Suggested Additional Assignments
Research: Exculpatory Clauses
Students should find an exculpatory clause, perhaps on a parking lot claim check, check-room receipt, or
sports admission ticket, and report in class precisely what conduct or events the clause covers, and
whether, in their view, it is legal.
Drafting Exercise: Noncompete Clause
Students should assume that they are partners in a bakery in St. Louis, Missouri, that specializes in exotic,
expensive pastries. The business has grown quickly in its first four years, and now sells its products to
stores and restaurants throughout Missouri, Illinois, and Iowa. Sandra has applied for a management
position and appears to be the perfect candidate. She has five years experience as a food wholesaler and a
reputation as a superb amateur chef. Sandra would analyze the market for new products, create new
pastries and other foods, and assist in selling new and existing products. Sandra would work with
company chefs, salespeople, and customers–just about everyone. The assignment: draft a noncompete
clause for Sandra’s contract that a court would enforce.
Chapter Overview
Chapter Theme
No matter how profitable a particular contract clause may appear to be, it is worthless if it is illegal. For
example, a noncompete or exculpatory clause that is too one-sided may lead a court to ignore it. Make
sure your agreement is lawful.
Quote of the Day
“Gambling is the child of avarice, the brother of iniquity, and the father of mischief.” –George
Washington (1732-1799), United States president.
The Sadri Case1: Legal Background
This chapter’s opening vignette about the suit in California over Soheil Sadri’s Nevada casino gambling
debts can generate many questions, some not directly related to the legality issue, that nevertheless
deserve answers so students can put the case in its proper context.
Question: Why did the casino sue in California?
Question: Why was the credit collection agency the plaintiff?
Question: What does that mean?
Answer: It means the collection agency paid Caesar’s Tahoe something less than $22,000 and stepped
Question: Why was the lawsuit in California?
Question: Could it have sued Sadri in Nevada?
Answer: Yes, if the Nevada court decided that it could exercise long-arm personal jurisdiction over Sadri
Question: Would the outcome have been different if Sadri was sued in Nevada?
1 Metropolitan Creditors Service of Sacramento v. Sadri, 15 Cal. App. 4th 1821, 1993 Cal. App. LEXIS
559, 19 Cal. Rptr. 2d 646 Court of Appeal of California, First Appellate District, Division Five, 1993
Answer: Probably. Had the casino or collection agency obtained a judgment against Sadri in the Nevada
Question: Then why the different result in this case?
Answer: Because the collection agency was not seeking to enforce a Nevada court judgment, but a
Question: Why are illegal contracts unenforceable?
Answer: It would be socially destructive if the courts, which are intended to uphold the law, began to
Question: Isn’t it unfair to allow someone to gamble on credit and then refuse to pay the debt by hiding
behind this legal doctrine? Why should a casino suffer the loss?
Answer: Many of us might disagree with Sadri’s ethics. There is an important lesson in this case,
Comment: Students might be surprised to learn that the statute making contracts for gambling debts
enforceable in Nevada only came into effect in 1983.
Contracts That Violate a Statute
Wagers
Almost all states now permit some form of wagering, but a gambling contract is illegal unless it is a
type of wagering specifically authorized by state statute.
Insurance
Anyone taking out a policy on the life of another must have an insurable interest in that person.
Additional Case: Chem v. New York Life Insurance Company2
Facts: Suulan Chem asked an acquaintance, insurance agent Thuan Wu to purchase an insurance policy
on the life of her young son, Michael. Wu purchased a short term policy through Surety Life Insurance.
Later, without telling Chem, he renewed that policy and bought additional policies on Michael’s life
through New York Life and three other companies for a total of $750,000. Wu planned to murder the boy
and his mother and collect the insurance proceeds. Wu orchestrated the eight-year-old boy’s killing but
failed to kill Chem. He was convicted of murder. Chem sought to collect the $750,000, but all of the
companies refused to pay. She sued and the court dismissed the case ruling that Wu, who took out the
policies without Chem’s knowledge, had no insurable interest in Michael’s life.
Issue: Are the insurance policies void for lack of insurable interest?
Holding: The Ninth Circuit affirmed the dismissal. A policy purchased by someone without an insurable
interest is a mere wager on the life of the insured, and unenforceable. That is dispositive but in this case,
to make matters worse, Wu planned to murder Michael and Suulan. Case law also holds that any policy
purchased with the intention of murdering the insured is void. A void contract cannot be ratified.
Although the companies took the premiums and acted as if the policies were valid, their actions do not
transform the void policies into valid ones. A void contract is void from the beginning and the companies’
behavior does not change that fact. Chem had also asked the court for leave to amend her complaint. The
2 168 F.3d 498 United States Court of Appeals for the Ninth Circuit, 1999
Ninth Circuit denied the request, ruling that any amendment would be futile. There was no possible
pleading that could cure the basic deficiency in her complaint.
Question: How does life insurance work?
Answer: A person (the “applicant”) applies for a policy of insurance on the life of some person (the
Question: Why does the law require that the person taking out a life insurance policy have an
insurable interest in the life of the insured?
Question: Chem was Michael, the insured’s, mother. Why doesn’t she have an insurable interest?
Answer: Wu purchased these policies, not Chem. Under California law the purchaser must have an
Question: But she was Michael’s mother! The policies named her as principal beneficiary! Aren’t
those reasons enough to honor her claim?
Answer: No. Those facts don’t change the illegality of these policies at the time they were
Question: Why, then, was Wu able to purchase them? These insurers didn’t care about contract
legality when they were taking payment for the policies’ premiums.
Answer: It does seem wrong for the insurers to have sold these policies, yet if it was wrong that does
Question: Could the court nevertheless award Chem some amount of damages to compensate for her
loss?
Answer: No. Awarding some measure of damages would undermine the public policy that makes
Licensing Statutes
When a licensing requirement is designed to protect the public, any contract made by an unlicensed
worker is unenforceable.
Case: Authentic Home Improvements v. Mayo3
Facts: Authentic Home Improvements (Authentic) performed work on Diane Mayo’s home. Mayo sued
for return of the money she paid. In court, Authentic admitted that it had no contractor’s license when it
began the work, but had expected to obtain it shortly. The court ordered Authentic to return the money
Mayo had paid. Authentic returned to court when it discovered that the license had in fact been issued
soon after work began, and thus it should not be obligated to return Mayo’s money but should be paid its
full fee for the work completed.
Issue: Did the new license entitle Authentic to its home improvement fee?
Holding: Judgment for Mayo affirmed. The court acknowledged that under certain circumstances it may
seem unfair when contractors are hurt when a consumer refuses to pay and then argues “illegality” based
on the contractor’s failure to obtain a license, and that perhaps there might be room for some exceptions.
3 2006 WL 2687533, District of Columbia Superior Court, 2006.
However, the court noted to high incidence of consumer complaints based on fraud in the home
improvement industry.
According to the court, it is irrelevant that the parties may be of equal fault in this case. An
unlicensed contractor may not recover even where the homeowner already knew that the
contractor was not licensed, and in fact “waived” that requirement in exchange for the work being
completed promptly. Even here, where the contractor is the “victim” and Mayo knew in advance
that the contract would be invalidated, yet still benefitted unfairly from the contractor’s good
work, the homeowners is allowed to prevail.
Authentic argues that it was expecting to receive its license, and in fact did get its license
within a reasonable time of beginning the work. According to the court, the requirement is clear:
you need a license or permit before the work is to begin. The court likens this requirement to that
of a drivers license: you cannot legally drive a car in anticipation of receiving your drivers
license in the mail on the premise that eventually you will get the license so it is all right to drive
while you wait for it.
Question: Authentic did get its license shortly after it began the work for Mayo. Isn’t this result a
triumph of form over substance?
Answer: Many of the legal issues we discuss in this course fall somewhere in the gray area and
Question: Mayo is taking advantage of a loophole—is that a result the law should encourage?
Answer: The illegality of a contract is not a “loophole.” The licensing requirement for contractors
Question: Could the court award Authentic damages on a theory of quasi-contract to compensate
him for whatever benefit he bestowed on Mayo?
Answer: Again, the answer is no. Allowing Mayo to recover damages indirectly on quasi-contract
Usury
Usury laws prohibit charging excess interest on loans.
Credit Card Debt
Issuers of credit cards may charge interest rates based on either the state of the consumer or the state of
the credit card issuer. Therefore, a citizen of one state may find himself subject to the laws of a different
state.
Case: American Express Travel Related Services Company, Inc. v.
Assih4
Facts: American Express Travel Related Services (American Express) alleged that New York
resident Titus Assih missed a credit card payment. His interest rate ballooned from 12.24% to 21%,
and eventually to 27.99%. Assih made small payments for a time, but soon stopped paying
altogether.
4 893 N.Y.S.2d 438 Civil Court of the City of New York, Richmond County, 2009
American Express sued Assih. The company sought to enforce this provision of its agreement:
“This Agreement is governed by Utah law and applicable federal law.”
The agreement’s only connection to Utah was that American Express assigned its interest to a
one-branch bank in Utah.
Assih argued that New York law, which sets strict limits on maximum rates of credit card interest,
should apply instead.
Issues: Should New York or Utah law apply? Did the increased rates violate usury statutes?
Excerpts from Judge Straniere’s Opinion: Having dealt with thousands of consumer credit cases
over the years the court is sometimes caused to wonder if the regulations governing this industry
originated in the Wonderful Land of Oz. For example, the scene where Dorothy and friends approach
the gates of the Emerald City and ring the bell seeking entrance seems to present a number of the
issues arising in debt collection litigation.
Guardian: Well, that’s more like it! Now state your business!
Dorothy and Friends: We want to see the Wizard!
Guardian: The Wizard? But nobody can see the Great Oz! Nobody’s ever seen the Great Oz!
Even I’ve never seen him!
Dorothy: Well, then how do you know there is one?
Like the Land of Oz, run by a Wizard who no one has ever seen, the Land of Credit Cards permits
consumers to be bound by agreements they never sign, agreements they may have never received,
subject to change without notice and the laws of a state other than those existing where they reside.
The Utah usury statute provides: The parties to a lawful contract may agree upon any rate of interest
for the loan that is the subject of their contract.
Is it any wonder that credit card issuers, such as plaintiff, make their agreements subject to Utah law?
An interest rate is not usurious so long as the parties “agree upon any rate of interest.” If Nathan
Detroit had known he could make loans charging 100% interest a day by reducing them to writing,
signed and subject to Utah law, he would not have had to seek a living running the “oldest,
established, permanent floating crap game in New York.” Incredibly courts are expected to enforce
these agreements against unsophisticated, unrepresented consumers who reside in states such as New
York which do not have similar statutes and who have no idea that their agreement is subject to Utah
law.
Is New York required to apply the Utah usury statute to credit card interest charges which far exceed
the legal rate in New York? New York follows the “substantial relationship” approach that provides:
The law of the state chosen by the parties to govern their contractual rights and duties will be
applied…unless the chosen state has no substantial relationship to the parties.
The corporate plaintiff is incorporated in New York and its principal place of business is in New York.
Defendant resides in New York. Most of the transactions charged to the credit card took place in New
York. Payments on the credit card are mailed to a New York address. Utah has no substantial
relationship to the parties.
Taking all of the above into account, it is clear that New York has the most significant contacts to the
parties and New York law will apply to the Agreement.
The legal rate of interest in New York in general obligations [is] sixteen per cent. New York still
retains a criminal usury statute for interest rates which exceed twenty-five per cent. Except for the
initial interest rate charged on defendant’s account by plaintiff of 12.24%, all other interest charges
assessed by plaintiff violated the New York civil usury statutes. The last billings on this account in
fact exceeded the criminal usury rate of 25% when they reached 27.99%.
Under New York law all usurious contracts are void and the lender forfeits both principal and interest.
The Wizard in the “Wizard of Oz” warned Dorothy and friends, “Do not arouse the wrath of the great
and powerful Oz,” I am sure the court will likewise be arousing the wrath of the plaintiff.
Plaintiff’s cause of action is dismissed.
Question: Which state law will be followed in this case?
Question: What is a consumer to do?
Contracts That Violate Public Policy
Restraint of Trade: Noncompete Agreements
Noncompete agreements violate public policy against restraints of trade. It is often useful in the midst of
a discussion of noncompete cases, when students may lose sight of the reason for analyzing a clause’s
reasonableness, to ask why a noncompete clause raises the issue of legality. Returning to the big picture
can put the discussion of the reasonableness of a clause in a new light.
Ancillary to the Sale of a Business
Students may want mechanical rules-of-thumb to determine whether a noncompete clause ancillary to the
sale of a business is reasonable: Is a distance of ten miles too close? Too far? Just right? Whether a
noncompete clause ancillary to the sale of a business is reasonable requires case-by-case analysis of the
geographic area from which the business draws its customers, the nature of businesses that compete with
it, and the time necessary for the new owner to create (or fail to create) its own goodwill.
Students will often ask, in a case where a court rules a noncompete clause to be invalid, whether that
leaves the person subject to the clause free to open a competing business across the street from its former
location. While the following case concerns a noncompete clause in employment, the way in which the
court instructs the trial court to refashion the invalid clause provides an answer to this question.
Case: King v Head Start Family Hair Salons, Inc.5
Facts: For the most recent 16 years, Kathy King had worked at Head Start, which provided hair cuts,
coloring and styling for men and women. King was primarily a stylist, though she had also managed one
of the Head Start facilities. King quit Head Start and began working as manager of a Sports Clips shop,
located in the same mall as the store she just left. Head Start sued King, claiming that she was violating
the noncompetition agreement that she had signed. The agreement prohibited King from working at a
competing business within a two-mile radius of any Head Start facility for 12 months after leaving the
company. The trial court issued an injunction enforcing the noncompete and King appealed.
Issue: Was the noncompetition agreement valid?
Holding: Reversed and remanded. Excerpts from the court’s opinion:
King has been in the hair-care industry for 25 years, and that it is the only industry in which she is
skilled and the only industry in which she can find employment. Head Start has 30 locations
throughout the Jefferson County and Shelby County area, making it virtually impossible for her to
find employment in the hair-care industry at a facility that does not violate the terms of the
noncompetition agreement. The geographic restriction constitutes a blanket prohibition on practicing
her trade. It isn’t reasonable to assume King can learn a new job skill that would allow her to be
gainfully employed and meet her family’s needs. Enforcement of this noncompetition agreement
works an undue hardship upon King.
Head Start is nevertheless entitled to some of the protection it sought in the noncompetition
agreement. King may be able to attract many of her former Head Start customers if she is allowed to
provide hair-care services unencumbered by any limitations. To prevent an undue burden on King
and to afford some protection to Head Start, the trial court should enforce a more reasonable
geographic restriction–such as one prohibiting King from providing hair-care services within a
5 886 So.2d 769 Supreme Court of Alabama, 2004
two-mile radius of the location of the Head Start facility at which she was formerly employed, or
imposing some other limitation that does not unreasonably interfere with King’s right to gainful
employment while, at the same time, protecting Head Start’s interest in preventing King from
unreasonably competing with it during the one-year period following her resignation.
Question: How does the court analyze the reasonableness of this noncompetition agreement?
Question: Why does it rule that the noncompetition is invalid?
Answer: It would bar King from working within a two-mile radius of any Head Start facility. Head
Question: Since it ruled the clause to be invalid, is King free to take a job anywhere?
Answer: No. The court recognized that it would be unfair to Head Start to throw out the entire
Question: What effect would that have on King?
Answer: Ironically, it would result in King losing the job to which she moved from Head Start,
Question: Courts tend to be antagonistic to noncompetition agreements. Why is that?
Answer: They restrain trade and injure the public. The primary goal is to protect the public, though
Question: Suppose an employer could request any restrictions it wanted on future employment.
What problems could that create?
Answer: An employer might demand that the employee not work anywhere in the particular field
Question: But if an employee agrees to certain conditions, why shouldn’t they be enforced? If a
worker knowingly agrees he will never work for another employer, anywhere, in the same field, why
not require him to live up to his word?
Answer: Contemporary courts will not do so, because they consider such agreements harmful to the
Question: If a court is free to ignore a contract provision, such as a noncompete agreement, doesn’t
that render the contract worthless?
Answer: It does not make a contract worthless, but it does diminish the ability of the parties to
Drafting Exercise: Noncompete Clause
If students completed the exercise to draft a noncompete clause they could review their treatment of these
issues:
• Trade Secrets. The bakery is entitled to protect trade secrets. The contract may prohibit Sandra from
making any use of recipes or formulas, she may not take them to a competitor or use them herself.
• Confidential Information. The bakery is entitled to protect any other truly confidential information,
such as the bakery’s own costs and profits, how much each of its customers spends, how much it pays
its chefs, and products it has developed that have succeeded and failed, and the reasons for each.
• Customer Lists. The bakery is entitled to protect customer lists developed over an extended period. A
customer list that has grown slowly, based on sales calls, word of mouth, and so forth, can be
protected. A customer list derived from the Yellow Pages cannot be protected.
• Other Issues. A court is unlikely to enforce other noncompete clauses. If a contract prohibits Sandra
from working for a bakery in St. Louis, a court is likely to reject it. The law will also permit Sandra
to take with her any general baking knowledge she acquired.
Comment: Note that, if Sandra leaves to establish her own business, a court may allow additional
restrictions. In analyzing such noncompete agreements courts often apply the standard used for the sale
of a business–that prohibitions will be valid if reasonable in time, geography, and scope of activity.
Exculpatory Clauses
An exculpatory clause is generally unenforceable when it attempts to exclude an intentional tort
or gross negligence.
An exculpatory clause is usually unenforceable when the affected activity is in the public interest,
such as medical care, public transportation, or some essential service.
An exculpatory clause is generally unenforceable when the parties have greatly unequal
bargaining power.
An exculpatory clause is generally unenforceable unless the clause is clearly written and readily
visible.