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Contracts 5 – Rakoff – 5/16/2005

Question One

Dear Mary,

        I should note at the outset that Bill probably has a legitimate claim against Sam
for the full value of his debt. Since Bill received nothing in consideration for his loan, it
is probably not a contract, but Bill would likely have an action in restitution against him.
The agreement they struck, because Bill got no interest, had only Sam’s love and
affection as consideration, something not recognized as consideration. Nonetheless, Bill
conferred a benefit on Sam which Sam promised to repay; a court would with a certainty
conclude that the loan was not meant as a gift (despite its low interest rate) and thus Sam
would be unjustly enriched if the promise to repay the loan was held unenforceable. The
close familial nature of the agreement is unlikely to sway the court into believing that no
contract was formed. Though the loan was to take more than a year, Sam signed a written
note, satisfying the statute of frauds.
        The enforcement action by the bank against you, however, is on less certain
ground. Your promise to him, if a contract, could be construed as a contract to be a
surety, and thus would be within the statute of frauds, but this is satisfied because of your
email communication: it specifies that there is a contract, its essential terms, as well as
the nature of the subject matter. The only statute of frauds issue arises if your reply to
him is not construed as a signature. I think given the overall circumstances, a court would
be likely to so construe it: the email presumably carries your identifying mark in your
address, and is signed “Sis.” The circumstances seem to indicate your assent.
        The next question is whether or not your promise to Bill is a contract. The most
likely outcome is that it is, and you will be bound to pay, but we will still have some
arguments to make if it comes to it. First, for your promise to be binding, there must
generally be consideration. While there was no direct benefit flowing to you, Bill did give
up a legal right on your assurance. Bill had a right to pursue a claim against Sam, and he
forewent that claim. While the benefit flowed to Sam, because of the close familial nature
of the arrangement a court is likely to be persuaded that you honestly desired that
outcome, and because of your exchange with Bill, arguing over the terms of repayment, a
makes it appear that you bargained for it. You sought Bill’s promise not to pursue a claim
against Sam in reciprocal exchange for your promise to guarantee Sam’s loan. Despite
the fact that it appears that Bill might not have pursued the claim in any event, courts
generally do not make it a requirement that Bill actually be induced to make his promise
by your promise; instead it is sufficient that you sought his promise for yours.
        However, we might make a strong argument that this case is more like. Newman
and Snells Bank v. Hunter. In that case, the court refused to enforce a widow’s promise to
pay the debts of her deceased husband out of her assets when the husband’s debts were
wholly unrecoverable from the husband’s estate. If Sam’s company was worthless at the
time you made the promise, then the benefit that flowed to you might be construed as
only consisting of the preservation of Sam’s honor and your own guilt about Sam’s
position. Neither would likely be sufficient as consideration.




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         However, many of the elements of Newman are not present here. First, while the
widow’s status as a widow is not doctrinally important, it probably swayed the court in
some measure. The enforecement of the note against the widow would have seriously
eroded her widow’s pension. Your position is much different – you had 50k to loan to
Sam of you own, and don’t appear to be in financial straits. Thus the sympathy factor
might work against us.
         Second, in that case, the husbands debts were definitively worthless, according to
the court. Here, Sam’s ability to pay the debt appears to at least have been in honest
doubt: both of you appeared to believe that Sam would be good for the money eventually,
and he may have had assets at the time that could satisfy the debt, though he was
unwilling to do so. Sam might have plead impracticability in any action to recover the
debt, on the argument that the non-happening of 9/11 was a basic assumption of the
contract, and that its effects on the market made it impossible for him to repay the debt,
thus reducing the value of his debt to zero. This argument is problematic for a number of
reasons: first, 9/11 did cause serious market difficulties, but courts have not wantonly
found contracts made before hand unenforceable. Moreover, because the action would be
in restitution, and courts generally seek to avoid unjust enrichment in these cases, Sam’s
duty to repay the loan would probably be enforced. In any event, the defense is doubtful.
Generally, a court will construe the forbearance of an action to recover a debt as
consideration if the debt is in doubt.
         Third, in this case, Bill’s action might have seriously harmed Sam’s credit rating,
and while the reputation of a dead relative is probably not sufficient to be consideration,
the reputation and future earning power of a living one might be.
         You might have a claim for duress on the argument that Bill was threatening legal
action against Sam to induce you to insure his debts. This argument would be much
strengthened if Sam had very few assets at the time of Bills action, rendering Bill’s action
worthless. Courts will recognize actions for duress when there’s an improper threat that
produces a lopsided deal. In Sisbee v. Webber, the court refused to enforce a contract
whereby a woman gave a security for a debt incurred by her son’s theft in exchange for
the victim not telling the boy’s father. The facts seem remarkably similar. If Sam’s debt
was worthless (and Bill could recover nothing by pursuing the claim at the time), then
pursuing the claim against Sam would not benefit Bill, but would put Sam into
bankruptcy, damaging his reputation. That threat would be improper if it produced a deal
on uneven terms; your guarantee would be on strongly imbalanced terms if the debt was
worthless. It might also be a bad faith use of the civil process to threaten suit. Bill got
25,000 dollars in exchange for virtually nothing. His threat is probably enough to
overcome the will of a reasonable person, and your unwillingness to pay the debt seems
to indicate that it overcame your will as well. A court may very well enforce your
promise to repay Sam’s debt.
         It may be difficult to construe Bill’s argument with Sam as a threat. He did not
appear to use any language like “if you don’t pay me, I’ll sue Sam.” It’s not even clear he
talked about legal action. But the circumstances seem to indicate that at least once you
showed up, Bill sought to induce you to make a promise out of concern for Sam. A court
could even construe Bill’s actions as a staged event to induce you to make the promise.
There’s not much evidence to support this assertion, but it might at least get us past
summary judgment.



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         However, the doubtfulness of Sam’s financial health makes this claim difficult. If
Sam had assets, then Bill’s action was not worthless, and his threat to take legal action
might appear much more legitimate. A court might hestitate to sustain a claim of duress
here. I think it unlikely that a court would consider an action to recover a legitimate debt,
particularly one given on such generous terms, to be in the zone of improper threat. In
fact, it might render all promises to act as a surety unenforceable if made after the time
for collection of the debt has come to pass, an outcome the court might find undesirable.
It may be better that sometimes people can guarantee loans for others, rather than all
debts creating causes of action. Frankly, we may not have enough evidence to convince a
court that Bill’s threat was illicit, but we have a chance.
         We might also be able to argue that you in fact did not promise to guarantee his
debt, but merely promised to use the power of maternal nagging to persuade Sam to pay
his debt when 9 months were up. However, even if that were true, then Bill’s email reply
to you, using the word “guarantee” could be construed as a counteroffer, and I suspect
that your reply, though it did not expressly state your commitment in those words,
appears to accept the terms. Courts apply an objective test to determine assent, and your
reply would probably convince a reasonable person that you had agreed. Especially in the
context of a family relationship. Your silence could also be construed as assent, because
the making of the offer delayed his recovery action, and thus put him at risk (though this
argument is much more doubtful).
         Finally, the one area I’m convinced we’re right about is that you do not owe
interest on the debt. Your promise to guarantee only extended to Sam’s debt by the terms
of both your original offer and Bills acceptance / counteroffer. Sam’s debt did not have
an interest rate provision for the period after the debt came due. Any interest to be
accrued after that should probably have been provided for in the document.
         Ultimately, I think you will be on the line for 25,000 without interest, but I do
think that we might obtain settlement for a lower number if Sam’s financial condition
when you made the promise was dire.

Your attorney,

10612691




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Question Two –

…whether the original contract was a valid one. I first note that the contract is under the
UCC. Tomatoes are goods and the contract is for their sale. The contract is written, so
there is not problem under the statute of frauds. The contract price is not set, but the UCC
allows an open price term when an external measure determines the contract price. The
quantity is not set, but the UCC recognizes output contracts as enforceable. There is an
enforceable contract.
         Farmer first argues that the cancellation clause is unconscionable, contending that
it should be modified under the contract. The clause itself, argues Farmer, is so one-sided
that it is evidence of the unconscionability of the contact. Indeed, the effect of the
contract is to pass off all of the risk of shifts in market price to the Farmer, and assume
none for GGG. If the price of tomatoes rose, GGG would collect a windfall profit. If the
price fell, GGG could cancel in advance and buy potentially the same tomatoes on the
open market at discounted prices. The only protection afforded the Farmers in the
contract is the thirty day insulation against cancellation. My knowledge of the tomato
market is minimal, but this seems like a very minimal protection, unless much of the
normal fluctuation in market price happens in the month before harvesting. This clause
seems to go beyond the normal allocation of risk and enter into the zone of oppression
envisioned by the UCC. As both parties are businessmen, and not unsuspecting
consumers, the bargaining imbalance may not seem severe. However, farmers are
certainly more vulnerable than small farmers, and the extent of the reliance on GGG by
the farmers is indicative of a bargaining power.
         Farmer’s argument is strengthened because the clause appears in a contract of
adhesion. Even if the terms are not so one sided as to be unconscionable, they are
certainly one sided, producing a marked advantage for GGG. While terms of contracts of
adhesion are generally held presumptively enforceable they are still reviewed for
fundamental fairness. Where a term is bizarre or oppressive, or, under the restatement,
where one party would not have agreed to the contract if they had known about the term,
the term may be excluded from the agreement. It is doubtful whether or not Farmer
would have agreed to the term if he had known about it – especially if he had
contemplated this particular use of the term. Indeed, the term is so damaging that it
negates the primary purpose of the agreement for Farmer, and leaves him exposed given
his reliance.
         However, the imbalance of bargaining power between GGG and Farmer is not so
severe as to negate any meaningful choice. Farmer had the ability to read the contract –
indeed, it was probably the only contract he would sign all year for his business. He was
experienced with the tomato market and knew the risks. Moreover, he did receive a
benefit. Normally, if negotiating for futures sales, Farmer would be required to sell his
crop in advance, potentially taking the risk that if he had a shortfall in production he
could be exposed to the risk of loss. Here, he got a market for his tomatoes without the
risk of a price spike combined with less-than-average production leaving him exposed.
Ultimately, Farmer made a calculated decision to enter the contract, and he should be
held to the terms of the deal, despite the apparently severe consequences of the
cancellation clause. In particular, by implying a good faith obligation in the exercise of



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the clause, the court can mitigate the impact of the clause and prevent the abusive use of
the clause to damage Farmer.
        Farmer also argues that the use of the term to cancel the agreement constituted a
breach of good faith. Courts disagree about the extent of the obligation of good faith, but
all contracts are subject to a non-disclaimable obligation of good faith under the UCC.
Moreover, these parties entered a deal which made them substantially reliant on one
another; each had to cooperate to produce mutual benefits. Indeed, the agreement
specifies that they are entering into a long term agreement, and provides for specific
performance if the contract is breached by the farmers. Good faith is a central element of
this contract. It is only enforceable under the UCC as a requirements contract because
good faith defines the obligation of production. Both parties are highly vulnerable: GGG
is required to buy whatever farmers produce, exposing them to a risk of overproduction,
and the farmers are dependent on GGG to be a consumer – they have to change their
entire structure of production relying on GGG to consume their purchases. It seems only
reasonable that GGG be held to high level of good faith in the execution of the contract.
        Farmer also argues that the obligation of good faith should void the cancellation
provision. Good faith is a non-disclaimable obligation under the UCC and that the clause
functionally allows GGG to cancel at any time without cause, and thus should be voided.
This argument, while creative, fails. The parties are generally free to use language to
define their obligations of good faith, and the requirement that the clause be exercised in
good faith eliminates this problem.
        However, GGG may make a strong argument that it is complying with its good
faith obligations. While the effects on the farmers are severe, GGG does not appear to be
canceling all of its contracts to exploit the lower market price. Instead, GGG is merely
mitigating its losses by cutting back on orders, but still paying the contract price for the
purchases it does make. If GGG were to cancel and then re-order on the market at the
cheaper market price, this would certainly be the kind of trickery, and effort to deny the
other party a profit that the duty of good faith seeks to prohibit. GGG might also be in
violation of its duty of good faith if it had only kept the contracts carrying the cheapest
price. But there is no evidence that they have done so. For Farmer to prevail, he must
imply a duty of good faith which goes beyond the duty to cooperate to produce a benefit
and into the uncertain territory of Parev products and Feld, where the duty of good faith
requires that you consider the interests of the other party. But even Feld was not willing
to go as far as requiring that the company continue in its contract when it faced financial
ruin. Absent evidence that GGG chose its suppliers strategically, this court does not find
that GGG breached its duty of good faith.
        GGG may also argue impracticability. Though serious costs are not usually
enough to void a contract for impracticability, and market shifts are usually considered to
be within the risks undertaken by firms. But the severity of the market shift might not
have been in contemplation of the parties at the time of the agreement. Though a market
downturn was certainly possible, the utter collapse of a formerly mainstay industry like
tomato sauce was probably beyond the pale. Generally, to plead impossibility, a party
must not have undertaken a greater responsibility than required, indicating that
impracticability is primarily about risk allocation over unforeseen circumstances. The
cancellation clause could be construed as a means of allocating the risk of this kind of
downturn onto the farmers.



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         If farmer were entitled to a remedy, specific performance would be inappropriate.
Though GGG is entitled to specific performance, that does not necessarily entitle Farmer
to the same remedy. Indeed, an order for specific performance would needlessly increase
the damage done by the contract, because Farmer would engage in the apparently
economically wasteful act of picking the tomatoes. Instead Farmer would be entitled to
his expectancy, which is the difference between the contract price (40) and the market
price (0), less the saved cost of picking the tomatoes (and the value of the tomatoes as
compost). He is not, however, entitled to the above amount for the reasons stated above.
         Farmer makes one final claim. They argue that they relied on the contract to make
substantial changes in their business position, and are thus entitled to the costs of their
improvements. The promise did induce them to make the change, the change was
foreseeable, and the reliance was definite. Under this theory Farmer would at least be
entitled to the cost of fertilization and seed (20,000) though possibly not for the 35,0000
for irrigation changes, as they still may have a future value not actually destroyed by
GGG’s breach. And they were made in reliance on future contracts which would not
necessarily have to be renewed. However, the risk allocation measure created by the
cancellation clause should dispose of this. If any contract containing a cancellation clause
could be enforced through § 90, then they would have little effect. Farmer could have
insured the contract against cancellation by GGG and should have.
         The result is harsh for Farmer, but a contrary result would have equally
devastating effects on GGG. GGG lost much of its market through unexpected
conditions, and provided a cancellation clause in the contract that contemplated just this
eventuality, passing the responsibility to insure onto the Farmer. GGG was obligated only
to cancel in good faith and not strategically.




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