Law

Chapter Overview

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5.1 Valid, Voidable, Unenforceable, and Void Agreements

5.2 Capacity • Capacity and Age: Minors • Capacity and Mental Incompetence

5.3 Genuine Assent • Mutual Mistake of Material Fact • Fraud • Duress • Undue Influence

5.4 Unenforceable Contracts and the Statute of Frauds

• A Promise to Pay the Debt of Another • A Promise That by Its Terms Cannot Be Performed

Within One Year of the Date the Contract Is Made • A Promise in Consideration of Marriage • Contracts for the Sale of Goods With a Price of $500

or More • Contracts Creating an Interest in Real Estate • Requirements of the Writing Under the Statute

of Frauds

5.5 Illegality • Contract Interpretation and the Parol Evidence Rule

5.6 Chapter Summary • Focus on Ethics • Case Study: Lamle v. Mattel, Inc. • Case Study: Sherman v. Burton • Critical Thinking Questions • Hypothetical Case Problems • Key Terms

Learning Objectives

After studying this chapter, you will be able to:

1. Distinguish between voidable, unenforce- able, and void agreements.

2. Explain the requirement of capacity and describe why a person might lack it.

3. Describe mutual mistake, duress, undue influence, and fraud.

4. List the types of contracts required to be in writing.

5. Give examples of illegal agreements.

Contracts: Capacity, Genuine Assent, the Statute of Frauds, and Illegality

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CHAPTER 5Section 5.1 Valid, Voidable, Unenforceable, and Void Agreements

After determining that an offer and acceptance are valid, and that there is valid consideration, each party to the contract must have the capacity to enter into a binding contract and must give his or her genuine assent to enter into a binding agreement. To put it another way, the parties must fully understand that they are entering into a contract, and they must willingly enter into a contractual relationship with each other. To use a simple example, if Felipe holds a gun on Heather to persuade her to sell him her car, there may be offer, acceptance, and consideration, but the contract is defec- tive due to lack of mutual assent. Heather was not truly agreeing to sell her car; she just wanted to avoid getting shot.

In this chapter we will examine a number of impediments that might invalidate what oth- erwise appear to be valid contracts. These include lack of capacity, defective assent issues (mutual mistake of material fact, duress, undue influence, fraud), illegality, and having an oral agreement in one of the few situations in which the law requires a writing.

But first, it’s time for some more terminology!

5.1 Valid, Voidable, Unenforceable, and Void Agreements

A valid contract is one that meets all legal requirements. It’s what people generally aim for when they seek to make a contract. Sometimes, though, it’s not what they end up with. A voidable contract results from lack of either capacity or genuine assent. Voidable means that at least one of the parties, and sometimes both, can get out of the contract without being liable for breach, generally because of some circumstance present when the contract was made. Contracts made by minors (people under a statutory age) are voidable at the option of the minor. Contracts made under duress or undue influence, or contracts that involve fraud by one party, are voidable at the option of the victim. However if the victim wishes to go through with the contract, he or she can hold the “bad guy” to the deal. Sup- pose that Heather, in the above example, discovers that Felipe actually contracted to pay more than market value for her old car. If she decides to forgive him for the whole gun thing and hold him to the contract rather than voiding it, she can. Lastly, a contract made when there was a mutual mistake of material fact is voidable at the option of either party.

A contract that is unenforceable is one that was legally required to be in writing and is not. A law called the statute of frauds (which is not the same as the fraud mentioned above) requires that five types of contracts be evidenced by writing.

Lastly, an agreement that is illegal is void, which generally means it will be given no legal effect.

Now that we understand the terminology, let’s begin with a closer look at the voidable contracts, followed by an examination of unenforceable and void agreements.

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CHAPTER 5Section 5.2 Capacity

5.2 Capacity

There are two separate issues that may arise with regard to contractual capacity: age and mental competency. First, let’s look at age. Capacity and Age: Minors Minors are people who have not reached the age of majority, which is set by statute in any given state. The most common age for majority is 18. By law, minors’ contracts are voidable at the option of the minor, because minors have the right of disaffirmance. This means that a person can get out of the contract he or she made while a minor without being liable for breach. Why have such a rule? The theory is that minors, young and inex- perienced, might be lured into making unfair and unnecessary contracts by older, sneaky types. Picture, if you will, a fast-talking, slick salesman persuading a teenager to buy a car on a complicated installment contract she is unlikely to understand!

Of course, the law could have chosen to just let minors void their unfair and unnecessary contracts. The problem with this type of rule is that it would be unpredictable and almost every case would go to trial on the question of fact of whether the contract was unfair. The general rule that minors can disaffirm at least has the advantage of being easy to apply and it gets rid of many conflicts before they go to trial.

Example 5.1. Mary, age 16, buys a used car from Dan for $3,000. She drives the car for six months, crashes it, has the wreck towed back to Dan’s house, and shows up on his doorstep, demand- ing her money back.

Can Mary actually get away with this? Yes, she can. She is a minor and she has disaffirmed. When a minor dis- affirms, she has the duty to return the consideration in whatever shape it’s in. In exchange, in a majority of juris- dictions, the other party must return the minor’s full con- sideration. So Dan must give Mary back her $3,000. The law even allows a person to disaffirm within a contract made while a minor within a reasonable time after attain- ing majority age.

Example 5.2. Michael, age 17, buys a car from Cathy for $2,000. A week later, he turns 18, the age of majority in that state. A few days later, he begins to have transmission trouble, goes to a garage, and is told it will cost $800 to repair the car. Michael decides to disaffirm instead.

If the boy decides he doesn’t like this flavor, can he get his money back? Once an offer is accepted, a contract has been formed, but the contracts of a minor are voidable.

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CHAPTER 5Section 5.2 Capacity

How long is a reasonable time? This is a question of fact that depends on the individual case, but clearly in the example above Michael can disaffirm. It’s been less than two weeks since he made the contract, and a few days since he came of age.

How does a minor disaffirm? By saying anything, or doing anything, that would indicate to a reasonable person that the minor does not intend to go through with the contract.

Example 5.3. Renaldo, a minor, buys a car from the local dealership, on an installment payment plan. He makes the down payment of $1,000 and has made three monthly payments when the car is stolen. Renaldo stops mak- ing payments to the dealer.

Renaldo’s cessation of payments would indicate he does not intend to be bound to the contract, so this is an implied disaffirmance. He does not have a legal duty to return the car, because he does not have it.

What if Renaldo lied to the dealer about his age in order to get the car? The states have a variety of rules dealing with a minor’s misrepresentation. Some still allow disaffirmance, some allow it under some circumstances, and some don’t allow it at all. Also, states differ on whether the minor can be held liable for fraud in such situations.

If a person makes a contract while a minor, comes of age, and ratifies the contract, he or she is now bound. Once you ratify, you lose forever the right to disaffirm. Ratification can be either express or implied.

Example 5.4. Mary the minor buys that car from Dan. Then she turns 18. Now of majority age, Mary tells Dan she considers the contract to be bind- ing. A week later, she changes her mind and wants to disaffirm. Mary can- not disaffirm, because she came of age and expressly ratified the contract.

Example 5.5. Renaldo the minor buys the car from Dealer. He turns 18. He makes a payment on the car. Now the car is stolen, and Renaldo wants to disaffirm. He cannot, because he has already ratified. He must continue to pay for the car.

The right of minors to disaffirm contracts can place a heavy burden on merchants who sell goods to minors on a regular basis. Yet most merchants are quite happy to deal with minors. The reason? It makes good business sense to bear the risk that a minor may disaf- firm a contract, since only a very small percentage of minors ever do so. One way around this potential risk is to have an adult cosign any contract with a minor. If this is done, the adult contracting with a minor has a greater measure of protection, since she may recover the full price of the contract from the cosigner in the event that the minor decides to dis- affirm the contract. It should also be noted here that only the minor has the right to void a contract entered into during minority—the adult who contracts with a minor is fully bound by his contract. (If both parties to the contract are minors, then either may void the contract at her option, but neither has any special rights of enforcement.) Likewise, a cosigner or guarantor of a contract entered into by a minor may not exercise the minor’s right to disaffirm the contract—only the minor may do so.

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CHAPTER 5Section 5.2 Capacity

Emancipated Minors Sometimes a person who is still a minor may be treated legally as an adult. In some states, the minor may petition the court to have the power of disaffirmance legally removed.

Example 5.6. Mary Lou wins the Olympic gold medal for all-around gym- nastics. She is a hot commodity for endorsement contracts, but no one wants to do business with her because she’s a minor. Mary Lou petitions for and is granted emancipation. Now she can make binding contracts, so she signs to promote a soft drink for a fee of $1 million.

In some states, if a minor is independent and self- supporting, the minor is considered to be emancipated and contracts are no longer voidable.

Example 5.7. John, a minor, works full time, is married, and has a baby. John has not spoken with his own parents for more than five years; neither has he received any support from them. In states that view independence as emancipa- tion even without a court procedure, John’s con- tracts are binding.

By statute in every state, there are some types of con- tracts that minors cannot disaffirm for public policy reasons. The typical examples are insurance contracts, contracts with financial institutions (which also issue most credit cards), and contracts made to fulfill a legal duty. For example, regardless of your age, if you are yourself a parent, you have a duty to supply necessi- ties for a minor child. If you own real estate, you have a legal duty to pay the taxes on it. If you make a contract to carry out such a legal duty, it is binding even if you are a minor.

Example 5.8. Mary, age 15, has a baby. One night the baby gets very sick and Mary takes her to the emergency room of the hospital for treatment. Mary then refuses to pay the bill. Mary will be liable, because as a parent she had a duty to pro- vide medical care for her child.

Contracts for Necessities Another exception to the general rules for minors involves necessities purchased by the minor. A necessity can be defined as anything that a minor reasonably needs to live and covers such essential items as food, clothing, shelter, medical care, and credit in most states. Educational expenses are also treated as necessities in some states. While minors can disaffirm these contracts, they can still be held liable for the fair market value of the necessity.

Olympic gymnast Mary Lou Retton sought emancipation in order to take advantage of endorsement contracts. Because she was under the age of majority, companies did not want the risk of a voidable contract. Emancipation meant that Retton could no longer disaffirm her contracts.

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CHAPTER 5Section 5.3 Genuine Assent

Example 5.9. Michael, a minor, comes home from boarding school to find his family home locked up and deserted. None of his friends are around, so he goes to a hotel for a few nights. Michael will be held liable for the rea- sonable value of staying in the hotel, since shelter was a necessity for him and he had to provide it for himself.

What constitutes a necessity depends in part on the facts of each case. If a minor’s parents are willing to provide him with housing, an apartment is not a necessity for the minor, even if he would prefer to have his own place. On the other hand, if the minor is an orphan and must provide his own housing, the apartment would be deemed a reasonable necessity. If a minor needs a job to help support herself and her family, and she cannot reach work without a car, the car is a necessity. But if she could have just as easily walked or ridden her bike to work, the car is not a necessity, and she would not be liable in quasi contract if she disaffirms the contract for the car.

Capacity and Mental Incompetence To have a valid contract, both parties, at the time the contract is made, must have sufficient mental competency to understand the nature and circumstances of the transaction. This does not necessarily mean they would understand every clause of legalese in a long, com- plicated written contract, but does require that they know basically what they are doing.

Example 5.10. Cassandra’s landlord comes to her door to ask if she intends to renew her lease for another year. Cassandra, a paranoid schizophrenic who is not taking her meds, is suffering from complex hallucinations and thinks he is an alien asking her to sign a peace treaty on behalf of Planet Earth. Not wanting to be responsible for a war with aliens, Cassandra signs the new lease. Cassandra lacks capacity and can void the contract when she realizes what she has done.

If Cassandra had already been declared mentally incompetent by a court, her contract would be void rather than voidable.

The relevant time period for capacity is when the contract is made. The law generally pre- sumes both parties to have capacity unless there is something in evidence that puts it in question. Then the burden is on the party who wants the contract to stand to show that the other really did understand what he was doing. People can lack capacity for a variety of reasons: mental illness, senility, even intoxication! (This is one of the few times in your life when being drunk is actually a legal excuse.) But the issue is not whether you are mentally ill, or too drunk to drive; the issue is whether because of your condition, you were unable to understand the contract.

5.3 Genuine Assent

Sometimes it appears that there is an agreement, but when we examine the circum-stances more closely, we can see that one or both parties did not truly have a “meet-ing of the minds.” Such defective assent makes a contract voidable. Let’s take a closer look at the specific grounds for voiding a contract on this basis.

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CHAPTER 5Section 5.3 Genuine Assent

Mutual Mistake of Material Fact If both parties to a contract make a mistake about a material fact (something a reasonable person would consider in choosing to make the contract), either one can void the contract.

Example 5.11. If Jeremy contracts to sell his yacht to Keisha for $1 million, and unknown to either at the time the yacht has already sunk to the bottom of the slip where it was moored, the contract is voidable.

A classic case involving mutual mistake had a seller contracting to sell bales of cotton to a buyer. The contract seemed very specific, calling for the 125 bales of cotton to be shipped from Bombay, India, to Liverpool, England, on a ship called Peerless. How could there be a misunderstanding? It turns out there were two ships called Peerless, both carrying Surat cotton, both sailing from Bombay to Liverpool. One was scheduled to arrive in October, and the other in December. The buyer was thinking of the October ship, and when his cargo isn’t on the Peerless, he sues for breach. But all along the seller had the December ship in mind. The parties never truly agreed on the terms, because of their factual mistake. Thus the contract is voided by the seller, and the buyer is out of luck.

Note that a mistake in value is not a mistake of fact. If you are simply ignorant of the sub- ject matter, you are not making a mistake. If you buy a painting on eBay that is correctly identified as being by Juan Picasso, paying $5,000 for it because you did not know that the famous Picasso’s name is Pablo, you will not be able to void the contract when you dis- cover you can only resell the painting for about $500 instead of the millions you planned on getting. Enjoy your painting!

A unilateral mistake by one party to the contract generally will not void the agreement. If Bret offers to sell milk wholesale to Organic Grocery for $1.44 per gallon when he meant to type in $1.55 and Organic accepts his offer, Bret cannot get out of the contract. There is a possible exception if the other party knew or should have known about the mistake. For example, if Sam offers to sell his deluxe mansion in Beverly Hills for $50,000, it is quite obvious that some zeros were left out, and a court might let Sam avoid the contract.

Fraud In addition to being a tort, fraud is also a way to avoid a contract. Review the elements in Chapter 2! We will add a few details here. For simplicity, since either party could be plain- tiff or defendant in a contract fraud case, we will refer to the person committing the fraud as “Bad Guy” and the person seeking to void the contract as “Victim.”

There are two basic types of contract fraud. The first is fraud in the execution, where Vic- tim is deceived in such a way he does not even realize he’s made a contract. For example, suppose Vic is asked by Bad Guy to sign a guest book, but there is a carbon sheet under- neath that transfers Vic’s signature to a contract to buy BG’s car. The contract will be void- able at Vic’s option: he could still buy the car if he wanted to.

The second type of fraud is fraud in the inducement, where Vic knows he is making a contract but is deceived as to some aspect of the subject matter. The remainder of our examples deal with this type, which is far more common.

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CHAPTER 5Section 5.3 Genuine Assent

Note that while generally silence is not making a false statement and thus not fraud, if Bad Guy owed victim a fiduciary duty (discussed previously), silence might be fraud. Another situation where silence can be fraudulent is when Bad Guy’s original statement, though true at the time, ends up giving Victim a mistaken impression.

Example 5.12. Bad Guy tells Victim, who is considering buying BG’s house, “Accord- ing to the last inspection, there is no sign of termites.” This is true, but before Vic makes an offer, BG discovers termites in the house. Because it was BG’s statement that has given Vic the idea the house is termite free, BG is committing fraud by not giving Vic an update.

Silence can also be fraud if there is active conceal- ment of information; in other words, if Bad Buy is doing something to cover up a material fact.

Example 5.13. Bad Guy’s house has a bad fire. Rather than make real repairs, BG takes the insurance money and makes cos- metic repairs, painting over the smoke dam- age, installing some new sheetrock, but not replacing burnt out support beams. Vic buys the house, and two weeks later falls through the living room ceiling when a beam col- lapses. Vic can void the contract and get his money back, or sue for damages to repair the house properly.

The final situation where silence can be fraud is where the information is unusual, something Victim would not normally check out, and Bad Guy is aware it could be a deal-breaker.

Example 5.14. Bad Guy’s house has no usable water source. The well is contaminated with industrial pollutants, and the house is too far from the center of town to connect with a water main. BG “forgets” to tell Vic this fun fact about the house. When Vic discovers the problem, he will have a good case against BG for fraud.

Keep in mind that predictions and opinions are generally not statements of fact, and there- fore not fraudulent. If another student tells you to sign up for Business Law because it’s dead easy and you later decide it’s actually a really hard class, you cannot sue, because that is an opinion. If your advisor tells you “Business Law is the greatest class in the whole world! A life-changing experience! Fantastic!” this is called puffery, and is not a basis for

In February 2012, Proview Electronics Co. filed a lawsuit against Apple for intentional misrepresentation, fraud by concealment, fraudulent inducement, and unfair compensation. Apple purchased the “iPad” trademark from the Taiwanese company using a United Kingdom–based proxy called “IP Application Development,” which later turned the trademark over to Apple. The lawsuit was thrown out in May of that same year.

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CHAPTER 5Section 5.4 Unenforceable Contracts and the Statute of Frauds

fraud. If your stockbroker tells you, “This one will be a winner,” and the stock you buy tanks, your broker was merely making a prediction, and this is not fraud.

In addition to an intentional misrepresentation of a material fact, made with intent to deceive, remember that Vic must also show he reasonably relied on BG’s statement. In a contract case, to prove the final element of damage, Vic does not have to have an economic loss to avoid the contract. His damage is that the deal he thought he was getting is not the one he wound up with!

Remember, fraud is intentional. Sometimes negligent or innocent misrepresentation may affect the legal status of a contract, but the rules differ from state to state.

Duress Duress occurs when one party (shall we keep calling him Bad Guy?) uses wrongful coercion to get the other (yes, Victim) to make a contract. For example, BG shows Vic a gun/threatens to beat him up/burn his house down/beat up his girlfriend/file criminal charges against Vic, in order to get Vic to pay $10,000 for BG’s car. All of these threats are unlawful coercion and would be duress, allowing Vic to void the contract (once he feels safe!). If BG threatens Vic with a civil lawsuit, that is perfectly lawful and Vic cannot void the bargain. That is an example of what lawyers call “tactics”; in other words, do what I want or I’ll sue you.

Undue Influence The concept of undue influence is difficult to define but easy to recognize, since it almost always is going to involve one of two fact patterns: (1) the parties have a fiduciary rela- tionship, or (2) one party is highly dependent on another due to illness, age, infirmity, etc. In these situations the dominant person is seeking to take advantage of the weaker person. For example, suppose Mabel is an elderly woman who is a shut-in, unable to leave her condo. Her neighbor David gets her groceries, picks up her prescription medications, and does her yard work. Now David suggests that Mabel sell him the condo for 40 percent under market value. He does not have to threaten her; Mabel knows she will be in a des- perate situation if he stops helping her. David has a perfect right to stop helping, but he cannot use Mabel’s dependence on him to get a benefit for himself in this fashion.

5.4 Unenforceable Contracts and the Statute of Frauds

Most oral contracts are valid and enforceable. If Juan offers in a phone conversation to sell Kaylie his scooter for $400 and Kaylie accepts, the contract is binding. Of course, it is usually easier to prove a contract that the parties put into a written form, and it is definitely recommended if the contract involves anything much at stake! Also, the process of drafting a written agreement will often help the parties to think more specifically about the transaction and may minimize the chances of a misunderstanding. Nonetheless, the law typically requires a written document in only five types of contracts, namely those involving:

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CHAPTER 5Section 5.4 Unenforceable Contracts and the Statute of Frauds

1. A promise to pay the debt of another; 2. A promise that by its terms cannot be performed within one year of the date the

contract was made; 3. A promise in consideration of marriage; 4. A promise for sale of goods with a price of $500 or more; and 5. A contract creating an interest in real estate.

The reason for the writing requirement in these situations goes back to the original statute of frauds, passed by the English Parliament in 1677. The law was concerned with fraud on the courts, rather than the tort of fraud such as we examined in Chapter 2. In other words, the authorities were concerned that people were suing for breach of contract and lying in court about having an oral agreement. It seemed as though whoever could bribe the most witnesses would win the case! The English legislature decided that in cases where it was difficult to understand why a person would have promised something (for example, why would you want to pay someone else’s debt?) or where the stakes were high (such as the sale of land), the law should require that the parties put their agreement in writing, or it would be unenforceable.

Note that unenforceable simply means that if one party refuses to go through with the deal, the other cannot sue successfully for breach. In many situations the parties will go ahead and perform the oral contract. Once they have performed, it no longer matters that the contract was oral when it should have been written. These contracts are not voidable.

One tricky thing about the statute of frauds is that with regard to each type of contract, there are exceptions. In other words, there may be situations where even though the con- tract was supposed to be in writing, the oral contract can still be enforced. But the excep- tions are different for the different types of contracts!

In the Media: “MAN SIZED KLEENEX” and Other Interesting Requests in Celebrity Performance Contracts

Just because a contract isn’t covered by the statute of frauds doesn’t mean that it shouldn’t be in writ- ing, particularly when one party to the contract has many performance obligations. Consider a music group’s contract with the venue where it will be performing. Often called a “backstage rider,” this con- tract includes the personal and often idiosyncratic desires of the group for wherever it is to perform. The greatest band in history, The Beatles, had simple tastes. Their backstage accommodations included “four cots, mirrors, an ice cooler, portable TV set and clean towels.” And they asked for two limousines, which meant they shared rides.

But times have changed. For Paul McCartney’s 2002 rider, he demanded a stretch limousine with- out leather seats (due to his vegan lifestyle), and made sure that “There will be no meat, or meat by-products allowed to be served in the dressing room . . . or within the backstage area.” (But his “24 large bars of Ivory Soap” seems an odd demand, since Ivory has animal fats in it.) Meat-loving rocker Ted Nugent’s 2002 rider included that he be provided one box of “MAN SIZED KLEENEX.” Katy Perry’s 45-page rider for her 2011 world tour requires both a dressing room and a “Glam Room.” In the dressing room, Perry’s contract requires the following flower arrangement: “White (continued)

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