Contracts II
Foundational principles of contract law are covered in Contracts I. In Contracts II, you will develop an understanding of topics that are more advanced or that flow from the foundational principles. Further, because, The American Contract is one of the most frequently used casebooks in law school, Contracts II follows the American Contract Organization.
The American Contracts Organization is contracting, performance and breach, the consequential or punitive damages for breach, contractual defenses and equitable remedies, third party rights, and assignment, delegation, and contract termination. Note that I have broken up this very common organization for clarity in this series on contract law terms. With that said, here is a quick introduction to Contracts II.
Contracting
Contracts are formed when an offer, an acceptance, and consideration are present. In contracts II, you will learn more about offers and acceptances because without them, there is no contract. This is why, among other reasons, Contracts I covers offer and acceptance in much detail. It is also essential to learn about consideration before moving to the next principle in the American Contracts Organization, performance. For more information about offer, acceptance, and consideration, check out Contracts I and check out my contract law blog posts on offer and acceptance: Introduction to Offer; Offer and Acceptance in LPM; Offer and Acceptance in Action.
Performance and Breach
In Contracts II, you will cover performance (fulfilling the promise(s) in the contract) and breach (failing to fulfil the promise(s) in the contract in a timely manner). Note that the discussion of breach and performance will include a discussion of Sale of Goods and the Uniform Commercial Code (contracts for the sale of goods/money in exchange for goods hereafter referred to as UCC contracts). This is because almost no act of performance or breach is done by the parties to a contract. This is because almost every promise is delegated to a third party (e.g., a painter, with an underlying construction contract between the homeowner and the contractor) and most breaches occur because one party hurts a third party (e.g., as the result of defective paint, a painter fails to fulfil its promise to that third party and causes the other party to breach its promise to its client).
Consequential Damages (punitive damages)
Further, in Contracts II, you will learn about the types of damages awarded for breach (consequential damages and punitive damages) . To get around a breach of contract, try creating a well-crafted contract with well-placed conditions. A condition suspends the promise. However, satisfaction clauses are not conditions because they are measures of satisfaction (or "objective," "reasonable," or "subjective" satisfaction). Be advised, because some satisfaction clauses require "subjective" satisfaction, they are almost always void if the promise is not the moving party’s personal status.
Equitable Remedies
In Contracts II, you will learn about damage (contract remedy) and equitable (non-damages remedy) relief for breach. Types of remedies for breach are money in the form of damages, specific performance (requiring the breaching party to do what it promised to do in the contract), and recission (requiring the other party to undo what is in the contract). To win a breach of contract case, you must prove (1) you are not entitled to order the court to undo the contract, (2) you are entitled to an order requiring the defendant to do what was promised (or something similar), and (3) the defendant has some ability to do what was promised.
Third Party Rights
The parties to the contract are the promisor, the promisee, and third party. Generally, only the promisor(s) and promisee(s) can sue in a breach of contract case. However, third party beneficiaries exist to receive money in the form of damages, specific performance (requiring the breaching party to do what it promised to do in the contract), and recission (requiring the other party to undo what is in the contract). To win a breach of contract case, the third party must prove (1) he or she is not entitled to order the court to undo the contract, (2) he or she is entitled to an order requiring the defendant to do what was promised (or something similar), and (3) the defendant has some ability to do what was promised.
Assignment, Delegation, and Contract Termination
Finally, Contracts II will cover assignment (talked about in the context of delegation), delegation (empowering a third party to carry out an act), and contract termination (a form of discharge). Although contract termination occurs, the parties to the contract, their agents, their representatives, the acquirer of a party’s duties under the contract, and the assignee of a party’s rights under the contract may still be liable for breach.
Breach and Remedies
Contracts are not always performed, either due to bad faith, negligence or other acts by one of the parties. When a breach of contract occurs, whether partial or total, there are many accepted remedies. Indeed, whether the contract is an oral or written agreement, all promises form the basis of a contract and may be breached. Most contracts, however, unless they are in writing, are global damages contracts. That is, there is no specific method of compensation outlined in the agreement and any award is solely up to the discretion of the trier of fact.
In determining how to successfully address a breach of contract, the Plaintiff’s counsel must do an analysis of the cause of action and determine how to prove liability, from there the Plaintiff should determine what is the measure of damages. The major damages are compensatory damages. Compensatory damages are monetary damages that will compensate a party for the actual loss of the bargain caused by the breach. For example, in a passenger bill contract (bus ticket) there is a "delayed train schedule" or a different combination of wording. If the plaintiff purchases a bus ticket for Pittsburgh to New York worth $75.00 and the bus breaks down and the person does not make it to Pittsburgh on time for an important appointment, the damages that can be awarded would be the value of the ticket or the cost of additional transportation to Pittsburgh. Aside from the example above and the classic remedies, another type of damages are general (non-consquential) damages. These are direct losses or losses that usually have a total value or cash equivalent. It is important to note that general damages do not include speculation or conjecture. In addition to general damages, consequential (special) damages may be examined. Specifically, these are damages that do not normally flow from the breach. The distinction between general and special damages is exponential. Any pleading for general damages can be challenged and any proof offered will not be believed. Without the proof of special damages that can only be found upon proper inquiry, the trier of fact is not in a proper position to believe any such damage may be ascertained from the available evidence. There are also punitive damages which are "deterrent" damages in addition to compensatory damages that will inflict punishment upon the defendant. Generally, punitive damages are awarded sparingly and would only exist where the conduct of the defendant is wilful and contumacious and the injury is of a kind that can be expected to endanger others and shocked the conscious. In addition, there are nominal damages. A nominal damage award is the legal injunction of a violation of the plaintiff’s rights. Nominal damages would not necessarily reflect the loss of the same value or cash equivalent as the measure of general damages. Because of the practicalities of the matter, and especially within the commercial context, most contracts contain an express or implied limitation on recoverable damages. The limitation may be on any or all of the following: the type of which cannot be recovered; on the limit itself, predicated upon the principle of requirements; on certain types of contracts for unforeseeable damages; on the measure of recovery; on the category of damages. This contextual and conventional practice is designed to fix the quantum of liability and risk of loss. Accordingly, the defendant usually seeks to exclude liability within some phase of the contract and the plaintiff tries to limit exposure to a circumscribed field of liability. It becomes a balancing of risks against each other. The plaintiff, therefore, who knowingly takes the risk with knowledge of the economic circumstances that might beset him is limited in recovery. That is, the plaintiff is entitled to recover only to the extent of the risk that he freely undertook. Also, when one party chooses a remedy, the party is bound to that remedy and cannot alter, change, amend or overhaul the contract at that point. In addition, the non-breaching party may only recover the actual value as measured by the contract. So, for example, if the contract states that you are to receive $200.00 for Plaintiff’s services, and the plaintiff overdoses on his medication, misses his court date and loses the case, the plaintiff will be entitled to recover at least the punitive value of the worl. If the contract does not state that you will also be compensated for the aggravation suffered, the court will not award it to you. Furthermore, if the contract allows for economic damages, you should present evidence and be prepared to prove those damages at the time of trial.
Formation and Construction of Contracts
Legally Binding Contracts
To be a valid (legally binding) contract, there always must be these 5 things:
- Agreement by the parties.
- An exchange of consideration.
- Competency of the parties
- The subject of the agreement must be legal in nature.
- Mutuality of Obligation.
Contract Interpretation
If a dispute arises regarding the terms of a contract, a court will look to the parties’ intentions, and interpret the contract according to its "plain meaning", unless the terms are ambiguous.
The basic rules of contractual interpretation are as follows:
- The interpretation must be consistent with what the words mean in the contract.
- Words are to be interpreted in their grammatical and ordinary sense unless the context indicates otherwise.
- Unintended results which would flow from such an interpretation should not be avoided by departing from the normal grammatical or ordinary meaning of the words used.
- The contract must be read as a whole in order to determine the meaning of any one part in the context of the contract as a whole.
- The contract must be interpreted so as to avoid an unreasonable result (where possible).
- An ambiguous provision may be construed against the person responsible for drafting it (that is, the person creating the ambiguity is responsible for it).
Legal Defenses to Enforcement
Even when the elements necessary for a contract are in place, there may be defenses to enforcement. A contract should not be enforced if the party moving to avoid the contract can show the existence of one of the defenses, although whether they will actually avoid enforcement varies.
Duress
A contract is formed under duress if a party’s agreement was obtained under a wrongful threat. The threat in such a case may be physical or economic—and the threat need not actually be unlawful, as long as it is wrongful and coerced consent. A classic example of economic coercion involves a threat by one party to a car dealer that it would move its business to a competitor if the dealer did not agree to certain terms.
Misrepresentation
A contract may be avoided on the basis of misrepresentation if a false statement of material fact induced a party to enter into it. The false statement must have been material, and if an important fact is intentionally hidden, judged by the objective standard of a reasonable person. Depending on the situation, the misrepresentation may be actionable as fraud, but not with respect to other aspects of the contract. The buyer in a commercial sale for example, might get out of the sale due to misrepresentation of a product’s actual value—because the seller knew that the product was not worth as much as the seller was selling it for.
Undue Influence
Contracts can also be formed through undue influence, which is when a party to the contract exerts pressure on a party who has shared a confidential relationship with the party in order to derive an improper benefit. Undue influence is a form of coercion that is more subtle than others. Situations constituting undue influence normally involve a person who has some sort of position of trust over another party, like one that comes from a prior or ongoing business relationship, or one based on a relationship involving a higher degree of trust or authority, like spouse to spouse or parent to child. In such a case, the pressure that is illegal is that which arises because of the special relationship between the parties.
Unconscionability
Unconscionability may be an available defense where the terms of the contract create an unfairness that is substantive or procedural, and where that unfairness is "striking." The unfairness is substantive if it is so unfair that it shocks the conscious of the court, or is egregious. Procedural unfairness occurs if the process involved in creating the contract was such that the weaker party was unaware of the unfairness, or without a fair bargaining power. For example, the typical contract for the sale of a house might not be found unconscionable, even where the buyer does not fully understand the terms and conditions, because the buyer would typically have the opportunity to read and be charged for advice concerning the contract.
Contracts Affecting Third Party Rights and Obligations
The doctrines of third-party beneficiaries and assignment and delegation are two of the most complex and misunderstood subjects in contract law. The former determines when a person who is not a party to a contract may sue for breach of that contract, and the latter dictates how and under what conditions a party may transfer contract rights.
The first area for inquiry to determine whether a third party’s interest is intended to have legal effect is to ask whether the contracting parties’ intent is clear on the subject. Texas courts may resort to extrinsic evidence to determine whether such an interest is intended.
Whether the contracting parties intend that the third-party beneficiary shall be able to enforce the contract depends upon the part played by the beneficiary in the contract formation. In some instances, the beneficiary has rendered a detriment that induced the promise, thereby making the promisor a debtor with respect to the promisee’s debtor. In other instances, the beneficiary has a legal or equitable duty to give the consideration promised by the promisor.
Whether a third-party beneficiary can sue on a contract depends upon whether he is an intended beneficiary or a mere incidental beneficiary. Subject to a few exceptions, "only intended beneficiaries have rights under a contract." If the claimant is an incidental beneficiary, then he cannot maintain an action on the promise because he was not intended to be benefited; and his claim for damages fails.
The American Law Institute Restatement (Second) defines a donee third-party beneficiary as "one who is to receive a benefit, gratuitously, from a promisee if there is a breach."
A creditory third-party beneficiary, on the other hand, is one who has a creditor’s claim on the promise, "i.e., a promise made to a debtor with the intent of discharging a debt arising out of a protected relationship between the debtor and the third-party beneficiary . " For example, under section 3.48 of the Restatement (Second), a promise to pay certain liabilities of a debtor "to a creditor of the debtor, which is made to the creditor directly, and which the creditor knows to be made to him, creates a creditor beneficiary’s right to relief . . ."
A third-party beneficiary of a contract cannot sue a promissor unless the promisee’s breach of the contract also breaches a duty owed by him to the third-party beneficiary.
A contracting party has the right to assign its rights and delegate its duties or responsibilities under a contract. In other words, the person to whom the right is assigned or whose duties have been delegated is the ‘assignee.’ An assignment is the transfer of rights from one party to another, while a delegation is the transfer of duties. The party who delegates performance to another is still liable for damages if the other fails to perform. Where one party assigns its rights, but the duties are still retained by the assigning party, the promise is effectively from both the original party and the assignee, and either is liable for breach of contract.
Contractual rights are assignable unless the assignment would materially change the duty of the obligor, increase materially the burden or risk imposed on the obligor, or impair materially the prospect of obtaining a return performance. The parties to a contract may agree to limit or eliminate the right to assign, in whole or part. The validity of a contractual provision prohibiting assignment – designating the agreement as non-assignable, prohibiting assignment, etc. – is generally upheld so long as it is not explicitly against public policy.
A legally assignable right does not require consideration. However, if keys to breach or enforcement, are missing, a right, though validly assigned, may be unable to be enforced.
Uniform Commercial Code and the Contract
The Uniform Commercial Code (the "UCC") is a set of laws and regulations governing commercial transactions in the United States. It provides a framework and set of rules for these transactions that, while not necessarily federal regulations, have been adopted by individual states under their own Uniform Commercial Code statutes. The UCC regulates sales and other transactions in goods for profit.
The UCC’s provisions are particularly relevant in commercial transactions. The UCC contains several unique provisions governing commercial contracts that differ from general contract provisions or common law contract principles. While commercial contracts are often governed by the common law, the UCC statutorily modifies some contract principles for many commercial transactions. The UCC applies to both tactical contracting and integrated contracting, but the scope and terms of application varies.
UCC streamlined process rules allow for (and some may require) 3rd party review or review by those who will not be signing the contract (as in contracts administered between two licensed professionals subject to review by the appropriate board), or no review at all for transactions of any value exceeding a few thousand dollars. The lack of review is intended to expedite complex transactions involving a large volume of contracts and facilitate the ability of parties to do business without involving contracting attorneys. The UCC also provides rules for contracting on behalf of third parties, which can allow contracting for 3rd parties without a contract signed by that 3rd party.
Most significantly, the UCC introduces the concept of "good faith" into commercial contracting. This good faith obligation is unique in that it imposes a duty on contracting parties to perform their contractual obligations honestly, and "honesty" is judged from the perspective of a reasonable business person in the same position. The UCC duty of good faith usually is described as an "implied covenant": although not expressly stated in the contract, the duty of good faith is implied from the expressed terms of the contract. The UCC provides that the good faith obligation is the basis for an implied obligation to perform those obligations that are necessary to fulfill the purpose, or "state of performance" of a contract. This means that where the contract does not state a period for performance of an obligation, the UCC assumes that a deadline for performance is implied based on what is necessary to fulfill the purpose of the contract.
UCC drafters are encouraged to facilitate joint risk management, including by disclosing information and working cooperatively, just as contracting parties are expected to do in good faith. The UCC also provides rules for the applicability of UCC article 2 and other UCC articles to contracts that involve multiple parties or parties that are subject to multiple articles, or parties that do not qualify as "merchants" under the UCC. A UCC contract must include a statement that the parties are doing business pursuant to the UCC articles, but the contract does not have to contain words such as "party" or "liability" or "responsibility." The UCC provides for officiating, interpretation, and modification of contracts, including rules regarding mistakes and misrepresentations which differ from the common law standards. A contract may not be modified without consideration pertaining to the contract. A contract with a merchant, however, may be verbally modified without consideration if a written memorandum is provided within a reasonable time following the oral modification. The UCC provides specific rules for contract performance such as what constitutes payments due and what constitutes a material breach of contract, and what remedies parties have pursuant to the rules for breach of contract.
Recent Trends and Key Cases
Recent trends in contracts law reflect the increasing importance of contract interpretation. One of the most recent developments involves the California Supreme Court’s decision to expand the parol evidence rule’s impact on available defenses. In Mountain Lion v. Employment Development Dept., a claimant applied for unemployment benefits after leaving employment with his temporary agency. The agency asserted that he was an independent contractor and, therefore, ineligible for benefits. Claimant alleged that he was entitled to benefits under a statutory provision. The California Unemployment Insurance Appeals Board denied the claim in part because of the alleged independent contractor relationship and entered judgment for the claimant. The California Superior Court reversed, and the California Court of Appeal entered judgment for the agency. In affirming the appellate court’s judgment, the California Supreme Court held that to determine whether there is a statutory right to benefits based on a supposed independent contractor relationship and to determine whether a party is presumed to be an employee or an independent contractor under the relevant provision, courts should use a "fact-specific consideration of the circumstances of the case." In other words, courts can consider extrinsic evidence to evaluate whether the presumption of employment under the relevant provision is rebutted.
The California Supreme Court’s application of the parol evidence rule to defenses for other causes of action has been thus far limited; however, this case may open the door to the rule’s increased application to defenses in other areas. Thus, although the parol evidence rule is still primarily limited to interpreting the contract itself, it is stretching into the area of affirmative defenses. An area where the parol evidence rule’s application is wide-ranging is whether the contract is unconscionable. When courts determine unconscionability, it is necessary to build a factual record, and then question whether the facts give rise to vehicles for relief such as duress, misrepresentation, undue influence, and the absence of a meeting of the minds.
A recent case involving this area is the California Court of Appeal’s decision in Ramirez v. AT&T Mobility LLC. Although there is no bright-line test for unconscionability, this case demonstrates that courts may consider unconscionability when the plaintiffs claim fraud.
Wrap Up – The Future of Contract Law
The future of contract law will be much like the present – lawyers will negotiate, draft, and interpret contracts. However, the tools we use to negotiate, draft, and interpret will be much different. As such, we will not be able to ignore the impact technology will have on the practice of contract law. In fact, such things as collaborative drafting and negotiation tools that are already popular and in use today will be ubiquitous. Artificial Intelligence ("AI") will certainly help with automating many tasks, such as drafting. The computer will be a valuable tool we use to help us better serve our clients Even so, true mastery of contracts requires experienced business lawyers – people who listen, communicate, evolve , and negotiate. Lawsuits over contracts will be litigated by lawyers specializing in AI – computers and networks of computers owned by law firms and their clients. Contract negotiation will be necessary because no computer will be universally competent in all issues and legal areas.
This blog series represents a compendium of the Contracts II course I teach for the Texas Executive Education (TXED) MBA program in Dallas, Texas. It helps students learn what they need to know to not get in trouble in the first place – that is, prevent the things they did that got them in trouble in the first place. This course is not a primer on how to draft a contract. I hope the series has helped you understand that the purpose of contracts is to eliminate surprise.