The Legal and Social Environment of Business (part 2)/Contracts (part 1)






Legality and Public Policy

Agreement is illegal when formation or performance is a crime or a tort, or when contrary to public policy, or unconscionable.

When agreement is illegal, parties are left where the courts found them and are not entitled to the aid of the courts.

If illegal agreement has not been performed, neither party can sue.
If it has been performed, neither party can sue the other for damages, or to set agreement aside.

An agreement may seem legal on its face, but be illegal because entered into for illegal purpose.

Exceptions:
(a) When the violated law is intended to protect one of the parties, that party may sue.
(b) When parties are not equally guilty (in pari delicto), least guilty party is granted relief when it benefits the public interest.

If an agreement has both legal and illegal portions, the legal portions will be enforced if they can be separated from the illegal parts.

If a contract has two interpretations (one legal one illegal), courts will assume the legal meaning was intended unless it's clearly indicated it wasn't.

An agreement to perform a crime or civil wrong, or to obtain equipment for committing a crime, are illegal and automatically void.

Every contract has an implied covenant of good faith (absence of knowledge of any defects or problems) and fair dealing.

A provision in a contract that the court believes gives too much advantage to one of the parties may be voided as unconscionable.

Both procedural and substantive unconscionability must be present for court to refuse to enforce a contract provision.
Procedural unconscionability – matters where there is inequality of bargaining power and absence of real negotiations.
Substantive unconscionability – contract terms are so one sided or extreme as to appear unconscionable according to business practices.

Contract of adhesion – contract offered by a dominant party to a party with inferior bargaining power on a take-it-or-leave-it basis.

Agreement may not violate law, but may be offensive to public policy. Contracts unenforceable as violation of public policy relate to protection of public welfare, health or safety; protection of the person; protection of recognized social institutions.

Gambling contracts are illegal, as well as private lotteries involving the three elements (prize, chance and consideration).

Giveaway plans and games are lawful as long as no purchase is necessary.

Activity is not gambling if the result is predominantly a matter of skill. Is when the result is solely a matter of luck.

Statutes provide that contracts of a given class follow a specific model or contain specified provisions.

If a license is required by law, a contract made by an unlicensed person is unenforceable.

A noncompetition agreement maybe held invalid because of vagueness concerning duration and geographic area of the restriction.

When a business is sold, commonly states in contract seller will not go into business for certain time frame or geographic area to protect the buyer.

Restrictions to prevent a former employee from competing are held valid when reasonable and necessary to protect the interest of the former employer.

When the noncompetition restriction is too great due to time or area, some courts trim it down using the “blue-pencil” rule to a scope it feels is reasonable.

Usury – lending money at an interest rate that is higher than the maximum rate allowed by law.

Any fee that goes beyond the reasonable expense of making a loan is interest.

Penalties for violation of usury laws vary from state to state. Some restrict lender to recovery of loan but no interest; some allow recovery of loan principal and interest up to maximum contract rate; some impose a penalty on lender of double the interest paid on a usurious loan; some have forfeiture of entire principal amount.

Writing, Electronic Forms, and Interpretation of Contracts

Unless there's a statute requiring a written contract, oral contracts are valid.

A service contract that can be performed within one year can be oral.

Statute of frauds: statute that, in order to prevent fraud through the use of perjured testimony, requires that certain kinds of transactions be evidenced in writing in order to be binding or enforceable.

Part performance may exist when the plaintiff’s part performance is “unequivocally referable” to the oral agreement.

A contract that cannot be completed within one year from the time the oral contract is made (not when performance is to begin) cannot be enforced. No part performance exception exists for these oral contracts.

If no time frame is specified and the contract could be conceivably performed within a year, the statute of frauds does not apply.

When a contract can be terminated at will by either party, contract may be terminated within a year, so statute of frauds does not apply.

Written contract that is not required to be so because it is terminable at will may be varied by a new oral contract – but the burden of proof on party asserting the oral modification is a heavy one.

All contracts to sell land, buildings, or interest in land (example: mortgages) must be in writing. Leases are interests in land, but in some states, leases of one year or less do not have to be in writing.

Suretyship – undertaking to pay the debt or be liable for the default of another. Must be in writing. Sometimes called a collateral or secondary promise.
Exception: When main purpose of promise to pay debt of another is to benefit the promisor, oral promise to pay is binding.

Personal representative (executor) of an estate handles the affairs of a deceased person, pays debts from the proceeds of the estate, and distributes any remaining balance. Executor is not personally liable for any claims against the estate of the decedent. If promises to pay debts with executor’s own money, must be in writing.

Promises to pay money or give property to another in consideration of marriage must be in writing.

Prenuptial or antenuptial agreements are entered into before marriage after full disclosure of assets and liabilities (in some states also income). Must be in writing, and cannot be set aside unless unconscionable (which means former spouse unable to support themselves).

Sale of goods $500 or more must ordinarily be in writing.

Can get around statute of frauds when there’s an enhanced promissory estoppel. Along with requiring that the promisee rely on the promise, also must prove of unconscionable injury or unjust enrichment.

Statute of frauds requires a writing, not necessarily a full blown written contract. A note or memorandum can suffice, as long as it is signed by the party to be held to the “contract”. Must contain essential terms of the contract so courts can determine what was agreed.

Electronic signature = any electronic sound, symbol, or process attached to, or logically associated with, a contract or other electronic record and executed with the intent to sign the record.

Electronic record = any contract or other record created or stored in an electronic medium and retrievable in a perceivable form.

E-Sign = Electronic Signatures in Global and National Commerce Act – Signatures cannot be denied legality because they are in electronic form, nor for being delivered electronically. They are just as enforceable as handwritten and signed paper documents.

UETA = Uniform Electronic Transactions Act – enacted by 48 states + Washington DC. Specifies that e-signatures and e-records can be used in contract formation in audits, and as evidence.

Neither E-Sign nor UETA require security procedures or certification authority for the verification of electronic signatures.

E-Sign exempts docs and records on trust and estate law. Does not cover wills, codicils, and testamentary trusts or commercial law matters (checks, negotiable instruments, letters of credit); documents and cancellation of health and life insurance.

Consumers must consent to receive documents electronically, and business must tell consumers of their rights to receive hardcopy documents.

UETA states electronic record is sent when (1) properly directed to an information processing system designated or used by the recipient, (2) in a form the recipient may recover the record, (3) enters an information processing system that is in the control of the recipient but outside the control of the sender. Electronic record is received when (1) enters information processing system designated or used by the recipient, (2) in a form that the recipient’s system can process.

To avoid unjust enrichment, an oral contract that cannot be enforced due to statute of frauds may still allow one party to seek recovery. Example: oral contract for services cannot be enforced, but person performing the work may recover reasonable value of services rendered.

Only parties to the oral contract can raise defense of statute of frauds – third party cannot.

Parole evidence rule – rule that prohibits the introduction of oral or written statements into evidence that are made prior to or contemporaneously with the execution of a complete written contract, deed, or instrument, in the absence of clear proof of fraud, accident, or mistake, causing the omission of the statement in question.

If a written contract is ambiguous (having more than one reasonable interpretation) or may have two or more different meanings, parol evidence may be admitted for clarification.

If a contract omits a provision then parol evidence may be admissible to show it was omitted as a result of fraud, duress, or mistake, and to show what the provision stated.

Ordinary words are to be interpreted according to the ordinary meaning. If there is a common meaning to a term, that meaning will be followed even though the dictionary may contain additional meanings.

Incorporation by reference – contract consisting of both the original or skeleton document and the detailed statement that is incorporated in it.

When a contract refers to another document, the contract must sufficiently describe the document or so much of it as is to be interpreted as part of the contract (can't just reference, must be specific).

When a contract is party printed (or typed) and partly handwritten, and handwritten part conflicts with typed, then handwritten will overrule. When there is a conflict between the printed and typed part, the typed part will prevail.

When there is a conflict (such as on a check) between amount expressed by words and amount expressed by numbers, the amount expressed by words is taken.

An ambiguous contract is interpreted strictly against the party who drafted it.

In every contract there is an implied obligation that neither party shall do anything that will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract. In other words, all contracts have an implied covenant of good faith (absence of knowledge of any defects or problems) and fair dealing.

Usages of trade – language and customs of an industry. Cannot override express provisions of a contract that are inconsistent with custom and usage. When hardship arises because the contract made no provision for the situation that has occurred, the court will sometimes imply a term to avoid the hardship.

Third Persons and Contracts

Intended beneficiary – third person of a contract whom the contract is intended to benefit. May bring suit on and enforce the contract. Sometimes classified as a creditor beneficiary when the promisee's primary intent is to discharge a duty owed to the third party. Called a donee beneficiary to whom the promisee's primary intent in contracting is to give a benefit.

Third-party beneficiary – third person whom the parties to a contract intend to benefit by the making of the contract and to confer upon such person the right to sue for breach of contract.

Third party does not have to be identified by name. Beneficiary may be identified by class, with the result that any member of that class is a third-party beneficiary.

If contract contains an express provision allowing a change of beneficiary or cancellation of the contract without consent of the third-party beneficiary, parties to the contract may destroy the rights of the intended beneficiary by acting in accordance with the contract (changing beneficiary on a life insurance policy for example).

If third-party benefit was not intended, then person is an incidental beneficiary, and does not have standing to sue as third-party beneficiary.

Assignment – transfer of contractual rights to a third party.

Assignment takes effect the moment it is made. Assignee should give immediate notice to obligor in order to prevent improper payment to the assignor instead of the assignee.

A claim (right to payment) or cause of action (right to damages or other judicial relief when a legally protected right of the plaintiff is violated by an unlawful act of the defendant) against another person may be assigned.

When the assignment of a right would increase the burden of the obligor in performing, an assignment is ordinarily not permitted.

Contracts for personal services are generally not assignable.

When a transaction is based on extending credit, the person to whom credit is extended cannot assign any rights under the contract to another.

The making of an assignment does not relieve the assignor of obligations from the contract, unless there is a novation.

Novation – substitution for an old contract with a new one that either replaces an existing obligation with a new obligation or replaces an original party with a new party.

When an assignment is made for a consideration, the assignor is regarded as providing an implied warranty (warranty that was not made but is implied by law) that the right assigned is valid.

Delegation of duties – transfer of duties by a contracting party to another person who is to perform them.

Delegation – transfer to another of the right and power to do an act.

Under certain circumstances contracting party may delegate work to another. In such cases, however, contracting party remains liable for the work in case of default of the person doing the work, just as though no delegation had been made.

Discharge of Contracts

Ordinary method of discharge is by performance (which may be the doing of an act or the making of payment).

Condition – stipulation or prerequisite in a contract, will, or other instrument.

Condition precedent – event that if unsatisfied would mean that no rights would arise under a contract (something must happen before a party has an obligation to perform under a contract, such as pay when paid).

Condition subsequent – event whose occurrence or lack there of terminates a contract (if something happens the event extinguishes the contract, such as employment contract that terminates on failing a drug test).

Most bilateral contracts are condition concurrent; that is, both parties actions take place at the same time. Example would be upon delivery of goods, payment must be made.

Tender – goods have arrived, are available for pickup, and buyer is notified. Tender is an offer to perform.

If a debtor owes more than one debt and pays money specifying which debt it is to go to, the creditor must apply the funds to that debt.

Payment by check (or other commercial paper) is a conditional payment. It merely suspends the debt until it clears the bank.

When time for performance is not specified, an obligation to perform in a reasonable time is implied.

Perfect performance of a contract is not always possible.

Substantial performance – equitable rule that if a good-faith attempt to perform does not precisely meet the terms of the agreement, the agreement will still be considered complete if the essential purpose of the contract is accomplished.

Party cannot complain that a performance was defective when it follows the terms of the contract required by the complaining party.

Most contracts cannot be canceled by just one party, but some (such as insurance policies) can be upon proper notice.

Consumer Credit Protection Act gives debtors three days to cancel a credit transaction that would impose a lien on the debtor's home.

Federal Trade Commission also gives three days for home-solicited sale of goods or services costing more than $25.

Contracts may be discharged by a provision or subsequent agreement. Discharge may be:
(1) terms of original contract where there is an end specified on a specific date.
(2) Mutual cancellation.
(3) Mutual rescission (action of one party to a contract to set the contract aside when the other party is guilty of a breach of the contract).
(4) Substitution of a new contract between the same parties.
(5) Novation or substitution of a new contract involving a new party.
(6) Accord and satisfaction (agreement to substitute for an existing debt some alternative form of discharging that debt, coupled with the actual discharge of the debt by the substituted performance). For this, there must be a bona fide dispute of the original agreement, proposal to settle the dispute, and performance of the agreement.
(7) A release.
(8) A waiver.

Discharge may be due to impossibility. To prove impossibility, must show (1) unexpected occurrence of an intervening act, (2) the risk of the unexpected occurrence was not allocated by agreement or custom, and (3) the occurrence made performance impossible.

Impossibility only relieves nonperformance in extreme circumstances, and if impossibility is removed (such as if it was due to terrorist attacks), usually calls for the contract to be put back into place. If later date performance can cause substantially greater burden on the party obligated to perform, however, some courts will discharge the obligor from the contract.

Unless the contract can be performed “by anyone”, or has a clause for continuance after the death of one of the parties (such as binding to “heirs and assigns”), the death of either party is the death of the contract.

Because of change in circumstances, purpose of the contract may have no value to the party entitled to receive performance. In such a case, performance may be excused if both parties were aware of the purpose and the event that frustrated the purpose was unforeseeable.

Force majeure – uncontrollable event.

To avoid litigation, many contracts specify the failures that will excuse performance in the contracts. These are called force majeure clauses.

Weather usually does not terminate a contract even though they make performance difficult.

Operation of law – attaching of certain consequences to certain facts because of legal principles that operate automatically as contrasted with consequences that arise because of the voluntary action of a party designed to create those consequences.

Bankruptcy – even though all creditors have not been paid in full, it eliminates ordinary contract claims against the debtor.

Statute of limitations – statute that restricts the period of time within which an action may be brought.

Breach of Contract and Remedies

Breach – failure to act or perform in the manner called for in a contract.

Anticipatory breach – When promisor tells promisee that it will not perform the contract prior to when it is supposed to perform it.

Anticipatory repudiation – declaration of the anticipatory breach. Must be a clear, absolute, unequivocal refusal to perform the contract according to its terms.

A refusal to perform before performance is required unless the other party does an act or makes a concession that is not required by the contract is anticipatory repudiation.

If the other party has not yet acted (changed position based on the repudiation) on the anticipatory repudiation, then the party refusing may retract.

Anticipatory repudiation may be made by conduct that makes it impossible to subsequently perform.

Waiver – release or relinquishment of a known right or objection.

A party allowing the other party to continue performance without objecting that the performance is not satisfactory waives the right to raise that objection when sued for payment by the performing party.

Waiver of a breach extends only to the matter waived, and does not show an intent to ignore other provisions of the contract.

Reservation of rights – assertion by a party to a contract that even though a tendered performance (e.g. a defective product) is accepted, the right to damages for nonconformity to the contract is reserved.

Remedy – action or procedure that is followed in order to enforce a right or to obtain damages for injury to a right.

Aggrieved person to anticipatory repudiation has several options. He can (1) do nothing beyond stating performance at proper time will be required, (2) regard the contract as having been broken and bring a lawsuit, or (3) regard repudiation as an offer to cancel the contract (which can be accepted or rejected).

Specific performance – action brought to compel the adverse party to perform a contract on the theory that merely suing for damages for its breach will not be an adequate remedy.

Monetary damages are classified as:
Compensatory damages – sum of money that will compensate an injured plaintiff for actual loss. Have two categories – direct damages and consequential (or specific) damages.
Nominal damages – nominal sum awarded the plaintiff in order to establish that legal rights have been violated although the plaintiff in fact has not sustained any actual loss or damages.
Punitive damages – damages, in excess of those required to compensate the plaintiff for the wrong done, that are imposed in order to punish the defendant because of the particularly wanton or willful character of wrongdoing; also called exemplary damages.

Direct damages – include incidental damages (extra expenditures made by injured party to rectify breach).

Consequential damages (special damages) do not necessarily flow from type of breach of contract but happen to do so in a particular case as a result of the injured party's particular circumstances. Can only be recovered if reasonably foreseeable to defendant that loss in question could be sustained by plaintiff if contract were broken.

Injured party must mitigate damages – in other words, must not permit damage to increase if preventable.

Injunction – order of a court of equity to refrain from doing (negative injunction) or to do (affirmative or mandatory injunction) a specified act. Statute use in labor disputes has been greatly restricted.

Liquidated damages – provision stipulating the amount of damages to be paid in the event of default or breach of contract. To be valid, contract must have a liquidated damage clause (specification of exact compensation in case of a breach of contract) that satisfies two requirements:
(1) Situation must be one in which it is difficult or impossible to determine the actual damages
(2) Amount specified must not be excessive when compared with the probable damages that would be sustained.

If amount is clearly unreasonably large, clause will be held void as a penalty.

The so called “American Rule” states each party is responsible for its own attorney fees in the absence of an express contractual or statutory provision to the contrary.

Exculpatory clause – provision in a contract stating that one of the parties shall not be liable for damages in case of breach. Also called limitation of liability clause (when a monetary limit to damages for breach of contract is set).

If exculpatory clause is only for negligent conduct, liability is not excluded nor limited if the conduct is found to be grossly negligent, willful, or wanton.

Personal Property and Bailments

Personal property = all things of value other than real estate. Property that is moveable or intangible, or rights in such things.

Property includes the rights of a person to possess, sue, enjoy, and dispose of a thing.

Real property – land and all rights in land.

Chose in action – intangible personal property in the nature of claims against another, such as a claim for accounts receivable or wages.

No title is aquired by theft, only possession. Selling a stolen item only transfers possession, not ownership.

Gift – title to an owner's personal property voluntarily transferred by a party not receiving anything in exchange. Person making the gift is the donor, person receiving is donee.

Inter vivos gift – any transaction that takes place between living persons and creates rights prior to the death of any of them.

Intent to make a gift requires intent to transfer title at that time. Delivery of property without intent to make a gift does not transfer title.

Symbolic (constructive) delivery – deliver of goods by deliver of the means of control, such as a key or a relevant document of title, such as a negotiable bill of lading.

If donor dies before doing what is needed to make an effective gift, the gift fails. An agent or executor of the estate cannot thereafter perform the missing step on behalf of the decedent.

Gift causa mortis – gift made by the donor in the belief that death was immediate and impending, that is revoked or is revocable under certain circumstances: (1) donor does not die, (2) donor revokes the gift before dieing, (3) donee dies before the donor.

For minors: Custodian can hold property, and use for the benfit of the minor, but cannot use for custodian's benefit. Custodianship terminates when minor reaches 21.

Gifts may be conditional. Condition precedent – must be satisfied before getting the gift (you get the car if you graduate); condition subsequent – cancels gift if something happens (you get the car unless you drop out of school).

Engagement rings are conditional gifts subject to condition subsequent of a failure to marry.

Uniform Anatomical Gift Act allows those 18 or older to make gifts of their bodies or any parts thereof.

Finding lost property does not give title, just possession. Ordinarily, finder is required to surrender property to true owner. Unless there is a contract with the owner or a statute so providing, finder is not entitled to a reward or compensation for finding or caring for the property.

If found in a public place, such as hotel, under circumstances that it would appear property was intentionally left and owner would likely recall where it had been left and return for it, finder is not entitled to possession of the property, and must give to proprietor or manger of public place to keep for the owner. If it does not appear it was intentionally placed where it was found, this exception does not apply.

Wild animals in nature are not owned by anyone. A person acquiring dominion or control over a wild animal (kill, tie, imprison, or otherwise prevent from going at its will) becomes the owner. If the animal escapes, it becomes wild again. If this is done on someone's land without the landowner's permission, animal becomes the property of the landowner, not the hunter.

Personal property is deemed abandoned when owner relinquishes possession with intention to discaim title. Title to abandoned property may be acquired by first person who obtains possession and control.

If owner flees in face of an approaching peril, property left behind is not abandoned. Only abandoned if owner voluntarily leaves the property.

Escheat – transfer to the state of the title to a decedent's property when the owner of the property dies intestate and is not survived by anyone capable of taking the property as heir. Funds held by stores for layaway items for customers who fail to complete the layaway purchases are subject to escheat to the state.

Severalty – ownership of property by one person.

Contenancy – when two or more persons hold concurrent rights and interests in the same property.

Tenancy in common – relationship that exists when two or more persons own undivided interests in property. Interest of a tenant in common may be transferred or inherited.

Joint tenancy – estate held jointly by two or more with the right of survivorship as between them, unless modified by statute. If interest is transferred to another, changes to a tenancy in common.

Tenancy by entirety – transfer of property to both husband and wife. Right of survivorship cannot be extinguished, and interest cannot be transferred to a third person.

Community property – contenancy held by husband and wife in property acquired during their marriage under the law of some of the states, principally in the southwestern U.S.

Prima facie – evidence that, if believed, is sufficient by itself to lead to a particular conclusion.

Bailment – relationship that exists when personal property is delivered into the possession of another under an agreement, express or implied, that the identical property will be returned or will be delivered in accordance with the agreement. Person turning over the possession is the bailor, and person who accepts possession is the bailee. Must have agreement, delivery and acceptance of delivery.

Real property cannot be bailed.

In the absence of a prior agreement to the contrary, valid delivery and acceptance require that the bailee be aware that goods have been placed within the bailee's possession or control.

Title to the property does not pass to the bailee, and the bailee cannot sell the property to a third person.

Bailment for mutual benefit – bailment in which the bailor and bailee derive a benefit from the bailment.

Gratuitous bailment – bailment in which the bailee does not receive any compensation or advantage.

Constructive bailment – bailment imposed by law as opposed to one created by contract, whereby the bailee must preserve the property and redeliver it to the owner.

When a person rents a space or locker or building under an agreement that gives renter right to use that space, placing of goods by the renter in that space does not create a bailment.

Bailee is under a duty to care for the bailed property, and duty of care owed differs according to classification based in terms of “benefit”.

Bailment may be for sole benefit of the bailor (only responsible for gross negligence), or sole benefit of the bailee (responsible for even slight negligence). Most are for mutual benefit, however.

Bailee's lien – specific, possessory lien of the bailee upon the goods for work done to them. Commonly extended by statute to any bailee's claim for compensation, eliminating the necessity of retention of possession. Example is getting a car repaired, must pay for repairs before car can be given back.

Breach of duty of care by a bailee is not contractual at all but based on tort principles.

Burden of proof first is on the bailor to show that the property was given in good condition, and returned damaged or could not be returned. Once done, then the bailee has to proove loss or damage was not caused by bailee's failure to exercise the care required by law.

In mutual benefit bailments, bailor must inform bailee of known defects and make a reasonable investigation to discover defects. Bailor is responsible for harm resulting from any such defects.

If bailment is for sole benefit of bailee, bailor must inform bailee of known defects.