Contract Defenses- Module 4 of 5

Contract Defenses- Module 4 of 5


Module 4: Contract Defenses


While we discussed building a binding contract in modules 1-3, we now turn to contract defenses, which make otherwise binding contracts unenforceable due to defect in the agreement, the terms or the bargaining process.


Incapacity

Contractual capacity is required of both parties to a binding agreement.[1] Some people are unable to contract or limited in the types of contracts they can enter due to their inability to understand “the nature and quality of the act to be performed, or its consequences.”[2] By requiring a minimum level of mental capacity, our legal system protects these groups from being taken advantage of through unfair agreements.[3] 

Minors

Minors (under 18 in most states) are limited in their capacities to enter into contracts.[4] Minors may enter enforceable agreements if they have been emancipated (which usually means moving into her own residence, getting married or obtaining a declaration of emancipation from a court).[5] Minors may also enter into enforceable agreements for necessities, like food, shelter, and medical services.[6] This exception allows business to enter into contracts with minors for the provision of these services without fear that the minor could breach at will. 

For example, child actor Derek Cox-Berg initially hired Craig to be his agent. After landing a role on the sitcom, Malcolm in the Middle, he terminated Craig, who sued for breach of contract. The court allowed Berg to disaffirm the agreement, observing that “one who provides a minor with goods and services does so at her own risk.”[7] 

If a minor does enter into an unenforceable agreement, she may disaffirm the agreement at any time before reaching adulthood[8] or for a reasonable time thereafter.[9] However, if she fails to disaffirm in a reasonable time or if she “ratifies” the contract by expressing intent to be bound by it after reaching adulthood,[10] the contract is binding. 

If a minor lies about her age when entering into a contract, in most states, the contract is still unenforceable, as the fact that the minor lied doesn’t make him any more capable of entering into an agreement. Still, the minor may be liable for fraud if the other party sustained damages due to the false representation of age. In some states, if a party relies in good faith on the minor’s misrepresentation and the minor reasonably appears to be the age of majority, she cannot disaffirm the contract.[11]

Mental Incapacitation

Mental incapacity can occur from a variety of causes, including debilitating diseases like schizophrenia or Alzheimer’s disease or temporary intoxication from alcohol or drugs.[12] 

Incapacity is a difficult defense to pull off, as under the “cognitive test,” if the person understands the nature and obligations of the contract, he may enter into a binding contract.[13] A temporarily incapacitated person who enters into an agreement can ratify the agreement after regaining capacity and will be presumed to have ratified the agreement unless he disaffirms within a reasonable time.[14]

In a 2005 case, a homeowner attempted to get out of her mortgage by arguing that she suffered from Alzheimer’s disease at the time she entered into the contract. However, since she was diagnosed only after she had signed the mortgage, the court found that the evidence of her incapacity was insufficient, stating: “without medical evidence relating to the Debtor's condition [at the time of the agreement] ... it would be speculative to find that she was incapable of understanding the transaction.”[15]

In the case of voluntary intoxication, courts are often reluctant to allow voluntarily drunk or drugged people to avoid contracts because of general policy considerations discouraging intoxication.[16] Therefore, a contract entered into by an intoxicated person is generally enforceable unless the other party had reason to know that the intoxicated person could not understand his obligations under the contract.[17] Courts have allowed the contract to be voided where the drunkenness was “such as to have drowned reason, memory, and judgment, and to have impaired the mental faculties to such an extent as to render the party (not sane) for the time being.”[18]


Contracts that are Against the Law or Public Policy 

For a contract to be enforceable, it’s subject matter must be legal, and the parties must be able to legally perform the terms of the agreement.[19] The simplest example of an illegal contract is an agreement to commit a crime.[20] Other common examples include agreements that violate gambling laws, contracts that restrain trade in violation of antitrust laws and those that violate usury laws setting maximum interest rates. 

Public Policy 

Even where the subject matter is not per se illegal, a court may void a contract that violates public policy.[21] Courts have invalidated agreements where the called-for performance may be injurious to the interest of the public or interferes with the public welfare or safety.[22] 

            For example, in a case that reached the Supreme Court of New Jersey, In the Matter of Baby M, Mr. and Mrs. Stern, who were not able to naturally conceive children, entered into a surrogacy contract with a third party, Mrs. Whitehead. This surrogacy contract provided that, in exchange for a fee, Mrs. Whitehead would be artificially inseminated with Mr. Stern’s sperm, deliver a child, and terminate her parental rights to the child, allowing Mrs. Stern to adopt the child. 

After the child’s birth, however, Mrs. Whitehead grew emotionally attached to the child and refused to part with the child. The Supreme Court of New Jersey found that the surrogacy contract was unenforceable because it violated state public policy. The court cited a variety of public policy considerations, including state interest in protecting children from unnecessary separation from their parents, the concept that natural parents have custody rights and the state interest in prohibiting payment in connection with adoptions.[23] 

Non-Compete Agreements 

At common law, covenants not to compete were commonly viewed as restraints on trade and therefore void. Today, while non-compete clauses are regularly upheld, courts continue to invalidate agreements that unfairly limit free trade.  Specifically, courts have modified agreements that contain non-compete clauses in the business and employment context, when they exceed the normal bounds of what is considered reasonable. A promise unreasonably restrains trade if it limits “competition in any business or restricts the promisor in the exercise of a gainful employment.”[24] 

A promise not to compete will not be upheld if:

 

·         “The restraint is greater than necessary to protect the employer’s legitimate interest,” or

·         The “interest is outweighed by the hardship to the employee and the likely injury to the public”[25]

 

For example, in one Arizona case, Valley Medical Specialists sued a former employee, an internist and pulmonologist who specialized in AIDS and HIV treatment, to enforce a three-year non-compete clause in his contract. The non-compete clause covered a five-mile radius from several branches of the defendant’s medical facilities, covering a total of 235 square miles. It also did not allow an exception for emergency medical treatment and it purported to cover the entire practice of medicine. 

The Supreme Court of Arizona invalidated the agreement, holding that the agreement must be strictly construed because it involved a physician’s practice of medicine – something that inherently involves the public and patients’ freedom to choose their own doctors.[26] Furthermore, the court explained that a restraint must be reasonable in scope – including in its duration, subject matter, and geographic area. Here, the restriction was unreasonable because of how much geographical area was covered, that ir did not allow for emergency treatment and that it was overly broad in covered practice areas. 

Exculpatory Provisions

Exculpatory provisions are provisions that purport to limit liability for injuries. Commonly referred to as “hold harmless” clauses, the signer promises to refrain from suing for injuries sustained during activities run by the defendant (usually something dangerous). In a 2009 case, the plaintiff, McGrath, was snowboarding at Crotched Mountain Ski Area when she collided with a snowmobile operated by an employee.[27] McGrath had signed agreements to assume all risk of personal injury and releasing the defendant from any liability for injury resulting from negligence. 

McGrath cited two public safety laws that regulated snowmobiling and argued the contract allowed the defendant to avoid statutory safety rules. The court rejected this argument because the public safety laws were enforceable by the state but not by a citizen. McGrath then argued that the ski resort had entered a special relationship with its customers because it operated a place of public accommodation. The court rejected this argument because a ski resort is not charged with a duty of public service. While the ski provider does serve the public, it is not “of such great importance or necessity to the public that it creates a special relationship.”[28] Finally, the court noted that the agreement was not for an essential service, and so McGrath was under no compulsion to sign the agreement.


Unconscionability

Another example of a contract that will be void on the grounds of public policy is an agreement that is overwhelmingly one-sided. A contract is considered unconscionable when one of the parties lacks meaningful bargaining power in entering a contract which is “unreasonably favorable” to the other contracting party.[29] 

One-sided agreements are frequently seen where contracts contain unreasonable limitations of liability. In a New Jersey case, a young couple contracted for a home inspection with Cambridge Associates. Boilerplate language in the agreement limited Cambridge’s liability to $500 or 50% of the fees paid, whichever was smaller. After moving in, the couple found a major leak that the inspectors should have detected. The Superior Court of New Jersey found that the limitation of liability clause was unenforceable as against public policy because a home inspection should lead to a “reliable evaluation of a home's fitness for purchase” and because these professionals should be held to industry standards.”[30]

In determining whether the contract negotiation process was so unfair as to render the contract unconscionable, courts may rely on a combination of the following factors:

·         Whether the parties used “a standardized agreement executed by parties of unequal bargaining power”;

·         Whether the parties had an “opportunity to read or become familiar with the document before signing it”;

·         Whether there was a “use of fine print in the portion of the contract containing the provision”; and

·         “The relationship of the parties, including factors of assent, unfair surprise, and notice”[31]

Unconscionability also requires that the terms themselves be unfair, which depends on the commercial reasonableness of the transaction. Prices that are too high or too low do not, themselves, render contracts unconscionable. But negotiation processes dominated by the party receiving the benefit of the unfair bargain may lead to a finding of unconscionability.[32] If a court finds a contract is unconscionable, it may void the whole contract, void part of the contract or modify the contract as it relates to the unconscionable provisions.[33]

Click-wrap agreements, which require customers to check boxes indicating assent to the terms and conditions are common on e-commerce websites and are generally upheld if they are sufficiently clear.[34] For example, in a Colorado case, the plaintiffs had signed up for Qwest’s “Price for Life” subscription program, which required customers to sign up for a minimum two-year contract under which they would receive a discounted rate for retaining the company’s services. Customers who cancelled early were charged a $200 cancellation fee.

Customers were told they could locate the terms of the Subscriber Agreement through an automated voice message that directed them to a web page. Customers who enrolled over the internet were required to click a box to confirm they agreed to the terms and conditions, which included an arbitration clause and waived the right to bring a class action lawsuit, which was stated in bold, italicized terms.[35] A welcome letter also informed customers of the arbitration provision and limit on liability. Four customers who were charged cancellation fees sued, claiming the agreement was unconscionable, arguing that the terms were presented in a “convoluted manner” in which the customers had to go online to view the terms of the agreement. 

The court found the customers had the opportunity to read the agreement and there was no use of unfairly small fine print. Also, the customers had “notice of the arbitration agreement, it was reasonably conspicuous, and the customers gave their unambiguous consent.” Thus, the court concluded the agreement was not unconscionable. The court also noted that, while the terms were not entirely consumer-friendly, they were not unfair enough to be considered unconscionable.


Duress and Undue Influence

A contract is voidable if it is entered under duress. According to the Restatement of Contracts, “if a party’s manifestation of assent is induced by an improper threat by the other party that leaves the victim no reasonable alternative, the contract is voidable by the victim.”[36] Duress can be physical or economic. 

In one New York case, Loral Corporation was awarded multiple multi-million-dollar Navy contracts to produce radar sets.[37] It then solicited bids from subcontractors to supply precision gear components required to complete the sets. Austin bid to supply the gear components and was awarded the subcontract for those parts. After a later dispute, Austin threatened to cease delivery under the existing contract unless Loral agreed to a substantial increase in prices. Loral acceded to Austin’s demands. However, the court held that Loral acted under economic duress because Austin withheld goods to force Loral to agree to further demands, and it was clear that Loral was unable to receive the goods from another source of supply within a reasonable time.

Undue Influence    

A contract may also be voidable due to undue influence, which occurs when one party is unfairly persuaded by another person’s domination. When there is a confidential relationship between the parties, which means that one person has “gained the confidence of the other and purports to act or advise with the other’s interests in mind,”[38] or where one party is reliant on the other (as where one party is the other’s doctor, lawyer or primary caretaker), undue influence is more easily inferred. 


Mistake and Misrepresentation

A mistake as to the fundamental nature of an agreement can also be grounds for unenforceability. A mistake can be unilateral, which means made by one party, or mutual mistake, made by both parties. In either case, a mistake is grounds for rescission when “the mistake is so material that . . . it goes to the foundation of the agreement.”[39] A mistake does not affect the validity of a contract if the contract implicitly allocates to one party the risk or responsibility for a mistake. So, for example, if parties agree to exchange a car for $10,000 under the shared assumption that the car runs properly, the fact that the car’s engine is dead might be grounds for rescission. However, if the seller gave the buyer the opportunity to inspect the car and bring in an auto mechanic or the parties formally agreed that the car would be sold “as is,” then the fact that the engine was dead would likely not be grounds to avoid the contract.[40]

Misrepresentation

A misrepresentation is “an assertion that is not in accord with the facts.”[41] A contract is voidable if a misrepresentation goes to a material part of the underlying bargain.[42]  For example, in one Rhode Island case, a couple was inspecting a home they planned to purchase.[43] The homeowner and real estate agent made certain representations to the couple that the home did not have a termite problem.  Before the deed was transferred, the couple had a termite inspection done, which revealed that the house was infested with termites. The court held that even though the misrepresentation may have been innocently made, the statement was relied on by the couple and was a material misrepresentation. Therefore, the court held they could rescind the agreement. 

While the common law rule was caveat emptor (let the buyer beware), the modern rule is that even silence can amount to a misrepresentation, especially in the case of house sales.[44] In one New Jersey case, a home seller failed to disclose that the house had an infestation of roaches. Furthermore, the homeowner showed the purchaser the home with the lights on, possibly because roaches only come out in the dark. One night, the purchaser visited the home and discovered it was infested with roaches and attempted to rescind the contract. The court held that because the homeowner concealed a material fact that in good faith he ought to have disclosed, and because it would create an injustice to force the purchaser to continue through with the purchase, the court allowed the purchaser to rescind the agreement. [45]


Statute of Frauds

            While the general rule is that contracts need not be in writing to be enforceable, the Statute of Frauds, which dates all the way back to 1677 in England, requires certain agreements to be in writing to be enforceable. The “common law” Statute of Frauds, still enforced in all states, requires the following agreements to be in writing:

-       Contracts incapable of being performed within one year of the agreement;

-       Contracts for the transfer of interests in real estate

-       Promises to guarantee the debt of another or of a deceased person

-       Contracts in consideration of marriage (such as prenuptial agreements). [46]

In addition, under the Uniform Commercial Code, contracts for the sale of goods of $500 or more ($5,000 in some states) also must be in writing.[47] Some states add additional categories to those that must be in writing, such as insurance contracts. 

Contracts covered by the statute of frauds that are not in writing and signed by the party against whom it is being enforced are not enforceable unless they are admitted to by the other party. However, performance of the contractual responsibilities by one party (and acceptance or acquiescence of that performance by the other party) also makes the agreement enforceable, as performance and acceptance of the performance is powerful evidence of an agreement.

            In our final module, we will look at performance under a contract and remedies when one party breaches an agreement.

 



[3] See 42 Am. Jur. 2d Infants § 74 (minors); Restatement (Second) of Contracts § 15 (1981) (mentally incapacitated); Restatement (Second) of Contracts § 16 (1981) (intoxicated individuals).

[4] Restatement (Second) of Contracts § 14 (1981).

[5] 42 Am. Jur. 2d Infants §§ 4-8.

[6] Restatement (Second) of Contracts § 12 (1981).

[7] Berg v. Traylor, 148 Cal. App. 4th 809, 812-813 (Cal. Ct. App. 2007).

[8] Restatement (Second) of Contracts § 14 (1981).

[9] 42 Am. Jur. 2d Infants § 76.

[10] 42 Am. Jur. 2d Infants § 104.

[11] 5 Willistonon Contracts § 9:22 (4th ed.).

[12] 5 Willistonon Contracts § 10:3 (4th ed.).

[14] 5 Willistonon Contracts § 10:5 (4th ed.).

[15] In re Lewis-Pride, 330 B.R. 660, 663 (Bankr. N.D. Ill. 2005).

[16] 17A C.J.S. Contracts §§ 179, 180.

[17] Restatement (Second) of Contracts § 16 (1981).

[18] Martin v. Harsh, 83 N.E. 164 (Ill. 1907). See also Luebbert v. Simmons, 98 S.W.3d 72, 78 (Mo. Ct. App. 2003).

[19] 17A Am. Jur. 2d Contracts § 222.

[20] 17A Am. Jur. 2d Contracts § 217.

[21] 17A Am. Jur. 2d Contracts §§ 217, 231.

[24] Restatement (Second) of Contracts § 186.

[26] Lawyers are also given special protection against non-compete agreements under most ethics rules.

[27] McGrath, 158 N.H. at 541-42.

[28] Id. at 544.

[30] Lucierv. Williams, 841 A.2d 907, 912 (N.J. App. Div. 2004).

[33] Kourosh Akhbari, What is an Unconscionable Contract?, LegalMatch, (April 11, 2018) https://www.legalmatch.com/law-library/article/what-is-an-unconscionable-contract.html.

[34] Id. at 1191.

[35] Id. at 1188.

[36] Restatement (Second) of Contracts § 175.

[40] Leacock v. Leacock, 132 A.D.3d 818 (N.Y. App. Div. 2015).

[41] Restatement (Second) of Contracts § 159.

[42] Restatement (Second) of Contracts § 164.

[44] See Restatement (Second) of Contracts §§ 160-161.

[46] Restatement (Second) of Contracts § 110; Unif. Comm. Code §2-201.

[47] UCC § 2-201