CH-5-7 Business, Societal, and Ethical Contexts of Law – The Legal Environment of Business: A Managerial Approach: Theory to Practice : Book Guide

This Document Contains Chapters 5 to 7 Chapter 5: Business, Societal, and Ethical Contexts of Law OVERVIEW After setting forth the fundamentals for understanding the purposes and function of the legal system in the first four chapters, this chapter focuses on a concurrent set of guideposts for business owners and managers. Coverage begins with definitions of business ethics and an introduction to the concept of primary and secondary stakeholders. The focus then shifts to values management, the benefits of using a decision making paradigm, and the study of two ethical decision-making case studies: Enron and AIG Bonusgate. Finally, the concept of Corporate Social Responsibility is covered using several viewpoints. KEY LEARNING OUTCOMES Outcome Accreditation categories Articulate a working definition of business ethics and differentiate between primary and secondary stakeholders. Ethics, Knowledge Define values management, articulate several reasons why it is important in business operations and list the common traits of an ethical organization. Ethics, Knowledge Employ an ethical decision-making paradigm used by managers for resolving ethical dilemmas and give examples of ethical lapses using historical case studies of businesses facing ethical dilemmas. Ethics, Analysis, Critical thinking. Identify the various views on corporate social responsibility and defend a particular view Ethics, Critical thinking TEACHING OUTLINE A. Business Ethics Defined [P.123] Points to emphasize: • Business ethics is a consciousness of what is right or wrong in the workplace and taking responsibility for an ethical course of action in business operations given its impact on its owners, investors, employees, customers, and the community at large (collectively known as stakeholders). • Primary and Secondary Stakeholders: Primary stakeholders are generally those who will feel a direct impact based on the decision, while secondary stakeholders are those without any direct connection to the business, but may suffer some adverse consequences in an indirect way. • Ethical Culture in Which Managers Operate: Managers are frequently faced with the resolution of dilemmas that have no clear indication of what is right or wrong when dealing with potential conflicts of interest, wrongful use of resources, or mismanagement of assets, contracts, and agreements. • Moral Philosophy and Ethical Decision Making: Morals refer to generally accepted standards of right and wrong in a given society while ethics is the term used to describe having a conscious system in use for deciding moral dilemmas. o Principles-Based Approach: Approach employed by ethical decisions that are made according to a set of established principles or standards as the source of individual decision making, such as religious tenets or codes. • In addition to religious-based principles, some philosophers and ethicists also use a notion that humans have certain inherent moral rights that spring from their ability to reason and choose freely what they do with their lives. • Kant theorized the belief that ethical dilemmas must be resolved through a categorical imperative test whereby individuals make ethical decisions with an eye toward the potential consequences if everyone in society acted the same way. o Consequences-Based Approach: Approach stemming from the utilitarian stream of moral philosophy, stating that the course of action that results in the most benefits for the most individuals is the most ethical. Self-Check: Principles-Based or Consequences-Based Approach [P. 126] Concept Summary: Moral Philosophy and Ethical Decision Making [P. 126] B. Values Management and Challenges to Business Ethics [P.127] Points to emphasize: • Values management is the prioritizing of moral values for the organization and ensuring behaviors are aligned with those values; yet, despite evidence that embracing business ethics promotes profitability and contributes to sound public policy, a resistance to values management programs exists in some business cultures (Table 5.1: Challenges and Realities in Business Ethics [P.127]). C. Strategic Advantages of Values Management [P.127] Points to emphasize: • Managing ethics in the workplace involves identifying and prioritizing values to guide behaviors in the organization, and establishing associated policies and procedures to ensure those behaviors are conducted. • Moral Minimum vs. maximizing profits: Focus on “do no harm” or “do at least harm as possible.” Legal/Ethical Reflection and Discussion [P. 129] Moral minimum and maximizing profit • Values management should have strategic parity with other management priorities as it provides both business and public policy benefits. o Cultivation of Strong Teamwork and Productivity o Clarity in Business Operations o Strong Public Image o Staying the Ethical Course in Turbulent Times Case 5.1 Ypsilanti v. General Motors (1993) [P. 130] Facts: General Motors Corporation (GMC) operated two plants in Ypsilanti Township, Michigan (Ypsilanti). From 1997 until 1988, GMC took advantage of eleven tax abatements (lowering or eliminating taxes owed on real estate) provided for in a Michigan state statute to encourage business owners to create and maintain jobs in the state. As part of the tax abatement application process, GMC would consistently represent that its plants offered local residents nearly 13,000 jobs. Public officials, anxious to retain those jobs, agreed to the tax abatements. In 1991, GMC announced that it was consolidating its operations and that one of the Ypsilanti plants would be closed. More than 4,000 jobs were lost. Issue: Did GMC breach its promise and misrepresent its intentions in order to gain the tax abatement. Ruling: No. No promise was created and no precedent exists that establishes that tax abatement carries a promise of continued employment. Answers to Case Questions: 1. Did GMC breach its promise and misrepresent its intentions in order to gain the tax abatement? Answer: Very little. Short of a formal agreement, GM’s actions could not offer any legally binding promises. 2. Who are the primary and secondary stakeholders affected by GMC’s actions in this case? Answer: Primary: Employees, Stockholders; Secondary: Merchants around the plant, citizens of the township (tax base). 3. How does this case illustrate the difference between legal rights and ethical obligations? Answer: This question is intended to spur discussion on the difference between legal rights and ethical obligations. The case shows that while GMC was legally not bound to maintain employment levels, ethically, there may have been an expectation to honor the spirit of their representations to the community. 4. What does this case reveal about the tension between adhering to moral minimums and pursuing profit maximization? Answer: This question is intended to spur discussion of moral minimum vs. maximizing profits. The case highlights the conflict between meeting legal requirements and the ethical responsibility to consider the broader impact of profit-driven decisions on employees and the local community. D. Common Traits of Effective Ethical Programs in Business [P.131] Points to emphasize: • Typically, ethics programs convey corporate values, often using codes and policies to guide decisions and behavior, and can include extensive training and evaluation depending on the organizational structure. Solutions for Managers: Developing Codes of Ethics and Conduct [P.132] Legal/Ethical Reflection and Discussion: Penn State and Sex Abuse Charges [P. 133] E. Ethical Decision Making: A Manager’s Paradigm [P.134] Points to emphasize: • Ethical dilemmas faced by managers are often complex, with no clear ethical choice, therefore, the use of a paradigm can help managers apply ethical decision making more consistently (Figure 5.2: Ethical Decision Making [P.134]). F. Ethical Decision-Making Case Studies [P.134] Points to emphasize: • Business ethics cannot be studied in a vacuum, underlying principles and theories are only useful if they are understood in a business context. • The Enron Scandal: Enron, once a hundred billion dollar company, collapsed under the weight of ethical lapses by its management team who ignored their company’s own values management policies. o Enron’s Business Model: Enron was involved in energy trading and when Congress deregulated the energy markets, Enron began the practice of acting as a sort of energy bank by purchasing energy at discount rates and selling it to markets with a where the demand was greatest for energy while retaining the difference as profits. • Rise to the Top: Following deregulation, Enron’s business model became highly profitable virtually overnight and Enron used these profits to add on additional business ventures that complemented their energy trading business, including technology companies (providing convenient hiding places to disguise losses incurred by other Enron entities).Enron’s rapid growth made their stock highly attractive and seemingly low risk ---Enron’s executive management’s compensation shot up in to the tens of millions of dollars based on stock options in the company while top-level management and the board of directors received generous bonus compensation packages. • Key Enron Players: Kenneth Lay was the founder and first CEO of Enron who served as the public face for the company; Jeffrey Skilling was Enron’s COO and was the mastermind behind the energy trading business model; Andrew Fastow was Enron’s CFO who oversaw Enron’s transactions; and Rick Causey was Enron’s CAO who deviated from established accounting standards and then pressured auditors to sign off on dubious financial statements. • Vision and Values: Lay defined Enron’s vision and values as “respect, just treating other people the way we want to be treated, we’re sincere, we mean what we say, we say what we do,” and the company’s code of business ethics articulated a philosophy of honesty and transparency. o The Fall: Enron focused its efforts on showing revenue streams and keeping its stock price high and pushing it even higher by keeping Wall Street investors enthusiastic about the company, and downplaying any bad news; however, as the economy began to slow and the technology bubble deflated, Enron’s boils began to show as they kept their operations afloat through the use of credit that was now in short supply. • Financial news media began to scrutinize Enron’s financial transactions, and despite flat denials by the board, investors became increasingly skeptical about Enron’s numbers resulting in a decrease in the stock that snowballed as each entity began to run out of cash to cover expenses. • Increased publicity led to government investigations that discovered fraud in an effort to manipulate the stock; Skilling resigned, and as lenders pressured the company to pay back loans with Enron’s stock in free fall with no end in sight, the company filed for bankruptcy. • Arthur Anderson: Enron’s auditing firm, was one of the world’s leading accounting firms and they not only actively turned a blind eye and gone along with the fraudulent cover up, but lead Auditor David Duncan became more of an Enron advocate within Andersen rather than an auditor, motivated by the massive fees he was collecting. Case 5.2 Arthur Anderson LLP v. United States, 544 U.S. 696 (2005) [P.114] Facts: As Enron Corporation’s financial difficulties became public, Andersen, Enron’s auditor, instructed its employees to destroy documents pursuant to its established document retention policy. Andersen was indicted under a federal statute that makes it a crime to “Knowingly…corruptly persuad[e] another person…with intent to…cause” that person to “withhold” documents from, or “alter” documents for use in, an “official proceeding.” The jury returned a guilty verdict, and the Appellate court affirmed, holding that the district court’s jury instructions properly conveyed the meaning of “corruptly persuades” and that the jury need not find any consciousness of wrongdoing in order to convict. Issue: Were the jury instructions correctly submitted in that the jury need not find any consciousness of wrongdoing in order to convict Andersen? Ruling: No. The Supreme Court reasoned that the instructions allowed the jury to convict Andersen in error without proving that the firm knew it had broken the law or that there had been a link to any official proceedings that prohibited the destruction of documents. o Aftermath: After an intensive investigation, federal prosecutors brought charges of wire fraud, securities fraud, conspiracy, insider trading, falsifying financial reports, and tax returns, and obstruction of justice against Skilling, Fastow, Lay, and a host of other Enron executives. • As a result of the scandal, Congress passed several laws to improve the quality of the financial disclosure by public corporations, including the Sarbanes-Oxley Act that dramatically increased the responsibilities of people in charge of running the finances of public companies. • The government also indicted the entire firm of Arthur Andersen on charges of obstruction of justice stemming from their massive shredding of documents once it suspected that the SEC would investigate Enron; Andersen was sentenced to a $500,000 fine and was banned from performing audits for publically traded companies. Enron Scandal: Questions for Discussion [P.139] • AIG Bonus gate: Legal, Managerial, and Ethical Perspectives: Insurance giant AIG initiated public and political outrage when, amidst the financial crisis of 2008, they distributed $165 million in performance bonuses to some of its executives just months after having received a $173 billion bailout. o Political Reaction: President Obama promised that the government would pursue all “legal means to prevent the bonuses from being paid;” however, the White House subsequently revealed that Treasury Secretary Geitner had knowledge of the bonuses and did not move to stop them from being paid because they were contractual obligations between a private company and an employee. • Congress reacted to the increasing public outrage by holding press conferences, subpoenaing witnesses for hearings, and announcing plans to introduce a law to tax the entire amount of the bonuses retroactively; the attorney general of New York launched an investigation into the bonuses; and Edward Libby, the CEO appointed to the turnaround, called on AIG executives to return a portion of their bonuses. o Mounting Pressures: The bonus recipients argued that they met they met their individual performance goals despite the collapse of AIG and thus were entitled to their bonuses; however, as the attorney general continued to pressure them with the threat of investigation, and Congress threatened to tax 100 percent of the bonus amounts, many recipients returned all or portion of their bonus money totaling nearly $50 million. o Cooler Heads: The rage dampened down, Senate halted the bonus taxation bill in order to maintain the confidence of private investors in the investment community, and though no official action was taken either by Congress or the Obama administration, bonus gate took its toll on AIG. AIG Bonus Gate: Questions for Discussion [p. 140-141] G. Corporate Social Responsibility [P.141] Points to emphasize: • CSR involves a broader-based identification of important business and social issues, and a critique of business organizations and practices with the underlying notion that conscience resides not just in individuals but also in the corporation. • The Narrow View: Invisible Hand: The only responsibility a business has is to maximize shareholder wealth because what is good for business is good for society’s well being, as the market’s efficiencies provide an invisible hand that guides morality and responsibility. • The Moderate View: Government’s Hand: Corporations have the responsibility to pursue objectives that are rational, legal and purely economic, as the regulatory hands of the law and the political process provide the basis for ethical decision making. • The Broad View: Management’s Hand: Corporations have a primary social responsibility and profitability is secondary, therefore, it is not necessary to justify the need for a greater corporate role in social responsibility. o Under the broad view, CSR is in the public’s interest and a company’s self-interest, and a company does well by employing socially responsible principles in their business operations. o An integral part of the broad CSR perspective is the focus on the triple bottom line that emphasizes not only the conventional creation of economic value, but also a company’s creation (or destruction) of environmental and social value. Landmark Case 5.3 Grimshaw v. Ford Motor Company, 119 Cal. App. 3d 757 (1981) [P.143] Facts: During the design of the Ford Pinto, engineers became concerned that the placement of the gas tank was unsafe and subject to puncturing and rupturing at low-impact speeds. Engineers recommended halting production until a solution was developed when crash tests confirmed the dangerous design flaw, but Ford’s management overruled the engineers and pushed the Pinto into the manufacturing phase after determining that the proposed fix would have a higher overall cost than the risk of liability from lawsuits as a result of injuries to its customers. Grimshaw purchased a Pinto and was injured as a result of the design flaw and, after bringing suit, was awarded $3.5 million. Issue: Is Ford liable for manufacturing the Pinto after having knowledge of this serious design flaw? Ruling: Yes. The dangerous design flaw carried with it the severe risk of injury and there was substantial evidence that Ford’s management decided to proceed with the production of the Pinto with knowledge revealing this flaw. Answers to case questions: 1. Which view of CSR do you believe Ford’s managers were aligned to when making this decision? Answer: Ford’s managers were aligned with the Narrow View of CSR. Under this view, the only responsibility a business has is to maximize shareholder wealth. This was in fact what Ford calculated in their analysis of the cost of the proposed fix against the risk of liability from lawsuits as a result of injuries to its customers. 2. Suppose that the changes would cause Ford to expend $1,000 per car rather than $15.80. Would that have changed the outcome of the case? Could it be argued that, given the fact that Ford’s sales plummeted after this lawsuit was filed, Smith’s invisible hand actually worked here? Answer: Even considering a showing that the changes would cause Ford to expend more money per car, it is unlikely that the outcome of the case would be any different. The crux of the matter is that Ford had knowledge of the test results revealing design defects which rendered the fuel tank extremely vulnerable on rear impact at low speeds and endangered the safety and lives of the occupants. One could argue that ultimately Smith’s invisible hand actually worked here, on the basis that because Ford acted unethically, they inevitably suffered. In contrast, Smith’s invisible hand failed because a lack of concern for society’s well being that actually kept the Pinto in production END OF CHAPTER PROBLEMS, QUESTIONS, AND CASES Theory to Practice [P. 144] 1. This question is intended primarily to spur discussion about petty theft (such as office supplies) as an ethical dilemma. Jacob’s dilemma amounts to a “no one will know” rationale. This rationale indicates that Jacob does have a consciousness that his actions are wrong. The fact that no written code exists is irrelevant to consciousness. [Ties to Business Ethics Defined] 2. This question is intended primarily to spur discussion about petty theft as a means to earn extra income as an ethical dilemma. Again, Jacob’s dilemma indicates that he is conscious of wrongdoing: the very definition of business ethics. [Ties to Business Ethics Defined] 3. Under a principles based approach, Jacob’s actions are unethical because if everyone acted in the same way (self-interest and giving away the goods owned by his employer), the result would be chaos. Under a consequences-based approach, Jacob’s actions are unethical because the majority does not realize any benefit. [Ties to Moral Philosophy and Ethical Decision Making] 4. One response to Miguel’s notion that ethics cannot be taught is that altering people’s values are not the primary purpose of values management. Rather, the idea is to manage the conflict among the organizational and personal values. Since management inherently incorporates a value system, communicating and managing those values are an important part of business strategy. [Ties to Strategic Advantages of Values Management]. 5. If Miguel believed in the broad view of CSR, he would refuse to buy the coffee beans from the Asia-based vendor. The vendor’s argument amounts to: if it’s legal, it’s ethical. This stems from the moderate view whereby the only guidelines for CSR are based solely on government regulation. [Ties to Corporate Social Responsibility] Manager’s Challenge [p. 145] Sample answers to all Manager’s Challenge exercises are provided in the student and instructor’s versions of this textbook’s Web site: www.mhhe.com/melvin2e. Case Summary 5.1:Ethics in Debt Collection: Goswami v. American Collections Enterprise, Inc. [P.145] 1. Is the letter misleading? Answer: Yes. ACEI made misleading statements about the settlement authority it held from Capital One in the discount it was authorized to offer. 2. Is it ethical to tell a partial truth as ACEI did here? Answer: In this instance, there is no clear ethical choice on the part of ACEI but because they acted deceitfully, one could reasonable find their partial truth to be unethical behavior. 3. Do private debt collections agencies serve any public policy function? Answer: Yes, debt collection in itself is necessary and ethical conduct includes borrowers repaying the debts that they have accrued. Private debt collection is ethical so long as it is reasonable and truthful. Case Summary 5.2: Professional Ethics: Greenen v. Washington State Board of Accountancy [P.146] 1. Should ethical codes apply to employees outside their scope of employment? Answer: Yes, it is reasonable for professional employees like Greenen, who represent themselves as such, to be held under their respective ethical codes outside their scope of employment because they are held to a higher standard of integrity. 2. If Greenen were accused of a violent crime, would she have been charged by the State Board of Accountancy for an ethical violation? Answer: Yes, Greenen could have been charged by the State Board of Accountancy for an ethical violation because she is held to a higher standard of integrity as a professional. 3. What is the purpose of having mandatory ethical codes for professionals such as CPAs? Answer: Society places even higher expectations on professionals because people need to have confidence in the quality of the complex services provided by professionals and mandatory ethical codes call for their members to maintain a level of integrity that goes beyond the requirements of laws and regulation to accomplish this objective. Case Summary 5.3: Corporate Social Responsibility: Luther v. Countrywide Home Loans Servicing [P.146] 1. Does Countrywide have an ethical obligation to refuse making risky loans to consumers? Answer: While Countrywide may not necessarily have an ethical obligation to refuse making risky loans to consumers, they do have the ethical obligation disclose the terms of the policies and to act in good faith by not deceitfully drawing consumers into subprime loans with the intent to subsequently capitalize on their mis-judgment. 2. Is there an ethical obligation for Countrywide to verify the income of its applicants? Answer: It is reasonable to assume that a home mortgage company has the ethical obligation to verify the income of its applicants. However, one could also contend that this ethical obligation falls on the consumer’s representations when applying for a loan. 3. What ethical duty does an applicant have when applying for a loan? Answer: An applicant has the ethical duty to provide truthful and accurate information when applying for a loan. 4. Could Countrywide’s program to offer mortgages to those that otherwise could not buy a home be construed as being socially responsible? Why or why not? Answer: Though such mortgages provide opportunities for those that cannot purchase a home due to low credit scores, generally, subprime mortgage loans are not socially responsible. There is a reason for credit-scores, and though there are exceptions, the general rule is that lending money to consumers who can’t afford to pay back doesn’t do society any good. Case Summary 5.4: Ethics: In re: Exxon Valdez [P.147] 1. What are the ethics of punitive damages awards? Answer: Punitive damages serve as a deterrent for businesses from acting unethically because of they increase the risk of liability. 2. Is it ethical to try and bankrupt a company using a lawsuit? Answer: Attempting to bankrupt a company using a lawsuit can be seen as unethical behavior as an abuse of the legal system. It may be an ethical consequence of a lawsuit, but filing suit with the sole intention of bankrupting a company is unethical. 3. Should courts be able to reduce punitive damage awards? Answer: Yes, courts should be able to reduce punitive damage awards because without the ability to do so, there would be no ceilings for punitive damages and the excessive results would result in unethical litigation. 4. Is $5 billon excessive against a company as large as Exxon? Answer: Yes, notwithstanding this size of Exxon, $5 billion is not justified by the facts of the case, as compensatory damages were $287 million, which constitutes and excessive 17 to 1 ratio. Case Summary 5.5: CSR: Dodge v. Ford (1919) [p. 147] 1. Should a corporation act solely to maximize shareholders wealth? Answer: No. As we have seen in this chapter, the balance of interests can maximize shareholders wealth and advance societal interests in a broad sense. 2. Were the Dodge brothers primary or secondary stakeholders? Answer: Primary (shareholders). 3. Which moral philosophy approach describes Ford’s action? Answer: Consequences-based Approach 4. Was Ford acting in an ethical manner if his actual reason was to slow down the new Dodge company? Answer: This question is intended to spur a discussion of the ethics of competition. UNIT ONE FLEXERCISE [P. 148] This Flexercise is based on the facts of Ferlito v. Johnson & Johnson, 983 F.2d 1066 (2nd Cir. 1992) Quick Assessment Questions (QAQs) 1. Which of the following is/are considered a business entity’s stakeholders? a. Customers b. Suppliers c. Board of Directors d. Employees e. All the above Answer: e 2. Which view(s) of Corporate Social Responsibility expresses the view that corporation play a significant role in social responsibility? a. The Narrow View: Invisible Hand b. The Hybrid View: Society’s Hand c. The Moderate View: Government’s Hand d. The Broad View: Management’s Hand e. c and d Answer: d 3. Which of the following models of moral philosophy contemplates that an action is ethically sound if it produces positive results for the most people? a. Principles-Based Approach b. Categorical Imperatives c. Invisible Hand d. Utilitarian e. None of the above Answer: d 4. Values management should have strategic parity with other management priorities. Answer: True 5. Ethics is the term referring to generally accepted standards of right and wrong in a given society. Answer: False 6. Altering people’s values isn’t the primary objective of an organizational ethics program. Answer: True Chapter 6: Overview and Language of Contracts OVERVIEW This chapter, the first in the Law and Commerce unit, begins a four chapter sequence focused on the study of contracts. Chapter 6 is a broad overview of contract law including source of law and categories of contract. Chapter 7 covers the requirements for formation while Chapter 8 is devoted to performance and breach issues. Chapter 9 covers sales contracts under Article 2 of the UCC. KEY LEARNING OUTCOMES Outcome Accreditation Categories Distinguish between contracts based on categories, and explain the concept of mutual assent and other elements required for the formation of a valid contract. Knowledge, Application Define and apply the correct source of law. Knowledge, Application Identify and articulate the categories that contracts maybe described under. Knowledge Apply the seven categories of contracts and be able to describe the contract in seven ways. Application, Critical thinking TEACHING OUTLINE A. Definitions and Categories of Contracts [P.157] Teaching tip: Everyday contracts When introducing a topic that is as significant and complex as contracts, the challenge becomes how to introduce the topic in broad based terms with which students can readily connect. Students are fascinated when they find out that contract law is a part of everyday life. This is often a good way to pique interest. I usually put the definition “promises or set of …” on the board and ask students to give me examples of contracts that they enter into on campus. “Have any of you entered into a contract in the last week?” They typically come up with some obvious examples such as simple purchases etc. “Let’s suppose that you promised your roommate that you would do her laundry for her if she agrees to drive you to your internship location on Tuesday and Thursday mornings. Is that a contract? Isn’t it a set of promises? If you perform your end of the bargain by doing your roommates laundry, but she refuses to drive you to your internship, can you sue her? If you forget to do her laundry one week, can she sue you? Are all promises legally enforceable?” Points to emphasize: • A contract is a promise or a set of promises enforceable by law. • Overview of the elements of a contract B. Sources of Law [P.158] Points to emphasize: • In general, contracts for services or real estate are governed by the state common law, and contracts for goods or products are governed by state statutory law based on the UCC. • Contracts involving terms for both goods and services are known as hybrid contracts and in this case, the source of law is established by determining the predominant thrust of the contract subject matter. Legal Implications in Cyberspace: The Uniform Electronic Transactions Act [P.159] • A procedural model law that applies to transactions as long as the parties to a contract agree to use electronic commerce for that transaction. • UETA elevates electronic signatures and records to the same legal status as are accorded to traditional signature and paper records. Concept Summary: Definition and Sources of Law [P. 160] Self-Check: Which sources of law govern this contract? [P. 160] • Categories of Contracts: It is important to note that these categories are not mutually exclusive o Written versus Oral Contracts: Any agreement, oral or written, may result in a binding contract so long as it meets certain requirements o Bilateral Contracts versus Unilateral Contracts: A bilateral contract involves two promises and two performances. • A unilateral contract involves one promise, followed by one performance, which then triggers a second performance from the offeror. o Express Contracts versus Implied Contracts versus Quasi-Contracts: An express contract is created when the parties have expressly agreed on the promises and performances, an implied contract is one in which the agreement is reached by the parties actions rather than their words, and a quasi-contract is enforceable where one party suffers losses as a result of another party’s unjust enrichment. Case 6.1: Chatler v. U.S., 632 F.3d 1324 (Fed. Cir. 2011) [P. 162] Facts: Chattler applied for a U.S. passport and requested an expedited processing procedure outlined in the application materials. The expedited processing option was included as part of the application’s instructions stating that expedited requests would be processed by a government passport agency in three business days in exchange for a fee of $60. Chattler paid the expedited fee and filed her application on June 11, 2007. After three months, the passport had still not arrived and Chattler applied, in person, for a second time. Chattler received her passport in time to fulfill her travel plans and the government did not dispute that her first expedited request was not processed in the three day time period. Issue: Was the expedited process a valid offer which Chattler accepted by paying the $60 fee? Ruling: No express contract was formed by the timing provision in the passport application. The court cited precedent that maintained that obligations created by statute are not contracts in the usual sense due to the lack of a bilateral exchange. Case Questions: 1. Is the precedent that statutory obligations do not truly create contracts sound as the federal government continues to grow and promulgate more and more regulations? Answer: This question is intended to spur debate on why the government’s actions typically do not create express contracts and whether or not that is good as a public policy matter. 2. Had the government substituted more proactive words for the words “will be processed,” could the court have come to a different decision? Answer: Probably not. Most of the court’s focus was on the notion that the transaction was not a bilateral exchange of promises in a contract sense. 3. Chattler could have accepted the government’s offer to drop the suit, write a letter requesting a refund, and be done with the matter. What would have been lost had she withdrawn her suit? Answer: This question is intended to spur debate on the use of lawsuits to resolve disputes versus other means. Had Chattler withdrawn her suit, she would have lost the opportunity to obtain a judicial resolution and enforce any potential claims or damages through the legal process. Additionally, withdrawing could mean forfeiting any legal precedents or clarifications that might benefit future cases. • Valid versus Void Contracts: When a contract has the necessary elements, it is said to a valid contract, while void contracts are those agreements that have not been formed in conformance with the law from the outset of the agreement ad, thus, cannot be enforced by either party. • Voidable versus Unenforceable Contracts: A voidable contract is one in which though a valid contract is formed, one party may at its option, either disaffirm the contract or enforce it; an unenforceable contract, on the other hand, is one that meets the elements required by law for an otherwise binding agreement, but is subject to a legal defense. Case 6.2: Georgia Malone & Company, Inc. v. Ralph Rieder et al., 86 A.D.3d 406 (2011) [P. 163] Facts: Georgia Malone Company (MaloneCo) was a real estate brokerage firm that entered into a Confidentiaty Agreement with CenterRock Realty, LLC (CenterRock) related to CenterRock’s potential purchase of a group of buildings in midtown Manhattan. Rieder was the managing member of CenterRock. The agreement required CenterRock to treat all information provided to it by MaloneCo (e.g., financial projections, property conditions, etc) as confidential and to pay MaloneCo a commission fee in the event that CenterRock purchased the property. After considering the confidential information provided by MaloneCo, CenterRock entered into a contract for the sale of the property. Part of the agreement allowed CenterRock to terminate the transaction during their due diligence (inspection) period. On the last day of the due diligence period, CenterRock terminated the transaction. Ultimately, the property was sold to another party through Rosewood Realty Group (Rosewood), one of MaloneCo.’s competitors, and MaloneCo received no commission. Issue: Is MaloneCo. entitled to damages under a quasi-contract theory of unjust enrichment? Ruling: Yes. The court held that an unjust enrichment claim is intended to prevent one party from unjustly profiting at the expense of another party. In this case, the confidential information provided to CenterRock’s principals was part of a sales transaction that ultimately cheated MaloneCo out of their commission. Case Questions: 1. Was MaloneCo justified in relying on Ralph and Elie’s assurances that CenterRock was continuing to pursue the original contract? Answer: Yes. The parties to the agreement have a good faith obligation to carry out their assurances. 2. The court requires a connection or relationship for quasi-contract claim. How close a connection or relationship must be shown? Answer: A connection related to the same transaction (as in this case) is typically enough for a quasi-contract theory. 3. The court described a quasi-contract as “an obligation imposed by equity to prevent injustice.” Explain how equity applies to quasi-contracts. Answer: Equity applies to quasi-contracts to extent that when one party is unjustly enriched at the expense of another party, that equity allows the injured party to recover losses. Teaching tips: Trouble spot- voidable versus unenforceable The topic of voidable versus unenforceable contracts confounds many students. Because students have not yet learned the circumstances under which a contract may meet the elements for formation but is unenforceable, it is difficult for them to understand these concepts in the abstract. I use two simple examples: age capacity to illustrate “voidable” and statute of frauds to illustrate “unenforceability”. I have also provided a flow chart that uses these simple examples in context. • Figure 6.1: Is a Contract Valid, Void, Voidable, or Unenforceable? [P.165] • Formal (Statutorily required seal) vs. Informal • Executed (contract complete) vs. Executory (obligations still remain). • Entire (each component depends on the other) vs. Divisible (may be broken into individual parts). Case 6.3: Advanced Technology Services, Inc. v. KM Docs, LLC, (N.D. Ga. 2011) [P. 166] Facts: Advanced Technology Services, Inc. (ATS) sells a document software imaging program called OptiDoc. Waldron and Heath were employees at ATS who signed an agreement with three components: a non-competition covenant, a non-solicitation agreement, and a non-disclosure agreement. The agreement also contained a severability clause. Waldron and Heath resigned from ATS and soon launched their own company which sold DocUnity, a direct competitor to OptiDoc. ATS brought a lawsuit against Waldron and Heath and sought to enforce their ATS agreement. Waldron and Heath moved to dismiss the suit arguing that the non-competition agreement was too broad and therefore unenforceable. Issue: If the non-competition covenant was unenforceable, does that render the entire agreement was unenforceable because the contract’s term “Specified Activities” required reference to the other two agreement components? Ruling: The court ruled that although the non-competition covenant was unenforceable, the severability clause is enforceable based on the intent of the parties. The illegality of the non-competition clause did not diminish the value or effectiveness of the remaining agreements. Case Questions: 1. Even if the contract did not contain a specific severability clause, could the court still have found the contract divisible, leaving the remaining legal agreements in place? Answer: Probably. If evidence exists that the parties intended to make the contracts terms divisible (e.g., separate agreements). 2. How could ATS have worded the agreements so that the question of severability would not have been an issue? Answer: “If any court decides that any one part of this agreement is invalid, such a finding shall have no effect on the remaining parts of the agreement.” 3. If the court had determined that the parties’ intent in this contract was that it be entire and not divisible, what would the decision have been? Explain. Answer: The entire contract would have been void. In a contract that is entire, each clause depends on another clause and any clause that is invalid renders the entire agreement invalid. Self-Check: Categories of contracts: 1 [P. 167] Self-Check: Categories of contracts: 2 [P. 167] Concept Summary: Categories and types of contracts [P.167] END OF CHAPTER PROBLEMS, QUESTIONS, AND CASES Theory to Practice [P. 169] 1. The contract with the individual homeowner is fully executed when TractorCo is paid and the customer receives possession of the tractor. The contract regarding the industrial tractors is fully executed when the customer has taken possession of the tractor and the credit line is fully paid. 2. Both the consumer and industrial line contracts are bilateral because promises are exchanged and once the agreement is made, each side may hold the other liable should a breach occur. 3. No. Size and cost do not imply or require formal contracts. Formal contracts occur in specific situations and even a million dollar contract is not such a situation. This contract does however need to be in writing because of the statute of frauds, but no seal is mandated. 4. Both the consumer and industrial line contracts are express. The parties are knowingly and intentionally entering into the agreements. Manager’s Challenge A sample answer to all Manager’s Challenge exercises are provided in the student and instructor versions of this textbook’s Web site. To the Vice-President of Sales, FarmCo’s Sales Manager is proposing a divisible contract with a rescission clause based on sales performance. They are proposing that each delivery of four tractors be considered a separate contract. After the delivery of the second batch, they will have the opportunity to cancel remaining tractor orders should they have six or more tractors in their inventory. The ultimate effect regarding TractorCo is that we will be guaranteed the sale of eight tractors. Any future lots of four will be subject to FarmCo’s sales and inventory. If we consider accepting their proposal, I recommend that dates be specified regarding when their inventory is counted. “At any time during the contract” is not in our best interests. For example, should they sell two tractors from the first batch, immediately upon receiving the second batch they would be at six tractors and be eligible to cancel the contract. If accepting their proposal, we should specify that their inventory be determined at some set time, perhaps three days before the first of the month when a new batch of tractors to be shipped. Certainly you understand that rejecting their proposal would obligate them to accept all 20 tractors for the full $1million cost should they go ahead with the contract. Case Summary 6.1: Unilateral Contract: Chambers v. Travelers Companies [P. 169] 1. Had Chambers performed her job well, the climate survey come back positive, and no irregularities occurred in her expense reports but she was still terminated due to cutbacks, could she have compelled Travelers to pay her the bonus? Answer: Probably not. A unilateral contract requires a definite offer and any language that the bonus was discretionary (rather than fulfilling certain conditions). 2. Was Travelers’ bonus statement in the compensation summary a unilateral offer that could be accepted by performance? Answer: No. the language was not definite enough to constitute a unilateral offer. Case Summary 6.2: Void Contract: Rochon Corp. v. City of Saint Paul [P. 170] 1. The city claimed that it benefited the public by allowing the bid change because it resulted in monetary savings for the city. Does this explanation justify the city’s disregard of established precedent? Can the court of appeals disregard established state precedent? Answer: This question is intended to spur discussion on the topic of whether or not courts should revisit precedent. No, monetary savings alone do not justify disregarding established precedent, as adherence to legal principles is crucial for maintaining consistency. The court of appeals generally cannot disregard established state precedent but may address or clarify it in specific cases. 2. Shaw-Lundquist was able to prove that its original bid was wrong due to a legitimate clerical error. Should this have mattered? Answer: Yes. Where the other party knew or should have known of such a mistake, the bid should be allowed to be amended as a mistake. 3. Why is it good policy to not permit amendments of bids in competitive bidding situations? Answer: Such a rule discourages corruption resulting from bidders changing bids after they have seen competing bids. Case Summary 6.3: Implied Contracts: Forest Park Pictures v. Universal Television Network, Inc. [P. 170] 1. Who wins and why? Answer: Forest Park. They have alleged an enforceable implied contract on the price terms because of an industry standard that sets such a price. 2. What allows Forest Park to argue that this is an implied contract? Answer: California recognizes an implied contract when a party submits and idea (offer) that the other party subsequently uses (acceptance) without compensating the offeror (breach). Case Summary 6.4: Unenforceable Contracts: Morrow v. Hallmark Cards, Inc., [P. 171] 1. Employment agreements for binding arbitration are valid only if agreed to. Should Morrow’s continued employment be considered an agreement to the Hallmark Dispute Resolution Program terms? Answer: The court ruled that neither the promise of access to the DRP, nor Ms. Morrow’s continued employment, gave her enforceable rights against Hallmark which could constitute consideration. Thus, the agreement is unenforceable against her. 2. Should the binding arbitration provision of the Hallmark Dispute Resolution Program be found enforceable or unenforceable? Why or why not? Answer: This question is intended to spur debate on the propriety of ADR clauses in employment contract. The enforceability of the binding arbitration provision in the Hallmark Dispute Resolution Program depends on whether it meets legal standards for fairness and transparency. If it is deemed to lack fairness or was imposed coercively, it could be found unenforceable. Case Summary 6.5: Divisible Contracts: Matrix Realty Group, Inc. v. Food Management Group [P. 171]. 1. Should the U.S. Court of Appeals affirm or reverse the district court’s decision? Answer: The court upheld the lower court’s decision that Matrix repudiated the contract. 2. Was the contract entire or divisible? Explain. Answer: Divisible. As a general rule, a contract is divisible when its terms are susceptible to division or apportionment. Case Summary 6.6: Existence of a Contract: Stevens & Wilkinson of South Carolina, Inc., et al. v. City of Columbia [P. 172]. 1. Is the MOU a contract? Why or why not? Answer: Possibly. The lower court ruled that the MOU is not a contract on summary judgment. However, the appellate court ruled that a jury should determine whether a contract existed because the language and promises in the contract were evidence that the parties had a meeting of the minds. Chapter 7: Contract Formation OVERVIEW This chapter continues a broad overview of contract law with a focus on the requirements for formation. It begins with an overview of a contract transaction, covers the formation elements leading to mutual assent, as well as the other elements of a contract. It also covers enforceability, genuine assent, and the state of frauds. KEY LEARNING OUTCOMES Outcome Accreditation Categories Explain the concept of mutual assent by defining the legal requirement of agreement. Knowledge, Application Identify and explain the other requirements for the formation of a valid contract. Knowledge, Application Identify what contracts must be in writing to be enforceable and explain the minimum required terms that satisfy the law. Knowledge Give examples of circumstances where the legal requirements of capacity or legality are at issue. Application, Critical thinking TEACHING OUTLINE A. Overview of a Contract Transaction [P.167] Points to emphasize: • A contract is formed when two or more parties reach a mutual agreement on terms, and this agreement is recognized as legally binding so long as it meets certain formation requirements. • After the formation requirements are met, the contract is governed by laws that set out requirements for enforceability of the agreement. • Assuming that the contract was properly formed and is legally enforceable, performance then governs parties performing (or not performing) the terms of the agreement and provides compensation if one party fails to perform. • Table 7.1: Overview of a Contract Transaction [P.168] B. Contract Formation [P.168] Points to emphasize: • The formation of a contract requires mutual assent whereby the parties reach an agreement using a combination of offer and acceptance. • Formation of a valid contract also requires that the agreement is supported by consideration, the parties entering into the agreement have capacity, and the subject matter and performance of the contract is legal and consistent with public policy. • In order for the contract to be enforceable, the agreement must also be the product of genuine assent and, in some cases certain terms must be in writing as required by the statute of frauds. Chalk Talk: Mapping out Mutual Assent Students benefit from seeing the entire topic of Mutual Assent mapped out as they progress during the material. I list them on the left side of the board in a checklist format—then explain the details of each element on the right side of the board while using the checklist as a handy review device along the way. E.g., • Mutual Assent Part 1: Offer: An offer is a promise or commitment to do (or refrain from doing) a specified activity in exchange for the offeree’s counter-promise to perform. o In order for an offer to have legal effect, the offeror must have an objective intent to contract when making the offer: Given the language and circumstances of the offer, would a reasonable person in the position of the offeree conclude that the offer was an objective manifestation of serious intent to contract? o Under modern case law, the importance of the parties’ intention, or lack of intention, to form a contract depends largely upon the context of the agreement. Landmark Case 7.1 Lucy v. Zehmer, 84 S.E. 2d 516 (VA 1954) [P.132] Facts: Lucy was a farmer who knew Zehmer for a period of 15-20 years and, during a meeting at a restaurant over drinks, offered to buy Zehmer’s farm. Lucy’s previous offers to buy Zehmer’s farm had been rejected, but during this meeting Lucy persuaded Zehmer to put it writing that he would sell Lucy the farm for $50,000. The parties modified the writing several times and discussed the terms over a period of 30-40 minutes before signing the contract. The next day, Zehmer failed to acknowledge the contract, and claimed that had understood the whole transaction as a joke and that he was as “high as a Georgia Pine” while modifying the contract. Thus Zehmer argued that the contract void because it lacked objective intent to contract. Issue: Is the contract between Lucy and Zehmer enforceable even though Zehmer had no actual intent to sell the farm and may have been joking? Ruling: Yes. The court ruled that actual intent is not required for formation of a contract; rather, the objective standard is used in determining that a reasonable person would have construed Zehmer’s actions and words as a serious intent to contract. Answers to case questions: 1. What factors does the court focus on when deciding whether Lucy’s understanding of the contract formation was reasonable? Answer: The court applies the objective standard in determining that a reasonable person would have construed Zehmer’s actions and words as a serious intent to contract. In this case they examined first that there was the appearance of the contract, that this contract was under discussion for forty minutes or more before it was signed, Lucy’s objection to the first draft, and the discussion of what was to be included in the sale and other terms. 2. What facts could you change in this case that would result in the court determining that no contract existed? Answer: Any actions or words that would lead a reasonable person to believe that no contract existed could have changed the courts determination. Here, if Zehmer expressly indicated that he would not sell Lucy the farm and therefore ended the negotiations after only a few minutes, the objective standard would be much more difficult to satisfy. Similarly, the court might find that no contract existed if Zehmer omitted discussion on any material terms of the contract such as price. o Advertisements as an Offer: Advertisements are generally not considered an offer; rather, they are an invitation for the consumer to make an offer to a seller of goods or services. • Certain advertisements can be considered an offer when the advertisement is specific enough to constitute a unilateral contract. Case 6.1 Leonard v. PepsiCo. Inc., 210 F.3d 88 (2d Cir 2000) [affirming lower court decision and reasoning in 88 F. Supp. 2d 116 (S.D.N.Y. 1999)] [P.134] Note to the instructor: The actual video of the Pepsi commercial involved may be found via a link on this textbook’s website www.mhhe.com/melvin. Facts: Pepsi produced a television advertisement promoting its Pepsi Points program whereby consumers could obtain points by purchasing Pepsi products, or for a certain dollar figure, and then redeem the points for certain apparel and other items found in a catalog. The advertisement featured many of the apparel items and, in an obvious joke, a Harrier Jet for 7,000,000 points. Leonard noticed the catalog did not include the Harrier Jet, so he wrote the item on the order form and sent the order to Pepsi with a check for $700,000, the amount necessary to purchase the requisite points as stated in the advertisement. Pepsi refused to transfer title on the basis that no contract existed. Issue: Was the Pepsi Points advertisement specific enough to constitute a valid offer or a unilateral contract? Ruling: No. While certain advertisements could be an offer if the promise is clear, definite, and explicit, such was not the case here because the advertisement reserves the details of the offer to a separate writing (the catalog). Answers to case questions: 1. What facts would support Leonard’s primary argument as to why this commercial was a unilateral offer to contract? Answer: By definition, a unilateral contract is a contract involving one promise, followed by one performance, which then triggers a second performance from the offeror. Here, the initial promise would be the advertisement whereby Pepsi indicated that one could obtain a Harrier Jet if they could raise 7,000,000 Pepsi Points. This was followed by Leonard’s performance in obtaining the requisite points, which then would trigger the second performance in Pepsi tendering a Harrier Jet to Leonard. In order to support this theory, Leonard had to show that the initial promise was clear, definite, and explicit. Under this notion, facts indicating that the catalog mentions a Harrier Jet, or the commercial itself directed anyone who appeared at Pepsi headquarters with the 7,000,000 Pepsi Points on a certain date would receive the Harrier Jet would support a clear, definite and explicit promise necessary for a unilateral contract. 2. If the language in the catalog order form had allowed a consumer to write in the item (rather than check a box next to the time), would that change the outcome of the case? Answer: Given this hypothetical, it is still unlikely that the outcome of the case would be any different. Though such a finding would help support Leonard’s argument, it still does not make Pepsi’s promise any more clear, definite or explicit. In light of the obvious absurdity of the commercial, an indefinite order form by itself would not be sufficient to change the outcome of the case. • Mutual Assent Part 2: Acceptance: An acceptance is the offeree’s expression of agreement to the terms of the offer, which can be exercised so long as the offer is still in force. o Events of Termination of the Power of Acceptance: Action of the Parties versus Operation of Law: An offer may be terminated by action of the parties in one of three ways: (1) revocation, (2) rejection, and (3) counteroffer; offers may also be terminated by operation of law. • Revocation: Where the offeror revokes (withdraws) the offer by expressly communicating the revocation to the offeree prior to acceptance. • Most states follow the rule that revocation is only effective upon receipt by offeree or the offeree’s agent. • Certain offers are considered irrevocable: • Option Contracts: The offeror agrees to hold an offer open for a certain period of time in exchange for consideration. • Partial Performance and Detrimental Reliance: An offer can be temporarily irrevocable if the offeree, prior to actual formation of the contract, takes some action that relies on the offer (partial performance), or if the offeree makes preparations prior to acceptance based on a reasonable reliance on the offer (detrimental reliance). • Rejection and Counteroffer: An offer is terminated once the offeree has either rejected the offer outright or makes a counteroffer by rejecting the original offer and making a new offer. • The mirror image rule requires that any acceptance by the offeree must be the mirror image of the original offer, any deviation from the original offer results in a rejection and counteroffer. o Operation of Law: An offer may also be terminated by certain happenings or events including lapse of time, death or incapacity, and destruction of the subject matter. • Lapse of Time: Offers expire by operation of law after a time limit as attached by the offeror or after a reasonable time given the circumstances. • Death, Incapacity, or Destruction: In the event that the offeror or the offeree either dies or becomes incapacitated, or the subject matter of the contract is destroyed before acceptance, the offer is considered terminated by operation of law. • Self-Check: Mailbox Rule: For each transaction, does a contract exist? If yes, and what is the date of the contract. If no, why not? [P.176] o When Acceptance Is Effective: The Mailbox Rule: The acceptance of an offer is generally effective upon dispatch using a commercially reasonable manner (Figure 7.1: When Is Acceptance Effective? [P.177] Concept Summary: Agreement [P.178] • Insufficient Agreement: In some cases the parties may actually have satisfied the elements of offer and acceptance, but the agreement still lacks mutual assent and is therefore insufficient to constitute a properly formed contract. o Indefinite Terms: For an offer to be valid, the parties must reach mutual assent on all of the essential terms of the agreement (parties, subject matter, time, and consideration). • Even though an agreement does not contain all the required terms, courts have held that the court may supply missing terms when the term may be implied as “reasonable” or by the course of past dealing. • Agreements to Agree: In cases where parties leave essential terms unfilled, intending to agree upon the term in the future, so long as the court determines that the parties themselves intended to make a binding contract, the agreement is enforceable and a court may supply the missing term. Landmark Case 7.3 Raffles v. Wichelhaus, 159 Eng. Rep. 375 (1864) [P.140] Facts: Wichelhaus contracted to purchase a shipment of cotton from Raffles, with the contract requiring the goods to arrive in England aboard the Peerless, a freighter ship from Bombay. Wichelhaus had intended for the contract to require the goods to be shipped on the Peerless from Bombay in October, while Raffles believed the shipment was to be on a different freighter (also called Peerless) that left from Bombay in December. When the goods arrived in December, Wichelhaus refused to accept them contending that he had already purchased the cotton from the Peerless ship that arrived in October. Issue: Was a valid contract formed even though the parties both had believed the ship Peerless to mean two different ships? Ruling: No. The court found this misunderstanding to be a mutual mistake resulting in a lack of mutual assent because the parties attached materially different meanings to an essential term of the contract. Therefore, there was no binding contract and the parties are discharged from any obligations. Answers to case questions: 1. If there were some evidence that one party was unreasonable in their understanding of what Peerless meant, would that affect the mistake analysis? Answer: Yes, if one party had reason to know of the mistake or his actions caused the mistake, a court will allow the mistaken party to avoid the contract under a unilateral mistake analysis. The original facts of the case employ the mutual mistake doctrine because both parties held an erroneous belief. If one party were unreasonable in their understanding of what Peerless meant, then it would now be classified as a unilateral mistake. 2. What made this mistake one that qualifies as an essential term that required “consensus”? Answer: The mistake qualifies as an essential term because it concerned a basic assumption on which the contract was made—shipment of goods at a specified time aboard a specified ship. Time for performance or delivery is categorized as an essential term of the agreement. o Mistake: The law recognizes certain mistakes and provides a remedy intended to make the parties whole again. • A mistake is defined in contract law as an erroneous belief that is not in accord with the existing facts. • A mutual mistake may be the basis for canceling a contract when both parties hold an erroneous belief concerning a basic assumption on which a contract was made. • Generally, courts will not consider market conditions or financial ability as a mistake that allows a contract to be avoided. • A unilateral mistake is when only one party had an erroneous belief about a basic assumption in the terms of the agreement and, generally, it is not a valid reason to avoid a contract unless the nonmistaken party had reason to know of the mistake or his action caused the mistake. • Consideration: For a binding contract to exist the agreement must be supported by consideration, which includes a suffering a legal detriment and a bargained for exchange. o Legal Detriment: Satisfied if the party promises to perform something that the party is not legally obligated to do or refrains from doing something that party had a right to do. FIGURE 7.2: Exchange of Consideration in a Contract o Preexisting Duty Rule: If a party does or promises to do what she is already legally obligated to do, the law generally does not recognize this as a legal detriment. • There are certain exceptions to the preexisting duty rule such as when the promising party assumes additional duties, or where either party did not reasonably anticipate certain circumstances when the original contract was formed. o Bargained for Exchange: A performance or return promise is “bargained for” only if it was exchanged for another promise. o Past Consideration: When a promise is made in return for a detriment previously made by the promisee there is no consideration. o Amount and Type of Consideration: Ordinarily, courts will not look to the amount or type of consideration, or the relative bargaining power of the parties in deciding the validity of consideration. • Most courts have held that nominal consideration is sufficient in meeting the consideration requirement so long as the amount is truly nominal. o Promissory Estoppel: Theory allowing for the recovery of damages by the relying party, even though the original promise lacked consideration, if the promisee actually relied on the promise and the promisee’s reliance was reasonably foreseeable to the promisor. • Capacity: Courts will only enforce contracts where each party had the legal capacity to enter into a contract. o Minors: Until a person reaches her majority age (18), any contract that she may enter into is voidable at the minor’s option. • A contract made by a minor is not automatically void; rather, the minor either avoids the contract or may enforce the contract. • There is an exception to the minor capacity rule for necessities. o Mental Incompetents: This category includes both the obvious cases and temporary incompetence. • In general, a person lacks capacity because of mental incompetents if either (1) she is unable to understand the nature and consequences of the contract, or (2) she is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of her condition. • In most states contracts made by an incompetent are voidable, and can be ratified if the incompetent party regains her mental capacity or has a guardian appointed. Legal/Ethical Reflection and Discussion: Gifts versus Contracts [P. 185] • Legality: In order for a contract to be enforceable, both the subject matter and performance of the contract must be legal; illegal contracts are void automatically. • Concept Summary: Contract Formation [P.187] Solutions For Managers: Enforcing Contracts with Covenants not to Compete [P.188-189] C. Enforceability [P.189] Points to emphasize: • Even if the elements of a contract are met, the contract must still be: (1) the product of genuine assent and (2) in writing under certain circumstances to be enforceable. • Genuine Assent: The law requires the parties have given genuine assent on the terms of the contract (absent any misrepresentation, duress, undue influence, or unconscionability). o Misrepresentation: A defense whereby a contract can be avoided when one party to an agreement makes a promise or representation about a material fact that is not true, and the other party justifiably relied on the misstatement. o Fraudulent Misrepresentation: The elements of misrepresentation plus the element of actual knowledge of the misrepresented fact is considered fraudulent misrepresentation, and the innocent party may be entitled to additional recovery. Case 7.4: Italian Cowboy Partners v. Prudential, 341 SW 3d 323 (Tex. Sup. Ct. 2011) [P. 191] Facts: Jane and Francesco Secchi negotiated a lease for space for purposes of opening Italian Cowboy restaurant. The negotiations took place through the property manager, Powell, who gave the Secchis various assurances that the leased space was practically new, was in perfect condition, and had no defects. Based on these representations, Secchi entered into a lease agreement with Prudential (the landlord) for the space and commenced renovations. During this initial period, the Secchi’s learned that the previous tenant in the space had complained to Powell about a noxious odor that made the space unfit for use. Powell denied that the previous tenant had complained and gave further assurances to the Secchi’s that there had never been a problem with the property. Eventually, the Secchis terminated the lease and sued their landlord and property manager for fraudulent misrepresentation. Issue: Were Powell’s representations puffery or material misrepresentation? Ruling: Powell’s statements were material misrepresentations. The court ruled that the representations were known to be false when made and are thus actionable. Answers to Case Questions: 1. Why did the court determine that the statements made by Powell were material? Answer: Primarily because Powell herself experienced the odor and still represented that it had not existed. This indicated an intention to hide the truth and is thus actionable. 2. Should the Secchis have contacted the prior tenant to verify Powell’s statements? Answer: Perhaps it would have been a good business decision. Still, contracts are not “buyer beware.” They involve warranties and good faith. 3. If the Secchis had contacted the prior tenant and found out that a prior problem existed, would that have affected the outcome of this case? Why or why not? Answer: It would be more difficult for the Secchis to recover for fraud because one element of a fraudulent misrepresentation is that the innocent party justifiably relied on the misstatement when forming an agreement. 4. Since the court found that fraud existed, what remedies and damages are the Secchis entitled to? Answer: Contract is void; May collect out of pocket and more speculative damages related to the fraud; Potentially eligible for punitive damages. • Concealment of Material Fact: While parties do not have a general duty to disclose all information to each other, courts have allowed the use of misrepresentation in cases where a party has asserted a half-truth that led to an overall misrepresentation, where on party takes affirmative action to conceal truth from the other, and when one party fails to correct a past statement that the other party subsequently discovers untrue. SELF-CHECK: Fraud and Misrepresentation [P. 192] o Duress: Defense whereby a contract can be avoided when one party uses any form of unfair coercion to induce another party to enter into or modify a contract. o Undue Influence: Defense that gives legal relief to a party that was induced to enter into a contract through the improper pressure of a trusted relationship. o Unconscionability: Narrowly applied defense whereby a contract can be potentially be avoided on the grounds that one party suffered a grossly unfair burden that shocks the objective conscience. • Statute of Frauds: The law governing which contracts must be in writing in order to be enforceable. o For common law contracts, the statute of frauds applies to (1) contracts involving the sale of land; (2) contracts that cannot be performed in under one year; (3) contracts to pay the debt of another; and (4) contracts made in consideration of marriage; o Under the UCC, the statute of frauds applies to any contract for the sale of goods for $500 or more, and any lease transaction for goods amounting to $1,000 or more. Self-Check: Which of the following contracts would need to be in writing to be enforceable? [P.194] o E-mail and the Statute of Frauds Case 7.5 Stevens v. Publicis, S.A., 2008 NY Slip Op. 02880 (N.Y. App. Div. 2008) [P.195] Facts: In a transaction to sell Steven’s public relations firm to Publicis, the parties entered an employment agreement whereby Stevens would be employed by Publicis as the CEO of the newly formed subsidiary, with the requirement that any modifications to the agreement had to be in writing and signed by both parties. Later, Publicis removed Stevens as CEO. An executive from Publicis and Stevens had subsequent e-mail exchanges regarding Stevens’ new role. The e-mail exchanges contained unambiguous terms of acceptance by Stevens and each e-mail transmission bore the typed name of the sender. Eventually, Stevens and Publicis had a breach of contract dispute and Stevens asserted the statute of frauds as an affirmative defense. Issue: Do the e-mails from Stevens constitute “signed writings” within the meaning of the statute of frauds? Ruling: Yes. The series of e-mails amounted to signed writings that could be used to modify the employment agreement since Stevens name at the end of his e-mail signified his intent to authenticate the contents and met the statute of frauds requirement. Answers to case questions: 1. If the parties did not wish to allow e-mail to serve as an appropriate method to modify the contract, what working could have been used in Steven’s employment agreement? Answer: If the parties had expressly stated in the employment agreement that any modification to the agreement had to be signed by paper record or under seal by both parties, that would have narrowed the scope of the traditional statute of frauds analysis. 2. Could the principle that the court articulates apply in a negotiation via e-mail for the sale of goods? That is, if two parties are negotiating a price via e-mail and there is language of agreement by the parties, does that alone satisfy the statute of frauds even if no actual written contract with the parties’ signatures exists? Answer: The principle that the court articulates could apply in a negotiation via e-mail for the sale of goods. Because e-mail transmissions in the context of satisfying the statute of frauds is a relatively recent problem, courts would look to principles like the one articulated here for guidance. Additionally, if the parties agreed to use electronic commerce for this transaction, courts may look to the UETA as a procedural law. o Interpretation Rules for Written Contracts: The parole evidence rule provides that any writing intended by the parties to be the final expression of their agreement may not be contradicted by any oral or written agreements made prior to the writing. • When contracts contain ambiguous terms, these terms are construed by the court against the interest of the side that drafted the agreement and courts may supply a reasonable term in a situation where the contract is silent and has omitted terms. END OF CHAPTER PROBLEMS, QUESTIONS AND CASES Theory to Practice [P. 198] 1. There are two contracts in this question. The first is the BTT-Chou contract for exclusive negotiation rights for a 90-day period. This is an example of an option contract. BTT has purchased the rights to negotiate a distribution agreement for Chou’s invention. If at the end of the period the parties do not agree on terms for a distribution contract, Chou is free enter into a contract with another company and to keep the $25,000 consideration. The second contract is the BTT-Chou distribution agreement. Although the parties did not use the word contract, the e-mail exchanges between the parties and the definiteness and specificity of the terms would typically satisfy the requirement that objective intent of the parties was to enter into a distribution agreement. The original agreement required that any subsequent distribution agreement be in writing. This was satisfied by the exchange of e-mail. [Ties to Agreement Part 1: Offer] 2. Facts that favor Chou: a) the parties had reached an oral agreement, b) the BTT manager repeated the key terms and these terms were definite and certain. Against Chou: BTT’s request, both before and after the e-mails, for a draft contract may indicate that the parties had an intent to continue negotiations rather than form a contract. [Ties to Agreement Part 1: Offer] 3. Based on the Stevens v. Publicis case (p. 152), e-mail constitutes a “writing” so long as the parties authenticated their e-mails with electronic signature lines. Thus, it would not impact the formation or enforceability of the agreement. [Ties to E-mail and the Statute of Frauds] 4. This is a contract for services and thus is only subject to the statute of frauds if the services cannot be performed in under one year. [Ties to the Statute of Frauds] 5. The doctrine of mistake may only be used to avoid the contract where there was a bilateral mistake of a material fact. A unilateral mistake of fact cannot be the basis for avoiding a contract unless the mistake was some obvious clerical error. [Ties to Insufficient Agreement – Mistake] 6. The bargained for exchange in the second BTT-Chou agreement is BTT’s payment for the right to distribute Chou’s product. Both parties suffered a legal detriment. [Ties to Consideration]. Manager’s Challenge A sample answer to all Manager’s Challenge exercises are provided in the student and instructor versions of this textbook’s Web site. Case Summary 7.1: Mutual Assent/Acceptance: Arizona Cartridge Remanufacturers Association v. Lexmark [P.198] 1. Can one party be deemed to accept an offer simply by opening a product box even if there is no evidence that the party actually read the terms? Answer: Yes. The consumers had notice of the restrictions on use and had a chance to reject the condition before opening the clearly marked cartridge container. Case Summary 7.2: Legality: Biomedical Systems Corp. v. GE Marquette Medical Systems, Inc. [P.199] 1. Can a party make a unilateral judgment as to illegality on a term of the contract when there is no affirmative finding from a regulatory authority? Answer: No. The contract unambiguously required GE to obtain clearance from the FDA and did not require Biomedical to violate federal law. 2. If GE had gone ahead with the clearance process and the FDA had told them it was not the proper procedure, would the contract be void for illegality? Answer: No. Even though proceeding with the clearance process may not have been the proper procedure, neither the subject matter nor the performance of the contract is illegal. Case Summary 7.3: Mistake: Reed’s Photo Mart, Inc. v. Monarch [P.199] 1. Who prevails and why? Answer: Reed prevails and would likely be able to avoid the contract because this is a clear case of a clerical mistake and Monarch had reason to know of the mistake. 2. Is this a unilateral or mutual mistake? What’s the difference? Answer: This is a unilateral mistake because only Reed had an erroneous belief about the number of labels he ordered. A mutual mistake on the other hand is when both parties hold an erroneous belief concerning a basic assumption on which the contract was made. Case Summary 7.4: Statute of Frauds: MediaNewsGroup v. McCarthey 1. Is the oral agreement enforceable? Why or why not? Answer: No, even if the agreement were to survive as a collateral oral agreement, that statute of frauds would act as an independent bar to its enforcement because it was never signed by the party being charged. 2. Could the parole evidence rule apply here? Answer: Yes. The parole evidence rule would bar the collateral oral agreement because the oral contract claims were superseded by written contracts to substantially the same effect. Case Summary 7.5: Fraud: Harley Davidson Motor Co., v. PowerSports [P.200] 1. Why were PowerSports misrepresentations “material”? Answer: PowerSports misrepresentations were material because evidence showed that Harley would only grant the license to a privately owned company that had no intention of becoming a company with stock that was traded publicly. In other words, without concealing or misrepresenting their desire to become a publicly held company, PowerSports would have never been granted the franchise license because the value of the contract to Harley would be substantially changed. 2. Suppose PowerSports went public two years after the awarding of the franchise agreement. Could Harley still sue for recession? How about 10 years? Answer: Harley could still sue for recession in both instances because it cases of fraudulent misrepresentation, the time limit runs until when the misrepresentation ought to have been discovered. However, if Harley discovered the misrepresentations before PowerSports went public and failed to take steps to avoid the contract, then they may not be able to rescind the franchise agreement. Case Summary 7.6: Unenforceability: Tafel v. Lion Antique [P. 200] 1. What defense can Tafel assert that would make the note unenforceable? Answer: The recited consideration in the note was past consideration and cannot support the contract. 2. What must the note contain to make the note enforceable? Give an example. Answer: There must be evidence of a bargained-for-exchange. There has be a direct burden on each party and a direct benefit for each party under the note. Quick Assessment Questions (QAQs) 1. According to the Court in Lucy v. Zehmer which of the following is true? a. Courts use the subjective standard in determining the intent of the offeror to contract. b. Offers made in jest cannot constitute a binding contract. c. Actual mental intent is not required for formation of a contract. d. A unilateral mistake is a valid reason to avoid a contract e. None of the above Answer: c 2. Which event(s) terminates the power of acceptance? a. Revocation b. Rejection c. Counter offer d. Operation of law e. All of the above Answer: e 3. Which element of contract formation requires legal detriment to the promisee and a bargained for exchange on the part of the promisor? a. Agreement b. Mutual Assent c. Consideration d. Capacity e. Legality Answer: c 4. A valid offer creates the power of acceptance for the offeree. Answer: True 5. To enforce a contract it must always be in writing. Answer: False 6. Advertisements are generally not considered an offer. Answer: True Solution Manual for The Legal Environment of Business: A Managerial Approach: Theory to Practice Sean P. Melvin, Michael A. Katz 9780078023804