt had the necessary financial standing to become a dealer. It is doubtful that Plt would have satisfied the conditions even if a letter of intent was issued.
The court rejected expectation damages because it wasn't clear that Plt would have been able to obtain the dealership. The court allowed reliance damages for out-of-pocket expenses. Here it is the difference between the actual value of the land and the amount paid for it. (Property was worth $550,000 and Plt paid $676,000.)
III. RESTITUTIONAL DAMAGES
Rest. § 371. Measure of Restitution Interest If a sum of money is awarded to protect a party's restitution interest, it may as justice requires be measured by either (a) the reasonable value to other party of what he received in terms of what it would have cost him to obtain it from a person in the claimant's position, or (b) the extent to which the other party's property has been increased in value or his other interest advanced.
Rest. § 373. Restitution When Other Party Is in Breach (1) Subject to the rule in Subsection (2), on a breach by non-performance that gives rise to a claim for damages for total breach or on a repudiation, the injured party is entitled to restitution for any benefit that he conferred on the other party by way of part performance or reliance.
(2) The injured party has no right to restitution if he has performed all of his duties under the contract and no performance by the other party remains due other than payment of a definite sum of money for that performance.
Rest. § 374 Restitution in Favor of Party in Breach (1) Subject to the rule stated in Subsection (2), if a party justifiably refuses to perform on the ground that his remaining duties of performance have been discharged by the other party's breach, the party in breach is entitled to restitution for nay benefit that he has conferred by way of part performance or reliance in excess of the loss that he has caused by his own breach.
38 (2) To the extent that , under the manifested assent of the parties, a party's performance is to be retained in the case of breach, that party is not entitled to restitution if the value of performance as liquidated damages is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss.
Rest. § 375 Restitution When Contract Is Within Statute of Frauds A party who would otherwise have a claim in restitution under a contract is not barred from restitution for the reason that the contract is unenforceable by him because of the Statute of Frauds unless the Statute provides otherwise or its purpose would be frustrated by allowing restitution.
Rest. § 376 Restitution When Contract Is Voidable A party who has avoided a contract on the ground of lack of capacity, mistake, misrepresentation, duress, undue influence or abuse of a fiduciary relation is entitled to restitution for any benefit that he has conferred on the other party by way of part performance or reliance.
Rest. §377 Restitution in Cases of Impracticability, Frustration, Non-Occurrence of Condition or Disclaimer by Beneficiary A party whose duty of performance does not arise or is discharged as a result of impracticability of performance, frustration of purpose, non-occurrence of a condition or disclaimer by a beneficiary is entitled to restitution for any benefit that he has conferred on the other party by way of part performance or reliance.
UCC §2-718 Liquidation or Limitation of Damages; Deposits (1) Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty.
(2) Where the seller justifiably withhold delivery of goods because of the buyer's breach, the buyer is entitled to restitution of any amount by which the sum of his payments exceeds (a) the amount to which the seller is entitled by virtue of terms liquidating the seller's damages in accordance with subsection (1); or (b) in the absence of such terms, twenty per cent of the value of the total performance for which the buyer is obligated under the contract or $500, whichever is smaller.
(3) The buyer's right to restitution under subsection (2) is subject to offset to the extent that the seller establishes (a) a right to recover damages under the provisions of this Article other than subsection (1), and (b) the amount or value of any benefits received by the buyer directly or indirectly by reason of the contract.
(4) Where a seller has received payment in goods their reasonable value or the proceeds of their resale shall be treated as payments for the purpose of subsection (2); but if the seller has notice of the buyer's breach before reselling goods received in part performance, his resale is subject to the conditions laid down in this Article on resale by an aggrieved seller (Section 2-706).
In restitution, the focus shifts from the Plt's damages to the Dft's benefits from the breach. Restitution can be thought of as another way of providing remedy for Plt's part performance. Plt had to have conferred a benefit to Dft under the contract and was not compensated for such conference. (Preparation of performance, foregone opportunities and collateral contracts do not confer benefits to the Dft and restitution would not be applicable.)
United States ex rel. Coastal Steel Erectors v. Algernon Blair p.1116 Plt is a subcontractor for Dft in a building project. Plt supplied the labor and rented construction cranes, expecting to be reimbursed by the Dft. Dft refuses to pay. Plt sues. The trial court found that there was a material breach by the Dft. Question on appeal is that of damages. There is evidence suggesting that the remaining unpaid portion of the contract was worth $37,000 and that the Plt would lose more than $37,000 if the contract was fully performance. This means that the reliance theory would not work. However, the Court held that Plt can still seek restitution damages. The Plt had, at is own expense, conveyed a benefit to Dft and Plt is entitled to recover the reasonable value of the performance "undiminished by any loss which would have been incurred by complete performance."
39 Notes - The court here uses the 'market value restitution' rule. The rule holds that when a plaintiff sues for restitution, the contract no longer exist because it is rescinded. Recovery is not limited to the contract price.
- The majority of courts still follow the rule of market value restitution. The Rest. § 371 allows for two approaches. 1) in §371(a), the market value approach is used, or 2) in §371(b) the wealth enhancement approach. [Looking at how much Dft was enriched by the performance and not the reasonable market value of performance.]
- Limit on restitution. One limitation on restitution: Oliver v. Campbell (p. 1120): if Plt has performed as far as the contract provides and all that’s left is payment, then Plt can only get expectation. 1) seems to be a sense of judicial economy: if the k is clear on what the payment is, and all work is done, it is just more efficient to say that the k rate governs rather than take evidence about reasonable fair value 2) but maybe more : ancient common law pleading principle: if you sued under the common counts for this type of claim all you could get was the contract price. Historical artifact.
Lancelloti v. Thomas p. 1121 In this case the Plt was the breaching party. Plt had agreed to buy the luncheonette business from Dft, to build additions to the premise and pay rent. After Plt breached the contract, Dft took over premises and found some equipments missing. Plt brought suit to recover $25,000 in down payments.
The court held that Plt could recover the down payments. The court noted that at common law breaching party were not allowed to recover. However, this concept had been eroded because it allows the non-breaching party to gain windfall from the breach "to allow injured party to retain the benefit of the part performance… without making restitution… is the enforcement of a penalty or forfeiture against the contract-breaker."
The first Restatement allows restitution recovery for breaching parties only when they are non-willful breaches. The Second Restatement §374 eliminated this limitation [influenced by UCC §2-718]. The Rest. now provides that breaching party may recover for any benefit in excess of loss he caused by his own breach.
Note - The language of §374 does not mention willfulness. Comment b indicates, however, that an intentional variation from the terms of contract (as distinguished from an intentional non-performance) will preclude restitution. - The breaching party may only recover restitution up to the contract rate and not the market value of the service or goods provided. This is because the breaching party should not be able to avoid the contract by breaching since if he is bound by the contract the contract price is what he would get.
- The whole concept of restitution is the notion of unjust enrichment where the dft. retained benefit unpaid for. The book points out that some restatements mix up the both restitution and reliance, §158 and §272, seems to suggest that if contracts are rescind the court would provide 'restitutionary reliance' damages.
- In Earhart p.1141, the Dft and Plt contracted to repair the Dft and a third party's lands simultaneously. Dft argued that he only is responsible for benefit given for work on his land. However, court argued that plt can recover for both Dft's and third party's benefit because the court presumes that Dft would contract for improvement to another land only be it benefits him in some manner.
- In Albre Marble, the general contract was voided because of defect in bidding process. But before this happens, subcontractor Plt has already began work on the marble work for the general contractor. Plt sued for restitution. Here the subcontract was rescinded due to impracticability. Dft argued that the work was of no benefit to the Dft. The court disagrees and said that the preparatory work was not voluntary by the Plt. Here the subcontract required Plt to provide test sample. Because of this, there is a presumption of benefit for the Dft.
40 - Wilmarth: these cases are not saying that restitution equals reliance. These cases involve the court taking an expansive interpretation of the term benefit. The restitution claim is not really based on detrimental reliance. Most court take this view, they do not mix up reliance with restitution claims. 158 and 272 should not be viewed as signals for using reliance in giving restitution.
EQUITABLE REMEDIES: SPECIFIC PERFORMANCE/INJUNCTIONS
Rest. §359 Effect of Adequacy of Damages (1) Specific performance or an injunction will not be order if damages would be adequate to protect the expectation interest of the injured party.
(2) The adequacy of the damage remedy for failure to render one part of the performance due does not preclude specific performance or injunction as to the contract as a whole.
(3) Specific performance or an injunction will not be refused merely because there is a remedy for breach other than damages, but such a remedy may be considered in exercising discretion under the rule stated in §357.
Rest. §360 Factors Affecting Adequacy of Damages In determining whether the remedy in damages would be adequate, the following circumstances are significant: (a) the difficulty of proving damages with reasonable certainty, (b) the difficulty of procuring a suitable substitute performance by means of money awarded as damages, and (c) the likelihood that an award of damages could not be collected.
Rest. §364 Effect of Unfairness (1) Specific performance or an injunction will be refused if such relief would be unfair because (a) the contract was induced by mistake or by unfair practices. (b) The relief would cause unreasonable hardship or loss to the party in breach or to third persons, or (c) The exchange is grossly inadequate or the terms of the contract are otherwise unfair.
(2) Specific performance or an injunction will be granted in spite of a term of the agreement if denial of such relief would be unfair because it would cause unreasonable hardship or loss to the party seeking relief or to third persons.
Rest. §366 Effect of Difficulty in Enforcement or Supervision A promise will not be specifically enforced if the character and magnitude of the performance would impose on the court burdens in enforcement or supervision that are disproportionate to the advantages to be gained from enforcement and to the harm to be suffered from its denial.
Rest. §367 Contracts for Personal Service or Supervision (1) A promise to render personal service will not be specifically enforced.
(2) A promise to render personal service exclusively for on employer will not be enforced by injunction against serving another if its probable result will be to compel a performance involving personal relations the enforced continuance of which is undesirable or will be to leave the employee without other reasonable means of making a living.
UCC §2-716 Buyer's Right to Specific Performance or Replevin (1) Specific performance may be decreed where the goods are unique or in other proper circumstances.
(2) The decree for specific performance may include such terms and conditions as to payment of the price, damages, or other relief as the court may deem just.
(3) The buyer has a right of replevin for goods identified to the contract if after reasonable effort he is unable to effect cover for such goods or the circumstances reasonably indicate that such effort will be unavailing or if the goods have been shipped under reservation and satisfaction of the security interest in them has been made or tendered. In the case of goods
41 bought for personal, family, or household purposes, the buyer's right of replevin vest upon acquisition of a special property, even if the seller had not then repudiated or failed to deliver.
Rest 359 and 360 sets forth the notion that specific performance and injunctions may be use if damages are inadequate compensations.
Factors for assessing whether damages are adequate remedies (§360): 1) Can Plt prove damages with reasonable certainty? 2) Will money damages allow you to plt to get suitable substitutes? 3) Even if Plt can prove damages, how likely will Plt recover them from the Dft?
Factors for assessing whether specific performance is suitable (§364): 1) Burden of supervision and enforcement for the court. 2) Unreasonable hardship or loss to party in breach or third parties. 3) Was contract induced by mistake or unfair practices? 4) Is the exchange grossly inadequate or terms of contract unfair?
Traditionally, specific performance is normally given to land related contracts because it was felt that each parcel of land is unique and alternative obtainable through damages are inadequate.
City Store v. Ammerman p.1146 The Plt was negotiating with Dfts for getting a lease in their new dept. store project. Dft is having problem getting the zoning regulations approved. The Dft wanted support for the zoning approval. Dft wrote a letter to Plt stating that they appreciated the Plt's assistance in zoning approval. Dft promised to give Plt a spot if the zoning is approved.
The court looked to correspondence letter between the two parties and held that there was a unilateral options contracts. Two conditions precedents must be satisfied for the contract to become binding. 1) Dft has to get favorable zoning. Here the county board approved the mall. 2) The Dft had to enter leases with other major dept. store tenants so that the terms of those leases would be use to apply towards the Plt's lease. Here the Dft did get two other department stores.
Question 1: Are damages adequate remedies? Here the court felt that the Plt could not prove damages to a reasonable certainty because it is a new venture. Plt would not be able to get suitable alternative because there are no other malls nearby. Damages would not be adequate remedies.
Question 2: Is it practical to give specific performance? The question here is can the court supervise the parties in negotiating a lease and also the construction. The court says that negotiation phase could be handled by looking at the leases with the other two department stores. The parties need to deal with each other in good faith and fair dealing. If the parties got deadlock, what remedy might the court use? The court may appoint a master to oversee the negotiation process. Also, the parties could decide on an arbitrator to work out the differences.
The court is saying here that it has ways to make the parties move towards a good faith agreement. What about supervision of construction? There are already construction plans for other leases and the court can look to that to see if the construction is made appropriately. The court here seems to be pretty confident that it could supervise the specific performance.
When determining whether specific performance: What is the benefit for granting the Plt this relief vs. what harm to the Dft or third party? The Dft argue that there is a lot of harm done to them because they will lose a lease with Sears. The court does not buy this argument because the Dft did not prove that they were ruined financially. The court also argued that the Dft could have leased one of the other two places to Sears. The Dft had boxed themselves in and it is their fault.
American Broadcasting Co. v. Wolf p.1159 -Negative injunction Dft was employed by ABC to be a sports commentator. Contract had covenants including exclusive good faith negotiation for first 45 of 90 days before contract ends, non exclusive good faith negotation for the remaining 45 days, followed by 90 days of first refusal for ABC to match any competitor's offer (applying only to broadcasting portion of contract).
42 Court determined that Dft violated the first exclusive good faith negotiation portion of the contract by negotiating with CBS. However, Court held that Dft did not violate the first refusal right because the agreement with CBS was a production agreement and not broadcast agreement.
The Court held that ABC cannot get negative injunction to prevent Dft from working with CBS. This is because the Plt is seeking to prevent the Dft from working after the employment contract expired. Courts normally allow injunction to prevent contract breaching employees from furnishing services to another employer for the duration of the contract. The court noted that after contract expires, negative injunctions would be enforced only if employee has expressly agreed not to compete with employer or is threatening to reveal trade secrets, customer lists, good will of employer's business, other unique nature of employee's service. Even where express non-compete covenant are present, these are rigorously examined. There is a general disfavor to non-compete covenants.
Notes: - Factors to consider when non-compete covenants might be applicable: 1) What are the harm to the employer, 2) harms to employee, 3) harm to the public by not being allowed to access employee's services. This is a balancing test similar to Rest. §364.
- Rest. § 367 recognizes the general rule for negative enforcement by way of injunction. The restatement disfavor specific enforcement of personal services (forcing a person to work against his will) and negative injunctions will not be issued if it produces "undesirable" continuance of personal relations or leaves the employee without means of making a living.
- Normally injunction relief for services requires showing that the services performed are 'unique.' Here athletes and entertainers will usually qualify.
- In addition, employers may normally get injunctions to prevent employees from revealing trade secrets, tech. secrets, intellectual property, financial conditions. However, there is a problem with know-how (certain skills gained through employment): does this belong to employee?
AGREED REMEDIES (LIQUIDATION DAMAGES)
Rest. §356 Liquidated Damages and Penalties (1) Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.
(2) A term in a bond providing for an amount of money as a penalty for non-occurrence of the condition of the bond is unenforceable on grounds of public policy to the extent that the amount exceeds the loss by such non-occurrence.
UCC §2-718
Parties may often agree to damages in advance (liquidating damages). However, the courts traditionally disfavor such pre- contract 'settlement'. For such liquidation clauses must met the three-prong test in order to pass judicial scrutiny. 1) Damages to be anticipated from breach must be uncertain or difficult to prove; 2) Parties must intend the clause to liquidate damages rather than operate as penalty; 3) The estimated amount must be a reasonable forecast of just compensation for harm of breach (here courts look to whether estimate of what losses might is reasonable and whether the actual loss is within reasonable bounds of the set amount.)
Colonial v. Sloan [handout] Plt made contract to sell 49% of ownership interest to Dft for $3.375 million. The sale was to be closed by June 21. The contract provided that, if closing does not occur, Dft must pay liquidated damages of $200,000. Closing never occurred. Plt later entered into another contract with Lincoln associates. Plt sue Dft.
43 Question1. How difficult is it for damages to be reasonably ascertained in advance? Plt didn't know how soon they will be able to get an alternative buyer or whether they can get another buyer. So, when the contract was made it is hard to figure out what the damages might be. However, there is an ascertainable potential of loss interest on the down payment to be made at closing.
Question 2. Is $200,000 a reasonable estimate of what the potential damages might be? The court felt that it is so. If we calculate the loss interest on down payment, that would come out to be about $200,000 and this does not include other effects of cash flow problem. So this is not unreasonable estimate.
Question 3. What did the actual damages turn out to be? The court found that it is a different situation once it looks retrospectively on the contract. When Lincoln came into the picture, Plt's financial situation changes. There is still a loss of interest from the Dft's breach between June 1 and Sept 1 (when new closing with Lincoln occurred). However, the Lincoln deal is more lucrative. Lincoln paid $3.7 million in closing. There was an interest gain that cancels off the interest loss by Dft breach.
Colonial argues that the court cannot compare a 50% sale contract vs. 49% ownership. Conceptually selling 49% is very different fro 50% since the veto power is now a deadlock. However, there was some doubt that Colonial's lenders would allow Colonial to sell 50%. In the agreement Colonial said to Lincoln that if they cannot sell 50%, they will not sell 1% for only $74,000 less. The court finds that the net gain between $3.375 million and $3.7 million different in two contract is higher than $74, 000. There is real net gain being made. ($250,000).
It turns out that the contract was unreasonable retrospectively. [This just shows how hard it is for liquidation clauses to prevail judicial scrutiny.]
Notes: - Not every court follows the Colonial ruling. The 9th Circuit looked to Rest. 365 and interpreted it as consisting of two separate analysis: either it is reasonable prospectively or it is reasonable retrospectively. As long as one condition is satisfied, the liquidation clause is enforceable. Facially, the Restatement appears to support this conclusion. However the commentary to the Restatement indicates that the terms are not supposed to read disjunctively; both tests has to be satisfied. But there is a split in the authorities over this issue.
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