978-1285427003 Chapter 18 Lecture Note Part 1

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Suggested Additional Assignments

Research: Lawyers and Public Opinion

Students should conduct an informal survey of friends and associates to gather ideas on public perception

of lawyers. They should categorize the comments and evaluate what types of people have a negative

opinion of lawyers and what type have a positive opinion.

Drafting: Contracts

Students should draft a simple contract from the perspective of a provider of a service, such as house

painting. Students must include specific terms on (1) price, (2) time and place of delivery, (3) method of

payment, and (4) warranties. They should then pair with another student who will be the “buyer.” The

“buyer” student should try to change the terms to more favorable ones. The “seller” students must do their

best to ensure that any resulting contract stays close to the original terms. They should negotiate until they

agree.

Chapter Overview

Chapter Theme

You have been studying the theory of contract law. This chapter is different – its purpose is to demonstrate

how that theory operates in practice. We will look at the structure and content of a standard agreement and

answer questions such as: Do you need a written agreement? What does all these legal terms mean? Are

any important provisions missing? By the end of the chapter, you will have a roadmap for understanding a

written contract.1 (Note that we do not repeat here what you have learned in prior chapters about the

substantive law of contracts.) This chapter has an additional goal: We will look at the relationship

between lawyers and their clients and their different roles in creating a contract.

Do You Need a Written Contract?

Some cases work out well without a written contract, but there are times when you should definitely have

a signed written agreement. You should have a signed written agreement when: (1) The Statute of Frauds

requires it; (2) The deal is crucial to your life or the life of your business; (3) The terms are complex; or

(4) You do not have an on-going relationship with the other party.

The Lawyer

Businesspeople often expect deals to go well. Lawyers are trained to be pessimists. Their primary goal is

to protect their clients by avoiding litigation, now and in the future.

Lawyers also prefer to negotiate touchy subjects at the beginning of a relationship when everyone is on

friendly terms and eager to make a deal, rather than waiting until trouble strikes.

The Contract

How to Read a Contract

Reading a contract should be a focused, multi-step process, asking yourself “what-if” questions and

determining the answers to those questions.

1 For further reading on practical contracts, see Scott Burnham, DRAFTING AND ANALYZING

CONTRACTS, LexisNexis; Charles M. Fox, WORKING WITH CONTRACTS, Practical Law Institute;

George W. Kuney, THE ELEMENTS OF CONTRACT DRAFTING, Thomson/West.

Mistakes

There are many common mistakes, including vagueness, ambiguity, and typos.

Vagueness

Businesspeople sometimes deliberately choose vagueness. They do not want the terms of the contract to

be clear. It may be that they are not sure what they can get from the other side, or in some cases, even

what they really want. So they try to form a contract that leaves their options open. However, as the

following case illustrates: Vagueness is your enemy.

Case: Quake Construction v. American Airlines.2

Facts: Jones Brothers Construction was the general contractor on a job to expand American Airlines

facilities at O’Hare International Airport. Jones Brothers invited Quake Construction to bid on the

employee facilities and automotive maintenance shop (“the project”). After Quake bid, Jones Brothers

orally informed Quake that it was awarding Quake the project and would soon forward a contract. Jones

Brothers wanted the license numbers of the subcontractors that Quake would be using, but Quake could

not furnish those numbers until it had assured its subcontractors that they had the job. Quake did not want

to give that assurance until it was certain of its own work. So Jones Brothers sent a letter of intent that

stated, among other things:

We have elected to award the contract for the subject project to your firm as we discussed on April 15. A

contract agreement outlining the detailed terms and conditions is being prepared and will be available for

your signature shortly.

Your scope of work includes the complete installation of expanded lunchroom, restaurant and locker

facilities for American Airlines employees as well as an expansion of American Airlines’ existing

automotive maintenance shop. A sixty (60) calendar day period shall be allowed for the construction

of the locker room, lunchroom and restaurant area beginning the week of April 22. The entire

project shall be completed by August 15.

Subject to negotiated modifications for exterior hollow metal doors and interior ceramic floor tile

material as discussed, this notice of award authorizes the work set forth in the [attached] documents

at a lump sum price of $1,060,568.00

Jones Brothers Construction Corporation reserves the right to cancel this letter of intent if the

parties cannot agree on a fully executed subcontract agreement.

The parties never signed a more detailed written contract, and ultimately Jones Brothers hired another

company. Quake sued, seeking to recover the money it spent in preparation and its loss of anticipated

profit.

Issue: Was the letter of intent a valid contract?

Excerpts from Justice Calvo’s Decision: [A]lthough letters of intent may be enforceable, such letters are

not necessarily enforceable unless the parties intend them to be.

In determining whether the parties intended to reduce their agreement to writing, the following factors

may be considered: whether the type of agreement involved is one usually put into writing, whether the

agreement contains many or few details, whether the agreement involves a large or small amount of

money, whether the agreement requires a formal writing for the full expression of the covenants, and

whether the negotiations indicated that a formal written document was contemplated at the completion of

the negotiations.

[We conclude that] the letter was ambiguous. The letter of intent included detailed terms of the parties’

agreement. The letter stated that Jones awarded the contract for the project to Quake. The letter stated

further “this notice of award authorizes the work.” Moreover the letter indicated that the work was to

commence approximately 4 to 11 days after the letter was written. This short period of time reveals the

parties intent to be bound by the letter so that work could begin on schedule. We also agree that the

2 141 Ill. 2d 281, 565 N.E.2d 990, 1990 lll. LEXIS 151 Supreme Court of Illinois, 1990.

cancellation clause exhibited the parties’ intent to be bound by the letter because no need would exist to

provide for the cancellation of the letter unless the letter had some binding effect. The cancellation clause

also implies the parties’ intention to be bound by the letter at least until they entered into the formal

contract. These factors evinced the parties’ intent to be bound by the letter.

On the other hand, the letter referred several times to the execution of a formal contract by the parties,

thus indicating the parties’ intent not to be bound by the letter. The cancellation clause could be

interpreted to mean that the parties did not intend to be bound until they entered into a formal agreement.

Thus, we hold that the letter of intent in the case at bar is ambiguous regarding the parties’ intent to be

bound by it. Therefore, on remand, the circuit court shall allow the parties to present parol evidence

regarding their intent. The trier of fact must then determine, based on the parties’ intent, whether the letter

of intent is a binding contract.

NOTE: The court stated that letters of intent are enforceable only if the parties intend them to be. In

determining the intent of the parties, the following factors are important: is this type of agreement usually

put into writing, how detailed the letter is, how much money is involved, whether the letter indicates that

the parties intended a more formal agreement would follow.

Because the letter of intent in this case was so ambiguous, the appellate court remanded to the trial court

to determine the intent of the parties when they signed the document.

Question: Can letters of intent be binding?

Question: What is another type of incomplete bargaining?

Ambiguity

Ambiguity occurs in contracts when the parties think only about what they want a provision to mean,

without considering the literal meaning or the other side’s perspective.

Any ambiguity is interpreted against the drafter of the contract.

Case: Cipriano v. Patrons Mutual Insurance Company of Connecticut3

Facts: Juacikino Cipriano purchased an insurance policy on his house from Patrons Mutual Insurance

Company. The policy stated that the company would not pay for any damage to the residence caused by

vandalism or burglary if the residence was vacant for more than 30 days in a row just before the loss.

Furthermore, the company would not pay for damage to personal property caused by fire, lightening or

vandalism.

After Cipriano’s house had been vacant for more than 30 days, an arsonist burned it down. Patrons denied

his claim on the grounds that arson is vandalism, which his policy did not cover. Cipriano filed suit

against Patrons. The insurance company filed a motion for summary judgment.

Issue: Is arson a type of vandalism?

Excerpts from Judge Devine’s Decision: [T]here are no genuine issues of fact that the fire was the result

of arson and that the dwelling house was vacant for more than 30 days prior to the fire. The defendant

contends that the term “vandalism” includes the act of arson. The plaintiff argues that, in reviewing the

insurance policy as a whole, an insured may not be able to discern what “vandalism” means, as that term

is used in the separate sections of the insurance policy.

Under our law, the terms of an insurance policy are to be construed according to the general rules of

contract construction. It is a basic principle of insurance law that policy language will be construed as

3 2005 Conn. Super. LEXIS 3577 SUPERIOR COURT OF CONNECTICUT.

laymen would understand it and not according to the interpretation of sophisticated underwriters, and that

ambiguities in contract documents are resolved against the party responsible for its drafting; the

policyholder’s expectations should be protected, as long as they are objectively reasonable from the

layman’s point of view. However, a court will not torture words to import ambiguity where the ordinary

meaning leaves no room for ambiguity, and words do not become ambiguous simply because lawyers or

laymen contend for different meanings.

In the present case, the defendant has drafted an insurance policy where “vandalism” and “fire” are

undefined terms. Reading the insurance policy as whole, the terms “vandalism” and “fire” are found to be

included as separate perils covered under the personal property coverage. In the exclusionary provision

for the coverage of the residence, “vandalism” is listed as an excluded loss. “Fire” is not mentioned.

Because the terms “vandalism” and “fire” are undefined, and are listed as two distinct perils, it is

ambiguous as to which peril, “vandalism” or “fire,” covers arson. Therefore, “vandalism,” is susceptible

of two reasonable interpretations. As such, the insurance policy must be construed against the party

responsible for its drafting.

ORDER: The defendant’s motion for summary judgment is hereby denied.

Question: What is a preventive measure in negotiating and drafting contracts?

Typos

What is the law of typos? First of all, the law has a fancier word than typo – it is scrivener’s error. A

scrivener is a clerk who copies documents. In the case of a scrivener’s error, a court will reform a contract

if there is clear and convincing evidence that the mistake does not reflect the true intent of the parties.

You Be the Judge: Heritage Technologies v. Phibro Tech4

Facts: Heritage wanted to buy a substance called TBCC from Phibro but, because of uncertainty in the

industry, the two companies could not agree on a price for future years. It turned out, though, that the

price of TBCC tended to rise and fall with that of copper sulfate, so Heritage proposed that the amount it

paid for TBCC would increase an additional $15 per ton for each $0.01 increase in the cost of copper

sulfate over $0.38 per pound.

Two top officers of Heritage and Phibro met in the Delta Crown Room at LaGuardia Airport to negotiate

the purchase contract. At the end of their meeting, the Phibro officer hand wrote a document stating the

terms of their deal and agreeing to the Heritage pricing proposal.

Negotiations between the two companies continued, leading to some changes and additions to their

Crown Room agreement. In a draft prepared by Phibro, the $.01 number was changed to $0.1, that is,

from 1¢ to 10¢. In other words, in the original draft, Heritage agreed to a first increase if copper sulfate

went above 39¢ per pound, an additional price rise at 40¢, and so on. But in the Phibro draft, Heritage’s

first increase would not occur until the price of copper sulfate went to 48¢ a pound, with a second rise at

58¢. In short, the Phibro draft was much more favorable to Heritage than the Heritage proposal had been.

At some point during the negotiations, the lawyer for Heritage asked his client if the $ 0.1 figure was

accurate. The Heritage officer said that the increase in this amount was meant to be payment for other

provisions that favored Phibro. There is no evidence that this statement was true. The contract went

through eight drafts and numerous changes but, after the Crown Room meeting, the two sides never again

discussed the $0.1 figure.

4 2008 U.S. Dist. LEXIS 329 United States District Court for the Southern District of Indiana.

After the execution of the agreement, Heritage discovered a different mistake. When Heritage brought the

error to Phibro’s attention, Phibro agreed to make the change even though it was to Phibro’s disadvantage

to do so.

All was peaceful until the price of copper sulfate went to $ 0.478 per pound. Phibro believed that, because

the price was above $.38 per pound, it was entitled to an increased payment. Heritage responded that the

increase would not occur until the price went above $.48. Phibro then looked at the agreement and for the

first time noticed the $ 0.1 term. Phibro contacted Heritage to say that the $ 0.1 term was a typo and not

what the two parties had originally agreed in the Delta Crown Room. Heritage refused to amend the

agreement and Phibro filed suit.

You Be the Judge: Should the court enforce the contract as written or as the parties agreed in their Crown

Room meeting? Which number is correct — $.10 or $.01?

Argument for Phibro: In the Delta Crown Room, the two negotiators agreed to a $15 per ton increase in

the price of TBCC for each 1¢ increase in copper sulfate price. Then by mistake, the contract said 10¢.

The two parties never negotiated the 10¢ provision and there is no evidence that they had agreed to it. The

court should revise this contract to be consistent with the parties’ agreement, which was 1¢.

Also, the 10¢ figure makes no economic sense. The point of the provision was that TBCC went up at the

same rate as copper sulfate. One cent for each ton is a much more accurate reflection of the relationship

between these two commodities than 10¢ per ton.

Argument for Heritage: The Delta Crown Room agreement was nothing more than a draft. The contract

went through eight rounds of changes. The change in price was in return for other provisions that

benefited Phibro. The parties conducted negotiations by sending drafts back and forth, rather than by

talking on the phone. Both parties were represented by a team of lawyers, the agreement went through

eight drafts and this pricing term was never altered despite several other changes and additions. There is

no clear and convincing evidence that both parties were mistaken about what the document actually said.

Ultimately the parties agreed to 10¢ and that is what the court should enforce.

Ethics: When Heritage found a different mistake in the contract, Phibro agreed to correct it, even though

the correction was unfavorable to Phibro. But when a mistake was found in Heritage’s favor, Heritage

refused to correct it. Is Heritage behaving ethically? Does Heritage have an obligation to treat Phibro as

well as Phibro behaved towards Heritage? Is it right to take advantage of other people’s mistakes? What

principles would you apply in this situation?

Holding: The Court finds in favor of the plaintiff, Heritage Technologies, L.L.C. The court declares that

the term means a dime, $0.10.

Question: What does this case teach us?

Preventing Mistakes

Before signing a contract, check carefully and thoughtfully the names of the parties, the dates, dollar

amounts and interest rates.

Suggested rules for a sensible client:

Complain if your lawyer gives you a contract with provisions that are irrelevant to your situation.

If you do not know what a provision means, ask.

Remember that a contract is also a reference document. During the course of your relationship

with the other party, you may need to refer to the contract regularly.

The Structure of a Contract

Title

Contracts have a title, which generally is in capital letters, underlined and centered at the top of the page,

and should be as descriptive as possible.

Introductory Paragraph

The introductory paragraph includes the date, the names of the parties and the nature of the contract and

should also include specific language indicating that the parties entered into an agreement. Traditional

contracts tended to use archaic words– whereas and heretofore were common. Modern contracts are more

straightforward, without so many linguistic flourishes.

De.nitions

Most contracts have some definitions. Usually, the names of the parties are defined [e.g., “Joe Jones

(Seller)”] in the introductory paragraph. Other definitions are included in a separate section or they can

appear throughout the contract.

Covenants

Now we get to the heart of the contract: What are the parties agreeing to do? Failure to perform these

obligations constitutes a breach of the contract and damages will result. A legal term for a promise in a

contract is covenant. To clarify who exactly is doing what, covenants in a contract should use the active,

not passive voice. For important issues where disputes are likely to arise, the language should be precise,

detailed and complete.

Breach

To constitute a violation of the contract, the breach must be material. A material breach is important

enough to defeat an essential purpose of the contract.

Many of the covenants in a contract provide that the right must be exercised reasonably or that a decision

must be made in good faith. Reasonable means ordinary or usual under the circumstances. Good faith

means an honest effort to meet both the spirit and letter of the contract. A party with sole discretion has

the absolute right to make any decision he wants on that issue.

Case: LeMond Cycling, Inc. v. PTI Holding, Inc. 5

Facts: American Greg LeMond won the Tour de France, cycling’s most prestigious race. Sports

Illustrated named him one of the forty most influential people in sports during the prior forty years. He

formed LeMond Cycling, Inc. (LCI) to handle his business dealings. Protective Technologies

International, Inc. (PTI) sold cycling accessories under brand names like Barbie, Playskool and Tonka to

retailers such as Target, Walmart, K-Mart and Toys R Us.

LeMond and PTI signed a contract (the Deal Memo) providing that PTI would use LeMond’s name to sell

bicycle accessories. In return, PTI would pay LCI $500,000 a year plus a six percent royalty on annual

sales exceeding $8.33 million. The Deal Memo required PTI to

use commercially reasonable efforts to produce and market LeMond bicycle accessories

keep LCI apprised of PTI’s efforts, including information about marketing and media plans

PTI tried to sell LeMond products to Target, Walmart and Toys R Us. Only Target was interested and then

only in a minor way. It agreed to allocate just six feet of shelf space to LeMond products. It also rejected

PTI’s proposal to install a video kiosk that featured LeMond. PTI did not tell LCI about this deal.

LeMond accessories sold poorly at Target. PTI itself did not do any promotional activities or advertising

for the products beyond the initial video for the kiosk that Target rejected. PTI argued that it was Target’s

role to advertise them.

Because of poor sales, Target reduced the amount of shelf space for LeMond items to just four feet.

Ultimately, Target discontinued these products altogether. In neither instance did PTI inform LCI. PTI did

try to sell LeMond accessories to Wal-Mart, Toys R Us and other stores, but there were no takers.

5 2005 U.S. Dist. LEXIS 742 US DISTRICT COURT FOR THE DISTRICT OF MINNESOTA.

Shortly thereafter, PTI began to sell Schwinn bicycle accessories to the retailers that had rejected LeMond

products. PTI earned over $30 million from Schwinn sales. The company then abandoned all effort to sell

LeMond items.

LCI filed suit against PTI for breach of contract. In response, PTI filed a motion for summary judgment,

seeking to have the suit dismissed.

Issue: Did PTI breach its contract with LCI?

Excerpts from Judge Magnuson’s Decision: To prevail on a breach of contract claim, LCI must prove

that PTI breached a material term of the contract. A material breach goes to the root or essence of the

contract, and is so fundamental to the contract that the failure to perform that obligation defeats an

essential purpose of the contract. Even when express conditions of the contract are violated, the breach is

not necessarily material.

LCI contends that PTI’s alleged failure to provide LCI with annual marketing and media plans was

material. LCI submits that these documents serve a critical purpose in licensing agreements, because they

allow the licensor to monitor sales and corresponding royalty payments.

The Court disagrees. The fact that PTI failed to give reports or other documents to LeMond does not

frustrate the essential purpose of the contract. Furthermore, there is no causal connection between PTI’s

failure to provide LCI with these reports and LCI’s lost profit. Therefore, these terms of the Deal Memo,

by themselves, are not material as a matter of law.

However, whether or not PTI used commercially reasonable efforts to produce [and] market the Product

Line is a material term of the contract, as it is the primary purpose of the contract itself. Thus, the issue is

whether PTI breached this duty.

The Deal Memo fails to define commercially reasonable. LCI is convinced that commercially reasonable

requires an examination of customary practices within the licensing industry. LCI’s broad argument that

only industry standards are relevant to the commercial reasonableness determination is unpersuasive.

Although an objective component is instructive as to whether or not PTI acted with commercial

reasonableness, there must be a subjective evaluation as well. No business would agree to perform to its

detriment, and therefore whether or not PTI performed with commercial reasonableness also depends on

the financial resources, business expertise, and practices of PTI.

The Complaint also alleges that PTI breached its implied covenant of good faith and fair dealing with

LCI. Good faith requires a party to act honestly. Bad faith exists when a party’s refusal to fulfill its

obligations is based on an ulterior motive. LCI submits that PTI abandoned LCI and its obligations under

the Deal Memo when it engaged in its relationship with Schwinn. Indeed, LCI has submitted evidence

that PTI narrowly focused on its Schwinn obligations, despite its continuing obligation to LCI under the

Deal Memo. There is a dispute of fact as to whether PTI exercised good faith in its performance under the

terms of the Deal Memo. Thus, PTI’s Motion on this point is denied.

IT IS HEREBY ORDERED that:

Defendants’ Motion for Summary Judgment is GRANTED in part and DENIED in part as set forth in this

Order.

Question: The court denied what part of the motion?

Question: What action by PTI could be considered bad faith?