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Chapter 10

Nature and Terminology See Separate Lecture Outline System

INTRODUCTION

This chapter introduces the topic of contracts by defining a number of terms, giving an overview ofthe topic, and looking at the judicial interpretation of contracts. At this point in a discussion of contracts, itmay be advisable to point out that learning the definitions of offer, acceptance, valid, voidable, and the otherterms in this chapter are only a starting point. Memorizing theses definitions will not provide a completeunderstanding of the concepts.

Contract law shows what promises or commitments our society believes should be legally binding. Itshows what excuses our society will accept for the breaking of promises. And it shows what kinds of prom-ises will be considered to be against public policy and therefore legally void. The use of contract principles togovern the relationships of those who make promises to one another dates back thousands of years. Early inhistory the importance of contracts was recognized and given legal effect. Modern capitalist society couldnot exist without the law of contracts. The foundation for most commercial activity is the contract. We couldnot order our daily activities without contracts. The chapters in the contracts unit explain how contractsare formed, how they are discharged, and what happens when they are not performed.

ADDITIONAL RESOURCES—

AUDIO & VIDEO SUPPLEMENTS

The following audio and video supplements relate to topics discussed in this chapter—

190 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, ELEVENTH EDITION

PowerPoint Slides

To highlight some of this chapter’s key points, you might use the Lecture Review PowerPointslides compiled for Chapter 10.

South-Western’s Business Law Video Series

The situational video Contracts illustrates material covered in this chapter.

CHAPTER OUTLINE

I. An Overview of Contract Law

A. SOURCES OF CONTRACT LAWContract law is common law. The common law governs all contracts except when statutory lawor administrative agency regulations have been modified or replaced it. Statutorylaw—particularly the Uniform Commercial Code (UCC)—governs all contracts for the sale ofgoods. It should be stressed that it is essential to know when the UCC applies.

B. THE FUNCTION OF CONTRACT LAWContract law is needed to ensure compliance with a promise or to entitle a nonbreaching party torelief when a contract is breached. All contractual relationships involve promises, but all prom-ises do not establish contractual relationships. Most contractual promises are kept; keeping apromise is generally in the mutual self-interest of the promisor and the promisee.

C. DEFINITION OF A CONTRACTA contract is a promise for the breach of which the law gives a remedy or the performance ofwhich the law recognizes as a duty (in other words, an agreement that can be enforced in court).A contract may be formed when two or more parties each promise to perform or to refrain fromperforming some act now or in the future. A party who does not fulfill his or her promise may besubject to sanctions, including damages or, under some circumstances, being required to per-form the promise.

D. THE OBJECTIVE THEORY OF CONTRACTSThe intent to enter into a contract is important in the formation of a contract. The objective the-ory of contracts determines intent. Under this theory, a party’s intention to enter into a contractis judged by outward, objective facts as a reasonable person would interpret them, rather thanby the party’s own secret, subjective intentions. Objective facts include: (1) what the party said;(2) how the party acted or appeared; and (3) the circumstances surrounding the transaction.

II. Elements of a ContractThe four essential elements of a contract are (1) agreement, (2) consideration, (3) contractual capac-ity, and (4) legality. Defenses to the formation or enforcement of a contract include (1) genuineness ofassent and (2) form.

III. Types of ContractsEach of these categories signifies a legal distinction regarding a contract’s formation, performance, orenforceability.

CHAPTER 10: NATURE AND TERMINOLOGY 191

SPECIAL EXHIBIT—

Types of Contracts

The following illustration summarizes the types of contracts discussed in the text.

BILATERALA promise for a promise

UNILATERALA promise for an act

EXPRESSFormed by words

IMPLIED IN FACTFormed at least in part by the

parties’ conduct

QUASI CONTRACTImposed by law to prevent

unjust enrichment

FORMALRequires a special form for

creation

INFORMALRequires no special form for

creation

EXECUTEDA fully performed contract

EXECUTORYA contract not yet fully

performed

VALIDA contract that has the

necessary elements

VOIDNo contract, or a contractwithout legal obligation

VOIDABLEA contract that a party hasthe option of avoiding or

enforcing

UNENFORCEABLEA valid contract that cannotbe enforced because of a legal

defense


A. CONTRACT FORMATIONThese contracts are based on how and when a contract is formed.

1. Bilateral v. Unilateral ContractsEvery contract involves at least two parties: an offeror and an offeree. The offeror prom-ises to do or not to do something. Whether a contract is unilateral or bilateral depends onwhat the offeree must do to accept. A bilateral contract is a promise for a promise; if an of-feree can accept simply by promising to perform, a contract is bilateral. A unilateralcontract is a promise for an act; if an offeree can accept only by complete performance, acontract is unilateral. A unilateral contract’s offer becomes irrevocable once substantialperformance is completed.

ANSWER TO VIDEO QUESTION LTR. A

In the video, Renfro (Robert Downey, Jr.) says to Bowfinger (Steve Martin), “You bring methis script and Kit Ramsey and you’ve got yourself a ‘go’ picture.” Assume for the purposesof this question that their agreement is a contract. Is the contract bilateral or unilateral?Is it express or implied? Is it formal or informal? Is it executed or executory? Explain youranswers. The contract between Bowfinger and Renfro is unilateral, as Renfro’s offer is phrased sothat Bowfinger can only accept by completing the contract performance (giving Renfro the script andarranging for Kit Ramsey to act in the movie). The contract is express because its terms were fullyand explicitly stated in words. The contract required no special form or method of creation, so it isinformal. Because the contract has not yet been fully performed on both sides, it is executory.

CASE SYNOPSIS—

Case 10.1: Ardito v. City of Providence

The City of Providence, Rhode Island, decided to begin hiring police officers to fill vacancies in itspolice department. Because only individuals who graduated from the Providence Police Academywere eligible, the city also decided to conduct two training sessions, the “60th and 61st PoliceAcademies.” The applicants deemed most qualified were sent a letter informing them that they hadbeen selected to attend if they successfully completed a medical examination and a psychological ex-amination. The letter to the applicants to the 61st Academy, dated October 15, stated that it was “aconditional offer of employment.” Meanwhile, a new Chief of Police, Dean Esserman, decided to revisethe selection process, which caused some of those who had received the letter to be rejected. DerekArdito and thirteen other newly rejected applicants filed a suit in a federal district court against thecity, alleging in part that the city was in breach of contract.

The court issued an injunction to prohibit the city from conducting the 61st Police Academy un-less the plaintiffs were included. The October 15 letter was a unilateral offer that the plaintiffs hadaccepted by passing the required medical and psychological examinations—”a classic example of anoffer to enter into a unilateral contract. The October 15 letter expressly stated that it was a ‘condi-tional offer of employment’ and the message that it conveyed was that the recipient would be admit-ted into the 61st Academy if he or she successfully completed the medical and psychological examina-tions, requirements that the City could not lawfully impose unless it was making a conditional offer ofemployment. ... The plaintiffs accepted the City’s offer of admission into the Academy by satisfyingthe specified conditions.”

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Notes and Questions

As part of the application process, the applicants had been sent a booklet, and had been asked toacknowledge in their applications, that they understood successful completion of each step in theevaluation process did not necessarily guarantee acceptance into the Academy. The city pointed thisout to the court. What was the court’s response? The city’s argument that “the plaintiffs did noteven have a contractual right to be admitted into the Academy because ... they acknowledged un-derstanding” that acceptance was not guaranteed “overlooks the fact that the October 15 letter wasmore than a mere notification that the plaintiffs had successfully completed another step in theevaluation process. As already noted, it was a conditional offer of admission to the 61st Academy,which the plaintiffs accepted by performing the specified conditions.”

Why didn’t the court simply deny relief to the plaintiffs on the ground that the selectionprocess had been revised? This result would have required the court to deny the enforcement of theparties’ contract, which would have undercut the parties’ reasonable expectations. Without a legalframework of reasonably assured expectations within which to plan and act, one person would not beable to rely on the good faith of another. This inability would inhibit entering into contracts generally,which would obstruct, or even stifle, the smooth operation of our market economy.

ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?” IN CASE 10.1Suppose that the October 15 letter had used the phrase “potential offer of employment”

instead of using the word “conditional.” Would the court in this case still have consideredthe letter to be a unilateral contract? Why or why not? This might have been acceptable, depend-ing on each party’s interpretation of the word “potential,” but it might have required splitting hairsbecause of the words “offer of employment.” The city would have done better to phrase its October 15letter in the same terms as its other letters to the applicants to avoid the letter’s being considered acontract. Specifically, the city should not have used the phrase “conditional offer of employment.”

ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”QUESTION IN CASE 10.1

Why did the court order the city to stop the 61st Police Academy unless the plaintiffs wereincluded? The court reasoned that the letter to the rejected applicants was a unilateral offer thatthe plaintiffs had accepted by passing the required medical and psychological examinations. Theletter expressly stated that it was a “conditional offer of employment” and “the message that itconveyed was that the recipient would be admitted into the 61st Academy if he or she successfullycompleted the medical and psychological examinations, requirements that the City could not lawfullyimpose unless it was making a conditional offer of employment.” Furthermore, “[t]he plaintiffsaccepted the City’s offer of admission into the Academy by satisfying the specified conditions. Each ofthe plaintiffs submitted to and passed lengthy and intrusive medical and psychological examinations.In addition, many of the plaintiffs, in reliance on the City’s offer, jeopardized their standing with theirexisting employers by notifying the employers of their anticipated departure, and some plaintiffspassed up opportunities for other employment.”

2. Formal v. Informal ContractsFormal contracts require a special form or method of formation to be enforceable. Formalcontracts include contracts under seal, which are writings with a special seal attached, and


letters of credit. All other contracts are informal contracts, or simple contracts. For these,no special form is required (except for certain types of contracts that must be in writing).

3. Express v. Implied-in-Fact Contracts• An express contract is one in which the terms are expressed in words, oral or written.• A contract that is implied from the conduct of the parties is an implied-in-fact contract,

or simply an implied contract. The parties’ conduct reveals that they intended to forma contract and creates and defines its terms.

• To establish an implied-in-fact contract: (1) the plaintiff must have furnished some ser-vice or property; (2) the plaintiff must have expected to be paid and the defendant knewor should have known that payment was expected; and (3) the defendant had a chanceto reject the service or property and did not.

CASE SYNOPSIS—

Case 10.2: Gary Porter Construction v. Fox Construction, Inc.

The University of Utah contracted with Fox Construction, Inc., to build a Women’s GymnasticsTraining Facility. Fox subcontracted with Gary Porter Construction to do excavation and soil place-ment work, according to specific sections of the project’s plans (the “Included Sections”), for $146,740.Later, Fox asked Porter to do more work that was not in the subcontract (the “Excluded Sections”).Porter did all of the work, but Fox refused to pay more than the amount of the subcontract, claimingthat the added work had been mistakenly excluded. Porter filed a suit in a Utah state court againstFox, alleging, among other things, breach of an implied-in-fact contract. The court granted Porter’smotion for summary judgment. Fox appealed.

The state intermediate appellate court affirmed. Porter met the requirements for an implied-in-fact contract: Porter provided its services at Fox’s request, expecting to be paid, which Fox knew orshould have known. “(1) Jeff Wood, Fox’s project manager, drafted the subcontract which containsonly the Included Sections; (2) Fox repeatedly asked Porter to perform work outside the subcontractunder the Excluded Sections; (3) Porter performed all work identified in the subcontract as well asthe requested work under the Excluded Sections; (4) for months, Fox reviewed and paid *** billsfrom Porter which identified the work performed, the costs of the work, and the specific section underwhich the work was done; [and] (5) at times, Fox acknowledged that Porter was performing work out-side the subcontract.”

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Notes and Questions

If Porter had not done the work under the “Excluded Sections,” could Fox have recov-ered for breach of contract? Yes, presumably, although the parties would then have been arguingopposite sides of the question of the existence of the contract. If Porter had done the work underthe “Excluded Sections” but had not done it well, could Fox have maintained a claim forbreach of contract? Yes. In a contract for work, there is an implied duty to do the work skillfully,carefully, and in a workmanlike manner. It would constitute a clear breach off contract to fail to per-form the work in a skillful and workmanlike manner.

What might be the most important term of an implied contract to perform work? In a con-tract for work, there is an implied duty to do the work skillfully, carefully, and in a workmanlikemanner.


ANSWER TO “THE ETHICAL DIMENSION” QUESTION IN CASE 10.2

Should a court accept without proof a party’s assertion that something was or was notdone “by mistake”? Explain. No, in part because the temptation might be irresistible to make thiscontention in almost any case. Thus, even if it were legal, as it would be if a court were to accept it, itcould be unethical, encouraged by avarice or self-interest, or caused by carelessness.

ANSWER TO “THE E-COMMERCE DIMENSION”QUESTION IN CASE 10.2

Would the outcome of this case have been different if the parties had communicated viaan e-mail system that limited the size of the documents that they could transmit to eachother? Why or why not? This might have supported Fox’s argument that the “Excluded Sections”were omitted from the parties’ contract by “mistake.” The outcome likely would not have beendifferent, however, because the court based its decision not solely on a lack of proof as to how the“mistake” occurred. More significantly, there was a lack of evidence that Porter should have knownabout the “mistake.”

ADDITIONAL CASES ADDRESSING THIS ISSUE —

Recent cases considering whether an implied-in-fact contract existed in particular circum-stances include the following.

• Detroit Tigers, Inc. v. Ignite Sports Media, LLC, 203 F.Supp.2d 789 (E.D.Mich. 2002) (a majorleague baseball team stated a claim for breach of an implied-in-fact contract by alleging that the op-erator of an Internet Web site created and ran the team’s official site, and the team licensed itstrademarks, as part of a sophisticated commercial transaction, despite the absence of details regard-ing the nature of the contract and its breach).

• Union Light & Power Co. v. District of Columbia Department of Employment Services, 796 A.2d665 (D.C.App. 2002) (a subcontractor was held solely liable for paying benefits on the death of anemployee killed in a work-related accident when, at the time of the accident, the decedent was per-forming “a voluntary act which arose out of and in the course of his employment with Union Light”and there was no implied contract establishing that he was a special, borrowed, or joint employee).

• Ward v. National Geographic Society, 208 F.Supp.2d 429 (S.D.N.Y. 2002) (there may have beenan implied-in-fact contract between an author/photographer, who contributed freelance articles andpictures to a magazine, and the magazine, in the author’s copyright infringement suit against themagazine, when there was an industry custom that freelance contributors retained the copyright totheir contributions).

B. CONTRACT PERFORMANCEContracts are also classified according to their stage of performance. A contract that has beenperformed is an executed contract. A contract that has not been performed is an executory con-tract. If one party has fully performed but the other has not, the contract is said to be executedon the one side and executory on the other, and it is classified as executory.


ENHANCING YOUR LECTURE—

AVOIDING UNINTENDED EMPLOYMENT CONTRACTS Employers have learned many lessons from court decisions. In recent years, for example, the

message has been clear that employers should be cautious about what they say in their employmentmanuals.

EMPLOYMENT MANUALS AND IMPLIED-IN-FACT CONTRACTS

Promises made in an employment manual may create an implied-in-fact employment contract. Ifan employment handbook states that employees will be fired only for specific causes, the employermay be held to that “promise.” Even if, by state law, employment is “at will”—that is, the employer isallowed to hire and fire employees at will, with or without cause—the at-will doctrine will not apply ifthe terms of employment are subject to a contract between the employer and the employee. If a courtholds that an implied employment contract exists—on the basis of promises made in an employmentmanual—the employment is no longer at will. The employer will be bound by the contract and liablefor damages for breaching the contract.

TAKING PRECAUTIONS

Employers who wish to avoid potential liability for breaching unintended employment contractsshould therefore make it clear to employees that the policies expressed in an employment manual arenot to be interpreted as contractual promises. An effective way to do this is to inform employees,when initially giving them the handbook or discussing its contents with them, that the handbook isnot intended as a contract and to include a disclaimer to that effect in the employment manual. Thedisclaimer might read as follows: “This policy manual describes the basic personnel policies andpractices of our Company. You should understand that the manual does not modify our Company’s‘at will’ employment doctrine or provide employees with any kind of contractual rights.”

The employer should make the disclaimer clear and prominent so that the applicant cannot laterclaim that it was the employer’s fault that the employee did not see the disclaimer. A disclaimer willbe clear and prominent if it is set off from the surrounding text by the use of larger type, a differentcolor, all capital letters, or some other device that calls the reader’s attention to it.

In the handbook, the employer should also avoid making definite promises that employees will befired only for cause, that they will not be fired after they have worked for a certain length of time ex-cept for certain reasons, or the like. The handbook itself should include a clear and prominent dis-claimer of contractual liability for its contents.

CHECKLIST FOR THE EMPLOYER

1. Inform new employees that statements in an employment handbook are not intended as contrac-tual terms.

2. Include a clear and prominent disclaimer to this effect in employment applications.

3. Avoid including in the handbook any definite promises relating to job security, and include a clearand prominent disclaimer of contractual liability for any statements made within the handbook.

C. CONTRACT ENFORCEABILITYA valid contract results when all of the elements necessary to contract formation exist—whenthe parties agree, through an offer and an acceptance, to form a contract; the contract is sup-


ported by consideration; the contract is for a legal purpose; and the parties had legal capacity tocontract.

1. Voidable ContractsA voidable contract is a valid contract in which one or both of the parties have the option ofavoiding his or her legal obligations. If the contract is avoided, both parties are released. Ifit is ratified, both parties must perform.

2. Unenforceable ContractsAn unenforceable contract is a valid contract that cannot be enforced due to certain defenses.For example, a valid contract barred by a statute of limitations is an unenforceable contract.

3. Void ContractsA contract that is void is no contract. A void contract gives rise to no legal obligation on thepart of any party. An illegal contract is, for example, a void contract.

ANSWER TO VIDEO QUESTION LTR. C

Recall from the video that the contract between Bowfinger and the producer was oral.Suppose that a statute requires contracts of this type to be in writing. In that situation,would the contract be void, voidable, or unenforceable? Explain. A valid contract that is ren-dered unenforceable by some statute or law and cannot be enforced because of legal defenses is con-sidered unenforceable. In this situation, Renfro has a legal defense because the contract was not inwriting although a statute required it to be. Thus, the contract between Bowfinger and Renfro wouldbe unenforceable rather than void (as when one party is legally insane) or voidable (as when oneparty has the option to avoid the contract).

IV. Quasi ContractsA quasi contract is not based on an express promise to pay for a benefit received or on conduct imply-ing such a promise. Quasi contracts, or contracts implied in law, are imposed by courts to avoid un-just enrichment—the theory that individuals should not be allowed to profit or enrich themselvesinequitably at the expense of others.

A. LIMITATIONS ON QUASI CONTRACTUAL RECOVERYThere are situations in which the recipient of a benefit is not liable. People cannot normally beforced to pay for benefits thrust on them, for example.

B. WHEN AN ACTUAL CONTRACT EXISTSA quasi contract will not normally be imposed when there is a contract that covers the matter.

V. Interpretation of ContractsThe most important principle to keep in mind in considering these rules is that the law attempts notjust to enforce a contract but to enforce the contract the parties made.

A. THE PLAIN MEANING RULEWhen a contract is in writing that is not subject to conflicting meanings, a court will enforce thewriting according to its plain meaning. Under this plain meaning rule, the meaning of the wordsmust be determined from the face of the instrument—a court cannot consider evidence extrinsicto the document.


CASE SYNOPSIS—

Case 10.3: Wagner v. Columbia Pictures Industries, Inc.

Robert Wagner entered into an agreement with Spelling-Goldberg Productions (SGP over therights to “Charlie's Angels.” The contract entitled Wagner to 50 percent of the net profits that SGPreceived “for the right to exhibit photoplays of the series and from the exploitation of all ancillary,music and subsidiary rights.” SGP hired Ivan Goff and Ben Roberts to write the episodes of the“Charlie’s Angels” television series under a contract that gave the writers the right to make andmarket films based on the material. In 1995, Columbia bought the movie rights to the material fromthe writers’ heirs. In 2000 and 2003, Columbia produced and distributed two “Charlie's Angels” films.Wagner filed a suit in a California state court against Columbia, claiming a share of the profits fromthe films. The court issued a summary judgment in Columbia's favor. Wagner appealed.

A state intermediate appellate court affirmed. The contract “unambiguously” stated theconditions under which the parties were to share the films’ profits, and those conditions had notoccurred. An “agreement is the writing itself.” Extrinsic evidence is not admissible “to show intentionindependent of an unambiguous written instrument.” In this case, even if the parties intendedWagner to share in the profits from all sources, “they did not say so in their contract.” Under thecontract, Wagner was entitled to share in the profits from the exercise of the movie rights to“Charlie's Angels” if those rights were exploited as “ancillary” or “subsidiary” to the primary “right toexhibit photoplays of the series” but not if those rights were acquired separately. Columbia obtainedthose rights separately.

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Notes and Questions

This case can be used a springboard to explain the parol evidence rule, which is discussed morefully in a later chapter. Under this rule, parol evidence of the negotiations underlying a contract isadmissible to explain, but not to contradict, the meaning of its terms. Did Wagner’s offeredevidence of the “Love Song” agreement explain or contradict the “Charlie’s Angels”contract? The court concluded, “The problem with Wagner's extrinsic evidence is that it does notexplain the contract language, it contradicts it. Under the parol evidence rule, extrinsic evidence isnot admissible to contradict express terms in a written contract. ... Thus, as Justice Holmesexplained, parol evidence is not admissible to show that when the parties ‘said five hundred feet theyagreed it should mean one hundred inches, or that Bunker Hill Monument should signify the OldSouth Church [Goode v. Riley, 153 Mass. 585, 28 N.E. 228 (1891)].’”

Under what circumstances might SGP have held the movie rights to “Charlie’s Angels”as “subsidiary” to its primary “right to exhibit photoplays of the series”? The court explainedthat “if SGP held the motion picture rights to ‘Charlie's Angels’ from the beginning or if it acquiredthem by exercising its [five-year] right ... as producer to purchase the rights from Goff andRoberts, then it could be said to have acquired those rights by exploiting its right to exhibitphotoplays of the series and [Wagner] would be entitled to a share of the profits. But if SGP ...purchased the motion picture rights to ‘Charlie's Angels’ on the open market, independent of anyright it had as producer of the TV series, then it could not be said to have acquired those rights byexploiting its right to exhibit photoplays of the series and [Wagner] would not be entitled to a share ofthe net profits.” With the substitution of Columbia for SGP, the latter is what occurred in this case.


ANSWER TO QUESTIONS AT THE END OF CASE 10.31. How might the result in this case have been different if the court had admitted theWagners’ extrinsic evidence of the “Love Song” contract”? In this circumstances, the courtmight have construed the language of the “Charlie’s Angels” contract to the same effect. But becauseColumbia acquired the movie rights to the property independent of any right it might have had inrelation to the television series, the court might still have considered the acquisition separate fromthe exploitation rights covered by the Wagner contract, and the result would have been the same.

2. Under what circumstance would the Wagners’ evidence of the “Love Song” contract havebeen irrelevant yet they still would have been entitled to a share of the profits from the“Charlie’s Angels” movies? The court explained that “if SGP held the motion picture rights to‘Charlie's Angels’ from the beginning or if it acquired them by exercising its [five-year] right ... asproducer to purchase the rights from Goff and Roberts, then it could be said to have acquired thoserights by exploiting its right to exhibit photoplays of the series,” which was the “unambiguous”meaning of the SGP contract with the Wagners. In that circumstance, the Wagners would have beenentitled to a share of the profits from the movies.

B. OTHER RULES OF INTERPRETATIONWhen the writing is unclear, a court will interpret the language to give effect to the parties’ in-tent as expressed in their contract. A court will not make or remake a contract nor interpret thelanguage according to what the parties claim their intent was when they made it. In interpret-ing the terms, the following rules apply. If the terms are still susceptible to more than one mean-ing, a court will consider extrinsic evidence.

1. A reasonable, lawful, and effective meaning will be given to all of a contract’s terms. 2. A contract will be interpreted as a whole; individual clauses will be considered subordinate

to the contract’s general intent. All writings that are part of the same transaction will beinterpreted together.

3. Terms that were negotiated separately will be given greater consideration than standard-ized terms and terms that were not negotiated separately.

4. A word will be given its ordinary, commonly accepted meaning, and a technical word orterm will be given its technical meaning, unless the parties clearly intended something else.

5. Specific and exact wording will be given greater consideration than general language. 6. Written or typewritten terms prevail over printed ones.7. When the language used has more than one meaning, it will be interpreted against the

party who drafted the contract.8. When evidence of trade usage, prior dealings between the parties, and previous course of

performance under the contract is admitted, what each of the parties does in pursuance ofthe contract will be interpreted as consistent with what the other does and with any rele-vant usage of trade and course of dealing and performance. In these circumstances, ex-press terms are given the greatest weight, followed by course of performance, course ofdealing, and usage of trade, in that order. When considering custom and usage, a court willlook at the customs and usage of trade of the particular business and the locale where thecontract was made or is to be performed.

ANSWER TO VIDEO QUESTION LTR. BWhat criteria would a court rely on to interpret the terms of the contract? When the terms

of a contract are clear, a court enforces it according to its plain terms. If the terms are not clear, a


court will give a reasonable, lawful, and effective meaning to all terms. The court interprets the con-tract as a whole, with specific clauses considered subordinate to the contract’s general intent.Greater consideration is given to terms that are negotiated separately over standardized terms andterms not negotiated separately. Words are given their commonly accepted meanings, and technicalwords are given their technical meanings unless the parties clearly intend otherwise. The courtgives greater consideration to specific wording over general language and considers written or type-written terms over preprinted terms. The court also interprets any ambiguous terms against theparty who uses them and considers evidence of prior dealing, course of performance, or usage oftrade to further clarify any ambiguous wording. Express terms are given the greatest weight, fol-lowed by course of performance, course of dealing, and custom and usage of trade—in that order.

ADDITIONAL BACKGROUND—

Restatement (Second) of Contracts, Sections 201, 202, 203, and 206

The terms of an agreement or promise generally define the obligation. When the parties to a con-tract have adopted a writing as the final expression of all or part of their agreement, interpretationfocuses on the writing. In the Restatement (Second) of Contracts, Sections 201, 202, 203, and206, general rules are provided concerning the determination or effect that the meaning of the prom-ise or agreement may have on the scope of contractual obligations. The following is the text of thosesections with Comments.

§ 201. Whose Meaning Prevails

(1) Where the parties have attached the same meaning to a promise or agreement or a term thereof,it is interpreted in accordance with that meaning.

(2) Where the parties have attached different meanings to a promise or agreement or a term thereof,it is interpreted in accordance with the meaning attached by one of them if at the time the agreementwas made

(a) that party did not know of any different meaning attached by the other, and the other knew themeaning attached by the first party; or

(b) that party had no reason to know of any different meaning attached by the other, and the otherhad reason to know the meaning attached by the first party.

(3) Except as stated in this Section, neither party is bound by the meaning attached by the other,even though the result may be a failure of mutual assent.

Comment:

a. The meaning of words. Words are used as conventional symbols of mental states, with standard-ized meanings based on habitual or customary practice. Unless a different intention is shown, lan-guage is interpreted in accordance with its generally prevailing meaning. See § 202(3). Usages ofvarying degrees of generality are recorded in dictionaries, but there are substantial differences be-tween English and American usages and between usages in different parts of the United States.Differences of usage also exist in various localities and in different social, economic, religious and eth-nic groups. All these usages change over time, and persons engaged in transactions with each otheroften develop temporary usages peculiar to themselves. Moreover, most words are commonly used inmore than one sense.


b. The problem of context. Uncertainties in the meaning of words are ordinarily greatly reduced bythe context in which they are used. The same is true of other conventional symbols, and the meaningof conduct not used as a conventional symbol is even more dependent on its setting. But the contextof words and other conduct is seldom exactly the same for two different people, since connotations de-pend on the entire past experience and the attitudes and expectations of the person whose under-standing is in question. In general, the context relevant to interpretation of a bargain is the contextcommon to both parties. More precisely, the question of meaning in cases of misunderstanding de-pends on an inquiry into what each party knew or had reason to know, as stated in Subsections (2)and (3). See § 20 and Illustrations. Ordinarily a party has reason to know of meanings in generalusage.

c. Mutual understanding. Subsection (1) makes it clear that the primary search is for a commonmeaning of the parties, not a meaning imposed on them by the law. To the extent that a mutual un-derstanding is displaced by government regulation, the resulting obligation does not rest on “inter-pretation” in the sense used here. The objective of interpretation in the general law of contracts is tocarry out the understanding of the parties rather than to impose obligations on them contrary totheir understanding: “the courts do not make a contract for the parties.” Ordinarily, therefore, themutual understanding of the parties prevails even where the contractual term has been defined dif-ferently by statute or administrative regulation. But parties who used a standardized term in anunusual sense obviously run the risk that their agreement will be misinterpreted in litigation.

Illustrations:

1. A and B agree that A will sell goods to B “f.o.b.” the place of destination. Prior correspondenceshows that the price has been adjusted on the assumption that B’s insurance policies will cover thegoods during shipment. Notwithstanding the normal meaning of the “f.o.b.” term declared in UniformCommercial Code § 2-319, it may be found that the parties have “otherwise agreed” under that sec-tion and that B bears the risk in transit.

2. A signs a negotiable promissory note payable to B’s order, and C signs his name on the back with-out more. Under Uniform Commercial Code § 3-402, C’s signature is an indorsement, and evidence ofa contrary understanding is not admissible except for the purpose of reformation of the instrument.This conclusion does not rest on interpretation of the writing.

3. A agrees to sell beer to B at a specified price per barrel. At the time of the agreement both partiesand others in their trade use as standard barrels wooden barrels which originally hold 31 gallonsand hold less as they continue in use. A statute defines a barrel as 31 1/2 gallons. The statute doesnot prevent interpretation of the agreement as referring to the barrels in use.

d. Misunderstanding. Subsection (2) follows the terminology of § 20, referring to the understanding ofeach party as the meaning “attached” by him to a term of a promise or agreement. Where the rulesstated in Subsections (1) and (2) do not apply, neither party is bound by the understanding of theother. The result may be an entire failure of agreement or a failure to agree as to a term. There maybe a binding contract despite failure to agree as to a term, if the term is not essential or if it can besupplied. See § 204. In some cases a party can waive the misunderstanding and enforce the con-tract in accordance with the understanding of the other party.

Illustrations:

4. A agrees to sell and B to buy a quantity of eviscerated “chicken.” A tenders “stewing chicken” or“fowl”; B rejects on the ground that the contract calls for “broilers” or “fryers.” Each party makes aclaim for damages against the other. It is found that each acted in good faith and that neither hadreason to know of the difference in meaning. Both claims fail.


5. A orders goods from B, using A’s standard form. B acknowledges the order, using his own stan-dard form. Each form provides that no terms are agreed to except those on the form and that theother party agrees to the form. One form contains an arbitration clause; the other does not. Thegoods are delivered and paid for. Later a dispute arises as to their quality. There is no agreement toarbitrate the dispute.

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§ 202. Rules in Aid of Interpretation

(1) Words and other conduct are interpreted in the light of all the circumstances, and if the principalpurpose of the parties is ascertainable it is given great weight.

(2) A writing is interpreted as a whole, and all writings that are part of the same transaction are in-terpreted together.

(3) Unless a different intention is manifested,

(a) where language has a generally prevailing meaning, it is interpreted in accordance with thatmeaning;

(b) technical terms and words of art are given their technical meaning when used in a transactionwithin their technical field.

(4) Where an agreement involves repeated occasions for performance by either party with knowledgeof the nature of the performance and opportunity for objection to it by the other, any course of perfor-mance accepted or acquiesced in without objection is given great weight in the interpretation of theagreement.

(5) Wherever reasonable, the manifestations of intention of the parties to a promise or agreement areinterpreted as consistent with each other and with any relevant course of performance, course ofdealing, or usage of trade.

Comment:

a. Scope of special rules. The rules in this Section are applicable to all manifestations of intention andall transactions. The rules are general in character, and serve merely as guides in the process of in-terpretation. They do not depend upon any determination that there is an ambiguity, but are used indetermining what meanings are reasonably possible as well as in choosing among possible meanings.

b. Circumstances. The meaning of words and other symbols commonly depends on their context; themeaning of other conduct is even more dependent on the circumstances. In interpreting the wordsand conduct of the parties to a contract, a court seeks to put itself in the position they occupied at thetime the contract was made. When the parties have adopted a writing as a final expression of theiragreement, interpretation is directed to the meaning of that writing in the light of the circumstances.See §§ 209, 212. The circumstances for this purpose include the entire situation, as it appeared tothe parties, and in appropriate cases may include facts known to one party of which the other hadreason to know. See § 201.

Illustrations:

1. A contracts with B to do concrete work on a bridge, to be paid for according to “the number ofsquare yards of concrete surface included in the bridge deck.” An estimate included in the proposalfor bids and an estimate submitted by A to B after award are shown to have been based on the topsurface only, not including the side and bottom surfaces. On a finding that this was the mutual un-derstanding, the contract is to be so interpreted.


2. In a written agreement between A and B it is stated that B owns half of the stock of C Company,that “A has rendered valuable services to C Company for which B desires to compensate A in the sumof $25,000 payable in the manner hereinafter set forth,” and that B will pay A “one-half of all moneyreceived from C Company, such as dividends, or profits until A has been paid the said amount of$25,000.” It is shown that the written agreement was executed after the services were rendered,that there was no prior explicit understanding that A would be compensated, and that before signingthe written agreement A and B orally agreed that the $25,000 was to be a “bonus out of B’s profit,”“double or nothing,” “a gamble.” The written agreement is to be interpreted in accordance with theoral agreement.

c. Principal purpose. The purposes of the parties to a contract are not always identical; particularlyin business transactions, the parties often have divergent or even conflicting interests. But up to apoint they commonly join in a common purpose of attaining a specific factual or legal result whicheach regards as necessary to the attainment of his ultimate purposes. Moreover, one party mayknow or have reason to know the purpose of the other and thus that his meaning is one consistentwith that purpose. Determination that the parties have a principal purpose in common requires in-terpretation, but if such a purpose is disclosed further interpretation is guided by it. Even languagewhich is otherwise explicit may be read with a modification needed to make it consistent with such apurpose.

Illustrations:

3. A promises B as follows: “In consideration of your supplying my nephew C with china and earthen-ware during the coming year, I guarantee the payment of any bills you may draw on him on accountthereof to the amount of $200.” C is engaged in the business of selling such goods. B sells C $2,000 ofchina during the year and draws bills for their price in varying amounts. C pays $1,000 and thendefaults. A’s promise is to be interpreted as a continuing undertaking, not limited to the first $200 ofpurchases.

4. A agrees with his divorced wife B and C, trustee, to pay to C $1,200 each year for the benefit of D,the 10-year-old son of A and B, until D enters college, and to pay $2,200 each year for the period ofD’s higher education but not more than four years. At age 19 D completes high school and isinducted into the army. Upon a finding that the main purpose of the agreement is to provide for D’smaintenance and education, the agreement is to be interpreted as not requiring payments during D’smilitary service.

d. Interpretation of the whole. Meaning is inevitably dependent on context. A word changes meaningwhen it becomes part of a sentence, the sentence when it becomes part of a paragraph. A longerwriting similarly affects the paragraph, other related writings affect the particular writing, and thecircumstances affect the whole. Where the whole can be read to give significance to each part, thatreading is ]preferred; if such a reading would be unreasonable, a choice must be made. See § 203.To fit the immediate verbal context or the more remote total context particular words or punctuationmay be disregarded or supplied; clerical or grammatical errors may be corrected; singular may betreated as plural or plural as singular.

Illustrations:

5. A written agreement between A and B for the exchange of real estate provides that A and B willeach pay a $200 commission to C, a broker, “upon the signing of this agreement by both partieshereto.” The last sentence of the agreement states, “The commission being due and payable upon thetransfer of the properties.” It is shown that A refused to sign the agreement until the last sentencewas added. The agreement is to be interpreted to make the commission due only when both thesigning and the transfer take place.


6. A agrees to appoint B exclusive distributor in a specified area for a new product to bemanufactured by A, and B agrees to use his best efforts to promote sale of the product. The writtenagreement includes an initial retail price list and a provision that A will sell to B at the lowest priceand highest discount it gives to any distributor. Whether the parties intend to be bound before anyother distributor is appointed or any price fixed is a question of the meaning of the entire agreementin its context. If they do, the agreement has the effect of an agreement to sell at a reasonable price atthe time for delivery. See Uniform Commercial Code § 2-305.

7. A contracts in writing to build a house for B according to specifications, and C, a surety company,guarantees A’s performance. After completion and acceptance the house and its contents are dam-aged by hot water because of defective work by the plumbing and heating subcontractor. In deter-mining the responsibility of A and C, the contract, specifications and surety bond are to be readtogether.

e. General usage. In the United States the English language is used far more often in a sense whichwould be generally understood throughout the country than in a sense peculiar to some locality orgroup. In the absence of some contrary indication, therefore, English words are read as having themeaning given them by general usage, if there is one. This rule is a rule of interpretation in the ab-sence of contrary evidence, not a rule excluding contrary evidence. It may also yield to internal indi-cations such as inconsistency, absurdity, or departure from normal grammar, punctuation, or wordorder.

Illustrations:

8. A issues to B a fire insurance policy covering lumber stored in “sheds.” In the absence of contraryindication, lumber in the basement of a two-story warehouse is not covered.

9. A leases restaurant premises to B. The lease provides that A will pay for electricity and that Bwill “pay for gas or fuel used in the preparation of food.” In the absence of contrary indication, “fuel”should be read not to include electricity.

f. Technical terms. Parties to an agreement often use the vocabulary of a particular place, vocationor trade, in which new words are coined and common words are assigned new meanings. But techni-cal terms are often misused, and it may be shown that a technical word or phrase was used in a non-technical sense. Moreover, the same word may have a variety of technical and other meanings.“Mules” may mean animals, shoes or machines; a “ram” may mean an animal or a hydraulic ram;“zebra” may refer to a mammal, a butterfly, a lizard, a fish, a type of plant, tree or wood, or merelyto the letter “Z”.

Illustrations:

10. The facts being otherwise as stated in Illustration 9, there is a local usage in the restaurant tradethat “fuel” includes electricity used in cooking. In the absence of contrary indication, “fuel” may beread in accordance with the usage. But a provision in the lease that if B installs a new electric rangehe will also install a special meter and pay for electricity used by the range would show that the par-ties did not adopt the local usage.

11. A contract for the sale of horsemeat scraps calls for “minimum 50% protein.” As both partiesknow, by a usage of the business in which they are engaged, 49.5 per cent is treated as the equiva-lent of 50 per cent. The contract is to be interpreted in accordance with the usage.

g. Course of performance. The parties to an agreement know best what they meant, and their actionunder it is often the strongest evidence of their meaning. But such “practical construction” is not con-clusive of meaning. Conduct must be weighed in the light of the terms of the agreement and their


possible meanings. Where it is unreasonable to interpret the contract in accordance with the courseof performance, the conduct of the parties may be evidence of an agreed modification or of a waiverby one party. See Uniform Commercial Code § 2-208. Or there may be simply a mistake whichshould be corrected. The rule of Subsection (4) does not apply to action on a single occasion or to ac-tion of one party only; in such cases the conduct of a party may be evidence against him that he hadknowledge or reason to know of the other party’s meaning, but self-serving conduct is not entitled toweight.

Illustrations:

12. A discloses to B a secret formula for an antiseptic liquid and B agrees to pay monthly royaltiesbased on amounts sold. Fifty years later the formula has been published in medical journals. Aftercontinuing to pay for 25 years more, B contends that the duty to pay royalties ended when the for-mula ceased to be secret. B’s conduct strongly negates the contention.

13. Several railroads agree in writing to share working expenses and taxes of X, another railroad, ona “wheelage basis.” For several years they pay shares in proportion to their stock ownership in theother railroad. Then all but one agree that they have been mistaken and that future payments willbe made on a basis of use of X’s physical properties. Stock ownership is so plainly unrelated to anypossible meaning of “wheelage” that the course of performance does not support an interpretation of“wheelage basis” as requiring payments in proportion to stock ownership.

h. Preference for consistency. Subsection (5) states a rule fairly implied in Subsections (1) and (2);words and conduct are interpreted in the light of the circumstances, and writings are interpreted asa whole. A meaning consistent with all the circumstances is preferred to a meaning which requiresthat part of the context be disregarded. But the parties may have agreed to displace normal mean-ings, may have modified a prior understanding, or may have agreed to confusing or self-contradictory terms. They may even have entirely failed to agree, though each thought there was anagreement. See §§ 20, 201.

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§ 203. Standards of Preference in Interpretation

In the interpretation of a promise or agreement or a term thereof, the following standards of perform-ance are generally applicable:

(a) an interpretation which gives a reasonable, lawful, and effective meaning to all the terms is pre-ferred to an interpretation which leaves a part unreasonable, unlawful, or of no effect;

(b) express terms are given greater weight than course of performance, course of dealing, and usageof trade, course of performance is given greater weight than course of dealing or usage of trade, andcourse of dealing is given greater weight than usage of trade;

(c) specific terms and exact terms are given greater weight than general language;

(d) separately negotiated or added terms are given greater weight than standardized terms or otherterms not separately negotiated.

Comment:

a. Scope. The rules of this Section are applicable to all manifestations of intention and all transac-tions. They apply only in choosing among reasonable interpretations. They do not override evidenceof the meaning of the parties, but aid in determining meaning or prescribe legal effect when meaningis in doubt.


b. Superfluous terms. Since an agreement is interpreted as a whole, it is assumed in the first in-stance that no part of it is superfluous. The parties may of course agree to supersede prior manifes-tations of intention; indeed, this is the normal effect of an integrated agreement. See § 213. But, par-ticularly in cases of integrated agreements, terms are rarely agreed to without reason. Where an in-tegrated agreement has been negotiated with care and in detail and has been expertly drafted for theparticular transaction, an interpretation is very strongly negated if it would render some provisionssuperfluous. On the other hand, a standard form may include provisions appropriate only to some ofthe transactions in which the form is to be used; or the form may be used for an inappropriate trans-action. Even agreements tailored to particular transactions sometimes include overlapping or re-dundant or meaningless provisions. The preference for an interpretation which gives meaning to every part of an agreement does notmean that every part is assumed to have legal consequence. Parties commonly direct their attentionto performance rather than breach, and it is enough that each provision has meaning to them as aguide to performance. Stipulations against particular legal consequences are not uncommon. Thus itis not unusual to define the intended performance with precision and then to provide for toleranceswithin which variation is permitted. See Uniform Commercial Code § 2-508(2).

c. Unreasonable and unlawful terms. In the absence of contrary indication, it is assumed that eachterm of an agreement has a reasonable rather than an unreasonable meaning, and that the agree-ment is intended to be lawful rather than unconscionable, fraudulent or otherwise illegal. But partiesare free to make agreements which seem unreasonable to others, and circumstances may show thateven an agreement innocent on its face has an illegal purpose. The search is for the manifested inten-tion of the parties. If a term or a contract is unconscionable or otherwise against public policy, itshould be dealt with directly rather than by spurious interpretation. See § 208 and UniformCommercial Code § 2-302 and Comment.

Illustration:

1. A licenses B to manufacture pipes under A’s patents, and B agrees to pay “a royalty of 50 centsper 1,000 feet for an output of 5,000,000 or less feet per year, and for an output of over 5,000,000 feetper year at the rate of 30 cents per thousand feet.” The 60 cent rate is payable on the first 5,000,000feet, the 30 cent rate only on the excess. The more literal reading is unreasonable, since it would in-volve a smaller payment for 6,000,000 feet than for 4,000,000 feet.

d. Priority of express terms. Just as parties to agreements often depart from general usage as to themeaning of words or other conduct, so they may depart from a usage of trade. Similarly, they maychange a pattern established by their own prior course of dealing. Their meaning in such cases is or-dinarily to be ascertained as a fact; no penalty is attached by the law of contracts to their failure toconform to the usages of others or to their own prior usage. Course of performance may establishmeaning, or it may show mistake or oversight or modification or waiver. See § 202. The prioritiesstated in Subsection (b) are those stated in Uniform Commercial Code §§1-205 and 2-208, rephrasedto fit the different context of the Restatement.

e. General and specific terms. People commonly use general language without a clear consciousnessof its full scope and without awareness that an exception should be made. Attention and understand-ing are likely to be in better focus when language is specific or exact, and in case of conflict the spe-cific or exact term is more likely to express the meaning of the parties with respect to the situationthan the general language. If the specific or exact can be read as an exception or qualification of thegeneral, both are given some effect, in accordance with the rule stated in Subsection (a). CompareUniform Commercial Code § 2-317. But the rule yields to manifestation of a contrary intention.

f. Superseded standard terms. The rule stated in Subsection (d) has frequent application in cases ofstandardized documents. Printed forms are often misused, and there may be a question whether the


parties manifested assent to a printed term on a writing. A printed provision that is clearly part ofan integrated contract is normally to be interpreted as consistent with other terms, but in cases ofinconsistency a handwritten or typewritten term inserted in connection with the particular transac-tion ordinarily prevails. Similarly, a typewritten term may be superseded by drawing a line throughit, modified by interlineations, or controlled by an inconsistent handwritten insertion in another partof the agreement. It is sometimes said generally that handwritten terms control typewritten andprinted terms, and typewritten control printed. See Uniform Commercial Code § 3-118(b); compare §2-316(1) (disclaimer of express warranty), § 3-110(3) (instrument payable both to order and tobearer). But the rule yields to manifestation of a contrary intention.

Illustrations:

2. A, an agent of C, authorized to make contracts for C, writes a letter to B beginning “We offer,” andstating a proposal in detailed and clear language, signed “C by A, Agent.” At the bottom of the officestationery which A uses for the offer there is printed “All contracts and orders taken are subject tothe approval of the executive office.” A portion of the letter is typed over a portion of this printing. Ajury’s finding that the printed words were not part of the letter and that it is therefore an offer willnot be set aside.

3. A charter party contains the printed provision “vessel to have turn in loading.” There is writtenbelow this, “vessel to be loaded promptly.” The printed and written provisions are given the consis-tent meaning that the vessel shall take its turn in loading, though this involves considerable delay,but when its turn arrives, the vessel shall be loaded promptly.

4. A’s agent B draws checks on the C bank, imprinting the amounts with perforations made by acheckwriting machine. The amounts are also handwritten in figures. In case of conflict, since theperforated amounts are more difficult to alter, they control the handwritten figures. See UniformCommercial Code § 3-118(b), (c).

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§ 206. Interpretation Against the Draftsman

In choosing among the reasonable meanings of a promise or agreement or a term thereof, that mean-ing is generally preferred which operates against the party who supplies the words or from whom awriting otherwise proceeds.

Comment:

a. Rationale. Where one party chooses the terms of a contract, he is likely to provide more carefullyfor the protection of his own interests than for those of the other party. He is also more likely thanthe other party to have reason to know of uncertainties of meaning. Indeed, he may leave meaningdeliberately obscure, intending to decide at a later date what meaning to assert. In cases of doubt,therefore, so long as other factors are not decisive, there is substantial reason for preferring themeaning of the other party. The rule is often invoked in cases of standardized contracts and in caseswhere the drafting party has the stronger bargaining position, but it is not limited to such cases. Itis in strictness a rule of legal effect, sometimes called construction, as well as interpretation: its op-eration depends on the positions of the parties as they appear in litigation, and sometimes the resultis hard to distinguish from a denial of effect to an unconscionable clause.

b. Compulsory contract or term. The rule that language is interpreted against the party who chose ithas no direct application to cases where the language is prescribed by law, as is sometimes true withrespect to insurance policies, bills of lading and other standardized documents. In some cases, how-ever, the statute or regulation adopts language which was previously used without compulsion and


was interpreted against the drafting party, and there is normally no intention to change the estab-lished meaning. Moreover, insurers are more likely than insureds to participate in drafting pre-scribed forms and to review them carefully before putting them into use.

TEACHING SUGGESTIONS

1. In introducing the subject of contracts, ask students under what circumstances they believe thelaw should enforce a promise that the promisor does not wish to keep. Begin the discussion by askingstudents to recognize contracts that they recently entered into—buying a textbook, buying a cheese-burger, buying a compact disc. Under what circumstances do they think that they should beheld to these contracts? Under what circumstances do they think that they might be ex-cused? Concepts that can be woven into the discussion include:

a. Although it is a good idea to keep promises, there are times when they should be excused.

b. Some duties arise from consensual acts, but some duties are nonconsensual.

c. There is not always a legal duty to do or not to do something because it seems like theright thing to do.

d. There are costs as well as advantages to requiring that society enforce promises.

e. There may be reasons for forcing a person to enter into a commitment.

2. Divide students into small groups (four to five persons) and require each group to think of a con-tract for each of the following combinations:

a. Bilateral, informal, executed contract.

b. Bilateral, informal, executory contract.

c. Unilateral, informal, executed contract.

d. Bilateral, formal, executed contract.

Have each group share their ideas with the entire class.

Note: Any combinations of the types of contracts discussed in the text will work. Allow approxi-mately fifteen to twenty minutes for the groups to complete four descriptions, and another fifteen totwenty minutes to discuss the groups’ descriptions with the class.

3. Discuss the circumstances under which the failure to make good on a social contract—such as at-tending the prom—can give rise to civil liability.

4. Students often confuse implied-in-fact and implied-in-law contracts. They might find it easier todistinguish between the two types of contracts by viewing implied-in-fact contracts as looking at ac-tions leading up to what occurred and implied-in-law contacts as looking at the results.

Cyberlaw LinkAre contracts entered into over the Internet enforceable? If so, are they express or implied

contracts? Formal or informal? What other issues discussed in this chapter must be con-sidered for online contracting?


DISCUSSION QUESTIONS

1. What is the objective theory of contracts? Intent to enter into a contract is important in the con-tract’s formation. Intent is determined by the objective theory of contracts. That is, it is judged by outward,objective facts as they would be interpreted by a reasonable person, rather than by the party’s own secret,subjective intentions. These facts include what the party said, how he or she acted or appeared, and the cir-cumstances surrounding the transaction. Generally, courts examine objective facts, conduct, and circum-stances surrounding a particular transaction to determine whether the parties made a contract and, if so,what its terms are.

2. What distinguishes a bilateral contract from a unilateral contract? Every contract has anofferor and an offeree. The offeror promises to do or not to do something. What the offeree must do to acceptthe offer determines whether the contract is unilateral or bilateral. A bilateral contract is a promise for apromise—if the offeree need only promise to perform, the contract is bilateral. A unilateral contract is apromise for an act—if the offeree can accept only by complete performance, the contract is unilateral. A uni-lateral contract’s offer becomes irrevocable once performance has begun. Under a unilateral contract, onlythe promisor is obligated to perform (because in accepting, the promisee has already performed). Under abilateral contract, both parties are obligated to perform.

3. What is the difference between express and implied contracts? An express contract is one inwhich the terms are expressed in words, oral or written. An implied contract is one that is implied from theconduct of the parties—the parties’ conduct reveals their intent to form a contract and creates and defines itsterms. To create an implied contract: (1) one party must furnish a service or property; (2) the party must doso expecting to be paid and the other party must or should know that payment is expected; and (3) the otherparty must have a chance to reject the service or property and not reject it.

4. How does a quasi contract differ from an express or an implied-in-fact contract? A quasicontract is not based on an express promise or on conduct implying a promise; in other words, a quasi con-tract is not based on a contract. Quasi contracts are imposed by courts to avoid unjust enrichment. Thedoctrine under which the court imposes a quasi contract is called quantum meruit, or “as much as he de-serves,” and that also describes the extent of compensation that a court will award. The recipient of a bene-fit does not have to pay for it if it was thrust on him or her. A quasi contract will not normally be imposedwhen there is a contract that covers the matter.

5. What is the difference between a formal contract and an informal contract? Formal con-tracts are enforceable because of their special form or method of formation. Formal contracts include con-tracts under seal and letters of credit. All other contracts are informal contracts—they require no specialform is required (except for certain types that must be in writing).

6. How does a party distinguish between an executed and an executory contract? This is a con-tract classification based on performance. An executed contract is one that has been performed. An execu-tory contract is one that has not been performed. If a contract is executed on one side and executory on theother (that is, if one party has fully performed and the other has not), it is classified as executory.

7. What are the differences among valid, void, voidable, and unenforceable contracts? A validcontract results when all elements of contract formation exist—through an offer and an acceptance, two ormore parties agree to form a contract; the parties have capacity to contract; the contract is supported byconsideration; and the contract is for a legal purpose. A void contract (such as an illegal contract) is nocontract—it gives rise to no obligation on the part of any party. A voidable contract is a valid contract un-der which one or both of the parties has the option of avoiding his or her obligations—if the contract isavoided, both parties are released; if it is ratified, both parties must perform. An unenforceable contract is avalid contract that cannot be enforced due to certain defenses (such as a statute of limitations).


8. What is the plain meaning rule? When the law attempts to enforce a contract, it attempts to en-force the contract that the parties made. When a contract is in writing that is clear and unequivocal, a courtwill enforce the writing according to its plain meaning—this is the plain meaning rule. The meaning of thewords will be determined from the face of the instrument; a court will not consider extrinsic evidence (includ-ing prior agreements or contemporaneous oral agreements).

9. What are some of the other rules regarding the interpretation of contracts? (1) When a writingis ambiguous, a court will interpret its language to give effect to the parties’ intent as expressed in their con-tract. (This is an important point: a court will not make or remake a contract nor interpret the languageaccording to what the parties claim their intent was when they made it.) (2) A reasonable, lawful, and effec-tive meaning will be given to all of a contract’s terms. (3) A contract will be interpreted as a whole; individ-ual clauses will be considered subordinate to the contract’s general intent. (4) All writings that are part ofthe same transaction will be interpreted together, although terms that were negotiated separately will begiven greater consideration than standardized terms and terms that were not negotiated separately. (5) Aword will be given its ordinary, commonly accepted meaning, and a technical word or term will be given itstechnical meaning, unless the parties clearly intended something else. (6) Specific and exact wording will begiven greater consideration than general language. (7) Written or typewritten terms prevail over printedones. (8) When the language used has more than one meaning, it will be interpreted against the party whodrafted the contract. (9) When evidence of trade usage, prior dealings between the parties, and previouscourse of performance under the contract is admitted, what each of the parties does under the contract willbe interpreted as consistent with what the other does and with any relevant usage of trade and course ofdealing and performance.

ACTIVITY AND RESEARCH ASSIGNMENTS

1. Have each student keep track of all contracts entered into within a given three-day period. At theend of the three days, discuss the contracts made by the students with the class.

2. Ask students to bring to class copies of written contracts into which they have entered. In discussingthese contracts, have students classify them according to the types of contracts outlined in the text. As stu-dents study subsequent chapters and their familiarity with the elements of contracts increases, return tothese contracts. Have the class discuss the contracts’ legal implications. Read the fine print and ask thestudents whether they were aware of all the terms to which they agreed. By the end of the contracts’ unit,the students should have a better idea of how they might have negotiated a better deal for themselves beforesigning.

ANSWERS TO ESSAY QUESTIONS INSTUDY GUIDE TO ACCOMPANY BUSINESS LAW, ELEVENTH EDITIONBY HOLLOWELL & MILLER

1. What are the basic elements of a contract? The elements of a contract are: Agreement.Agreement includes an offer and an acceptance. One party must offer to enter into an agreement, and an-other party must accept the offer. Consideration. Consideration is the inducement to a contract. Promisesmust be supported by legally sufficient and bargained-for consideration. Contractual capacity. The partiesmust have capacity to contract—that is, they must qualify as competent. Legality. The goal of the contractmust be legal and not against public policy. Also important are possible defenses to the formation or enforce-ment of a contract. These include: Genuineness of assent. The consent of the parties must be genuine.Form. A contract must be in whatever form the law requires.


2. What is the function of contract law? Contract law can ensure compliance with a promise or,when a contract is breached, entitle a nonbreaching party to relief. Most contractual promises are kept be-cause it is in the mutual self-interest of the promisor and the promisee to keep them.

Reviewing—

Nature and ClassificationGrant Borman, who was engaged in a construction project, leased a crane from Allied Equipment

and hired Crosstown Trucking Co. to deliver the crane to the construction site. Crosstown, while thecrane was in its possession and without permission from either Borman or Allied Equipment, used thecrane to install a transformer for a utility company, which paid Crosstown for the job. Crosstownthen delivered the crane to Borman’s construction site at the appointed time of delivery. When AlliedEquipment learned of the unauthorized use of the crane by Crosstown, it sued Crosstown fordamages, seeking to recover the rental value of Crosstown’s use of the crane. Ask your students toanswer the following questions, using the information presented in the chapter.

1. What are the four requirements of a valid contract? The four requirements of a validcontract are agreement, consideration, contractual capacity, and legality.

2. Did Crosstown have a valid contract with Borman concerning its use of the crane? If so,was it a bilateral or unilateral contract? Explain. Crosstown had a valid contract with Bormanto pick up a crane from Allied and deliver it to the construction site. The contract was valid becausethe parties had an agreement, consideration (delivery of the crane in exchange for payment), andcapacity (presumed, especially with businesspersons), and the agreement was legal. It was aunilateral contract because Borman promised to pay when Crosstown delivered the crane, so it was apromise for an act. A bilateral contract, in contrast, is a “promise for a promise” and does not requirethe performance of a specific act.

3. What are the requirements of an implied-in-fact contract? Can Allied Equipment obtaindamages from Crosstown based on an implied-in-fact contract? Why or why not? For animplied-in-fact contract to exist, the plaintiff must furnish property or a service to a defendant,expecting to be paid, and the defendant must have had a chance to reject the property or service.Allied did not furnish property or services to Crosstown expecting to be paid. Allied did provide thecrane to Crosstown, but only for the purpose of delivering it to Borman, who hired and paidCrosstown for its services. Because Allied did not know that Crosstown was going to use the craneelsewhere and did not expect that Crosstown would pay for this use, Allied had no implied-in-factcontract with Crosstown and cannot recover damages based on this theory.

4. Should a court impose a quasi contract on the parties in this situation to allow Allied torecover damages from Crosstown? Why or why not? Quasi contracts, or contracts implied in law,are imposed by courts to avoid unjust enrichment of one party at the expense of another. On thatbasis, a quasi contract might be imposed to allow Allied to recover the reasonable rental value forCrosstown’s use of the crane, because Crosstown benefited from the crane at Allied’s expense. A quasicontract will not be imposed, however, if a contract already covers the subject. In this case, therewas no contract between Allied and Crosstown, either express or implied.


ANSWERS TO QUESTIONS—

SPECIAL CASE ANALYSIS

Case No. 10.3Wagner v. Columbia Pictures Industries, Inc.

California Court of Appeal,Second District, Division 7, 2007.

146 Cal.App.4th 586,52 Cal.Rptr.3d 898.

(a) Issue: The dispute between the parties to this case centered on which contract and asked whatquestion? The issue in this case focused on the language of the Wagner contract with Spelling-Goldberg Productions (SGP): Was Columbia entitled to all of the profits from the two “Charlie'sAngels” films or was Wagner entitled to share in those profits?

(b) Rule of Law: What rule concerning the interpretation of a contract and the admission of evidencedid the court apply in this case? The court stated that an “agreement is the writing itself.” Extrinsicevidence is not admissible “to show intention independent of an unambiguous written instrument.”This is the plain meaning rule. Its application can significantly affect a court’s interpretation of thelanguage of a contract, which can in turn determine the result in a case.

(c) Applying the Rule of Law: How did the intent of the contracting parties and the language intheir contract affect the application of the rule of law? The court pointed out here that even if theparties intended Wagner to share in the profits from all sources, “they did not say so in theircontract.” In other words, it was what the parties said in their contracts, not what they may haveintended, that determined the outcome in this case. Under the language of the contract betweenWagner and SGP, Wagner was entitled to share in the profits from the exercise of the movie rights to“Charlie's Angels” if those rights were exploited as “ancillary” or “subsidiary” to the primary “right toexhibit photoplays of the series” but not if those rights were acquired separately. SGP’s contract withGoff and Roberts was subject to the Writers Guild of America Minimum Basic Agreement, underwhich the writers kept the movie rights, which the producer could buy if the writers opted to sellthem within five years. SGP did not acquire the movie rights to “Charlie's Angels” by exercising thisright within the five-year period. Columbia obtained those rights independently more than five yearslater.

(d) Conclusion: Did the court resolve the dispute in the plaintiff’s favor? Why or why not? Wagnerhad filed a suit in a California state court against Columbia, claiming a share of the profits from thefilms. Columbia filed a motion for summary judgment, which the court granted. Wagner appealed to astate intermediate appellate court, which affirmed the lower court’s judgment. The appellate courtheld that the contract “unambiguously” stated the conditions under which the parties were to sharethe films’ profits, and those conditions had not occurred.

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