Business Law I Elements of A Contract – Legality, Consent, and Writing

1. Business Law I Elements of A Contract – Legality, Consent, and Writing

2. Illegality • A contract is void due to illegality when it: • Requires thecommission of a crime or tort, • Is made illegal by statute, or • Is contrary to public policy

3. Contracts that May Violate a Statute • Wagers • Investments • Insurance • Licensing Statutes • Usury

4. Wagers • A gambling contract is illegal unless it is specifically authorized by state statute. • In some cases, wagers have been disguised as “investments” where the gambler places a bet on the price of stock, but never actually buys the stock. • Someone taking out a policy on the life of another must have an insurable interest in that person -- or else it becomes a “wager” on their life.

5. Licensing Statutes • When a licensing requirement protects the public (i.e., in jobs that require proof of character or skill), any contract made by an unlicensed worker is unenforceable. • When a licensing requirement is designed merely toraise revenue, a contract made by an unlicensed person is generally enforceable.

6. Usury • Usury laws prohibit charging excess interest on loans. • Remedies are forfeiture of excess or all interest, or of interest and principal.

7. Contracts that May Violate Public Policy • Restraint of Trade • Exculpatory Clauses • Bailment Cases • Unconscionable Contracts • Adhesion Contracts

8. Restraint of Trade To be valid, an agreement not to compete must be ancillary to a legitimate bargain. • Sale of a Business • When a noncompete agreement is ancillary to the sale of a business, it is enforceable if reasonable in time, geographic area, and scope of activity. • Employment • A noncompete clause in an employment contract is enforceable when it protects trade secrets, confidential information or customer lists developed over a long period of time.

9. Case AnalysisNoncompetition Agreements King v. Head Start Family Hair Salons, Inc., Supreme Court of Alabama, 2004 • Facts • Issue – Was the noncompetition agreement valid? • Decision – The noncompetition agreement was only partially valid. • Reasoning – The contract is essentially a blanket restriction, entirely barring the defendant from the business. The contract cannot be permitted to impoverish the defendant. The trial court should fashion a more reasonable geographic restriction.

10. LegalitySummary • There is a valid contract unless • The contract requires commission of a crime or tort • The contract is made illegal by statute • Wagering statutes • Usury Statutes • Licensing Statutes for activities where proof of character or skill is required • The contract is contrary to public policy • Represents an unreasonable restraint against competition • Contains exculpatory clauses where a duty to the public is involved • Is an unconscionable or adhesion contract resulting from unequal bargaining power

11. Exculpatory Clauses Part of a contract that attempts to release you from liability for injury to another party • Generally enforceable when: • the affected activity is in the public interest, such as medical care, public transportation, or some essential service. • Generally unenforceable when: • it attempts to exclude an intentional tort or gross negligence. • the parties have generally unequal bargaining power. • it is not clearly written and readily visible.

12. Bailment Cases • Bailment means giving possession and control of personal property to another person. • The person giving up possession is the bailor, and the one accepting possession is the bailee. • Bailees often try to limit their liability for damage to property by using an exculpatory clause. • Judges are slightly more apt to enforce an exculpatory clause in a bailment unless the bailee is involved in an important public service.

13. Unconscionable Contracts An unconscionable contract is one that a court refuses to enforce because of fundamental unfairness. • The two factors that most often lead a court to find unconscionability are: • oppression -- meaning that one party used its superior power to force a contract on the weaker party; and • surprise -- meaning that the weaker party did not fully understand the consequences of its agreement.

14. Adhesion Contracts Adhesion contracts are standard form contracts prepared by one party and given to the other on a “take it or leave it” basis. • They are generally enforced when the two parties are of equal power, but when the parties are unequal, the contract may be ruled unconscionable.

15. Capacity • Capacity is the legal ability to enter into a contract. • Minors (under age 18) and those with mental impairment usually lack capacity. • A voidable contract may be canceled by the party to the contract who lacks capacity. • In some cases, lack of capacity creates a void contract.

16. Minors • Disaffirmance • A minor generally may disaffirm a contract; that is, he or she may notify the other party that he or she refuses to be bound by the agreement. • The minor also has the option of filing a suit to rescind the contract, that is, to have a court formally cancel it. • Restitution • A minor who disaffirms a contract must return the consideration he or she has received, to the extent he is able.

17. Disaffirmance by Minors • Timing • Minors may disaffirm a contract up to a reasonable time after turning 18, unless they ratify the contract after turning 18. • Exception: Contract for Necessaries • A necessary is something essential to the minor’s life and welfare. • On a contract for necessaries, a minor must pay for the value of the benefit received.

18. Necessaries are essential to minor’s continued existence or welfare Minor’s age, station in life, and personal circumstances render an item necessary Necessaries have not been provided by parent or guardian Necessaries Adult must prove contract is for necessaries by showing: A minor may disaffirm but is held liable for reasonable value of necessaries used

19. Contract is for necessaries or Contract is for real estate and minor has not reached majority or Minor is required to return adult to status quo first or Minor has lied about age (in most states) or Minor has ratified contract on reaching maturity Minors’ Right to Disaffirm Minors can disaffirm a contract unless:

20. Mentally Impaired Persons • Definition • A person with mental illness or defect, who is unable to understand the nature and consequences of a transaction. • Generally creates only a voidable contract. • Intoxication • When an intoxicated person makes a contract, it is voidable.

21. CapacitySummary • A contract is voidable due to: • Lack of capacity because of minority. Exceptions (i.e. situations where contracts are not voidable): • Contract is for necessaries. • Contract is ratified on reaching majority. • Minor lied about age (in some states). • Lack of capacity because of mental impairment. Exceptions (i.e. situations where contracts are not voidable): • If adjudicated insane, contract is void. • Contract is for necessaries. • Contract is ratified on regaining capacity.

22. Misrepresentation and Fraud • Innocent misrepresentation • means the owner believes the statement to be true and has a good reason for that belief. • Fraudulent misrepresentation • means the owner knows that the statement is false.

23. Misrepresentation and Fraud • To rescind a contract based on misrepresentation or fraud, a party must show three things: • there was a false statementof fact; • Puffery (exaggerated “sales talk”) is not a statement of fact. • the statement wasfraudulent or material; and • the injured personjustifiably relied on the statement.

24. Defendant: Intentionally misrepresented a fact→ The fact was material Plaintiff: Relied on the fact → Reliance was justified →Plaintiff was harmed by reliance Defendant: Misrepresented a fact→ The fact was material Plaintiff: Relied on the fact → Reliance was justified →Plaintiff was harmed by reliance Misrepresentation and Fraud(cont’d) Misrepresentation: Fraud:

25. Plaintiff’s Remedy for Misrepresentation or Fraud • If the maker’s statement is fraudulent, the injured party generally has a choice ofrescinding the contract or suingfor damages.

26. Special Problem: Silence • Nondisclosure of a fact is misrepresentation only when disclosure is necessary to correct a previous assertion or to correct a basic mistake.

27. Case AnalysisDuty to Disclose Fimbel v. DeClark, Indiana Court of Appeals, 1998 • Facts • Issue – Did the Fimbels have a duty to disclose the septic problems? • Decision - Yes • Reasoning – If a buyer questions the condition or quality of property, a seller is obligated to disclose what he knows. Fimbel’s statement as to why he did not build on the land, and instead built on other land, concealed what he knew about the land, and is therefore misrepresentation, making the Fimbels liable for fraud.

28. Mistake -- Bilateral • A bilateral mistake occurs when both parties negotiate based on the same factual error. • If the parties contract based on an important factual error, the contract is voidable by the injured party. • Conscious Uncertainty • No rescission is allowed where one of the parties knows she is taking a risk.

29. Mistake -- Unilateral • Sometimes only one party enters a contract under a mistaken assumption, a situation called unilateral mistake. • To rescind for unilateral mistake, a party must demonstrate that he or she entered the contract of a basic factual error and that either: • enforcing the contract would be unconscionable; or • the nonmistaken party knew of the error.

30. Plaintiff: Made mistake → Mistake →Promptly notified →Serious injustice nonnegligently was of Defendant when would result or with slight a fact. mistake was if contract is negligence. discovered enforced Defendant: Will not suffer much or Knew or should have known of harm if recission the mistake and instead tried to allowed take advantage of it Unilateral Mistake

31. Duress Duress is the overpowering of the will of a person by force or fear. • Duress can be either: • Physical • Example: “Sign the contract or I’ll break your arm.” • Physical duress voids the contract. • Economic • Example: A subcontractor refuses to deliver parts that the general contractor needs to complete a project for a developer unless the general contractor pays a higher price. • Economic duress makes the contract voidable by the adversely affected party.

32. Defendant: Threatened → Threat was wrongful Plaintiff: Free will was overcome → Entered into a contract that would not otherwise have been entered into Duress

33. Undue Influence • To prove, one must demonstrate: • A relationship between the two parties either of trust or of domination, and • Improper persuasion of the stronger party

34. ConsentSummary • There is no voluntary consent if there is: • Misrepresentation • Misrepresentation of a material fact. • Justifiably relied on to the Plaintiff’s harm. • Fraud • Intentional misrepresentation of a material fact. • Justifiably relied on to the Plaintiff’s harm. • Duress • Wrongful threat. • Plaintiff’s free will was overcome.

35. ConsentSummary • There is no voluntary consent if there is: • Undue Influence • Confidential relationship. • Plaintiff was induced to make an unfavorable agreement. • Mistake • Mutual • Untrue belief by both parties about a material fact. • Either party can rescind. • Unilateral • Mistaken party may be able to rescind if meets certain conditions, or • If other party knew or should have known of the mistake and is trying to take unfair advantage of it.

36. Written ContractsThe Statute of Frauds • Many agreements are unenforceable, unless they, or some memorandum of them, is in writing and signed. • Agreements that must be in writing are those: • For any interest in land; • That cannot be performed within one year; • To pay the debt of another; • Made by an executor of an estate; • Made in consideration of marriage; and • For the sale of goods over $500

37. Agreement for Interest in Land • A contract for interest in land must be in writing to be enforceable. • Exception: Full Performance by the Seller • Exception: Part Performance by the Buyer • the buyer of land may be able to enforce an oral contract if he or she paid part of the price and either entered the land or made improvements to it. • Exception: Promissory Estoppel • If a promisor makes an oral promise that should reasonably cause the promisee to rely on it, and the promisee does rely, the promisee may be able to enforce the promise.

38. Case AnalysisAgreement for Interest in Land Baker v. Daves, Court of Appeals of Arkansas, 2003 • Facts • Issue – Was Lisa obligated to sell the house? • Decision - No • Reasoning – The alleged agreement concerns an interest in real property. In the absence of clear evidence that Lisa orally agreed in court to sell the property, the statute of frauds must control this case. There is no written evidence of a contract, and Lisa is not bound by any allegeged oral agreement.

39. Contracts That Must Be In Writing • Agreements That Cannot Be Performed Within One Year Unenforceable unless in writing. • Promise to Pay Debt of Another (“Collateral Guarantee Contract”) When one person agrees to pay the debt of another as a favor to that debtor, it is called a collateral promise and must be in writing.

40. Case AnalysisAgreements That Cannot Be Performed Within One Year You Be the Judge - Sawyer v. Mills, Kentucky Court of Appeals, 2007 • Facts • Issue – Does the statute of frauds prevent enforcement of Mill’s promise? • Decision – Yes. • Reasoning – If the legislature wanted to encourage secret tape recordings, it could have included an exception to the statute of frauds. However, no such exception exists, and the alleged oral contract is unenforceable. Lower court ruling AFFIRMED

41. Contracts That Must Be In Writing(cont’d) • Promise Made by an Executor of an Estate An executor’s promise to use his or her own funds to pay a debt of the deceased must be in writing to be enforceable. • Promise Made in Consideration of Marriage Unenforceable unless in writing.

42. What the Writing Must Contain • The contract or memorandum must be signed by the Defendant, and • It must state with reasonable certainty: • the name of each party • the subject matter of the agreement, and • all of the essential terms and promises.

43. Sale of GoodsUCC §2-201(1) - The Basic Rule • A contract for sale of goods worth $500 or more is not enforceable unless there is some writing, signed by the defendant, indicating that the parties reached an agreement.

44. Sale of GoodsUCC §2-201(2) - Merchants’ Exception • Within a reasonable time of making an oral contract, if one merchant sends a written confirmation to the other, and the confirmation is definite enough to bind the sender herself, then the merchant who receives the confirmation will also be bound by it unless he objects in writing within 10 days.

45. Electronic Contracts • In this age of Internet commerce, contract rules must be interpreted in light of the technology. • Is an e-mail sufficient to be a writing? • Is an electronic signature sufficient? • The laws regarding electronic contracts are still being refined. • The Uniform Electronic Transaction Act declares that a contract or signature may not be denied simply because it is electronic. • The Electronic Signatures in Global and National Commerce Act applies in states that have not adopted the UETA.

46. Parol Evidence • Parol evidence refers to anything (apart from the written contract itself) that was said, done, or written before the parties signed the agreement or as they signed it.

47. The Parol Evidence Rule • When two parties make an integrated contract, neither one may use parol evidence to contradict, vary, or add to its terms. • Exception: Incomplete or Ambiguous Contracts • If a court determines that a written contract is incomplete or ambiguous, it will permit parol evidence. • Exception: Misrepresentation or Duress • A court will permit parol evidence of misrepresentation or duress.

48. Ambiguity • Ambiguous terms are interpreted in favor of the party who had less reason to know of the ambiguity. • Terms are interpreted against the drafting party since he or she had the power to clarify the terms.

49. Written ContractsSummary • A contract is unenforceable if it lacks a writing as required by the Statute of Frauds. Contracts covered by the Statute of Frauds include those: • For any interest in land; • That cannot be performed within one year; • To pay the debt of another; • Made by an executor of an estate; • Made in consideration of marriage; and • For the sale of goods over $500 • A contract may be unenforceable if promissory estoppel or other exception applies. • A written contract cannot be varied by parol evidence (unless exception applies).

50. Usury Unconscionable Exculpatory Licensing statute Noncompete 1.  A contract clause intended to relieve one party from potential tort liability. 2.  A contract clause designed to prevent, among other things, an employee from working for a competitor. 3.  A contract provision that no one who understood it would sign. 4.  Illegally high interest rates. 5.  A law designed to protect the public from incompetent professionals and trades-people. QuizMatching Questions