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Impossibility
If performing a contract was truly impossible, a court will discharge the agreement. But if honoring
the deal merely imposed a financial burden, the law will generally enforce the contract.
True Impossibility
These cases are easy—and rare. True impossibility means that something has happened making it
literally impossible to do what the promisor said he would do. This is generally limited to three
causes: (1) destruction of subject matter, (2) death of the promisor in a personal services contract,
and (3) illegality.
Commercial Impracticability and Frustration of Purpose
It is rare for contract performance to be truly impossible, but very common for it to become a
financial burden to one party.
Commercial impracticability means some event has occurred that neither party anticipated and
fulfilling the contract would now be extraordinarily difficult and unfair to one party.
Frustration of purpose means some event has occurred that neither party anticipated and the
contract now has no value for one party.
Case: HOOSIER ENERGY V. JOHN HANCOCK
Hoosier Energy Rural Electric Cooperative, Inc. v. John Hancock Life Insurance Co.
582 F.3d 721
United States Court of Appeals for Seventh Circuit, 2009
Facts: John Hancock Life Insurance Co. receives lots of cash in premium payments, which it
then invests so that it will have enough funds to pay claims from its policy holders. To this end,
it entered into a leveraged lease with Hoosier Energy. This transaction was highly complex and
only profitable because of convoluted provisions of the tax code. (You definitely do not want to
try this at home.) In short, Hancock paid Hoosier $300 million to lease a power plant for 63
years, which Hoosier then leased back for 30 years
But Hancock foresaw some risks: What if the power station became unprofitable? What
if Hoosier stopped paying rent? (What would Hancock do if it was stuck with a power plant?)
To mitigate these risks, it asked to Hoosier to secure a credit-default swap (CDS). A CDS is a
financial contract that acts as insurance against a loan default and other contingencies. Ambac
Assurance Corporation, the CDS provider, agreed to pay Hancock if certain events occurred.
One of those triggering events was a decline in Ambac’s own credit rating below a certain level.
In that case, Hoosier had to find a replacement swap partner. If Hoosier was unsuccessful,
Ambac would pay Hancock $120 million.
And then came 2008—and a global financial crisis. ’Ambac’s credit rating plummeted,
along with pretty much everyone else’s. Hancock demanded that Hoosier find a replacement,
but Hoosier stalled. If it replaced Ambac, it would have to pay big money—enough to send
Hoosier into bankruptcy. So Hoosier sued, requesting an injunction to suspend its duty to find a
swap partner. It claimed that the global financial crisis rendered its performance impossible—or
at the very least, “temporarily impracticable” until the economy improved. The lower court
sympathized with Hoosier and granted the injunction. Hancock appealed.
Issue: Did the global credit crisis render performance impossible?
Excerpts from Judge Easterbrook’s Decision: Like other states, New York recognizes the
doctrine of impossibility—but even then only the kind of impossibility that the parties could
not have anticipated. Here, the parties anticipated the possibility that Hoosier, Ambac, or both
might get into financial distress and provided what was to happen
Suppose that Hoosier had an in-the-money option to purchase the Indianapolis Colts,
and that as a result of the reduced availability of credit it was unable to find a lender to finance
the transaction. That would not make performance “impossible.” The “impossibility” doctrine
never justifies failure to make a payment, because financial distress differs from impossibility.
It is hard to see why Hoosier should be able to stiff John Hancock, just because the very
risk specified in the contract has occurred. Hoosier did not expect an economic downturn.
Downturns are types of things that happen, and against which contracts can be designed. When
they do happen, the contractual risk allocation must be enforced rather than set aside.
The district court called the credit crunch of 2008 a “once-in-a-century” event. That’s an
overstatement (the Great Depression occurred within the last 100 years, and the 20th Century
also saw financial crunches in 1973 and 1987), and also irrelevant. An insurer that sells
hurricane or flood insurance against a “once in a century” catastrophe, or earthquake insurance
in a city that rarely experiences tremblors, can’t refuse to pay on the ground that, when a
natural event devastates a city, its very improbability makes the contract unenforceable.
The defense works only if some unexpected event upsets all parties’ expectations; it is
not enough that the unexpected event puts one side in a bind. Financial distress could be and
was foreseen; that’s what the credit-default swap is all about.
Question: What is an injunction?
Question: Why didn’t the global credit crisis render performance impossible?
Force Majeure Clauses
You are an executive vice-president of StikM, a company that manufactures various adhesive products
and sells them to manufacturers and retailers. Your company uses large quantities of Apocryphonium,
an essential chemical that is manufactured by only one corporation, ToxIck. You are negotiating with
ToxIck for a three-year requirements contract for Apocryphonium.
Question: First, a refresher: what is a requirements contract?
Answer: In a requirements contract, the buyer (StikM) agrees to purchase 100 percent of its needs for
You are able to agree with ToxIck on most of the important contract terms, including the quantities that
Question: What problems might this force majeure clause cause you?
Answer: Its language is quite broad. Although such open-ended clauses are very common, you may
None of these is a rare event—which means agreeing to a force majeure clause can expose one to
one.
Question: What steps can one take to protect against nonperformance based on force majeure?
Answer: Attempt to pass through the risk in contracts with your own buyers with a clause that
Multiple Choice Questions
1. CPA QUESTION: Nagel and Fields entered into a contract in which Nagel was obligated to
deliver certain goods by September 10. On September 3, Nagel told Fields that he had no intention
of delivering the goods. Prior to September 10, Fields may successfully sue Nagel under the
doctrine of:
(a) promissory estoppel
(b) accord and satisfaction
(c) anticipatory breach
(d) aubstantial performance
2. Most contracts are discharged by:
(a) agreement of the parties
(b) full performance
(c) failure of conditions
(d) commercial impracticability
(e) a material breach
3. If a contract contains a condition precedent, the ____ has the burden of proving that the condition
actually happened. If a condition subsequent exists, the ____ has the burden of showing that the
condition occurred.
(a) plaintiff; plaintiff
(b) plaintiff; defendant
(c) defendant; plaintiff
(d) defendant; defendant
4. Big Co., a construction company, builds a grocery store. The contract calls for a final price of $5
million. Big Co. incurred $4.5 million in costs and stands to make a profit of $500,000. On a final
inspection, the grocery store owner is upset. His blueprints called for 24 skylights, but the finished
building has only 12. Installing the additional skylights would cost $100,000. Big Co. made no
other errors. How much must the grocery store owner pay Big Co.?
(a) $5,000,000
(b) $4,900,000
(c) $4,500,000
(d) $0
5. Lenny makes K2, a synthetic form of marijuana, in his basement. He signs an agreement with the
Super Smoke Shop to deliver 1000 cans of K2 for $10,000. After the contract is signed, but before
the delivery, Super Smoke Shop's state legislature makes the sale of K2 illegal. Lenny's contract
will be discharged because of ____.
(a) true impossibility
(b) commercial impracticability
(c) frustration of purpose
(d) none of the above
Case Questions
1. ETHICS Commercial Union Insurance Co. (CU) insured Redux, Ltd. The contract made CU liable
for fire damage, but stated that the insurer would not pay for harm caused by criminal acts of any
Redux employees. Fire destroyed Redux’s property. CU claimed that the “criminal acts” clause
was a condition precedent, but Redux asserted it was a condition subsequent. What difference does
it make, and who is legally right? Does the insurance company’s position raise any ethical issues?
Who drafted the contract? How clear were its terms?
Answer: The type of condition determines who must prove the source of the fire. CU claimed that
the clause was a condition precedent, meaning that Redux had the burden of proving the fire was
not arson. Redux argued that the clause was a condition subsequent, meaning that CU became
liable to pay benefits as soon as the fire started, and could escape its duty only if the insurer proved
Redux had committed arson. The court agreed with Redux, held that the clause was a condition
subsequent, and placed the burden on CU to prove arson. Redux, Ltd. v. Commercial Union Ins.
2. Stephen Muka owned U.S. Robotics. He hired his brother Chris to work in the company. His letter
promised Chris $1 million worth of Robotics stock at the end of one year, “provided you work
reasonably hard & smart at things in the next year.” (We should all have such brothers.) Chris
arrived at Robotics and worked the full year, but toward the end of the year Stephen died. His
estate refused to give Chris the stock, claiming their agreement was a personal satisfaction contract
and only Stephen could decide whether Chris had earned the reward. Comment.
Answer: The estate is right that this is a personal satisfaction contract, given the nature of Chris's
work and the “provided you work reasonably hard” language. But it errs in concluding that only
3. Ken Ward was an Illinois farmer who worked land owned by his father-in-law, Frank Ruda. To
finance his operation, he frequently borrowed money from Watseka First National Bank, paying
back the loans with farming profits. But Ward fell deeper and deeper into debt and Watseka became
concerned. When Ward sought additional loans, Watseka insisted that Ruda become a guarantor on
all of the outstanding debt, and the father-in-law agreed. The new loans had an acceleration clause,
permitting the bank to demand payment of the entire debt if it believed itself “insecure,” that is, at
risk of a default. Unfortunately, just as Ward’s debts reached more than $120,000, Illinois suffered a
severe drought, and Ward’s crops failed. Watseka asked Ruda to sell some of the land he owned to
pay back part of the indebtedness. Ruda reluctantly agreed but never did so. Meanwhile, Ward
decreased his payments to the bank because of the terrible crop. Watseka then “accelerated” the
loan, demanding that Ruda pay off the entire debt. Ruda defended by claiming that Watseka’s
acceleration at such a difficult time was bad faith. Who should win?
Answer: The bank won. Good faith in this setting requires that the bank honestly believe itself to
be insecure, and that there be some basis for the belief. The bank honestly did consider itself at
4. Loehmann’s clothing stores, a nationwide chain with headquarters in New York, was the anchor
tenant in the Lincoln View Plaza Shopping Center in Phoenix, Arizona, with a 20-year lease from
the landlord, Foundation Development, beginning in 1978. Loehmann’s was obligated to pay rent
the first of every month and to pay common area charges four times a year. The lease stated that if
Loehmann’s failed to pay on time, Foundation could send a notice of default, and that if the store
failed to pay all money due within 10 days, Foundation could evict. On February 23, 1987,
Foundation sent to Loehmann’s the common area charges for the quarter ending January 31, 1987.
The balance due was $3,500. Loehmann’s believed the bill was in error and sent an inquiry on
March 18, 1987. On April 10, 1987, Foundation insisted on payment of the full amount within 10
days. Foundation sent the letter to the Loehmann’s store in Phoenix. On April 13, 1987, the
Loehmann’s store received the bill and, since it was not responsible for payments, forwarded it to
the New York office. Because the company had moved offices in New York, a Loehmann’s officer
did not see the bill until April 20. Loehmann’s issued a check for the full amount on April 24 and
mailed it the following day. On April 28 Foundation sued to evict; on April 29 the company
received Loehmann’s check. Please rule.
Answer: Loehmann's violated the lease by failing to pay common charges within 10 days of the
default letter, regardless of whether 10 days is measured from the day of mailing or receipt. But
5. You Be the Judge: WRITING PROBLEM Kuhn Farm Machinery, a European
company, signed an agreement with Scottsdale Plaza Resort, of Arizona, to use the resort for its
North American dealers’ convention during March 1991. Kuhn agreed to rent 190 guest rooms and
spend several thousand dollars on food and beverages. Kuhn invited its top 200 independent dealers
from the United States and Canada and about 25 of its own employees from the United States,
Europe, and Australia, although it never mentioned those plans to Scottsdale.
On August 2, 1990, Iraq invaded Kuwait and on January 16, 1991, the United States and allied
forces were at war with Iraq. Saddam Hussein and other Iraqi leaders threatened terrorist acts
against the United States and its allies. Kuhn became concerned about the safety of those traveling
to Arizona, especially its European employees. By mid-February, 11 of the top 50 dealers with
expense-paid trips had either canceled their plans to attend or failed to sign up. Kuhn postponed the
convention. The resort sued. The trial court discharged the contract under the doctrines of
commercial impracticability and frustration of purpose. The resort appealed. Did commercial
impracticability or frustration of purpose discharge the contract?
Argument for Scottsdale Plaza Resort: The resort had no way of knowing that Kuhn anticipated
bringing executives from Europe, and even less reason to expect that if anything interfered with
their travel, the entire convention would become pointless. Most of the dealers could have attended
the convention, and the resort stood ready to serve them.
Argument for Kuhn: The parties never anticipated the threat of terrorism. Kuhn wanted this
convention so that its European executives, among others, could meet top North American dealers.
That is now impossible. No company would risk employee lives for a meeting. As a result, the
contract has no value at all to Kuhn, and its obligations should be discharged by law.
Answer: Reversed. Summary judgment granted for Scottsdale Plaza, with the case remanded to
the trial court to assess damages. Kuhn has no legitimate claim for impossibility or
impracticability. Kuhn does not and cannot allege that it was impossible for it to perform, but
Discussion Questions
1. Evans built a house for Sandra Dyer, but the house had some problems. The garage ceiling was too
low. Load-bearing beams in the “great room” cracked and appeared to be steadily weakening. The
patio did not drain properly. Pipes froze. Evans wanted the money promised for the job, but Dyer
refused to pay. Comment.
Answer: This case creates an issue of substantial performance. The court held that the low garage
ceiling was a minor problem and would not defeat substantial performance. But the cracked beams
were very serious and might require major reconstruction. The water collecting in the patio could
2. Krug International, an Ohio corporation, had a contract with Iraqi Airways to build aeromedical
equipment for training pilots. Krug then contracted for Power Engineering, an Iowa corporation, to
build the specialized gearbox to be used in the training equipment, for $150,000. Power did not
know that Krug planned to resell the gearbox to Iraqi Airways. When Power had almost completed
the gearbox, the Gulf War broke out and the United Nations declared an embargo on all shipments
to Iraq. Krug notified Power that it no longer wanted the gearbox. Power sued. Please rule.
Answer: Power wins. Although it was impossible for Krug to complete its deal with Iraqi
Airways, it was entirely possible for Krug to accept and pay for the gearbox. Defenses of
3. Westinghouse sold uranium in long-term contracts at fixed prices, betting that market prices would
be stable or fall (as they had been). But this was a bad bet: Uranium prices skyrocketed as a result
of a cartel. Faced with large losses if it had to fulfill its contracts, Westinghouse argued that the
unanticipated spike in uranium prices made its performance impossible. Should Westinghouse be
freed of its contractual duties to sell uranium at a loss?
Answer: The argument failed; the court observed that Westinghouse and its customers had
negotiated over the risk of higher prices for uranium, and that the occurrence of the risk did not
4. Jacobs Builders entered into a contract with Kent to build him a home. The agreement stated that
Jacobs would use only certain brand-name materials. Upon completion of the home, Kent
discovered that Jacobs had installed high-quality, but not brand-name, pipes throughout the house.
This was an oversight, which even the architect failed to catch. Kent asked Jacobs to replace all the
pipes, but this meant destroying all of the floors and walls in the house. Should Kent have to
rebuild the house to get paid?
Answer: Based on Jacobs & Young v. Kent, 230 N.Y. 239 (1921). In this case, Justice Cardozo laid
out the doctrine of substantial performance. To Cardozo, denying the contractor recovery because
5. Franklin J. Moneypenny hires Angela to paint his portrait. She is to be paid $50,000 if the painting
is acceptable "in Franklin's sole judgment." At the big unveiling, 99 of 100 attendees think that
Angela has done a masterful job. Franklin disagrees. He thinks the painting makes him look like a
toad. (He does in fact look like a toad, but he does not like to contemplate this fact.) Franklin
refuses to pay, and, because he signed a personal satisfaction contract, Angela gets nothing. Is this
fair? Should the law allow personal satisfaction contracts?
