Law For Small Business (Mgmt 349) Contracts (Chapter 20) Professor Charles H. Smith Fall 2011

Introduction Purpose of this PowerPoint presentation is to introduce many fundamental and some specific concepts of contract law. Concepts introduced here will also apply to following PowerPoint presentations re Chapters 5, 10 and 13. Therefore, this PowerPoint presentation will be fairly lengthy (and may take more than one class session) and the other three PowerPoint presentations which will be covered on the second exam will be relatively short (and may take less class time than scheduled).

Terminology Used in Contract Law Unilateral contract – contract based on one party’s making a promise that calls for action. Bilateral contract – contract based on both parties making promises to each other. Express contract – contract is communicated in writing, orally, or both. Implied contract – no express contract but parties’ actions/relationship support avoiding unjust enrichment.

Terminology cont. Valid contract – enforceable in court. Voidable contract – one party can disavow contract under certain circumstances. Void contract – unenforceable in court due to illegal purpose. Executory contract – contract is not yet fully performed. Executed contract – contract has been fully performed.

Terminology cont. Written contract – contract is in writing (recommended). Oral contract – contract made orally (some enforcement problems). Electronic contract – contract made electronically. Offeror/promisor – party who makes offer. Offeree/promisee – party(ies) who are recipient(s) of offer.

Elements of a Contract A contract is often called an agreement, a bargain or a pact. No matter what label is used, the following elements are required Offer Acceptance Consideration

“Reasonable Expectations” and Objective “Reasonable Person” Standard The existence of any element of a contract – or whether a contract exists at all – is often informed by two related things The parties’ “reasonable expectations” shown by plain meaning of the contract language, surrounding circumstances and/or subsequent conduct. Objective standard based on what a “reasonable person” (judge, jury or even you!) would conclude based on the parties’ communications and circumstances.

Contract Interpretation Contract must be interpreted “to give effect to the mutual intention of the parties as it existed at the time of contracting” (Civil Code § 1636). This “mutual intention” is shown by expressed intent evaluated under objective “reasonable person” standard. Plain meaning rule – first rule of contract interpretation; what is the “plain meaning” of the words used in the contract? Assumes words used are “clear and unambiguous” and “does not involve an absurdity” (Civil Code § 1638).

Contract Interpretation cont. Contract can be explained by surrounding circumstances and matter to which it relates – “surrounding circumstances” evidence admissible if relevant to prove meaning of which the contract language is reasonably susceptible. Subsequent conduct – how the parties acted after contract executed but before controversy arose.

Offer Proposal/invitation by offeror to enter into a contract. Objective intent by offeror to be obligated by the offer; what would a “reasonable person” think? Terms of the offer must be reasonably definite; need not be exact. Must be communicated to the offeree (e.g., reward case).

Termination of an Offer After the offer is made, it can be no longer available to be accepted if Rejection by the offeree. Withdrawal/revocation by the offeror. By lapse of a specified or “reasonable” time. Counteroffer by the offeree (see next slide).

Acceptance Must be of the offer’s terms (“mirror image rule” or “mutual assent” – see next slide). An “acceptance” that changes an offer’s terms is an counteroffer, which is A rejection of the original offer, and A new offer in and of itself that can be accepted, rejected or the subject of another counteroffer; in contract negotiations, there are often many counter-offers back and forth before there is acceptance. By an authorized method of communication – usually, any method proper, but the offer itself may require a certain method of communication for acceptance.

Mutual Assent = Offer + Acceptance Shown by offeror’s offer and offeree’s acceptance of the offer. Traditional inquiries are Did the parties agree to the same thing? Was there a “meeting of the minds?” Both are judged by objective standard (again, what would a “reasonable person” think?).

What Can Eliminate Mutual Assent? Fraud – also called misrepresentation or deceit. Mistake – unilateral, which is usually not a defense, or bilateral, which is usually a defense; fact, which can be a defense, or law, which is usually not a defense. Duress – use or threat of physical or economic harm. Undue influence – abuse of authority, power or position. Existence of any of the above can provide basis for or defense to a contract case.

Consideration Each party must give up something of legal value; no consideration if party purports to give up something he or she is already obligated to do (or not do). There is no “reasonableness” requirements, so contract does not have to be “fair” or “equal” in order to have the requisite consideration. Be careful – many times, parties will agree to the same thing (mutual assent) but, with no consideration, there will be no contract that can be enforced in court.

Elements of a Breach of Contract Case Plaintiff must prove all of the following or defendant will win without needing to put on any defense Valid contract between the plaintiff and the defendant. The defendant’s “material” breach of the contract (failure to perform) – “substantial” performance is not Br/K (common abbreviation) – see next slide. The defendant’s breach of the contract causes damage (any financial loss, sometimes called injury) to the plaintiff. Plaintiff’s performance or excuse for nonperformance. But, even if plaintiff proves all of the above, defendant may still have some defenses (see slide re Defenses to Br/K Case).

Material Breach and Substantial Performance Material breach – breach is unimportant or minor. Substantial performance – look at the purpose to be served by the contract, defendant’s excuse for deviation, and only deviation has been technical or unimportant.

Br/K – Remedies Remedies at law and in equity Damages – money (most common). Equitable – non-monetary judgment (though may have great economic value). Election of remedies rule – usually only one remedy available for one Br/K.

Br/K – Damages Most common judgment sought in contract cases Compensatory – mathematical calculation based on value of contract less value of defendant’s performance. Consequential – loss based on consequences of defendant’s breach. Liquidated – exact amount of damages stated in contract.

Br/K – Equitable Remedies Not as common as damages but just as important; can have great economic value even if no “dollar sign” in the judgment being sought Specific performance – plaintiff wants judge to order defendant to perform the contract as agreed; plaintiff must be seeking unique subject matter (e.g., real estate, custom or rare item). Reformation – plaintiff seeks order changing written contract to correct mistake. Rescission and restitution – plaintiff requests judgment which requires both parties return any benefit they may have received.

Defenses to Br/K Case First line of defense – one or more elements missing. Capacity – legal ability to enter into a contract (voidable); e.g., contracting party has mental disability or is under age of 18. Legality – contract must have legal purpose; contract with illegal purpose unenforceable (void). Assignment/delegation – transfer of contract rights/duties to 3 rd party.

Defenses cont. Mitigation of damages – plaintiff’s obligation to take reasonable steps to reduce damages; any mitigation that could or actually did happen will be deducted from total amount of damages. Non-compete clause(restraint of trade) Illegal for employment contracts in California (subject to reasonableness rule in other states), but Legal for sale of “goodwill” as part of sale of business or for departing partner; must be reasonable in scope. See other slides re mutual assent, unconscionability, statute of frauds and parol evidence rule.

Unconscionability Relatively new type of challenge to enforceability of a contract – typical scenario is consumer argues that stronger party (e.g., employer, large retailer, etc.) took advantage of superior bargaining position to impose unreasonable and/or “hidden” terms on weaker consumer. Common challenge to enforceability of arbitration agreements so that will be our emphasis in this area of contract law.

Unconscionability cont. In order for unconscionability defense to succeed, both of the following must be present though not necessarily to same degree Substantive unconscionability – harsh, one-sided nature of contract; e.g., prohibition of or limits on remedies otherwise available in court. Procedural unconscionability – manner on which contract negotiated when there is unequal bargaining power; contract presented on “take-it-or-leave-it” basis or arbitration clause “buried in the fine print” (commonly called “adhesion” contracts).

Statute of Frauds Statute of frauds requires certain contracts to be in writing; examples include Promise to answer for debt of another (co-signing loan or personal guarantee for corporation’s debt). Transfer of any interest in real property. Contract cannot possibly be performed within one year.

Statute of Frauds cont. What is a “writing” for statute of frauds purposes? California Evidence Code § 240 provides a rather broad definition. California Civil Code § 1624(a) requires the “writing” to be “subscribed by the party to be charged” – can an electronic communication meet the “writing” requirement?

Statute of Frauds cont. When oral contract will be enforceable even if writing required by statute of frauds Partial performance. Admission – must occur in court proceedings; e.g., during deposition or trial testimony, or in papers filed with court. Promissory estoppel – detrimental reliance on oral contract; however, any reliance must be reasonable.

Parol Evidence Rule Old common law rule now in C.C.P. § 1856 – writing intended as final expression of parties’ agreement cannot be contradicted by evidence of prior agreement or contemporaneous oral agreement. Policy is to uphold written contract that is intended to be final statement of parties’ agreement. Therefore, written contract should correctly and fully reflect parties’ agreement.

Parol Evidence Rule cont. However, extrinsic evidence (other writings or oral communications) as to contract terms considered such as Course of dealing between the parties. Usage of trade in which parties involved. Validity of contract in dispute. Ambiguity – very broad definition.

Parol Evidence Rule cont. Sample integration clause “All prior or contemporaneous discussions, negotiations, communications and agreements between the parties are superseded by this contract, which constitutes a complete and exclusive expression of the parties’ agreement and may not be contradicted by evidence of any prior or contemporaneous discussions, negotiations, communications and agreements between the parties.”

Discharge of a Contract Discharge – no further performance per the contract required; ways to obtain discharge of a contract By full or “substantial” performance – most common. By subsequent agreement – accord and satisfaction (same parties, new contract; sometimes called “renegotiating a contract”); novation (same contract, new party). By operation of law – e.g., statute of limitations expires, defendant files for bankruptcy.

Other Details re Written Contracts Parties’ contact information for any notices to be given; e.g., default, termination. Effective date – may be different than signing date. Details of parties’ respective promises; examples include Any action by any party; e.g., services to be performed, money to be paid, etc. Deadlines. Payment schedule. Best to have more details than you might think necessary – see prior slides re Parol Evidence Rule.

Other Details cont. “Boilerplate” provisions or other “routine” contract matters – often overlooked but can have substantial impact; these can include Handwritten revisions to a typewritten contract before signing (interlineation) – acceptable but should be initialed. Use of copy acceptable under secondary evidence rule. Attachments or exhibits to contracts. Past waiver of rights does not waive same rights in future.

Other Details cont. More boilerplate Revision of written contract after it is signed – usually by signed writing only, but good to put in contract anyway. Choice of law and venue – traps for the unwary since may result in application of unfamiliar law or requirement that any lawsuit under contract must be filed in faraway place. Arbitration agreement – see next slide. Attorney’s fees clause – see next slide.

Arbitration Clauses In an arbitration clause, parties agree to have their dispute decided in arbitration; they waive their right to have the dispute decided in the court system. Sample arbitration clause “The parties agree that any claim in law or equity relating to this contract shall be decided by binding arbitration pursuant to California Code of Civil Procedure § 1280 et seq. Judgment on the arbitration award may be entered in any court having jurisdiction. By agreeing to binding arbitration, the parties expressly waive their right to a jury trial.”

Attorney’s Fees Clauses Parties to a contract can agree that the winner (prevailing party) can recover attorney’s fees from the loser. This is an exception to the general rule that parties bear their own attorney’s fees. Sample attorney’s fees clause “In any arbitration or other legal action between the parties relating to this contract, the prevailing party shall be entitled to an award of reasonable attorney’s fees.”