Chapter 12 Contract Formation

1. Chapter 12 Contract Formation

2. Chapter Objectives 1. Define the term contract, and discuss the function of contracts in our society. 2. Identify the types of contracts that are subject to Article 2 of the Uniform Commercial Code. 3. Summarize each of the four basic requirements for a valid contract. 4. Explain the contractual rights and obligations of minors. 5. Give some examples of how third parties may acquire rights in contracts.

3. The Function of Contracts • Contract law: • establishes what kinds of promises will be legally binding • supplies procedures for enforcing legally binding promises or agreements

5. Quasi Contracts • Quasi contracts, or contracts implied by the law, are really not contracts at all. The underlying theory is that individuals should not be allowed to be unjustly enriched at the expense of others. • Why is the term “contract” used in situations involving quasi-contractual recovery, in view of the fact that no agreement between the parties exists?

6. Employment Manuals and Implied Contracts • It is common for large companies or other organizations to distribute an employee manual or handbook containing the conditions of employment. Do statements made in an employee handbook constitute “promises” in an implied-in-fact employment contract? • Under the employment-at-will doctrine (Chap. 17), employers may hire and fire employees at will, with or without cause. The at-will doctrine will not apply, however, if the terms of employment are subject to a contract between the employer and the employee. • Why would any person accept employment with a firm without a written contract?

7. Requirements of a Contract The four requirements that constitute what are known as the elements of a contract are: CONSIDERATION AGREEMENT LEGALITY CAPACITY

8. Defenses to Contract Formation or Enforceability A contract that is otherwise valid may be unenforceable if: • the parties have not genuinely assented to the terms • the contract is not in the proper form

9. How Intent to Form a Contract Is Measured in Other Countries • Courts in some nations give more weight to subjective intentions. • U.S.—routinely adhere to the objective theory of contracts. • France—French law civil code prefers the subjective interpretation of contracts. • What problems may arise when a court attempts to look at the subjective basis of a contract?

10. Agreement Requirements of the Offer Termination of the Offer Acceptance

11. Requirements of the Offer Three elements are necessary for an offer to be effective: Intent There must be a serious, objective intention by the offeror to become bound by the offer. Nonoffer situations include: (a) expressions of opinion; (b) statements of intention; (c) preliminary negotiations; and (d) advertisements, catalogues, and circulars. Definiteness The terms of the offer must be sufficiently definite to be ascertainable by the parties or by a court. Communication The offer must be communicated to the offeree.

12. Case 12.1 Lucy v. Zehmer • Lucy and Zehmer had known each other for 15-20 years. Lucy always wanted to buy Zehmer’s farm, but Zehmer never wanted to sell. One night they met at a restaurant, and while consuming alcohol, wrote up an agreement on the purchase of the farm. Lucy then went to court to enforce the agreement, but Zehmer argued he was intoxicated at the time. The trial ruled in favor of the Zehmers. The Supreme Court of Virginia reversed the ruling and the Zehmers were ordered to sell. • How does the court’s decision in this case relate to the objective theory of contracts?

13. Termination of the Offer An offer can be terminated by: Action of the Parties An offer can be revoked or rejected at any time before acceptance without liability. A counteroffer is a rejection of the original offer and the making of a new offer. Operation of Law An offer can terminate by (a) lapse of time, (b) destruction of the specific subject matter of the offer, (c) death or incompetence of the parties, or (d) supervening illegality.

14. Acceptance • An acceptance can be made only by the offeree or the offeree’s agent. • It must be unequivocal. Under the common law (mirror image rule), if new terms or conditions are added to the acceptance, it will be considered a counteroffer.

15. Mailbox Rule • Also called the “deposited acceptance rule,” which the majority of courts uphold. Under this rule, if the authorized mode of communication is the mail, then the acceptance becomes valid when it is dispatched—not when it is received by the offeror. • What happens when offers and acceptances are sent by FedEx or via fax? How should traditional legal principles be applied to transactions over the Internet? • What other types of issues, other than signature problems, might arise when transmitting offers and acceptances via the Internet?

16. Consideration Consideration is broken down into two parts: • something of legally sufficient value must be given in exchange for the promiseand • there must be a bargained-for exchange

17. Sufficiency of Consideration • To be legally sufficient, consideration must involve a legal detriment to the promisee, a legal benefit to the promisor, or both. • One incurs a legal detriment by doing something that one had no prior legal duty to do.

18. Adequacy of Consideration • Adequacy of consideration relates to “how much” consideration is given and whether a fair bargain was reached. • The general rule is that courts will NOT inquire into the adequacy of the consideration. • Courts will inquire into the adequacy of consideration only when fraud, undue influence, duress, a gift, or unconscionability may be involved.

19. Hamer v. Sidway (1891) • Was there a valid contract where the uncle promises his nephew $5000 if he refrains from drinking, smoking, and gambling? • In refusing to pay, the executor of the estate argued that the promise resulted in neither a benefit to the uncle nor a detriment to the nephew (since it was good for him). What did the court rule? • How might one argue that this contract also benefited the promisor (Story, Sr.)?

20. Contracts Lacking Consideration • A number of so-called contracts may lack the necessary consideration to make them legally binding. • These include: • Contracts to perform a Preexisting Duty • Contracts based on Past Consideration • Contracts containing Illusory Promises

21. Promissory Estoppel When a promisor reasonably expects a promise to induce definite and substantial action or forbearance by the promisee, and the promisee does act in reliance on the promise, the promise is binding if injustice can be avoided only by enforcement of the promise.

22. Promissory Estoppel • Promissory estoppel allows a variety of promises to be enforced despite the fact that they lack what is formally regarded as consideration. • Can you name some common examples from the business world? • Can you think of any other contract doctrine under which, to ensure justice, courts will allow a party to recover based on detrimental reliance?

23. Should Social Promises be Enforced under the Doctrine of Promissory Estoppel? • Recently, a college freshmen whose boyfriend broke their prom date sued the boyfriend for the cost of her unused prom dress. A Minnesota state court dismissed the case, suggesting that “[w]hether the defendant has a social or moral duty to help the plaintiff with her prom costs is a question for the likes of Emily Post or Miss Manners, not for courts of this state.” • Contract law reflects society’s decisions on what promises will be enforced and what promises will not.

24. Case 12.2 Goff-Hamel v. Obstetricians & Gynecologists, P.C. • Julie Goff-Hamel worked for Hastings Family Planning for 11 years. In 1993, representatives of Obstetricians & Gynecologists, P.C. asked Goff-Hamel to work for Obstetricians full time. Goff-Hamel agreed and gave notice to Hastings. She was given uniforms and a copy of her work schedule. The day before she was to start her new job, she was told not to report because the wife of one of the owners opposed her hiring. The Nebraska state court ruled in favor of Obstetricians, which was later reversed by the Nebraska Supreme Court. • If you were a judge in the trial court to which this case was remanded, what factors would you consider in determining the amount of damages that should be awarded to Goff-Hamel?

25. Capacity • The third element required for the formation of a contract is contractual capacity, the legal ability to enter into a contractual relationship. • Three types of people who do not have the capacity to enter a contract are: Minors Intoxicated Persons Mentally Incompetent Persons

26. Minors • Contracts with minors are voidable at the option of the minor. • When disaffirming executed contracts, the minor has a duty to return received goods if they are still in the minor’s control or (in some states) to pay their reasonable value.

27. Intoxicated Persons • A contract entered into by an intoxicated person is voidable at the option of the intoxicated person if the person was sufficiently intoxicated to lack mental capacity, even if the intoxication was voluntary. • A contract with an intoxicated person is enforceable if, despite being intoxicated, the person understood the legal consequences of entering into the contract.

28. Mentally Incompetent Persons • A contract made by a person adjudged by a court to be mentally incompetent is void. • A contract made by a mentally incompetent person not adjudged by a court to be mentally incompetent is voidable at the option of the mentally incompetent person.

29. Legality • For a contract to be valid and enforceable, it must be formed for a legal purpose. • A contract to do something that is prohibited by federal or state statutory law is illegal and void from the outset and thus unenforceable. • A contract to commit a tortious act or to commit an action that is contrary to public policy is illegal and unenforceable.

30. Contracts Contrary to Statute USURY Occurs when a lender makes a loan at an interest rate above the lawful maximum. The maximum rate of interest varies from state to state. GAMBLING Gambling contracts that contravene (go against) state statutes are deemed illegal and thus void. LICENSING STATUTES Contracts entered into by persons who do not have a license, when one is required by statute, will not be enforceable unless the underlying purpose of the statute is to raise government revenues. SABBATH LAWS Laws prohibiting the formation or the performance of certain contracts on Sunday. Such laws vary widely from state to state, and many states do not enforce them.

31. Contracts Contrary to Public Policy • Contracts in Restraint of Trade • Contracts to reduce or restrain free competition are illegal. An exception is a covenant not to compete. It is usually enforced by the courts if the terms are ancillary to a contract and are reasonable as to time and area of restraint. • Unconscionable Contracts and Clauses • When a contract or contract clause is so unfair that it is oppressive to one party, it can be deemed unconscionable; as such, it is illegal and cannot be enforced. • Exculpatory Clauses • An exculpatory clause is a clause that releases a party from liability in the event of monetary or physical injury, no matter who is at fault. In certain situations, exculpatory clauses may be contrary to public policy and thus unenforceable.

32. Case 12.3 Brunswick Floors v. Guest • Brian Guest was a floor covering installer for Brunswick Floors, Inc. Guest signed a covenant not to compete that prohibited him for two years after termination of employment from engaging in the floor business in virtually any way, within an eighty-mile radius of the Brunswick location. After quitting Brunswick, Guest went to work as an independent flooring contractor. Brunswick filed a suit against Guest based on the covenant not to compete. The court ruled in part that the covenant unduly restricted Guest’s right to earn a living. The Court of Appeals agreed with the decision. • Should these same limits apply to employers who do business only on the Internet?

33. Third Party Rights There are two important exceptions to the rule of privity of contract: • A party to a contract may transfer the rights arising from the contract to another or to free himself or herself from the duties by having another person perform them. The first of these actions is referred to as an assignment of rights and the second, delegation of duties. • Where a contract involves a third party beneficiary contract.

34. Assignments • An assignment is the transfer of rights under a contract to a third party. The party assigning the rights is the assignor, and the party to whom the rights are assigned is the assignee. • The assignee has a right to demand performance from the other original party to the contract.

35. Assignments Generally, all rights can be assigned, except in the following circumstances: • When assignment is expressly prohibited by statute (for example, worker’s compensation benefits). • When a contract is personal in nature (unless all that remains is a money payment). • Where the assignment will materially increase or alter the risk or duties of the obligor. • If a contract stipulates the right cannot be assigned, then ordinarily it cannot be assigned.

36. Case 12.4 Reynolds and Reynolds Co. v. Hardee • Thomas Hardee worked for Jordan Graphics, Inc., as a sales representative under an employment contract that included a covenant not to compete. Reynolds and Reynolds Co. contracted to buy most of Jordan’s assets. On the day of the sale, Jordan terminated Hardee’s employment. Reynolds offered Hardee a new contract with a more restrictive covenant not to compete. Hardee declined and began selling in competition with Reynolds. Reynolds filed a suit against Hardee to enforce the contract between Hardee and Jordan. The court dismissed Reynolds’ claim. • What interests must a court balance when deciding whether a covenant not to compete is assignable?

37. Delegation • A delegation is the transfer of duties under a contract to a third party (the delgatee), who then assumes the obligation of performing the contractual duties previously held by the one making the delegation (the delegator). • A valid delegation of duties does not relieve the delegator of obligations under the contract. • If the delegatee fails to perform, the delegator is still liable to the obligee.

38. Third Party Beneficiaries • A third party beneficiary contract is one made for the purpose of benefiting a third party. • Third party beneficiaries can be categorized into: • Intended beneficiaries • Incidental beneficiaries

39. Intended beneficiary One for whose benefit a contract is created. When the promisor fails to perform as promised, the third party can sue the promisor directly. Examples of third party beneficiaries are creditor beneficiaries and donee beneficiaries. Incidental beneficiary A third party who indirectly benefits from a contract but for whose benefit the contract was not specifically intended. Incidental beneficiaries have no rights to the benefits received and cannot sue to have the contract enforced. Third Party Beneficiaries

40. For Review 1. What is the difference between a void contract and a voidable contract? 2. What are the four basic elements necessary to the formation of a valid contract? 3. What elements are necessary for an effective offer? What are some examples of nonoffers? 4. What is consideration? What is required for consideration to be legally sufficient? 5. Generally, a minor can disaffirm any contract. What are some exceptions to this rule?