CONTRACTS Dean Hunter Fall 1999 FORMATION OF A CONTRACT A. What is a promise, and when is it legally binding? 1. Professor Charles Fried: “Contract is the means by which free individuals can impose obligations on themselves (and others) where none existed before. Trust is the essential element in establishing efficient relationships among individuals.” 2. Restatement, Second, Contracts § 2, 4: A promise is a manifestation of intention to act or refrain from acting in a specified way so made as to justify a promisee in understanding that a commitment has been made. A promise may be stated in words either oral or written, or may be inferred wholly or partly from conduct. a. A bargain is an agreement to exchange: i. a promise for a promise j. a promise for performance k. performance for performance 3. Duty to Bargain in Good Faith: A majority of courts have taken, and still take, the view that a contract to make a contract, or an agreement to agree, must create an expectation of good faith and fair dealing. Implicit in every contract is the good faith obligation to do your best. Cardozo: “Instinct with Obligation.” (Wood v. Lucy Lady Duff Gordon) B. Elements of contract law 1. Legality of purpose (parties cannot contract to do something illegal 2. Capable parties a. must be the age of majority b. must be mentally competent c. some courts will not get involved in family relationships 3. Offer and Acceptance 4. Consideration 5. Performance 6. Breach 7. Damages 8. Other Contract Terms a. covenant – a promise between parties to the K about their mutual assent; a breach of a covenant is a breach of a K b. condition -an uncertain event that is external to the K c. guarantee -a promise of future obligation w/o present consideration d. gratuitous promise -a promise without consideration C. Types of Contracts 2 1. A unilateral contract: a promise in exchange for actual performance; the promisee is under no obligation. a. The acceptance of a unilateral K is complete performance; acceptance occurs with completed performance. b. The promisor can revoke before the requested act is completed; this view is consistent with the strict common law approach of mutuality of obligation (generally not used today). c. acceptance occurs when substantial performance is completed; the promisee can then sue for breach, although it is not clear how much performance is necessary to constitute “substantial performance” and thus show acceptance (this is a question of fact for the jury). d. partial performance estops revocation – a promisor is estopped to revoke once performance begins; because there is no obligation to complete performance, the extent of the promissor’s liability must be determined 2. A bilateral contract: there is a mutual exchange of promises; there is an offer, acceptance, and consideration. 3. Express contracts: are formed in either written or oral form. a. the source of the obligation is the intent of the parties 4. Contracts implied-in-fact (similar in theory to express Ks) a. not expressly written or stated b. the source of the obligation is the intent of the parties 5. Contracts implied-in-law (quasi-contract): a fiction developed in order to enforce legal duties when there has not been a meeting of the minds, and thus no proper contract exists. OFFER AND ACCEPTANCE A. What Constitutes an Offer? 1. An Offer must be clear and contain all the material elements of the agreement: a. initiates the contract b. is an expression of a willingness to enter into an agreement c. is clear, specific, and definite in its language regarding quantity, price, the length of time the price is effective d. parties must show intent e. an offer can only being accepted by the person to whom the offer is being offered f. an offer can be revoked before it is accepted 2. Firm Offers a. U.C.C. 2-205 for the sale of goods dispenses with the need for consideration if: i. The offer to buy or sell goods must be made by a merchant (i.e., one who trades professionally in certain goods) ii. The offer must be in writing iii. It must give assurance to the offeree that it will be held open 3 iv. If the insurance is contained on a form supplied by the offeree, the offeror must sign the assurance separately 3. Acceptance of an Offer: a. creates a contract b. silence is not acceptance (unless the parties or custom dictate) c. may accept by words, action, or conduct d. must be accepted by the offeree only e. reasonable diligence usually accepted f. Restatement, Second §62: If the offer does not mandate acceptance by performance, so that it can be accepted either by performance or promise, the commencement or tender of the performance is an implied promise to complete the performance. (The commencement or tender of performance is, in effect, an acceptance by promise creating a bilateral contract). 4. Mutual Assent and Meeting of the Minds a. In determining the parties intentions, the general rule remains that deeds count more than heavily than words and that words certainly count more heavily than unexpressed mental reservations or intentions. b. U.C.C. 2-204 (dealing with intention of parties) i. A contract for the sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract. ii. An agreement sufficient to constitute a contract for sale may be found even though the moment of its making is undetermined. iii. Even though one or more terms are left open, a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy. §2-204 favors finding a contract when the parties conduct is consistent with an agreement. iv. §2-204 differs from the old approach (i.e., to form a contract the parties must concurrently assent to exactly the same agreement at the same time), but most courts still require some certainty of terms such as quantity and quality of goods. 5. When an Offer Differs from the Acceptance a. The mirror image rule applies under the common law. This rule says that for an offer to be accepted, the acceptance cannot vary in any way from the actual offer. If it does, it will be considered a counter-offer and not an acceptance. REVOCATION OF AN OFFER A. Common Law Approach 1. General Common Law Rule: After an offer is communicated, the offeror is free to withdraw the offer without liability at any time before the offeree accepts the offer. a. Offeror may withdraw the offer before communicated to the offeree b. The offeror may revoke the offer without liability at any time before the offeree accepts 4 c. No reason must be given for withdrawal or revocation of an offer unless required by statute or mutual agreement 2. Common Law has treated an acceptance that varied in any way from the offer as a counter offer and not an acceptance. 3. U.C.C. §2-207: A response that varies from the offer may, in some instances, be an acceptance. 4. Restatement, Second §43: A revocation of an offer occurs when the offeror takes definite action inconsistent with an intention to enter into the proposed contract as long as the offeree learns of this inconsistent action from one source or another. a. Dickinson v. Dodds: an offeror can withdraw at any time prior to acceptance. B. Lapses in an Offer 1. An offer may lapse because the time limit for acceptance has passed, or because of the offeror’s death. Death revokes an outstanding offer, even if the offeree is not aware. C. When an Offer is Left Open for an Period of Time 1. When there is no consideration for an offer to be left open, even if the offeror promises to leave it open for a certain period of time, he is not bound by his promise. 2. Balfour v. Balfour (1919): Plaintiff (wife) seeking monthly allowance agreed to before Defendant (husband) filed for divorce after being overseas. While the promise was explicit, the court does not interfere because of the relation of the parties (marriage). a. as we will see, agreements made between spouses are viewed differently, and less strictly, in the eyes of the courts. b. Courts will not get involved in contracts not meant to be legally enforceable (such as those in a social or domestic situation) c. “too messy a problem” – the court cannot get involved in all instances where promises are broken in certain relationships (i.e., marriage); the court would get involved in too many disputes 3. Davis v. General Foods Co.: Plaintiff sends Defendant a recipe, which is later used by Defendant. Plaintiff simply had to put a copyright on the recipe, or not have sent it at all. The language in correspondence between Plaintiff and Defendant was too vague for the court to interpret. a. the parties were strangers, and the language was too vague. 4. The Mabley & Carew Co. v. Borden: Plaintiff’s sister had fulfilled every obligation, and when she died, the freedom to revoke the letter no longer existed. The death of a party removes the right to revoke an offer/agreement. The employee was promised certain benefits after her death (in order to get her to stay), revocable at any time; after the woman dies, the offer became irrevocable. a. The employee keeps her end of the bargain (complete performance) by being in continued employment until her death b. The company could not withdraw the offer after she had completed her obligations D. Irrevocable Offers 5 1. Option Contract: The offeree pays the offeror a consideration to keep the offer open. a. A is selling a house for $100,000. B, needing time to consider, offers to pay A an option of $500 to keep the offer open for 30 days. If A accepts the $500, an option contract exists and A must keep the offer to sell at $100,000 open for 30 days. B has 30 days to come up with the money. If he decides not to buy, B loses the $500 but he has no further contractual obligation. E. Should a contract be implied from a relationship or from a set of facts if the parties involved have not agreed specifically to a contract? 1. Examine what the parties were thinking about: What were the parties intentions? Did an exchange occur? Was there reliance? For a contract, all that is needed is the manifestation of mutual assent. 2. Cropsey v. Sweeney (1858): The wife of a bigamist was unable to recover damages because “performance of housework” (servant) was gratuitous and done while she believed she was his legal spouse. She wants to recover for her services rendered. The court ruled that she cannot recover because she did not perform the services with the intention of being paid. a. Putative Spouse: a person who thinks that he or she is married (legally) only to find out later that the spouse is a bigamist or that there was some legal shortcoming in the marriage. (Hunter, § 24:4) 3. Shaw v. Shaw (1954): By proposing marriage, there exists an “implied warranty”, one which is breached when the person proposing marriage is actually still married to someone else. 4. Cotnam v. Wisdom (1907): A doctor who aided an unconscious accident victim was allowed to claim against the estate of the victim for services rendered because the court implied a fictional agreement between the Dr. and the victim. a. it is assumed that an unconscious individual, if conscious, would consent to a doctor taking necessary medical measures to save their life. b. the court is also ruling for the good of the public (public policy argument): encourage doctor’s to come to the aid of injured persons. (Hunter § 16:4) 5. Vickery v. Ritchie (1909): In contracting to build a Turkish bath, both parties acted in good faith but were swindled by a crooked architect. The court held that the burden of risk was on the property owner, and as such he owed the fair market value for labor and materials to the subcontractor, because the labor and materials were furnished at the property owner’s request for the benefit of the property owner. How Specific Must the Parties be To Create a Binding Relationship? A. Where the offer is clear, definite, and explicit, and leaves nothing open for negotiation, it constitutes an offer, acceptance of which will complete the contract. B. Invitation to bid (§ 3:18) 1. Unless a statute provides to the contrary, a request for bids is nothing more than a request (invitation) to receive offers. The party who makes the request can accept whichever bid best suits 6 his purposes, or he can reject them all if none is acceptable. This rule may not apply when the invitation is cast as an offer and is highly detailed in stating conditions. 2. A majority of courts have taken, and still take, the view that a contract to make a contract, or an agreement to agree, is not binding, thus allowing each party to abandon negotiations with impunity. a. The courts are willing to grant damages when the party claiming lack of agreement has invited or encouraged the other’s reliance so that non-enforcement would leave the relying party in a disadvantageous position. C. Acceptance of Bid (§ 3:19) 1. Once an offeror submits a bid, its acceptance creates a contract. A bid is akin to a firm offer and usually is not revocable after submission. 2. Lefkowitz v. Greater Minneapolis Surplus (1957): The court found in favor of Plaintiff, who had responded to an advertisement posted in the local newspaper by defendant. The language in the advertisement was clear: it listed how many items were available, what each item cost, and stated “first come, first served.” a. Advertisements: An advertisement for a product is usually an invitation to deal (bid) rather than a specific offer to sell the particular product. b. Exception: If the advertisement is very specific, enough to induce the reasonable person to believe that the merchant is offering to sell that specific product (See Lefkowitz above) 3. Jenkins Towel v. Fidelity Trust (1960): Defendant claimed its request for sealed bids for a piece of property was only an invitation to bid. However, the court held that the language of the request was clear, definite and explicit as to what qualified for an acceptable bid. Plaintiff’s bid was the only bid meeting all of the criteria. An “offer to sell” versus an “invitation to bid”. a. Party Autonomy: In the creation of contracts, parties are free to set the terms, and to decide with whom to contract. 4. Moulton v. Kershaw (1884): Defendants were dealers in Michigan fine salt; Plaintiff received a telegram from Defendant, listing the salt at a specified price, and sent back a telegram “accepting Defendant’s” order and specifying an amount for delivery. Court found for Defendant, holding that the original telegram was too vague (did not include quantity or time deal was good for) to constitute an offer, and thus was only an invitation. a. Preoffer communications: In every jurisdiction, the guiding principle is that communications such as trade circulars, advertisements, catalogues, and solicitations of bids are not offers but are invitations to receive offers. b. An offer must be clear and contain all of the elements of the agreement, two of which are quantity and the length of time during which the stated price will be effective. What happens when a party is disappointed because the other party does not act as expected although there is no explicit breach of an obligation? A. General Background 1. Standardized Contract: Is used by companies in every bargain dealing with the same product or service; it reflects the impersonality of the market. 7 2. In reaction to the marketplace, courts have become more lenient and enforce contracts and find valid offers even when there are a number of gaps. B. Contextual Approach 1. A more expansive approach taken by the courts in examining contracts, first seen in Sun Printing, in which a court takes into account evidence extrinsic to the agreement. a. Extrinsic Facts: focus on prior facts of contract between parties (i.e., delivery schedules, amount delivered per shipment, past performance, industry standards/customs, etc.), or b. It is well settled that a contract includes, not only the promises set forth in express words, but, in addition, all such implied provisions as are indispensable to effectuate the intention of the parties and as arise from the language of the contract and the circumstances under which it was made. Restatement, Second, Contracts. c. What was the relationship of the parties? Determining this may create an expectation of good faith bargaining. What other extrinsic facts can help determine the parties’ prior relationship? d. Three (3) reasons to look at extrinsic evidence: i. The parties reasonably must have intended the omitted terms that a court and inadvertently failed to include them. j. The terms that a court supplies are necessary for a reasonable understanding and application of the contract. k. The parties would have agreed upon and included the implied terms had they known all of the facts. PAROLE EVIDENCE RULE A. Indefiniteness of Offer and Acceptance 1. The traditional rule held that if the agreement was not reasonably certain as to its material terms then there is a fatal indefiniteness with the result that the agreement is null and void. a. it is the contract which must be definite, not the offer b. material terms: subject matter, price, quantity, quality, payment terms, etc. c. it is enough that the agreement is sufficiently specific so that the court can perceive what the respective obligations of the parties are. 2. Where the parties have purported to agree upon a material term but have left it indefinite a. Example: A says to B, “If you work for me for one year as the foreman of my plant I promise to pay you a fair share of the profits.” This is too vague and indefinite to be enforced, but if B performs, he may obtain a quasi-contractual recovery measured by the reasonable value of services rather than by a share of the profits. b. Indefiniteness can be cured by the subsequent conduct of the parties, or a new agreement. c. Less certainty is required in an action for damages rather than in an action for specific performance. 3. When the parties are silent about a material term 8 a. In certain situations there is a strong possibility that a term may be implied from surrounding circumstances or supplied by a court using gap-filler. i. In such situations, the missing term may be supplied by external sources, including standard terms, usages by which the parties are bound, and a course of dealing between the parties prior to the agreement, or a course of performance after the agreement. ii. Gap-filler: a term supplied by the court either because the court feels that the parties would have agreed upon the term if it had been brought to their attention or because “it is a term which comports with community standards of fairness and policy.” iii. Example: In the case of a sale of goods where no price is stated, it will be assumed that the parties contracted in terms of a reasonable price (this rule has been adopted by the U.C.C.). b. Where the parties have been silent in their agreement to the kind or quantity of goods, or the specifications of a building contract, the courts have refused to fill in the gaps because no objective standard can ordinarily be found in such cases. c. Employee Contracts: If a hiring for a specified term exists, performance after the term expires usually gives rise to an inference that the parties have renewed their agreement for the same duration. 4. Where the Parties Agree to Agree a. The traditional rule is that an agreement to agree as to a material term does not result in a binding contract (too indefinite, suggests lack of present agreement) b. Modern U.C.C. View: rejects the formula that an agreement to agree is unenforceable and rejects defeating such agreements on the grounds of indefiniteness. Instead, the U.C.C. recognizes the dominant intention of the parties to have the deal continue to be binding upon both. i. U.C.C. 2-204 (3): Even though one or more terms are left open, a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for providing an appropriate remedy. ii. 2-204 prevents a contracting party who is dissatisfied with his bargain from taking refuge in the doctrine (of indefiniteness, the traditional rule) to renounce his agreement. However, when a dispute over a material term manifests a lack of intention to contract, no contract results. iii. What is clear is that the omission of an important term or terms does not necessarily prevent a contract from arising. B. Parole Evidence Rule 1. The parole evidence rule comes into play only when the last expression (of the parties intentions) is in writing and is a binding contract. a. a writing intended by the parties to be a final embodiment of their agreement may not be contradicted by certain kinds of evidence. 9 b. The parole evidence rule applies to terms agreed upon prior to the integration, regardless of whether the term agreed upon is written or oral. c. The policy of the rule is to give the writing a preferred status so as to render it immune to perjured testimony and the risk of “uncertain testimony of slippery memory.” 2. Is the Writing Integrated? a. a writing that evidences a contract is not necessarily a final embodiment of a contract. i. the parties may have intended their writings to be tentative and preliminary to a final draft (in such a case the parole evidence rule does not apply) ii. At common law it is often held that a confirmation letter acts as a total integration if the other party makes a no response to it prior to performance. (This does not signify total integration if the document is incomplete). b. The crucial requirement is that the parties have regarded the writing as the final embodiment of their agreement (does not have to be signed); the more complete and formal the instrument is, the more likely it is intended as an integration. 3. Is the Writing Totally Integrated? a. If the writing is final and complete, then there is total integration with the result that it may not be contradicted or supplemented. i. Four Corners Rule (In decline): If the interest is complete on its face (determined by a judge) the instrument is conclusively presumed to be a total integration. ii. Williston’s Rules: If the writing expressly declares that it contains the entire agreement of the parties in what is usually referred to as a merger clause, this declaration conclusively establishes that the integration is total unless the document is obviously incomplete or the merger clause was included as a result of fraud or mistake or any reason exists that is sufficient to set aside a contract. iii. In the absence of a merger clause, the determination is made by looking to the writing. This rule makes clear that if the writing is obviously incomplete it cannot amount to more than partial integration. iv. Where the writing appears to be a complete instrument expressing the rights and obligations of both parties, it is deemed a total integration unless the alleged additional terms were such as might naturally be made as a separate agreement by parties situated as were the parties to the written agreement, in which case it is a partial integration. (Pete says: Reasonable person approach) v. When a term not found in the writing is offered into evidence by one of the parties and the court concludes that it would have been natural for the parties situated as they were to have included that term into the writing, there is a total integration with respect to that term and the term may not be admitted into evidence even if it does not contradict the writing. (Pete’s guess: if a term is considered so natural that the parties were deemed to have considered it, then it is clear they left it out on purpose). 10 vi. Corbin’s Approach: Terms are either prior or subsequent to the writing and that the word “contemporaneous” merely clouds the issue. All relevant evidence should be included to determine the intent of the parties, including evidence of prior negotiations. In other words, the very evidence whose admissibility is challenged (by the parole evidence rule) is admitted on the issue of total integration. Corbin’s approach clearly undercuts the parole evidence rule. Corbin’s notion is to ascertain the actual intention of the parties and he is even willing to receive evidence of the prior negotiations. The U.C.C. and Restatement, Second are substantially in accord with this approach. 4. Merger Clauses: A merger clause is a clause in the instrument that states that the writing is a final expression of all the terms agreed upon and is a complete and exclusive statement of those terms. 5. It is generally agreed upon that parole evidence is admissible to show that a contract was never formed. a. For instance, a party may show that he was forced into executing what is or appears to be an integrated writing. (duress) b. Evidence proving fraud, mistake, illegality or unconscionability is admissible. BATTLE OF THE FORMS (U.C.C. 2-207) A. U.C.C. 2-207: Does away with the mirror image rule. Attempts to resolve disparities between boilerplate language in buyer and seller’s respective standardized forms. 1. Boilerplate: preprinted, standardized legal forms designed to protect the interests of the party who produced them. 2. Potential Problems with different forms: provides parties with a pretext for reneging on the contract (i.e., writing was different, thus a contract never existed); if disputes arise, which party’s terms become part of the contract? B. §2-207 Approach 1. Rejects the Mirror Image Rule: If a response can reasonably be interpreted as an acceptance, it is recognized as such despite a variation from the original offer. Except in narrow circumstances, the conflicting term in the acceptance falls away and does not become part of the contract. a. different term: a term that varies or contradicts something provided for in the offer b. additional term: adds new matter not covered in the offer 2. §2-207 rejects the last shot Rule: If the response cannot fairly be interpreted as an acceptance and is thus a counteroffer, subsequent performance is not deemed an acceptance by conduct. Therefore, although a contract is recognized by virtue of the mutual performance, it is not simply on the terms set out in the last communication. Rather, conflicting terms fall away and are replaced by supplementary terms in the U.C.C. 3. Replies that Are not Acceptance under §2-207 11 a. If the response is clearly not a definite expression of acceptance, or if it is sent after the offer has lapsed, (that is, it is not seasonable), or if it expressly states that acceptance is conditional on assent to its new terms, then it is a rejection or counter-offer. i. look for a divergence from the transaction (specific terms in the offer that cannot be considered a definite expression of acceptance). 4. Replies that Are Acceptable Under §2-207 a. If the response is a definite and seasonable expression of acceptance, and it is not expressly conditional on assent to any new terms, it is an acceptance even if it states terms different from or additional to those in the offer. i. even if boilerplate exists, the offeree’s (seller) expressed agreement with all the central terms of the offer gives rise to the reasonable interpretation that its primary focus was on making the sale, and its intent was to accept. ii. §2-207 only applies if the response to an offer is found to be an acceptance. iii. The additional terms are construed as proposals for addition to the contract. Between merchants, such terms become part of the contract unless: x. the offer expressly limits acceptance xx. the terms materially alter it xxx. notification of objection to them has already been given or is given within a reasonable time after notice. b. In most situations, the offeree does not succeed in adding terms in the acceptance and the general impact of §2-207 is to exclude most proposed additions 5. §2-207: Effect of Mutual Performance When No Contract is Formed By the Parties Writings a. (1) Conduct by both parties that recognizes the existence of a contract is (2) sufficient to establish a contract for sale, (3) although the writings of the parties do not otherwise establish a contract. (3) In such a case the terms of the particular contract consist of those terms on which the writings of the parties agree together with any supplemental terms from the U.C.C. PROMISSORY ESTOPPEL (§ 6:12) A. The Doctrine of Promissory Estoppel 1. A promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee and which does induce such action or forbearance is binding if injustice can be avoided only by the enforcement of the promise. (Calamari) 2. The principle that a promise made without consideration may nonetheless be enforced to prevent injustice if the promisor should have reasonably expected the promisee to rely on the promise, and the promisee did actually rely on the promise to his detriment. (as such, the reliance served as consideration for the promise). (Hunter) a. The promise must be one which the promisor should reasonably anticipate will lead the promisee to act or forbear (reliance must be foreseeable) 12 B. Restatement, Second, Contracts §90 1. A promise that is reasonably relied upon is enforceable to the extent of the reliance. 2. The key difference between a promise supported by consideration and a gratuitous promise supported by promissory estoppel is that in the former case the detriment is bargained for in exchange for the promise of the promisor; in the latter, there is no bargain. (Always look first to see if conventional consideration is present). a. Feinberg v. Pfeiffer (Mo. 1959): C. Reliance on Offers 1. In a recurring fact pattern a general contractor receives a low bid from a sub-contractor and uses that low bid in preparing his own bid on a project. The bid of the sub-contractor is an offer. Under the traditional common law rule, the offer may be withdrawn (revoked) prior to acceptance even though the general contractor has relied upon it in submitting his own bid. (Baird v. Gimbel) 2. Nor does the use of the bid by the general contractor amount to an acceptance even if the name of the sub-contractor is used in the bid of the general contractor. 3. The majority of courts which have considered this problem have held that justifiable injurious reliance on the offer will render it irrevocable. Thus, the offer is rendered irrevocable under the doctrine of promissory estoppel. The Restatement, Second, Contracts has explicitly adopted this approach. 4. Of course, there must be something upon which the contractor may justifiably rely. An estimate is not enough and if the sub-contractor’s bid is so palpably low as to indicate that it is based on a mistake, reliance is not justified. 5. It may also be observed that in cases which apply the doctrine of promissory estoppel, although the sub-contractor is bound by his bid, the general contractor is not bound to accept the bid because the general contractor has not made any promise on which the sub-contractor reasonably relies. 6. Part performance in response to an offer for a unilateral contract has the effect of rendering the offer irrevocable (Restatement, Second). However, this is not true if what was done was merely preparation. Under promissory estoppel reliance in the form of preparation may render the offer irrevocable. a. Nudum Pactum: an informal agreement that is not legally enforceable (lacks criteria). D. Four Components/Limitations of Promissory Estoppel 1. A promise was made, and was clear and unambiguous 2. There was reliance on the promise 3. The reliance was reasonable and foreseeable 4. Expenses were incurred; action caused some change in condition; or the promisee sustained an injury a. Hoffman v. Red Owl Stores (1965): Plaintiff, working with a representative of defendant, took a series of steps at significant financial cost, to qualify for the purchase of a Red Owl 13 franchise. When time came to purchase the franchise, defendant stated a price considerably higher than he had before, and higher than plaintiff could afford. Plaintiff claimed his actions were based on reliance on defendant’s sales representative. The court held that Red Owl was responsible for the detriment incurred by Hoffman by reason of his reliance on the Red Owl agent. ACCEPTANCE A. How does one say “yes”? (§4:1-18) 1. What is looked to is not the parties’ after-the-fact professed subjective intent, but their objective intent as manifested by their expressed words and deeds at the time. . .in determining whether the parties entered into a contractual agreement and what were its terms, “disproportionate emphasis is not to be put on any single act, phrase, or expression, but instead, on the totality of all of these, given the attendant circumstances, the situations of the parties, and their objectives. 2. The only person who is capable of accepting an offer, is the person to whom it is directed or that person’s agent. * To avoid problems, the offeror must make it clear that the offer is aimed specifically at a particular party or parties’. 3. If an offer does not specify the mode or manner of acceptance, the courts uniformly hold that any reasonable method of acceptance suffices (i.e., express words, acts or conduct that a reasonable person would understand to be an assent to the offeror’s terms). Case Examples U.S. v. Braunstein (1947): Langellier v. Schaefer: Butler v. Foley: B. How do courts interpret and apply “take it or leave it” contracts when there has been little or no negotiation, or when parties have relied on forms that neither has read? 1. U.C.C. 2-207: An acceptance does not become a rejection and, thus, a counteroffer unless it differs in a material way from the offer. There must be general conformity between offer and acceptance, but all the terms need not be fixed. 2. Section 2-207 deals solely with transactions between merchants, and favors the buyer. A seller can protect himself by insisting on conditions. a. U.C.C. Code 2-207 applies to the following transactions: Real Property (Real Estate transactions) Tangible Personalty (movable, tangible goods) Intangible Personalty (abstractions) --copyrights --patents 14 --stocks and bonds --contract rights b. Case Examples Air Products v. Fairbanks Morse (1973): Woodburn v. Northwestern Bell Telephone (1978): CONSIDERATION A. Why are some promises enforced and others are not? Does the reason have to do with the exchange of goods or services or the reliance of the promisee? 1. The standard definition of consideration is that it is a benefit to the promisor or a detriment to the promisee for which the parties bargain. (5:3) 2. General Rule: a promise not supported by consideration is not enforceable, no matter how serious the promisor may have been when the promise was made. (5:4) a. Case Examples Siegel v. Spear & Co. (1923): Plaintiff did not procure insurance for his stored furniture, on which he still had payments left to make, because Defendant said he would procure insurance. He didn’t, and the furniture was destroyed in a fire. --if a person makes a gratuitous promise, and then enters upon the performance of it, he is held to a full execution of all he has undertaken. Lusk Harbinson Jones, Inc. v. Universal Credit Co.: Feinberg v. Pfeifer Co.: REQUIREMENTS CONTRACTS A. Businesses commonly use requirements and outputs contracts. (§ 10:13) 1. U.C.C. §2-306: implies a good faith duty to have requirements or outputs on the parties to such contracts and also assures some certainty in determining quantities by referring to past practices and trade usages. 2. Courts prefer to find substance in an agreement rather than to imply the theory of conditions literally and find that there is no agreement. 3. A party is relieved from a requirements contract if they can prove a good faith excuse (i.e., going out of business). The essential test is whether the party is acting in good faith. (Example: a shut down by a requirements buyer for lack of orders might be permissible while a shut down merely to curtail losses would not). The good faith obligation adds certainty to these types of agreement. a. Case Examples Eastern Airlines v. Gulf Oil Co. (1975): Eastern had a long-standing business relationship with Gulf, which provided Eastern with 10% of its jet fuel. The price of the fuel was based on the Texas Sour standard. In 1973, the OPEC oil embargo caused significant increases in oil prices. The 15 Texas Sour standard only listed the U.S. government price-controlled oil cost, which was ½ of what Gulf could get per barrel on the open market. (§10:13, 13:15, 19:27) --change in market conditions that result in a substantial difference between the contract price and the market price of the goods that are the subject matter of the transaction generally do not excuse a decision not to have requirements, or to refuse delivery. Utah International v. Colorado-Ute Electric Assn.: 8. The obligation of good faith permeates all contractual relationships. Case Examples Wood v. Lucy Lady Duff-Gordon: 9. How do rules developed for commercial law situations work in non-commercial situations? MUTUAL MISTAKE/UNCONSCIONABILITY A. Mutual Mistake 1. Where both parties share a common assumption about a vital existing fact upon which they based their bargain and that assumption is false, the transaction may be avoided if, because of the mistake, a quite different exchange of values occurs from the exchange of values the parties contemplated, unless the risk is otherwise allocated by agreement or law. a. it is important that it be a basic assumption upon which both parties acted. b. Sherwood v. Walker (Mich. 1887): A cow of good breeding stock, Rose the II, was believed to be sterile and the owner contracted to sell her at a price far under that which she would have brought if fertile. Turns out that Rose the II was with calf. “The mistake was not of the mere quality of the animal, but went to the very nature of the thing. A barren cow is a substantially different creature than a breading one.” “The presence of facts quite different from those on which the parties based their bargain.” c. Wood v. Boynton (Wisc. 1885): Plaintiff sold a stone to defendant, a jeweler, for $1.00. Both were under the impression (good faith) that the stone was a topaz. It turned out to be a diamond worth $700-$1,000. The court found for defendant (jeweler). “There was no mistake about the stone itself, just conscious uncertainty. Each party took the risk that it was something more or less valuable than the agreed upon price.” B. Unilateral Mistake 1. Avoidance is generally allowed if two conditions concur: a. Enforcement of the contract against the mistaken party would be oppressive or at least result in an unconscionably unequal exchange of values. b. Rescission would impose no substantial hardship on the other. C. Unilateral Impalpable Mistake (i.e., Not obvious to party receiving the bid) 16 1. Relief is not available unless the agreement is entirely executory or the other party can be placed in status quo ante. 2. The mistake must be vital (substantial). If the mistake is large enough that it should be obvious, then the mistake is classified as palpable and relief is given. a. in bidding cases (contractor-sub-contractor) a mistake is substantial if it swallows up the allocation made in the bid for profit. 3. Mistake must be a computational or clerical error. Rescission is not allowed for mistake in judgement. D. Unconscionability 1. U.C.C. definition: 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 refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result. a. the purpose of the doctrine is two-fold: “prevention of oppression and unfair surprise.” b. Example: gross excessiveness of price is itself unconscionable. 2. Contract terms which transfer the risks or the burdens of a transaction from that which might be expected in an exchange, absent a written agreement, are unenforceable unless intelligently, knowingly, and voluntarily assumed. a. Typically, the cases in which unconscionability is found involve gross overall one-sidedness of a term disclaiming a warranty, limiting damages, or granting procedural advantages (tends to be buried in small print). b. There must be a lack of meaningful choice (Walker-Thomas, Campbell Soup cases) or a situation where freedom of contract is exploited by a stronger party who has control of the negotiations due to the weaker party’s ignorance, un-sophistication, etc. as to interest rates or similar business concepts. E. Duty to Read 1. However, in the current era of mass marketing, a party reasonably believes that he in not expected to read a standardized document and would be met with impatience if he did. In such circumstances, an imputation that he assents to all of the terms in the document is dubious law. a. Courts look at the true assent (i.e., Would a reasonable person have expected to find such a clause in the contract?). DAMAGES A. General Background 1. Writ of assumpsit: if Plaintiff had fully performed all or a severable part of his contractual obligation, and if the agreed exchange for his performance was the payment of money, if the Defendant breaches then the Plaintiff’s recovery is the agreed price, or, if no price had been agreed upon, the reasonable value of the labor and services he had rendered or the property which he had transferred to defendant. 17 2. Special assumpsit: Plaintiff can recover the pecuniary injury suffered when the defendant breaches his contract prior to a completed performance by plaintiff. B. Non-Compensatory Damages 1. Nominal Damages: (for every legal wrong there is a remedy). If the aggrieved party has suffered no damage he is entitled to a judgement for nominal damages, usually in the amount of $.06 or $1.00. a. Plaintiff brings case hoping to set precedent b. Plaintiff brings case in belief that he is due substantive damages 2. Punitive Damages: are granted to punish malicious or willful and wanton conduct. a. the purpose of awarding punitive damages is to deter the wrongdoer, and others, from similar conduct in the future. b. Where a contract breach constitutes, or is accompanied by, malicious or wanton tort, punitive damages are available. C. Compensatory Damages 1. General Standard: For breach of contract the law of damages seeks to place the aggrieved party in the same economic position he would have been in had the contract been performed. a. this involves an award of both the “losses caused and gains prevented by the defendant’s breach, in excess of savings made possible.” b. Example: P contracted to manufacture 100 specially designed automobile bodies. D repudiated on the contract after P had commenced production and delivered 25 auto bodies. P was unable to mitigate his damages because no market existed for his specially designed auto bodies. P was able to recover profits (contract price-P’s cost of full performance) as if the entire contract had been performed. P was also able to recover for losses sustained (labor, material and overhead that could not be salvaged). D. Modified Approach: Three Legally Protected Interests 1. Restitution interest: represents Plaintiff’s interest in the benefits he has conferred upon the other. 2. Reliance interest: represents the detriment he may have incurred by changing his position. 3. Expectation Interest: represents the prospect of Plaintiff’s gain from the contract. a. Example: P contracts with D to purchase Blackacre for $100,000 P pays D a down-payment to hold property $ 10,000 P pays his Bank (B) a fee to process mortgage $ 500 P pays B to assess the value of the Blackacre $ 500 B assesses the value of Blackacre $120,000 D learns of B’s assessment of Blackacre, and before P can purchase the property, D repudiates on the deal. What damages will P be able to recover? Restitution Interest: $10,000 Reliance Interest: $ 1,000 Expectation Interest: $20,000 $31,000 18 E. Foreseeability 1. Hadley v. Baxendale (Eng. 1854): Plaintiff operated a mill which was forced to suspend operations because of a broken shaft. Plaintiff delivered the shaft to Defendant who was to ship the shaft to a repair company. Defendant inexcusably delayed the shipment for several days. As a result the mill was shut down for a longer time than had the shipment been appropriately dispatched. 2. The aggrieved party may recover those damages as may fairly and reasonably be considered. . . arising naturally (i.e., according to the usual course of things) from such a breach of contract itself. a. Certain damages will so obviously and naturally flow from the breach that every one is deemed to have contemplated them. b. Applying this rule to Hadley: Several days delay of shipment, in the usual course of things, does not result in catastrophic consequences. 3. Plaintiff may recover damages “such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.” a. Such consequences must be foreseeable. b. Less obvious kinds of damages are deemed to be contemplated if the promisor knows, or has reason to know, the special circumstances which will give rise to such damages. 4. Post-Hadley (Tacit agreement) a. Expressed or implied manifestation of intent: the knowledge of special circumstances must be brought home to the party to be charged under the circumstances, that he must know that the person he contracts with reasonably believes that he accepts the contract with the special condition attached to it. b. This approach has been repudiated by the U.C.C., The Restatement, Second, Contracts, and most states. 1. The tacit agreement rule is dubiously based upon the contracting parties’ implied or express promise to pay damages in the event of breach, rather than based upon a secondary duty imposed by law as a consequence of the breach. 5. Examples of the Hadley-Baxendale Test a. a carrier is not liable for consequential damages consisting of lost profit when it delays shipment of a motion picture film to a theater if it has no notice that the theater could not procure a substitute film. b. If a carrier is told that the oil rig is the only one the consignor has and the consequent importance of timely delivery, the carrier is liable for loss of profit attributable to the lack of prompt delivery. (Would not be liable if temporary rental oil rigs were available in consignors area). F. Certainty as a Limitation Upon Recovery of Damages 19 1. Reasonable Certainty: damages must be certain both in their nature and in respect to the causes from which they proceed. a. It has usually been held that lost profits caused by breach of contract to produce a sporting event, theatrical performance, or other form of entertainment are too uncertain for recovery. b. evidence of past profits or profits earned in other venues does little to substantiate whether the event would have been profitable (or tell us how profitable the event would be) had defendant not breached. 2. Businesses a. Where defendant’s breach prevents or delays the opening of a new business, evidence of potential profits are too uncertain to determine whether the enterprise would have been profitable. b. Established businesses can prove lost profits with substantial certainty on transactions of a kind in which the particular business has traditionally engaged in. G. Alternative Recovery (Reliance Interest) 1. When the aggrieved party cannot establish his loss of profits with sufficient certainty, he is permitted to recover his expenses of preparation and of past performance, as well as other foreseeable expenses incurred in reliance upon the contract. a. Example: a farmer who purchases and plants defective seed may or may not be able to prove what the value of his crop would have been if the seed had been of merchantable quality. If not, the farmer is able to recover (1) the amount paid for the seed, (2) the rental value of the land on which it was sown, (3) the labor costs of preparing the land and sowing the seed. b. Reliance expenditures: include expenses incurred in part performance and in preparation for performance, as well as foreseeable collateral expenses (i.e., amounts expended in advertising) c. Security Store & Mftg Co. v. American Rys. Exp. Co. (Mo 1932): Not all contracting parties contemplate a direct and identifiable profit. A manufacturer may contract to have a product shipped to a convention for display in the hopes of attracting interest in its product, rather than immediate sales. If the shipper is aware of the manufacturer’s purpose, it can foresee that in reliance upon the contract the manufacturer will rent exhibition space and incur other expenses. In the event of breach such reliance expenditures are recoverable. H. The Concept of Value 1. Market Value as the Usual Standard: The standard of valuation considered is market value irregardless of any peculiar value the object in question may have had in the eyes of the owner. 2. Proof of Value: Publications reporting on prices of goods, commodities, stocks, etc. are admissible. Otherwise, reasonableness is a factor when looking to other evidence. I. Duty to Mitigate Damages 1. Absence of a Right to Recovery for Enhanced Damages: A party who has been wronged by a breach of contract may not unreasonably sit idly by and allow damages to accumulate. 2. Doctrine of Avoidable Consequences: merely requires reasonable efforts to mitigate damages. 20 a. the aggrieved party need not act if the cost of avoidance is unreasonable. b. The aggrieved party does not have to commit a wrong (for instance, breach other contracts) in order to minimize damages. J. Damages in Particular Actions 1. Wrongful Discharge of an Employee a. When an employee is wrongfully discharged he is entitled to the salary that would have been payable during the remainder of the term reduced by the income which he has earned, will earn, or could with reasonable diligence earn during the unexpired term. b. The employee does not have to seek or accept a position of lesser rank, reduced salary, or unreasonably far in distance from his home. 2. Wrongful Termination By Employee a. When an employee wrongfully terminates his employment, the employer’s recovery is measured by the additional market cost of obtaining substitute help for the remainder of the unexpired contract term. K. Total Breach of Sales Contracts: Buyer’s General Damages 1. U.C.C. §2-712(2): The U.C.C. has adopted the traditional measure of general damages for a total breach of contract by the seller, which is the difference between the market price and the contract price. a. under the U.C.C., the buyer may cover: he may make a good faith purchase or contract to purchase substitute goods without unreasonable delay. He may then recover the difference between the cost of the cover and the original contract price. b. If the aggrieved buyer does not cover, the relevant market price is that which is in effect at the time the buyer learned of the breach. c. Exception: the buyer cannot recover consequential damages that could have been avoided by cover. d. Exception: Replevin and Specific Performance are not available remedies if the disappointed purchaser could have obtained substitute goods elsewhere. i. Replevin: an action whereby the owner or person entitled to repossession of goods or chattels may recover those goods or chattels from one who has wrongfully taken or detained such goods and chattels. 2. The U.C.C. postpones the date on which damages are assessed in cases where the buyer is unaware of the breach until after performance is due. a. Example: Where defective goods are delivered and the defects are not discovered until after seller’s performance has been completed. b. U.C.C. §2-713: accelerates the date on which damages are assessed in cases where there is a breach by anticipatory repudiation. i. §2-610: permits the aggrieved party, after the repudiation, to await performance “for a commercially reasonable time.” 21 ii. While §2-713 and §2-610 contrast one another, a logical solution is to conclude that if the buyer exercises such patience, he has “learned of the breach” at the expiration of the “commercially reasonable time.” iii. Most courts follow §2-713, which has the principle of avoidable consequences built into it. If the buyer does not cover, he cannot enhance damages by remaining idle until the time for delivery under the contract. 3. Buyer’s General Damages For Seller’s Breach of Warranty or Fraud a. U.C.C. §2-714: For breach of warranty, the measure is the difference between the value of goods accepted and the value they would have had if they had been as warranted. i. in routine cases, value is established by showing the reasonable cost of repair. j. Value is normally determined at the time and place of acceptance, rather than, as under the Sales Act, at the time and place of delivery. 4. Buyer’s Consequential and Incidental Damages For Breach a. In ordinary cases, the buyer is made whole by the application of the rules of general damages. b. Example: if the buyer contracted to purchase sugar at $.04 per pound and the seller breaches when the market price is $.07 per pound, the buyer is entitled to damages of $.03 per pound of sugar contracted. 5. U.C.C. §2-715 a. Consequential Damages: any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise. i. It is sufficient that at the time of the breach no substitute is reasonably available and that the seller had reason to know the buyer’s needs. ii. However, the seller will not be liable for all consequential damages (Think Foreseeability!) b. Examples of When Consequential Damages Apply i. Known market shortages exist, or buyer has contracted to purchase brand named goods for which the seller solely controls the supply of that good. ii. Where a seller delivers goods to a manufacturer knowing they are to be used in the manufacturing process, the seller has reason to know that defective goods may cause a disruption in production and a consequent loss of profits. Under the U.C.C., the seller would be liable for lost profits, and he may be liable for any recalls the defective product creates. iii. The U.C.C. permits parties to limit or exclude consequential damages by agreement, unless the limitation or exclusion is unconscionable. iv. Frequently warranties are limited and consequential damages are excluded from the agreement. In lieu of more stringent warranties, the seller usually agrees to repair defects for a certain period of time. But, if the seller fails to repair, the U.C.C. allows the buyer to sue for consequential damages by waiving the remedies limitation clause in the original agreement. 22 v. The material breach of the contractual substitute entitles the purchaser to cancel the remedies clause of the contract and utilize the remedies provisions of the U.C.C. 6. Incidental Damages (U.C.C. §2-715) a. incidental damages: expenses reasonably incurred in inspection, receipt, transportation, and care and custody of goods rightfully rejected. Also, any commercially reasonable charges, expenses, or commissions in connection with effecting cover. L. Seller’s General Damages for Non-Acceptance or Repudiation by the Buyer 1. The seller’s general damages for non-acceptance or repudiation by the buyer is the difference between the market-price and the unpaid contract price. 2. U.C.C. §2-718: if the difference between the market price and contract price provides inadequate recovery, the measure of damages is the profit (including reasonable overhead) which the seller would have made from full performance by the buyer. a. The seller’s lost profits can be calculated by subtracting the cost (so called variable costs) to the dealer of the automobile price from the contract price. b. Neri v. Retail Marine Corp.: c. Inconsistencies must be resolved by following the U.C.C.’s guiding principle: the aggrieved party may be put in as good a position as if the other party had fully performed. 3. Seller’s Damages Following Resale a. In the event of a breach by the buyer, whether by wrongful non-acceptance of the goods, repudiation, or failure to make a payment when due, the seller may identify the goods to the contract and resell them at a private or public sale. b. He may then recover from the buyer the difference between the resale price and the contract price, provided that the sale is conducted in a commercially reasonable manner. i. partial payment by the buyer ought to be credited to the buyer when the difference is calculated. 4. Seller’s Consequential and Incidental Damages a. The U.C.C. does not have a provision which allows the seller to recover consequential damages. b. Most cases deal with a buyer who refuses to pay the contracted price. Thus, the only recovery allowable is the sum of money owed plus interest. c. Exception: Where payment is to be made to a 3rd Person, the creditor has been allowed to recover damages suffered by him, often consisting of injury to his credit and reputation (i.e., liability insurer failed to pay judgement against insured, leading to the insured’s subsequent arrest; the insurance company will be held liable for consequential damages) 5. U.C.C. §2-710: permits the seller to recover incidental damages, including any commercially reasonable charges, expenses, or commissions incurred in stopping delivery, in the 23 transportation, care and custody of the goods after the buyer’s breach, in connection with return or resale of the goods or otherwise resulting from the breach. M. Construction Contracts: Measure of Recovery by Contractor 1. If a contractor has completely performed he is unquestionably entitled to the agreed price. 2. If no work has been done the contractor is entitled to the profit he would have made measured by the difference between the contract price and the prospective cost of performance. a. ditto for partial performance, except the formula is the contract price minus [cost of performance plus progress payments made to date]. b. U.S. v. Behan (1884): 3. On a losing contract, the contractor would frequently find that his recovery would be greater in an action for restitution than in an action for damages. N. Construction Contracts: Measure of Recovery by the Owner 1. When a building contract is defectively performed, as a general rule, the owner is entitled to damages measured by the cost of remedying the defect. a. Jacobs & Young v. Kent (N.Y. 1921): Defendant inadvertently installed Cohoes Brand pipes instead of Reading Brand wrought iron pipes, contrary to contract specifications. The two brands were regarded in the trade to be of equal quality. Owner discovered the breach after the pipes had been installed and nearly all of the walls plastered. Cost to tear down the walls and install Reading pipes would be $35,000. The house currently was worth $250,000. Changing the pipes would still result in the house being worth $250,000. i. the owner was entitled to merely the difference between the value of the house if built to specifications and the value it has as constructed. ii. Court sought to avoid “unreasonable economic waste.” iii. In Jacobs, had the owner demonstrated an idiosyncratic attachment to the pipes (e.g., he was an executive at Reading Pipes) or had the owner proved the contractor was willful in his breach (e.g., purchased Cohoes pipes for a reduced price from another contractor who was under economic duress), then he could have recovered. Alas, these elements were not present. The contractor simply made an honest mistake, which lead to the breach. b. Peevyhouse v. Garland Coal Mining Co. (Okl. 1962): Defendant contracted to lease 60 acres of farmland for strip-mining purposes, agreeing to restore the land to specified grades and conditions once the mining was completed. The land was mined but not restored. Reclaiming the land would have cost $29,000, but currently the land is worth only $300 less than it would be worth if restored. i. the court granted Plaintiff’s damages of $300. ii. The breach was willful and the strip miner kept $29,000 that he originally committed to reclaim the land. iii. This verdict seems to go against moral obligation created by contractual promises (the policy of discouraging contract breaches and unjust enrichment). 24 c. Farrell Lines v. New York (N.Y. 1972): L, a municipality, owned a pier which it leased to T for a 10 year term at an annual rate of $200,000. T agreed to keep the pier in good repair at his own expense. When the lease expired, L discovered that T had failed to maintain the pier, leaving estimated repairs at $200,000. Soon thereafter, L demolished the pier for replacement by a container ship terminal. L sued T for damages and T countered by arguing that L suffered no damages since the pier had been scheduled for destruction anyway. i. repairs would be valueless (“economically inefficient”) ii. Court still awarded L damages, and by doing so prevented T from being unjustly enriched. When he signed the lease, T allocated the cost of repairs into his equation. There is no economic inefficiency in awarding L, rather than T, the savings caused by the lack of repair. O. Agreed Damages 1. Liquidated Damages Distinguished from Penalties a. Parties are free to enter into a contract containing whatever terms they wish regarding the establishment of primary rights, but except within narrow limits they are not free to determine that remedial rights will be provided. b. example: a contractual clause providing that in the event of breach specific performance will be granted will not be given effect by the courts. (The courts may take the clause into consideration when determining the appropriate remedy). 2. Liquidated Damages (Three Elements Must Exist) a. Intention: The parties must intend to provide for damages, rather than a penalty b. Uncertain Injury: the injury caused by breach must be uncertain or difficult to quantify i. U.C.C. and Restatement: “the difficulties of proof of loss” ii. A liquidated damages clause is most useful to the parties where actual damages are most difficult to prove (in such scenarios, they are likely to be upheld by the courts) c. Reasonableness: the sum stipulated must be a reasonable pre-estimate of the probable loss. Third Party Beneficiaries Background: Third Party Beneficiary Doctrine A. Developed out of trust law: typically involves a contract (trust agreement) between the trustee (promisor) and the settlor (promisee) for the benefit of a third party (beneficiary). Even though a stranger to the agreement between the trustee and settlor, the beneficiary usually has a right to enforce the trust agreement. The English courts do not recognize the third party beneficiary doctrine. 1. Promisor: the party who has made the promise on which the suit is being brought; the party which makes the promise which benefits the 3rd Party. 2. The English Rule (Privity of Contract Doctrine): Only the parties to a contract are legally bound by it and entitled to enforcement….a third party may be benefited or 25 burdened in fact by performance of the contract, but according to the privity doctrine only the contracting parties are benefited and burdened in law by the making of a contract. 3. U.S. Rule (Lawrence v. Fox N.Y. 1859): Holly lent Fox $300 on the condition that Fox pay the same amount to Lawrence the next day. If Fox performed, Holly would erase a debt he owed to Lawrence and Fox would clear the debt he owed Holly. Fox did not perform and Lawrence brought suit against him. The court held that “a promise made to one for the benefit of another, he for whose benefit it is made may bring an action for breach.” a. In general terms a third party beneficiary contract arises when two parties enter into an agreement with an intent to confer a direct benefit on a third party, allowing the third party to sue on the contract despite the lack of privity. B. Donee Beneficiary (1st Restatement) 1. A donee beneficiary (intended beneficiary) is a third party to whom the promised beneficial performance comes without cost as a donation or gift. The purpose of the Promisee in obtaining the promise from the Promisor is to confer a gift upon the beneficiary. a. Seaver v. Ransom (N.Y. 1918): Judge Beman promised to make amendments in his will to accommodate his dying wife’s wishes to leave their house to their niece. When Judge Beaman died, he had not made the change to his will and the niece brought suit against the estate. The court held that Judge Beman assumed liability for his deceased wife’s promise to their niece bequeathing upon her their house, and as such the niece was able to recover (also considered was the familial relationship). C. Creditor Beneficiary (1st Restatement) 1. If the purpose of the Promisee in obtaining the promise from the Promisor is “to discharge an actual or supposed or asserted duty of the Promisee to the Beneficiary”, the beneficiary is a creditor beneficiary (intended beneficiary). D. The Restatement (Second) of Contracts 1. The 2nd Restatement categorizes beneficiaries simply into two categories: intended beneficiaries who can recover, and incidental beneficiaries who cannot recover. a. The focus is on whether the Promisor and Promisee intended to benefit a third party, regardless of the nature of the transaction. 2. The performance of the contract will satisfy an (actual) obligation of the Promisee to pay money to the beneficiary, or (b) the circumstances indicate that the Promisee intends to give the beneficiary the benefit of the promised performance. E. Problem of Intent 1. There must be some showing of an intent to benefit the third party. 26 a. Two factors that many courts find significant are: (1) whether intent to benefit the third party is the primary purpose for a contract (2) whether a benefit to the third party is direct (a) the third party does not need to be the sole beneficiary of the contract as long as the benefits to that individual are direct and substantial 2. The majority of jurisdictions look at the Promisee’s intent; stems from Corbin’s argument that the Promisee’s intent is the most relevant because the consideration received solely motivates the Promisor. 3. Types of Approaches a. To whom is performance run: Under this test if it is decided that the performance is run directly to the Promisee, then the 3rd Party is generally an unprotected incidental beneficiary. But, if performance is run directly to a 3rd Party, then she is ordinarily an intended beneficiary. b. Intention of Promisee: This test stresses the intent of the Promisee, but also indicates that the Promisor must also have understood the Promisee’s intent. i. Lucas v. Hamm: Lawyer erred in the drawing of a will, resulting in the loss of $75,000 to Plaintiff’s, the beneficiaries named in the will. Plaintiff’s were able to recover because the testator intended for them to be beneficiaries. ii. Example: A owns property→A obtains mortgage loan from B, a bank→as part of the agreement, B promises to obtain liability insurance for A’s property, but fails to do so→C is subsequently injured on A’s property due to A”s negligence in maintaining the land. Answer: Yes, even though the promise of liability insurance “ran” from B to A, A’s intention for securing liability insurance was to protect 3rd Parties like C. c. Policy Considerations i. H.R. Moch v. City of Rensselaer ( N.Y. 1928): Defendant contracted with a water company to supply water for the city. Plaintiff’s warehouse burnt down when there was not enough water in the fire hydrants during a fire. Plaintiff brought suit as a 3rd Party Beneficiary to Defendant’s contract with the water supplier. a. The court concluded that plaintiff was not an intended beneficiary in part because defendant could have been destroyed financially if, for example, the entire city had been destroyed by fire. The court focused on the economic and social impact of expanding liability (rather than the intentions of the contracting parties). ii. Construction cases: “Should a sub-contractor be treated like a beneficiary of the owner’s promise (Promisor) to pay a general contractor (Promisee)?” Such a decision tends to be based on the court’s view of what is good for 27 the construction industry and society in general (versus intention of contracting parties). d. Reliance: if a 3rd Party reasonably relies, to their detriment, on an agreement between two other parties, the 3rd Party’s reliance may be enough to make them a beneficiary. i. reasonableness: if the beneficiary would be reasonable in relying on the promise as manifesting an intention to confer a right upon him, then they are a 3rd Party beneficiary. F. Mortgages (3rd Party Scenarios) 1. A mortgage is a security interest in real property typically given in exchange for a loan, usually evidenced by a bond or a note. 2. Vrooman v. Turner (1877): (1) there must be an intent to benefit, and (2) there must be an obligation owing from the Promisee to the beneficiary. i. Example: A purchases property with mortgage from B; A sells property to C, who does not assume the mortgage obligation; C sells property to D, who does assume the mortgage obligation. D defaults on mortgage payments. Answer: In this scenario, D’s promise to pay B is unenforceable. C (Promisee) was never under obligation to pay B (Beneficiary). ii. Second Restatement Approach: Most likely would have found for Plaintiff (B). B was an intended beneficiary under the reliance approach. G. Public Contracts 1. The primary question is whether an inhabitant of a governmental unit is a third party beneficiary to a contract made by the governmental unit (Promisee) with a private contractor (Promisor). a. In a sense, every contract made by a government unit is made for the benefit of its inhabitants, but the ultimate question is whether there was intent to benefit individual inhabitants (and in so doing confer upon them third party beneficiary rights). 2. Situations where individuals are third party beneficiaries. a. When the promisor agrees to perform services for a government unit which the unit is under a legal duty to perform to individual members of the public. i. Note: Courts are reluctant to find that an inhabitant qualifies as a third party beneficiary in public contracts. H. Surety Bonds 1. Background: a surety bond is essentially a payment bond: if the principal does not pay, the surety company will pay. 28 a. The Miller Act: for government contracts, requires a surety (payment bond) to cover: i. material men, laborers, and contractors who deal with the prime contractor directly ii. material men, laborers, and contractors who have a direct relationship with a sub-contractor I. Defenses in Third Party Beneficiary Agreements 1. General Rule: The promisor may assert against the beneficiary any defense that he could assert against the promisee. a. Defenses include: non-performance, fraud, mistake, lack of consideration and illegality b. Example: A (promisee) promises not to cut down a certain tree in exchange for B’s (promisor) promise to pay C $1,000→A cuts down the tree→C, as a third party beneficiary, sues B unsuccessfully because B has the defense of non-performance against A. 2. Exceptions to the rule a. In collective bargaining agreements, it has been held that the employer may not use against its employees a defense the employer has against the union i. Lewis v. Benedict Coal Co. (1960): b. At times the promisor will be estopped from asserting defenses that he has against the promisee by virtue of reliance on the part of the beneficiary. J. Vesting: Attempted Discharge or Modification of the Rights of a Third Party Beneficiary 1. At what point do the rights of a beneficiary vest? a. Modification/Alteration cannot occur to the original agreement if the rights of the 3PB vested before the time of the second agreement. b. First Restatement: Requires injurious/detrimental reliance on the part of the beneficiary before her rights vest. i. creditor beneficiary: rights vest upon 3PB’s learning of the original agreement and assenting to its terms. ii. Donee beneficiary: rights vest immediately upon the making of the contract. c. Second Restatement: The rights of a 3PB vest when the 3PB materially changes his position in justifiable reliance on the promise or brings suit on it or manifests assent to it at the request of the promisor or promisee. i. The parties may by agreement reserve “a power to discharge or modify the promisor’s duty.” 29 d. After the rights of a 3PB vest, he is not subject to any defenses that the Promisor has against the Promisee which purports to vary or discharge the 3PB’s rights. K. Defenses: May a Promisor Assert Against a 3PB a Defense Which the Promisee has Against the 3PB? 1. Rouse v. United States (1954): Two Possible Interpretations a. Promisor promises to pay whatever the Promisee owes. In this situation, the promisor can use the defense a promisee has against the 3PB. b. Promisor promises to pay irrespective of the liability of the promisee to the 3PB. In this case, the Promisor cannot assert the promisee’s defense against the 3PB. i. In Rouse, the court said a promise to assume amounts is a promise to pay irrespective of the liability of the promisee. L. Rights of a 3PB against a Promisee 1. Creditor Beneficiary Situation a. Example: C is indebted to A; C for a consideration causes B to assume indebtedness. As an intended creditor beneficiary, A has a cause of action against B and does not lose his rights against C. The original obligation remains. A has a claim against both B and C, but is entitled only to one satisfaction. 2. Donee Beneficiary: NO RIGHTS AGAINST PROMISEE a. The promisee has rights against the promisor because the promise breached was made to the promisee. GENERAL EXAM PRINCIPLES 1. Always look first to the Express Terms of the Contract. 2. Then look at the parties’ performance of the contract up to the time of dispute. 3. If not enough, look at the prior dealings between the parties (different contracts in the past). 4. Look at industry/business customary practices in the field.