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Suggested Additional Assignments
Drafting Exercise: Distinguishing Puery and Misrepresentation
Students should write one page of dialogue or prose describing a sales pitch made to a consumer. The
seller should tread the fine line between puffery and misrepresentation, and the student should be able to
declare whether the conduct was lawful, and why.
Research: Fine Art
This exercise focuses on the issues of misrepresentation, silence, and mistake. Ask students to research a
fine art auction house such as Sotheby's or Christie's. What has the auction house done to protect itself
against claims concerning a work's provenance? Does the company provide a warranty? How carefully
does it define terms such as “painted by” or “from the school of?” (Answer: very carefully.) Does the
auction house limit its warranty to works after a certain date, such as 1870? Why is the company being so
careful about this?
Chapter Overview
Chapter Theme
Both parties must have the capacity to make a deal, and both must give genuine consent.
Capacity
Capacity is the legal ability to enter into a contract. Two groups of people usually lack legal
capacity: minors and those with a mental impairment.
Minors
In contract law, a minor is someone under the age of 18. Because a minor lacks capacity, she normally can
create only a voidable contract.
Disaffirmance/Ratification
A minor may void (cancel) a contract by disaffirming the contract – notifying the other party that she
refuses to be bound by the agreement. The minor may disaffirm by telling the other party, orally or in
writing, that she will not honor the deal, or by refusing to perform her obligations under the contract; the
minor may also undo a contract that has already been completed by filing a suit to rescind the contract;
that is, to have a court formally cancel it.
A minor may disaffirm a contract at any time before she reaches age 18. She also may disaffirm within a
reasonable time after turning 18. But the minor’s right to disaffirm ends if she ratifies the contract.
Ratification is made by any words or action indicating an intention to be bound by the contract.
Restitution
A minor who disaffirms a contract must return the consideration he has received, to the extent he is able.
Restoring the other party to its original position is called restitution.
Exception: Necessaries
On a contract for necessaries – those things essential to the minor’s life and welfare - a minor must pay
for the value of the benefit received. Food, clothing, housing, and medical care are examples of
necessaries.
Additional Case: Star Chevrolet Co. v. Green1
Facts: Kevin Green paid $4,600 cash for a used Camaro from Star Chevrolet. When the car blew a
gasket, the dealer refused to give Kevin his money back. Kevin repaired the car himself and drove it on
the highway, where it was wrecked. Kevin sued Star, and the trial court awarded him the full price of the
car, because he was a minor when he bought it. Star appealed.
Issue: Is Kevin Green entitled to disaffirm the contract even though the Camaro has been destroyed?
Holding: The appeals court affirmed judgment for Green but reduced the award to $3,100, based on the
car's salvage value. A minor may disaffirm a contract. He is required to return the consideration only if it
is still in his possession. If the minor has wasted, squandered, or otherwise destroyed the consideration, he
need not return it and is still entitled to his money back.
Question: Star Chevrolet either did not know that Green was entitled to his money back, or knew but
refused to honor it. Why was that a particularly costly mistake by Star?
Answer: If Star had returned Green's money when he first asked, it would have received a basically
Question: Kevin Green knew that he was a minor. Why should he be allowed to make an agreement,
wreck a car, and then get his money back?
Answer: The policy behind the court's ruling was to discourage businesses from entering into
Exception: Misrepresentation of Age
What is the result if a minor misrepresents himself to be an adult when he enters the contract and then
attempts to avoid the agreement based on his status of a minor? There is no clear rule among the states. A
few states would allow the minor to disaffirm, but more states would not allow the minor to take
advantage of his fraud.
Mentally Impaired Persons
A person suffers from a mental impairment if by reason of mental illness or defect he is unable to
understand the nature and consequences of the transaction. A party suffering a mental impairment usually
creates only a voidable contract. The law creates an exception: if a person has been adjudicated insane,
then all of his future agreements are void.
Intoxication
Similar rules apply in cases of drug or alcohol intoxication. When one party is so intoxicated that he
cannot understand the nature and consequences of the transaction, the contract is voidable.
Landmark Case: Babcock v. Engel2
Facts: While Charles Engel's wife was out of town, he sat home alone, drinking mightily. During this
period, he made an agreement with G. M. Babcock to trade a 320 acre farm and $2000 worth of personal
property for a hotel. Engel's property was worth approximately twice the value of the hotel. Engel later
1 473 So. 2d 157, 1985 Miss. LEXIS 2141 Supreme Court of Mississippi, 1985.
2 58 Mont. 597; 194 P. 137, Supreme Court of Montana, 1920.
refused to honor the deal on the grounds that he had been intoxicated when he made the agreement.
Babcock sued, but the jury sided with Engel and dismissed the complaint. Babcock appealed.
Issue: Was Engel so intoxicated that his agreement with Babcock became voidable?
Decision: Yes, Engel’s inability to understand the nature and consequences of his act made the contract
voidable.
Reasoning: The main question here was not whether Engel was drunk. The facts indicated that he was
completely wasted and the jury agreed. Engel testified that as soon as his wife left town, he binged on
whisky for two days. (Let’s just say he missed her…) After stumbling into town, he downed four or five
more drinks of whisky and blackberry before negotiating a bad deal with Babcock.
The law was only concerned with the ugly details of Engel’s drunkenness in so far as they described his
mental capacity when he entered into the contract. Could Engel have freely consented in his condition?
Did he understand what he was doing? Did he know where and who he was? Four credible witnesses
testified that the befuddled Engel had no idea what he was doing and did not look qualified to transact
business.
Traditionally, the law refused to give a “free pass” to the drunk, opting instead to make them liable for the
consequences of their overindulgence. But alcohol intoxication is just one of many causes of incapacity,
all of which are subject to the same rule. If a party is unable to understand the nature and consequences of
his act, the resulting contract is voidable at his option when he regains capacity. The trial court’s decision
was affirmed.
Question: Under what circumstances can an intoxicated person disaffirm a contract?
Answer: When a party is so intoxicated that he does not understand the nature or consequences of the
Question: Why would every person who wanted to get out of a contract not claim intoxication?
Answer: Courts generally do not allow parties to avoid contracts on the basis of intoxication. The
Question: So, is slight intoxication ground for disaffirmance?
Restitution
A mentally infirm party who seeks to void a contract must make restitution. If a party succeeds with a
claim of mental impairment, the court will normally void the contract but will require the impaired party
to give back whatever she got.
Reality of Consent
Consent to enter into a contract must be genuine and voluntary. Parties often make the following four
claims in an effort to rescind a contract based on lack of valid consent: (1) fraud, (2) mistake, (3) duress,
and (4) undue influence.
Fraud
The distinction between misrepresentation and fraud lies in intent. Misrepresentation can occur
innocently, without awareness of a statement’s falsity. If the defendant knows a statement of fact is false,
or is uncertain whether it is true and intends that the other party rely on the statement, then there is fraud.
To recover from fraud, the injured person must show the following:
1. The defendant knew that his statement was false, or that he made the statement recklessly and
without knowledge of whether it was false.
2. The false statement was material.
3. The injured party justifiably relied on the statement.
Intentional or Reckless Misrepresentation of Fact
The injured party must show a false statement of fact. Opinions and “puffery” do not amount to fraud.
Materiality
The injured party must demonstrate that the statement was material, or likely to influence the decision of
the misled party significantly.
Justi)able Reliance
The injured party also must show that she actually did rely on the false statement and that her reliance
was justifiable, or reasonable.
No Duty to Investigate
A party to a contract has no obligation to investigate the other party’s factual statements.
Additional Case: Homan v. Stamper3
Facts: Plaintiffs alleged that Robert Beeman purchased dilapidated houses in poor sections of Baltimore,
searched for unsophisticated, low-income buyers, and promised them a renovated home for a mere $500
down payment. Beeman had the buyers sign contracts for greatly inflated prices and arranged 100%
purchase financing through an accomplice working in a mortgage company. To support this financing
Arthur Hoffman, a real estate appraiser, supplied an appraisal at exactly the sales price. When the buyers
took possession they found none of the promised repairs had been made. They sued multiple defendants
for fraud and the trial court awarded them compensatory and punitive damages. Hoffman appealed.
Issue: Did Hoffman commit fraud?
Holding: Judgment affirmed. Hoffman’s fraud was amply supported by the evidence. The court stated
“[p]laintiff Beeman purchased a property for $14,500 and sold it three weeks later to McFadden for
$52,000, without any change in its physical condition. Knowing these facts, Hoffman appraised the
property’s value at $52,000. Hoffman misstated the zoning applicable to and physical condition of
properties. He reported distant and dissimilar properties as comparable sales. [The court recited other
evidence showing Hoffman’s knowledge of the falsity of material statements of fact and his willing
participation in the fraudulent scheme.]”
Question: What is “flipping?”
Question: Is flipping illegal or inherently fraudulent?
Question: What made this flipping scheme fraudulent?
Answer: The defendants colluded to (a) purchase run-down housing, (b) locate unsophisticated
buyers, (c) enter contracts with these buyers to make substantial repairs to and sell the properties at
Question: What is “100 percent financing”?
Answer: That is a loan that covers the entire purchase price of the property and (often) closing costs
3 2005 WL 263996 Court of Appeals of Maryland, 2005.
Question: What was Hoffman’s role in this scam?
Question: What is an appraisal?
Answer: An appraisal is an independent expert assessment of the market value of property, based on
Question: Why were Hoffman’s appraisals fraudulent?
Answer: Hoffman’s appraisals were not independent—he reported values according to what was
Plainti’s Remedies for Fraud
In the case of fraud, the injured party generally has a choice of rescinding the contract or suing for
damages or, in some cases, doing both.
Innocent Misrepresentation
If all elements of fraud are present, except the misrepresentation of fact was not made intentionally or
recklessly, then innocent misrepresentation has occurred. So, if a person misstates a material fact
and induces reliance, but he had good reason to believe that his statement was true, then he has not
committed fraud. Most states allow rescission of a contract, but not damages, in such a case.
Special Problem: Silence
Silence generally does not amount to misrepresentation. However, non-disclosure of a fact amounts to
misrepresentation in these four cases: (1) where disclosure is necessary to correct a previous
assertion; (2) where disclosure would correct a basic mistaken assumption that the other party is
relying on; (3) where disclosure would correct the other party’s mistaken understanding about a
writing; or (4) where there is a relationship of trust between the two parties.
Case: Hess v. Chase Manhattan Bank, USA, N.A.4
Facts: Billy Stevens owned a paint company and on several occasions he ordered employees to dump
55-gallon paint drums and pallets of old paint cans on property that he owned. Employees notified the
Environmental Protection Agency (EPA) of this dumping and the EPA began an investigation. (Stevens
later served time for environmental crimes.)
Stevens defaulted on his mortgage for the property and Chase initiated foreclosure proceedings.
During those proceedings Chase learned of the EPA investigation. Chase put the property up for sale “as
is.” The bank did not inform interested buyers of the investigation. Hess bought the property for $52,000.
Hess later learned of the illegal waste and sued Chase for failing to disclose the EPA investigation.
The jury awarded Hess $52,000. Chase appealed.
Issue: Did Chase have a duty to disclose to Hess the ongoing investigation?
Decision: Yes, Chase had a duty to disclose the investigation. Affirmed.
Reasoning: Buyers of "as is" properties must exercise ordinary diligence before making the purchase.
Sellers of such properties need not disclose anything that buyers could discover during a reasonable
inspection. Chase argued that because old paint cans were strewn about the property, Hess should have
known that the previous owner had dumped hazardous waste there.
Hess responded that even though the paint cans were visible, he had no way of knowing that the EPA was
investigating the land. He claimed that he would not have purchased the property if Chase had notified
him of the government inquiry. Hess also presented evidence that two other potential buyers who were
4 220 S.W.3d 758, Missouri Supreme Court, 2007.
aware of the paint cans had made offers on the land. But both testified that they would not have done so if
they had known about the EPA investigation.
Chase was wrong to conceal its superior knowledge because Hess had no reasonable chance to discover
the EPA action during his inspection of the property. Chase's silence amounted to fraud, and Missouri law
does not allow a disclaimer like "as is" to protect a defendant from liability for fraud.
Hess may rescind the contract and recover the $52,000 purchase price.
Question: What is the issue in this case?
Question: I thought we had a rule called “caveat emptor“—let the buyer beware.
Question: What is the difference between fraud in the inducement of a contract and fraud in the
execution of a contract?
Answer: Fraud in the execution of the contract would include lying about the terms of the contract.
Fraud in the inducement of the contract would include lying about the subject matter of the contract
itself. For example, a person asks you to donate money to his charity and you sign a form pledging
Question: Why does Hess win?
Answer: Because Hess was claiming Chase fraudulently induced him into buying the property. He
Ethics of Disclosure
A state could adopt various rules concerning disclosure:
Caveat emptor – let the buyer beware
Seller has a duty to notify buyer of important considerations that buyer must check (soil condition,
building laws, problems with neighboring property, etc.)
Seller has a duty to disclose only if asked
Seller has a duty to disclose, regardless of whether asked
Caveat emptor has largely fallen out of favor. The trend is clearly towards a greater duty to disclose. As
mentioned, many states require a seller to disclose any latent defects of which he is aware. However, there
are limits to that trend. In Strawn v. Canuso, 140 N.J. 43, 657 A2d 420 (NJ 1986), the New Jersey
Supreme Court held that a builder-seller of residential real estate – and its broker – were obligated to
divulge not only problems on the property being sold but problems on neighboring land. In that case,
huge quantities of hazardous chemicals had been illegally dumped in a landfill nearby, and the odors, on a
given day, could dramatically decrease the value of the property being sold. This was about as
far-reaching as any court’s holding on disclosure.
However, the New Jersey legislature responded to the decision by passing a statute that greatly
limited the liability of a builder-seller. Under the new law, such a seller was only obligated to furnish to
prospective buyers a state-mandated list of off-property hazardous sites. The burden was placed on the
buyer to use the list to investigate, and to determine for himself whether the property for sale would be
affected. A builder-seller who furnishes the list cannot be sued for failing to disclose any off-site
conditions. Nobrega v. Edison Glen Associates, 167 N.J.520, 771 A.2d 368 (2001).
Disclosure in Business Contracts
Courts are likely to take more of a laissez-faire approach to disclosure in contracts between businesses
that are not governed by the UCC. It is common practice in many business transactions for a seller to limit
its liability for disclosure by providing the buyer with a period of time, 30 to 45 days, to perform due
diligence. The seller obligates itself to share information (pursuant to a non-disclosure agreement) which
the buyer could not otherwise obtain, such as internal financial statements, contracts with third parties,
and building plans, to provide the buyer access to the property to perform tests and inspections, and to
allow the buyer to review permits and approvals issued by third parties such as building departments and
zoning boards. The purpose is to minimize the extent to which the buyer relies on any representations or
warranties of the seller in making its decisions about the transaction.
Mistake
A mistake can take many forms. It may be a basic error about an essential characteristic of the thing
being sold. It could be an erroneous prediction about future prices, such as an expectation that oil
prices will rise. It might be a mechanical error, such as a builder offering to build a new home for
$300 when he clearly meant to bid $300,000. Some mistakes lead to voidable contracts, others create
enforceable deals. The first distinction is between bilateral and unilateral mistakes.
Bilateral Mistake
A bilateral mistake occurs when both parties negotiate based on the same factual error. If the parties’
contract based on an important factual error, the contract is voidable by the injured party.
Conscious Uncertainty
No rescission is permitted where one of the parties knows she is taking on a risk; that is, she realizes
there is uncertainty about the quality of the thing being exchanged.
Unilateral Mistake
Sometimes only one party enters a contract under a mistaken assumption, a situation called unilateral
mistake. In these cases it is more difficult for the injured party to rescind a contract. Courts are
unwilling to undo an agreement merely because someone made a bad deal. Nonetheless, if her proof
is strong, the injured party in a case of unilateral mistake still may sometimes rescind a contract.
To rescind for unilateral mistake, a party must demonstrate that she entered the contract because of a
basic factual error and that either (1) enforcing the contract would be unconscionable or (2) the
nonmistaken party knew of the error.
